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6 Chapter three describes the various revenue sources air- Factors Governing Airport Financial Operations port operators have developed to date and new revenues that some airports are starting to use or that could be Most of the sources of capital available to finance airport realized in the future. improvements have either direct or indirect external restric- Chapter four reviews financing options available to tions on their use (i.e., federal or contractual restrictions). This airport operators in the United States that would funda- section describes those external restrictions and provides the mentally change the way they operate. The two main context for airport access funding from different sources, as topic areas of this section include (1) privatization of air- will be discussed later. ports and airport assets and (2) third-party development and capitalization. Figure 1 reflects the typical factors that govern airport financial operations. Those factors include: (1) federal reg- ulations and policies and grant assurances made by airport GENERAL BACKGROUND ON AIRPORT sponsors, (2) the airport operator's authorizing legislation, FINANCIAL OPERATIONS (3) the bond indenture for the airport, and (4) the airport's airline use and lease agreement(s). The airport's concession Airport Legal and Financial Structure agreement(s) also affects the airport operator's net revenue and financial capacity. This section provides an overview of the legal organization of most U.S. airports, a discussion of the factors governing U.S. airport financial operations, and a discussion of the sources Federal Regulations and Policies of funding for projects at U.S. airports. Since 1982, the U.S. Congress has passed various legisla- tion (1) establishing the AIP that provides federal grant fund- Legal Organization of U.S. Airports ing, (2) creating the authority for airport operators to levy Most U.S. airports are operated as independent, not-for-profit PFCs, and (3) governing how airport revenue is generated entities with oversight by a politically appointed authority, or and used. U.S.DOT and FAA have established regulations as self-sustaining enterprise funds of a governmental entity and issued policy guidance to provide specific direction to such as a county, city, or state government. The form of gov- airport operators regarding the eligibility and use of AIP ernance for the 100 busiest airports in the United States is funds, PFC revenue, and airport revenue. U.S.DOT/FAA as follows (the top 100 airports were determined based on regulations and policies regarding airport rates and charges, numbers of enplaned passengers in 2005): which relate to how airport revenue is generated, have also been issued. Authority 39% City 33% Authorizing Legislation Regional 5% County 13% Airport operators that are independent entities or enter- State 7% prise funds of a city, county, or state government typically Other 3% are governed by authorizing legislation or a local charter that establishes the airport operator's organizational struc- Airports operated as enterprise funds of governmental ture, responsibilities, and powers. The authorizing legisla- entities may be overseen by boards or commissions structured tion may specify facilities that the airport operator is as decision-making entities, operating within the legal and responsible for developing and/or maintaining, such as air- political framework of the sponsoring jurisdiction. port access roads. Airport authorities exist in a variety of forms and their specific powers and responsibilities are established by their Bond Indenture enabling legislation. Some airport authorities are indepen- dent public bodies created by state legislation; others are The bond indenture (also called a bond resolution or bond municipal corporations or agencies created by one or more ordinance) provides the legal basis for issuing airport revenue local jurisdictions under general state statutes governing bonds and defines the terms under which additional bonds the establishment of independent authorities. Many airport might be issued, including the need for revenue-generating authorities sponsored by state or local legislation operate projects. The bond indenture defines what may or may not be relatively independently of their governmental sponsors, included in the definition and computation of airport rev- while remaining responsive to political concerns and prior- enues and expenses. The indenture establishes various funds ities. In other cases, the sponsoring jurisdiction retains some and accounts for the payment of interest and principal on the oversight of airport operation, such as approval of operating bonds from airport revenues, establishes the priority of pay- budgets and bond issues. ments for all of the airport operator's obligations, and sets

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7 FIGURE 1 Factors governing airport financial services. forth various covenants between the issuing entity and the calculating user rentals, fees, and charges, and applies those bondholders, including a rate covenant requiring the airport procedures consistently from year to year in enacting the rate operator to set rates and charges to produce specified levels ordinance and calculating airport charges. The FAA's "Policy of revenues. Some airport bond indentures may also include Regarding Airport Rates and Charges" (1996) broadly governs principles to guide the establishment of rates and charges for airport rate setting in the absence of an airline agreement and the use of airport facilities. dispute resolution. Airline Agreements Concession Agreements An airportairline agreement generally stipulates the rights, Many airport operators also enter into various agreements with privileges, and obligations of the airport operator and the air- providers of nonaeronautical services, such as parking garage lines serving the airport, and sets forth the manner in which operators; rental car agencies; and merchants and vendors of the rentals, fees, and charges paid by the airlines for use of food, news items, and gifts on airport premises. These agree- the airport are calculated and adjusted. Parties to a use and ments are often the largest source of nonairline revenues at lease agreement are called Signatory Airlines. most airports. The agreements do not, however, govern how an airport operator can use those revenues. Many airline agreements contain provisions that require a certain number or percentage of the Signatory Airlines to approve or disapprove certain decisions of the airport opera- Airport Capital Needs tor, most often those involving airport capital expenditures. These provisions are known as Majority-in-Interest provi- The capital requirements of airports are significant today, and sions and are designed to give the Signatory Airlines some are expected to increase in the future. The capital needs of control over long-term financial obligations undertaken by the airports are principally driven by: airport operator. Traffic growth and the need to expand facilities; Some airports, however, are not governed by such agree- Normal wear and tear of facilities as a result of use and ments, and instead rates are established by ordinance or reg- age; and ulation. In those instances, the airport operator typically Changing technology, particularly aircraft technology adopts a policy setting forth the procedures to be used in that over time can render older facilities obsolete.

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8 According to the Capital Needs Survey, airport capital needs are estimated to exceed $70 billion for the 5-year period from federal fiscal year (FFY) 2005 through FFY 2009 con- ducted by Airports Council InternationalNorth America (ACINA). The survey reflected capital investments of approx- imately $14.3 billion per year, a figure that is to be updated early in 2007. According to the National Plan of Integrated Airport Sys- tems (NPIAS) for FFY 2007 through FFY 2011, airport oper- ators will have $41.2 billion (or $8.24 billion per year) in capital projects eligible for federal aid as shown in Figure 2. However, even though AIP has been at historic levels, it totaled just over $3.5 billion in FFY 2006 (the FFY 2007 appropriation was pending at this time), leaving a funding gap of just over $4.7 billion annually for airport projects eli- gible for federal aid. It is important to note that overall capi- tal needs for airports are higher than the NPIAS estimate: projects eligible for federal aid that are paid for by other local FIGURE 2 Sources of airport capital (20012004, sources (including airport bonds and PFCs) are not included average). Source: Thomson Financial, FAA, and in the NPIAS estimate, nor are capital projects ineligible ACINA. for federal aid (e.g., revenue-producing parts of the termi- nal or parking garages). According to the most recent ACI NA Capital Needs Survey, once capital projects that are to be bonds backed solely by revenues from a facility constructed funded from sources other than federal grants are included, with proceeds of those bonds; and (5) other debt instruments. such as bonds, the total increases significantly. Bonds and other debt instruments are discussed in greater detail in chapter two. Airport Sources of Funding Passenger Facility Charges As indicated earlier, increasing capital investments will be required for airport operators to provide needed infrastruc- In 1990, Congress enacted legislation to provide airports with ture. The principal sources of funds for airport capital projects an additional source of funding for capital projects, subject to include the following, cited from largest to smallest: FAA approval, in the form of PFCs. The Aviation Safety and Capacity Expansion Act of 1990 required U.S.DOT to issue Proceeds of bonds and other forms of debt regulations under which a public agency may be authorized PFC revenues to impose a PFC of $1.00, $2.00, or $3.00 per enplaned pas- AIP grants from FAA senger at commercial airports it controls. Under this act, air- Internally generated capital resulting from retained air- port-related projects that preserve or enhance safety, capac- port revenues ity, or security of the national air transportation system; Security grants from TSA reduce noise from an airport that is part of the system; or fur- State grants and local financial support nish opportunities for enhanced competition between or among air carriers are eligible. The distribution of airport sources of capital is shown in Figure 2. The Wendell H. Ford Aviation Investment and Reform Act for the 21st Century (AIR-21) included authorization to charge a PFC at the $4.00 and $4.50 levels that meet specific Proceeds of Bonds and Other Forms of Debt eligibility requirements. One such requirement, which applies only to large- and medium-hub airports, is that a project must Four basic types of bonds are issued to fund airport capital make a "significant contribution" to improving air safety and improvements, including (1) general obligation bonds sup- security, increasing competition, reducing congestion, or ported by the overall tax base of the issuing entity (the airport reducing noise (in comparison with the "adequate justifica- sponsor); (2) general airport revenue bonds (GARBs) secured tion" requirement for projects at a lower level). For operators by the revenues of the airport and other revenues as may be of large- and medium-hub airports that are approved to collect defined in the bond indenture; (3) bonds backed either solely a $4.00 or $4.50 PFC, passenger entitlement grants are reduced by PFC revenues or by PFC revenues and airport revenues by 75% (rather than the 50% associated with lower PFC generated by rentals, fees, and charges; (4) special facility levels). Figure 3 shows:

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9 a b FIGURE 3 (a) Passenger facility charge levels by hub size; (b) total PFC revenue by hub size. Source: FAA, PFC Branch, Feb. 2006. The number of airports charging PFCs, and the level of debt. These forms of financing will be discussed in greater being charged by hub size compared with the total num- detail in chapter two. ber of airports of that hub size. It shows that the number of airports by category and the number charging a PFC increases as one moves from large- to medium-, small- AIP Grants from Airport and Airway Trust Fund and non-hub airports, although the highest percentage of Administered by FAA airports charging PFCs are in the large-, medium- and Federal AIP grants administered by FAA are funded by avi- small-hub categories. ation user taxes. AIP grants are made available to airport The amount of PFC revenue collected by airport hub operators in numerous forms: size, which are orders of magnitude larger for large-hub airports than for the other hub sizes. Entitlement funds, which are apportioned to primary air- ports based on levels of passenger traffic and to cargo ser- More than $2.2 billion in PFC revenues are collected by air- vice airports based on levels of cargo aircraft landed port operators each year. PFC revenues are: (1) used on a "pay- weight, subject to certain minimum and maximum levels. as-you-go" basis, where PFC collections and interest earnings Small airport funds, which are apportioned to general are spent directly on capital projects, and/or (2) leveraged; that aviation (including reliever) and non-hub commercial is, used to pay debt service on bonds or to repay other forms service airports.

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10 Set aside funds, which are dedicated to noise compati- reasonable, and not unjustly discriminatory prices for bility planning and implementation, the Military Airport those services. Program, and reliever airports. Nonexclusive right of use--Ensures that the airport oper- State apportionments, which are principally apportioned ator will not permit exclusive use of its aeronautical for nonprimary commercial service, general aviation, facilities by those providing aeronautical services. and reliever airports based on an area/population for- Fee and rental structured to provide airport financial self- mula among the 50 states, the District of Columbia, sufficiency--Ensures that the airport fee and rental struc- Puerto Rico, and insular areas. In Alaska, Hawaii, and ture will be set so as to make the airport as self-sustaining Puerto Rico these amounts may be used at any primary as possible. or nonprimary airport in addition to other designated Nondiversion of airport revenues--Ensures that all rev- entitlements. enues generated by the airport and local taxes on avia- Nonprimary apportionments, which are apportioned tion fuel will be expended on the operating and capital based on the needs for a particular nonprimary airport costs of the airport or other facilities, directly and sub- in the most recently published NPIAS, subject to over- stantially related to aeronautical activity, owned and all caps. operated by the operator of the airport. Discretionary funds, which are distributed based on the ranking of the airport's projects in relation to others Through FFY 2003, AIP grants were used to fund explo- deemed most important for improving the national air- sives detection system (EDS) infrastructure at airports. Begin- space system. ning in FFY 2004 through FFY 2006, U.S.DOT's annual appropriation acts have prohibited spending AIP funds for There are two important steps in the federal policy making baggage screening infrastructure. This prohibition is expected process. to continue through FFY 2007 and possibly beyond. An authorization provides the legal authority for the federal government to undertake a program. The length Internally Generated Capital Resulting from of an authorization is typically between 3 and 5 years, Retained Airport Revenues with Vision 100 running the period between FFY 2004 through FFY 2007. The next authorization bill will run Airport operators charge and collect rentals, fees, and charges from October 1, 2007, to the end of the authorization for the lease and use of facilities to passenger and cargo air- period, for which the duration is to be determined. lines, concessionaires, and other entities providing airport sup- An appropriation must be separately enacted by Congress port services. Rentals, fees, and charges collected from airlines each FFY for funding actually to be spent on a program. cover a portion of the operating expenses and debt service incurred by airport operators. Rentals, fees, and charges col- Confusion often occurs when Congress authorizes a pro- lected from tenants of airport facilities are also often the pri- gram at a particular level and then either does not provide any mary source of funds for repayment of principal and interest funding or does not appropriate monies to the authorized on bonds. Airport sources of revenue are discussed in detail level. As shown in Figure 3, this has happened frequently, in chapter three. although the differences, if any, have been slight since 2001. Total revenues, less total operating expenses incurred by FAA has issued AIP grants as multiyear letters of intent the airport operator, equal the net operating income gener- (LOIs) as well as 1-year grants. Airport operators must conduct ated by the airport operator. Net operating income (1) can be benefitcost analyses to obtain discretionary grants for more used to fund debt service (along with the portion recovered than $5 million or for multiyear LOIs to fund capacity projects. from airline rentals, fees, and charges), (2) can be invested as cash in capital improvements (this constitutes slow forming Airport operators must give certain assurances to FAA to equity because it typically takes years to retain significant receive federal grants. More than 30 assurances must be certi- retained earnings), and/or (3) can be returned to the airlines fied by the sponsor as a condition of grant approval depending in the form of revenue-sharing or credits in the calculation of on the type or scope of the project for which the grant is being rentals, fees and charges. sought. Examples of assurances that directly affect the legal and financial structure of airports are: Security Grants from the General Fund Economic nondiscrimination--Ensures that the airport Administered by TSA will be operated for public use on fair and reasonable terms, and that those engaged in aeronautical activities Since FFY 2003, TSA grants have been available to airport at the airport are providing services on a fair, equal, operators on a limited basis to make terminal modifications and not unjustly discriminatory basis and charging fair, to accommodate EDS. TSA grants have been issued as

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11 FIGURE 4 AIP funding levels. multiyear LOIs as well as 1-year grants, called other trans- provided only 1-year grants since FFY 2004 through OTAs. action agreements (OTAs), to fund baggage screening To date, approximately 33 OTAs have been issued by TSA infrastructure. Through FFY 2004, TSA executed eight (see Figure 5). LOIs to provide grant funding to each of nine airports over a 3- or 4-year period, with the last payments to be made in FFY 2007 providing the funding is appropriated. Figure 4 State Grants and Local Financial Support reflects the budget for EDS installation and integration since FFY 2003. Certain states provide funding for airport and aviation-related projects in the form of outright grants or matching share Owing to concerns about making multiyear commitments for federal AIP grants. States fund such grants or local match- without the safeguards of a trust fund or other form of guar- ing funds from a variety of sources--registration and licensing anteed future year funding, and because the funding stream has fees and dedicated or special taxes such as fuel taxes. Support not supported additional long-term grant agreements, TSA has from local governments generally takes the form of general FIGURE 5 Current TSA obligated funding levels. Source: TSA Finance and Administration staff, Aug. 2006.

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12 FIGURE 6 Strategic targeting of airport funding sources. taxes. State or local grants may be provided to fund capital and AIP grants have restrictions in how they can be used. In improvements at an airport, such as roadway and access proj- addition, sources such as revenue bonds are more effective ects. As shown in Appendix A, 30 states levy aviation fuel when targeted to projects having a direct income stream, taxes and 10 states have aircraft sales or use taxes. State grants especially when airline approvals are required. are used as the local match to AIP funds or as direct grants for various types of projects as shown. Certain states also After maximizing the use of federal AIP grants and PFC provide lower or no interest loans. revenues for major capacity-enhancing projects, airport oper- ators can fund capital projects from a combination of debt and Using Sources of Funding Strategically equity. Private and/or third-party funding may also make sense for certain types of facilities, such as maintenance facilities, Aligning the sources of capital funds with allowable and opti- flight kitchens, and cargo facilities. Figure 6 summarizes the mal uses is essential for airport operators to maximize the strategic use of capital sources among the competing uses to impact of each dollar. Certain funding sources such as PFCs optimize financial capacity.