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Innovative Finance and Alternative Sources of Revenue for Airports (2007)

Chapter: Chapter One - Introduction

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Suggested Citation:"Chapter One - Introduction." National Academies of Sciences, Engineering, and Medicine. 2007. Innovative Finance and Alternative Sources of Revenue for Airports. Washington, DC: The National Academies Press. doi: 10.17226/14041.
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Suggested Citation:"Chapter One - Introduction." National Academies of Sciences, Engineering, and Medicine. 2007. Innovative Finance and Alternative Sources of Revenue for Airports. Washington, DC: The National Academies Press. doi: 10.17226/14041.
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Suggested Citation:"Chapter One - Introduction." National Academies of Sciences, Engineering, and Medicine. 2007. Innovative Finance and Alternative Sources of Revenue for Airports. Washington, DC: The National Academies Press. doi: 10.17226/14041.
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Suggested Citation:"Chapter One - Introduction." National Academies of Sciences, Engineering, and Medicine. 2007. Innovative Finance and Alternative Sources of Revenue for Airports. Washington, DC: The National Academies Press. doi: 10.17226/14041.
×
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Suggested Citation:"Chapter One - Introduction." National Academies of Sciences, Engineering, and Medicine. 2007. Innovative Finance and Alternative Sources of Revenue for Airports. Washington, DC: The National Academies Press. doi: 10.17226/14041.
×
Page 8
Page 9
Suggested Citation:"Chapter One - Introduction." National Academies of Sciences, Engineering, and Medicine. 2007. Innovative Finance and Alternative Sources of Revenue for Airports. Washington, DC: The National Academies Press. doi: 10.17226/14041.
×
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Page 10
Suggested Citation:"Chapter One - Introduction." National Academies of Sciences, Engineering, and Medicine. 2007. Innovative Finance and Alternative Sources of Revenue for Airports. Washington, DC: The National Academies Press. doi: 10.17226/14041.
×
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Suggested Citation:"Chapter One - Introduction." National Academies of Sciences, Engineering, and Medicine. 2007. Innovative Finance and Alternative Sources of Revenue for Airports. Washington, DC: The National Academies Press. doi: 10.17226/14041.
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5This report presents the results of ACRP Project 11-03, S01-01, ACRP Synthesis of Airport Practice 1: Innovative Finance and Alternative Sources of Revenue for Airports. This introductory chapter describes the purpose of the report, pre- sents the methodology used to develop the report, provides general background information, and outlines the organiza- tion of the report. PURPOSE OF REPORT This synthesis topic was identified by a 10-member panel of industry experts charged with overseeing syntheses of informa- tion related to airport problems and was initiated out of concern about challenges to airport operators’ ability to finance oper- ations and needed capital improvements in the context of: • Increasing air traffic volumes nationwide and emerging congestion at certain airports necessitating investment in future capacity and other measures. • Uncertainty about the financial health of the airline industry and the actual or potential affect airline bank- ruptcies may have on air service decisions and airport finances. • Concerns regarding how willing the U.S. Congress will be to appropriate funds to aviation given the wars in Iraq and Afghanistan, the status of the federal budget, and other federal priorities. • The potential effect that reauthorization of FAA, the Airport and Airway Trust Fund, and TSA may have on various funding sources for airports, including passenger facility charges (PFCs), Airport Improve- ment Program (AIP) grants from FAA, and grants from TSA. • Construction inflation owing to post-hurricane rebuild- ing efforts and the increasing demand for construction materials by growing economies elsewhere in the world, particularly by China and India. Given these and other financial challenges, the panel believed it would be prudent for airport operators to consider innovative finance mechanisms and alternative sources of rev- enue. This study is therefore intended to inform airport opera- tors, stakeholders, and policymakers about alternative financ- ing options and revenue sources that are currently available to airport operators in the United States, or that could be available in the future if certain developments occur to facilitate them. Because what is innovative to one airport operator may be common practice to another, no attempt is made in this report to stipulate where certain “traditional” financing mechanisms or sources of revenue become “innovative.” Rather, a con- tinuum is presented, starting with the most common practices at U.S. airports, and progressing to increasingly innovative practices. STUDY METHODOLOGY Information used in this study has been acquired through a literature review and selected interviews of airport operators and industry experts. Literature and Data Search A comprehensive search of literature and data sources was conducted to document financing trends and innovative ideas explored by airport operators, FAA, TSA, and other trans- portation agencies. The research had three primary areas of focus: (1) nontraditional revenue sources airport operators could explore, (2) innovative financing mechanisms, and (3) new ways for airports to operate financially. Interviews Various interviews have been conducted to gather information on innovative financial alternatives for airports. Although air- port operators have the most thorough knowledge of innov- ative financial alternatives used at their airports, rating agency analysts, investment bankers, and financial advisors have also been valuable resources in identifying those airports imple- menting innovative structures. REPORT STRUCTURE The remainder of this report includes the following: • Chapter one concludes with a general background sec- tion to provide a brief overview of common capital funding sources used by airport operators. • Chapter two provides a high-level review of capital financing mechanisms used by airports to obtain the most flexibility and/or capital funding from its revenue sources. CHAPTER ONE INTRODUCTION

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

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

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 International–North America (ACI–NA). 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 sources (including airport bonds and PFCs) are not included in the NPIAS estimate, nor are capital projects ineligible 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 funded from sources other than federal grants are included, such as bonds, the total increases significantly. Airport Sources of Funding As indicated earlier, increasing capital investments will be required for airport operators to provide needed infrastruc- ture. The principal sources of funds for airport capital projects include the following, cited from largest to smallest: • Proceeds of bonds and other forms of debt • PFC revenues • AIP grants from FAA • Internally generated capital resulting from retained air- port revenues • Security grants from TSA • State grants and local financial support The distribution of airport sources of capital is shown in Figure 2. Proceeds of Bonds and Other Forms of Debt Four basic types of bonds are issued to fund airport capital improvements, including (1) general obligation bonds sup- ported by the overall tax base of the issuing entity (the airport sponsor); (2) general airport revenue bonds (GARBs) secured by the revenues of the airport and other revenues as may be defined in the bond indenture; (3) bonds backed either solely by PFC revenues or by PFC revenues and airport revenues generated by rentals, fees, and charges; (4) special facility 8 bonds backed solely by revenues from a facility constructed with proceeds of those bonds; and (5) other debt instruments. Bonds and other debt instruments are discussed in greater detail in chapter two. Passenger Facility Charges In 1990, Congress enacted legislation to provide airports with an additional source of funding for capital projects, subject to FAA approval, in the form of PFCs. The Aviation Safety and Capacity Expansion Act of 1990 required U.S.DOT to issue regulations under which a public agency may be authorized to impose a PFC of $1.00, $2.00, or $3.00 per enplaned pas- senger at commercial airports it controls. Under this act, air- port-related projects that preserve or enhance safety, capac- ity, or security of the national air transportation system; reduce noise from an airport that is part of the system; or fur- nish opportunities for enhanced competition between or among air carriers are eligible. 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 eligibility requirements. One such requirement, which applies only to large- and medium-hub airports, is that a project must make a “significant contribution” to improving air safety and security, increasing competition, reducing congestion, or reducing noise (in comparison with the “adequate justifica- tion” requirement for projects at a lower level). For operators of large- and medium-hub airports that are approved to collect a $4.00 or $4.50 PFC, passenger entitlement grants are reduced by 75% (rather than the 50% associated with lower PFC levels). Figure 3 shows: FIGURE 2 Sources of airport capital (2001–2004, average). Source: Thomson Financial, FAA, and ACI–NA.

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

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

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

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

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TRB’s Airport Cooperative Research Program (ACRP) Synthesis 1: Innovative Finance and Alternative Sources of Revenue for Airports explores alternative financing options and revenue sources currently available or that could be available in the future to airport operators, stakeholders, and policymakers in the United States. The report examines common capital funding sources used by airport operators, a reviews capital financing mechanisms used by airports, describes various revenue sources developed by airport operators, and a reviews privatization options available to U.S. airport operators.

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