Innovative Airport Financing:
Will the PFC-backed bond be a savior?

Holly Arthur

Airport Magazine, Sept./Oct. 1996 (c. American Association of Airport Executives)

As the next century approaches, airports face an ever-increasing need to finance capacity enhancements while dealing with shrinking Airport Improvement Program (AIP) funding. House transportation appropriations subcommittee Chairman Frank Wolf (R-Virginia) warned in a letter earlier this year to other members of Congress that without reinstatement of airline excise taxes to fund the aviation trust fund-which was in question at the time-AIP reserves could run out as early as January. And even though the taxes were reinstated in August, Wolf expressed concern in his letter that a move so late in the fiscal year could cause FAA to face "serious cash flow problems" for items such as salaries, on-going contracts and other immediate needs slated to use up the majority of the trust fund over the first few months after reinstatement.

"To address this problem, FAA would most likely defer award of AIP grants and new contracts for air traffic control equipment until a sufficient balance is restored," Wolf said, adding that all such programs are funded through the end of this fiscal year. "If the aviation taxes are not reinstated in the next few months, it is likely that airports and air traffic control sites may see a break in their funds extending several months long," Wolf said.

Airport representatives, AAAE, and the Airports Council International-North America told Congress that U.S. airports need at least $60 billion for necessary and essential projects by 2002-$10 billion in capital needs, of which $2.7 billion will not be funded without a boost in AIP funding.

Although airports have other means of financing capital projects -- commercial loans, airport rates and charges reserves and state grants -- the majority of airport financing comes from the sale of tax-exempt bonds and AIP grants, DOT in March reported to Congress in Innovative Approaches for Using Federal Funds To Finance Airport Development .

Between 1985 and 1995, 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, relievers and general aviation facilities), DOT said.

'Powerful' PFCs

The PFC program, now generating $1 billion annually, provides "an extremely powerful tool for financing critically needed airport development, particularly at the nation's largest airports," DOT said in its report. Half of all PFC generated revenue is concentrated at the top 10 enplaning airports in the U.S., DOT noted, with seven of the top 10 airports currently collecting PFCs. "This has the effect of concentrating the PFC revenue at airports with the greatest capacity development and noise mitigation needs."

Under current law, revenues generated by PFCs can be used for airport planning, airside development, terminal development, noise compatibility planning and implementation, and airport access.

DOT said that FAA's cooperation with the airport finance community to "increase PFC revenue leveraging potential" has led banks and insurers to provide credit enhancement for PFC secured bonds. "FAA is committed to working with the airport finance community to further increase the leverage potential for PFC revenues," DOT said.

Late last year, municipal bond insurance firm AMBAC Indemnity Corporation announced it would insure PFC-backed airport debt-particularly for airports with at least one million enplanements each year. In its report to Congress, DOT noted that using AIP monies to pay for commercial bond insurance offers "the most promise" of many of its innovative financing options by effectively helping airports that cannot afford or qualify for such insurance. "This option would have to be implemented to ensure that 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," DOT said.

'Regulatory Hammer'

Until recently, municipal bond ratings groups have been unwilling to assign investment-grade ratings to airport bonds backed solely by PFCs. Moody's Investors Service said it will not rate PFC-backed bonds given FAA's authority to terminate an airport's ability to collect PFC revenues, effectively leaving bondholders without recourse.

"FAA and DOT have been party to ongoing discussions over these issues and have chosen to retain the termination provision rather than seek a legislative or regulatory fix," Moody's said. "A reasonable inference is that adherence to the existing provisions provides for the use of termination provisions as a regulatory 'hammer.' "

Another hamper to Moody's issuing an investment grade rating is the question of whether PFCs are to be viewed as part of the debtor's estate in airline bankruptcy-an issue raised in the MarkAir bankruptcy proceedings. "This issue is complicated because airlines are allowed by the enabling legislation to commingle PFCs with other funds of the airlines. To evaluate PFC-backed debt without taking into consideration the credit standing of the collecting airlines, it would be necessary to become comfortable with these bankruptcy issues through adequate legal options and through tightly drafted and enforced collection and remittance procedures."

Moody's noted, however, that it may consider investment grade rating of PFC-secured debt for short-term bond issues. "Assuming no change in the status quo, it may be possible on a case-by-case basis to assess the political landscape and other potential problems that could cause the FAA to terminate the PFC over a limited time horizon." Standard & Poor's (S&P) and Fitch Investor's Service have rated such bond sales at investment grade.

In May, an unlikely candidate blazed the trail for airports seeking to leverage the revenue stream generated by PFCs-Little Rock National Airport in Arkansas. Categorized as a small hub by FAA, Little Rock issued $2.635 million in revenue bonds backed by PFCs and received a 'BBB' investment grade rating from S&P. The sale will finance a runway extension, a new Category 3 instrument landing system and various taxiway improvements.

S&P and Fitch both assigned investment grades to Chicago O'Hare International Airport's $250 million PFC revenue bonds series 1996 A and B sold through negotiation via a syndicate led by Smith Barney of New York. Key to the positive rating, S&P said, was language in FAA's record of decision (ROD) authorizing the city of Chicago to collect $925 million in PFCs outlining the notification period for suspected violations. The ROD contained an additional agreement that significantly narrows the possibility of complete PFC authority termination as long as the bonds are outstanding, S&P said.

The city pledged to provide investors with an annual update of its financial plan to show sufficient projected PFC cash flow necessary to pay debt service until maturity or to redeem the bonds, as well as strong airport management and oversight that "lessens the possibility" of regulatory violations that would lead to termination of the city's PFC authority.

Despite the investment grades, both ratings houses found the bond sale to have some risks-such as the limited security provided by the capped PFC authorization, inherent "risks and ambiguities" in the federal regulations governing PFCs and debt maturities that extend beyond the period during which the city currently expects to be authorized to collect PFCs.

Fitch factored in sensitivity analyses, including a "no enplanement growth" scenario-even with static enplanement over the life of the bonds, debt service coverage remained adequate. If enplanements decreased by 2.5 percent or if O'Hare lost one of its hub airlines, American or United, debt service levels would cover the bonds.

Moody's Investors Service said FAA's "major policy shift" in the Chicago ROD has prompted the ratings group to consider investment grade ratings on long-term, stand-alone PFC debt on a case-by-case basis. Moody's cited the specific language in the ROD that pertains to a limited waiver of FAA's terminating ability until after bond repayment is completed.

"While FAA retains the right to terminate PFC collections for a violation of the Airport Noise and Capacity Act (ANCA), Moody's believes that given the defined nature of the ANCA violation, an airport can covenant against committing any action that would jeopardize its ability to collect PFCs with respect to ANCA," Moody's said.

Opening Doors

"The PFC-backed bond should open up a large number of doors for airports," S&P analyst Ernest Perez told Airport Magazine. "It is possibly the best and most innovative [airport financing] option in terms of moving forward."

Little Rock financial advisors attribute the airport's ability to break new ground with the bond sale to credit strengths, including AMBAC's willingness to insure the bond sale, Susan Fleming of Little Rock-based Stevens Inc. said.

Since the Little Rock sale was the first of its kind, it allowed S&P to loosely set some basic guidelines for future PFC-backed bond sales. Covenants to the PFC statute and the ANCA were fundamental to the rating, S&P said.

"We are putting a tremendous amount of weight on the management and its ability to act prudently to ensure that any violations of the [PFC] act do not end up with the PFC being terminated," Perez said. "If the management is negligent and not prudent, then the General Aviation Revenue Bond (GARB) rating will go down as well, given that the GARB is also based strongly on management."

Perez noted that based on the historical success of PFC collection, issuing debt backed with PFCs does not have the same inherent risk level associated with funding projects from other airport revenues dependent upon airline rates and charges. "Airlines have had some success in terms of questioning projects and the overall cost of rates and charges," he said. "That is ongoing and is a concern to us. Just the ability [of an airline] to appeal to the federal government now puts a stumbling block in an airport's capital program."

This question about many airports' ability to raise rates and charges to meet outstanding debt has raised concerns about other innovative financing mechanisms, Perez said. "A rate covenant is crucial to all our airport ratings."

Perez emphasized that an airport must have a GARB in place before a PFC bond rating can be assigned. "No PFC-backed bonds will be rated on par with an airport's GARB," he said. "Legal documents associated with the issue and enplanement trends are what determine how far off we will rate the [PFC] issue from the GARB rating."

S&P also noted that in the case of a suspected PFC violation, collected funds should be trustee held after being collected from the airlines. "We also want copies of any and all reports that are out-for example, from the airport to the airlines-that justify the projects being proposed," Perez said.

Other Innovations

Another innovative means of airport finance examined by DOT is federal loan guarantees, given no change in an airport's tax-exempt status. Under such an option, the DOT secretary would have the authority to guarantee payment of principle and interest of debt issued by airports-as long as the proceeds of the debt were used to finance qualified airport improvements. The guarantee would be limited to no more than 80 percent of outstanding principal and interest, providing an incentive to lenders to scrutinize an airport's creditworthiness and reduce federal payments in the event of a default.

One obstacle, DOT notes, is that federal law provides that the interest on an obligation either directly or indirectly guaranteed by the U.S. is not exempt from federal income tax. "Therefore, absent a change in federal tax law, only taxable airport bonds could be guaranteed under this option," DOT said. Without tax exempt status on the bonds, investors will demand higher interest rates-the net result likely being an increase in the borrowing costs of most airports, DOT said.

"These mechanisms score especially highly in relation to small airports, doubtless the most vulnerable airport sector from the perspective of capital shortfalls," DOT said. "However, the administration opposes providing tax-exempt status to any securities that also receive federal guarantees."

Debt Reserves

Using AIP money to fund debt reserves would allow airports to curb the practice of borrowing additional funds at the time of a bond sale to establish the requisite debt service reserve fund, DOT said. "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."

DOT said that while other innovative financing alternatives exist, any would depend upon the budgetary status of AIP. "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 non-federal sources."

DOT proposed, as part of its AIP reauthorization bill, a two-part follow to its report: (1) formation of a select panel from the aviation and financial communities and local governments with an interest in airport development; and (2) statutory authority for the FAA administrator to test and evaluate effects of innovative financing proposals using AIP funds on airport development. DOT noted that the panel will assess a wide range of financing mechanisms for airport development, including modifications to the PFC program, public/private partnerships and the possible creation of new financial institutions and techniques.