Airport/Airline Agreements—Practices and Characteristics (2010)

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PART III ROADBLOCKS WE MAY ENCOUNTER

7.1 Background In the early years of formal agreements between airport operators and airlines, the vast major- ity of Agreements were long term, often running concurrent with the term of any outstanding bonds. They were also predominantly residual in nature to ensure that bond payments were essen- tially guaranteed by the air carriers. Residual Agreements generally include some type of MII pro- vision that permits the airlines to approve or disapprove capital expenditures. The rationale behind such approval rights was to provide the airlines, which were responsible for making the airport whole, input into the net cost of any improvement that directly affects their rates, fees, and charges. Furthermore, as residual agreements provided for a year-end settlement to ensure airport opera- tors recovered their costs and met their debt service obligations, any year-end surpluses were gen- erally returned to the airlines through rebates or credits, thereby limiting the amount of cash held by airport sponsors. With the ascendency of compensatory/hybrid (compensatory) use and lease agreements, air- port operators began to accept greater short-term risk and responsibility for their capital pro- grams. As such, the ability of an airport operator to generate internal cash and hold reserves began to become an increasingly important consideration in terms of operations and ongoing capital funding. These resources serve two vital functions (1) to provide airport operators a source of internal capital (i.e., discretionary funding) and (2) to absorb short-term revenue short falls due to decreased activity (i.e., surplus cash). Because it is generally not considered practical, efficient, or even prudent, to allow airlines to approve every single capital expenditure at an airport, airport operators may have some authority to incur capital expenditures based solely on management’s judgment that an expenditure is appro- priate. Thus, airport operators may seek to retain cash generated from non-airline sources as a means to internally finance necessary improvements without placing an additional burden on the airlines. Surplus cash should be considered different than discretionary funding given the two different purposes. An acceptable level of surplus cash has always been a consideration for airport operators that operate under a compensatory agreement because under most such business arrangements, the airport operator generally bears the responsibility to make up any short-term revenue shortfall in its operation. To the extent that an Agreement does not allow an airport operator to promptly adjust airline rates and charges to recover its costs and meet its debt service requirements, an air- port operator needs some amount of uncommitted cash to fund cyclical shortfalls and unforeseen events (e.g., unanticipated repairs or uninsured damages) as well as catastrophic changes in the nation’s transportation network, such as occurred in the immediate post 9/11 era. The issues regarding discretionary and surplus funds boil down to the level of spending that the airport operator is permitted to incur without first obtaining consensus agreement from its 55 C H A P T E R 7 Discretionary and Surplus Revenue

airline tenants and the level of uncommitted or unencumbered cash that an airport operator has at its disposal. Impacts to both airport operators and airlines are discussed in the following sections: 7.2 Impact on and Importance to Airport Operators Airports can be complex businesses that must financially stand on their own and require sig- nificant amounts of capital investment in infrastructure. It is important for an airport operator to have a reasonable level of cash available to fund fluctuations in operations as well as for plan- ning purposes and capital needs. It is also important to note that an airport operator is generally planning for a longer-term horizon than its airline tenants. This can become an issue in deter- mining the overall need for a certain project. During the economic downturn that began in late 2007 and accelerated through 2008 and into 2009, many airport operators needed to use reserves (or surplus funds) to cover certain expenses or to provide rate mitigation to the airlines as passenger activity, and thus revenues, contracted. While not a requirement, the bond rating agencies generally look favorably toward an airport operator that has higher levels of unrestricted funds. While the rating agencies do not specify a particular level of cash needed to support an airport operator’s rating, their criteria indicates maintaining an adequate level of cash on hand is an important rating factor. As with any busi- ness, airport operators must have funds available to cover downturns, minimize the need for borrowing, and react to opportunities in an efficient and timely manner. 7.3 Impact on and Importance to Airlines Airlines feel that most any expenditure, directly or indirectly, has an affect on their rates, fees, and charges at an airport. Airlines do, however, recognize the need for airports to have some amount of independent spending authority as well as some level of reserve funds available. Air- lines simply strive to minimize those amounts to levels that they feel are adequate. While the per- ceived level may vary from airport to airport, airlines like to maintain control over as much of the surplus funds as possible. Limiting levels on discretionary and surplus funds is of particular interest or importance to the airlines because these funds are derived either from direct contributions incorporated in air- line rates or by funding from non-airline sources that might otherwise be available to credit air- line rates, fees, and charges. In compensatory Agreements, these funding levels are also important to the airlines, but the method of funding these accounts may not affect rates, fees, and charges if they are funded from non-airline sources of revenue. In any case, airlines will promote their view that airports do not need to accumulate excessive levels of cash reserves because it imposes a cost, either through higher rates and charges or through reduced return on investment. 7.4 Various Alternatives for Treatment in Agreements Each airport operator must evaluate its own specific situation. Different levels of funding are likely to be required at different sized airports and can be dependent on the type of Agreement in place, whether or not an airport is primarily an O&D market versus a connecting hub, the reliance on one carrier or a small group of carriers for the majority of its passenger volume, age of its infrastructure, its ownership (which can affect its efficiency or ability to access outside fund- ing), and airline costs compared with alternative opportunities that airlines might have available. 56 Airport/Airline Agreements—Practices and Characteristics

Alternative funding treatments in airline agreements may include the following: • An annual amount included as a line item in the budget to fund the accounts • Funding from debt service coverage collected on general airport revenue bond debt service payments • Funding from non-airline revenue sources (e.g., parking revenue) • Replenishment through rates for actual amounts expended each year • Retention of all revenue in the airport’s “bottom” fund, often called the general purpose fund Funding ceilings may also be treated in different manners: Specific annual amounts agreed to in the airline agreement Replenishment of expenditures until the fund balance reaches a specified maximum balance No limit or ceiling specified There are also potential different methods of identifying these funds and their uses: • Discretionary and surplus funds might not have any limit on use. • Airports may or may not include a return on investment equal to their cost of borrowing when amortizing reimbursement payments from the airlines. Even with a return on investment, the end cost of using funds that are internally available is less expensive than the annual debt service resulting from the issuance of general airport revenue bonds given the associated transaction costs associated with a bond issue. • Funds may be divided among two or more accounts for (1) airline supported projects and (2) airport supported projects. • Return on investment may not be included in recovery of funds on deposit in an airline dis- cretionary account. • Airport only includes return on investment on airline requested projects when funding comes from the airport account not the airline account. 7.5 Linkages to Other Agreement Provisions • Types of rate-setting methodologies—how airlines contribute to discretionary and surplus funds (see Section 2.3). • Capital program requirements and control—what type of flexibility does the airport operator have to use discretionary and surplus funds for capital improvements (see Section 4.4 and Chapter 8). Discretionary and Surplus Revenue 57

8.1 Background Capital project control and consultation is typically an issue that will surface in most Agree- ment negotiations between airlines and airport operators. Some Agreements address this issue through an MII provision. This provision will generally indicate how much control (if any) the signatory airlines have over an airport operator’s capital development program, and will detail the formal procedures for how such controls are executed. Capital project control and consultation provisions vary considerably, ranging from no control to very strict and struc- tured airline control. There are also numerous variations in between. Since the airlines bear the financial risk, more airline capital development control generally occurs as Agreements become more residual in nature. Before the deregulation of the airline industry in the late 1970s, Agreements were gener- ally long term and were considered the primary financial security for an airport operator’s revenue bond debt. Before deregulation, Agreements were in many cases coterminous with an airport operator’s 30-year revenue bond debt. Given the financial security provided by the airlines, many of these Agreements were also set up with a residual rate-setting methodology where the airlines assumed the financial risk for the airport financial operation. Because of this financial risk and the potential cost exposure that larger capital programs can present, the airlines have historically sought controls over airport operator capital spending. Also, because of varying and evolving airline business models and perspectives, there can also be disagreements regarding “what is the right type” of airport capital development. As such, capital development and control continues to be a significant issue for airlines and airport operators. Since deregulation of the airline industry, the following trends have impacted the treatment and relevance of airline capital project controls at airports: • Airport operators have trended away from residual-type rate-making approaches in their Agree- ments and, in many cases, may rely more on non-aeronautical revenue sources for capital development. • The length of Agreements has decreased from the historical 30-year terms to shorter durations such as 5 years or less. • The concept of pre-approval of airport capital development programs within Agreements has gained some prominence. It could be argued that, in general, these trends have somewhat reduced airline financial expo- sure to capital program costs; however, airline rates and charges still remain a critical funding source. As trends have changed, so have the types of Agreement provisions addressing capital 58 C H A P T E R 8 Capital Project Control and Consultation

project control and consultation. These provisions vary widely from airport to airport depend- ing on the individual situation. The impacts on both airport operators and airlines are discussed in the following sections; along with recent trends, treatments, and linkages of the capital project control and consultation provisions with other critical airport operator/airline negotiation issues. 8.2 Impact on and Importance to Airport Operators An airport operator is charged with meeting the aviation needs for its local community or region, and as such, has a staff of professionals to analyze, plan, and implement capital develop- ment programs. Additionally, an airport operator is required to perform certain analyses and studies of its capital program for its development to be in compliance with and eligible for FAA grant funding, passenger facility charges, or other state or local funding. Meeting these various obligations and planning for capital development that meets the needs of the surrounding com- munity’s current and future aviation demand requires careful coordination and planning. Thus airport capital planning is a very challenging undertaking because of the very dynamic nature of the aviation industry combined with the fact that large airport capital projects almost always take several years to plan, develop, and implement. Given these factors and the required planning process, airport operators generally take a longer- term view of their CIPs. It is commonplace for an airport operator to have a forward-looking 5-year CIP, moreover, those that have completed master plans and have an FAA-approved air- port layout plan (ALP) have capital development programmed out 10 to 20 years into the future. Airport operators will find that their planning horizon is typically much longer than that of their airline partners, which can become an issue in seeking agreement on certain development. This issue is also very apparent during times of an economic downturn for capital projects that can take several years to implement. For instance, an airport operator may want to start the process for planning the development of a terminal expansion that will not be operational until 3 years from now. However, this expansion may be a tough one to sell to the airlines that have currently cut back on their capacity and are seeing current decreases in numbers of passengers. Given the many steps it can take for an airport operator to develop a capital program that has buy-in from its various stakeholders including, but not limited to, its airline partners, the local community it serves, and the FAA, too much control by any one stakeholder can become or at least be perceived as an issue. For example, it is important for the airport oper- ator to understand the impacts on competition that could arise if facility expansion oppor- tunities are limited to meet demand from new entrant or expanding incumbent carriers. Other issues airport operators can face when dealing with airline control are the differences in preferences among the airlines and, for some smaller airports, the attention from airlines to their capital programs. In most cases, the capital program that is developed at an airport becomes the responsi- bility of the airport operator, who must operate and maintain it for the current airport tenants. If the airport becomes “over-built,” it could become very costly for airlines to oper- ate there and, thus, future air service could be compromised. On the other hand, if the air- port operator does not keep its infrastructure on pace with demand, operational delays at the airport could become more frequent, and could also result in decreases of air service due to the declining level of service offered. Therefore, airport operators are faced with very impor- tant, yet difficult challenges when planning for future capital development. As such, many airport operators may be less inclined to compromise on control over their capital develop- ment programs. Capital Project Control and Consultation 59

8.3 Impact on and Importance to Airlines The primary importance to airlines regarding MII provisions is the ability to have some con- trols over capital spending at airports. All things considered, airlines need to achieve long-run profitability in an extremely competitive and dynamic industry to have a sustainable opera- tion. While airport costs as a percentage of total airline operating costs may not be as consid- erable as some other expense categories such as fuel or labor, they are still significant enough to warrant attention. For First Quarter 2008 (using Air Transport Association of America’s Airline Cost Index based primarily on U.S. DOT Form 41 data), the categories of non-aircraft rents and ownership and landing fees combined constituted approximately 6.2 percent of U.S. domestic carrier operating costs.26 It should be noted, however, that the expense category of “non-aircraft rents and ownership” also includes the cost of hangars, ground service/support equipment (GSE), storage and distribution equipment, and communication and meteorolog- ical equipment that may or may not necessarily be included as part of an industry standard for calculating airport costs. Airport capital development that does not effectively promote efficient movement of passen- gers through an airport can be detrimental to both the operational and financial ability of air- lines to serve a specific market. While airport operators have dedicated professional staff for the planning and development of capital programs, the airlines are important stakeholders, and it is suggested that their input be considered because they are, in many cases, the primary users of facilities related to the terminal and airfield areas. At many airports, especially those with residual-type rate-setting approaches, the airlines provide an overall financial guarantee to the airport operation. Therefore, as a tradeoff, some degree of airline control over capital development and spending is typically deemed to be war- ranted. Without any controls and as parties to a residual-type Agreement, the airlines could potentially be at the mercy of the airport operator for costs related to capital projects that the airlines may view as not needed or even politically driven. This type of risk tradeoff is generally not acceptable to the airlines. Depending on how the rate-setting methodology is structured, at non-residual Agreement airports with shorter Agreement terms, capital project control may be viewed as somewhat less important compared with a residual Agreement airport. However, airlines as critical stakeholders will still be interested in the capital projects that will be imple- mented, because in most cases the core group of airlines plans to operate at that airport beyond the term of the Agreement. 8.4 Various Alternatives for Treatment in Agreements In summary, the treatment of capital control and consultation provisions in Agreements is dependent on the overall nature of the airline rate-setting methodology. For example, an Agree- ment where the airport operator is taking most of the financial risk may have limited to no air- line control over capital development. However, for a more residual-type business arrangement, an Agreement generally contains a stricter application of these types of provisions. With many Agreements falling somewhere in between compensatory or residual, there are various ways Agreements can treat capital consultation, control, or MII provisions that are consistent with the level of risk each party is assuming. The following represent various treatments, if applicable, for structuring a capital control or MII provision in Agreements: 60 Airport/Airline Agreements—Practices and Characteristics 26Passenger Airline Cost Index, Air Transport Association, http://www.airlines.org/economics/finance/Cost+Index. htm, accessed June 2009.

MII Thresholds MII Thresholds should be set strategically based on the market share specifics of the market: • Double-barrel—a certain number of airlines representing a certain amount of activity thresh- old must be met (e.g., 50 percent of airlines in number representing 60 percent of landed weight). • Single-barrel—an activity level or number of airlines threshold must be met. • Cost center-specific—multiple thresholds are established based on the cost center which is impacted by the project (e.g., enplanement or fee activity for terminal projects, and landed weight or fee activity for airfield projects). Types of MII Provisions • “Affirmative” or “Positive” MII—the airport operator is required to receive the threshold of “affirmative” or “yes” votes from the signatory airlines to obtain approval to proceed with a capital project. • “Negative” MII—the airport operator has approval to proceed with a capital project unless it receives the appropriate threshold of “no” votes from the signatory airlines. Types of Control over Capital Development • Absolute disapproval—the airport operator may not undertake the capital project during the term of the Agreement unless it receives approval from the signatory airlines. • Rate-base disapproval—the airport operator may not fund the capital project through airline rates and charges during the term of the Agreement unless it receives approval from the sig- natory airlines. • Deferral—if the airport operator does not receive approval from the airlines to undertake the capital project through the MII process, it may undertake the project after a certain agreed- upon period of time has passed (e.g., 1 year, 6 months). Processes for Airline Consultation An airport operator may be required to do one or more of the following: • Conduct meeting with signatory airlines to present project • Provide written justification for capital project • Provide cost estimates and funding plan for capital project • Provide drawings and time schedule for capital project • Estimate the financial impacts to the airlines resulting from the capital project (including impacts to capital costs, operating expenses, and non-airline revenues) • Allow certain period of time for signatory airlines to assess capital project and submit MII vote (e.g., 2 weeks, 30 days) Capital Project Exceptions from MII Process Included in Some Agreements • Safety and security projects or those of an emergency nature • Projects mandated by the government • Projects to settle claims or lawsuits, satisfy judgments, or comply with judicial or administra- tive orders • Projects with capital costs less than a certain level • Projects to repair or replace airport property damaged or destroyed by fire or other casualty • Projects funded entirely from sources other than airline rates and charges (e.g., FAA AIP, PFCs, airport operator discretionary funds) • Projects pre-approved per the Agreement Capital Project Control and Consultation 61

8.5 Linkages to Other Agreement Provisions • Cost centers—how capital projects are linked to cost centers for airline rates and charges (see Section 4.3). • Types of rate-setting methodologies—how the rate-setting methodology may impact the type of MII provision (see Section 2.3). • Capital program requirements—additional information on airport capital development pro- grams (see Section 4.4). • Discretionary and surplus revenue—types of funding for capital projects relating to the MII process (see Chapter 7). • Signatory status—which group of airlines is permitted to participate in the MII process (see Chapter 10). 62 Airport/Airline Agreements—Practices and Characteristics

9.1 Background The leasing and use of terminal resources has always been a critical element of the business and operating relationship between airlines and airport operators. Years ago, it was more com- monplace for an airline to lease more terminal space than it may have needed for its actual oper- ation, because this gave an impression to the traveling public of the airline being larger and more successful than its competitors. It also helped prevent competing airlines from being able to lease or use more terminal space, thereby limiting the competition for passenger traffic at an airport. However, as passenger traffic continued to grow, particularly in the years after the 1978 passage of the Airline Deregulation Act, increased use of terminal facilities put additional pressure on ter- minal capacities, necessitating expansion of these facilities at airports across the country. Before the introduction of PFCs in the early 1990s, these expansions typically required the issuance of general airport revenue bond debt due to the limited availability of other types of funding sources. This increased the costs to the airlines through increased annual debt service, and in many instances debt service coverage, in the terminal rate base. There were not many options for avoiding this type of situation, as many Agreements were long-term 30-year agreements, and the terminal facilities leased by an airline were generally leased on an exclusive-use basis. Before airline deregulation, it was typically considered additional security by the invest- ment community when terminal facilities were leased on an exclusive-use basis for a long term, generally coterminous with the revenue bond issue. However, airlines became less able to obtain long-term agreements with airport operators as the investment community began to recognize that the real security for airport revenue bond debt was the underlying economic strength of the market area the airport served, and as airports began to obtain favorable financing rates without long-term airline commitments. After years of airline bankruptcies in the 1980s and 1990s, which tied up gates and other facilities in the terminal, airport oper- ators began negotiating to lease their facilities on a preferential and common-use basis when Agreements expired. An additional impact of increased passenger traffic in the post-airline deregulation era was a broadening of the types of airlines serving those passengers. The introduction of LCCs often further aggravated terminal facilities constraints, as the markets with the greatest increases in this type of passenger activity also saw the largest demand for additional facilities in their terminals. These con- straints were not strictly limited to the terminal itself, but also included aircraft parking, particularly overnight parking at many airports. And, with most, if not all, of the facilities being currently leased by incumbent airlines, the ability to make room for other airlines became extremely difficult. When airport operators planned their respective expansion programs, there was an increased interest in building an extra gate or two to provide space that the airport operator could lease (or charge on a per-use basis) to expanding incumbent or new entrant airlines. 63 C H A P T E R 9 Facility Control

In October 1999, responding to concerns that new entrant airlines were having difficulty gain- ing access to critical facilities, particularly at certain heavily used airports, the U.S. DOT issued a report titled “Airport Business Practices and Their Impact on Airline Competition.” This report provides information to airport operators on airport business and leasing practices that may enhance opportunities for airline access. Building on this report, in 2000, the Wendell H. Ford Aviation Investment and Reform Act for the 21st Century (AIR-21) requires the submission of a written Competition Plan to the FAA by large and medium hub airports at which one or two car- riers control more than 50 percent of the passenger boardings (covered airports) for a new PFC to be approved for collection or a grant to be issued under the AIP. According to AIR-21’s legisla- tive history, the purpose of these Competition Plans was for covered airports to demonstrate how they would provide for new entrant access and expansion by incumbent carriers. As exclusive use leases were replaced, in part, with preferentially and jointly leased facilities, airport operators and airlines had to address such issues as controlling usage on preferentially leased facilities; how to charge for usage at a gate that was on a per-turn basis; arriving at the appropriate methodology for charging for joint use facilities; providing stability for airlines leas- ing preferential-use gates yet allowing for usage by other airlines; how an airport operator could recover a gate from an airline that was underutilizing it; permitting and charging for, where appropriate, ground handling of an airline’s activity on a non-leased gate; permitting and charg- ing for overnight usage and parking of aircraft at gates not leased by that airline; and ensuring that all costs were borne by the appropriate users and tenants. 9.2 Impact on and Importance to Airport Operators The airport operator typically seeks the ability to manage and control its facilities to maximize usage; provide for a constant revenue stream; and control the need for additional expansion unless absolutely necessary. The airport operator prefers to serve as the “landlord” over the facil- ities, yet must also acknowledge that the airlines need to be able to operate their flights and have assurance that gates and other facilities will be available for the handling of passengers and bag- gage. While there has been a transition to more preferential space in airports at airline premises, the airport operator should be willing and able to enforce the accommodation provisions in its Agreement to achieve the results that having preferentially leased space provides. 9.3 Impact on and Importance to Airlines An airline’s primary interest is in having the necessary and appropriate facilities available to handle its flights and process its passengers at an airport at a reasonable cost. Airlines are con- tinually evaluating whether it is more efficient and effective to use facilities on a per-turn basis rather than lease that particular facility for the term of the Agreement. It is challenging for air- lines to strike a balance between providing flexibility in the use of an airport’s terminal facilities and controlling costs. 9.4 Various Alternatives for Treatment in Agreements Many provisions in recently negotiated Agreements are allowing airport operators to manage and better control usage of terminal facilities, while permitting incumbent airlines to continue to oper- ate their respective schedules without the fear of frequent disruptions. Inclusion of preferential- use provisions in Agreements may permit the airport operator to relocate an incumbent airline if 64 Airport/Airline Agreements—Practices and Characteristics

that airline is not maintaining a minimum amount of activity on a gate (“minimum use” require- ments). There are often Agreement provisions that address handling of aircraft by other airlines and third-party providers, and for managing potential airline subleases of their facilities to another airline. Another approach that is commonly being included in Agreements is the leasing of terminal facilities on a common-use basis. While not recommended across the board, this approach has addressed capacity issues and concerns at certain airports through improved management of exist- ing terminal facilities rather than construction of additional facilities to provide for the increases in both passenger and airline activity. This approach has produced a number of concepts for man- aging and controlling usage of limited terminal facilities, including CUPPS (Common Use Passen- ger Processing Systems) and CUSS (Common User Self-Service) kiosks. Essentially, these recent approaches and Agreement provisions related to controlling the use of terminal facilities are prompted primarily by the desire to limit the need for rushing into terminal expansion projects while ensuring that the airlines are able to handle and process their passengers at a level of customer service satisfactory to both the airlines and the airport operator. At that point, focus on cost impacts shifts from dealing with a major capital program to determining how the existing terminal costs are spread throughout the terminal facility and what formulas determine how all tenants and users of those facilities are assessed. 9.5 Linkages to Other Agreement Provisions • Joint use formulas—how costs of common use facilities are distributed among the users (see Chapter 12). • Signatory status—minimum use requirements for gate and ticket counter space to maintain signatory status (see Chapter 10). Facility Control 65

10.1 Background Airlines began executing long-term Agreements during the era when the airlines were subject to regulation by the Civil Aeronautics Board. During that same period, airport operators first gained access to the municipal bond market as a method to fund capital improvements. The financial health of a certificated airline was relatively assured, thus the credit associated with an airport operator’s issuance of municipal bonds centered more on air service than on the econom- ics and demographics of the airport’s air trade area to sustain service. For that reason, the finan- cial markets looked for commitment from the airlines that they planned to operate at the airport and pay fees in accordance with the Agreement for the full term of any outstanding bonds. Signing a long-term Agreement signified a commitment to the market and a revenue stream to the airport operator in return for lower fees being charged to the signatory airlines than to those airlines not willing to commit for an equivalent period of time. In view of that, non-signatory air- lines, then and now, usually pay higher landing fees and rents than do signatory airlines. In October 1978, the Airline Deregulation Act partially shifted control over airline traffic from the federal government to the marketplace and resulted in a fundamental shift away from regula- tion toward an air transportation system that relied on competitive market forces to determine the quality, variety, and price of air services. Airlines have found that they have had to operate in a more business-like fashion and retain flexibility to enter and leave markets that do not produce sufficient revenue to support their network’s operations. The term of Agreements has generally decreased from the 30-year terms to 15- and 10-year terms and then to terms of 5 years or less, depending on the market being served. The credit markets now focus on the economic climate and the demo- graphics of an airport’s air trade area (as discussed in Section 6.1). Under the assumption that there are numerous airlines operating that are flexible enough to react to varying levels of demand, less of an emphasis has been placed on the airlines serving the market than had been in the past. However, a strong mix of airlines that are signatory to an Agreement is still considered a plus by the credit mar- ket. Further, at an airline hub, the credit market reacts positively to a longer term Agreement. 10.2 Impact on and Importance to Airport Operators While airport operators highly desire obtaining airline commitment to the local market, they recognize that airline networks are very complex and that airlines have a need to maintain flex- ibility in a market, whether it is by varying fleet mixes owned by themselves or operated by affil- iate airlines or other business partners, or to cease all operations in a market at any point in time. If an airline is signatory to an Agreement at an airport, but decides it is not viable to continue serving the local market, the fact that the airline has a contractual commitment to lease space at 66 C H A P T E R 1 0 Signatory Status

an airport could have little, if any, affect on making a decision to cease operations and vacate its space at the airport. The departing airline will either seek to sublease its space or continue with lease payments even though it no longer serves the market. Thus, airlines often want to limit the term of their signatory status at an airport in order to reduce exposure to future liability. Obtaining signatory commitment from airlines is generally more important to airports that are situated in a weak economic location, airports that serve as airline hubs, airports that have only one or two airlines serving the airport, or airports that calculate their airline rates and charges using an airport residual rate-setting methodology. Airports situated in a stronger business locale, having diverse air service, and calculating airline rates and charges on a compensatory or hybrid basis are less likely to be concerned about which airlines are signatory to an Agreement. In some cases, an airport operator may feel that it is diverse enough that airline commitment may not cause any significant benefit to the credit markets and may not even offer an Agreement for considera- tion by the airlines. Most Agreements contain provisions that allow the airport operator to reconcile the airlines’ actual financial requirement at year end with what was paid for the year and collect any shortfall in revenue from the signatory airlines. Depending on the type of rate-setting methodology used, this reconciliation will pertain to specific revenue and cost centers or to the entire airport system. Obtaining signatory commitment from non-hubbing airlines may be important to the oper- ators of airports that serve as connecting hubs for particular airlines. The airport operator likely has significant liability related to ongoing maintenance and debt service on facilities constructed for the benefit of the hubbing airline’s connecting passengers, as well as support operations that would not be necessary if the airport were to need only facilities to serve the local market. His- tory shows that airlines have shut down or relocated hub operations without significant regard to the resulting economic effect on the airport. In the case of a commitment to a large amount of space, the continuation to pay the cost of abandoned facilities for as long a term as possible can be valuable to a hub airport. The business deal contained in the Agreement might also provide the airlines with some form of approval rights on certain types of capital projects at the airport, generally contained in an MII provision of the Agreement. Depending on the operating philosophy of an airport operator, such a provision may be either desirous or not. To limit airline approval rights on appropriate expenditures and to determine which airlines are granted the lower signatory rate structure, airport operators have developed signatory requirements as well as various classes of signatory airlines. 10.3 Minimum Requirements Airport operators typically allow any airline with a request to lease ticket counter, operations, and gate space for the full or remaining term of the Agreement to be signatory to the Agreement. Airport operators that lack a particular category of space or that want to permit scheduled char- ter airlines to pay the signatory rate may make adjustments to the basic requirement that airlines lease space sufficient to handle their complete operations. Sometimes an airport operator has ticket counter space available, but not a sufficient number of gates to permit leasing of a gate to an airline desiring to commit to the term of the Agreement. In these cases, the requesting airline will share gates under a sublease or preferential use provision and the definition of “Signatory Airline” will include a minimum amount of square feet that must be leased (generally an estimate of the square feet necessary for the number of ticketing positions and support space needed to support its operation). In most cases, in exchange for benefiting from Signatory Status 67

the signatory rates, the airport operator’s objective will be to obtain the largest commitment it can reasonably expect from the requesting airline. 10.4 Treatment of All-Cargo Airlines Because all-cargo airlines do not have a need for space in an airport terminal building, they may not execute the same Agreement as the commercial passenger airlines that are limited to carrying belly-cargo. At some airports, the all-cargo airlines execute the same Agreement and all references to terminal requirements and fees simply do not apply to them. On the other hand, they might execute an operating agreement that commits them to paying fees, carrying appro- priate insurance, indemnification, and other legal and regulatory matters. They may also have a ground lease or other building lease for support of their operation. The Agreement signed by the passenger airlines will often permit the all-cargo airlines to ben- efit by paying signatory fees if they provide a minimum level of landed weight at the airport and lease space from the airport operator for a term at least as long as the term of the passenger air- lines’ Agreement. If the Agreement contains an MII clause, the all-cargo airlines’ approval partic- ipation is generally limited to matters pertaining to the airfield. 10.5 Classes of Airlines Classes of airlines can include mainline airlines, affiliate airlines, all-cargo airlines, and sched- uled charter operators (more often, scheduled charter airlines are not granted signatory status). An affiliate airline is usually not signatory to the Agreement if its mainline airline or a different affiliate of its mainline airline leases space at the airport and executes the Agreement on the affil- iate’s behalf. At some airports, the affiliate airline may be granted signatory privileges for rates and charges if the mainline airline or different affiliate airline agrees in writing to guarantee its payment of all rates and charges, including passenger facility charges (for further discussion of affiliates see Chapter 13). 10.6 Rights and Privileges Airlines with signatory status generally pay the lowest rates available to airlines serving the air- port. In return, they are assured specific premises in the terminal building from which to oper- ate. They can also be granted the right to handle their affiliate airlines without any additional permits or ground handling fees. If, at the end of the year, the Agreement calls for a distribution of shared revenue or a refund, the signatory airlines receive the benefit of a further reduction in cost to operate at the airport. However, if there is an unanticipated shortfall, they will pay the necessary amounts to eliminate the shortfall. Signatory status may provide for airline review and comment on an airport’s operating and capital budgets. It may include rights, subject to the MII formula, to disapprove or defer the undertaking of a capital project or inclusion of a certain cost as part of its rate base and to par- ticipate in the planning of airline facilities. 10.7 Impact on and Importance to Airlines An airline’s major benefit in obtaining signatory status is to ensure that it is charged the low- est rate at an airport and is positioned to receive any revenue that is shared with the airlines. Being signatory will also preserve adequate space for its operation (except in instances where 68 Airport/Airline Agreements—Practices and Characteristics

shared use is being required for a temporary period) and may provide a level of control over air- port expenditures that impact its rates. The airlines that are signatory want to ensure that any other airline receiving the benefits of signatory rates, rights, and privileges has also made a financial commitment to the airport at least equal to the investment it has made. Scheduled airlines may be less sympathetic than airport operators are about granting signatory status to non-scheduled and international airlines. An airline that wants to test the market or wants freedom to leave without the requirement to continue paying rent for leased premises must weigh the incremental cost of non-signatory fees against the flexibility it desires. Sometimes, airlines may decide to execute the Agreement after they have operated for a period of time sufficient enough to provide confidence in the market and the ability to produce the necessary revenue to support its operation. 10.8 Various Alternatives for Treatment in Agreements Signatory treatment is relatively consistent in Agreements, generally with the objective of obtain- ing a financial commitment for the term of the Agreement that is as large as possible. Alternatives or modifications to the standard requirement to lease space (ticketing, operations, and gate) suffi- cient for its operations include the following: • At airports where no gates are available, limiting commitment to ticketing and support space • Allowing scheduled charters and international airlines to pay signatory rates • Allowing all-cargo airlines to execute the Agreement and benefit (partially) from the signatory benefits • Varying MII formulas—discussed in Chapter 8 10.9 Linkages to Other Agreement Provisions • Affiliates—how can an affiliate attain signatory status (see Chapter 13). • Capital project control and consultation—the type of control signatory airlines have over the capital development process (see Chapter 8). • Facility control—what facility control provisions are signatory airlines subject to, for exam- ple, minimum use requirements for gates (see Chapter 9). • Airline rates, fees, and charges—how signatory and non-signatory airlines pay for their use of the airport (see Section 2.3 and Chapter 11). Signatory Status 69

11.1 Terminal Rental Rate Divisors and Methodologies There are a number of methodologies employed at airports to calculate terminal rental rates, each with their own set of reasons and implications pertaining to their use. In general, the ter- minal rental rate methodology used revolves around the following considerations: • Balancing airport/airline risks and rewards • Balancing overall airline costs versus the airport’s financial performance • Maximizing the use of terminal space • Maintaining level of cost recovery Generally, these various factors are quantified in the three primary approaches to establishing terminal rental rates as follows: • Compensatory rental rates • Commercial compensatory rental rates • Residual rental rates To best understand the various terminal rate-setting methodologies and their implications, it is best to first understand the different rental rate divisors (measured in terms of square feet) that are primarily used throughout the industry. The following provides a general definition of the rental divisors used and the individual components of terminal space that are included within each. • Useable Terminal Space: Useable terminal space is defined as the gross square foot area of the terminal, less the mechanical and electrical area and voids within the terminal. As a gen- eral rule, airport administrative space is usually included within the definition of useable space, with the understanding that airport administrative space could otherwise be used if it were not occupied by the airport operator. In some cases, however, airport administra- tive space may also be excluded from the definition of useable terminal space. • Rentable Terminal Space: Rentable terminal space is defined as all space within the terminal that can be rented or leased to any airlines or other tenants. As such, rentable terminal space includes total airline space, terminal concessions space, and other rentable space within the terminal, and specifically excludes public circulation areas, restrooms, voids and mechanical and electrical areas. Rentable terminal space can also include space for airline ticket counter queuing, airport administrative space, rental car counter queuing, as well as space for the TSA offices and the footprints for EDS machines. • Airline Leasable Space: Airline leasable space consists of all space within the terminal that is available for occupancy by an airline. • Airline Leased Space: Airline leased space consists of all space within the terminal that is occu- pied and leased by an airline, but excludes vacant, or unleased, airline space. In general, airline space consists of airline offices, ticket counter, baggage claim, inbound and outbound bag 70 C H A P T E R 1 1 Terminal Rental Rate Methodologies and Considerations

Terminal Rental Rate Methodologies and Considerations 71 make-up areas, operations areas, hold rooms, and aircraft gates. In many cases, the ticket counter queuing area in front of the airline ticket counters is also included within the airline’s leased areas. Table 4 provides a summary of the various terminal space components that are included within the definition of each terminal space divisor. The primary rental rate approaches are described in greater detail as follows: • Compensatory Terminal Rental Rates A compensatory rate-making approach represents a cost-based approach, in that an airline pays only for the cost of terminal space that it leases or uses. Under a compensatory rental rate methodology, a useable space divisor calculates the average terminal rate per square foot. By using a useable space divisor, total costs are effectively spread across all terminal space, including airline, concessions, public space, and other space. As a result, the space divisor is larger and results in a lower average rental rate. Since the airlines pay rent on only the space that they lease, the airlines are not responsible for covering the costs associated with the other areas of the terminal—namely terminal concessions, public, or airport administrative space. As a result, the airport operator and revenue generated from the terminal concessions must cover the costs associated with other space, including vacant airline space. With a compen- satory terminal methodology, the airport operator not only bears the risk of ensuring that terminal concession and other tenant revenues cover the costs of the remaining space within the terminal, but also bears the risk of any vacant airline space. • Commercial Compensatory Terminal Rental Rates A commercial compensatory approach is consistent with the methodologies employed at com- mercial retail buildings with multiple tenants and large public or common areas such as shop- ping malls. Similar to the compensatory approach, a commercial compensatory rate-making approach represents a cost-based approach. However, under a commercial compensatory Terminal Space Included In Divisor Terminal Space Useable Rentable Airline Leasable Airline Leased Leased Airline Vacant Airline Ticket Counter Queuing Concessions Other Rentable TSA / Security Offices EDS Machine Footprint Airport Administrative Security Checkpoint Public Restrooms Mechanical/Electrical Notes: = Space component is usually included as part of the overall definition of the terminal space divisor. = Space component is sometimes included as part of the overall definition of the terminal space divisor. Source: Ricondo & Associates, Inc., May 2009. Prepared by: Ricondo & Associates, Inc., May 2009. Table 4. Terminal space divisors.

approach, the airlines, concessionaires, and other tenants are allocated their pro-rata share of the costs of the public or common areas and administrative areas. With a commercial compen- satory rental rate methodology, a rentable space divisor is used to calculate the average termi- nal rate per square foot.27 By using a rentable space divisor, total costs are effectively spread across only the airline, concessions, and other rentable space. As a result, the space divisor is smaller and results in a higher average rental rate. Under this methodology, the airport opera- tor is not responsible for covering the cost of the public or administrative space, and revenue generated from the terminal concessions must cover the remaining total costs of the terminal. With a commercial compensatory terminal methodology, the airport operator still bears the risk of any vacant airline space within the terminal. • Residual Terminal Rental Rates A residual rate-making approach assumes that the airlines pay any net remaining costs within the terminal after crediting all terminal concession and other non-airline terminal revenues against the total operating and capital costs of the terminal. Under a residual approach, the air- lines assume the risk of the residual terminal costs and are responsible for guaranteeing the air- port terminal operates on a financial break-even basis. After crediting all non-airline terminal revenues to the total terminal requirement to derive the net terminal requirement, a residual methodology uses a leased airline space divisor. As such, 100 percent of the net remaining ter- minal costs are spread among the airlines leasing space within the terminal, and the airport operator does not assume the risk of any vacant airline space. Table 5 presents a basic example of the traditional terminal rental rate approaches. Based on the basic examples presented in Table 5, the commercial compensatory approach (rentable divisor) resulted in the highest airline rental rate. Alternatively, the compensatory approach (useable divisor) generated the lowest terminal rental rate, while the residual approach (leased divisor) produced a rate between the two. While this is typically the result one might expect from each of the three traditional methodologies, it is not always the case. Depending on a num- ber of factors and relationships, including the relative ratios of useable, rentable, airline leased, and airline vacant space within the terminal, and the amount of non-airline terminal revenues, the rental rates produced by each methodology can vary. 11.2 Equalized versus Differential Terminal Rental Rates At airports having a single terminal building, there is generally one average terminal rental rate calculated for the entire terminal. In the case of an airport with two separate terminal buildings, or even two different concourses, however, the airport may choose to establish either “equalized” rates or “differential” rates between the two terminal buildings or concourses. (It is important to note that this is different than establishing “weighted” terminal rental rates based on the type of airline space being leased, which is covered in Section 11.3). For the purposes of this discussion, the following sections provide definitions of both equal- ized and differential terminal rental rates: • Equalized Terminal Rental Rates At an airport with two or more unit terminals or concourses, equalized terminal rental rates are being used when the overall average terminal rental rate being charged to the airlines is equal (on a per square foot basis) regardless of what terminal or concourse they may be located in and what the cost differential of those terminals or concourses may be. In this case, the sin- 72 Airport/Airline Agreements—Practices and Characteristics 27While 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.

gle equalized rate for all airlines is generally calculated by totaling operating expenses, capital costs, and other terminal costs associated with all terminals or concourses and dividing by the appropriate square footage divisor for all terminals or concourses. As a result, all operating and maintenance costs, as well as capital costs, are spread equally to all airlines. • Differential Terminal Rental Rates At an airport with two or more unit terminals or concourses, differential terminal rental rates exist when an airport operator charges different terminal rental rates to airlines operating at each unit terminal or concourse. In the case of differential terminal rates, terminal costs (i.e., operating expenses, debt service) are accumulated and accounted for separately for each specific terminal. The rental rate for each terminal is then calculated by dividing each respective terminal’s costs by the appropriate square footage divisor for each terminal. Traditionally, differential terminal rental rates have evolved at airports where different unit ter- minals or concourses have been constructed at different points in time for substantially different Terminal Rental Rate Methodologies and Considerations 73 Compensatory Approach (Useable Divisor) Commercial Compensatory Approach (Rentable Divisor) Residual Approach (Leased Divisor) Total Terminal Requirement $1,100,000 $1,100,000 $1,100,000 Less: Other Airline Reimbursables 1 100,000 100,000 100,000 Less: Non-airline Terminal Revenues n/a n/a $500,000 Net Terminal Requirement $1,000,000 $1,000,000 $500,000 Terminal Space Divisor (square feet) 135,000 70,000 50,000 Terminal Rental Rate per square foot $7.41 $14.29 $10.00 Airline Leased Space (square feet) 50,000 50,000 50,000 Airport Space Vacancy Risk 16.7% 16.7% 0.0% Total Airline Rent $370,370 $714,286 $500,000 Example Terminal Space (square feet) Leased Airline 50,000 Vacant Airline 10,000 Total Airline 60,000 Concessions 9,000 Other Rentable 1,000 Total Rentable 70,000 Public 50,000 TSA/Security 5,000 Airport Administrative 10,000 Total Useable 135,000 Mechanical/Electrical 10,000 Voids 5,000 Total Terminal 150,000 1 Includes airline revenues that are being reimbursed from the airlines for costs that are already included in the total airline requirement. Examples include payments for airline equipment such as flight information displays and baggage system equipment. Source: Ricondo & Associates, Inc., May 2009. Prepared by: Ricondo & Associates, Inc., May 2009. Table 5. Example of terminal rental rate methodologies.

costs. For example, an airport operator that originally constructed a unit terminal building in 1980 may decide that to accommodate anticipated growth in passengers it now needs to construct a new additional unit terminal. Due to inflationary impacts, however, the second additional unit terminal now costs several hundred million dollars more than the original unit terminal. In an effort not to burden the airlines still located in the older unit terminal with the costs of the newer unit terminal, the airport and the airlines may choose to assess differential terminal rental rates to the airlines operating in the old terminal versus those operating in the new terminal. In addi- tion to this example, there are several other instances that differential rates may evolve from including the following: • Domestic versus international terminal buildings • Terminal facilities being constructed primarily for the benefit and at the request of one airline • Terminal facilities having large differences in operating expenses • Terminal facilities having large differences in capital costs Complications surrounding equalized versus differential rates during airline negotiations gen- erally arise from two areas: equality issues among airlines (e.g., costs and age of facilities) and the use of other funding sources, particularly PFCs. The issue of equalized versus differential terminal rental rates typically is influenced by who is driving the need for new terminal facilities, the airport operator or the airlines, and which air- lines are benefitting from the new facilities (or conversely, which airlines may be benefitting from the cheaper facilities). Depending on the circumstances, a number of equality issues can surface. Those airlines to be located within the new terminal facilities would probably prefer equalized rates for all terminals to benefit from an overall lower average rental rate. Alternatively, those airlines expected to remain in the older terminal facilities would likely favor differential rates, so they can benefit from lower rates for the older facilities. In the case where differential rates are considered, airlines may also request to be located within the older terminal to benefit from lower rates, causing issues with how to divide up the terminal space among the airlines. However, the airport operator may prefer to use equalized rates so as not to negatively burden certain airlines with higher costs than others. All these factors must be weighed when considering equalized or differential terminal rental rates. • Compliance with PFC Assurances The other issue that can surface with differential terminal rental rates is with the FAA’s PFC Assurances. Appendix A of 14 Code of Federal Regulations (CFR) Part 158 contains a list of Assurances that must be complied with in the conduct of a project funded with PFC revenue, in particular, Assurances 8(b) and 8(c). As documented in the FAA’s Passenger Facility Charge Audit Guide for Public Agencies: “Assurance 8(c) was intended to prevent the use of PFC funds to construct a terminal facility that would be leased exclusively or preferentially to an air carrier at a greatly reduced rate (due to Assur- ance 8(b)) from that paid for comparable facilities used by other carriers. The carrier using the PFC- built facility would be required by Assurance 8(c) to pay a rent equivalent to the one paid for a com- parable non-PFC facility, even if this rent leads to a higher payment than would otherwise be permitted by Assurance 8(b). Compliance can be achieved by increasing the rent of the PFC financed facilities to the rate for equivalent non-PFC financed facilities (rate equalization), reducing the rent of the non- PFC financed facilities (rent reduction), or a combination of both. With regard to Assurance 8(c), any rate differential between two terminal facilities at an airport should not be the result of the use of PFC funds at one terminal and not the other. Thus, in the case of a rent higher than permitted by Assur- ance 8(b), the public agency must demonstrate that the higher rent is needed to establish comparable rental rates for facilities in accordance with Assurance 8(c).28” 74 Airport/Airline Agreements—Practices and Characteristics 28Passenger Facility Charge Audit Guide For Public Agencies, Federal Aviation Administration, Passenger Facility Charge Branch, APP-530, Revised September 2000.

11.3 Weighted Rental Rates At its most basic level, airport operators simply charge an airline based on the average rental rate per square foot across all types of airline space. In other words, the airlines are charged the same rate per square foot, regardless of the type of space they occupy (i.e., ticket counter, baggage claim, holdrooms, bag makeup). Alternatively, airport operators use weighted terminal rental rates, whereby the average terminal rate at an airport is multiplied by a factor to calculate different rates for each type of airline space. Table 6 presents an example of how an airport’s terminal rental rates may be weighted by type of airline space. The more visible or premium airline space, such as ticket counters and hold rooms, are typi- cally given a higher weighting factor than other airline space that is less visible or more readily available such as baggage claim or bag makeup space. There are a number of reasons that the air- port operator or airlines may want to consider weighted terminal rates, for example: • From an airport operator standpoint, it may want to consider implementing weighted rates to prevent the airlines from leasing more space than they may need, particularly premium space such as ticket counters. • From an airline standpoint, it may prefer weighted terminal rates so it can consider taking more non-premium space for its operations or offices at lower rates. Alternatively, an airport operator may prefer not to employ weighted terminal rates in an effort to simplify its rates and charges calculations, accounting system, and invoicing requirements. Terminal Rental Rate Methodologies and Considerations 75 Airline Space Type Average Terminal Rental Rate Weighting Factor Weighted Terminal Rental Rate Type I - Ticket Counter $40.00 1.50 $60.00 Type II – Holdroom $40.00 1.25 $50.00 Type III - Baggage Claim $40.00 1.00 $40.00 Type IV - Bag Makeup $40.00 0.75 $30.00 Source: Ricondo & Associates, Inc., May 2009. Prepared by: Ricondo & Associates, Inc., May 2009. Table 6. Example of weighted terminal rental rates.

12.1 Background Joint use and common use facilities refer to facilities that are used by more than one airline for a similar purpose. Because more than one tenant uses these facilities the cost of the facilities should not be born by a single airline. Consequently, airport operators have had to develop a methodology to fairly distribute the cost of joint use facilities among the users. When airport operators began developing Agreements that focused on specific methods for developing rates, fees, and charges, the inbound baggage equipment and associated areas were the areas most often used by more than one airline. While gates may also be joint use facilities, the majority of airline gates were initially leased on an exclusive basis. Over time, airport opera- tors began making some gates available on both a preferential and a shared use basis and formu- las have also been developed for these facilities. Joint use facilities may be used by more than one airline simultaneously or, depending on activity schedules, may be used on an individual basis by an airline at certain times of the day. Joint use formulas were developed to recognize the significant capital investment required for baggage claim devices, belts, and motors as well as the size of the areas needed and to gain an air- line’s commitment to the market. A method of sharing the relatively high investment cost among the multiple users of the facility was necessary. Joint use formulas for gate areas may differ from formulas used for baggage claim areas for two main reasons: (1) only a subset of the airlines serv- ing the airport may use the joint use gates and (2) while the overall finish of airline gates is usu- ally completed at a higher level of finish than baggage claim areas, the level of capital investment for these facilities is usually less than the baggage claim areas. Usually, a formula is developed and the cost of a portion of the facility is prorated among the users on one particular basis while the remaining cost is prorated among the users on a different basis. In the case of baggage claim areas, the initial formulas were based on the phi- losophy that all users should make an equal commitment to the investment in the facility and the remaining portion of the cost would be shared on the basis of use of the facility and equip- ment. In recent years, airport operators have expressed concerns about the financial impacts of the equal commitment portion of joint use formulas, especially on the smaller market share carriers. This has contributed to the increased focus on the activity portion of the formula. Several different joint use formulas exist, but regardless of the formula used, airport oper- ators recover the full cost of the facility. Thus, airport operators may not have as strong an opinion on which formula is used as the airlines might, as long as the airport operator feels it is fair and equitable. 76 C H A P T E R 1 2 Joint Use Formulas

Impacts on both airport operators and airlines are discussed in the following sections; how- ever, the issue is somewhat philosophical in nature, and there is not necessarily a right or wrong approach. 12.2 Impact on and Importance to Airport Operators Airport operators will recover the full cost of the joint use facilities so the importance to an airport operator generally centers on the cost for new entrants that want to test the market. In addition to offering facilities at an affordable cost, airport operators also want the cost to be shared fairly, but at the same time recognize that the operating philosophies of network airlines and LCCs are different and the success of each airline’s operation at the airport is dependent on its operating margin. While usually not of significant importance, if all else is equal, airport operators may prefer a formula that incurs the least administrative burden for calculation and invoicing purposes. A complex formula can delay billing and receipt of revenue. 12.3 Impact on and Importance to Airlines Airline views on this topic vary greatly and it is unusual to obtain unanimity on a particular formula. Each formula has a different monetary effect on each airline depending on the circum- stances of the particular airport. Airlines with large enplanement shares may seek a formula with the greatest percentage of the total cost as possible split between all users on an equal basis to gain a financial advantage. At the other end of the spectrum, airlines with a limited market share may seek a formula that recognizes its limited use of the facility. If the airport is a hub airport for an airline, the hub airline will have a strong preference for a joint use formula for use of baggage claim facilities to require all airlines to contribute on an equal basis to as large a share of the total cost as possible because a hub airline’s connect- ing passengers do not use the baggage claim facilities, yet usually it is the airline’s total enplanement count that is included in the formula. In a few airports, the hub airline has been successful in excluding its connecting passengers from inclusion in baggage claim joint use formulas. 12.4 Various Alternatives for Treatment in Agreements Both the airport operator and the airlines will need to understand and evaluate the situation at a particular airport to decide what type of formula to support. The traditional and probably the most prevalent formula is known as an “80/20 formula.” There can be variations, but the fol- lowing list represents the most prevalent formulas used for baggage claim facilities: • 80/20 formula, wherein 80 percent of the total cost of the facilities is prorated among all the airlines based on their percentage of enplaned passengers, even though it is deplaning passen- gers that use these facilities. The number of enplaned passengers has been an easily obtainable statistic for airport operators to audit and it is accepted that in most cases an enplaning pas- senger does return and becomes a deplaning passenger. Thus, enplanements and deplane- ments are roughly equal. The remaining 20 percent of the cost of the facility is shared equally amongst the number of airlines using the facility. Joint Use Formulas 77

• 90/10 formula, wherein 90 percent of the total cost of the facilities is prorated among all the air- lines based on their percentage of enplaned passengers. The remaining 10 percent of the cost of the facility is shared equally amongst the number of airlines using the facility. • 100 percent enplanement, where the total cost of the facility is prorated amongst the airlines using the facility based on their percentage of enplaned passengers. • Either the 80/20 formula or 90/10 formula with a stipulation that airlines having an enplane- ment market share below a specified small percentage pay a fixed fee per passenger, deter- mined by the airport operator and credited against the total cost that is being split by the other airlines that are subject to the joint use formula. Typical joint use formulas for gate facilities include the following: • 80/20 formula, with 80 percent of the cost being charged based on a per passenger basis for the passengers using the gate(s) and 20 percent of the cost is shared equally among the airlines using the gate(s). • 50/50 formula, where 50 percent of the total cost is prorated based on the number of each air- line’s aircraft departures at the gate(s) and 50 percent is prorated on the number of enplaned passengers using the gate(s). • 100 percent enplanement, where the total cost of the gate(s) is prorated on the number of enplaned passengers using the gate(s). 12.5 Linkages to Other Agreement Provisions • Affiliates—whether an affiliate is treated as part of the signatory airline and, therefore, does or does not participate in any joint use formula as a user (i.e., is the airline, its enplanements, and its operations contained in the signatory airline’s count?) (see Chapter 13). • Facility control—what airport facilities are joint use facilities (see Chapter 9). • Terminal rate methodologies—how the joint use formula is integrated into the terminal rates and charges structure (see Chapter 11). 78 Airport/Airline Agreements—Practices and Characteristics

13.1 Background Historically, an airline was required to execute an Agreement to be considered a signatory air- line at that airport. Then, as “network” or “legacy” airlines began to develop relationships with other airlines in the form of code-sharing, some Agreements allowed for these code-sharing air- lines to receive the same rights and privileges as the airline executing the Agreement. However, not all Agreements permitted this expansion of rights and privileges. While some airport oper- ators accepted these relationships, others still required an airline to execute an Agreement to receive the rights and privileges of signatory status. In recent years, some Agreements have allowed for an expansion of this definition—generally termed as “affiliates” or “affiliated airlines.” For example, a network airline that maintains a rela- tionship with a regional airline may be willing to designate that airline as an affiliate for that airline to receive signatory rights and privileges. This can include wholly owned subsidiaries, a parent com- pany of an airline, and an airline that operates under the same trade name as the signatory airline and essentially uses the same livery as the signatory airline. After the introduction of LCCs to the industry, and especially after LCCs began to serve more markets and their respective market shares at those airports increased over the past decade, a greater awareness was created and there was concern by the LCCs that through the granting of signatory airline rights and privileges to an expanded group of airlines, the individual rights and privileges of an LCC could be diminished. This was exacerbated by the fact that LCCs historically did not have regional affiliate relationships with other airlines. In addition, LCCs took issue that while these affil- iates were granted signatory rights and privileges, they were not necessarily required to commit to leasing space in the terminal over the term of the Agreement. From the network airlines’ perspec- tive, however, operating through a relationship with another airline was a normal part of their busi- ness model, and was nothing more than using other aircraft types while not being required to actu- ally purchase or lease such aircraft. The impacts to both airport operators and airlines are discussed in the following sections; however, the issue of affiliates is more philosophical in nature, and there is not necessarily a right or wrong approach. 13.2 Impact on and Importance to Airport Operators Airport operators need to determine their objectives concerning airline commitment to the market (executing the Agreement and leasing space in the terminal during the Agreement term), the distribution of enplanement market share between network and LCCs, whether the airport is a hub for a network airline, and the lost revenue opportunity by granting affiliates signatory 79 C H A P T E R 1 3 Affiliates

rights and privileges. While an airport operator that has an airport residual Agreement with its signatory airlines would not experience any financial risk, there is still the distribution of the rev- enue requirement through the airline parties that should be fair and equitable. For example, an airport operator must recognize the cost and operating implications to the network airlines serving the airport if that airport is a hub for that network airline, representing a large percentage of the traffic at that airport. If primarily an O&D airport, the airport operator will need to consider the distribution of market share between network airlines and LCCs at that airport. While a residual Agreement would not produce any financial risk or exposure for the airport, a compensatory Agreement would, depending on how broadly affiliates are defined, but financial implications overall are generally considered marginal. An airport operator would also need to understand the accounting and administrative burden to its staff to monitor and man- age affiliates at the airport. However, the accounting and administrative burden potential can be minimized at an airport if the definition of affiliate has certain restrictions and limitations and identifies the signatory airline as the sole responsible party in dealings with the airport operator. 13.3 Impact on and Importance to Airlines The impact to airlines is not universal. There clearly is a differentiation between network air- lines and LCCs. Network airlines generally will prefer a fairly broad definition of affiliate at an airport, which serves to provide greater flexibility for the signatory airline and lower overall oper- ating costs for the combined entity. On the other hand, LCCs believe that their status is dimin- ished, as other airlines will be receiving signatory rights and privileges, yet they are not required to make the same commitment to the market during the term of the Agreement. How an airline (whether a network or LCC) responds to this issue will, in part, be determined by whether the airport is a hub for the network airline and the distribution of market share between those network airlines and the LCCs. 13.4 Various Alternatives for Treatment in Agreements Recognizing that both the airport operator and the airlines will need to understand and evaluate the circumstances at that particular airport and the impact of affiliates, there are various treatments of affiliates that can be contained in an Agreement. The list ranges from a rigid requirement that a signatory airline must execute the Agreement to receive the rights and privileges of signatory status, to a fairly broad interpretation that allows affiliates to receive those rights and privileges with no commitment to leasing space during the term of the Agreement. The following represents various alternatives to address in Agreements: • An airline must execute the Agreement for signatory status. • A wholly owned subsidiary or the parent company of the airline is granted signatory status. • A wholly owned subsidiary, a parent company, an airline operating under the same trade name or that essentially uses the same livery as the signatory airline are granted signatory status. • For Agreements with the broader definition of affiliates, provisions can also include “sig- natory airline must notify the airport operator which airlines will be that airline’s affiliates; and the signatory airline will be responsible for the payment of the affiliates’ rentals, fees, and charges.” • Some Agreements will further limit affiliate participation at an airport to just the same level of rentals, fees, and charges as the signatory airline, but affiliates would be excluded from any revenue sharing calculated for signatory airlines at that airport. 80 Airport/Airline Agreements—Practices and Characteristics

13.5 Linkages to Other Agreement Provisions • Capital project control and consultation—whether an affiliate has the right to participate in MII discussions (see Chapter 8). • Joint use formulas—how an affiliate’s passengers are treated for purposes of calculating the joint use requirement (see Chapter 12). • Signatory status—further delineation of signatory status at airports (see Chapter 10). • Airline rates, fees and charges—whether or not affiliates may be granted signatory airline rates and charges (see Section 2.3 and Chapter 11). Affiliates 81

14.1 Background By their nature, airports are capital intensive enterprises. Airport Council International–North America’s (ACI–NA) 2009 capital needs survey identifies approximately $94.3 billion in projects at domestic airports through 2013. Of this amount, 30% ($28.3 billion) is expected to be financed through GARBs.29 As the ACI-NA survey does not distinguish between PFC and CFC revenues used for debt service and direct payment for projects (pay-as-you-go), the actual amount of proj- ects financed through various forms of debt is likely higher, and may approach 50 percent of the total project costs. Given the importance of external financing to the development of the nation’s airport infrastruc- ture, airport operators seek to preserve their access to the bond market at the lowest possible bor- rowing costs by maintaining the highest possible bond ratings. The credit quality of airports is bolstered by the airports’ importance to the overall structure of the national economy, the limited competition between facilities in local markets, and the high barriers to entry into the airport indus- try. These factors provide the basis for the sector’s strong investment-grade ratings, which are further supported by the lack of a default by a major domestic commercial airport. Despite these inherent strengths, as the aviation industry has evolved over the 30-year period following the deregulation of the airline industry in 1978, the financial liquidity and level of debt service coverage generated by airports have become increasingly important measures of credit quality by the rating agencies and the investment community. Developments during this period that raised the profile of liquidity and coverage include (1) increased volatility in enplanement activity and the growing importance of passenger-related revenues such as PFCs, parking, and concessions to an airport’s overall financial structure; (2) the intense competitive position and weakened financial performance of the domestic airlines and resultant bankruptcies of numer- ous airlines; (3) the activity shocks experienced after September 11, 2001, and the outbreak of Severe Acute Respiratory Syndrome (SARS); and (4) the acceptance of greater levels of financial risk by airport operators through the use of compensatory/hybrid rate-setting methodologies and the shorter terms of Agreements. The increased focus on liquidity and coverage metrics is noticeable in the commentary put forth by the rating agencies in their published research. In its airport rating criteria Fitch states the following: “An important part of Fitch’s analysis focuses on unrestricted liquidity, defined as cash and marketable investments available to airport management for any legal and lawful purpose. Fitch views positively air- ports that generate and accumulate significant surplus revenues since a strong liquidity position gives an 82 C H A P T E R 1 4 Airport Financial Liquidity and Debt Service Coverage 29ACI–NA, “Airport Capital Development Costs 2009–2013,” February 2009.

airport greater security in the near term in the event that a tenant airline fails to meet its financial obliga- tions. Airports can also use these surplus funds to internally finance capital improvements and potentially lower the debt burden passed on to airlines or passengers . . .”30 Moody’s is more specific about the environment of 2009, a period of declining economic activ- ity, reduced demand for air service, and contraction in the operations of the domestic airlines. Moody’s states in its 2009 U.S. Airport Sector Outlook that “Airports that were able to develop robust operating margins and build substantial financial liquidity as the airlines expanded in recent years are well positioned with the financial flexibility to manage the current contraction in airline ser- vice.” Moody’s indicates that a level of enplanement volatility over time is anticipated in its ratings and that “The debt service coverage margins and liquidity expected at certain rating levels during normal growth periods allow for a moderate decline in airport activity and operating revenue with- out resulting in rating action.”31 14.2 Impact on and Importance to Airport Operators As a result of the importance of an airport to the economic well-being of its underlying ser- vice area, and the extensive capital planning requirements related to maintenance and improve- ments to the facility, airport operators take a long-term approach to the financial and physical operations of an airport enterprise. This approach takes into account the need for airport man- agement to maintain the financial flexibility to support strong credit ratings to maintain cost- efficient access to the capital resources available in the municipal bond market. The rate-setting mechanism employed at an airport plays a significant role in determining the internal liquidity and debt service coverage generated at an airport. Residual-based air- ports tend to have less unrestricted cash on their balance sheet and a coverage ratio nearer the rate covenant than a compensatory/hybrid-based airport. In the residual setting, the air- lines hold the financial resources on their balance sheet in return for assuming the financial risk of the airport. This generally results in lower airport costs passed along to the airlines during periods of economic expansion. However, in times of economic weakness, this mech- anism generally results in higher costs passed along to the airlines to compensate for reduced non-airline resources—a point in time at which airlines are particularly sensitive to rising air- port rates and charges. The compensatory/hybrid model generally allows airport operators to generate higher levels of internal liquidity and debt service coverage by incentivizing their management to maximize non-airline related revenues such as parking and concessions. While compensatory-based air- line rates may be marginally higher relative to residual rates during periods of economic expan- sion, the presence of financial reserves should allow an airport operator to absorb the effects of a moderate economic downturn without turning to the airlines for significant increases in their rates and charges. Moody’s fiscal year 2007 U.S. Airport Medians demonstrate the difference in liquidity and coverage levels between the two rate-setting methodologies in terms of liquidity and debt service coverage. Moody’s found the median level for unrestricted cash at residual-based airports equaled 354 days of expenditures in fiscal year 2007, compared with a median of 394 days at compensatory/hybrid-based airports. Median debt service coverage provided by net revenues, as measured on a bond ordinance-defined basis equaled 1.61 times annual debt service for resid- ual airports, compared with 2.19 times for compensatory/hybrid facilities. Airport Financial Liquidity and Debt Service Coverage 83 30Fitch Ratings handbook. 31Moody’s 2009 rating outlook.

While compensatory/hybrid-based airport operators have assumed a greater financial risk, with the ability to hold significant financial resources to mute the effects of underlying economic volatility, many such airport operators maintain an extraordinary coverage provision in their Agreements to protect against an unexpected decline in their financial position. These provisions allow an airport operator to recover resources from the airlines sufficient to meet the rate covenant contained in their bond ordinance/indenture through a special adjustment to their rates and charges, providing bondholders assurance of debt service payments in periods of sig- nificant financial distress. However, as in the residual model, an airport operator is likely to invoke this clause at a time of economic distress when airlines are also under financial pressure and sensitive to increases in their rates and charges. With the increased number of airline bankruptcies, airports have also become more insistent that airlines post performance deposits to protect themselves against a sudden change in a partic- ular airline’s financial position. These deposits typically range from 2 to 6 months of estimated rates and charges due. The deposits may take the form of a cash escrow, surety bond, or letter of credit. Airports should be aware that in certain instances a cash escrow may be considered the possession of an airline in a bankruptcy and therefore inaccessible to the airport in such a circumstance. There- fore, a surety bond or a letter of credit may be preferred for this purpose. Airports have also become diligent in collecting receivables in a timely fashion to both ensure their liquidity position and pro- tect against a large pre-petition debt in case of an airline bankruptcy filing. 14.3 Impact on and Importance to Airlines As the prime users of these capital intensive facilities, airlines benefit from the strong credit posi- tion of airports in the long term through their lower cost of capital, which translates into lower rates and charges. However, airlines have become focused on their short-term financial operations as a result of the extreme economic cyclicality and resultant financial distress the airline industry has experienced in the last 20 years. This short-term focus places tension on the airport-airline relationship, as airlines seek to maintain as much liquidity as possible on their balance sheets to manage through cyclical swings and limit future commitments to airport CIPs to control long-term costs. Airlines tend to view the high liquidity levels of airports as a cost because significant reserves can be an inefficient use of resources compared with the higher returns generated through other applications. Particularly in times of economic stress, airlines may seek to have the airport oper- ator reduce its reserves to lower rates and charges, thus reducing the short-term operating costs of the airlines. Airlines also tend to view deposit requirements as placing costs on their operations, either through the reservation of an airline’s cash resources or the expense of maintaining a surety bond or letter of credit. From the airlines’ view, shortened aging of payables may be viewed as another restriction on their cash resources because this limits their ability to “play the float” and gener- ate investment earnings. 14.4 Various Alternatives for Treatment in Agreements In general, the amount of net revenue an airport operator must legally generate in a given fiscal year to support its general airport revenue bonds is pursuant to a rate covenant established pursuant to its bond indenture. Agreements are generally subordinate to bond indentures. While the airport operator and the signatory airlines may negotiate a certain rate-making approach, it must at a minimum meet the rate covenant obligations set forth in the bond indenture. 84 Airport/Airline Agreements—Practices and Characteristics

Additional financial liquidity is extremely dependent on factors such as the underlying airport market, its planned uses for such liquidity, and the type of rate-making methodology. Airport operators with a residual-type rate-making approach generally have less flexibility in creating additional liquidity and tend to have less unrestricted cash on their balance sheet and a coverage ratio nearer the rate covenant compared with a compensatory/hybrid-based airport. Airport operators that employ a compensatory/hybrid model may have the inherent ability to generate higher levels of internal liquidity and debt service coverage due to higher levels of non-airline related revenues such as parking and concessions. The inclusion of certain other “non-cash” items in airline rates and charges such as debt service coverage or amortization can also impact an airport operator’s ability to meet its rate covenant or generate internal liquidity. An airport operator must at a minimum meet its rate covenant obligations and including these items in rates and charges may be necessary. How- ever, the inclusion of these items in airline rates and charges is a function of need and nego- tiations between the two parties. 14.5 Linkages to Other Agreement Provisions • Airline rates, fees, and charges—types of methodologies (see Section 2.3 and Chapter 11). Airport Financial Liquidity and Debt Service Coverage 85