Return to NCARC Background papers Index

AIRPORT DEVELOPMENT NEEDS AND
FINANCING OPTIONS

June 4, 1997
AIRPORT DEVELOPMENT NEEDS AND FINANCING OPTIONS

Table of Contents

I. Introduction
II. National Airport System Description and Basis of Federal Interest
III. Airport Capital Needs Requirements
IV. Current Funding Sources
V. AIP and the Current Budget Environment
VI. Financing Options

APPENDICES

Appendix A

• Formula Distribution of Funds for Fiscal Year 1997
• Funding Distribution
• Formula Distribution

Appendix B

Scheduled LOI Payment Stream

AIRPORT DEVELOPMENT NEEDS AND FINANCING OPTIONS

I. Introduction

The National Civil Aviation Review Commission (NCARC) is encouraged by its enacting legislation to consider airport infrastructure needs for large, medium, and small airports, and to provide recommendations on funding alternatives for airport capacity development. In examining the issues associated with airport capital financing requirements, the Commission will need to address several key questions:

• What are the capital needs of airports and is current funding (considering all sources of revenue--Federal/non-Federal) sufficient/insufficient to meet this need?
• Should a Federal grant program be continued?
• If a Federal grant program is to continue, how should it be financed, at what level should it be funded, and which airports should be eligible to receive grants?
• How does the Federal role and public interest in airports remain intact if some airports become ineligible for Federal grants?
• If PFCs are increased, what terms and conditions should accompany the increase?
• In addition to AIP and PFCs, are there other funding alternatives for airport capacity development that warrant consideration?

II. National Airport System Description and Basis of Federal Interest

The United States accounts for approximately 40 percent of all commercial aviation and 50 percent of all general aviation (GA) activity in the world. An extensive system of airports has been developed to support this system. The Secretary of Transportation, in a biennial report to Congress, is required to identify those airports that are important to national transportation and, therefore, eligible to receive grants under the Airport Improvement Program (AIP). This report--the National Plan of Integrated Airports (NPIAS)--currently designates 3,331 of the 18,292 existing airports in the United States as components in the national system.

Historically, Federal involvement in airport development has been intended to ensure the public on-demand access to the national air transportation system. Four objectives have guided Federal investments at airports:

1. Pursuing system goals such as safety and security;
2. Stimulating capacity projects of national significance;
3. Helping finance small and general aviation airports that are dependent on aid; and

4. Paying a major part of noise and environmental mitigation costs.

The Federal government's goal has been to provide a balanced transportation system, taking into account the diverse needs of different communities and the various segments of aviation, and coordinating planned airport development with plans for air traffic, approach and navigational aids, and other components of the air transportation system. As such, a broad range of airports are included in the NPIAS to provide a safe, efficient, and integrated system of public-use airports deemed necessary to serve various national interests associated with civil aviation, national defense, emergency readiness and the U.S. Postal Service. Airports currently designated in the NPIAS include:

• 411 primary airports, which have the vast majority of scheduled commercial service and enplane more than 10,000 passengers annually each. These airports, with their high level of commercial activity, form the vital network of air transportation needed to ensure the movement of people and cargo critical to interstate commerce and international competitiveness.
• 155 additional airports, which have commercial service and enplane at least 2,500 and no more than 10,000 passengers annually. These airports typically play important roles in providing scheduled commercial service to smaller communities.
• 319 reliever airports, which provide general aviation with access to large metropolitan areas, and aid in alleviating the demand placed on limited runway capacity of congested commercial service airports.
• 2,446 general aviation airports, which play an important role in linking the vast rural areas of the nation to the national economy. These airports are typically sponsored by county governments. In some regions, notably Alaska, general aviation is the principal means of passenger transportation. GA airports also frequently serve as the "spawning grounds" for aviation, providing training for all components of the aviation industry (i.e., facility managers, pilots, mechanics, etc.).

III. Airport Capital Needs Requirements

A. 5 Year Outlook--Independent Assessments

Capital needs at airports have traditionally been defined as those expenditures required to comply with Federal mandates (such as safety and security regulations), maintain infrastructure, accommodate growth, meet user requirements, incorporate technological enhancements or improvements, and mitigate noise and other environmental impacts. Some of these requirements are eligible for AIP grants, other, such as hangars and parking facilities, are generally not AIP-eligible.

As part of the Federal Aviation Reauthorization Act of 1996, Congress requested that both the General Accounting Office (GAO-Airport Development Needs, April 1997) and an independent entity (Coopers & Lybrand LLP-Independent Financial Assessment, February, 1997) provide independent assessments of future airport development capital needs. Both entities reviewed three airport capital requirement studies which had different conclusions as to the total estimated needs over the next 5 years. The studies were completed by three separate groups with certain differing underlying assumptions: (1) Airport Capital Development Needs Survey, developed by Airports Council International/American Association of Airport Executives, (2) Airport Marketing Information System (AMIS), obtained from an independent consulting firm by the Air Transport Association (ATA) and (3) The National Plan of Integrated Airport Systems (NPIAS), developed by the FAA.

Comparison of Three Estimates of Airport Capital Development Needs:

Source: United States General Accounting Office, "Airport Development Needs", April 1997. p.7.

Both the GAO and Coopers & Lybrand agree that there are several key reasons for the differing assessments of airport capital requirements: incompatibility and purpose of collected data, availability of data, and the underlying premise of the collection process. There are significant differences in terms of time periods, AIP eligibility, and data sources. Moreover, the purposes of the studies are different. The NPIAS is used primarily to describe the scope and needs of the national airport system, including a determination of which airports are eligible for AIP grants. The ACI/AAAE survey is used by the airport trade associations primarily to provide testimony to Congress and to "secure maximum funding for AIP". Finally, the AMIS is compiled primarily to assist companies that do business with airports by identifying future airport capital spending plans.

In its report, Coopers & Lybrand estimated that the average annual capital requirements total for 1997-2002 will be between $7-8 billion per year in constant 1997 dollars. However, this was not an independent assessment as their estimate was based on the three alternatives for estimating future airport capital requirements and the recent history of actual airport capital spending.

In trying to estimate future airport capital expenditure needs, the GAO created 4 separate models to create an estimated range of $1.4 billion to $10.1 billion per year from 1997-2001. This report also was not an independent assessment as the GAO relied on the three capital needs estimates as the basis for their study. The GAO airport capital needs range was summarized as follows:

Source: United States General Accounting Office, "Airport Development Needs", April, 1997.

1. Needs versus Demand

At present, there is no independent means of estimating airport capital needs requirements. The three studies noted above have all been made by parties with a direct interest in the level of Government AIP funding. Coopers & Lybrand notes: "It is difficult to rule out the possibility that current projections of needs might be shaped at least in part to influence AIP funding levels." A reduction in the Federally funded portion of projects may result in a self-prioritization of future capital needs.

Coopers & Lybrand suggested an analytical model that could be used to create an independent assessment of actual airport capital needs. They concluded, however, that having this information is unlikely to be worth the investment necessary to develop such a model.

Airports and airlines are likely to continue to debate airport "needs versus demand." On the one hand, airlines and the financial community argue that projects with "real" demand get funded, and that the negotiation process results in the best determination of the size and scope of an airport's capital program. In their view, financial feasibility serves as a test of need. On the other hand, airports believe that the size and character of airport investment needs are clear; that such needs are large, growing, and increasingly underfunded relative to the resources being made available. Further, airports argue that airlines have a stake in reducing the perceived magnitude of capital needs, and that airlines are not likely to be interested in landside and noise mitigation projects or facilities that permit new services and competition.

FAA has been urged to adopt alternative means of determining the capital requirements of airports. For example, the development of performance measures for the national airport system would enable the FAA to assess the condition and requirements of the nation's airport infrastructure. While the FAA's movement toward broader application of cost-benefit analysis to target grant decisions is a step in the right direction, the development of performance measures would aid greatly in understanding the infrastructure requirements of the system.

C. Emerging Costs

The FAA anticipates that airports will or could face additional capital requirements not quantified in recent capital projections. The cost figures associated with these requirements are not yet available. Emerging areas include:

• Security - Implementing recommendations from the FAA's aviation security advisory council and the Gore Commission will likely produce new access control requirements at medium hub airports in the fiscal year 1998-1999 timeframe;
• Next generation large aircraft - The introduction of larger commercial aircraft will significantly impact larger airports. Runway, taxiway and apron pavement will require strengthening and widening; land will be required for greater separation of runways and taxiways; and airfield signage and lighting will require reconfiguration. Introduction of the first of these aircraft is projected by the year 2003. The FAA, working with Boeing, has a RE&D effort underway to validate new design standards for pavement these aircraft will require.
• Part 139 requirements - Congress provided FAA authority to extend Part 139 certification requirements to additional airports, as proposed in a National Transportation Safety Board recommendation. The extension of Part 139 certification requirements will affect small non-hub and non-primary commercial service airports served by commercial aircraft with 10 to 30 seats. In total, 55 airports with limited certificates and 44 non certificated airports (excluding Alaska airports) will be affected. Costs are being determined in FAA rulemaking currently underway.
• NAS Hand-offs - Shifting financial responsibility to airports for Facilities and Equipment and Operating and Maintenance costs traditionally borne by the FAA continues to be considered as a potential source of cost savings for the FAA. An example of such cost shifting is airport approach lighting systems. Potential cost impacts to airports have not yet been determined.
• Environmental Mitigation - Potential changes in regulatory environmental requirements, particularly for air quality and clean water, could introduce substantial new costs for mitigation measures.
• Surface Movement, Guidance and Control Systems (SMGCS) - A new FAA safety and capacity program to permit continued surface operations in very low visibility weather conditions, SMGCS will involve planning and equipment costs at each of the approximately 75 airports expected to adopt SMGCS plans. Costs associated with compliance could run as high as $1 million per affected runway and taxiway system.

IV. Current Funding Sources

A. Overview: Airport Financing Dynamics and Partnerships

The preponderance of NPIAS airports in the U.S. are owned and managed by local governments or other nonfederal public authorities. The management structure of airports varies according to several factors, including size and type of airport and nature of market served. However, major U.S. commercial airports function as mature enterprises, employing up-to-date techniques of financial management and administration and generally accepted accounting principles.

The system of airport financing in the U.S. has been distinguished by its unique partnership between public and private interests. In the case of large and medium commercial airports, airport capital development financing has been disciplined by the interplay of airports and airlines, the checks and balances of the municipal bond market, and the "institutionalization" of particular procedures, methodologies and formulas employed in airport financial management.

Professor Richard de Neufville, MIT, in discussing the efficiency of this partnership structure, notes that in the US, public interest in airports is expressed in two ways: (1) Through public ownership of airports--both through the public agencies that directly own the airports, and indirectly through the Federal grant agreements that guarantee the existence, availability and open access of airport facilities of all sizes; and (2) Federal assistance--both directly by grants and indirectly because airports can finance projects through tax-exempt bonds which reduce the costs of financing. Professor De Neufville further notes that the public interest aspects of this partnership are balanced by economic efficiency--private lenders go to great efforts to insure that the commercial benefits associated with airport projects will be sufficient, and airlines likewise typically exert degrees of control over the size and timing of many airport projects.

B. Traditional Sources of Airport Capital Funding

There are basically five resources that are used separately or in combination to finance airport development:

1. Airport Cash Flow (rates and charges, concession revenue, rentals, fees, etc.)--Airport revenues include receipts from airline rates and charges such as landing fees and rentals, and revenue from airport concessions. Airport revenues are used to pay O&M expenses, to finance "pay as you go" capital projects, and are pledged to pay bondholders both principal and interest. At most commercial service airports, the financial and operational relationship between an airport and the airlines it serves is defined in legally binding agreements that specify how the risks and responsibilities of airport operations are to be shared between the two parties. Commonly referred to as "airport use agreements," these contracts generally specify the methods for calculating the rates airlines must pay for use of airport facilities and services, as well as identify the airlines' rights and privileges, which in some cases include the right to approve or disapprove any major proposed airport capital development projects (which the airlines are required to finance).
2. Revenue and General Obligation Bonds--In the 1950's and early 1960's, general obligation (GO) bonds were more widely used than revenue bonds for airport development. GO bonds were backed by the taxing authority of the issuer. Since the 1960's, airport revenue bonds have been the major financing mechanism for capital improvements at large, medium, and some small hub airports. These financial instruments pledge the airport's revenue streams to repay bond holders. The ability of an airport to utilize revenue bonds depends on a number of factors, including: debt structure; airport management, administration and scope of operations; revenue structure and financial operations, economic base; and plant. The availability of tax-exempt bonds is estimated to save airports and airlines over $1 billion a year in interest costs. (Airports and airlines also make extensive use of Special Facility bonds which are revenue bonds that are usually secured by the guarantee of an airport tenant. Also, airports continue to make use of GO bonds that are secured by the taxing authority of the issuer, but there is heavy competition to use such bonds for other municipal purposes.)
3. Airport Improvement Program (AIP) Grants--Since its inception in 1958, the FAA has managed federal grants for airport planning and capital improvement projects. Until 1970, these grants were appropriated from the general fund; in that year, the Airport and Airway Trust Fund and the resulting grant program entitled the Airport Development Aid Program (ADAP) were established by Congress. Revenues for the trust fund are derived from passenger ticket taxes and other excise taxes. The Airport and Airway Act of 1982 made some minor changes in the schedule of excise taxes and the grant program was renamed AIP. In FY 1997, the AIP appropriation was $1.46 billion. Appendix A details the formula distribution of funds.
4. Passenger Facility Charges (PFCs)--In 1990, Congress removed the statutory prohibition on airports charging a per passenger enplanement fee. Funds from PFCs were intended to finance airport capital improvements, with emphasis placed on capacity, security and noise/environmental mitigation projects. In granting airports the authority to impose PFCs (up to $3/passenger), the legislation adopted a PFC eligibility standard for PFC-funded projects largely similar (but not identical) to AIP eligibility. The legislation required airports to consult with airlines and other airport tenants, but overall "control" over the imposition and use of PFCs was reserved to the airport, subject to FAA approval of the application. At the time the legislation was passed, airport "control" over PFCs was viewed as in the public interest in order to foster competition and ensure longer term investments in airport infrastructure less likely to be supported by airlines, which tend to be driven by shorter term financial considerations. Since it was recognized that principally large and medium hub airports would benefit from PFC revenues, such airports imposing PFCs were required to "turnback" 50 percent of their AIP entitlement funds. (75 percent of the forfeited entitlements funds were used to create the AIP Small Airport Fund, benefiting non-commercial service airports and non-hub commercial airports. The remaining 25 percent was added to the AIP discretionary fund. Of this 25 percent, half was to be provided to small hub airports and half was to be distributed between other discretionary accounts. The idea was that small airports would not raise PFCs directly, and this was a way for them to benefit indirectly from PFCs levied by the larger airports.) In 1996, PFC funds generated over $1.1 billion. If all airports able to collect PFCs did so, the estimated revenue potential would be $1.35 billion a year. It should be noted that some airports have already fully pledged their PFC revenue potential well into the future. At these airports, PFCs may not be available to meet additional capital requirements, unless the PFC cap is lifted.
5. State and Local Grants--Aviation aid from State governments is estimated at about $500 million per year. State-imposed fuel taxes are the major revenue source for state aviation programs.

Revenue generating potential is a function of an airport's type and amount of aviation activity. As such, access to these five sources of financing varies widely among airports:

• Some large airports maintain substantial cash reserves. Large and medium airports are considered a sound credit risk and compete well in the credit markets with other municipal bond issues for capital. In fact, the borrowing power of large and medium airports has, through the years, led to arguments against continued Federal investments in airport capital financing at these airports. However, these airports face constraints--such as restrictions in use agreements, bond covenants, and local ordinances--which can limit access to bond financing. Further, the pressure to remain cost competitive with other airports limits the amount of borrowing an airport may elect to rate-base.
• Small commercial and GA airports often require subsidies from local and state governments to fund operating expenses and finance modest improvements.
• More than 50 percent (by dollar value) of all AIP grants are allocated to small commercial and GA airports. Most of these grants either fund safety related projects or preserve the existing infrastructure. Federal aid is critical to these airports because they generally cannot finance projects through rates and charges, and they have limited ability to borrow.
• PFC revenues are concentrated at high activity airports, with the top 10 airports generating 50 percent of total PFC revenue. The top 80 airports (those with over 1 million annual enplanements) are the greatest beneficiaries of PFC authority.

C. Estimated Airport Capital Development Expenditures

There is no well defined, widely accepted, and comprehensive database on airport capital expenditures. The table below outlines the capital financing from "known" sources, 1990-1996. This is a particularly interesting period to examine because PFCs were introduced as a new revenue stream beginning in 1992. During the past seven years, these sources have provided, on average, fairly constant capital spending at slightly over $6 billion a year.

"KNOWN" Sources of Airport Capital Financing

(in $ billions)

*Does not include GO bonds

It should be noted that the level of investment in any given year may vary depending on many factors. As such, the $6 billion "average" should not be viewed as a "cap" or a "standard" level of investment--the peak years in the table bear out this point. Further, the investment community is quick to point out that, if a "financially feasible" project is put forward, the marketplace will make the capital available.

In addition to the "known" sources of revenue, other potential sources of revenue are available but more difficult to quantify. For example, many small projects at airports are paid for directly out of the current airport operating budget. There is also significant private investment in hangars, cargo buildings, food preparation buildings, as well as substantial investments by tenants and concessionaires in the interior finish to terminal buildings. No reliable estimate is available for these expenditures.

V. AIP and the Current Budget Environment

During the past 10 years, the annual Airport Improvement Program appropriations rose from $1.268 billion to a high of $1.9 billion, and then declined to $1.460 billion. The current, frugal outlook for the Federal budget has put severe downward pressure on AIP spending, as evidenced by the Administration's original proposal of a $1 billion AIP funding level in FY 98. The pressure is particularly acute because of competition for funds from other FAA activities.

This has caused a number of problems for FAA program administrators and for potential recipients of grants. AIP has become a less dependable source of fund, as the relationship between authorized and appropriated levels has diverged. For example, the AIP appropriation for FY 97 is slightly less than two-thirds of the authorized level (see Table 1 on p. 10a). The instability of funding greatly complicates the ability of local airports to formulate multi-year capital financial plans, which must estimate Federal support as part of the total financing package.

The statutory formulas (entitlements, set-asides, and discretionary funds) that are used to direct Federal aid to specific types of development, do not function well at reduced program levels. The formulas that were put in place in 1990 were developed in anticipation of an AIP of about $2 billion annually. They recently have been tailored to accommodate the FY 1997 level of $1.46 billion. Further reductions in the AIP, using the existing formulas, would severely constrain allocations to reliever and GA airports, to discretionary funds and sharply reduce certain high priority set-asides, such as noise abatement.

Yet, reductions are clearly being considered.

The FAA budget can be divided into four major categories: operations; facilities and equipment (F&E); research, engineering and development (RE&D) and AIP. The budget for operations in FY 1997 is $4.955 billion, the F&E budget is $1.937 billion, RE&D is $208 million, and AIP is $1.46 billion. If the FAA is to meet even the most modest goals of its system modernization program there is little room to reduce the F&E budget. It is unlikely in the current legislative environment that funding for safety, security, certification and research will be further reduced. The operations budget pays the day-to-day cost of keeping the existing system going, and has proven to be the strongest competitor for monies that might otherwise have been appropriated to the AIP. While F&E and RE&D have remained essentially constant or decreased slightly over the past five years (with the sole exception of the safety and security increases suggested by the Gore Commission), the costs to operate the FAA have increased. That increase has been effectively offset by the reductions in the AIP (and, to a lesser extent other FAA programs).

The decision to continue AIP spending, at any level, will require a mechanism for program funding and some form of legislative change. For instance

• Using the existing tax mechanisms would require some form of legislative protection to ensure that adequate monies flow to the grant program on a stable basis.
• Assuming the FAA were to become completely user fee financed, substantial issues (such as a waiver under current "User fee" requirements) would need to be resolved to continue a grant program that subsidizes smaller users.

VI. Financing Options

A. AIP Modifications

Two AIP options have been developed. The first assumes that AIP funding will not decline below present levels. The second option assumes AIP funding levels will continue to decline.

1. Option 1: Maintain Basic Program with Refinements

The U.S. airport financing system is dynamic. As such, it is difficult to assign an optimal spending level to AIP. However, 3 ranges of AIP spending are discussed below:

• $2.0 billion or higher: during the 1990 debate on airport capital needs, consensus emerged in the aviation industry that, in addition to granting airports PFC authority, AIP spending would need to be increased to $2 billion a year or higher to satisfy infrastructure needs. Subsequent surveys of capital requirements have largely remained constant with the needs projected in 1990.
• $1.7 billion to $1.45 billion: On the high end of this range, the FAA is able to fund most safety, security, rehabilitation, standards and capacity projects. Toward the lower end, fewer capacity projects and LOIs can be funded, and the FAA imposes caps on the level of noise abatement grants. Refinements to the formulas might permit the FAA to better target AIP funds. Possible refinements could include:

(1) Increased funding for capacity projects and LOIs at large and medium hub airports, along with increased funding for noise mitigation. This would produce the greatest system benefits and enhance targeting of Federal investments to actual needs--such increases could be funded through reducing entitlements received by large and medium hubs;

(2) Large and medium airports not imposing PFCs should not be eligible to receive discretionary funds;

(3) States and the FAA should be permitted greater flexibility to increase the local matching share of Federal grants when issuing State apportionment funds and discretionary grants, thus leveraging more total investment.

• $1.2 billion and lower: At this level, the formulas do not permit an efficient targeting of AIP funds. Small and GA airports, as well as the noise abatement set-aside, would face severe cuts. AIP could require a new allocation system and alternative revenues would warrant serious consideration. (see AIP Option 2).

2. Option 2: Cost Savings Potential Within AIP

Future Federal grant investments at airports can be focused on four general areas targeted to support the national interest in NPIAS airports:

(a) Preserving infrastructure and accommodating modest growth at airports dependent on Federal aid;

(b) Ensuring compliance with Federal safety and security mandates;

(c ) Assisting local communities in mitigating noise and other environmental impacts associated with airport operations; and

(d) Stimulating capacity projects of national significance.

To arrive at potential cost savings within the AIP, each of these categories were examined below against the following factors: the FAA's Airport Capital Improvement Plan (ACIP) and National Priority System; the ability of airports to absorb the costs should AIP support be reduced or eliminated; and the ability to preserve the public interest absent the Federal expenditure. As a cross-reference, Table 2 (p. 12 a) identifies actual AIP allocations by airport category in FY 1996.

(a) Infrastructure Preservation at Smaller Airports Dependent on Federal Aid--AIP funds at airports dependent on Federal aid are invested principally on safety projects and to maintain the existing airfield infrastructure, particularly at GA airports. On a more limited basis, reliever, non-primary commercial service, and small and nonhub primary airports can also receive AIP for projects which enhance the efficient operation of the airport and expand capacity.

With the exception of some small hubs and the busiest GA airports, these airports have little or no ability to borrow. While small airports are very dependent on Federal aid, the current mandatory matching formula (typically 90% Federal, 10% State and local) does not permit scarce AIP funds to be spread widely.

The FAA estimates that an annual Federal investment level of $700 million to $800 million is necessary to preserve the public interest at the 3200 smaller airports. Almost half of this cost is to modify airports to satisfy current FAA design standards, which have changed since many of the airports were built. There is some question whether the cost of modifying low activity airports is warranted. Small airport costs might be substantially reduced if the FAA relaxed its emphasis on conformity to current design standards.

(b) Safety and Security Requirements (excluding projects at small airports addressed above)--FAA's National Priority System provides its highest rating to safety and security projects needed to comply with Federal mandates under Parts 139 and 107. At large and medium hub airports, safety and security projects account for $70 million to $100 million of AIP allocations annually. If AIP funding were eliminated for safety and security projects, alternative sources of revenues could provide replacement funding: (1) most airport-airline use agreements permit airport operators to rate-base costs of complying with Federal mandates, thus permitting costs to be transferred directly to airline rates and charges; (2) an increase in PFCs could also provide additional funds. The FAA's ability to ensure compliance with safety and security mandates is preserved by its Parts 139 and 107 enforcement powers; hence, AIP funds for these projects are not critical to preserving the public interest. (Note: arguments could be made that, particularly for security projects, Federal (not local) dollars should be obligated to protect U.S. citizens. In addition, by eliminating AIP funding for these projects, local governments would argue that it creates further unfunded Federal mandates.)

(c ) Noise and Environmental Mitigation--AIP funds noise compatibility planning and projects to mitigate adverse noise and other environmental impacts. Funding such projects may also play an important role in community acceptance of capacity enhancements at an airport. At its peak, the AIP noise set-aside was $238 million. The FY 1996 level was $182 and was insufficient to address worthy noise mitigation projects. This caused the FAA to ration available funds in order to allocate noise grants to as many airports as possible. FY 1997 noise funding of $140 million has exacerbated complaints about the inadequacy of Federal spending in this area. The FAA estimates that noise mitigation should be funded in the $200 million to $225 million range annually to support the level of requests currently identified in the FAA's ACIP.

If AIP funding were eliminated for these types of projects, small commercial and GA airports would most likely be unable to find alternative funding sources for noise mitigation. Large and medium hub airports could replace lost AIP funds if PFCs were increased or through rate-basing such costs (subject to airline approval in most cases). However, the FAA notes that AIP discretionary funds have been the primary source for noise mitigation projects. Airports have generally been reluctant to apply AIP entitlement funds or PFCs to environmental projects, and financing with bonds is rare. Preserving the public interest in noise mitigation, without AIP funding, may require imposing new conditions for approval on any PFC increase.

(d) System Capacity--The demand for AIP funding of capacity projects at large and medium hub airports can be gauged by the AIP amount needed for existing and new LOIs and to support phased construction projects begun in prior years:

• Appendix B identifies the payment streams for all outstanding LOI commitments. In FY 1998, LOIs at large and medium hub airports total $158 million.
• FAA has received new LOI requests totaling $2.3 billion. Of this amount, FAA estimates that $100 million to $125 million annually in new LOI payments would be sufficient to leverage and accelerate major capacity projects producing system-wide benefits.
• Current demand for phased capacity projects is $20 million annually.
• In addition to capacity projects, large and medium hub airports funding needs associated with major airfield rehabilitation projects are estimated roughly at $400 million a year.

A PFC increase would be necessary to offset a partial or complete AIP cut for capacity projects. A discussion of the attendant public interest and policy issues is contained in the PFC option section of this paper below.

B. Innovative Financing Techniques

Airports have had a traditional openness to innovation, with nearly 75 percent of airport development being financed with local and private funds. In this sense, the basics of innovative finance have long been institutionalized at large, medium and small commercial service airports capable of borrowing. However, there may be some potential to expand innovation to lower activity airports.

In a Report to Congress prepared by the FAA in 1996, four options for innovative airport finance were identified:

• use AIP grants to fund debt repayment reserves of airport revenue bond issues;
• authorize Federal guarantee of airport loans, analyzed assuming tax-exempt status;
• AIP eligibility for commercial bond insurance; and
• institute an airport loan fund.

In 1996, Congress granted the FAA authority to conduct a demonstration program and issue up to 10 AIP grants using the following innovative financing techniques:

• use of AIP for the payment of interest;
• use of AIP for credit enhancements, such as bond insurance; and
• flexible non-Federal match to AIP grants.

The FAA was prohibited from issuing AIP grants as a direct or indirect loan guarantee. (The U.S. Treasury is prohibited from directly issuing obligations exempt from Federal 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).

The FAA's initial experience with the program suggests all three techniques offer modest opportunities to leverage Federal funds. The experience also indicates that smaller airports are more likely to use AIP funds to pay interest or credit enhancements. Flexible non-Federal match also provides the opportunity to achieve greater local participation in projects, particularly at general aviation and reliever airports.

The concept of an airport loan fund is treated as a separate option.

C. PFC Modifications

Significant reductions in AIP levels and/or the removal of certain commercial service airports from AIP entitlement or discretionary eligibility would increase the role of the PFC. If entitlement funds were eliminated, the loss might be offset by increasing the maximum level or removing the cap on PFCs. The effect would vary with the level of passenger enplanements at the airport:

• at large airports, a $1 PFC increase would produce a $4 to $2 increase in new PFC revenue for every $1 of entitlement dollars foregone;
• at medium airports, a $1 PFC increase would produce a modest increase of revenue or no total change in revenue (break-even) for 50% of the airports; the remaining medium airports would experience a loss unless a $2 increase occurred;
• at small airports, for 25 percent of the airports, a $2 PFC increase would produce a modest revenue increase for some and a break-even for the rest; the next 25 percent would require a $3 PFC increase to enjoy either a modest increase or break-even point; and 50 percent of the airports would experience a net revenue loss even if the PFC were increased by $3.

A PFC increased tied to the reduction or elimination of AIP at affected airports raises a number of policy issues:

1. Preservation of Grant Assurances-- Airports accepting Federal grants must execute numerous binding assurances, including that the airport will be available on a non-discriminatory basis, and that rates and charges will be fair and reasonable. The threat of withdrawal of Federal funds has proven a formidable tool in achieving largely unbroken compliance with grant assurances. A PFC increase which concurrently ends eligibility under AIP for large and/or medium hub airports, will result in both airport users and the Federal government seeking new and equally persuasive means to achieve compliance. Options include adding such assurances to PFC approvals, to use of tax exempt financing, to an airport's Part 139 certificate, or to AIP grants if AIP discretionary funds are still available. This is largely a long range problem since current grant assurances are tied to the life of a facility financed with AIP (20 years).

2. Preservation of a National Airport System --- AIP and the FAA's attendant National Priority System guide investment decisions to ensure system uniformity and benefits. If airports are "opted" out of AIP, alternative means of achieving "system" goals will need consideration. For instances, AIP and PFCs tend to fund different kinds of projects. At large and medium hub airports, only 3 percent of AIP was used for surface access, compared to 22 percent of PFC for the same period. Airside/capacity work represented 76 percent of AIP at these airports, versus 23 percent of PFC. However, under the existing PFC statute, the FAA cannot apply its AIP priority system to proposed PFC projects. If a PFC increase is intended as a substitute for AIP funds, then AIP funding priorities warrant consideration as prerequisites to future PFC approvals.

AIP funds play an important role in providing seed money and in assisting airports in attracting private investment dollars for large scale development programs. The FAA has used AIP discretionary dollars to help shape investments in projects which generate system benefits. Depending on the level, a PFC increase at large and many medium hub airports could provide dollar-for-dollar substitution of forgone AIP entitlement and discretionary funds in most cases. Nonetheless, the allocation of some Federal dollars is often critical to securing local and financial community support for major development projects. Further, massive public works projects, such as a new commercial service airport, could be affected, in either timing, scale, or financial feasibility, without the presence of Federal dollars. One option for maintaining some level of Federal partnership in major projects would be to preserve an amount of discretionary AIP for projects generating significant system benefits. Preserving some AIP discretionary funds for large and medium hub airports also addresses, in part, "equity arguments". In other words, since revenues used to finance grant programs will likely continue to be generated from the commercial airports, some argue that these airports should receive some of the funds, rather than having the funds exclusively subsidize smaller airports.

3. LOI Obligations--Appendix B provides a schedule for Letter of Intent (LOI) payment streams at large and medium hub airports. LOIs have proven to be a successful and popular tool that airports and the FAA use to "seed" major development projects and to attract non-Federal funding sources. While a PFC increase could replace AIP entitlement and discretionary funds pledged in LOIs, there may be some desire to honor these obligations through continued use of AIP funds. In this case, a phaseout of AIP eligibility at large and medium hubs could be one approach or, if a discretionary AIP fund were preserved, LOI commitments could continue to be met.

4. Control--An increase in the PFC cap will inevitably re-open a key issue debated during the 1990 PFC legislative proceeding: who controls the use of the PFC funds. Under the existing statute and regulations, airports are required to "consult" with airport users on PFC plans and then make formal application to the FAA for approval. The statute requires that PFC projects must: preserve or enhance capacity, safety or security of the national system; reduce noise; or enhance opportunities for competition between or among air carriers. The FAA's authority to disapprove PFC use is limited to finding that the projects do not meet the statutory criteria, are not eligible projects or, if nominally eligible, are not justified by airport needs. The FAA cannot apply its AIP priorities to proposed PFC projects. However, the FAA has disapproved PFC use for runways, aprons and airport equipment not justified by the level of activity or the type of service at the airport.

The issue of control addresses the question of who, ultimately, is best positioned to make investment decisions at an airport. The U.S. financing system has been successful largely because this decision-making process has been shared. Because of the significant revenue potential of PFCs, and the potential that such funds could replace airport revenue bonds as well as AIP funds, the question of who controls any increase is one that will affect the financing partnership among the various parties, and the nature and timing of airport development. Three basic options have been identified on the control issue of a PFC increase:

a) Maintain the present system;

1. Grant airlines "veto" power over projects financed with the PFC increase;

c) Increase project justification requirements and expand FAA approval authority.

5. Level of Increase--The level of increase over the existing $3 cap will likely be dependent on the level of AIP funding and which airports are eligible to receive such funding. Given the legislative debate of 1990 which capped PFCs, it is doubtful that Congress will support an unlimited increase in the amount of PFCs an airport can impose.

D. Airport Infrastructure Bank

In 1995, the two principal airport trade associations (ACI-NA and AAAE) proposed the creation of the National Aviation Infrastructure Development Bank (NAIDB). Although loosely described as a "bank," it would not strictly follow traditional banking and deposit and lending practices.

This proposed funding mechanism would be managed by a not-for-profit organization, NAIDB, established by Congress. The NAIDB would be empowered to issue debt and provide funding for the FAA Facilities and Equipment (F&E) budget, the AIP budget, the Contract Tower program, and the Essential Air Service program. (It should be noted that since the NAIDB proposal was put forth, the EAS program has met its funding needs (up to $50 million per year) through another mechanism.) The NAIDB also would be empowered to collect user fees equivalent to 40 percent of the existing aviation excise taxes. The remaining federal aviation excise taxes would be reduced by a corresponding amount, and, along with General Fund contributions, would continue to fund FAA operations. According to proponents, the NAIDB could be structured to result in a reduced General Fund contribution.

The NAIDB would be authorized to provide funding of grants to airports for projects currently eligible under AIP standards. Individual grants would be subject to approval by the FAA. The NAIDB also would be authorized to provide funds for the portion of the Contract Tower Program that would become ineligible under cost-benefit criteria issued by the FAA in September 1995. Finally, it could issue guarantees and credit enhancements for debt issues of less than $15 million by small and non-hub airports and for other innovative airport financing arrangements.

This concept is discussed in greater detail in the Budget Treatment paper.

E. Privatization

Airports generate cashflow through two principal means: airside rates and charges, and landside revenue. Federal policy places constraints on the methodologies airports may use in establishing airside rates and charges. However, airports can employ a number of strategies to increase revenue streams from landside operations.

Airports have long recognized the importance of public-private partnership. Although all commercial airports in the United States are publicly owned, the private sector plays a significant role in their operations and financing. Airports have eagerly sought private sector investment in concessions and have encouraged private companies to operate many of the services provided by the airports. Employees of private companies, airlines, concessionaires, and contractors account for 90 percent of all employees at the nation's largest airports.

Commercialization of Assets

Despite the high level of private involvement, the trend toward further commercialization of airport activities is continuing. Some argue that airports have not yet exhausted the revenue generating potential of their facilities, and that the US could improve its ability to finance its airport system if it could improve its capability to develop and manage revenues.

Recent experience in Burbank, Indianapolis and Pittsburgh demonstrates the potential of further commercialization of airport assets. For example, at Pittsburgh International Airport, a private terminal operator has increased non-aeronautical revenues (food/beverage, retail and duty-free) at the airport from $23 million in 1991 to $66 million in 1995 while simultaneously receiving praise for customer service. At Indianapolis International Airport, the same private operator has guaranteed reductions in charges of $32 million over the ten year management contract to the carriers using that airport.

If airport operations were systematically commercialized on a large scale, one could expect to see the development of nationwide companies specializing in these kind of activities. These companies could develop world-class expertise in these operations, and may be able to apply it effectively over the range of airports for which they have contracted.

To induce airport operators to take full advantage of commercialization opportunities, it may be necessary to create incentives to prompt airports into taking the necessary steps. Such incentives might include:

• allow airport employees to share financially in revenue growth/cost savings;
• allow municipal/state airport owners to share gains in revenue and cost reductions with air carriers, while also allowing owners to use their portion for non-airport purposes.

Alternatively, disincentives could be put into place to spur further airport commercialization:

• require FAA to exercise oversight responsibility to ensure that all airports seeking AIP grants and PFC charges have maximized all revenue opportunities.

Privatization

Private operators have several advantages which permit them to operate airports more efficiently, resulting in higher revenues and lower costs. Therefore, even with the above incentives, it is likely that the privatization of airports has further potential to maximize revenue and minimize costs.

The possible sale or lease of commercial airports in the United States to private companies has generated considerable attention in recent years. Cities such as New York and Los Angeles have considered privatizing their airports. Privatization refers to shifting governmental functions and responsibilities, in whole or in part, to the private sector. The most extensive privatizations involve the sale or lease of public assets. Selling or leasing any of the nation's public commercial airports would require the support of local, state, and federal governments. Commercial airports are owned by local governments and, in limited circumstances, states and the federal government. However, commercial airports also receive federal airport development grants, have access to federal tax­exempt financing, and are subject to federal regulatory control. As a result, federal laws can substantially influence whether public owners would choose to sell or lease their airports and whether a private entity would want to be a buyer or lessee.

While several factors, such as providing additional private capital for development, are motivating greater interest in privatization, legal and economic constraints currently impede the sale or lease of U.S. airports. Although the FAA has permitted and even encouraged some limited forms of privatization, such as contracting for airport management or allowing private companies to develop and lease terminals, it has, in the past, had questions about the sale or lease of an entire airport to a private entity. The FAA will ensure that an airport sponsor, in selling or leasing an airport, meets the legal obligations that the airport had made to obtain a federal grant. Chief among these obligations are restrictions on using airport revenue. These restrictions are intended to ensure that revenue is not diverted from the airport for other uses and are interpreted by the FAA as not permitting public owners of airports to retain the proceeds from selling or leasing their airports. Also, according to the FAA, these legal obligations cannot be extinguished by repaying past grants to the federal government. The FAA's recently proposed policy on the use of airport revenue states that the agency will consider privatization proposals on a case­by­case basis and will be flexible in specifying conditions on the use of airport revenue that will protect the public interest and fulfill restrictions on diverting revenue without interfering with privatization. However, the FAA has not had a recent opportunity to specify these conditions in an actual case, and privatization is effectively discouraged as long as FAA considers sale or lease proceeds to be airport revenue subject to restrictions on diversion.

Predicting how various stakeholders might be affected by the sale or lease of airports largely depends on how such privatization might ultimately be implemented. For example, if sale or lease proceeds are not bound by federal restrictions on the use of airport revenue, then the local and state governments that own airports could receive millions of dollars from these proceeds as well as future tax receipts from privately owned or leased airports. However, airlines and their passengers could incur substantial additional costs if fees charged to airlines by privately owned or leased airports are unregulated or if privately owned airports lose access to some federal grants and tax­exempt bonds. Conversely, continuing to bar privately owned airports from obtaining some federal grants and from issuing federal tax­exempt bonds would have a positive effect on the federal budget if a significant number of airports were sold to the private sector.

Recognizing the barriers to and the opportunity to test the potential benefits of privatization, the Congress established an airport privatization pilot program as part of the Federal Aviation Reauthorization Act of 1996. As of October 9, 1996, the Secretary of Transportation could exempt up to five airports from some legal requirements that impede their sale or lease to private entities. The pilot program also requires that a sale or lease agreement meet certain conditions, such as requiring that the private owner or lessee maintain airport safety and security at the highest levels. In April 1997, the FAA proposed procedures for beginning to accept applications in December for participation as one of the five airports in the privatization pilot program.

F. Enhance Tax-exempt Financing

Airport revenue bonds are the single most important financing tool available to large, medium, and certain small hub airports. The nation's top airports boast an unbroken record of creditworthy financial performance, earning large and medium hub airports the status of premium-grade investments in the tax-exempt municipal bond market. Preservation of this financing tool will be essential to meeting the capital demands of the busiest airports. Notwithstanding the impressive trackrecord of airport revenue bonds, opportunities do exist to further enhance the borrowing power of airports. Under current rules, airport revenue bonds are categorized as "private activity" bonds subject to additional restrictions than "public/government purpose" bonds. If airport revenue bonds were re-categorized as government purpose bonds, debt financing would become an even more attractive component of an airport's overall financing strategy.

APPENDIX A

• Formula Distribution of Funds for Fiscal Year 1997
• Funding Distribution
  
  APPENDIX B