U.S. General Airport Revenue Bond Rating Methodology

Transcription

1 U.S. Public Finance Municipal Finance Rating U.S. General Airport Revenue Bond Rating Analytical Contacts: Harvey Zachem, Senior Director Karen Daly, Senior Managing Director April 23, 2014

2 Table of Contents Executive Summary... 4 Background... 5 Bankruptcy Assessment... 6 Analytic Focus... 7 Stress Testing... 7 Key Rating Determinants for Airport Debt... 8 Rating Determinant 1: Management... 8 Challenges of Deregulation and Evolving Airline Business Models... 8 Exogenous Events Ownership and Governance Management Experience Enterprise Risk Management Marketing Campaigns KBRA Management Assessment Rating Determinant 2: Economics/Demographics of the Service Area Economic/Demographic Drivers for Passenger Activity Connecting Hubs Multiple Airport Selection Los Angeles Region KBRA Key Economics/Demographics Metrics and Ratios Rating Determinant 3: Airport Utilization Airline Route Determinants Leasing Policies and Terminal Space Management KBRA s View of Enplanement Measures Physically Diverse Layouts Competitive Threats KBRA Key Airport Utilization Metrics and Ratios Rating Determinant 4: Airport Debt/Capital Needs KBRA s Analysis of Capital Planning Approach MII Approval Airport Funding Sources Debt Structuring Page 2 April 23, 2014

3 Variable Rate Debt & Other Products KBRA Key Debt/Capital Planning Metrics and Ratios Rating Determinant 5: Airport Finances Airline/Airport Business Arrangements Strongly Influence Airport Finances Cost Recovery Mechanism Financial Metrics Debt Service Coverage System Liquidity Airport Cost per Enplanement, an Overused Metric Airline Yield versus CPE Revenue Stream Diversification Revenue/Expense Management KBRA Key Finances Metrics and Ratios Rating Determinant 6: Legal Mechanics and Security Provisions Revenue Pledge Rate Covenant Additional Bonds Test Required Reserves Debt Service Reserve Fund Flow of Funds Bond Indenture or Bond Contract Amendments Additional Security Sources KBRA Key Legal Mechanics and Security Provisions Metrics and Ratios Applying the Key Rating Determinants Surveillance Summary Appendix I - Example of Applying the Key Rating Determinants Appendix II Glossary of Airport-Related Terms Page 3 April 23, 2014

4 Executive Summary This rating methodology describes the major factors that Kroll Bond Rating Agency (KBRA) considers when rating U.S. airport credits. Airports are among the most complex credits in the municipal sector, as many elements must be considered. The methodology provides a framework for assessing the credit quality of airports that encompass a wide diversity in size, operating environment, and revenue and cost structures. It also identifies the key rating determinants used in the rating assessment and discusses how they are applied in making a rating determination. For information on KBRA s rating scale, please see KBRA s Rating Scale and Definitions. The rating is based on an assessment of the airport or airport system s general airport revenue bond (GARB) overall credit strength and reflects the ability to make timely and in-full debt service payments. KBRA s analysis combines both qualitative and quantitative factors through a comprehensive assessment of the airport s: Management, Economics/Demographics of the Service Area, Airport Utilization, Airport Debt/Capital Needs, Airport Finances, and Legal Mechanics and Security Provisions Most airports are publicly owned, including ownership by local or state government, regional authorities and multiple jurisdictions. U.S. airports are unique governmental operations in that there is significant involvement from the private sector the airlines, terminal concessionaires, parking and rental car operators are mainly private entities. This differs from other municipal bond sectors. Airport roles are multi-faceted. They are charged with the movement of passengers and cargo, but also are critical to the national economy, as well as their local regional economies. Yet, by nature, airports are highly capital intensive, with reliance on external financing to meet infrastructure needs. Financing airport infrastructure is primarily achieved through the issuance of GARBs, although more limited bond security structures are also used, and in a few cases so is the general obligation pledge. Examples of airport projects that are financed include terminals and runways, control towers, baggage and security systems, airport transit systems, parking, and consolidated car rental facilities. In many cases, there is limited competition between individual airports within a particular market, and given high infrastructure-related entry costs and limited land availability, this situation is not expected to change measurably. All publicly owned airports operate under state statutes or state constitution recognition. State statutes and constitutions provide for state agencies, counties, municipalities, port authorities, or airport authorities to establish and operate airports. Federal law does not control the way that airports are operated in the same manner as state law. Federal law influences airport governance by requiring that the airport governing body have the ability to meet obligations to the Federal Aviation Administration (FAA) and the Transportation Security Administration (TSA). Federal law prohibits governmental entities that have no responsibility for the airport from regulating or taking revenue from the airport. All commercial airports that accept grant funding from the federal Airport Improvement Program (AIP) are required to agree to certain obligations, also referred to as AIP grant assurances. These include that the airport holds good title, airport revenues must be used for airport purposes, with revenue diversion prohibited except for a few grandfathered airports, make airports available for public use on a non-discriminatory basis, do not provide an exclusive right to an airline to conduct aeronautical activity, and maintain rentals and fees which make the airport as selfsustaining as possible. Federal law requires the airport operator to have a security program in place. Federal Page 4 April 23, 2014

5 law also prohibits state and subdivisions that neither own nor operate an airport from involvement in pricing, and route or service of an airline at the airport. Federal law makes a clear distinction between the entity that has decision making responsibility for the airport and other state and local jurisdictions. 1 Airports typically issue GARBs pursuant to a bond indenture. The bond indenture sets out the obligations and legal responsibilities, in the form of representations, warranties and covenants that the bond issuer grants to the bondholder. The representations, warranties and covenants will vary in form and definition and some indentures will provide for greater credit protection than others. Debt is typically paid through a net revenue pledge with debt service being the first payment priority obligation after operating expenses. KBRA s analysis will also generally examine the level of credit protection provided by the legal documents, including the airline-airport use and lease agreement, which lays out the responsibilities of both the airport and airlines, method of allocating airline costs, and airline rights and privileges. Background The airline industry has gone through upheaval commencing with the Airline Deregulation Act of 1978 and its attendant restructuring, followed by multiple recessions, the September 11, 2001 terrorist attacks, pandemics and tsunamis, fuel price spikes, the financial crisis, and current slow economic recovery. Following deregulation, the airline industry has gone through boom and bust cycles, and more than 150 airlines have entered various stages of bankruptcy, or gone out of business. This is attributable to oversaturation as deregulation encouraged many new carriers to enter the market and increased competition, as barriers to entry declined. Notwithstanding these issues, deregulation has made air travel affordable to large numbers of people who previously could not afford to fly, increasing the number of passengers, especially leisure travelers. Another aspect of change for the airline industry and airports has been the institution by airlines of huband-spoke systems for cost saving and flight frequency reasons, under which air passengers are delivered to hubs, where they connect on other flights to their ultimate destination. The hub and spoke system also allows for more efficient use of equipment and labor for a network carrier. Arrivals and departures are staggered so that employees and equipment can be used on a number of flights. The result for airlines is reduced capital and labor expenses for an equal number of flights. A recent trend has been the consolidation of the smaller hubs, especially those that are not well situated geographically, or whose function can be more efficiently performed by a nearby larger airport. Low cost carriers (LCC), which employ a point-to-point approach, rather than hub-and-spoke, have also become a significant factor in the airline industry. Historically, these carriers generally have had lower cost structures than the legacy carriers, and have offered lower fares with generally fewer amenities. However, in recent years the distinction in service between legacy airlines and LCCs has narrowed, and the fares by some of the most well-known LCCs are equal to or higher than the legacy carriers in many markets. Frequent flier programs, which are an incentive to passengers to choose an airline on a basis other than price, are now being offered by most carriers, legacy and LCC, with a variety of benefits and requirements. Legacy carriers benefit from global networks and marketing advantages that come with size, including negotiating corporate travel contracts. Increasing fuel costs exert pressure on airline cost structures. After relative stability in the first 20 years following deregulation, fuel costs have been anything but stable in subsequent years. Between 2002 and 2008 fuel prices increased continuously tripling between January 2002 and 2006, and then doubling between January 2006 and July 2008, when a peak of $3.82 per gallon was reached. Fuel costs have been 1 Airport Cooperative Research Program (ACRP) Legal Research Digest 7 Airport Governance and Ownership, Transportation Research Board of the National Academies, Washington, D.C., August Page 5 April 23, 2014

6 volatile in subsequent years, and as of December 2013 the cost was $ Airlines can make adjustments in scheduling in response to fuel spikes in an expeditious manner, but have limited capacity to make significant near-term changes in their aircraft fleets (i.e. older, less efficient fleet). The sharp spike in fuel costs and fiscal crisis in 2008, as well as consolidations and chapter 11 filings, resulted in a substantial reduction in service at many U.S. airports. At its peak, fuel costs accounted for approximately 40% of airline operating costs. Resultant airline activity changes fanned airport concerns regarding operating budget and capital plan impacts. 3 This degree of complexity demands a high level of management expertise, with an ability to adjust to an evolving environment. KBRA believes that heretofore the quality of management has been underemphasized as a factor in airport credit analysis in this the municipal market. Bankruptcy Assessment KBRA recognizes that significant uncertainty exists as to how the courts will rule on a number of issues regarding payments of different classes of municipal debt in bankruptcy (Chapter 9). Based on the current prevailing interpretation of Chapter 9, KBRA believes the following to be reliable assumptions. The following analysis assumes that a municipal airport or airport system meets the eligibility requirements under Chapter 9, including that it qualifies under the definition of municipality under the U.S. Bankruptcy Code and is located in a State that has specifically authorized it to file a Chapter 9 petition. Under Chapter 9, generally, revenues of a municipal enterprise, such as an airport or airport system, pledged to pay debt service on revenue debt, such as municipal airport bonds, would be classified under the definition of special revenues. Holders of bonds secured by special revenues that have been legally pledged to pay principal and interest as they come due on the bonds are entitled to certain protections unavailable to other creditors in a Chapter 9 bankruptcy proceeding. First, unlike with other pledges made by a debtor municipality that occurred before it filed its municipal bankruptcy petition, a pledge of special revenues to payment of revenue debt does not terminate upon a bankruptcy filing. Thus, pledged special revenues received by a municipal airport or airport system after the filing of a Chapter 9 petition remain subject to the pledge contained in the underlying bond documents, although the special revenues collected are subject to the necessary operating expenses of the airport or airport system, which must be paid before bondholders may be paid as set forth in the bond documents. Therefore, subject to the necessary operating expenses of the airport or airport system and subject to the availability of special revenues received with respect to the airport or airport system, KBRA believes that bondholders should continue to receive regularly scheduled payments on the revenue bonds as provided under the bond documents during a Chapter 9 proceeding. Secondly, under Chapter 9, the preference provisions contained in the U.S. Bankruptcy Code do not apply to payments made on bonded indebtedness by a municipality, meaning that a debtor municipality may not claw back payments made to bondholders pursuant to the terms of the bonds that were made within the 90 days preceding the filing of the bankruptcy petition. Additionally, KBRA believes that general creditors of the municipality may not receive payment of their claims from the pledged special revenues securing the municipal airport bonds and holders of bonds secured by a pledge of special revenues may not receive payment from sources other than the revenues pledged for payment on the bonds. Along with the protections afforded to holders of bonds secured by a pledge of special revenues in Chapter 9, some state statutes may include language automatically establishing a lien in favor of bondholders on the airport revenues of a municipality without requiring the municipality to take any action. KBRA believes that should such a state statute exist, the lien created by the statute should not 2 Bureau of Transportation Statistics F41 Schedule P12A as of 3/10/14, U.S. Department of Transportation. 3 ACRP Report 48 Impact of Jet Fuel Price Uncertainty on Airport Planning and Development, Transportation Research Board of the National Academies, Washington, D.C Page 6 April 23, 2014

7 be terminated by the filing of a bankruptcy petition and should survive the bankruptcy filing, requiring that the funds collected to pay the principal and interest on the bonds may only be used by the municipality for that purpose. KBRA acknowledges that the legal status of the pledged special revenues under Chapter 9 may not insulate the airport from being impacted by a Chapter 9 filing. The City of Detroit Chapter 9 filing has highlighted the potential for a water and sewer system debt and by extension airport revenue debt to be brought into the negotiations with creditors when the water and sewer system or airport is owned by a city or county, a situation which applies to approximately 55% of airports across the country. KBRA notes that the Detroit bankruptcy court has not made any ruling that would change the status of special revenues under a bankruptcy and it seems likely that the legal status will not change, though, through negotiation, bondholders may agree to certain changes in security provisions. KBRA further notes that at the time of this assessment, the City of Detroit s proposed plan of adjustment suggests that the City could alter its obligations to holders of the City s water and sewer debt, although the City proposes paying the principal due on that debt in full. The bankruptcy court has not issued a determination as to whether the water and sewer bonds may be altered by a plan of adjustment given the application of the special revenue provisions of Chapter 9. KBRA will continue to monitor changes in case law under the U.S. Bankruptcy Code pertaining to the status of special revenues in bankruptcy proceedings. As part of the rating assessment for municipal airport bonds, KBRA will review the statutory framework within the particular state as well as the legal and financing documents for the specific issue to determine that the pledge of the airport system revenues is legal and in the form that would allow the pledge to be classified under the definition of special revenues in Chapter 9. To the extent that KBRA is satisfied with the legal analysis of the special revenue pledge and is of the opinion that a bankruptcy filing by the municipality would not impact the special revenue pledge of its utility systems, the airport revenue bond rating should not be limited by the general obligation rating of the municipality. Analytic Focus KBRA s rating of airport revenue bonds will be based on the analysis of six rating determinants that encompass the important aspects of an airport or airport system credit, including management, security provisions, service area, system characteristics, financial metrics and debt structure. A focus of KBRA s analysis will be the assessment of the strength of management and the underlying factors that support demand for air travel at the airport. As part of the overall rating evaluation, KBRA will typically assign a rating to each rating determinant. Within each rating determinant, KBRA has identified a set of characteristics that are reflective of different rating levels for the specific rating determinant. These characteristics are representative but do not encompass all factors taken into consideration when making credit judgments, and should not be considered in isolation. After completing an assessment of each rating determinant, KBRA will typically balance the specific rating factors and assign an overall rating to the issue. Stress Testing KBRA typically applies a stress test during the airport rating process. The goal in this process is to fully assess the resiliency of an airport or airport system s ability to make in-full and timely debt service payments under certain stress scenarios. The stress testing scenarios will be tailored to the issuer and will be based on scenarios that KBRA expects the issuer could reasonably experience. KBRA may haircut projected airport revenues from a largest carrier or particular group of carriers to test revenue concentration sensitivity levels. In general, KBRA may change the assumptions about revenues an issuer anticipates receiving from a new infrastructure project. KBRA may stress test airport enplanement assumptions and the resulting impact that economic downturn; pandemics, weather-related events or geopolitical crisis could have on revenues Page 7 April 23, 2014

8 collected. KBRA may also stress test a system s ability to accommodate the financial ramifications of an unexpected emergency capital expense. The ultimate goal in applying the stress testing scenarios would be to study the impact on airline costs and the airport s competitive position. In general, each stress test scenario that is applied will be described in the KBRA rating report. Key Rating Determinants for Airport Debt KBRA s rating evaluation of the long-term credit quality of airport revenue bonds generally focuses on six key rating determinants: Management, Economics/Demographics of the Service Area, Airport Utilization, Airport Debt/Capital Needs, Airport Finances, and Legal Mechanics and Security Provisions As part of the overall rating evaluation, KBRA will typically assign a rating to each rating determinant. However with respect to the management determinant, KBRA believes a characterization of Favorable, Satisfactory or Weaker best describes the outcome of our analysis. The analytical process employed in determining an issuer s rating will be flexible enough to account for the significant differences that exist between individual issuers. The rating determinants listed above may communicate different profiles about the creditworthiness of the issuer and weakness in one category may be balanced by strength in another. Within each of these six primary rating determinants, KBRA has identified specific credit factors that will generally be considered in the rating process. Each of the six determinants is assigned an individual rating based on the individual credit factors that are considered within the individual determinants. After the individual ratings are assigned to each determinant the KBRA ratings are balanced to arrive at the final KBRA rating. Rating Determinant 1: Management KBRA believes that evaluation of airport management is an important component of our credit analysis. Airport management requires a high degree of expertise, since it is complex and multi-faceted. Management s horizon spans the near-term, medium-term and long-range, encompasses daily operations, capital planning/debt issuance, maintaining financial stability, and articulating policy goals. Airport managers are charged with crisis management, overseeing relationships with airlines, negotiating use and lease agreements, concessions management, delivering capital projects within budget and without unnecessary delays, marketing the airport as a means of encouraging airlines to establish additional destinations and raise flight frequencies, cost recovery mechanism implementation and oversight, attending to environmental and regulatory issues, and community affairs. Challenges of Deregulation and Evolving Airline Business Models KBRA believes that the role of management has taken on increased prominence beginning in October 1978 with the passage of the Airline Deregulation Act. Prior to the Act s enactment, the airline industry was more like a regulated utility, as airline routes and fares were set by the Civil Aeronautics Board (CAB). In the 27 years before airline deregulation, no airline went bankrupt. 4 Today the industry reflects the dynamics of the market. Airline fares, routes, and schedules now derive from the public s demand for travel, airline 4 The High Price of Airline Deregulation David Harris, AlterNet, September 14, Page 8 April 23, 2014

9 operation and maintenance costs, and the competitive environment among airlines. Since deregulation, many airlines, including a number of legacy carriers have filed for bankruptcy protection. The competitive landscape has undergone a total transformation, as passenger volumes skyrocketed, and fares dropped sharply. The emergence of low cost carriers was a critical factor. In response to deregulation, legacy carriers greatly expanded the use of hub-and-spoke networks and created connecting hub airports around the country. Another trend as part of evolving airline operations has been shortened airline-airport use and lease agreements. Historically, these agreements were in place for periods of up to 30 years, and coincided with the term of the airport s bond issue. It was assumed by the investor markets that stable and long-term commitments by the airlines were required in order to ensure the continuation of the revenues to support the repayment of debt. Today the duration of agreements has shortened to a great degree, with many in place for five years. Airports have demonstrated the credit strength of their underlying markets and investors have come to understand that the market rather than the brand of the airline currently serving the passenger provide the foundation for the revenues. The shortened agreement length reflects a more dynamic environment, with both airline and airport management requiring greater latitude to modify their operations and governing documents as conditions merit. In KBRA s opinion, the shorter duration of the agreements may increase airport operator vulnerability to airline industry uncertainties, since agreements now have to be negotiated on a more frequent basis. However, this also provides the opportunity to adapt to changing conditions. This situation is made more complicated given the current potential for heightened airline financial weakness. In the current ever dynamic airline industry, the likelihood is high that the carrier mix serving the airport and the levels of service by all carriers could change significantly before the debt associated with a capital project is fully retired. This places a premium on management s ability to correctly size its capital projects to expected demand, and also maintain a level of unrestricted reserves for contingencies. With these changes, the credit analysis of an airport rightly shifted from an assessment of airlines to a true evaluation of the airport. 5 Commercial airports are highly complex entities. Unlike other public finance bond sectors, there is a need to manage relationships with private entities, namely the airlines. These interactions come to the fore at the time of renegotiating use and lease agreements, which include majority-in-interest (MII) 6 provisions, which determine control over airport capital development projects. The fact that these agreements are now of more limited duration means that negotiations are more frequent, potentially creating more basis for contention. Furthermore, the environment has stabilized in recent years but remains prone to cyclicality, and exogenous shocks. The industry is now characterized by limited competition for market share, a diminished threat of new entrants, low, but improving profit margins, and volatile fuel prices and economic conditions. Labor issues also loom. Voters in the Seattle, Washington suburb that includes Sea-Tac Airport approved a ballot measure requiring a $15 minimum hourly wage in November While the economic effects of such a measure are debatable, the potential for higher airline costs caused Alaska Airlines to announce it may consider re-routing certain Sea-Tac flights as a cost saving measure. 5 Airport/Airline Agreements-Practices and Characteristics, Airport Cooperative Research Program (ACRP) Report 36, Transportation Research Board, Washington, D.C MII clauses are usually found in residual-based use and lease agreements. Under these clauses, signatory airlines have the right to approve or reject proposed airport capital programs. A typical clause may grant MII rights to 50% of scheduled airlines that account for more than 50% of landed weight. Page 9 April 23, 2014

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11 Sources: USDOT O&D Survey, Form41, and T100 Databank. Data compiled by InterVISTAS Consulting LLC. Graphic by HNTB Corporation Exogenous Events The airport sector is subject to risks, some that can be planned for, but others may be largely unforeseen. Twenty-first century events provide confirmation. The September 11 th, 2001 terrorist attacks have had a significant adverse impact on the airline industry, specifically affecting security, regulations, and operational costs. Airline industry upheaval results in revenue reduction for airports. The 9/11 attacks occurred during the economic recession following the technology bubble bust, which led to five years of negative profitability for the industry. The Iraq War also reduced air travel. During , the U.S. airline industry recorded a large boost in profitability, which was again reversed in 2008 due to the financial market collapse and a large oil price spike, and rose to profitability again in Favorable trends continued in 2013, and record profits are expected in 2014, according to the International Air Transport Association (IATA). Driving the recent airline trend is continued capacity discipline, and network restructuring through consolidation. The years following the 9/11 terrorist attacks underscore how the impact of exogenous factors on airport operations has sped up and intensified. Besides terrorist attacks, airport management has had to react to recession and pandemic in the form of the Severe Acute Respiratory Syndrome (SARs) outbreak in and the H1N1 virus in 2009, the spread of which was facilitated through air travel. The timeliness and effectiveness of management s ability to adapt to changed circumstances is critical. This is why KBRA views management as an important rating determinant by itself, but it is also incorporated in other rating factors that we consider. In general, KBRA believes there is no substitute for management experience, especially when demonstrating a successful record of dealing with adverse events. KBRA believes that airport managers are at the mercy of a quickly evolving aviation industry, where there is increased competition among airlines, aging infrastructure and/or outmoded facilities due to technology advances, airline financial instability due to economic weakness, wage pressures, and fuel cost variability. In addition, airports have come under growing pressure to increase non-airline revenues. Since airline deregulation in 1978, airline competition has been so intense that there have been in excess of 150 bankruptcy filings, although not all of these have resulted in liquidation. Bankruptcies raise issues for airport managers that could severely affect revenues, including the payment of pre-petition and post-petition amounts owed by airlines for use of airport facilities, passenger facility Page 11 April 23, 2014

12 charges, and the bankrupt airline s acceptance or rejection of its leases at the airport. Bankruptcy may be of a more critical nature when an airport s revenues rely on a primary carrier. For example, the 2004 bankruptcy of US Airways, the second in two years, occurred amidst its de-hubbing at Pittsburgh International Airport (PIT) and sharp reductions in flights. In 2000, US Airways and its affiliates accounted for more than 87% of passenger enplanements, and 60% of all enplanements were connecting. More than $900 million in revenue bonds were issued in the early 1990s to build facilities largely to US Airways specifications. The airport was downgraded by other rating agencies to the mid-bbb level in In KBRA s view, during a crisis the onus is on management to formulate solutions which limit the airport s long-term financial exposure. For example, the implementation of payment plans for pre-petition debt for airlines in and emerging from bankruptcy. After 9/11, various approaches were tried to stabilize airport and tenant operations. Various airports undertook refinancings for savings that were passed through to the airlines in the form of reduced charges. Some airports restructured outstanding debt by deferring principal retirement. Management also delayed capital projects, or reassessed planned capital programs. In instances where airports have had carriers defaulting on or rejecting leases or contracts, some airports have worked out sub-leasing arrangements with the bankrupt airlines to reclaim these facilities, and subsequently reallocate them to other airlines. 7 Ownership and Governance While essentially all commercial airports are publicly owned, the governmental ownership structures differ. They include general purpose governments at the federal, state, county and city levels, and special purpose entities like airport authorities and port authorities. While state and local governments govern airports directly, in many cases they have placed day-to-day operations in the hands of an airport authority. Although airports can be categorized by ownership, it is how they are governed that forms the basis for evaluation. Due to the various governance approaches, no two airports are exactly alike in structure. Airport owners choose governance structures that foster efficient operations, ease capital market access, and lessen political intrusion. Several of these public entities like the Port Authority of New York and New Jersey (PANYNJ), and the City of Chicago operate more than one airport. Some, including PANYNJ and the Massachusetts Port Authority are responsible for additional modes of transportation besides airports. 8 Management Experience Given this level of complexity, management experience is highly valued. We expect that management turnover will be limited and transitions will be smooth. In reviewing management, KBRA requests disclosure regarding how the airport is governed, and which governmental entity or entities own the airport, and how they interact. This includes a description of both the governing body and the ownership entity, whether it is a state, county, municipality, or independent authority. KBRA also expects to review information on the powers granted to the airport s governing body, as opposed to being retained by ownership, and the method of selection for members of the airport s governing board. KBRA looks at the degree of day-to-day operational autonomy of the governing board, and who bears responsibility for setting strategies, planning, forecasting, overseeing capital plans and operating budgets, and financial and debt management policies. To that end, KBRA typically requests biographical information regarding senior airport management, whether they are employees of a state, county, municipality, or an independent authority. This information includes tenure at the airport, prior industry experience, and responsibilities. In general, KBRA also assesses the airport s organizational structure, and employment base. 7 The Impact of Airline Bankruptcies on Airports Legal Research Digest 6, Airport Cooperative Research Program, May Airport Governance and Ownership Legal Research Digest 7, Airport Cooperative Research Program, August Page 12 April 23, 2014

13 Airport managers face economic, political and environmental challenges, and must deal with an array of business partners and stakeholders. These include airlines and other tenants, passengers, local communities, and auditors. In addition, airports are subject to federal, state, and local regulations and ordinances. In an era where environmental practices have come under greater scrutiny, airport management is charged with water conservation efforts, wastewater and air quality management, noise mitigation, and recycling programs. Environmental policies, together with social and economic practices are the three components of airport sustainability. Sustainability has taken on increased importance for the aviation industry over time. Meeting goals and objectives associated with sustainability requires funding and additional staffing. Given limited available airport resources, ongoing challenges are likely for airport managers. Enterprise Risk Management All aspects of airport operations are susceptible to risks. They are subject to weak macro-economic conditions like the global financial crisis, increasingly important geopolitical events that result from greater world connectivity, natural catastrophes, weather extremes, airplane accidents, terrorism, volatile fuel prices, and environmental factors. Managing these risks is among airport management s diverse responsibilities. Management needs to be cognizant of the potential impact of such factors in the course of establishing its initiatives, financial plans, and capital programs, and establish plans that account for potential risk scenarios. As part of establishing a process, managers must identify, assess, and prioritize these risks, and formulate mitigation plans. KBRA believes that forward thinking policies and procedures are critical for an airport s long-term viability. These policies and procedures should be formalized as long-term strategic plans, evaluated as to their appropriateness over time, and modified when necessary. Foremost among strategies is business continuity. Management should engage in succession planning to ensure that pending retirements, and unexpected departures will not hamper operations. Ideally, management will have adopted a leadership development program that establishes a culture of continuous improvement which broadens knowledge and increases redundancy. Given the capital-intensive nature of an airport and limited resources, KBRA believes management needs to be continually looking to find efficiencies in personnel and resources. Marketing Campaigns Besides the obvious role in providing critical transportation links that facilitate the movement of people and goods, airports are also significant economic assets that are viewed as catalysts for local economic development. Their ability to generate jobs and attract new business has been used to justify airport investment and expansion. Airport management is at the forefront of these efforts. Airports operate in highly competitive environments, and there are frequently winners and losers. Therefore, the effectiveness of the airport s marketing campaign is critical in meeting goals. Convincing airlines to increase the number of domestic and international destinations served by the airport and raise flight frequency brings prestige and improved customer access. It can also potentially result in the siting of nearby corporate and regional headquarters, shipping operations, and service jobs. In addition, businesses like hotels, freight forwarders, warehouses, and manufacturing and service industries are attracted to the vicinity of an airport. The ability to market effectively is critical to promoting enhanced airport utilization, and/or retaining current passenger, business, and tenant levels. A marketing plan that lays out goals and objectives is also critical to enlist community support for the airport. Airport operator outreach should be focused on galvanizing support among key area governmental and institutional stakeholders. Management needs to employ business development professionals to market the airport using market research tools, prepare and develop marketing plans, and out-source marketing efforts when the degree of program complexity exceeds internal expertise. Page 13 April 23, 2014

14 KBRA Management Assessment Airports or airport systems with ratings in the following assessment categories for Rating Determinant 1 (Management) may demonstrate one or more of the following characteristics: Management Tenure and Track Record Rating Determinant 1: Management Favorable Satisfactory Weaker Management is highly experienced and has demonstrated success in management of facilities and relations with public and private constituents, met budget requirements, navigated through adverse economic events, "acts of god", and executed complex capital plans. Management departures are opportunities to supplement management skills and add new perspectives Management has likewise been effective, but has not had experience with the adverse exogenous events. Management team turnover has not resulted in any transition issues. Management has less industry experience, or a shorter tenure at the airport being evaluated. Some turnover in management team noted, and transition issues are evident. Forward-Thinking Policies and Procedures Management has formalized process/procedures and adopted business strategy, financial forecasts, business continuity planning, risk management, marketing plans, corporate plans, and outreach programs. Management has formalized process/procedures and adopted business strategy, financial forecasts, business continuity planning, risk management, marketing plans, corporate plans, and outreach programs. Absence of, or piecemeal approach to policies and procedures. Airport/Airline Relations Airport management and signatory airlines have demonstrated an ability to reach consensus on airline/airport use and lease agreement issues, and have settled grievances in an expeditious manner. Leasing and terminal use policies present an effective balance in meeting airline needs, and protecting airport's long-term interests for optimal facility utilization. While agreement was ultimately reached, process was not entirely smooth, and took longer than anticipated. Inability to achieve consensus results in periods lacking use and lease agreements. Situation may also be characterized by airline turnover. This scenario should be distinguished from a situation where airports are operating under ordinance methodology, reflecting strong airline-airport relations, which precludes need for an agreement. Management of Operations and Facilities Management has processes and procedures for the safe, secure and efficient operations of the airport in compliance with state regulations. Management has developed and effectively carries out plans for irregular operations due to weather as well as airline problems. Management has defined the maintenance needs necessary to keep its facilities in a "state of good repair", and practices effective enterprise asset management. Management focuses on promoting customer services as part of its operations. Management has processes and procedures for the safe, secure and efficient operations of the airport in compliance with state regulations. Management has developed and effectively carries out plans for irregular operations due to weather as well as airline problems. Management has defined the maintenance needs necessary to keep its facilities in a "state of good repair", and practices effective enterprise asset management. Management focuses on promoting customer services as part of its operations. Numerous safety and security breaches and discrepancies noted by FAA/TSA. Several major facilities are in a state of disrepair. Management is ineffective in managing irregular operations. Numerous customer and community complaints are received regarding poor facility conditions and customer service levels. Financial Management Policies and Procedures Formalized financial management policies that require multi-year budgeting and frequent review of performance; financial plan and debt management policy with attention to management of financial risks; consistent application of policies Formal and informal policies, adequate procedures for the proper management of the organization's finances are in place. Informal policies; gaps in financial procedures and checks and balances. Page 14 April 23, 2014

15 An airport or airport system with a management assessment that is extremely weak may have a very limited management team with inadequate, or notably absent financial management practices and procedures, contentious relations with airlines, troubling safety and security breaches, and a high level of customer/community complaints. Rating Determinant 2: Economics/Demographics of the Service Area In KBRA s view, the size, strength, nature and diversity of the airport service area s economic base is the key determining factor in origination and destination passenger volume at an airport. An additional variable is the proximity of competing airports. Connecting passenger activity through the establishment of hubs essentially relates to geographical considerations and/or strategic decisions made by airlines. These decisions may or may not reflect the characteristics of the indigenous service area. KBRA uses metropolitan statistical areas (MSAs) as delineated by the Office of Management and Budget (OMB) of the U.S. Department of Commerce for service area analysis. KBRA believes that MSAs are economically and socially integrated, and form catchment areas for origin and destination travel. Nevertheless, each airport and the service area that supports it, have unique characteristics. Economic/Demographic Drivers for Passenger Activity The nature and magnitude of economic activity in a metropolitan area is a driver of origination and destination enplanement numbers, as business activity generates air travel, although certain businesses are more prodigious generators than others. Airlines place a premium on business travelers, since they are somewhat less sensitive to high fares than non-business travelers. Wealth levels are an additional indicator, as higher wealth correlates with increased discretionary air travel. Areas that are destinations for leisure activity generally yield relatively greater destination enplanement activity, although they may exhibit cyclical behavior, especially during periods of economic weakness, and are more sensitive to fare increases. Trends in population, income per capita, and unemployment are also illustrative of recent and future patterns. KBRA also generally reviews educational attainment and poverty levels of the area population. A well-educated, working-age population and a population with low levels of poverty generally translate into proportionately higher levels of air travel, as well as acting as an impetus for businesses seeking to locate new offices or plants. KBRA typically looks at the relative level and growth in educational attainment ratios, defined as the percentage of the population that holds a Bachelor s degree or higher. KBRA commonly reviews the current poverty level, defined as the percent of the population below poverty, and the trend over the past 10 years. As discussed in KBRA s U.S. Local Government G.O. Rating, KBRA typically analyzes the trends in population gains or losses between census surveys and examines the explanation behind the changes, which may include: an aging population, regional trends, employment shifts, immigration, migration, and cost of living. MSA trends may be compared with state and national trends. KBRA expects MSA population to be stable to growing. KBRA would also expect to see the rate of population growth equal or exceed that of the nation. A declining population, or one that is growing at a slower pace than the nation, may be indicative of a deteriorating or non-competitive underlying economic base. KBRA also typically evaluates the degree of population diversity in the MSA. An ethnically diverse population is likely to generate demand for air travel, whether it is trips to homeland countries, or relative visits from abroad. It has been shown that members of ethnically and racially diverse groups spend a higher proportion of income on air travel than do average U.S. households. 9 Income and employment are key measures in wealth levels in a service area and will likely correlate with airport passenger activity. KBRA typically assesses per capita and/or household income within the service 9 Who s Buying for Travel, 7 th Edition, 2010, New Strategist Publications, Tapestry Segmentation Reference Guide, 2012 ESRL Page 15 April 23, 2014

16 area relative to state and national averages. KBRA ranks the following per capita personal income levels as a percent of the national average into the following categories: Above 130% Very High Between 115% and 130% High Between 100% and 115% Average to Above Average Below 100% Below Average to Low Housing values are also an important indicator of economic health of the service area, as is affordability. KBRA recognizes that housing costs vary depending on the region of the country, and that all regions recorded declines during the financial crisis. Housing value declines resulted in lower wealth levels that contributed to reduced expenditures on air travel. To gauge the degree of recovery, KBRA uses the Standard & Poor s/case-shiller Home Price Index, comparing the ratio of most recent price to the peak price for the MSA. In general, KBRA reviews total employment trends and the composition of the employment base to assess overall economic activity in the area. Workforce composition and employment mix by type of employer and industry concentrations are other key variables that will typically be reviewed by KBRA. Annual and monthly data are available from the U.S. Department of Labor, Bureau of Labor Statistics, and is frequently found in the airport consultant s report. A service area with an unemployment level or trend that is above state and/or national averages would be viewed as a credit weakness. KBRA is typically looking for a diverse employment base centered on sectors that have demonstrated resilience to economic downturn. A concentration in cyclical employment sectors such as manufacturing, agriculture, natural resource development, or tourism could point to less employment stability and a reduction in the MSA s flexibility to navigate through difficult economic periods. KBRA also generally analyzes trends within different employment sectors to detect any shifts among sectors over time. It is important to understand the forces behind employment trends for a particular MSA in relation to both its State and the national economy. KBRA also generally assesses the economic base on a more granular level by reviewing rankings of the largest MSA private sector employers. This table is supplemented by a listing of the Fortune 500 and headquartered companies in the air trade area. These tables are usually found in the airport consultant s report. KBRA also typically reviews businesses moving to or expanding in the air trade area, as well as any major contractions or departures. Headquarters and larger companies generate disproportionate amounts of air travel, and freight shipments, and are generally stable presences in the metropolitan area. These organizations and airports have synergistic relationships, as these employers oftentimes cite the scope and frequency of service available at the airport as an important locational decision, and airports are granted additional service based on demand. For example, AT&T cited air service as the main reason for moving its headquarters from San Antonio to Dallas in Stability is also afforded by a sizable public and private college and university/community college, hospitals, and military installations presence. A federal agency regional headquarters and large state and/or local governmental presence may also yield significant airport activity. Professional associations, foundations, and charitable organizations have significant associated enplanement activity. The presence of a large convention facility also acts to encourage air travel, and is abetted by a sizable hotel base. The market area of an airport benefits from an extensive highway system that provides links to the airport. Access may be improved to the point that the airport can attract customers from a more distant secondary market surrounding the metropolitan area. Price sensitive travelers in the secondary market will choose which airport to use based on air fares and distance from the airport. These consumers may be willing to drive a greater distance to save air fare costs. Page 16 April 23, 2014

17 In addition to driving higher passenger volumes and airline revenues, KBRA believes that a strong local economy and high socioeconomic indices are significant factors in generating non-airline operating revenue. While KBRA typically looks to the metropolitan area for our evaluation of economic and demographic factors of the air trade area, the central city of the area is also factored in. KBRA believes that the economic health of the central city may be essential to the long-term well-being of the metropolitan area, and deterioration in the primary city may eventually spread to the surrounding area. Therefore, KBRA may assign a lower than the aggregate of the individual sub-determinants would warrant economic and demographic factors rating to an airport with an economically stressed central city. Connecting Hubs KBRA believes that the establishment of a connecting hub is a function of an airport s geographical location, the type of facilities that the airport can offer airlines, and business decisions made by the airlines. Locations in the middle of the continental United States benefit from their strategic locations along well-traveled east/west air routes. Whereas locations in the southern U.S. like Miami and Houston are natural gateways to Latin America. While a large service area population base with high socioeconomic characteristics creates the critical mass needed for extensive routes and high frequency service, hubbing location decisions are sometimes made independent of this factor. However, during periods of airline capacity reductions, secondary hubs (Cincinnati, Cleveland, Pittsburgh, and St. Louis) have proven to be vulnerable. The bottom line after consolidation is fewer travel options for airline passengers at those airports. There is a general trend of consolidation of hubs, and those airports with greater levels of underlying demand seem to be the most resilient. Multiple Airport Selection 10 Most large U.S. metropolitan areas have more than one commercial airport. A notable exception is Atlanta. KBRA believes that the presence of more than one commercial airport in a metropolitan area necessitates an additional level of credit review beyond economic and demographic factors. Consideration of the factors that drive this decision for both passengers and airlines is important to understanding passenger demand and airline service levels. In situations where there are multiple airports within the metropolitan area, passenger decisions as to which airport to choose are determined by airline pricing, levels of service, and ease of access and convenience of the airport. Level of service includes routes, frequency, non-stop flights and available capacity. Leisure travelers have the reputation of being more price sensitive than business travelers. However, in KBRA s opinion, a more disciplined approach to travel by businesses is part of the fall-out of the last recession. Other considerations may include ease of highway access, efficient terminal layout, parking availability and cost, public transportation options, internet accessibility, concession options, airline preference, and the efficiency of the security screening process. Airline decisions to serve particular airports in metropolitan areas relate to revenue generation and profitability, and evaluation of demand. Whether an airline serves one or more airports in a particular market is a function of the level of net income that can be potentially realized. Airlines analyze the same factors that KBRA uses. These include market size, business/leisure travel, wealth levels, corporate presence, and ethnic and cultural diversity. 10 ACRP Report 98 Understanding Airline and Passenger Choice in Multi-Airport Regions, Airport Cooperative Research Program., Transportation Research Board, Washington, D.C Page 17 April 23, 2014

18 2012 Enplanements at U.S. Large, Medium & Small Hub Commercial Service Airports Source: USDOT T100 Databank. Data compiled by InterVISTAS Consulting LLC. Graphic by HNTB Corporation The multiple airports of the Los Angeles region provide a good illustration of how selection factors interact. Los Angeles Region Metropolitan Los Angeles is the nation s second largest metro area, with a population of over 18 million, dispersed over a sprawling area of more than 36,000 square miles. It is served by an international airport (LAX), and four regional complementary airports. LAX is the region s primary airport, and serves as an international gateway with service to all major U.S. cities. The regional airports offer significant connecting service to domestic hubs and closer-by destinations both within California and the western U.S. Of the five airports, LAX, John Wayne Airport (SNA) in Orange County about 50 minutes (41 miles) south-southeast of LAX, and Ontario International Airport (ONT) in the Inland Empire area 65 minutes (55 miles) east of LAX are served by mainline carriers and low cost carriers (LCCs). The remaining two airports, Long Beach Airport (LGB), 30 minutes (22 miles) south of LAX and Bob Hope Airport (BUR) near Burbank, 40 minutes (28 miles) north of LAX provide more limited service. These regional airports are all located in highly populated areas. While these driving times to LAX do not appear overly onerous, they do not take into account the impact of traffic congestion, which at certain times during the day can add significantly to travel times. Congestion and delay characterize many driving trips to LAX, although the area has an extensive freeway system, and is increasing its mass transit options. Business and corporate activity are also highly dispersed. Consequently, avoidance of traffic congestion is a determinant of airport selection, along with airline fares, and level of service. While the regional airports provide passengers with alternatives to using LAX, the levels of service offered are all significantly lower than LAX. Passengers are therefore left to choose between faster driving time and more flight options. The regional airports also have a lower legacy airline presence, which may inform decisions made by passengers, especially those who are loyal to a particular airline. However, legacy airlines do have significant service at SNA and ONT because of the high population densities in the vicinity of these airports. All of the airports, with the exception of LGB, have similar airfares, due to the presence of Southwest Airlines. LGB is the exception; it is a focus city for JetBlue. Page 18 April 23, 2014