Airport/Airline Agreements—Practices and Characteristics (2010)

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PART I WHY IS THERE A NEED FOR THIS MANUAL?

This resource manual (the “Manual”) contains the results of the research efforts undertaken by the research team for the ACRP Project 01-07, “Airport/Airline Agreements and Rate Methodologies—Practices and Characteristics.” The introduction chapter explains the intent of the Manual and why this research effort was undertaken, the overall methodology employed, how this Manual should be used by both airport operators and airlines, and the overall organ- ization of the Manual. It is important to note that this Manual is intended to be an objective resource tool, and no recommendations are provided about specific negotiation issues, provisions, or strategies. The material provided in this Manual is intended to assist both airport operators and airlines with negotiating and understanding various aspects related to airline/airport operator business relationships, including those in an Airport/Airline Use and Lease Agreement (“Agreement”), by providing sufficient information to enhance the decision-making process during negotiations. This Manual will also describe a business arrangement in the absence of an Agreement, as there are no legal obligations for the airlines or airport operators to enter into Agreements. 1.1 Intent and Purpose of the Manual 3 C H A P T E R 1 Introduction “I heard that Airport ‘X’ got (name the provision) in its Agreement. I want to make sure we get that in ours.” “Our current Agreement expires in (‘x’ number of days). Can we get a new Agree- ment in place, and approved by our Board, before the expiration of the current Agreement?” “I want to make sure our Agreement provides for us to maintain (‘x’ number of days) of operating cash, regardless of any other provisions we negotiate.” “We airlines are OK with (name that provision) in your airport’s Agreement, but we are concerned with the precedent it will set in the industry.” “We airlines would suggest you take the Agreement from (Airport ‘X’), as it is a well-run airport and they keep their airline costs low.” “Despite the downturns in the economy, our capital program still makes sense over the long run, and we will need it approved under this new Agreement.”

The above questions and statements are frequently heard from both airport operators and air- lines. It has been the experience of the research team that many desired outcomes in the very dynamic aviation industry are based, in part, on what others are doing or have already accom- plished. While both airport operators and airlines want to be “state of the art” and “to think out- side the box,” both parties rely a great deal on concepts that have been developed and validated through previous negotiations, and are, therefore, easier to get approved from the airport oper- ator’s governing body and the airline’s senior management. The airport industry has historically been a dynamic environment that is influenced by deci- sions made and actions taken by federal and local governments and regulatory agencies, airline policies and practices, airport capital development and improvement needs, the amount and nature of the demand for airline travel in each market, and worldwide economic conditions that vary by region, among other factors. Each airport operator, although constrained by laws, regu- lations, and management practices and policies, is essentially an independent decision maker continuously challenged with establishing a vision and a roadmap for the future amid a chang- ing operating, regulatory, and political environment. In addition, each airport is unique. A gen- eral statement heard over the years is “If you see one airport, you’ve seen one airport.” On the other “side of the table” are the airlines. They are struggling with their own issues, many of which are not even airport-related. In the current economic environment, many air- lines are in survival mode, merely trying to continue flying their aircraft and passengers from destination to destination while maintaining the cash flow necessary to operate. When the avail- able resources to dedicate to product differentiation are limited, and passengers increasingly view an airline seat as a commodity, it is challenging for an airline to differentiate itself from competi- tors, and to be profitable while doing so. Controlling costs, both operating and capital, poses sig- nificant challenges for the airlines as they balance trying to limit increases in airport costs, while retaining access to the necessary facilities to support growth expectations at most airports. Both the airport operators and the airlines have been and are still experiencing turbulent times. Both parties may believe that they have reached the outer limits of their ability to reduce their operating costs further. While some airport operators still believe that the airlines need them more than they need the airlines and vice versa—the airport/airline relationship is symbiotic. Therefore, formalization of the operating and financial framework in which both parties function becomes extremely important. Essentially, an Agreement defines the rights, responsibilities, and limitations of both parties throughout its term. At the completion of the negotiations, it is important that both parties be able to answer the following questions satisfactorily: • Did the airport operator and airlines achieve their respective primary goals and objectives within the context of an Agreement or business arrangement? • Does the airport operator have the flexibility to undertake needed capital development? • Are the rates and charges formulas fair, reasonable, and equitable to the airlines? • Do the airlines operating at the airport have the appropriate facilities to operate their preferred flight schedule? • Does the Agreement appropriately balance both risk and reward between the parties? • Do both the airport operator and the airlines feel they benefit from the business relationship memorialized in the Agreement? • Is the Agreement flexible enough to adapt to changing economic or other dynamic industry circumstances? 4 Airport/Airline Agreements—Practices and Characteristics

The primary intent of this Manual is to provide a tool to assist both airport operators and air- lines during business arrangement negotiations by describing the range of business relationships between airports and airlines including the underlying rates and charges methodologies, pre- senting a general negotiation process and schedule, identifying key information for a negotia- tion, identifying the various issues that typically surface, describing the various alternatives for resolving potential conflicts and issues, and identifying the linkages among these various critical issues. It will be important for airport operators and airlines to learn from and understand what others have incorporated in their respective Agreements, but it will also be important for an air- port operator to understand that provisions in any agreement satisfy the needs of that partic- ular airport setting, and are not being negotiated because they are in some other airport operator’s agreement. Meanwhile, it will be important for the airlines to understand that pro- visions in a particular airport operator’s agreement are intended for that particular airport setting, and are not intended to set a precedent for all new agreements. The information presented in this Manual is intended to assist both airport operators and air- lines in gaining better awareness and understanding of what motivates the other party and why, to provide alternative approaches and options that may assist for resolving issues, and to share what other airport operators and airlines have experienced in previous negotiations. It will be important for readers of this Manual to understand that, in many instances, there will not nec- essarily be right or wrong ways to resolve certain issues. What is important is that the provi- sions negotiated are those that address and satisfy the needs of that particular airport and the airlines operating there. If this is understood, the Manual can be a valuable tool for the indus- try for years to come. 1.2 Study Methodology The information contained in this Manual is based on research efforts conducted over the last 18 months and supplemented by the overall experience of the research team. The primary research efforts consisted of a relevant literature search, interviews and focus group sessions with industry stakeholders, online surveys for both airport operators and airlines, and a workshop with industry participants. A comprehensive search of relevant industry literature, existing research, current regulatory requirements, significant litigation, existing Agreements, and other appropriate written material was performed. This information was gathered, reviewed, and analyzed for its applicability to the Manual. A completed annotated listing of all this material is contained in Appendix A. To engage executives from both airport operators and airlines of various sizes and character- istics, several focus groups were developed and interviewed. The primary objective of the focus groups was to gain insight of a more subjective and complex nature that may be difficult to acquire through a formal written survey. Through interactive discussions with the research team, these focus groups provided valuable insight and perspectives related to Agreement negotiations, the development of rate-setting approaches, and other critical issues associated with the overall business relationships between parties. Interviews were also conducted with other industry stake- holders such as rating agencies, investment bankers, and financial advisors to gain their perspec- tives on Agreements. On-line surveys were developed and distributed to both airport operators and airlines. The primary objective of the surveys was to obtain data and information of a more factual and less subjective nature from a large group of stakeholders. The on-line survey provided the basis for much of the factual data presented in this Manual. Introduction 5

In July 2009, the research team conducted a workshop to obtain feedback from the industry regarding the draft resource manual. Participants at this workshop included airport finance directors, airport executive directors, and airline property representatives. Also present were the members of the ACRP Project 01-07 panel. Information and feedback obtained from this work- shop were reviewed and evaluated and, where appropriate, incorporated in the draft resource manual. 1.3 Organization and Structure of the Manual This Manual is categorized into four main parts: (1) defining the need for this Manual, (2) pro- viding guidance on how airlines and airport operators start and prepare for negotiations, (3) giving perspectives on various critical issues that can surface during airline/airport operator negotiations, and (4) providing an outlook on the future of Agreements and creative approaches for addressing various issues. Also, given the related nature of several airline/airport operator business arrange- ment issues and provisions, this Manual has also been developed to provide several cross- references and linkages among topics to guide the reader to the appropriate information for each topical area. It is important to note that this Manual is intended to be an objective resource tool. No rec- ommendations are provided about specific negotiation issues, provisions, or strategies. The pri- mary objective of this Manual is to assist both airport operators and airlines with negotiating an Agreement by providing sufficient information to enhance the decision-making process during negotiations. 6 Airport/Airline Agreements—Practices and Characteristics

This chapter describes the purpose of an Agreement. Also discussed is whether an Agreement is actually “needed,” and what alternative arrangements are available for airport operators and airlines to consider. The three primary types of underlying business arrangements or airline rate- setting methodologies inherent in Agreements are described along with examples of circum- stances in which an airport operator and its airlines might consider a certain approach. The last section provides a brief history of the trends in business arrangements that have been negotiated in Agreements in recent years. 2.1 Purpose of Agreements Basically, an Agreement is the contract between the airport operator and its tenant airlines that establishes the rights, privileges, and obligations for each party and defines how the airport is to be used by the airlines. In addition, an Agreement also provides the following: • Establishes the business arrangement and rate-setting methodology with the airlines (e.g., compensatory, hybrid, residual); • Identifies the premises and facilities leased by the airlines and defines the degree of control by the lessee (e.g., exclusively leased, preferentially leased, leased in common, etc.); • Defines the level of control over the expenses at the airport, if any (typically capital expenses are those where the airlines may have some control through a majority-in-interest or similar- type provision); and • Identifies general party responsibilities and obligations for indemnification, insurance, envi- ronmental issues, and other governmental inclusion. In addition, an Agreement can also be viewed as beneficial because it symbolizes that the air- port operator and airlines have worked together to arrive at a common business relationship. It is important to understand, however, that an Agreement approach may not always be the pre- ferred business arrangement for an airport operator or an airline, nor is it a required approach. Several large and medium hub U.S. airports do not have an Agreement. 2.2 Non-Agreement Approach The establishment of the business arrangement between the airlines and the airport operator without an Agreement is generally referred to as the “ordinance” approach (or, in some cases, a resolution, regulation, or tariff approach). In the absence of a negotiated contract, the local gov- erning body for the airport will enact certain legislation, typically an ordinance that will state the conditions and terms under which airline tenants of an airport will operate. This legislation or ordinance will also set the airline fees and charges for use of the airport. 7 C H A P T E R 2 Background

While an Agreement may be desired by certain airport operators and airlines as a method of entering into a business relationship, it is important to recognize that Agreements are not required by law. In the absence of an Agreement, airports can establish by ordinance, resolution, tariff, reg- ulation or other unilateral action the local rules that will govern the airlines’ use of their airport facilities. At a number of airports, rates and charges, rules controlling the use of terminal space, and other important terms and conditions for the use of the airport have been established in this way. In the absence of an Agreement, however, airlines serving an airport retain their right to chal- lenge the legality of the terms and conditions imposed by the airport operator. The following are several examples of airports that currently operate without Agreements: • Gerald R. Ford International Airport (Grand Rapids) • Phoenix Sky Harbor International Airport • Sacramento International Airport As an established principle under the U.S. Department of Transportation’s (U.S. DOT’s) Pol- icy Regarding Airport Rates and Charges, June 19, 1996,1 an airport operator may not require the airlines to cover any financial losses it may experience in absence of an Agreement. Therefore, without an Agreement, the airport operator may only set fees and charges via a compensatory rate-setting approach (see Section 2.3.2). Additional information regarding the legal require- ments and constraints impacting airline rate setting can be found in Chapter 5 of this Manual. It is important that both airport operators and airline parties be aware of these parameters when entering into a business negotiation. If it is necessary for an airport operator to undertake the ordinance approach, it must adhere to rate-setting policy per the U.S. DOT’s Policy Regarding Airport Rates and Charges, June 19, 1996, and it must set aeronautical fees and charges under a compensatory approach. The airlines may file a complaint to the U.S. DOT if the rate-setting approach does not adhere to this policy. 2.3 Types of Business Arrangements and Rate-Setting Methodologies The two primary rate-setting approaches used in airport/airline business arrangements are the residual and compensatory approaches. A pure residual methodology is where the airlines bear the overall financial risk for the airport operation and, in turn, receive the benefit of all non-aeronautical revenue credited toward the calculation of their rates and charges. On the opposite side of the spectrum, a pure compensatory rate-making approach is where the airport operator assumes the overall financial risk for the airport operation. As such, the airport oper- ator also does not provide any non-aeronautical revenue credits toward the airline rate base. There is also a third approach, generally called a hybrid methodology, that is any mixture or combination of the prior two approaches and may include a “revenue sharing” component of excess non-airline revenues generated at the airport. It is important to note that when the term “risk” is used in this Manual, it is referring to “finan- cial risk,” and with situations that are in the normal course of business at an airport. For exam- ple, it is clear that under a residual approach, the financial “risk” is entirely airline risk. It is also generally clear that under a pure compensatory approach, the financial “risk” is borne by the air- port operator. It is, however, also important to note that the airlines do still have some financial risk exposure under a compensatory arrangement if, for example, operating expenses increase. It is also recognized that, for those airports with outstanding revenue bond debt, with requirements 8 Airport/Airline Agreements—Practices and Characteristics 1Policy Regarding Airport Rates and Charges, U.S. Department of Transportation, June 19, 1996.

in a bond resolution that must be addressed and satisfied, that when circumstances may warrant that an airport’s ability to satisfy the rate covenant requirement of providing for a minimum of 1.25 times annual debt service, the airport operator will primarily seek to recover the shortfall nec- essary from the airlines. In that circumstance, the “risk” is then borne by the airlines, rather than the airport operator. For purposes of this Manual, any discussions of where financial risk resides is under the assumption of a normal day-to-day operating environment, and not under irregular or abnormal circumstances. Federal law does not require any single approach to airline rate setting; however, it does require that the methodology used be applied consistently to similarly situated aeronautical users and con- forms with the U.S. DOT’s Policy Regarding Airport Rates and Charges. This policy also identifies five fundamental principles for airport operators to follow in setting airline rates and charges: 1. In general, the U.S. DOT prefers that airport operators and the airlines negotiate a rate- setting approach directly that is based on the local market within which they operate. 2. Airline rates, fees, and charges must be fair and reasonable. 3. Airline rates, fees, and charges may not unjustly discriminate against aeronautical users or user groups. 4. Airport operators must maintain a fee and rental structure that makes the airport as finan- cially self-sustaining as possible. 5. In accordance with federal statutory provisions governing the use of airport revenue, airport operators may expend revenue generated by the airport only for statutorily allowable purposes. Further details on each type of business arrangements/airline rate-setting methods are described below. 2.3.1 Residual A pure residual rate-setting methodology is where the airlines assume the financial risk at the airport and the airport operator generally recovers the “net costs” of the airport operation from the airlines. Because an Agreement must be in place to employ a residual methodology, this means that the signatory airlines (or the airlines that are party to an Agreement) receive the benefit of all non-aeronautical revenues credited toward their rate base and only pay the airport operator fees and charges that are based on the remaining or the “net” cost of the airport operation. Additional general points about residual approaches are as follows: • Airport operators have a strong assurance of revenues based on the financial guarantee by the airlines. • Airport operators generally have less incentive for maximizing non-aeronautical revenue sources due to the airline’s financial guarantee. • Airport operators have less incentive for controlling operating expenses, as any increases are covered through airline rates and charges. • As a tradeoff for the airline financial guarantee, airport operators generally have weaker bal- ance sheets, reduced debt service coverage margins, and limited liquidity or discretionary cash balances. • With limited available cash on hand, airport operators may generally have a higher cost of capital, because they may be required to bond finance a majority of its capital development. • With all of the financial risk, the airlines are more exposed to financial and economic down- turns in the aviation industry. Since the airlines bear the financial risk, more airline capital development control often accompanies a residual Agreement. For example, the signatory airlines may be granted the right to review and approve airport capital development projects typically permitted through a Background 9

“majority-in-interest” (MII) provision. Some residual Agreements also provide for varying degrees of airline consultation on an airport’s operating expenses. There are two primary types of residual rate-making approaches that are generally employed throughout the airport industry: an airport (or airport system if more than one airport is included) residual method and a cost center residual method. Under the airport residual method, the land- ing fee is generally calculated to cover all the remaining airport costs that are not recovered through all other airline and non-airline revenue sources. This methodology is also referred to as the “single cash register” method, in that the landing fee serves as the “balancing account” to provide assurance that the airport operator will not have a deficit. Table 1 presents a typical approach for airport system residual rate setting. The cost center residual approach allocates all airport costs and revenues to the various air- line cost centers that are used to derive airline rates (e.g., the airfield area, terminal building, apron area). These cost centers are then calculated to break even such that the net require- ment of each is equal to the calculated airline revenue. For example, the airfield cost center will generally use signatory airline aircraft landed weight as the divisor, and the terminal cost center will generally use airline rented space within the terminal building as the appropriate rate divisor. Under the pure methodology, the signatory airlines receive all non-aeronautical revenue credits toward their rate base. Table 2 presents a typical approach for cost center residual rate setting. 10 Airport/Airline Agreements—Practices and Characteristics Cost Centers Terminal Airfield Other Areas Total Airport Operating Expenses $9,000,000 $4,000,000 $15,000,000 $28,000,000 O&M Reserve Fund Requirement 100,000 80,000 180,000 360,000 Debt Service 4,000,000 4,000,000 7,000,000 15,000,000 Debt Service Coverage 1,000,000 1,000,000 1,750,000 3,750,000 Capital Charges 300,000 420,000 270,000 990,000 Other Fund Requirements 600,000 500,000 800,000 1,900,000 Total Requirement $15,000,000 $10,000,000 $25,000,000 $50,000,000 Less: Non-Airline Revenue $9,000,000 $1,000,000 $22,800,000 $32,800,000 Less: Other Airline Reimbursements 1,000,000 200,000 1,200,000 Net Requirement $5,000,000 $8,800,000 $2,200,000 $16,000,000 Airline Leased Space (s. f.) 100,000 Average Terminal Rental Rate (per s. f.) $50.00 Total Terminal Rental Revenue $5,000,000 Less: $5,000,000 Net Airport Requirement $11,000,000 Total Airline Landed Weight (000-lbs) 4,400,000 Landing Fee Rate (per 1,000 lbs) $2.50 Airline Landing Fee Revenue $11,000,000 Source: Ricondo & Associates, Inc., September 2009. Prepared by: Ricondo & Associates, Inc., September 2009. Table 1. Typical airport residual rate-setting approach.

2.3.2 Compensatory Compensatory rate making generally represents a “cost-based” approach, in that an airline pays for only the cost of facilities used or leased at a specific airport. This is different from the residual rate-making approach, where the airlines assume the risk and are responsible for guar- anteeing that the airport operates on a financial break-even basis. Under the compensatory approach, the airport operator bears the “risk” of the financial performance of the airport; how- ever, any potential financial “rewards” will also accrue to the airport operator if non-airline rev- enues sources are strong and perform well. Generally, compensatory Agreements or ordinances are found at mature airports that realize successful revenue generation and typically reflect pos- itive cash flow. Some other key points regarding a compensatory approach are as follows: • Airport operators have an incentive to maximize non-aeronautical revenue because they bear the financial risk, and, thus the financial rewards. • Airport operators generally have higher levels of liquidity and discretionary cash on hand. • Airport operators generally carry stronger operating and debt service coverage margins because there is less “margin for error” and they do not have the airline financial guarantee. • Airport operators are more exposed to financial and economic downturns. Background 11 Source: Ricondo & Associates, Inc., September 2009. Prepared by: Ricondo & Associates, Inc., September 2009. Cost Centers Terminal Airfield Other Areas Operating Expenses $9,000,000 $4,000,000 $15,000,000 O&M Reserve Fund Requirement 100,000 80,000 180,000 Debt Service 4,000,000 4,000,000 7,000,000 Debt Service Coverage 1,000,000 1,000,000 1,750,000 Capital Charges 300,000 420,000 270,000 Other Fund Requirements 600,000 500,000 800,000 Total Requirement $15,000,000 $10,000,000 $25,000,000 Less: Non-Airline Revenue $9,000,000 $1,000,000 $22,800,000 Less: Other Airline Reimbursements 1,000,000 200,000 Plus: Allocation from Other Areas 1,100,000 1,100,000 Net Requirement $6,100,000 $9,900,000 $2,200,000 Less: Allocation to Terminal $1,100,000 Less: Allocation to Airfield 1,100,000 $0 Airline Leased Space (s. f.) 100,000 Average Terminal Rental Rate (per s. f.) $61.00 Total Terminal Rental Revenue $6,100,000 Total Airline Landed Weight (000-lbs) 4,400,000 Landing Fee Rate (per 1,000 lbs) $2.25 Airline Landing Fee Revenue $9,900,000 Table 2. Typical cost center residual rate-setting approach.

Because they do not bear the financial risk, the airlines generally have limited control over an airport operator’s capital development under a pure compensatory business arrangement. The airlines may have some ability to review or vote on certain development occurring in the airline cost centers such as the terminal, airfield, and apron. Otherwise, capital development control may be eliminated entirely or pertinent provisions are very broad in definition, allowing the airport operator to undertake projects at its discretion without airline approval. Under the compensatory approach, the airlines pay only for the cost of the facilities used or leased. Costs are calculated in the respective rate-making cost centers (e.g., airfield, apron, and terminal) based on direct assignment and include the allocation of indirect costs which support the direct day-to-day activities at the airport. This is generally done for operating expenses, oper- ating expense reserve, debt service, debt service coverage, and amortization. The total cost requirement is then divided by the appropriate measurement in each respective cost center to arrive at the specific rate. For example, the airfield cost center will generally use total aircraft landed weight as the divisor, and the terminal cost center will generally use useable space (or sometimes rentable space) within the terminal building as the appropriate rate divisor. Under the pure methodology, the airlines do not receive any direct credit in their rate base for non- aeronautical sources of revenue. For the purposes of calculating compensatory terminal rental rates, there are two basic types of compensatory rates (see Chapter 11 for further information on these rates): 1. Compensatory Rental Rate—uses useable space as a divisor, where useable space is gen- erally defined as gross terminal space less electrical and mechanical space within the ter- minal. Under this methodology, the space divisor is larger and results in a lower average rental rate. 2. Commercial Compensatory Rental Rate—uses rentable or leasable space as a divisor, where rentable space is defined as airline space, plus concessions space, plus any other rentable space within the terminal building. Under this methodology, the space divisor is smaller and results in a higher average rental rate compared with the compensatory rental rate. While not the standard approach, there are circumstances where the divisor may be rented or leased, rather than rentable or leasable due to specific circumstances at a particular airport. Table 3 presents a typical method for calculating rates and charges per a compensatory approach. 2.3.3 Hybrid In most cases an Agreement may not reflect either a pure compensatory or pure residual business approach, because the risk/reward relationship negotiated is somewhere in the middle, as opposed to the absolute ends of the risk/reward spectrum. As such, it is very common to find a business arrangement or rate-setting approach that uses various elements from both. This methodology is called a “hybrid approach.” For example, an airport rate-setting approach may incorporate a resid- ual airfield area and a compensatory terminal into its overall business deal. Another example is where an airport operator and airlines agree that a form of compensatory rate-setting is appropriate for that airport; however, some form of non-airline revenue credit or sharing is preferred to keep air- line rates and fees at levels considered reasonable. The options for a hybrid scenario are somewhat endless and generally match the level of risk each party is willing to bear at a particular airport; how- ever, several “revenue-sharing” approaches (i.e., distribution of annual airport operator surplus net revenue) are presented as follows: • Amount of net revenue distributed can be based on a determined percentage (e.g., 50 percent to airlines), a certain amount of revenue, or based on a certain non-airline revenue category(s). 12 Airport/Airline Agreements—Practices and Characteristics

• Application of net revenue to the airlines can be based on several factors including, but not limited to, enplaned passengers (where only passenger carriers are applicable), amount of rates and charges paid, and direct credit against specified cost centers. • Treatment of revenue sharing credit can also differ. For example, once it is calculated in the current fiscal year, it can be applied as a credit into the next fiscal year. Another example is that it can be estimated at the beginning of the fiscal year and then the actual amount can be applied in the current fiscal year upon the settlement of airline rates and charges. It is important to note that the sharing of certain non-airline revenues generated in one cost center to subsidize another cost center can pose issues to the airlines regarding “fairness of costs.” For example, a credit to the airfield cost center of non-airline revenue generated in the terminal or ground transportation could be viewed as an “unfair” subsidy to cargo carriers. On the other-hand, crediting airfield non-airline revenues in the terminal could also be viewed as “unfair.” Section 4.3 contains additional information about cost center allocations of expenses and revenues. Also, additional details and issues regarding terminal rate-setting methodologies are contained in Chapter 11. Background 13 Terminal Rate Calculations Compensatory Commercial Compensatory Landing Fee Calculation Operating Expenses $9,000,000 $9,000,000 $4,000,000 O&M Reserve Fund Requirement 100,000 100,000 80,000 Debt Service 4,000,000 4,000,000 4,000,000 Debt Service Coverage 1,000,000 1,000,000 1,000,000 Capital Charges 300,000 300,000 420,000 Other Fund Requirements 600,000 600,000 500,000 Total Cost Center Requirement $15,000,000 $15,000,000 $10,000,000 Total Useable Space (s. f.) 350,000 Total Rentable Space (s. f.) 200,000 Average Terminal Rental Rate (per s. f.) $42.86 $75.00 Airline Leased Space (s. f.) 100,000 100,000 Total Terminal Rental Revenue $4,286,000 $7,500,000 Less: Airline Revenue Share Credit 1 1,500,000 Airline Terminal Rental Revenue $6,000,000 Total Landed Weight (000-lbs) 4,800,000 Landing Fee Rate (per 1,000 lbs) $2.08 Airline Landed Weight (000-lbs) 4,400,000 Airline Landing Fee Revenue $9,152,000 1 Certain airport operators that employ a commercial compensatory terminal rate-setting methodology may also have an airline revenue sharing credit. Source: Ricondo & Associates, Inc., May 2009. Prepared by: Ricondo & Associates, Inc., May 2009. Table 3. Typical compensatory rate-setting approach.

2.3.4 Settlement Because actual financial and aviation activity will differ from that budgeted or estimated, an Agreement generally includes a provision for a year-end financial settlement between the airport operator and signatory airlines. This can also be more commonly referred to as “true-up.” Essen- tially, a settlement consists of comparing the budgeted rates and charges calculations for a particu- lar fiscal year with the final year-end actual rates and charges for that same fiscal year. A settlement provision is generally included in all Agreements no matter the type of rates and charges methodol- ogy used. However, it is not normally included without an Agreement. It is also important to note that while the signatory airlines may receive some level of economic benefit for signing an Agreement and making a financial commitment to the airport operator (see Chapter 10), they are also the only group of airlines that will participate in a settlement. The airport operator has no legal recourse for settlement with those airlines that do not sign the Agreement. Therefore, the signatory airlines bear some financial risk if actual financial perform- ance does not meet budgeted levels. Near the start of each fiscal year, an airport operator prepares the airline rates and charges for that fiscal year based on budgeted information which generally includes enplaned passengers, aircraft landed weight, terminal space, operating expenses, debt service, non-airline revenue, and any other activity and financial information that is pertinent to the rates and charges formulas at a particular airport. Then throughout the year, airlines pay their respective rentals, fees and charges based on the budgeted rates. At some point, an Agreement could include a provision for a “mid-year” review of budgeted airline rates and charges to compare with actual (generally unaudited) results to date. To avoid large financial settlements and potential cash flow issues for both parties, there may also be other provisions in an Agreement that require a review and poten- tial adjustment of airline rates and charges if actual results vary by a certain amount or percent- age from budget. After the end of the fiscal year, the airport operator will recalculate airline rates and charges per the formulas established in the Agreement based on actual results for that fiscal year. While this information can be unaudited or audited, the rates and charges formulas are generated with this actual information to determine what is required for settlement. If the airlines have paid more to the airport operator than was required, the airport operator reimburses the airlines for the differ- ence. If the airlines have underpaid, then the airlines remit the difference to the airport operator. There are several variations in Agreements regarding the mechanics of settlement provisions (e.g., actual checks written by either party; settlement amounts credited or charged to the sub- sequent fiscal year calculations). These provisions are generally determined during Agreement negotiations between airport operators and the airlines. However, the primary objective is that an Agreement will specify how the process takes place and that the appropriate amount of air- line rates and charges to be paid by the signatory airlines and collected by the airport operator is based on actual financial performance for that fiscal year. 2.4 Recent Trends in Airport/Airline Business Arrangements Prior to deregulation of the airline industry in 1978, Agreements were generally long term and were considered financial security for an airport operator’s revenue bond debt. As a result, the Agreements at many airports were for a term of 30 years, which made them coterminous with revenue bond debt. Many of these Agreements were also residual in nature, further providing for the financial security of the revenue bond debt. 14 Airport/Airline Agreements—Practices and Characteristics

However, with deregulation and the ease of entry for airlines into markets, the investment community gradually began to recognize that the true credit security for an airport’s revenue bond debt was the underlying strength of an airport’s market and its ability to continue to sup- port growth in passenger traffic, rather than the Agreement in place at that particular airport. The following quote from Standard & Poor’s Rating Service supports this point: While use agreements may provide an additional level of comfort if a particular airline ceases to operate or alters its routing structure, the inherent demand in the air traffic market remains the ultimate security for the bondholder. A strong market will continue to attract carriers to serve that demand, while even the strictest use agreement will not, in and of itself, ensure the timely payment of debt service.2 As such, there has been a trend over the last several years toward airport operators moving fur- ther away from the residual side of the business arrangement spectrum. Generally, airport opera- tors have been assuming more of the financial risk for their airport operation. Subsequently, airport operators have been assuming more control over their facilities as well. It is important that an airport operator fully understand its unique economic drivers and methodologies and its strengths and weaknesses before determining which methodology or combination of rate setting it wants to negotiate with the airlines (see Section 4.2). A sustainable level of risk needs to be built into any long-term business arrangement for both parties. Background 15 2Standard & Poor’s Rating Service, Criteria: Governments: U.S. Public Finance Airport Revenue Bonds, June 13, 2007.