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CHAPTER TWO
FINANCING MECHANISMS--AIRPORT PRACTICES AND INNOVATIONS
This chapter gives a high-level review of capital financing Interest Costs
mechanisms used by airport operators. Although certain of
these mechanisms may be commonplace at one airport, they The interest paid by airport operators to attract investors rel-
may be innovative at another. Specifically, the following are ative to what other municipal enterprises pay is a measure
discussed in this chapter: of the attractiveness of airport debt in the capital markets.
Airport interest costs also reflect whether interest on the
· Airport access to credit, bonds is taxable for federal income tax purposes, is subject
· Types of airport bonds, and to the alternative minimum tax (AMT), or is tax-exempt (see
· Other forms of airport financing. Ways of Addressing Alternative Minimum Tax Issues).
AIRPORT ACCESS TO CREDIT Insurability
The cost to airport operators to access the capital markets is a The affordability of purchasing bond insurance to improve
function of several key factors that determine airport invest- credit ratings and reduce interest costs is a third factor relat-
ment quality: ing to the cost of airports accessing the capital markets. Bond
insurance is an important means by which airports can reduce
· Bond ratings, their interest costs. That airport operators of all size cate-
· Interest costs, gories can afford insurance is a signal of creditworthiness in
· Insurability, and the capital markets. Although airport operators do not always
· Defaults. buy bond insurance, especially those with strong ratings, the
overwhelming majority of the bonds issued since 9-11 have
Airport operators are major and regular participants in the been insured.
municipal bond markets. Figure 7 shows the value of state
and local transportation-related financing transactions for 2000 Defaults
through 2004. In addition to the value of financings transacted
by airport operators, it shows the value of transactions by oper- The frequency with which airport operators have defaulted on
ators of toll roads and highways, mass transit, and other modes bond issues is the fourth measure of the competitiveness of
of transportation such as seaports, bridges, tunnels, and parking airports in the capital markets. By this measure, the compet-
facilities. Airport financings are a significant share of the total, itiveness of airports is particularly strong. The airport industry
second to transactions carried out by operators of toll roads and never experienced a single default. There have been several
highways and, in some years, mass transit operators. instances of airline special facility debt defaults.
Airport Bond Ratings TYPES OF AIRPORT BONDS
Major investor services use rating systems to grade bonds Airport sponsors and operators issue various forms of bonds
according to investment quality to inform potential investors to finance generally large-scale capital projects with long-term
about the creditworthiness of specific types of bonds at specific debt. This section discusses the following types of bonds:
airports. Figure 8 shows the distribution of bond credit ratings
for airports of all hub sizes as of August 2006, for two types · General obligation (GO) bonds
of debt: (1) GARBs and (2) stand-alone PFC bonds. Despite · GARBS
the financial challenges airports have faced since September · Bonds backed by PFCs
11, 2001 (9-11), airports remain financially sound. The three · Bonds backed by customer facility charges (CFCs)
major credit rating agencies--Moody's Investors Service, · Bonds to be paid with future grants
Fitch Ratings, and Standard & Poor's--have concluded that, · Ways of addressing AMT issues
on the whole, the airport system has performed well under · Potential new tax credit bonds (TCBs) for baggage
difficult circumstances. screening infrastructure.
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FIGURE 7 State and local transportation--Related financings. [(a) includes seaports,
bridges, tunnels, parking facilities, and other transportation.] Source: Government
Accountability Office, Federal Tax Policy, Information on Selected Capital Facilities
Related to the Essential Governmental Function Test.
General Obligation Bonds the bonds being issued, and so constitute a larger per-
centage of the GARB for small airports issuing smaller
GO bonds may be issued to finance airport capital improve- numbers of bonds. This makes GO bonds more attrac-
ments, backed by general tax revenues of the city, county, or tive the smaller the bond issue is, and because smaller
state that owns and operates the airport. Specifically, local gen- airports typically have smaller capital needs, GO debt
eral tax revenues such as sales, income, or property taxes may is typically more attractive for them.
be pledged as a source of repayment for GO bonds, although · No coverage requirement--Airport operators are typi-
the airport operator may actually pay debt service from airport cally required to maintain coverage of 1.25x or 1.35x; that
sources, or, in rarer instances, general local taxes may directly is, the ratio of net revenues after paying operating costs to
pay debt service on proceeds used to fund airport projects. annual debt service must be at least 125% or 135% to give
investors comfort that their debt will be repaid. Because
Some large airports such as Honolulu International Airport of the strength of GO bond credits, coverage is not
pay debt service on outstanding GO bonds issued on their required, which can also save airport operators money.
behalf by their airport sponsor (in this case, by the state of
Hawaii); however, the bonds were generally issued decades
ago and the outstanding balances are relatively small. GO General Airport Revenue Bonds
bonds are currently a key financing tool for many small air-
GARBs are traditionally the most commonly issued bonds for
ports for several important reasons:
airport infrastructure. Their credit rating is based on revenues
· Stronger credit with lower interest rates--GO bonds are generated at the airport from airline rates and charges, park-
a stronger credit than GARBs, which are discussed later. ing, rental car operations, terminal concessions, other leases,
GO bonds therefore result in lower interest costs for the interest, and any other revenues of the airport. Following the
airport because the bonds are backed by the full faith economic downturn in 2000 and the terrorist attacks of 9-11,
and credit of a city, county, or state that (1) has a much GARB credit ratings for several airports were downgraded, and
larger and diverse tax revenue base than an airport's 19 of the 31 large-hubs carried negative outlooks (Aviation
revenue base, and (2) can typically adjust tax rates often Infrastructure Innovative Financing 2002). The financial out-
more readily than an airport operator can adjust airport look and accompanying credit ratings for airports have sub-
rates and charges. However, in certain states voters must sequently steadily improved as airport operators have taken
approve tax rate adjustments and/or issuance of bonds, many steps to manage their financial results, and as traffic
which may make GO debt less attractive than GARBs. levels have returned to pre-9-11 levels.
· Lower issuance costs--GO bonds do not have the upfront
costs of developing a separate indenture/ordinance, The remainder of this chapter discusses other types of
getting bond ratings and insurance, and preparing fea- bonds that reflect innovations by airport operators and the
sibility studies that GARBs have. These upfront GARB financial markets. Even within the category of GARBs various
costs do not generally vary significantly with the size of innovations can be seen.
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a
b
FIGURE 8 Bond credit rating for all hub sizes as of August 2006: (a) General airport revenue bonds;
(b) stand-alone PFC bonds.
· Use of sureties in lieu of funded reserves--Airport oper- and/or free cash held in a reserve to be used for any allow-
ators historically funded required debt service reserves able airport purpose (allowable uses may need to be deter-
from either available retained earnings (cash) or from mined by the airport operator's bond counsel, depending
bond proceeds. Sureties can be obtained from the finan- on the provisions of its bond indenture or ordinance).
cial markets either at the time of, or any time, after bond · Use of intermediate and subordinate liens--It is increas-
issuance, to be used in lieu of a funded reserve. Sureties ingly common for airport operators to issue bonds with a
are recognized by the rating agencies, bond insurers, and lower pledge of airport revenues than its senior debt. Issu-
investors as equivalent security to providing a funded ing intermediate and subordinate debt can reduce cover-
reserve. The airport operator pays a fee at issuance, usu- age requirements and annual airline rates and charges.
ally a percentage of the new or outstanding principal, The downside is that such liens typically require new
and in the event that it is needed to pay debt service, the bond indentures or ordinances, which can add time and
surety is drawn on. Use of sureties can reduce the size of costs to the issuance process (see, for example, Figure 9).
a bond issue and therefore annual debt service by elimi- · Interest rate swaps--Airports increasingly enter into
nating the need to fund a debt service reserve account "over-the-counter" contracts with investment banks to
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FIGURE 10 ManchesterBoston Regional Airport. Revenue
bonds under a swap agreement.
Advance refunding (synthetic fixed)--Examples
include operators of the airports in Atlanta and Man-
chester, New Hampshire.
Swaption for refunding--A swaption is a financial
instrument granting the owner an option to enter an
interest rate swap pursuant to certain agreed upon
terms. Examples include the operators of airports
serving Philadelphia, Portland (Oregon), Chicago
funds to further manage coverage.
(Midway), and Albany.
FIGURE 9 SeattleTacoma International Airport. Use Forward hedge for new money--Examples include
of subordinate liens to reduce debt service coverage and the Indianapolis Airport Authority and the Metropol-
airline payments. itan Washington Airports Authority.
Synthetic variable--Have been used by the operators
"swap" or exchange a stream of interest payments for of airports serving Boston, Las Vegas, and Orlando.
another party's stream. Each swap is a unique contract Basis swap--Also known as "floating to floating"
between the parties and cannot be bought and sold like swaps, have been used by the operators of airports in
securities or futures contracts. Interest rate swaps are nor- Cleveland, Las Vegas, and New Orleans.
mally "fixed against floating," where an airport operator
exchanges fixed-rate obligations for floating rate obliga-
Passenger Facility Charge Bonds
tions, or "floating to fixed," where the reverse happens.
The principal amounts are not exchanged, and are referred Airport operators have increasingly issued bonds that either
to as the notional principal (with the exception of basis include a pledge of PFC revenues and/or are to be repaid in
swaps). Swaps are often used to hedge certain risks, for part or in full from PFC revenues. Approaches to leveraging
instance interest rate risk (see, for example, Figure 10). PFC revenues include:
By swapping interest rates, an airport operator is able
to synthetically alter its interest rate exposures and bring · Combined flow of funds--These bonds are a form of
them in line with management's appetite for interest rate GARB, where the bonds are secured by an underlying
risk. Forms of interest rate swaps include (Market Update pledge of airport revenues. Under this structure, PFC
and Interest Rate Swaps Presentation, Oct. 18, 2005): revenues, or certain PFC revenues, are defined as air-
Forward current refunding (synthetic fixed)--A fairly port revenues in the bond indenture. Combined airport
common type of swap transacted by operators of revenues are then used to pay GARB debt service.
airports such as Charlotte/Douglas International, This bond structure is used by the airports serving
Jacksonville International, MiamiDade International, Albuquerque, Guam, and Orlando, among others.
Sacramento International, Salt Lake City Interna- Advantages--it is relatively easy to incorporate into
tional, and Wayne County (Detroit). an existing revenue bond indenture, and debt service
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coverage requirements can be lower relative to stand- Disadvantages--(1) PFC revenues are completely
alone PFC bonds (i.e., 1.25x1.35x instead of 1.5x dependent on passenger volumes; (2) the bonds entail
for stand-alone PFC-backed bonds). development of a new indenture or ordinance; (3) they
Disadvantages--bonds issued under this approach require FAA termination protection and approval of the
reduce the airport sponsor's GARB capacity, and bond indenture; (4) they require more rigorous tests and
sometimes more importantly, may require airline sensitivity analysis; (5) they have higher required debt
majority-in-interest approval. service coverage levels, typically 1.5x; and (6) they are
· Direct debt service offset--These bonds are another form not applicable to airports where the definition of airport
of GARB secured by airport revenues. PFC revenues "Revenues" includes PFC revenues, or that pledges
are used to pay all or a part of the GARB debt service, them elsewhere.
but they do not secure the bonds. Debt service may be · Convertible lien PFC bonds--Another concept is to
included in the airline rate base if projected PFC rev- issue bonds initially secured solely by PFC revenues
enues are not realized under this structure. This bond that subsequently convert to GARBs. To date, the only
structure is used by the airports serving Albany, Austin, airport to issue such bonds is Broward County, which
Cleveland, Denver, El Paso, Grand Rapids, and Provi- operates Fort LauderdaleHollywood International Air-
dence, among others. port (see Figure 11).
Advantages--they result in higher demonstrated debt
service coverage relative to the combined flow of
Bonds Backed by Customer Facility Charges
funds structure, as PFC revenues directly offset debt
service (the denominator in the coverage calcula- As discussed in chapter three, CFCs are collected by rental
tion). Also, debt service coverage requirements can car companies from their customers at certain airports to pay
be lower relative to stand-alone PFC bonds. operating expenses and debt service for consolidated rental
Disadvantages--(1) they do not preserve GARB car facilities. As with PFC revenues, CFC revenues can be
capacity, (2) they are not applicable to airports where structured in many of the same ways as the various forms of
the definition of airport "Revenues" includes PFC PFC bonds.
revenues, or that pledges airport revenues elsewhere,
and/or (3) they may require airline majority-in-interest · Combined flow of funds--These bonds have the same
approval. characteristics, advantages, and disadvantages as PFC
· Back-up pledge of subordinate airport revenues--These bonds structured as a combined flow of funds. Exam-
bonds are secured by PFC revenues with a back-up ples include the bonds issued for the consolidated rental
pledge of airport revenue that is subordinate to a more car facility at Fort LauderdaleHollywood International
senior lien on airport revenue. This bond structure is used Airport.
by the airports serving Baltimore, Las Vegas, Nashville, · Direct debt service offset--These bonds have the same
and Sacramento, among others. characteristics, advantages, and disadvantages as PFC
Advantages--(1) it enhances the creditworthiness of bonds structured with a debt service offset. No specific
the bonds versus stand-alone PFC bonds, (2) it keeps examples of this type of CFC bond have been identi-
the costs out of the airline rate base, (3) debt service fied; however, they could be implemented by interested
coverage requirements can be lower relative to stand- airports.
alone PFC bonds (i.e., 1.25x1.35x), (4) it preserves · Back-up pledge of subordinate airport revenues--These
the senior lien GARB capacity, and (5) it maximizes bonds have the same characteristics, advantages, and
airport management control over airport financing disadvantages as PFC bonds structured as CFC bonds
decisions. with a back-up pledge of subordinate airport revenues.
Disadvantages--they are not applicable to airports No specific examples of this type of CFC bond have
where the definition of airport "Revenues" includes been identified; however, they could be implemented
PFC revenues or that pledges them elsewhere. by interested airports.
· Stand-alone PFC bonds--Issuance of bonds backed · Stand-alone CFC bonds--These bonds have the same
solely by PFC revenues has evolved since they were first characteristics, advantages, and disadvantages as stand-
issued in 1994. Stand-alone PFC bonds have been issued alone PFC bonds. Examples include the bonds issued
by the airports serving Boston, Chicago, Fort Lauderdale, for the consolidated rental car facility at Dallas/Fort
Lee County (Fort Myers, Florida), Little Rock, New Worth International Airport.
Orleans, Palm Springs, Portland (Oregon), Richmond,
and Seattle. Single-Tenant Special Facility Bonds
Advantages--(1) they preserve GARB capacity,
(2) keep costs out of the airline rate base, and (3) max- Special facility bonds issued by a single tenant are used to
imize airport management control over airport financ- finance unit passenger terminals or portions of terminals,
ing decisions because they do not require airline hangar and maintenance facilities, cargo buildings, and ground
majority-in-interest approval. equipment support facilities for the exclusive use of an airline.
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FIGURE 11 Fort LauderdaleHollywood International Airport. Passenger facility charge convertible
lien bonds for airport expansion.
The bonds are backed solely by an airline corporate pledge to Ways of Addressing Alternative Minimum
repay the debt. According to a study by the FAA Office of Pol- Tax Issues
icy and Plans, however, this form of financing has come under
significant scrutiny as a result of recent airline bankruptcies and Under current tax rules, interest on private-activity bonds,
defaults (Aviation Infrastructure Innovative Financing 2002). including most airport debt, is subject to the AMT, which was
introduced in 1969 to ensure that top income earners paid
For example, one airline rejected payment of its special their share of income taxes. Despite the public nature of most
airport facilities and the public benefit derived from their use,
facility bond obligations and discontinued use of its mainte-
more than 60% of airport bonds currently can only be sold as
nance facility at an airport. Another airline closed its mainte-
private-activity bonds rather than as tax-exempt governmental
nance facility that had been funded with special facility bonds.
purpose bonds. Historically, the interest rate penalty for inter-
est on bonds for which interest earnings are subject to the AMT
Multi-Tenant Special Facility Bonds ranges from 16 basis points (0.16%) to 49 basis points (0.49%),
depending on the status of tax reform proposals that would
Special facility bonds have been issued to fund multi-tenant affect the AMT ("Airline Agreement Paves Way for Non-AMT
terminals, fuel storage and distribution facilities, and consol- O'Hare Bonds" 2005) (see Figure 12). Another key problem
idated rental car facilities, as discussed in chapter four. These with AMT debt is that under current law, governmental pur-
bonds have greater credit strengths than single-tenant special pose bonds may be advance-refunded once and only once, at
facility bonds because of the more diverse revenue base from any time 10 years after issuance, but airport private-activity
multiple tenants and users. bonds are prohibited from being advance refunded. This elim-
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nal projects that are still considered not open to the pub-
lic and therefore are to remain AMT funded.
Many airports carried out multipurpose allocations to
refund the portions of prior bonds associated with air-
field projects that could be changed to non-AMT debt
with lower interest rates. Denver International Airport
is an example. However, some operators at airports with
residual airline agreements were unable to get bond
counsel concurrence because net revenues go back to
signatory airlines, and the airports have differential rates
for signatory and nonsignatory airlines. The city of
Chicago addressed this problem by changing its airline
agreement, as described in Figure 12.
· Reform of the federal tax treatment of airport bonds--
Airport operators have, for some time, discussed the
need to reclassify airport private activity bonds that
directly benefit the general public as governmental pur-
pose bonds, similar to the way GO debt is treated under
the tax code. The change in status would eliminate the
AMT penalty that increases interest rates on the bonds
FIGURE 12 Chicago O'Hare International Airport. Interest
and allow advance refundings of airport bonds.
savings using non-alternative minimum tax bonds.
inates the ability of airport operators to realize interest savings Potential New Tax Credit Bonds for Baggage
by refunding AMT debt when interest rates are lower. Screening Infrastructure
Two key developments relating to AMT restrictions and A recent Baggage Screening Investment Study conducted on
associated interest rate penalties are: behalf of TSA resulted in the recommendation that Congress
adopt new legislation authorizing the use of a federal tax
· Multi-purpose allocation refundings--Historically, it has credit bond program for the capital costs of a baggage han-
been possible for airport operators to issue "non-AMT" dling system and related infrastructure.
(i.e., tax-exempt) debt with lower interest rates for park-
ing facilities (as long as the airport's bond counsel con- Tax credit bonds (TCBs) involve the issuance of taxable
curs), because such facilities are used by the public and debt by state and local governments or other non-federal enti-
not private companies. A ruling by the Internal Revenue ties for designated capital purposes. As shown on Figure 13,
Service a number of years ago clarified that airfield proj- bondholders receive annual tax credits that can be applied
ects could be financed on a non-AMT (tax-exempt) basis, against their federal income tax liability instead of cash inter-
which triggered multipurpose allocations to allocate prior est payments. The tax credit itself represents taxable income
bond proceeds between airfield projects (to be refunded to the bondholder. Principal is repayable by the issuer from
with non-AMT debt with lower interest rates) and termi- nonfederal sources. The bonds are generally structured as
FIGURE 13 Tax credit bond mechanisms--Investor perspective (TSA).
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FIGURE 14 Tax credit bond mechanics--Airport issuer perspective (TSA).
"bullet" term bonds, where the principal is repaid in a lump The TCBs could be on parity with an airport's traditional
sum at bond maturity. TCBs are generally structured as bullet revenue bond indebtedness or issued on a subordinate or
term bonds to maximize the value of the tax credit, and the stand-alone basis. Possible pledged revenue streams include
issuer makes periodic deposits to a sinking fund to provide one or more of the following:
for principal retirement at maturity.
· General airport revenues from airline rents and fees
Figure 14 shows the issuer perspective. Unlike other fed-
and nonairline sources, as is the case for traditional
eral tax credit programs oriented to equity capital (such as tax
GARBs.
credits for investments in low-income housing), TCBs do not
· PFC revenues, as is the case for stand-alone PFC-backed
require the project sponsor to be the "consumer" of the tax
bonds and double-barrel bonds backed by PFC revenues
credit. Instead, this form of tax subsidy encourages private
and general airport revenues.
investment in desired infrastructure through lower-cost debt
· General local governmental resources such as sales
capital for the issuer.
and property taxes, as is the case for general obligation
As shown on Figure 15, TCBs provide a substantial sub- municipal bonds issued to fund airport projects (more
sidy to the issuer, as the interest expense can represent common for small- and non-hub airports than large- and
50% to 80% of the effective cost of long-term borrowing. medium-hub airports)
The extent of the subsidy depends on the term (maturity)
of the bonds and the interest (credit) rates. The longer the Airport participation in the TCB program would be entirely
term and the higher the interest rates the greater the sub- voluntary. It is anticipated that large- and medium-hub air-
sidy level. ports, which frequently access the capital markets to raise
FIGURE 15 Tax credit bond mechanics--Airport sinking fund (TSA).
