Airport Finance Challenges for the Next Decade

Jean M. DeLuca, Charles E. DeWitt, Jr., and Scott P. Lewis*

Airport Magazine, May/June 1995 (c. American Association of Airport Executives)

As we approach the beginning of a new century, the nation's airport owners and operators face the greatest need to upgrade and expand their facilities since the advent of commercial jet service. Both passenger and cargo traffic are expected to grow rapidly in the years ahead. The FAA currently estimates that passenger growth will increase at a rate of 3.5 per cent per year for the foreseeable future, with air cargo growth expected to rise at a rate of 6.5 per cent to 8 per cent. It has been conservatively estimated that airports need to invest $50 billion in capital improvements over the next five years alone.

Whether airports meet this demand for new facilities is critical to our nation's economic progress. The National Commission to Ensure a Strong Competitive Airline Industry found that without a financially sound air transportation system, "our country will be hamstrung in its ability to participate in an increasingly global community and marketplace."

Paying for the costs of needed airport improvements would be a daunting task even if the traditional sources of airport capital-airport-generated revenues and federal grants under the Airport Improvement Program (AIP)-could be expected to support airport development in the future to the same extent as they have in the past. Unfortunately, they cannot.

The trend for the AIP is for reduced funding that will represent a shrinking percentage of total airport funding. At its peak in fiscal year 1992, AIP spending was $1.9 billion, almost 25 per cent of that year's national airport capital costs. Since then, AIP spending has dropped to $1.45 billion in federal FY 1995, and further cuts are under consideration by the current Congress. AIP funds, therefore, will be an increasingly small proportion of overall airport capital in the future.

At the same time, the ability of airport owners to use their own rates and charges to generate much needed revenue, particularly from aeronautical users, has become constrained. Although the airlines failed to convince the Supreme Court, in the Kent County suit, or Congress, in its proposed amendments to what became the Federal Aviation Administration Authorization Act of 1994, to outlaw the use of compensatory ratemaking, the FAA recently adopted its policy on airport rates and charges, which imposes for the first time a complex set of rules that may significantly reduce aeronautical revenue streams at many of the nation's airports and will require careful compliance by airport operators. Within the first two months of the policy, there have been a number of airline complaints against airport operators, and the full implications of the federal government's intervention in airport rate-setting will not be known for many years.

The key to the expansion of the financial capacity of airports is to respond with foresight and energy to the recent shifts in federal policy toward reduced AIP funding and regulated airport rate-setting by increasing non-aeronautical revenues, creatively using PFC revenue and implementing innovative financing mechanisms.

While mandating that an airport must limit its total aeronautical revenues to its total aeronautical costs-thus prohibiting any operating income from aeronautical sources-FAA refused to regulate non-aeronautical rates and charges, thereby encouraging airports to be "as self-sustaining as possible" by enhancing their commercial or groundside revenues.

Airport operators in Europe have demonstrated how commercial activity can raise large amounts of new revenue for airport improvements. At London's Heathrow Airport and Amsterdam's Schiphol Airport, for example, non-aeronautical revenues have grown by huge proportions in recent years, as these airports have found new ways to offer goods and services to both travelers and shoppers. As BAA plc, operator of Heathrow, has articulated, its mission is to "create a world class retailing experience for all our customers." Commercial revenues now account for nearly 60 percent of the total revenues at Heathrow.

The opportunities for U.S. airports to follow the lead of the Europeans are enormous. It will, however, require a new, customer-oriented entrepreneurial attitude and the development of creative airport/private partnerships. The city of Pittsburgh signed a long-term development contract with the BAA plc to import the Heathrow model to its airport. The result has been widely recognized as having dramatically increased the commercial revenue from the airport. The Port Authority of New York and New Jersey recently selected a developer for the central terminal at LaGuardia Airport and negotiated an innovative financial agreement that gives the authority a percentage of the net profit from the services in the terminal.

Airports must continue their efforts to maximize the financial benefit from passenger facility charges. As of 1994, the FAA had granted airports approval to impose and use almost $10 billion in PFCs into the next century. Although the ratings agencies have expressed concerns about the FAA's ability to terminate an airport's authority to impose PFCs, they also have expressed a willingness to entertain creative use of PFCs. Airports can use non-PFC revenue to support PFC financings. The Maryland Department of Transportation recently sold bonds backed by certain toll revenues as well as PFCs. Other airports plan to use PFC revenue on a pay as you go basis, thus freeing up other revenue to support long-term financing.

Pursuant to a congressional mandate, the FAA is currently exploring the development of innovative financing techniques. Some of these proposals only represent alternative uses for already limited AIP grant funds and are not likely to provide much assistance in the search for additional capital sources. One concept under consideration involves the establishment of a revolving loan fund similar to the fund established under the federal Clean Water Act. Several airport advocates, including AAAE, have urged the FAA to consider a revolving fund, but only as a supplement to, not a substitute for, AIP grants. The U.S. Department of Transportation is considering a revolving loan program not only for airports but for all programs under its jurisdiction, including federally supported highway and transit programs.

The Clean Water Act loan program demonstrates how a similar airport program might work. In 1987, Congress enacted legislation phasing out the existing construction grant program under the Clean Water Act and authorized funding of $8.4 billion through 1994 to capitalize revolving fund programs. States were able to obtain capitalization grants by providing a 20 per cent state "match" for the federal funds, to establish programs to finance local wastewater projects. While some state programs use amounts in the revolving fund to make direct loans, other programs have used the fund as leverage for bond financings. Under a bond financed program, capitalization funds can be used to produce up to three times the amount of bond proceeds to fund loans, the amount of leveraging available depending upon the structure of the program. Under either a leveraged or direct loan program, as initial loans out of the fund are repaid, new loans are made, thus providing a self-perpetuating financing mechanism. Through June 1994, states received approximately $9.8 billion in capitalization grants and had funded approximately $11.9 billion in loans.

While the Clean Water Act revolving fund program may serve as a useful starting point, an airport program would raise several issues regarding its administration and its application to particular airport borrowers. Due to the small number of potentially qualified airport projects on a state-wide basis, an airport revolving fund program might work better, certainly from a leveraging perspective, at a regional or federal level.

A regional or federal program would raise certain complexities not present in a state program. Under current federal tax laws, the ability to structure a leveraged tax exempt program may be limited, thus causing interest rates on the loans to be higher than what an airport might achieve outside the program. Unlike in the wastewater financing arena, many airports have in place existing revenue bond programs. The ability of an airport to maximize the usefulness of a revolving fund program will be dependent on fitting such a program into its current debt structure in a way that does not dilute the security for its own revenue bonds.

If a revolving fund program is to effectively augment limited airport capital resources to meet growing airport capital needs, the capitalization grants required to fund the program must come from a source other than existing AIP grant funds. One source for supplemental funding is the unobligated balances from the Aviation Trust Fund. Airport owners may want to consider creation of a loan program from these balances. Under federal budget accounting practices, a loan is not included in the same way as is a grant for purposes of calculating the federal deficit. Congress does not appropriate the loan amount but only the much smaller amount representing the associated risk of non-payment. The key will be to develop a program utilizing these fund balances that is acceptable to Congress.

Although the changes in the world of airport finance present many challenges to airport operators, airports will be able to meet these challenges by the creative use of PFCs and new financing tools and an entrepreneurial approach to their economic mission in the decade to come.

(*)Jean M. DeLuca, Charles E. DeWitt, Jr. and Scott P. Lewis are members of the Airport Group of Palmer & Dodge, a Boston, Massachusetts, law firm that specializes in airport issues.