HomeMy Public PortalAbout1996.03 FAA Innovative Financing Options for Airport Improvement ProgramFEDERAL AVIATION ADMINISTRATION
AN ASSESSMENT OF INNOVATIVE FINANCING
OPTIONS FOR THE AIRPORT IMPROVEMENT
PROGRAM
A Report Prepared Under the Requirements of Section 520 of the Federal Aviation
Administration Authorization Act of 1994.
March, 1996
TABLE OF CONTENTS
EXECUTIVE SUMMARY 1
Summary Table 1 - Impact of Innovative Financing Options vii
Summary Table 2 - Ranking of Innovative Financing Options viii
I. SCOPE AND METHODOLOGY -1
PLAN OF THE REPORT 1-1
SCOPE AND METHODOLOGY 1-1
II. AIRPORT FINANCE UNDER CURRENT FEDERAL POLICY 2-1
THE FEDERAL ROLE IN AIRPORT FINANCE 2-1
THE ROLE OF DEBT CAPITAL IN AIRPORT FINANCE 2-2
Airport Financial Management 2-2
Airport Financial Performance, Creditworthiness, and Competitiveness
in the Capital Markets 2-3
Regular Participation. 2-6
Table 2.1 - AII' Allocations by Program Category for Fiscal Years 1985
to 1993 and Type of Project 2-7
Table 2.2 - Contribution of Federal Grants and Debt Finance to Airport
Investment Funds 2-8
Figure 2.1 - Volume of Airport Municipal Bond Debt 2-9
Table 2.3 - Average Annual Interest Rates Paid on Airport Bond Issues and
Difference Relative to Other Municipal Issues 2-1 Q
Table 2.4 - Annual Municipal Bond Debt in Selected Years and Total
1985-1994 and By Airport Size 2-11
III. INNOVATIVE FEDERAL FINANCING: OPTIONS AND IMPACTS 3-1
OPTIONS 3-1
Option 1: Use All' Grants to Fund Debt Repayment Reserves of Airport
Revenue Bond Issues 3-2
Option 2: Federal Guarantee of Airport Loans 3-2
Option 3: AIP Eligibility of Commercial Bond Insurance 3-3
Option 4: An Airport Loan Fund 3-3
IMPACT OF INNOVATIVE FINANCING OPTIONS ON THE COST OF
CAPITAL 3-3
The Forecasting Framework 3-3
Quantitative Assumptions 3-4
Consensus Model. and Assumptions for Each Option 3-5
Projected Impacts and Risk Analysis 3-5
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IMPACT OF INNOVATIVE FINANCING OPTIONS ON AIRPORT BORROWING
FOR CAPITAL INVESTMENT 3-7
FACT OF INNOVATIVE FINANCING OPTIONS ON NET AIRPORT
DEVELOPMENT 3-8
Benchrharking Analysis 1-9
Figure 3.1 - Framework for Simulating Impact of Innovative Financing
Options on Credit Ratings 3-11
Figure 3.2 - Framework for Simulating Impact of Innovative Financing
Options on Cost of Capital 3-14
Table 3.1 - Estimated Impact of Market Factors on Airport Credit Ratings 3-16
Table 3.2 - Estimated Impact of Market Factors on Airport Cost of
Debt Capital 3-17
Table 3.3 - Impact of Innovative Financing Options 3-18
Figure 3.3 - Framework for Simulating Impact of Cost of Capital on
Airport Borrowing 3-19
IV. INNOVATIVE FINANCING FOR AIRPORTS IN THE CONTEXT OF
FEDERAL FISCAL RESTRAINT 4-1
Table 4.1 - Ranking of Innovative Financing Options 4-2
V. CONCLUSIONS 5-1
APPENDIX A: DEFINITIONS AND NOTES A-1
APPENDIX B: WHAT INVESTMENT -GRADE BOND RATINGS MEAN B-1
APPENDIX C: ATTENDEES FOR RISK ANALYSIS SESSION C-1
APPENDIX D: RISK ANALYSIS OF ALTERNATIVE INNOVATIVE FINANCING
MECHANISMS D-1
APPENDIX E: ECONOMETRIC ANALYSIS OF CREDIT RATINGS E-1
APPENDIX F: ECONOMETRIC ANALYSIS OF COST OF CAPITAL F-1
APPENDIX G: ECONOMETRIC ANALYSIS OF CAPITAL BORROWING IN
RESPONSE TO COST OF CAPITAL G-1
APPENDIX H: ECONOMETRIC ANALYSIS OF AIRPORT CAPITAL SPENDING IN
RESPONSE TO AVIATION DEMAND H-1
ffi
APPENDIX I: REVIEW AND SENSITIVITY ANALYSIS REGARDING TECHNICAL.
ISSUES I -I
APPENDIX J: HOW TO AUDIT CALCULATIONS PREPARED FOR SUMMARY
TABLE 1 J-1
EXECUTIVE SUMMARY
Section 520 of the Federal Aviation Administration (FAA) Authorization Act of 1994 (Public
Law 103-305) directs the Secretary of Transportation to conduct a study of innovative
approaches for using Federal funds to finance airport development as a means of supplementing
financing available under the Airport Improvement Program (AIP). The Secretary is mandated
to consider (at a minimum):
• Mechanisms that will produce greater investment in airport development per
dollar of Federal expenditure;
Approaches that would permit entering into agreements with non -Federal entities,
such as airport sponsors, for the loan of Federal funds, guarantee of loan
repayment, or purchase of insurance or other forms of enhancement for borrower
debt, including the use of unobligated AIP contract authority and unobligated
balances in the Airport and Airways Trust Fund;
• Means to lower the cost of financing airport development.
Accordingly, this study examines the following matters of Congressional interest:
1. Several feasible options for innovative Federal approaches to airport finance;
2. The change in airports' cost of borrowing funds for capital investment projects
("the cost of capital") as a result of innovative financing mechanisms (potentially
reducing costs to airport users);
3. The extent to which reductions in the cost of capital would increase or accelerate
airport borrowing for the purpose of capital investment;
4. The extent to which increased or accelerated airport borrowing would precipitate
the addition of more infrastructure to the airport system versus a substitution for
other forms of available airport finance (such as state and local grants); and
5. The possibility that options for innovative finance could help diminish airline
near term financial constraints that inhibit timely construction of needed airport
improvements.
OPTIONS
The options listed below were developed to respond to Congressional direction for this study.
Reviewed in consultation with over 150 financial services and airport industry stakeholders, this
study identifies and assesses four feasible Federal options for innovative airport finance:
itF
Option 1: Use AIP grants to fund debt repayment reserves of airport revenue bond
issues.
Option 2: Authorize Federal guarantee of airport loans, analysis assuming retention of
tax exempt status.
Option 3: AIP eligibility for commercial bond insurance.
Option 4: Institute an airport loan fund.
These options seek to reduce the cost of borrowing and increase the leverage airports can
exercise over their Federal financial assistance. The desired result is greater net investment at
congested and under -developed airports for each dollar of Federal expenditure. However, these
techniques need to be consistent with government financial policies, including policies which
take into consideration potential risks to the Federal government and the efficient and effective
use of Federal financial assistance. For example, Federal loan guarantees and direct loans are
appropriate only when it is necessary to alleviate a credit market inefficiency, or when it is
necessary to achieve specified Federal objectives by providing a credit subsidy and a credit
subsidy is an efficient way to meet those objectives on a borrower -by -borrower basis.
AIRPORT FINANCE UNDER CURRENT POLICY
Airport finance today is marked by a prominent Federal role and an even more significant role of
debt finance. The Federal role is exerted in two ways, (1) AIP formula and discretionary grants
funded by user taxes on airline tickets, aircraft fuel, freight waybills and international departures,
and (2) an exemption from Federal tax on interest income for holders of airport bonds (a "tax
expenditure" funded by the general taxpayer). In addition, the Passenger Facility Charge
program (PFC), administered by the FAA, generates local funds to finance airport
improvements.
Between 1985 and 1995, the AIP financed 14 percent of all capital spending at large commercial
airports, 28 percent at medium-sized commercial airports and 41 percent at small airports (small
commercial airports as well as reliever and general aviation facilities).
The Federal tax exemption shaves almost two full percentage points off interest costs for airport
borrowers of all sizes, an estimated saving of clearly $1 billion per year for airports over the
period 1985 to 1993. Although airports are locally owned and operated, Federal grant and tax
exemption policies assist significantly in airport capital development.
The PFC program, now generating $1 billion annually, provides a extremely powerful tool for
financing critically needed airport development, particularly at the nation's largest airports.
Fully one half of the total revenue generating potential of the PFC program is concentrated at the
top ten enplaning airports in the country (seven of the top ten airports are currently collecting
PFCs). This has the effect of concentrating PFC revenue at airports with the greatest capacity
development and noise mitigation needs. Although credit rating agency concerns about FAA
authority to terminate (for cause) an airport's PFC collection have limited, to some degree, PFC
revenue leveraging potential, FAA has worked to alleviate investor concerns that FAA might act
precipitously in such cases. For airports using PFC revenue as sole security for airport revenue
bonds, the FAA offers a detailed agreement to notify all parties involved with the bond issue
about possible PFC violations (excluding those pertaining to airport access restrictions). In
addition, the agreement provides for multiple opportunities to remedy violations and remove all
threat of termination. The FAA's efforts have helped to persuade banks and insurers to provide
credit enhancement for PFC secured bonds, and have moved two credit rating agencies to begin
considering PFC secured debt for possible investment grade rating. The FAA is committed to
work with the airport finance community to further increase the leverage potential for PFC
revenue.
Clearly, powerful policy instruments through which the Federal government can exert significant
influence over airports' access to debt capital and borrowing costs are in place. The AIP reduces
the amounts that airports need to borrow for capital development while the Federal tax
exemption reduces airport interest costs on borrowed funds. The PFC program provides
additional revenue for airport development As a result of these policies and programs, and
together with the mature nature of airport financial management practices, the nation's
commercial airports today do not face systemic or widespread obstacles to finding willing
investors, financing debt -service reserve funds, obtaining bond insurance and other debt
guarantees, and generally exercising leveraging strategies that foster airport development.
Although the potent Federal role and mature airport investment market create a healthy
environment for airport investment, that environment is not entirely fluid with respect to
changing investment opportunities and economic needs. At large and medium-sized airports,
where major airlines exert significant influence over the scope and timing of investment, near -
term financial realities facing airline management can create divergent airport -airline
perspectives on the appropriate timing and scope of capital improvements due to their immediate
implications for landing fees and other airline costs. Although this study uncovered no evidence
of systemic development constraints at large and medium-sized airports, local situations are
known to arise in which economically worthwhile investment initiatives (such as congestion and
noise -reducing projects) are delayed or scaled back for financial considerations.
At small airports there is evidence of financial barriers to the desired level of development of
terminal and land -side facilities. This can occur when such facilities are incapable of generating
sufficient net revenues to cover debt -service (for revenue bonds, for example). It can also occur
when, without sacrificing higher priorities, states and localities are unable to; provide allocations
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from the limited pool of funds they are able to generate through the sale of securities backed by
the local tax base (general obligation bonds).
IMPACT OF INNOVATIVE FINANCE ON AIRPORT BORROWING COSTS AND
NET NEW INVESTMENT
Given the investment climate outlined above and the effectiveness of current Federal policies
and program levels, the prospective impact of innovative financing mechanisms on airport
development needs to be viewed from three perspectives:
• General System -Wide Development. Analysis indicates low -to -modest potential
gains for airport development;
Specific, Targeted Development.. Analysis indicates a potentially pivotal role for
innovative financing mechanisms; and
Development Under a Fiscally Constrained Federal Program. Analysis indicates
both a significant system -wide impact and targeted role.
System -Wide Impacts of Innovative Financing
Summary Table 1 indicates that the option found most effective analytically for large airports
(Federal guarantee of airport debt, analysis assuming retention of tax-exempt status) would
reduce interest expenses by an estimated 1.93 percent, or $124,300 on the average -sized bond
issue ($113 million for large airports in 1995). If airports were to leverage such a sum by using
the interest cost saving to fund added debt service, an extra $2.14 million would actually be
available for construction and related purposes. Although this amount represents a small
percentage of the total cost of a new runway (about $100 million), taxiway (about $60 million)
or terminal modernization (about $50 million), it is meaningful in relation to the cost of collateral
opportunities to enhance the effectiveness and local acceptability of such investments such as
advanced runway lighting systems and noise mitigation. Alternatively, an airport could lower its
annual rates and charges by $124,300. However, the Administration opposes providing tax-
exempt status to any securities which also receive Federal guarantees.
From a small airport perspective, projected impacts are proportionately more sign want. The
provision of Federal guarantee of airport debt, analysis assuming retention of tax-exempt status
(Summary Table 1, Option 2) for example would shave an estimated 5.85 percent off the debt
service bill for a small airport participating in the bond market. For an airport disseminating the
average -sized bond ($16 million for small airports in 1995) at interest rates prevailing in early
1995, this saving could be leveraged into an additional $994,000. For a small commercial
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airport such a sum is large enough to influence the scope of a project (the size of a terminal
building expansion, for example). Alternatively, an airport could use savings to lower its annual
rates and charges. However, the Administration opposes providing tax-exempt status to any
securities which also receive Federal guarantees.
To what extent would savings in borrowing costs precipitated by innovative financing
mechanisms lead airports to invest more heavily in airport facilities? In light of the moderate
reductions in interest costs likely to follow from such mechanisms, and given that large and
medium-sized airports do not face systemic financial obstacles to capital investment today, lower
debt -financing costs are projected to yield moderately higher levels of system -wide airport.
Such increases are in the range of three percent under the most promising innovative financing
options, as shown in Summary Table 1.
The role of innovative finance in promoting system -wide development at small airports is more
difficult to gauge. Many of the nation's 3,500 small airports use the private capital market to
finance investment. Yet some small airports are found to face constraints to their participation in
the capital markets, particularly for terminal and other groundside developments. However, the
constraint often stems from low passenger and aircraft volumes and weak operating revenues.
Statistical analysis of capital borrowing by small airports in response to reductions in the cost of
capital indicates virtually no measurable system -wide response. Thus the extent of interest cost
reductions projected in Summary Table 1 do not appear sufficient to precipitate significant
inroads on system -wide capital development.
On the other hand, targeting innovative financing mechanisms to particular airports could have
significant implications for local airport economic development.
Impacts of Targeted Innovative Financing
The modest system -wide impacts projected above mask potentially larger impacts in local
situations where factors such as airline financial restraint or local government bonding
restrictions delay worthwhile projects or diminish their scope. While there is always a risk that
interest rate subsidy can induce excessive capital spending - i.e., projects that would not pass a
rigorous market test of merit - it is known that airline financial conditions and influence can and
do diminish the scope of worthwhile investments at large and medium-sized airports or put them
on hold, sometimes for years. Airline influence over timing and scope of airport investment is
one of the reasons Congress authorized the Passenger Facility Charge program. Although the
dollar -volume of worthwhile airport investment that is foregone or delayed due to such conflicts
is unknown, innovative financing mechanisms that were carefully targeted on such cases could
help alleviate investment bottlenecks.
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hnpacts of Innovative Financing Under Federal Fiscal Restraint
A great many Federal programs are coming under inevitable pressure as the Administration and
the Congress forge plans to eliminate the Federal deficit. While large and medium-sized airports
draw less than 14 percent of their investment capital from the formula component of the AIP
program, discretionary grants frequently account for 25 percent or more of a project's total
capital cost. Small airports moreover draw more than 40 percent of their investment capital from
Federal grants.
Innovative financing mechanisms could help airports keep pace with aviation requirements in
the face of a fiscally restrained MP. For example, compared to grants, airport loan guarantees
create a smaller Federal budget liability, because only the actuarial risk of loan loss is "scored"
as a budget "outlay". At the same time, by insulating airlines from some of the burden created
by diminished grants, such innovative Federal financing mechanisms could help airports keep up
with their capital requirements.
Which mechanisms are likely to promote the aims of innovative financing mechanisms most
cost- effectively? Summary Table 2 provides a comparison among the four mechanisms
examined in this study. Taking together considerations of effectiveness, complexity and
administrative cost, the use of AIP funds to pay for commercial bond insurance offers the most
promise. This approach would assist airports that cannot afford or qualify for bond insurance by
permitting such airports to purchase commercial bond insurance with AIP funds. This option
would have to be implemented to ensure that the holders of such bonds would have no recourse
to the Federal Government in the event of default by the issuer of the bond and insolvency of the
bond insurer.
Loan guarantees would also rank high among the options studied if there was no change in tax-
exempt status. These mechanisms score especially highly in relation to small airports, doubtless
the most vulnerable airport sector from the perspective of capital shortfalls. However, the
Administration opposes providing tax-exempt status to any securities which also receive Federal
guarantees.
CONCLUSION
While other specific innovative financing alternatives could usefully be examined, the
appropriate packaging and design of any innovative financing program would depend upon the
budgetary status of the AIP program.
Under current AIP program levels, innovative financing mechanisms would need to be carefully
targeted in order to avoid the substitution of Federal dollars for capital dollars available from
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non -Federal sources. Targeting might give special weight to small airports, which face growing
state and local fiscal restraint in addition to limited access in the capital markets; yet some large
and medium-sized airports also face constraints, albeit those imposed by the financial condition
of major airlines.
On the other hand, if future funding levels for the ATP program were significantly reduced, a
more generally available innovative financing program would be suitable and perhaps necessary
to help sustain, required airport development.
Today's Federal budget realities dictate the consideration of a wide range of options for change,
including FAA reorganization. and financing reform. In this context of rapidly developing ideas
for Federal deficit reduction, the Administration is proposing, as part of its ATP reauthorization
bill, a two part follow up to this study. First, the Administration proposes the formation of a
select panel, drawn from the aviation, financial, and local government communities with an
interest in airport development. The panel will be charged with assessing the widest possible
range of mechanisms to finance airport development, including modifications to the Passenger
Facility Charge program, public/private partnerships, and the creation of new financial
institutions and techniques. The Administration's second proposal provides statutory authority
for the FAA Administrator to test and evaluate the effects on airport development of innovative
financing proposals involving ATP funds. Proposals thus tested which are found to provide
greater leveraging for Federal dollars and have a positive effect on investment in airport
infrastructure would provide a basis for future legislative proposals to further broaden airport
development financing options.
Summary Table 1: Impact of Innovative Financing Options
Option
Impact on cost of capital,
In Percent
Impact on Airport Capital
Borrowing
In Percent
Large
Airports
Mid -sized
Airports
Small
Airports
Large
Airports
Mid -sized
Airports
Small
Airports
1. AIP Funded Debt Service Reserve
2. Federal Guarantee for Airport Loans
*
3. AIP Funded Bond Insurance
4. Establish Airport Loan Fund
-0.26
-1.93
-1.54
-0.96
-0.09
-1.78
-1.60
-0.78
-0.34
-5.85
-5.51
-0.97
0.41
3.05
2.42
1.52
0.14
2.91
2.62
1.28
< 1.00
< 1.00
< 1.00
< 1.00
* Statisical results assume that airport debt receives a Federal guarantee and retains its tax-exempt status. However, it is a long-
standing
Federal policy, as well as law, to prohibit any security that receives a Federal guarantee from also retaining tax-exempt status.
it
SummaTable 2: Rankinof Innovative Financing Options
ry g
Impact on Capital Investment
(Ranking; "1" denotes highest)
Complexity in
Implementation
Administrative Cost
Large Medium Small
Airports Airports Airports
AIP Funded Debt Service
Reserve
Federal Guarantee for
Airport Loans
AIP Funded Bond
Insurance
Establish Airport Loan
Fund (Conservative Fund
Management)
4 4 4
1 1 1
2 2 2
3 3 3
- --
Negligible
Highly Complex Due
to Current Tax Code
Negligible
Complex
Negligible
Relatively Low
Negligible
Significant Start Up,
Moderate On -going
Costs
.�-
II. AIRPORT FINANCE UNDER CURRENT FEDERAL POLICY
Although airport capital investment today is funded by a combination of airport cash
reserves, debt capital raised in the municipal bond, commercial loans, and grants from
state and Federal governments, it is the sale of tax-exempt bonds and the provision of
Federal grants through the ALP program that finance the lion's share of major capital
projects.
THE FEDERAL ROLE IN AIRPORT FINANCE
Financed since 1970 by user taxes on domestic airline tickets, aircraft fuel, freight
waybills, and international departures, the Federal government funded $11.2 billion in
formula and discretionary grants over the period 1985 to 1993 (Table 2.1). Distributed
through the A1P, just over 65 percent of the funds were allocated to primary commercial
airports while 13.1 percent ($1.46 billion) were used in capital projects at reliever
airports. As shown in Table 2.1, more than half the AIP spending over the period 1985
to 1993 was used for "airside" development, including runway, taxiway and apron
infrastructure; 19 percent went to noise -related projects; and the remainder helped pay for
safety, security, terminals and other buildings, roadways and planning activities.
The volume of AIP spending has placed the Federal government second only to the
municipal bond market in financing airport capital development, although the Federal
role has declined significantly since 1980. Over the period 1985 to 1993 the Federal
percentage of total airport development funding for primary commercial airports was 24
percent (Table 2.2), down from 35 percent over the period 1978 to 1982.1
The Federal role in airport finance varies markedly among different sized airports, with
small airports using the program most intensively. As shown in Table 2.2, Federal funds
account` for 14.2% of spending by large commercial airports, 28% of spending by
medium-sized commercial airports, and 41% of spending by small airports.
In 1990 Congress relaxed its previous prohibition on the use of passenger facility charges
(PFC). Congress specified conditions under which airports could use PFC for capital
development and authorized the FAA to approve an airport's application to levy the
charge. Under these conditions, PFC revenues may be used for airport planning, airside
development, terminal development (including gates and related areas), noise
compatibility planning and implementation, and airport access. The PFC program
currently generates $1 billion annually for airport development. The FAA has worked
1 Congressional Budget Office, Financing U.S. Airports in the 1980s April 1984
2 See appendix A for FAA airport size definitions.
iv
closely with the airport finance community to increase PFC revenue leveraging potential.
In response to these. efforts, banks and insurers have been persuaded to provide credit
enhancement for PFC secured bonds, and two credit rating agencies have been moved to
consider PFC secured debt for investment grade rating. The FAA is committed to work
with the airport finance community to further increase the leverage potential for PFC
revenues.
Large and medium-sized hub airports that levy a PFC are required to concede MP
entitlement funds by an amount equal to one-half their PFC revenues (to a maximum of
50 percent of their A1P entitlement). One quarter of these funds are transferred to the
AM discretionary fund, half of which is used for grants to small hub airports and half for
a newly created Small Airports Fund. Between 1990 and 1994, 144 airports were
approved to levy a PFC, generating approximately $1 billion annually for airport
development. Entitlement funds returned by large and medium-sized airports through the
AIP program funded $7.0 million in grants to small hub airports, $28 0 million in grants
to non -hub airports and $13 9 million in grants to noncommercial service airports.
THE ROLE OF DEBT CAPITAL IN AIRPORT FINANCE
Evident in the above is the fact that airports of all sizes and functions raise investment
funds by borrowing money. Most borrowing takes place in the municipal bond market
but commercial loans are not uncommon for relatively small projects. Airports today are
regarded as premium -grade investments whose securities are held by mutual funds,
households, and other risk -conscious investors. Borrowing on this scale indicates that
airport sponsors are sophisticated enterprises that perform well under three tests of access
to capital markets:
Management framework of fmancial systems and controls that
accords with generally accepted principles of fmancial management.
Lenders insist on sound financial management systems and controls;
Strong fmancial performance, creditworthiness and competitiveness
for debt capital. Lenders demand that past and expected revenues, costs
and key financial ratios demonstrate the airport's ability to repay debt with
acceptably small risk of delay or default;
Regular participation in the market. Lenders gain confidence when
borrowers display regular and reliable participation in the capital markets.
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Airport Financial Management
;although airports in the United States are publicly owned and managed, they operate in
conjunction with private industry, namely the commercial airlines, which are the airports'
link to their customers. This unique public/private character distinguishes the financial
operation of commercial airports from that of wholly public utilities or wholly private
enterprises, and shapes airports' management practices, the pricing of airport facilities
and services, and approaches to airport investment planning.
At most commercial airports, the financial and operational relationship between an
airport and the airlines it serves is defined in legally binding agreements (called "use
agreements") that specify the management framework of systems and controls within
which the risks and responsibilities of airport operation are to be shared between the two
parties. Many approaches to airport financial management have evolved over the years,
but all are explicit hybrids of two basic methodologies, residual and compensatory.
Under the residual approach airlines collectively assume financial risk by agreeing to pay
any costs of running the airport that are not allocated to other users or covered by non -
airline sources of revenue (such as parking fees, concessions, Federal grants). Under the
compensatory approach, the airport operator assumes the financial risk of running the
airport and charges the airlines fees and rental rates set so as to recover the actual costs of
the facilities and services that they use. Hybrid approaches typically divide the airport
into cost centers and operate some on a residual basis and others according to
compensatory principles.
Many years of experience with these approaches to airport financial management has
convinced the bond market that airports operating under one or the other (or a hybrid)
have systems in place that are effective in managing and controlling airport revenues and
costs effectively and with due regard for the needs of lenders.
Airport Financial Performance, Creditworthiness, and Competitiveness in Capital
Markets
Like any enterprise, an airport's ability to borrow money hinges foremost on its financial
strength. In rating the creditworthiness of a major bond issue, rating agencies look
closely at financial ratios which measure the airport's availability of revenues beyond
those needed to pay regular operating expenses ("operating ratios") and ratios designed to
measure the airport's ability existing and new borrowing for capital investment ("debt
ratios")
Commercial airports tend to perform as well or better than borrowers in the municipal
bond market generally. Commercial airports typically use a smaller share of revenue to
cover operating costs than either electric utilities or water supply and wastewater
treatment authorities. They have been found to operate with smaller operating margins
than highway toll facilities, however.' Commercial airports have also been found to
carry a high level of debt relative to their total assets compared with power and water
utilities. However, despite their relatively high debt ratios, airports consistently appear
able to service more new debt than such utilities because of their lower operating and
maintenance costs. Airports also hold substantially greater reserves against unforeseen
shortfalls in revenue.
The competitiveness of airports in the capital markets can be gauged by four
conventional indicators of investment quality:
Bond Ratings -- a system used by major investor services to grade bonds
according to investment quality (see Appendix B);
Interest Costs -- the interest paid by airports to attract investors relative to
what other municipal enterprises pay;
Insurability -- the affordability of purchasing bond insurance in order to
improve credit ratings and reduce interest costs;
• Defaults -- the frequency with which airports have defaulted on a bond
issue.
Bond Ratings. For the 955 airport bonds issued between 1985 and mid-1995, all but one
has received an "investment grade" from the two major U.S. investment rating services,
Moody's Investors Service and Standard & Poor's Corporation. The bond issues include
"revenue bonds," those backed by airport revenues from fees and charges, and general_
obligation bonds, those backed by the full faith and credit of the municipal tax base.
While investors today clearly have considerable confidence in airport bonds, ratings do
vary between the top and medium grades (see Figure 2.1), with larger, medium-sized and
small airports performing about the same. A medium grade means that rating firms see
the investment as carrying a measure of speculative risk. Anything below medium grade
denotes a significant degree of speculative risk.
General obligation bonds, which are rated according to the economic vigor of an entire
state or municipality, draw the best ratings. Revenue bonds, on the other hand, draw
ratings according to the fiscal condition of the airport itself. Since more than 90 percent
of all airport bonds (in terms of dollar volume) are secured with airport revenues, the
criteria investor services use to rate such bonds are central to such bonds' marketability.
3 Based on the analysis of credit reports published by Moody's Investor Service.
vii
These criteria include a range of factors, including the financial performance of the
airport, the vitality of local economic conditions, the strength and nature4 of passenger
demand, and the nature of the airport's relationship with its tenant airlines..
Credit analysts also examine rate covenants and bond resolutions when rating airport
revenue bonds. The rate covenant is the airport's promise to establish rates, fees and
charges so as to provide net revenues (gross revenues minus operating and maintenance
costs) commonly equal to 1.25 to 1.40 times annual debt service. The bond resolution
establishes a number of special funds and accounts to facilitate the management of bond
proceeds and revenue. Together, the rate covenant and the bond resolution create a
cushion for bond holders against the risk of temporary shortfalls in an airport's ability to
service its debt.
Interest Costs. The difference between interest costs paid by airports and by other
public enterprises since 1985 indicates that airports generally hold a strongly competitive
position in the municipal bond market.5
Like municipal bonds in general, airport bonds are traded at prices that reflect both
general economic conditions and the credit quality of the airport enterprise (or state or
municipality in the case of general obligation bonds). An indication of competitiveness
is provided in Table 2.3 which indicates that interest costs for large commercial airports
have traded at as much as 74 "basis points" below the interest cost index for all municipal
bonds (a basis point is one one -hundredth of a percentage point). Bonds issued by
medium-sized airports trade at somewhat "above market," possibly an indication of the
nigh degree of investment in this category to accommodate the growth in airline hubbing
activity over the 1985 to 1995 period. Bond rating agencies and bond underwriters tend
to view hubbing-related capital investment as being relatively more risky due to the
transient rather than home -based nature of the underlying traffic. Simply stated, a
connecting carrier can choose to shift its hubbing operations to another airport. If so, the
traffic and associated airport revenues are lost as a basis for servicing the airport's debt.
The same is obviously not the case for home -based traffic.
Small airports consistently draw interest costs below the average for municipal bonds in
general (as seen in Table 2.3) and below the interest costs incurred by larger airports.
One reason for this is the tendency among smaller airports to depend relatively more on
general obligation bonds, bonds that routinely fetch stronger ratings and lower interest
costs than revenue bonds (see earlier). A second reason turns on the smaller and more
home -based nature of these bonds. Smaller issues are naturally less risky and the average
4 Rating agencies prefer origin -destination demand over connecting demand since
the latter is susceptible to airline management decisions regarding hub location.
5 The Congressional Budget Office drew the same conclusion from data for the
period 1978 to 1982. See U.S. Congressional Budget Office, April 1984.
viii
sized bond issue among small airports over the 1985 to 1995 period was less than one -
quarter the average sized large airport bond issue. As well, small airports are rarely
investing for the purpose of catering to significant volumes of connecting traffic and this
too reduces their relative degree of risk.
Insurability. The fact that airports in all size categories can afford such insurance is a.
signal of creditworthiness and competitiveness of airports in the capital markets.
Although bond insurance is not always viewed as a financial advantage among airport
financial managers, fully half the total volume of airport debt issued in the municipal
bond market between 1985 and 1995 carried such insurance, a statistic that varied only
marginally among different sized airports.6
Bond insurance is an important means by which airports can reduce their cost of capital.
In return for the payment of insurance premiums (established in relation to the risk profile
of the bond issue), airports enjoy bond ratings that equate to the rating of the bond
insurer. Other things being equal, the cost of capital for insured bonds is lower than the
cost of capital for uninsured bonds, a saving that can exceed the premiums incurred by
the airport in order to carry the insurance.
Defaults. As measured by the number of defaults, the investment value and
competitiveness of airport securities is especially strong. The airport industry has never
suffered a single default.
Regular Participation
Airports are a major and regular participant in the municipal bond market. Between 1985
and 1995 the nation's airports issued more than $42 billion in revenue and general
obligation -backed bonds, rising from $3.8 billion in 1985 to $5.5 billion in 1990 and
corning in at $4.3 billion in 1994 (in current dollars). Coupled with their strong financial
performance (see above), this regularity gives investors confidence in airports as
experienced and sophisticated borrowers.
Although airports of all sizes and types participate in the bond market, larger airports do
so to a greater extent than smaller ones and are far more prominent in terms of the dollar -
volume of debt issued (Table 2.4). Among the large and medium-sized commercial
airports, together serving about 90 percent of all passenger traffic, fully 85 percent -- 56
of 66 airports -- used bond financing for capital investment over the 1985 to 1995 period
(up from 58 percent over the 1978 to 1982 time frame).
6
7
Based on data obtained from Securities Data Company, Inc.
op. cit. Congressional Budget Office, 1984 and Securities Data Company, Inc.
ix
Many small airports do use bond financing. Indeed, 249 small commercial, reliever and
general aviation airports used bond financing over 1985 to 1995 period versus 56 large
and medium-sized airports. As a group however small airports participate in the bond
market in only a small way. The 249 small airports that participated over the last 10
years represent only seven percent of all public -use airports in that category. Even so, the
Federal share of total airport capital expenditure among small airports fell from 69
percent over the 1978 to 1982 time frame to 41 percent over the ten years since 1985 (see
Table 2.2) indicating significant growth in the rate of borrowing activity among these
airports, as well as declining AIP funding levels since 1993.
TABLE 2.1
AEP Allocations by Program Category for Fiscal
Fears 1985 to 1993 and Type of Project
(in billions)
Allocation Percent
Primary airports
Large $3.58 32.1
Medium 2.36 21.2
Small 1.38 12.3
Other commercial service airports 0.52 4.7
Reliever airports 1.46 13.1
General aviation airports 1.85 16.5
Total $11.15 100.0
Type of Project Percent
Landing areas, construction of runways 22.1
Landing areas, construction of taxiways 16.4
Landing areas, construction of aprons 13.9
Land, other than for noise control 8.1
Land for noise control 7.3
Safety and security 6.4
Lighting, navigation aids, and weather equipment 5.6
Roadways 5.3
Building, terminals 4.1
Noise control, other than land acquisition 3.5
Miscellaneous 2.5
Planning 1.9
State pilot block grant program 1.7
Building, other 1_2
Total 100.0%
Source: FAA, Twelfth Annual Report of Accomplishments Under the Airport
Improvement Program, FY 1993.
xi
TABLE 2.2
Contribution of Federal Grants and Debt Finance
to Airport Investment Funds, by Airport Size,1985-93
(billions of 1994 dollars)
Airport Size Debt Finance AIP Funds Total Percent Share
from AIP
Large 21.7 3.6 25.3 14.2
Medium 6.2 2.4 8.6 27.9
Small 7.5 5.2 12.7 _ 40.9
Total 35.4 11.2 46.6 24.0
Source: The Securities Data Company- Database of Municipal Bond Issues, 1995;
FAA, AIP Program, Twelfth Annual Report FY 1993.
&ii
Figure 2.i
VOLUME OF AIRPORT MUNICIPAL BOND DEBT
CLASSIFIED BY CREDIT RATING, 1985-1995
Bond Volume
Large Airport Bond Ratings
N
C
O
CD
12
10
8
6
4
2
0
47.8%
®1111 1111II=
BB BBB- BBB+ A
BB+ BBB A- A+ AA AAA
Rating
AA -
AA+
Bond Volume
Medium Airport Bond Ratings
5
4
c 3
0
m 2
1
0
®NEM
65.2%
i
BB BBB- BBB+
BB+ BBB A -
Rating
A
AA-
A+ AA AAA
AA+
BB BBB- BBB+ A AA- AA+
BB+ BBB A- A+ AA AAA
Rating
•
TABLE 2.3
Average Annual Interest Rates Paid on Airport Bonds
and Difference Relative to Other Municipal Issues,
by Size of Airport, 1985-1995
Size
1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995
Large 8.47 6,58 8.20 7.87 7.50 7.40 6.60 6.41 5.43 6.27 5.91
Medium 9.40 8.29 7.66 7.60 7.60 8.17 6.98 6.62 5.60 5.90 5.88
Small and 8.85 7,21 7.88 7.70 7.77 7.25 6.72 6.10 4.97 5.68 5.80
Other 1.
Bond Buyer 9.18 7.32 7.63 7.68 7.23 7.27 6.92 6.45 5.58 N/A N/A
Index
Difference from the Bond Buyer Index
Large -71 -74 57 19 27 13 -32 -4 -15 N/A N/A
Medium 22 97 3 -8 37 90 6 17 2 N/A N/A
Small -33 -11 25 2 54 -2 -20 -35 -61 N/A NIA
1. Includes commercial service and general aviation
Sources: Securities Data Company Inc. - Municipal Bond Database, 1995
Statistical Abstract of the United States, 1994
11
TABLE 2.4
Annual Municipal Bond Debt in Selected Years
and Total 1985-1994 and by Airport Size
(in Millions)
1985 1990 1994 TOTAL 1985-1994
Type $Millions Percent Millions Percent $Millions Percent $Millions Percent
Large $2,366 62 $4,556 82 $3,047 70 $26,041 62
Medium $867 22 $200 4 $623 14 $7,266 17
Small1. $538 14 $748 14 $675 15 $8,941 21
TOTAL $3,771 100 $5,504 100. $4,346 100 $42,247 100
1. Includes commercial service and general aviation
Source: The Securities Data. Company -Database of Municipal Bond Issues, 1995
M. INNOVATIVE FEDERAL FINANCING: OPTIONS AND IMPACTS
This Chapter assesses the likely impacts of Federal innovative financing mechanisms on airport
finance given the institutional, policy and financial context presented in Chapter II. Five topics
are addressed:
1. What feasible options are there for innovative Federal financing of airport capital
projects?
2. What magnitude of change in airports' cost of borrowing funds for capital investment
would stem from the introduction of innovative financing mechanisms?
3. To what extent would reductions in the cost of capital precipitated by innovative
financing mechanisms increase or accelerate airport borrowing for the purpose of capital
investment?
4. To what extent would increased or accelerated airport borrowing stimulate the
development of more needed airport infrastructure versus the substitution of debt for
other forms of available airport finance (such as state and local grants)? and
5. What is the possibility that options for innovative finance could help diminish airline
near term financial constraints that inhibit timely construction of needed airport
improvements?
OPTIONS
Reviewed in consultation with over 150 stakeholders in public and private finance and airport
management,' the Chapter examines the Federal options for innovative airport finance
highlighted in the Congressional report requirement.
Option 1: Use AIP grants to fund debt repayment reserves of aitport revenue bond issues.
Option 2: Authorize Federal guarantee of airport loans, analyzed assuming tax-exempt
status.
Option 3: AIP eligibility for commercial bond insurance.
s
Consultation regarding federal options for innovative airport financing was facilitated in
a two-day Workshop conducted by the FAA on February 1-2, 1995. The options are
reported in, John A. Volpe National Transportation Systems Center, Innovative
Financing of Airport Development, March 10, 1995.
ii
Option 4: Institute an airport loan fund.
A number of these options would require new legislative authority or new regulations, as well as
new administrative procedure. As discussed later in this Chapter; the cost of administration must
be taken into account in gauging the overall cost-effectiveness of each option.
Option 1: Use AIP Grants to Fund Debt Repayment Reserves of Airport revenue Bond
Issues
This option would allow airports to use a designated portion of their Airport Improvement
Program grants to establish debt service reserves. As shown in Chapter 2, debt service reserves
represent the safety margins needed to give lenders the assurance that airport borrowers_ can
withstand temporary revenue shortfalls without impairing their ability meet scheduled debt
repayments.
This use of ATP funds would enable airports to curtail the practice of borrowing additional funds
at the time of a bond issue in order to establish the requisite debt service reserve fund. However,
this use of AIP funds must be structured so that grants could not be used to guarantee, directly or
indirectly, tax-exempt airport debt. In particular, the use of AIP funds to establish a reserve fund
for a debt issue should be structured in a manner such that any reserve funds not drawn down as
a consequence of a financial emergency would revert to the issuer rather than be used to redeem
bonds.
Option 2: Federal Guarantee of Airport Loans
This option would authorize the Secretary of Transportation to guarantee the payment of
principal and interest of debt issued by airports, provided that the proceeds of such debt were
used to finance qualified airport improvement projects. Consistent with Federal credit program
policy, the guarantees would be targeted at those borrowers who are unable to borrow on
reasonable terms and conditions, but who also provide a reasonable assurance of repayment.
The guarantee should be limited to no more than 80 percent of outstanding principal and interest,
in order to provide an incentive for lenders to scrutinize the creditworthiness of borrowers and to
reduce Federal payments in the event of default. Further, consistent with the Federal Credit
Reform Act of 1990, the Secretary of Transportation could make commitments to guarantee
obligations only to the extent that appropriations of budget authority to cover subsidy costs were
provided in advance in appropriations Acts.
An obstacle to the application of this option is that Federal law provides that the interest on an
obligation which is directly or indirectly guaranteed by the United States, with certain
exceptions, is not exempt from Federal income taxation. Therefore, absent a change in Federal
tax law, only taxable airport bonds could be guaranteed under this option. While a Federal
iYl
guarantee would allow airports to issue taxable bonds at lower interest rates than without a
guarantee, it must also be considered that investors demand higher interest rates on taxable
bonds than on tax-exempt bonds, all other things being equal. It is likely that the net result
would be to increase the borrowing costs of most airports_
Because of this net result, this report has estimated the effect on airport financing assuming that
Federal law were amended to allow airport bonds which were Federally guaranteed to retain
their tax-exempt status. However, it must be emphasized that the Administration would strongly
oppose such a proposal because of its other effects. The U.S. Treasury is prohibited from
directly issuing obligations exempt from Federal income taxation. Federal guarantees of airport
bonds would create securities which are superior to direct obligations issued by the Treasury.
Federal guarantees of tax-exempt securities also have adverse effects on the municipal market,
because they create securities which are superior to all other tax-exempt securities issued by state
and local entities. Furthermore, a guarantee of a tax-exempt obligation is an inefficient means of
providing Federal assistance because the revenue loss to the Treasury exceeds the interest
benefits to the borrower. There is also the problem that granting an exception for airport bonds
would lead to pressure by interested parties seeking. exceptions for other types of tax-exempt
debt
Option 3: All' Eligibility for Commercial Bond Insurance
A variant of Option 2, this approach would assist airports that cannot afford or qualify for bond
insurance. Under one approach such airports would be permitted to purchase commercial bond
insurance with AIP funds. This option would have to be implemented in a manner that ensures
that the holders of such bonds would have no recourse to the Federal Government in the event of
default by the issuer of the bond and insolvency of the bond insurer.
Option 4: An Airport Loan Land
This option would establish an airport improvement loan program, using appropriations from the
Airport and Airways Trust Fund to cover subsidy costs, as defined in the Federal Credit Reform
Act of 1990. Although various approaches to the administration of such a program are possible,
most foresee it lending directly to airports at rates comparable to those in the insured tax-exempt
bond market. Consistent with Federal credit program policy, Federal loans should be available
only to those airports unable to borrow on reasonable terms and conditions, but are also able to
provide a reasonable assurance of repayment. Most airports, therefore, would not be eligible for
this type of Federal assistance.
iv
IMPACT OF INNOVATIVE FINANCING OPTIONS ON THE COST OF CAPITAL
A general forecasting framework, a range of quantitative assumptions, and a specific forecasting
model for each option lie at the heart of the estimates presented here.
The Forecasting Framework
Figures 3.1 and 3.2 present in diagrammatic form the detailed analytic framework within which
the study estimates the quantitative effects of new financing arrangements on airports' cost of
capital. The top row of boxes in each diagram depicts the causal factors in the determination_ of
credit ratings (Figure 3.1) and interest costs (Figure 3.2) The second row depicts the quantitative
significance of each factor in bringing about change in creditworthiness or interest costs. Some
factors are obviously quantitatively more significant than others and the second row of the
framework takes this into account.
This framework is designed to mirror the institutional, policy and financial realities of the capital
markets and the position of airports in those markets, as described in the previous Chapter. To
ensure that the framework represents a truly realistic portrayal of the marketplace it was exposed
to a panel of financial experts and airport managers and adjusted to accommodate their views.
The framework was then translated into a computer simulation program for use in analyzing the
effects of each option. The participants in this panel are listed in Appendix C.
The structure of Figures 3.1 and 3.2 reveals that credit ratings represent one of several factors
upon which interest costs 'ultimately turn and that some of these other factors also figure into the
determination of credit ratings. Credit ratings are in fact both a cause of interest costs and an
effect, since outstanding bonds are periodically reviewed and their ratings adjusted to reflect
changed economic, financial and other market circumstances, circumstances which are likely to
be reflected already through changes in the market price at which the bonds trade.
Quantitative Assumptions
Any particular innovative financing option will affect airport borrowing costs through one or
more of the factors that cause credit ratings and interest costs to change, namely those factors in
the top row of boxes in Figures 3.1 and 3.2. Since the size of the impact will depend upon the
quantitative significance of each factor in bringing about change (the second row in the diagram)
this study quantified the significance of such impacts. This was achieved in two steps. The first
was a detailed econometric analysis of credit ratings and the interest costs and the translation of
this analysis into a probability range of possible values for each factor. The second step exposed
v
these ranges to the panel of experts and managers (see Appendix C) who adjusted the estimates
in light of their field experience.
Details of the econometric analysis are presented in Appendices F (for credit ratings) and E (for
interest costs) and the results are summarized in Tables 3.1 and 3.2. As shown in Table 31 the
use of debt guarantees such as bond insurance and letters of credit have a material, positive
influence on bond ratings whereas the use of airport revenues in lieu of the tax base to secure the
bonds has a material, negative influence. For small airports, credit ratings tend to improve
somewhat for relatively larger issues.
Although Figure 3.1 indicates that a number of other factors influence bond ratings, the four
factors identified in the econometric analysis together account for more than 75 percent of the
variation in ratings from airport to airport (see Appendix E),
The eight factors shown in Table 3.2 account for 80 percent of the variation in interest costs
among airports (see Appendix F). Clearly a most significant factor for airports is their access to
the tax exempt municipal bond market.9 That factor alone, everything else remaining equal,
reduces borrowing costs by an estimated 187 basis points (1.87 percentage points) for large
airports; 139 basis points for medium-sized airports; and 167 basis points for small airports. Any
innovative financing mechanism that involved the elimination of this Federal tax expenditure
could cause airport interest costs to rise rather than fall.
A full increment improvement in bond rating has a measurable but moderate impact on interest
costs, about 20 basis points (one -fifth of a percentage point). Of greater importance is movement
in municipal bond rates generally (themselves a reflection of general economic conditions and
fiscal and monetary policy). For large airports, the use of bond insurance has about the same
impact as a one increment improvement in credit rating whereas the importance of bond
insurance outweighs improved credit ratings for medium-sized and small airports.
Consensus Modei and Assumptions for Each Option
As indicated above, the quantitative estimates were presented to the panel of experts along with
probability ranges for each to account for uncertainty. The panelists were also asked to review
the way in which the study team proposed to forecast the effects of each innovative financing
mechanism through the forecasting framework (the forecasting "model' for each option). What
emerged was a consensus regarding the appropriate model and quantitative assumption for each
Although use of a letter of credit appears to have an equal or greater effect than the tax
exemption, it must be recognized that such an instrument is germane only for very small
borrowings and are used in less than five percent (in dollar -volume) of airport loans or
bond issues.
vi
np6r,n The consensus mnrdel grid aSSi mntinnc including the nrrhahiiitc; ranges are presented
for each option in Appendix D.
Projected Impacts and Risk Analysis
Based on the model and assumptions reported in Appendix F, Tdbie 3.3 presents the projected
impacts of each innovative financing mechanism on airport interest costs (cost of capital). The
projected impacts are reported in the form of the expected percentage change in interest costs;
thus a 1.93 percent reduction in interest costs of large airports due to Option 2 (Federal airport
loan guarantees) means that an 8 percent interest rate would fall to 7.85 percent -- the appropriate
calculation is 8.0 x [1 - 0.01931
From the perspective of large and medium-sized airports, the impacts reported in Table 3.3 are
modest but not insignificant. For a large airport issuing bonds worth, say, $113 million (the
1985 to 1993 average -sized issue or these airports) at 5.91 percent interest (the prevailing rate in
early 1995, see Table 2.3), the interest expense would be $6.68 million. Option 2 (Federal
Guarantees of Airport Debt) would reduce interest expenses by an estimated 1.93 percent, or
$124,300 on the average -sized bond issue in 1995. If airports were to leverage such a sum by
using the interest cost saving to fund added debt service, an extra $2.14 million would actually
be available for construction and related purposes_ 10 Although this amount represents a small
percentage of the total cost of a new runway (about $100 million), taxiway (about $60 million)
or terminal modernization (about $50 million), it is meaningful in relation to the cost of collateral
opportunities to enhance the effectiveness and local acceptability of such investments such as
advanced runway lighting systems and noise mitigation. Alternatively, these saving could be
passed along to reduce the costs to airport users.
From a small airport perspective, projected impacts are proportionately more significant. The
provision of Federal Guarantees of Airport Debt (Table 3.3, Option 2) for example would shave
an estimated 5.85 percent off the debt service bill for a small airport participating in the bond
market. For an airport disseminating the average -sized bond ($16 million 1995) at interest rates
prevailing in early 1995, this saving could be leveraged into an additional $994,000.11 For a
to The interest rate reduction of 1.93% reduces the effective interest rate from 5.91% to
5.80%. On an average sized bond ($113 million in 1995) the lower rate yields savings in
debt service of $124,300 i.e., ($113 million* 5.91%) minus ($113 million * 5.80%) _
$124,300. If this amount were to be used to fund additional debt service at the lower
interest rate, the airport could leverage the savings into $2.14 million of additional
borrowing ($124,300/ 5.80% _ $2.14 million).
The interest rate reduction of 5.85 percent reduces the effective interest rate from
5.80 percent to 5.46 percent. On an average sized bond ($16 million in 1995) the lower
11
VDt
small commercial airport such a sl:i'i'i is large enough to influence the scope of a project (the size
of a terminal building expansion, for example).
Like all forecasts, those reported in Appendix F are uncertain. To determine whether a
significant risk exists that the estimates substantially under -state the prospective impact of
innovative financing mechanisms, Appendix D reports the range of possible outcomes in light of
the probability ranges associated with each of the estimating assumptions» A review of the
results in Appendix D indicates that the probability of any significant departure from the central
estimates reported in Table 3.3 is extremely small. Since the. probability ranges upon which the
risk analysis is based represent a consensus view among industry experts and managers, these
results may be interpreted as a consensus as well.
IMPACT OF INNOVATIVE FINANCING OPTIONS ON AIRPORT BORROWING
FOR CAPITAL INVESTMENT
Figure 3.3 presents the framework within which forecasts have been developed of the volume of
enhanced borrowing activity likely to stem from the cost of capital reductions discussed in the
section above. Like the previous forecasting framework, Figure 3.3 represents a consensus view
of industry experts and managers. In essence, the framework states that airport borrowing will
increase by some percentage amount in response to each one percent reduction in the cost of
capital (a relationship known in economic vernacular as an "elasticity").
What then is the elasticity of airport borrowing with respect to interest costs? The econometric
analysis reported in Appendix G indicates that over the period 1985 to 1995, each one percent
reduction in interest cost leads to a 1.6 percent increase in the volume of bonding activity among
large and medium-sized airports and virtually no measurable impact on the volume of bonding
activity by small airports.
However, since asizable proportion of bonding activity represents the re -financing of
outstanding debt rather than the issuance of bonds for new construction or repair activity, the
rate yields savings in debt service of $54,288.00 ($16 million x 5.46 percent) minus
($16 million x 5.46 percent) = $156,940. If this amount were to be used to fund
additional debt service at the lower interest rate, the airport could leverage the savings
into $994,285 of additional borrowing ($54,288 / 5.46% = $994,285). This is
approximately 6.2 percent of the average sine bond ($994,785 / R.16 million = 6.2 %).
12 The technique of "Monte Carlo simulation" was used to vibrate all assumptions
simultaneously according to their estimated probability distributions so as to produce the
prVUt1Ui116y U15t1iUUL1Ui1for U1C final outcome.
viii
estimates reported in Appendix (v represent the most that can be expPvted in the way of new
airport development in response to reduced interest costs.
Using the elasticity estimates reported above, Table 3.3 presents the estimated impact of reduced
interest costs on airport bonding activity, recognizing that the impact on capital investment will
be smaller. For large airports, the results range from 0.41 percent (Option 1) to 3.05 percent
(Option 2). For medium-sized airports the results range from 0.14 percent under Option 1 to
2.91 percent under Option 2.
For small airports, bonding activity is estimated to increase by less than one percent under all
options. Participating far less frequently and on a smaller scale simply by virtue of their size,
smaller airports do not have the same financial incentives to fine mince the timing of their entry,
into the market, as do larger airports.
To put these results in perspective, large and medium airports invested $33:3 billion in
infrastructure from January 1985 through June of 1995. Option 2 (Federal Guarantees of Airport
Debt ), is estimated to cause a 3.05 percent maximum increase in bonding activity for large
airports and a 2.91 percent increase for medium-sized airports. Thus this increased use of the
bond market would have resulted in $52.7 million of additional bonding activity in 1995.13
The impacts projected above ar'e drawn from statistical models of system -wide impacts and mask
potentially larger effects in local situations where factors such as airline financial restraint or
local government bonding restrictions delay worthwhile projects or diminish their scope.
Although the powerful Federal role and mature airport investment market revealed earlier create
a healthy environment for airport investment, it was also shown that the environment is not
entirely fluid with reCpPr:t to changing 1nve-gftnent rlpportunit1PC and Pennnmir nPedc, At large
and medium-sized airports, where major airlines exert significant influence over the scope and
timing of investment, near -term financial realities facing airline management can create
a. t +:,... -g ,7 �
divergent airp�ir"�i-airline perspectiJe3 on acre appropriate � and Scv^p2 ^vr capita
improvements due to their immediate implications for landing fees and other airline costs.
Although this study uncovered no evidence of systemic development constraints at large and
medium-sized airports, local situations are known to arise in which economically worthwhile
investment initiatives (such as congestion and noise -reducing projects) are delayed or scaled
back for financial considerations.
While there is always. a risk that interest rate subsidy can induce excessive capital spending - i.e.,
projects that would not pass a rigorous market test of merit, it is known that airline financial
,r, i a ,i diminish t i, hit fi t t i a a• a
CvrLivaui can and uv ui2 scope ^vi worthwhile li'1veS Li2nw as urge and iiicuiiiiii-Srzeu
13 The calculation assumes ($1.32 billion in large airport bonds in 1995 * 3.05%) +
($427 million in medium airport bonds in 1995 * 2.91 % ) _ $52.7 million of additional
bonds in 1995.
ix:
airports or nut them on hold, sometimes for years. A.lthounh the dollar-voliime of nrthwhile
airport investment that is foregone or delayed due to such conflicts is unknown, innovative
financing mechanisms that were carefully targeted in relation to such cases could help alleviate
investment bottlenecks.
IMPACT OF INNOVATIVE FINANCING OPTIONS ON NET AIRPORT
DEVELOPMENT
To the extent that airport borrowing activity is projected to rise as a result of Federal innovative
financing mechanisms, it is important to ask whether the funds would be used in lieu of other
available sources' of capital (bond finance and state and local grants, principally) or for net new
additions to airport infrastructure. The econometric benchmarking analysis reported in
Appendix H and summarized below indicates that in the case of small airports innovative
financing mechanisms are quite likely to yield net new additions to airside and terminal capacity.
For large and medium-sized airports the benchmarking analysis indicates that, since such
airports face no systemic obstacles to obtaining investment capital, interest rate relief through
innovative financing mechanisms creates a risk of substituting for otherwise available capital
dollars. On the other hand, the fact that some large and medium-sized airports face delays and
scope reductions in economically worthwhile investments due to airline financial pressures,
targeted applications of innovative financing mechanisms would likely generate investment that
would otherwise be deferred, cut -back or canceled.
Benchmarking Analysis
While many airport authorities lacer significant environmental and land -use development
constraints, sound balance sheets and access to debt capital enable the nation's largest airports to
fund capital investment without encountering serious or systematic financial constraints in the
capital markets. Airports sometimes face opposition to capital projects from airlines on financial
grounds and such opposition can delay or even annul publicly desirable projects (projects whose
economic benefits exceed their costs).14 Obstacles to investment also arise in the form of local
environmental, noise and land -use considerations. However, once airline and local project
approvals are obtained, large airports do not face constraints to securing bond finance in the
v
1,
capital markets. This means that larger airports cane taken en as a rough benchmark against
which to evaluate the magnitude and nature of any financial constraints facing the nation's
smaller airports.
14 Helping airports overcome such barriers to moving ahead with economically worthwhile
projects is one goal of the AIP.
Econometric analysis of airside capital spending (principally runways, taxiways and aprons) by
large and medium-sized airports between 1986 and 1994 (Appendix H) reveals that each one
aPTCeit growth in aircraft operations (take -offs and landings) led large airports to respond with
0.97 percent more investment in airside facilities (including the use MP funds). The
corresponding "growth -investment rate" for landside investment among large and medium-sized
airports (terminals, parking lots, roads and so on) was 1.0 over the 1986-1994 period (in relation
to growth in passenger enplanements).
For airside investment at small airports, the statistical analysis reveals a growth -investment rate
of 0.72 versus 0.97 for large airports. However, statistical tests indicate that these two values lie
'v'viL use 5anc 95 percent sLCLLIJLIcat range. The analysis LuuJ reveals piiiiibtG but weal;
evidence of a financial constraint to airside development among smaller airports. This
inconclusive finding is consistent with accounts given in Chapter II where it is shown that small
airports can raise needed capital for runway and taxiway development through the sale of bonds
but that they participate in the capital markets far less intensively than larger airports.
It must be recognized that the results reported above represent long -run outcomes for large
groups of airports. Since airline and local government financial constraints can delay or reduce
the scope of needed airport investment projects at a given point in tune, these results almost
certainly mask local situations in which financial constraints to airport investment are very real.
For landside projects, however, another story emerges even with regard to long -run outcomes at
small airports. In this category of investment, smaller airports display a growth -investment rate
of 0.78 versus 1.0 for larger airports and the statistical analysis reveals that these values do not
fall within the same statistical range. This finding indicates that smaller airports categorically do
face long -run, systemic financial constraints to engaging in their desired level of landside.
investment in response to aviation growth.
15 Based on a "Chow Test" of structural change. See Appendix H.
Figure 3.1: Framework for Si mul ati ng I mpact of I nnovative Fi nanci ng Opti ons on Credit Rati ngs
Strength of Local
Economy
(GDP,
Emp oymant)
Local Economy
Elasticity
Default History
Default History
Elasticity
Deli Service
Reserves
L% Impact of Using
AIPMoneyto
Fund Debt Service
Reserves
Bond Insurance
% Impact of
Holding Bond
Inauance
Debt Guarantee
% In of
Having a Debt
Guarantee
Diverety of
Revenue Sources
(Ability to
Service Debt)
Diversity of
Revenue: Sources
Elesticity
i
Bond Rating/
Creditworthiness
I nput
II.„ Result
ii
Figure3.1: Continued
Debt Securities
Issued from
Underlying Pool
of Airport Debt
% Impact of Risk
Pooling
Debt to Asset
Ratio
Debt to Asset
Ration
Elasticty
Operating Ratio
Operating Ratio
Elasticity
Bond Type,
Gendal Airport
(GARB)=1,
General
Obligation=0
Bond
Elasticity for
Rating Model
Loan
Loan
Elasticty for
Rating Model
Equity Issue
Equiy Isve
Elasticity for
Rating Mode
Legend
n Input
n, Result
Bond Rating/
Creditworthiness
f
Figure3.1: Continued
Airport Loan Fund
% Impact of
Federal Rating
Process
AirlineUm
Agreernents
(e g. Gate Control)
AirlineU�
Agreenents
El eel city
1
AirlineSavice
Pattern, Hubs 1,
O & D=0
Ai rl i ne Service
Elalicity
Financial Strength
of Airline Carriers
Financial Strength
of Airline Carriers
Elasticity
Airport Flnancial
Management,
Compensitory=1,
Residual=0
Financial
Management
Elasticity
Debt
Underwr Ong COA
Elms tcity
Bond Rating/
Creclitworthi flees
E I nput
n, Result
rv._
Vol umeof Capital
Borrowing
Capital
Borrowi ng
Elasticity
F igure 3.2: Framework for Si mul ati ng I mpact of I nnovative Fi nanci ng Opti ons on Cost of Capital
M arket I nterest
Rates
(eg. bond buyers
index)
Market Interest
Rates
Elasticity
Bond Maturity
Term
Term
Elasticity
Bond Rating/
Creditworthiness
Creditworthi new
Elmticity
Bond
Tax-exempt
Status
% I mpact of
Tex Exemption
Gross Spread
Gross Spread
Elasticity
Debt I rn.Arumertt
Insurance Fees
I nsurance Few
Elntirty
n I nput
n_i Result
Cost of
Capital
it
Figure3.2: Continued
Debt Securities
Issued from
Underlying Pool
of Airport Debt
% Impact of
Risk Pooling
Bond Type, GARB=1,
General Obligation=0
% Impact of Bond
Type
Loan
Loan Elasticity for
Cost Model
Equity Issue
Equity Issue
Elasticity for Cost
Model
Debt Guarantee
% Impact of
Having a Debt
Guarantee
Bond Insurance
% Impact of
Holding Bond
Insuramx
Cost of
Capital
n I nput
1
Result
i