Airport Case Studies

AIRPORT CASE STUDIES in connection with study on The Impact of Air Carriers Emerging from Bankruptcy on Hub Airports, Airport Systems and U.S. Capital Bond Markets
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AIRPORT CASE STUDIES in connection with study on The Impact of Air Carriers Emerging from Bankruptcy on Hub Airports, Airport Systems and U.S. Capital Bond Markets November 2003 Prepared for: Office of Airport Planning and Programming Federal Aviation Administration and Office of the Secretary of Transportation U.S. Department of Transportation Washington, DC 20591 NOTE These case studies were prepared under a contract with the Federal Aviation Administration and the Office of the Secretary of Transportation. The contractor is responsible for the facts and accuracy of the data and analyses presented in the report. The case studies contain information that has been obtained from publicly available sources. The case studies should not be construed as statements or representations of the respective airport operators. AIRPORT CASE STUDIES in connection with study on The Impact of Air Carriers Emerging from Bankruptcy on Hub Airports, Airport Systems and U.S. Capital Bond Markets Prepared for: Office of Airport Planning and Programming Federal Aviation Administration and Office of the Secretary of Transportation U.S. Department of Transportation Washington, DC 20591 Under Work Order OTTS59-03-P-00228 Contract No. DTFA01-98-C-00096 Prepared by: John F. Brown Company, Inc. 659 Van Meter Street, Suite 500 Cincinnati, OH 45202 Home Office: 659 Van Meter St, Ste 500 • Cincinnati, OH 45202 • (513) 321-6080 • Fax (513) 321-6125 • www.johnfbrown.com This page intentionally left blank TABLE OF CONTENTS PITTSBURG INTERNATIONAL AIRPORT .................................................................................1 LAMBERT-ST. LOUIS INTERNATIONAL AIRPORT..............................................................38 MINNEAPOLIS-ST. PAUL INTERNATIONAL AIRPORT .......................................................64 SAN FRANCISCO INTERNATIONAL AIRPORT .....................................................................84 LIST OF TABLES US Airways Group Scheduled Hub Departures ...............................................................................8 Nonstop Departures by US Airways Group .....................................................................................9 Specific-Use Airline Facilities and Equipment for Midfield Terminal ..........................................15 Jet Gate Leasehold Assignments ....................................................................................................22 Summary of Current Leased Premises ...........................................................................................23 Airline Fees and Charges Under the AOA for 2002 ......................................................................23 US Airways’ Lease Obligations Other than AOA..........................................................................24 Average Gate Utilization................................................................................................................27 Historical Net Revenues and Debt Service Coverage ....................................................................28 Cash and Short-Term Investments .................................................................................................29 American Airlines/TWA Daily Departures ....................................................................................43 Average Annual Rate of Increase in Population ............................................................................44 Average Daily Gate Usage – February 2002..................................................................................46 Plan of Finance for Capital Programs ............................................................................................48 LOI Payment Schedule...................................................................................................................49 Historical Net Revenues and Debt Service Coverage ....................................................................59 Cash and Short-Term Investments .................................................................................................60 Capital Program Funding Sources..................................................................................................69 MAC Airline Revenue....................................................................................................................75 Gate Leasehold Assignments – December 2002 ............................................................................76 Northwest Airline’s Obligations Other than Airline Agreement....................................................77 Historical Net Revenues and Debt Service Coverage ....................................................................79 Cash and Short-Term Investments .................................................................................................80 Average Daily Departing Flights and Seats ...................................................................................89 Approved Passenger Facility Charges............................................................................................91 Airline Terminal Space...................................................................................................................94 United Airlines Aircraft Maintenance and Overhaul Facilities......................................................95 Financial Measures.........................................................................................................................99 John F. Brown Company i LIST OF FIGURES Historical Originating and Connecting Passengers ..........................................................................5 Hub Comparison, US Airways Group (2002) ..................................................................................6 Airline Passenger Market Shares......................................................................................................7 Midwest Hubs...................................................................................................................................7 Passenger Recovery Rate Relative to 2000 Levels ..........................................................................8 PIT Catchment Area .......................................................................................................................10 Average Fare Paid Compared to U.S. Average, 2002 ....................................................................11 Application of Revenue Under the Bond Indenture and Airline Operating Agreement ................18 PIT Rate-Making Methodology .....................................................................................................20 Debt per Enplaned Passenger .........................................................................................................26 Airline Cost per Enplaned Passenger .............................................................................................29 Moody’s Airport Rating Distribution.............................................................................................35 Historical Originating and Connecting Passengers .......................................................................42 Application of Airport Revenues under the Indenture ...................................................................51 Debt per Enplaned Passenger .........................................................................................................52 Airline Cost per Enplaned Passenger .............................................................................................60 Total Enplaned Passengers, 1991-2001..........................................................................................65 Enplaned Passenger Trends............................................................................................................65 Enplaned Passengers Served ..........................................................................................................66 Runway Configuration ...................................................................................................................67 Application of Revenues under the Master Senior Indenture.........................................................71 Total Debt Outstanding per Passenger, 2001 .................................................................................72 Airline Cost per Passenger .............................................................................................................80 Enplaned Passenger Trends............................................................................................................87 Average Daily Jet Departures and Enplaned Revenue Passengers ................................................88 Regional Trends in Domestic O&D Passengers.............................................................................89 John F. Brown Company ii CASE STUDY PITTSBURGH INTERNATIONAL AIRPORT BACKGROUND On the eve of emerging from Chapter 11 bankruptcy proceedings and contrary to prior indications to the Allegheny County Airport Authority (ACAA), US Airways rejected all of its leases and agreements with ACAA effective January 5, 2004. The airline indicated a desire to renegotiate a new agreement with lower costs. This was an unprecedented move by US Airways and could have ramifications and implications on airport-airline tenant relations and airport bond ratings for the years ahead. According to the Federal Aviation Administration, Pittsburgh International Airport (PIT) was ranked the 23rd busiest airport in the United States for passenger traffic and 17th busiest for aircraft operations in 2002. EXECUTIVE SUMMARY Some of the conclusions from this review are as follows: Excellent facilities. As the fourth largest U.S. airport in land area, Pittsburgh International Airport (PIT) has excellent facilities as well as excess and highly efficient airside and terminal capacity to accommodate hub operations. Connecting passengers. Between 1980 and 2002, 75 percent of the growth in enplaned passengers at PIT came from connections. In the fall of 2002, US Airways significantly cut back flights at PIT while it started to build up its PHL and CLT hubs. Once the largest hub in US Airways’ system, PIT is now the smallest of the three hubs in terms of passengers and jet departures. PIT competes for connecting passengers with multiple other hubs in the Midwest, including Chicago (American and United), Cincinnati (Delta), Cleveland (Continental), Detroit (Northwest), Memphis (Northwest), Minneapolis (Northwest), and St. Louis (American). Some industry analysts predict a contraction in hubs, particularly in the Midwest. O&D passengers. Local or origin and destination (O&D) passengers have been growing at a relatively slow pace at PIT compared with the nation as a whole, reflecting the regional demographics and economics, and limited presence of low fare carriers. PIT is a high yield market with limited low fare competition. Low frequency low cost carriers have entered the PIT market with limited success because US Airways has matched their fares. A recent study prepared for ACAA estimated that approximately 600,000 enplaned passengers per year “leak” to other nearby airports for lower fares. Recent traffic declines. Passenger traffic at PIT increased 0.7 percent in 2001 and then declined 9.7 percent in 2002, and is projected by ACAA to decline a further 11.2 percent in 2003. Traffic at PIT after September 11, was recovering at a rate faster than the U.S. as a whole until the Fall of 2002 when US Airways significantly reduced service at the airport. Meanwhile Air Canada, Continental, Delta, and United all experienced double-digit growth in passengers in the first quarter of 2003 compared with the same period in 2002 at PIT. Midfield project scope and design. The midfield project was designed and sized in close cooperation with US Airways, including using the airline’s forecast of passenger activity. John F. Brown Company 1 Virtually all of the scope changes were approved by US Airway’s construction representative and amounted to $239 million over the original project budget. In addition, it was estimated that US Airways would realize $10 to $12 million per year in direct aircraft operating costs savings (in 1984 dollars) by moving from the former terminal site to the midfield terminal due to the more efficient runway use and reduction in aircraft taxiing times. Public investment in midfield project. The Commonwealth of Pennsylvania and Allegheny County made an unprecedented public investment in the $800 million midfield project ($127.5 million) at the behest of US Airways. The Commonwealth also fully funded the cost of the $200 million expressway that had to be constructed to provide access to the midfield site at no cost to the airlines. The Commonwealth and County were willing to invest this seed money in the midfield project in light of the expected economic development benefits arising from US Airways hub operations. In 1988, when airline agreements in support of the midfield project were executed, US Airways was one of the most profitable airlines in the U.S. (third largest in terms of operating profits and net profits in 1987). In addition, there was approximately $100 million in Airport Improvement Program (AIP) grant funding invested in the midfield project. Favorable airline financing. In an unusual move, the County financed $146.2 million in airline specific equipment and finishes with general airport revenue bonds (GARBs) for the midfield program to help reduce borrowing costs for the airlines. Of this amount, $60.5 million is for US Airway’s exclusive use automated baggage system and support facilities. The County was willing to take on this additional risk in light of the economic development benefits from the project and US Airways’ hub operation. We know of no other airport that has agreed to GARB financing for this type of airline exclusive use facilities. For all airlines, the costs associated with this debt amounted to $15.9 million in 2002 or $1.77 per enplaned passenger. Residual cost airline agreements. The residual cost airline agreements provide that if US Airways were to cease using and paying debt service on its facilities at PIT, the debt service and other costs payable by US Airways would be included in the rates and charges of the other signatory airlines, including the debt service associated with US Airways’ special equipment and facilities. It is important to note that British Airways was an original signatory airline at PIT in 1988 but withdrew from PIT in the early 1990s. However, British Airways has remained current on its $475,000 annual payments to PIT ever since. US Airways’ revenue contribution. US Airways currently leases a vast majority of airline space (84 percent) and jet gates (67 percent) at PIT and accounted for 78 percent of percent of total ACAA revenues in 2001. Airline payments. Over the past several years, PIT’s airline cost per enplaned passenger has been reasonable ($6.03 in 2000 and $6.36 in 2001), particularly in light of the timing, magnitude of investment, and efficiency of PIT’s facilities. However, the cost per e.p. is vulnerable to a significant increase due to decreases in connecting passengers. For example, the cost per e.p. for 2002 increased to $7.48 and is currently projected by ACAA to be $9.07 in 2003 even though operating expenses and debt service decreased each year. Cost per e.p. is increasing because passengers declined 9.7 percent in 2002 and are projected to decline an additional 11.2 John F. Brown Company 2 percent in 2003. ACAA consultants estimate the cost per e.p. could rise as high as $25 if US Airways rejects its lease and there is a significant decrease in connecting passengers.1 US Airways’ current demands. US Airways is demanding rent relief and facility funding at both PIT and Philadelphia International as consideration for not rejecting its leases at PIT, an unprecedented request. In particular, US Airways wants ACAA to reduce the amount of debt at PIT by $500 million from its current level of $676 million. Most of the debt was issued to fund elements of the midfield project in the late 1980s and early 1990s. Unlike US Airways’ special facility revenue bond funded leases, which the carrier also rejected, ACAA cannot “walk away” from its GARB obligation, which is secured by all airport revenues. Deferred PFC implementation. PIT was one of the last large-hub airports to levy a PFC. The amount of outstanding debt could have been lower if a PFC had been in place at PIT before October 1, 2001. US Airways did not want PIT to levy a PFC while the other signatory airlines did. If PIT had been collecting a PFC since 1993 at the level of $3.00 per e.p., it would have collected approximately $242 million through 2002.2 However, because most of the contracts for the midfield terminal project began before PFCs were approved by Congress (November 5, 1990), only a small fraction of the cost of the $800 million midfield project (approximately three percent) is currently eligible for PFC funding. ACAA is requesting a relaxation in the PFC eligibility date from November 5, 1990, to permit PFC funding of midfield project costs. Recent cost saving initiatives. ACAA has taken significant measures to achieve cost savings for the benefit of the airlines. ACAA has refinanced GARBs to the extent economic and permitted by law to achieve a 20 percent reduction in annual debt service from $74.4 million in 1997 to $59.5 million in 2002. In addition, ACAA recently reduced staff by ten percent and implemented other cost reduction initiatives that are expected to reduce operating costs by $5.4 million per year. US Airways’ options to deploy RJs. It would appear that US Airways has limited options on where to deploy the 170 regional jets that are scheduled to arrive between November 2003 and 2006, given its facility constraints at Boston, Charlotte, New York LaGuardia, Philadelphia, and Washington, D.C. Outstanding debt. ACAA’s only outstanding debt consists of $676 million in general airport revenue bonds. All of this debt is insured. In addition, PIT retains cash reserves equal to one year’s principal and interest payments on GARB bonds plus an additional 25 percent of annual debt service (rolling coverage) to demonstrate 1.25 times debt service coverage in compliance with the rate covenant in the bond indenture. Bond insurance companies would have the right to appoint a receiver to take over operation of the airport in the event of nonpayment on the bonds. Rating agency response. The rating agencies reacted swiftly to the news that US Airways may reject its leases at PIT. PIT is rated at the second lowest level of investment grade rating by both Moody’s Investors Service (Baa2) and Standard & Poor’s (BBB+), and is on negative outlook by S&P. On April 1, 2003, Moody’s placed PIT on Watchlist for downgrade and on July 3, 2003, Moody's dropped ACAA’s rating from Baa1 to Baa2, citing in part, the uncertainty 1. Pittsburgh Post-Gazette, Other Airlines Show No Interest in Filling a Void After US Airways, Mark Belko, October 6, 2003. 2. Assuming 85 percent of the passengers would have been eligible to pay the PFC, a conservative estimate. John F. Brown Company 3 regarding the negotiations to keep US Airways in Pittsburgh and the future viability of the carrier itself. On May 15, 2003, Fitch downgraded PIT from ‘A-‘ to BBB, its lowest investment grade rating. On July 21, 2003, Fitch said it considered the forward rejection of the PIT lease to be a “material negative event.” In the same report, Fitch characterized the PIT lease as containing “among the most beneficial financial terms for a hubbing airline at its respective hub airport.” Although these downgrades in PIT’s credit rating do not affect current costs, it could cost ACAA more in the future if it plans to refinance existing bonds or issue new bonds. Nevertheless, all PIT’s bonds are insured. Line of Credit withdrawn. ACAA maintained a $6 million line of credit (LOC) with PNC Bank for emergency cash flow purposes. After September 11, PNC told ACAA that the LOC would be cut to $3 million. When US Airways entered bankruptcy, PNC did not take further action on the amount of the LOC. However, when US Airways rejected the PIT leases, PNC pulled the LOC in its entirety. Although ACAA never made any draws on the LOC, it afforded liquidity that is considered important in rating reviews and decisions. Proof of claims settlement. On July 25, 2003, US Airways, Allegheny County, and ACAA reached a consensual agreement resolving all bankruptcy claims filed by the county and the ACAA against US Airways with regard to PIT. Under the agreement, ACAA and the county will be granted an allowed general unsecured claim in the amount of $211 million in the US Airways bankruptcy case. These claims will share, with claims of other unsecured creditors, in distributions of US Airways Group, Inc. equity under the company's plan of reorganization. Potential resolution. Some of the possible outcomes to the situation include: US Airways will remain at PIT under the current terms of the agreement operating a regional hub, US Airways will reduce operations at PIT and attempt to negotiate for a smaller amount of terminal space, US Airways will abandon its hub at PIT and be legally free of its obligations to PIT bonds and lease a limited amount of space as a non-signatory airline; or the Commonwealth will respond to US Airways’ request to invest equity and pay down PIT debt, plus some features of the three other possible outcomes. John F. Brown Company 4 TRAFFIC TRENDS AND CHARACTERISTICS Role of PIT as Connecting Hub for US Airways For many years, PIT served as the primary connecting hub airport in the route system of US Airways. The following graph shows the significant increase in connecting passengers at PIT between 1980 and the late 1990s, reflecting US Airways’ buildup of its PIT hub. The bump in 1993 reflects the opening of the midfield terminal, which provided additional gates and facilities for US Airways (from 40 gates in the former terminal to 53 in the midfield, including three international gates). Connecting passengers reached a peak of approximately seven million in 1996 and have ranged from 70 percent of total passengers in the early 1990s to approximately 62 percent since 1999. Figure 1 Historical Originating and Connecting Passengers Pittsburgh International Airport 12 Connections Originations 10 Enplaned passengers (millions) 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 8 6 4 2 Sources: Allegheny County Airport Authority; U.S. Department of Transportation, Air Passenger Origin-Destination Survey. John F. Brown Company 5 After being the largest hub in US Airways’ system through the late 1990s, PIT is now the smallest of the US Airways hubs in terms of passengers as shown below. Figure 2 Hub Comparison, US Airways Group (2002) 12,000,000 Total Enplanements Domestic Connecting 10,000,000 Enplaned Passengers Domestic O&D International Total 8,000,000 6,000,000 4,000,000 2,000,000 0 Charlotte/Douglas International Airport Philadelphia International Airport Pittsburgh International Airport Source: U.S. Department of Transportation, Schedules T-3, T-100, 298C T-1, Air Passenger Origin-Destination Survey, reconciled to DOT Schedules T-100 and 298C T-1. Note: US Airways Airways Group includes US Airways Airways and affiliated carriers. In 2002, 72.5 percent of US Airways’ passengers at PIT were connecting, which compares with the industry average of 63.2 percent for airlines at their hub airports.3 Figure 3 illustrates the dominance of US Airways and its affiliates in the PIT market as well as the contraction in mainline passengers and corresponding increase in US Airways Express passengers since 2000. In 2002, US Airways and its affiliates accounted for 86.8 percent of PIT passengers down from 90.1 percent in 1997. 3. 2003 Hub Factbook, Citigroup Global Markets, April 16, 2003. Data excludes Southwest Airlines’ “focus cities.” John F. Brown Company 6 Figure 3 Airline Passenger Market Shares Pittsburgh International Airport 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% 1997 1998 1999 2000 2001 2002 Source: Allegheny County Airport Authority. All others US Express US Airways US Airways competes for connecting passengers with multiple hubs in the Midwestern region of the U.S. as shown in Figure 4. Several industry analysts and airline executives believe that the U.S. is overhubbed, particularly in the Midwest and expect fewer, larger sized hubs.4 Figure 4 Midwest Hubs M SP DTW PIT CLE O RD STL M EM CVG US Airways hub (PIT) O ther hubs Source: John F. Brown Company. 4. 2003 Hub Factbook, Citigroup Global Markets, April 16, 2003. Remarks by Leo Mullen (Delta Air Lines CEO) at Aero Club of Washington on June 19, 2003. John F. Brown Company 7 Post September 11 Trends Traffic at PIT after September 11, was recovering at a rate faster than the U.S. as a whole until the fall of 2002. Figure 5 Passenger Recovery Rate Relative to 2000 Levels Domestic Traffic 10.0% 0.0% -10.0% -20.0% -30.0% -40.0% Mar-02 May-02 Nov-01 Nov-02 Mar-03 Apr-02 Feb-02 Aug-02 Sep-02 Sep-01 Dec-01 Dec-02 Feb-03 Jun-02 Jan-02 Jan-03 Oct-01 Oct-02 Apr-03 Jul-02 PIT U.S. Sources: Air Transport Association and Allegheny County Airport Authority. Since 2001, US Airways has significantly reduced its air service to PIT relative to PHL and CLT. Table 1 US Airways Airways Group Scheduled Hub Departures – Month of May PIT PHL 15,041 11,760 15,645 12,408 14,672 11,960 11,383 11,153 -24.3% -5.2% 2000 2001 2002 2003 CLT 14,835 15,658 14,828 14,096 -5.0% Percent change vs. 2000 Source: Official Airline Guide, all aircraft types. The types of aircraft serving PIT have also changed dramatically since 2000 – transitioning from a majority of service provided by mainline jets to a majority of service provided by US Airways Express on regional jets and turbo props. John F. Brown Company 8 Table 2 Nonstop Departures by US Airways Group US Airways Hubs May 2000 Hub Equipment Type CLT Jet RJ Turbo PHL Jet RJ Turbo Jet RJ Turbo 10,428 116 4,291 14,835 7,680 353 3,727 11,760 8,353 -6,688 -15,041 May 2001 10,650 629 4,379 15,658 8,017 597 3,794 12,408 8,480 597 6,568 15,645 May 2002 9,098 1,576 4,154 14,828 6,753 1,055 4,152 11,960 6,466 1,947 6,259 14,672 May 2003 7,624 1,739 4,733 14,096 6,164 1,446 3,543 11,153 4,224 2,227 4,932 11,383 PIT Source: Official Airline Guide. PIT’s Local Passenger Trends and Potential According to ACAA, PIT’s core catchment area consists of six counties in southwestern Pennsylvania with a population of 2.3 million. An estimated 5 million people live within a twohour drive of PIT. John F. Brown Company 9 Figure 6 PIT Catchment Area Source: Allegheny County Airport Authority. According to ACAA, the primary service region (Primary Region) consists of the following counties: Allegheny, Armstrong, Beaver, Butler, Washington, and Westmoreland. The population of the Primary Region has been steadily declining from 2,605,000 in 1970 to 2,282,443 in 2000 and is forecast to be 2,232,542 in 2005.5 The Primary Region has experienced an economic transformation over the past three decades from concentration in the heavy metal manufacturing industry to high-technology, services, and research/development. The two largest employment sectors in the Primary Region are services and retail/wholesale trade, which accounted for 58.4 percent of non-agricultural employment in 1997 as compared with 52.7 percent for the nation as a whole. The Primary Region is home to seven Fortune 500 companies (USX, ALCOA, H.J. Heinz, PPG Industries, PNC Bank Corp. Mellon Bank Corp., and Wesco, Inc.) Income levels in the Primary Region are somewhat lower than the nation as a whole – in 1995 only 27.8 percent of the households fell into the highest effective buying income category ($50,000 and higher) in the Primary Region while the national average was 34 percent. Median household income in the Primary Region in 1995 ($31,902) was also slightly lower than the national average ($32,238). From 1991 through 2001, PIT’s O&D traffic increased an average of 2.1 percent per year compared with an average increase of three percent per year for the nation as a whole. One of the reasons cited for this slower rate of increase at PIT is the presence of high fare levels there; the high fares cause passengers to “leak” to other nearby airports that offer lower fare options. As a major hub of US Airways, PIT’s average fare for O&D passengers was higher than the national average fare and higher than the average fare paid at nearby large airports as shown in Figure 7. 5. U.S. Department of Commerce, Bureau of the Census and Pennsylvania Business Resource Network. John F. Brown Company 10 A study performed for the ACAA in 1999 indicated that leakage at PIT accounts for a loss of approximately 600,000 enplaned passengers per year.6 Figure 7 Average Fare Paid Compared to U.S. Average, 2002 $180.00 $160.00 $140.00 $120.00 $100.00 $80.00 $60.00 $40.00 $20.00 $0.00 PIT 100 and 298C T-1. CLE CMH Source: U.S. Department of Transportation, Air Passenger Origin-Destination Survey, reconciled to DOT Schedules T- A recent study by Citigroup documented yield premiums enjoyed by hubbing airlines at their hubs for domestic O&D traffic.7 This study found that US Airways enjoys a yield premium (adjusted for stage length) over other airlines serving PIT of 27.6 percent in the second quarter of 2002. The average hub airline had a 27.3 percent domestic yield premium versus other airlines serving the same airport. PIT has a relatively small presence of low cost carriers (LCCs), especially considering the size of its O&D market. As of April 2003, the only LCC service at PIT was provided by America West and AirTran, which collectively operated eight daily departures compared with 481 total daily departures there. Historically, when a LCC has entered the PIT market, US Airways has matched the fares in the markets served by the LCC. In some instances this has caused the LCC to reduce or eliminate service in city-pair markets. ACAA has been actively seeking LCC service and offers an air service marketing incentive program to all airlines to encourage new and competitive service. The program provides up to $50,000 for any new citypair on a 50/50 match basis. The new flight must operate for a minimum of 120 days to be eligible for the program. 6. Air Traffic Status Report, Pittsburgh International Airport, the Boyd Group/ASRC, Inc., June 1999. 7. 2003 Hub Factbook, Citigroup Global Markets, April 16, 2003. John F. Brown Company 11 HISTORY OF THE MIDFIELD PROJECT Need for the Midfield Project The former terminal building was constructed in the early 1950s. Major expansions were undertaken in 1972 and 1980; however, a significant portion of the terminal was more than 35 years old when construction on the midfield terminal began. The concept of developing a new terminal complex at a midfield site between the Airport’s parallel runways originated during planning studies in the early 1970s. The midfield site was preferred over alternatives because of its potential for future expansion, continuity of operations during construction, and cost (it was the least costly alternative). The County and the airlines were motivated to proceed with the project by a number of factors, including: ƒ ƒ ƒ ƒ Increasing the capacity of the Airport. Providing for future expansion capability. Improving the operational efficiency of the Airport. Increasing passenger convenience and service. The old terminal complex was located in the northeastern corner of the Airport. All functional aspects of the old terminal complex (gates, ticketing, baggage handling, terminal roadway, curbside, public parking, aircraft apron, taxiways) had been developed the maximum extent possible at that site. The midfield project allowed for increases in: ƒ ƒ ƒ ƒ ƒ ƒ ƒ Airfield capacity (by allowing for greater use of the three-parallel-runway operation). Jet gate capacity -- from 52 to 75 gates, with room for future expansion. Public parking facilities. Terminal roadway and curbside capacity. Ticketing and circulation space. Baggage handling and baggage claim space. Concession space. The midfield project included a new midfield terminal (approximately 1.7 million square feet of enclosed space) with a landside terminal and airside terminal connected by an underground automated people-mover system, commuter terminal, and central services building. It also included an automobile parking structure, surface parking lots, aircraft parking apron and associated taxiways, terminal roadway system, fuel storage and distribution system, and special airline equipment and tenant finishes. A study performed for the County in 1984 determined that the midfield terminal would permit more efficient runway use and reduce aircraft taxiing times collectively amounting to annual operating cost savings to the airlines of $10 to $12 million per year (in 1984 dollars).8 8. Peat Marwick, Airfield Simulation Analysis for Greater Pittsburgh International Airport, October 1984. John F. Brown Company 12 Virtually all of these savings were projected to be realized by US Airways due to the peaking nature of their hub operation at PIT. The size, scope, and cost of the midfield project were carefully coordinated with US Airways. Facilities for US Airways were developed on the basis of forecasts prepared for the County using forecasts provided by US Airways for its operations. US Airways anticipated a significant increase in passenger traffic once the midfield terminal opened due to the facility constraints in the old terminal. In particular, it was forecast that enplaned passengers would increase nearly 14 percent in one year from 9,010,000 in 1992 to 10,246,000 in 1993, the first full year of operation for the midfield terminal.9 Public Investment and Project Risk Sharing In 1987, the County and US Airways entered into a Memorandum of Understanding (MOU) setting forth US Airways’ support for the midfield project and certain conditions. Under the MOU, the Commonwealth and County committed to a “Public Investment” in the midfield project to secure US Airways’ support for the project. The Commonwealth contributed $85 million and the County contributed $42.5 million funded by g.o. bonds, for a total of $127.5 million. The MOU provided that “neither this funding nor the debt service thereon will be made directly or indirectly a part of the rate base for purposes of calculating the Airlines’ rates and charges.” The magnitude of the public investment was and still is unprecedented for a major capital project at a hub airport. The Commonwealth and County made the Public Investment in recognition of the stimulus to economic development that the midfield project and US Airways’ hub were expected to provide to western Pennsylvania. The MOU also established an initial project budget and a cap on bonds and associated debt service that could be included in airline rates and charges. This “risk sharing” concept was further defined in the Airline Operating Agreement and Terminal Lease (AOA) that was executed in 1988. The bond funding limit was subject to changes in the scope and cost of the project that were approved by the County and a Majority-in-Interest of the Signatory Airlines. US Airways was the representative of the Signatory Airlines for construction matters. Under the project risk sharing, the County was responsible for up to an additional $62.5 million in “Contingent Public Investment” in the event the airline-approved funding limit was not sufficient to complete the project as defined according to a formula sharing the increased costs between the County and the airlines. The AOA also provided a reciprocal formula where the County and the airlines would share in “project savings” if the costs were lower than projected. In the event of project savings, the County would be reimbursed through airline rates and charges for the applicable share of the debt service on g.o. bonds paid by the taxpayers. When the midfield project was complete and all litigation was settled, the County determined that there were “project savings” equal to $4,965,000 of which $3,310,000 was the County’s portion. The County and the Signatory Airlines decided to apply the project savings to capital projects at PIT. 9. Actual enplanements in 1993 totaled 9,154,962, reflecting the downturn in the U.S. aviation industry at this time. However, enplanements increased 18.3 percent between 1991 and 1992 (from 8.3 to 9.3 million) and reached a high of 10.3 million in 1997. John F. Brown Company 13 Southern Expressway Access to the midfield complex was provided by a new “Southern Expressway” that was constructed by the Commonwealth and not part of the midfield project cost included in airline rates and charges. The Southern Expressway provides access to the midfield terminal from the Parkway West. The Commonwealth also constructed a new interchange, the Flaugherty Run Interchange, which provides access to the midfield terminal from the Beaver Valley Expressway. The cost of the Southern Expressway and Flaugherty Run Interchange was approximately $200 million. Project Scope Changes During construction of the midfield project, the scope and cost changed as the detailed drawings were prepared and as the requirements of the tenants were more clearly defined. The original cost of the project was $558.6 million, including a contingency of $26.2 million. The final cost of the project was $797.8 million, $239.2 million more than originally contemplated. The County determined that more than 70 percent of the increase was attributable to scope changes that were approved by the Signatory Airlines and to the inclusion of US Airways’ automated baggage system (ABS) in the budget for the project.10 Some of the more significant scope changes to the original budget included: ƒ ƒ An increase in jet aircraft gates from 66 to 75 driven by US Airways’ request for more gates. An increase of approximately 300,000 square feet in the size of the terminal, including the gate expansion and a two bay expansion in the landside terminal to accommodate US Airways’ request for more ticketing and office space. An expansion of Concourse C gates from three widebody and eight narrowbody gates to ten widebody gates and one narrowbody gate to accommodate anticipated increases in international passengers. During the construction of the midfield project, US Airways applied for international route authorities from PIT and expected to use three of the five common use international gates for its operations once the midfield terminal opened. Additional increase in tenant finishes and equipment (baggage systems, 400 Hz power, US Airways Airway Club expansion, flight information display systems, loading bridges) primarily driven by US Airways’ expansion needs. Ramp and taxiway expansions, including provision for dual aircraft movements around the entire airside building to enhance the operational efficiency of the ramp, in part for US Airways’ hub operations. Enclosure of the commuter walkways and expansion of the commuter holdroom area to accommodate increases in US Airways Express’ growth. US Airways Express has been the only airline to use this facility. Expansion of the size of the transit system to accommodate an expanded people mover system. The increase in demand for the people mover system resulted in part from the increased use of the commuter terminal and the need to transfer US ƒ ƒ ƒ ƒ ƒ 10. By virtue of its AOA and those executed by US Airways Express carriers, US Airways’ controlled MII approvals. John F. Brown Company 14 Airways Express passengers from the landside terminal to US Airways mainline jets in the airside terminal. Financing of Airline Equipment and Finishes The County provided a nearly “turn-key” facility to the airlines in the midfield terminal, including some equipment and finishes usually financed directly by the airlines. For example, the County financed with general airport revenue bonds (GARBs) interior walls and finishes, interior fixtures and furnishings, loading bridges, flight information displays, and baggage systems (outbound and inbound), including US Airways’ exclusive use, customized automated baggage system. The County also financed with GARBs certain exclusive use “support facilities” for US Airways, including a cargo building, mail sorting facility, ground services equipment (GSE) maintenance building, catering facility, and deicing pads. The following is a summary of the airline facilities and equipment included in the GARB financing for the midfield project. Table 3 Specific-Use Airline Facilities and Equipment for Midfield Terminal Pittsburgh International Airport Facilities/equipment US Airways Other airlines Total Automated baggage system $ 33,711,000 $ $ 33,711,000 Support facilities 22,864,000 22,864,000 Tenant finishes 11,770,000 2,943,000 14,713,000 Loading bridges 16,690,000 4,173,000 20,863,000 Finishes and equipment 12,510,000 3,124,000 15,638,000 Aircraft support systems 10,204,000 2,551,000 12,755,000 Fuel farm and distribution system 17,342,000 4,335,000 21,677,000 Total $129,050,000 $17,129,000 $146,179,000 Source: Allegheny County Airport Authority. John F. Brown Company 15 PIT FACILITIES SUMMARY According to ACAA, PIT is the fourth largest U.S. airport in land area with more than 10,000 acres. PIT has four runways, consisting of three parallel runways and one crosswind runway as follows: Runway 28L/10R Runway 28C/10C Runway 28R/10L Runway 14/32 11,500 feet long, 200 feet wide 9,308 feet long, 150 feet wide 10,500 feet long, 150 feet wide 8,100 feet long, 150 feet wide The midfield terminal opened in October 1992 and consists of approximately 1.7 million square feet of enclosed space. There are 69 domestic gates and six international gates for a total of 75 jet gates equipped with loading bridges, aircraft support systems, and hydrant fueling. In addition, there are 25 commuter aircraft parking positions in the commuter terminal. The Federal Inspection Services (FIS) facility is approximately 60,000 square feet and can accommodate 800 passengers per hour. ACAA has modified 22 of the jet gates on Concourse A to accommodate RJs for US Airways. The three-level parking garage contains approximately 2,170 public parking spaces, a rental car facility with about 800 ready and return spaces and 145 leased parking spaces for a total of approximately 3,115 spaces. The garage is connected to the landside terminal by enclosed moving walkways. Another 9,023 public parking spaces and 3,301 employee parking spaces are provided in the long-term, extended-term, and employee surface parking lots. The entrance to the midfield terminal consists of a four lane, two-level roadway serving both sides of the landside terminal with one side for commercial vehicles and the other for private automobiles. The above-ground aircraft fuel farm supplies fuel to the hydrant fueling system that serves all 75-jet gates and a fueling rack at the commuter terminal gates. PIT has four cargo buildings that encompass 233,000 square feet and a cargo aircraft apron comprising 721,750 square feet. There are approximately 2,000 acres at PIT available for non-aviation development, including the 178-acre site of the former terminal complex (now called the Airside Business Park). A 63,000 square foot flex building and 90,000 square foot office building were recently constructed at the Airside Business Park. US Airways operates its principal aircraft maintenance and training base at PIT (396,690 square feet). Other US Airways facilities at PIT include the “support facilities” financed with GARBs – mail sorting facility, deicing pads, a catering facility, GSE maintenance facility, and cargo building. John F. Brown Company 16 FINANCIAL FRAMEWORK Creation of Airport Authority On November 15, 1999, ACAA was formed under the terms of an Airport Operation, Management and Transfer Agreement and a Lease between Allegheny County and the Authority. The Lease term is 25 years, subject to two 25-year extensions at the option of ACAA. ACAA assumed all of the County’s obligations on outstanding debt related to PIT. In addition, the County transferred to ACAA all of its rights, title, and interest in all personal property owned and used by the County related to the administration, maintenance, and operation of the Airport System. The Airport System consists of PIT and Allegheny County Airport, a designated reliever to PIT. The County also transferred to ACAA all licenses, permits, agreements, approvals, and awards related to the Airport System, including grant agreements, the Airline Operating Agreements and Terminal Building Leases (AOA), and the revenue bond indenture. The indenture and the AOA provide the framework for the financial operations of the Airport System. Bond Indenture The County issued GARBs in 1988, 1990, 1992, and 1993 for a total principal of $920.2 million under the terms of a bond ordinance and associated supplemental ordinances, now collectively called the indenture. For purposes of structuring the revenue pledge of the indenture and the rate-making provisions of the AOA, certain cost centers were carved out of the revenue pledge to bond holders, including Allegheny County Airport, the Cargo Area, and portions of the Commercial/Industrial Area. However, certain portions of the net revenues generated in these “excluded costs centers” are pledged to the payment of GARBs and certain revenues derived from the “included cost centers” (landing fees) are applied to subsidize certain deficits in Allegheny County Airport and the Cargo Area. Figure 8 illustrates the structure of funds and accounts established under the indenture and the AOA and shows the priority for the application of revenues to the various funds and accounts. John F. Brown Company 17 Figure 8 Application of Revenue Under the Bond Indenture and Airline Operating Agreement Priority Revenue Fund Deposit all pledged Revenues (and retain balance of Other Available Funds) 1 2 3 4 5 6 Operation and Maintenance Fund Pay current Operation and Maintenance and Expenses Debt Service Fund Pay annual debt service on Revenue Bonds G.O. Bond Fund Pay annual debt service on G.O. Bonds Operation and Maintenance Reserve Fund Maintain reserve of 2 months of budgeted O&M Expenses Debt Service Reserve Fund Maintain a reserve for debt service on Revenue Bonds Renewal and Replacement Fund Maintain a reserve for emergency repairs or replacement Subordinate Debt Fund Pay debt service and reserves on Subordinate Lien Bonds Equipment and Capital Outlay Fund Pay for equipment purchases and small capital outlays Airport System Capital Fund Use for any lawful Airport System purpose Restricted Account: •Subaccount 1 -- $2 million per year •Subaccount 2 – settlements, asset sales Discretionary Account: Subaccount 1 -- $2 million per year •Subaccount 2 – Cargo profit (loss), concession revenue sharing 7 8 9 Source: Original Indenture and Airline Operating Agreement, Allegheny County Airport Authority. John F. Brown Company 18 In the indenture, ACAA covenants to maintain, charge, and collect rates, rentals, and other charges for the use of the included cost centers, which together with “other available funds” (equal to “rolling coverage”), will be sufficient each fiscal year to provide (1) revenues equal to amounts required to be deposited to the funds and accounts established by the indenture and (2) net revenues at least equal to 125 percent of the debt service requirement on the GARBs during the current fiscal year. This provision is called the rate covenant. In accordance with the AOA, the debt service coverage requirement (125 percent of annual debt service called other available funds) was funded through airline rates and charges prior to the opening of the midfield terminal. In addition, the Operation and Maintenance Reserve Fund and 50 percent of the required $2 million deposit to the Renewal and Replacement Fund were also funded through airline rates and charges prior to the opening of the midfield terminal. These accounts are fully funded at this time. Airline Operating Agreements and Terminal Building Leases As noted earlier, the AOA was negotiated in the context of the midfield project and was designed to insure timely payment of operating expenses and debt service under its residual ratemaking structure. The term of the AOA is coincident with the term of the midfield project debt – it extends to May 8, 2018. ACAA is party to the AOA with 11 signatory airlines: American Airlines, British Airways,11 Continental Airlines, Delta Airlines, Northwest Airlines, United Airlines, US Airways, and four of US Airways’ affiliated commuter airlines; Mesa Airlines, PSA Airlines, Chautauqua Airlines, and Pennsylvania Commuter Airlines d/b/a Allegheny Commuter. In addition, ACAA is party to several amendments to the AOA with US Airways, which obligate US Airways to pay debt service, fund deposit requirements, and operating expenses related to the US Airways support facilities, cargo facility and deicing pads. A separate site lease for these facilities obligates US Airways to pay ground rent. The AOA establishes procedures for adjusting airline rates and charges at least twice a year, if necessary, to enable ACAA to meet the requirements of the rate covenant. The AOA is considered to be one of the most complicated airport-airline business arrangements in the U.S. Terminal rentals, ramp fees, and landing fees are calculated under three cost center residual cost formulas whereby non-airline revenues are credited to one of these three cost centers to determine the net cost to be paid by the Signatory Airlines. Figure 9 is a diagram illustrating the rate-making procedures and the crediting of net revenues and net costs among the cost centers. 11. British Airways no longer serves PIT but remains a signatory airline. John F. Brown Company 19 Figure 9 PIT Rate-Making Methodology INCLUDED COST CENTERS TERMINAL RENTALS RAMP FEES LANDING FEES EXCLUDED COST CENTERS Old Terminal Complex (1st $250,000) Commercial/ Industrial Terminal Complex Area Ramp Area Hangar/ Field Support Area Airport Development Area* 50% Net Revenue 85% Net Revenue (Deficit) 15% Net Revenue (Deficit) Landing Area 50% Net Revenue Parking/ Rental Car Area (Deficit) Military Facilities Cargo Area $250,000 O&M + $350,000 Equipment and Capital Outlays *Established upon repayment of Public Investment Other Aviation Facilities (ACA) Source: John F. Brown Company John F. Brown Company 20 The signatory airlines are also obligated to pay “additional airline charges” to recover the costs associated with the airline equipment and finishes financed by ACAA with GARBs, including aircraft support systems, tenant equipment and finishes, and apron level space. In addition, US Airways is also obligated to pay 100 percent of the additional airline charges for its exclusive use automated baggage system (ABS), support facilities, and cargo facility as well as ground rent for the ABS tunnel. The residual rate-making methodology establishes an annual cap on the amount of the deficit that the airlines serving PIT will support for Allegheny County Airport, which is equal to $250,000 for operating expenses and $350,000 for equipment and capital outlays (escalated with inflation since 1988). The rate-making methodology also produces a relatively small amount of discretionary cash flow for equipment purchases and capital expenditures, consisting of: 1. 2. 3. 4. 5. $4 million for deposit to the Airport System Capital Fund for capital projects a concession revenue sharing fee of $500,000 50 percent of any net revenues from the Cargo Area net revenues from the Commercial/Industrial Area (which excludes the first $250,000 per year from the former terminal site) $1 million for equipment and capital outlays Each of these annual amounts is subject to adjustment for inflation starting in 1992. Of the $4 million per year, $2 million is deposited to the “restricted account” that is subject to airline MII approval and $2 million is deposited to the “discretionary account” that ACAA can use for any lawful Airport System purpose, including funding its share of deficits (if any) in the Cargo Area and Allegheny County Airport. In 2002, the Cargo Area operated at a net loss of $615,517 (including $695,086 in security expense) and Allegheny County Airport had a net loss of $510,116. The signatory airlines funded 50 percent of the cargo deficit ($307,758) and 58 percent of the Allegheny County Airport loss ($297,948). As noted above, the balance of the deficits ($519,927) must be funded from the discretionary account thereby reducing the funds available for capital expenditures for PIT. Most airline space is leased on an exclusive use basis, including ticketing, offices, outbound and inbound baggage areas, gates, VIP lounges and operations space. Gates are leased on an exclusive use basis except that at least one gate for each signatory airline must be preferentially assigned. For any airline leasing more than 14 gates (only US Airways) at least 15 percent of the gates must be preferentially assigned. A portion of the inbound baggage space and some corridors between ticketing offices are leased on a joint use or shared use basis. The six international gates in Concourse C are leased on a common use basis. The cost to use the Federal Inspection Services (FIS) facility is $8 per arriving international passenger (as escalated for inflation beginning in 1992). Other relevant provisions of the AOA include: ƒ Capital improvements other than those funded from the discretionary account must be approved by an MII of the signatory airlines. 21 John F. Brown Company ƒ ƒ ƒ The most favored nations clause provides that ACAA cannot offer any airline rates that are more favorable than those paid by the signatory airlines. ACAA is required to charge nonsignatory airlines no less than 120 percent of the signatory airline rates. New entrant airlines, nonsignatory airlines, and signatory airlines who committed an act or omission constituting an event of default are required to post a performance bond or letter of credit, which is equal to 25 percent of the estimated annual rates and charges. The following airlines have posted a security deposit with ACA – Airtran, ATA, America West, Air Canada Jazz, Shuttle America, Skyway, and Trans States. ACAA allows affiliated commuter/regional airlines to pay signatory rates if the airline is a wholly owned subsidiary of the major airline or the major airline agrees to be responsible for the payment of charges for the affiliate carrier. The following table shows the allocation of jet gates at PIT by airline and leasehold right: Table 4 Jet Gate Leasehold Assignments Pittsburgh International Airport Exclusive Preferential Common 42 8 3 1 1 1 1 2 1 1 1 1 1 6 5 50 14 11 Airline US Airways American Air Tran Continental Delta Northwest United International gates Unassigned Total Total 50 4 1 2 3 2 2 6 5 75 Percent 67% 5% 1% 3% 4% 3% 3% 8% 7% 100% Source: Allegheny County Airport Authority. John F. Brown Company 22 The following table summarizes current airline leased premises: Table 5 Summary of Current Leased Premises (square feet) Pittsburgh International Airport Space Category Exclusive Preferential Shared Commuter Walkway Commuter Lounge Subtotal – Enclosed Space ABS Apron Storage Subtotal – Unenclosed Space Total Enclosed and Unenclosed Source: Allegheny County Airport Authority. US Airways 321,402 14,365 22,042 36,780 6,230 400,819 207,268 3,103 210,371 611,190 Other Airlines 92,995 11,202 13,566 117,763 117,763 Total 414,397 25,567 35,608 36,780 6,230 518,582 207,268 3,103 210,371 728,953 Percent US Airways 77.6% 56.2 61.9 100.0 100.0 77.3 100.0 100.0 100.0 83.8% US Airways’ Share of Rentals, Fees, and Charges In 2002, US Airways’s obligations for rentals, fees, and charges under the AOA were as follows: Table 6 Airline Fees and Charges Under the AOA for 2002 Pittsburgh International Airport US Airways/ affiliates $15,554,861 33,866,160 Other airlines $2,500,963 11,089,098 660,672 1,087,885 260,655 $15,599,273 Percent Total US Airways $18,055,824 86.1% 44,955,258 75.3% 2,686,860 7,166,177 4,104,029 1,176,810 3,018,614 $81,163,572 75.4% 100.0% 73.5% 77.9% 100.0% 80.8% Landing fees Terminal rentals Ramp fees Additional airline charges ABS fee Tenant finishes Aircraft support system charges Support facilities charges Total Source: Allegheny County Airport Authority. 2,026,188 7,166,177 3,016,144 916,155 3,018,614 $65,564,299 John F. Brown Company 23 In addition to its obligations under the AOA, US Airways leases the following facilities at PIT: Table 7 US Airways’ Lease Obligations Other than AOA Pittsburgh International Airport Facility Annual Rent Hangars 1 & 2 $416,481 Hangars 3 & 4 350,480 Hangar 5 & Final Assembly Building 213,679 Hangar 6 214,035 Hangar 7 350,480 Hangar 8 158,112 Training Center 32,855 Support Facilities 301,524 Support Services Building 545,940 Total $2,583,586 Source: Allegheny County Airport Authority. PFC Program PIT was one of the last large hub airports in the U.S. to levy a PFC. This delay was in large part at the urging of US Airways while the other signatory airlines encouraged PIT to levy a PFC. The $3.00 per enplaning passenger PFC became effective October 1, 2001. All but a fraction of the costs of the midfield terminal (less than $20 million) are currently ineligible for PFC funding because the implementation dates for the various contracts preceded November 5, 1990, the date of enactment of the PFC legislation. If the PFC eligibility date were relaxed, ACAA could apply for authority to use PFC revenue to fund debt service and/or pay down debt for eligible costs of the midfield project, either of which could be of considerable benefit to ACAA. PIT currently has approval authority for $119.8 million in collections for 34 projects, including $68 million for deicing facilities. At the time the application was submitted, ACAA estimated the collection period would extend through October 1, 2006. However, since that time passenger activity has decreased significantly, reflecting the reduction in flights by US Airways. Therefore, the collection period is likely to be longer. John F. Brown Company 24 Outstanding Debt General Airport Revenue Bonds (GARBs) GARBs were issued in 1988, 1990, 1992, and 1993 for a total principal amount of $920.2 million. As of January 1, 2003, $676.2 million remained outstanding. Annual debt service is approximately equal to $62 million per year through 2017 then declines to $60 million in 2018, $53 million in 2019, $11.5 million per year in 2020 through 2022, and finally $3.6 million in 2023. Annual debt service in 1997 was $74.4 million. The 17 percent decrease in annual debt service since 1997 is attributable to the refinancing of prior bonds as they became eligible for refinancing. The weighted average effective yield on outstanding bonds is 4.99 percent. Because interest rates were at a relatively low level at the end of 2000 and early in 2001, ACAA wanted to refinance some of its existing debt. Due to the private activity nature of the Series 1992 Allegheny County GARBs, they could not be advance-refunded, and due to federal tax laws, the new refunding bonds could not be issued before October 2001. Thus ACAA entered into a synthetic refunding of the Series 1992 bonds employing a forward-starting variable-tofixed interest rate swap. This federally approved financing structure enabled ACAA to lock-in savings at the time of execution of the swap in July 2001. The September 11 attacks occurred between the execution of the swap and the issuance of the bonds. Although the bond insurer at the time of swap execution in July 2001 provided a firm commitment to issue its policy in October 2001 upon the issuance of the bonds, when the events of September 11 occurred, the insurer argued that there had been a 'material adverse change' which gave them the right to rescind their commitment. Although ACAA and its Counsel never agreed with the insurer's position, there was a renegotiation of the insurance premium. The insurer wanted 20 additional basis points to honor its commitment. The final negotiation resulted in an increase of 15 basis points (from 69 to 84 basis points). This translates into an additional cost of about $250,000 on a transaction size of about $110 million. The premium is calculated as a percentage of principal plus interest. Only $160 million of outstanding bonds at PIT remain eligible to be refinanced. Currently, the weak interest earnings environment would produce negative arbitrage in the refunding bonds escrow thus preventing PIT from realizing additional savings from a refinancing at this time. John F. Brown Company 25 As shown below, the debt levels at PIT are near the median of a sample of U.S. airports on a per enplaned passenger basis but well above the median on a per originating passenger basis, reflecting the debt to finance US Airways’ hub facilities: Figure 10 Debt per Enplaned Passenger $250 $200 $198 $150 $100 $88 $75 $70 $50 $0 PIT per e.p. U.S. median per e.p. PIT per O&D pax U.S. median per O&D pax Sources: Allegheny County Airport Authority and Moody’s Investor Services, Global Airport Sector, November 2002. Line of Credit In November 1999, ACAA entered into a $6 million line of credit (LOC) with PNC Bank for emergency cash flow purposes. After September 11, PNC told ACAA that the LOC would be cut to $3 million. When US Airways entered bankruptcy, PNC did not take further action on the amount of the LOC. However, when US Airways rejected the PIT leases, PNC pulled the LOC in its entirety. Although ACAA never made any draws on the LOC, it afforded liquidity that is considered important in rating reviews and decisions. John F. Brown Company 26 GATE UTILIZATION According to ACAA’s 2002-2003 update to its competition plan, the following table summarizes average gate utilization by airline based on 1999 data. Table 8 Average Gate Utilization Pittsburgh International Airport (based on 1999 data) Daily scheduled aircraft departures Jet Gates US Airways Delta (a) United (b) TWA (f) American (c) Northwest (d) Continental (e) Authority Subtotal Commuter gates US Airways Express Total 256 11 11 6 11 11 12 14 332 221 553 Gates 50 3 2 2 4 2 2 10 75 25 100 Daily departures per gate 5.1 3.7 5.5 3.0 2.8 5.5 6.0 1.4 4.4 8.8 5.5 Sources: Daily departures: Official Airline Guides, Inc.; Gates: Allegheny County Airport Authority Notes: (a) Includes commuter affiliate Comair. (b) Includes commuter affiliate Atlantic Coast. (c) Includes commuter affiliate American Eagle. (d) Includes commuter affiliate Mesaba. (e) Includes commuter affiliate Continental Express. (f) Terminated individual service July 8, 2001. John F. Brown Company 27 HISTORICAL FINANCIAL PERFORMANCE The following table shows historical revenues, operating expenses, and debt service coverage in compliance with the rate covenant in the indenture. It also shows airline costs per enplaned passenger with and without the additional airline charges, which consist of debt service and operating expenses for airline equipment and finishes (that are often provided by the airlines). Table 9 Historical Net Revenues and Debt Service Coverage Pittsburgh International Airport (in thousands except coverage and cost per enplaned passenger) Operating revenues Interest income Operating expenses Non-operating revenue (expense) Net revenue 1999 $131,421 8,821 (62,632) 1,835 $79,445 17,365 $96,810 69,458 1.39 2000 $130,990 11,510 (67,454) 2,505 $77,551 16,144 $93,695 64,576 1.45 2001 $129,907 8,969 (70,762) (2,695) $65,419 15,415 $80,834 61,660 1.31 2002 $125,082 5,478 (73,590) 7,640 $64,610 14,871 $79,481 59,485 1.34 Other available funds [A] Debt service Debt service coverage ratio Airline rates and charges Terminal, ramp, landing fees Additional airline charges Total Enplaned passengers Airline cost per e.p. With additional airline charges Without additional airline charges Source: Allegheny County Airport Authority. [B] [A/B] $57,815 16,797 $74,612 8,973 $8.32 $6.44 $57,005 16,234 $73,239 9,448 $7.75 $6.03 $57,810 16,017 $73,827 9,096 $8.12 $6.36 $65,698 15,466 $81,164 8,787 $9.24 $7.48 As shown, PIT’s airline cost per enplaned passenger (excluding additional airline charges) increased 17.6 percent from $6.36 in 2001 to $7.48 in 2002, reflecting the decrease in passengers and associated non-aeronautical revenues as well as the decrease in interest income. For 2003, ACAA currently projects the cost per e.p. (excluding additional airline charges) to increase 21 percent to $9.07, assuming a total of eight million enplaning passengers at the airport. John F. Brown Company 28 The following table shows how PIT’s cost per enplaned passenger (excluding additional airline charges) compares to other large hub airports: Figure 11 Airline Cost per Enplaned Passenger $10.00 $9.00 $8.00 $7.00 $6.00 $5.00 $4.00 $3.00 $2.00 $1.00 $PIT 2002 PIT 2003 (est) Large hub median 2002 $5.84 $7.48 $9.07 Sources: Allegheny County Airport Authority and Standard & Poor’s, Airport Operators Face Uncertainties, June 2002. PIT retains cash reserves equal to one year’s principal and interest payments on GARB bonds plus an additional 25 percent of annual debt service (rolling coverage) to demonstrate 1.25 times debt service coverage in compliance with the rate covenant in the bond indenture. The following table shows the amount of unrestricted and restricted cash and short-term investments at the end of each year. Table 10 Cash and Short-Term Investments Pittsburgh International Airport (in thousands) Operating Restricted Revenue bond funds Revenue bond investments Capital funds (including PFCs) Capital reserves Unexpended bond proceeds Other Total Source: Allegheny County Airport Authority. 2000 $11,503 80,504 60,081 21,101 29,266 376 1,280 192,608 $204,111 2001 $13,660 90,396 32,962 14 30,465 409 1,324 155,570 $169,230 2002 $2,452 42,416 61,184 24,694 30,421 87 555 159,357 $161,809 John F. Brown Company 29 ACTIONS TAKEN BY ACAA TO REDUCE AIRLINE RATES AND CHARGES Under the residual rate-making approach, the airlines pay the net costs to operate PIT after taking into account non-airline revenues. ACAA can adjust rates twice a year to account for unexpected changes in revenues and expenses in order to comply with the rate covenant in the indenture. ACAA has taken the following cost savings initiatives to reduce airline costs: Staffing ƒ Reduce staff by ten percent through layoffs, attrition, and offering early retirement program. ƒ ƒ Implement work schedule synergies. Reduce employee health benefit plan. Operations ƒ Close Concourse E due to reduced activity levels in the airside terminal. ƒ ƒ ƒ ƒ ƒ ƒ Close the fire station at Allegheny County Airport. Implement purchasing initiatives to maximize discounts. Acquire energy facility from private operator. Shut down moving walkways and escalators during off peak hours. Adjust terminal temperature settings to reduce energy use. Close commercial departure curb during off peak hours to reduce need for police coverage. Other ƒ Apply for reimbursement from TSA for security costs. ƒ ƒ ƒ Maximize the use of contract security, which costs one-third as much as County police. Refinance bonds to reduce annual debt service expense. Consolidate unspent construction fund amounts and refund to airlines. John F. Brown Company 30 US AIRWAYS BANKRUPTCY On August 11, 2002, US Airways filed for bankruptcy protection under Chapter 11. The key elements of the reorganization plan included (1) reducing costs, (2) increasing use of regional jets, and (3) entering strategic alliances for code sharing on domestic and international routes. US Airways emerged from Chapter 11 on March 31, 2003, after securing significant concessions from employees, vendors, lessors, and other groups. The airline struck a deal with its pilots' union that will permit it to fly up to 465 regional jets—planes that typically carry from 35 to 70 passengers, or about half as many passengers as of smaller mainline jets.12 On May 12, 2003, US Airways placed a $4.3 billion order for 170 regional jets configured to carry 50 or 75 passengers each. The order was evenly divided between Bombardier Aerospace (of Canada) and Embraer (of Brazil). The first of the new planes is scheduled to arrive in November: the remainder are to be delivered at the rate of two to six per month with the last jets arriving in 2006. The airline said it has options to buy an additional 380 of the same jets. US Airways said it closed on financing accords that provide it with $1.24 billion in liquidity, including a $240 million equity investment from the Retirement Systems of Alabama and a $1 billion loan, $900 million of which is guaranteed by the Air Transportation Stabilization Board. Twenty-one minutes before emerging from bankruptcy, US Airways informed ACAA and Allegheny County authorities that it set an effective rejection date of January 5, 2004, to complete the renegotiation of leases at PIT and related facilities. US Airways did not assume any of the leases in southwestern Pennsylvania, including those at PIT. US Airways President and CEO, David Siegel, said "As the industry continues to restructure and the focus of our operations at Pittsburgh shifts to accommodate more regional jets, we need the flexibility of renegotiating our leases at that airport and the broader campus of buildings." US Airways seeks to renegotiate 18 leases at Pittsburgh International, which include AOA, hangar maintenance leases, one Rockwell hanger lease, hangar and simulator center general office/administration leases, two hydrant fuel system leases, two cargo leases, a lift-use agreement, and three terminal-related leases. PIT is the only airport with which US Airways chose to renegotiate leases. US Airways rejected certain other airport leases including the use and lease agreements at Orlando, Daytona Beach, Tucson, and St. Louis. US Airways also rejected leases for maintenance facilities in Baltimore, Louisville, and Tampa. Even before US Airways’ bankruptcy filing, ACAA was meeting with the airline to find ways to accommodate its need for new maintenance facilities in light of fleet changes, in particular the airline’s new Airbus aircraft. At one point, US Airways had identified a $690 million “campus” at PIT, including a maintenance base and reservations center. ACAA was working with US Airways to develop a package to support the campus. Although this project was put on hold when US Airways and United announced in 2000 their intentions to merge, US Airways came back to ACAA to renew negotiations after the U.S. DOJ turned down the merger 12. As of December 31, 2002, the airline’s regional jet affiliates operated 70 regional jets as US Airways Express. The airline has reached agreements with these affiliates to place 70 additional regional jets into service during 2003 and 2004, subject to certain conditions. Between December 31, 1999, and December 31, 2002, US Airways reduced its narrow-body fleet from 400 to 260 aircraft. John F. Brown Company 31 The following chronology, provided by ACAA, is a summary of actions during the US Airways Chapter 11 bankruptcy proceedings related to ACAA: August 16, 2002 February 27, 2003 ACAA representative appointed to creditors committee US Airways files Docket No. 2607 Lease/Contract Assumption List, which includes all of PIT’s facilities with the exception of the engine test cell facility, which they reject US Airways sends ACAA a letter agreeing to the amount of the pre-petition rent due and committing to assume leases and contracts (Docket No. 2607) US Airways amends Docket No. 2945 to correct one assumed ACAA lease Bankrutpcy court confirms US Airways’ First Amended Plan of Reorganization and effectuates assumption of all listed ACAA leases and contracts (Docket No. 2986) US Airways reviews and confirms assumption of leases and contracts with ACAA ASTB requests collateral assignment of US Airways’ gates at PIT and ACAA agrees US Airways calls ACAA to add the PIT cargo facility lease to the list of assumed leases and takes off its rejection list US Airways files amendment to assumption list transferring all ACAA leases/contracts to the rejection list March 10, 2003 March 18, 2003 March 18, 2003 March 27, 2003 March 27, 2003 March 28, 2003 March 30, 2003 ACAA was part of the creditor’s committee and was represented throughout the Chapter 11 proceedings at each committee meeting and therefore was a party to each transaction and filing during the bankruptcy process. According to ACAA, US Airways never discussed the possibility of rejecting the PIT leases, except for the engine test cell facility. Also, US Airways never requested modifications to the AOA or a restructuring of debt throughout the bankruptcy process. In late April, at a Wall Street investors conference in New York Siegel called PIT "an uncompetitive place to do business" and said it must lower costs if it hopes to remain a US Airways hub or attract other airlines. In a letter sent to Governor Ed Rendell on April 25, Siegel said that "the primary issue that must be dealt with is the huge debt and debt service obligations that are imbedded in the cost of doing business" at PIT. As noted earlier, the outstanding debt at PIT totals $676 million. Siegel said he has told Allegheny County officials that the airport's debt "must be reduced by $500 million in order to lower the per passenger costs that we and other carriers pay at the airport." He suggested that ACAA restructure the debt to reduce airport costs even though ACAA has already refinanced almost all of its debt since 1993. Siegel also said that the most successful hubs "are those with very low costs and a large originating traffic base." Unfortunately, he said, Pittsburgh possesses neither. Siegel did however say US Airways wanted to work with ACAA "to find a solution that would allow us to maintain our hub operations in Pittsburgh." He said his company "will not prejudge any plan or strategy that you might put forward." John F. Brown Company 32 In addition to requesting a reduction in debt, US Airways is also asking for $115 million in infrastructure related improvements and $40 million to build a maintenance hangar and training center for regional jets at Pittsburgh. US Airways is also seeking $140 million in rent relief and $95 million in facilities and runway improvements at Philadelphia International (PHL). PIT and PHL are the only airports from which US Airways has requested lease payment relief as well as additional funding. According to ACAA, Mr. Siegel has acknowledged that the operating costs at PIT are not the problem, just the debt. Unlike US Airways’ special facility bond debt, ACAA cannot “walk away” from its GARB obligation.13 On June 11, Pennsylvania officials met with US Airways officials and offered U.S. Airways a package of funding incentives totaling $263 million over five years to keep its hub in Pittsburgh. On July 25, 2003, US Airways, Allegheny County, and ACAA reached a consensual agreement resolving all bankruptcy claims filed by the county and the ACAA against US Airways with regard to PIT. Under the agreement, ACAA and the county will be granted an allowed general unsecured claim in the amount of $211 million in the US Airways bankruptcy case. These claims will share, with claims of other unsecured creditors, in distributions of US Airways Group, Inc. equity under the company's plan of reorganization. 13. US Airways rejected leases on several facilities financed with special facility bond debt, including those at PIT (engine test cell facility) financed by the Allegheny County Industrial Development Corporation. John F. Brown Company 33 US AIRWAY’S IMPORTANCE TO PENNSYLVANIA According to US Airways, the airline provides a $1.8 billion direct economic benefit to Pennsylvania’s economy. They also claim to be the fourth largest private employer in Pennsylvania, second largest in Pittsburgh, and seventh largest in Philadelphia. US Airways employs 15,344 people statewide, of which 8,540 are based in Pittsburgh and 6,070 are based in Philadelphia. In 1993, US Airways employed 12,700 people in the Pittsburgh area, which was home to its principal aircraft maintenance and training base, flight training/simulator facilities, and largest reservations center. US Airways is the only commercial airline currently providing service to nine of the 16 cities in Pennsylvania with commercial service -- Reading, Williamsport, Lancaster, Latrobe, Johnstown, Altoona, DuBois, Bradford, and Franklin/Oil City. Small airports that rely entirely on US Airways Express service to Pittsburgh include those in Altoona, Bradford, Franklin/Oil City, DuBois, Latrobe, Johnstown and Morgantown, Clarksburg and Parkersburg, West Virginia. Therefore, if US Airways were to eliminate its hub at PIT, some of the most profound effects could be felt in these smaller communities. John F. Brown Company 34 RATING AGENCY REACTION TO US AIRWAY’S ACTION Moody’s Investors Services reacted swiftly to US Airways action at PIT. On April 1, 2003, Moody’s placed ACAA's airport revenue bonds on Watchlist for downgrade due to US Airways' announcement on March 31, 2003, that it did not assume its PIT leases and wanted to re-negotiate the leases. PIT’s Baa1 rating by Moody’s carried a negative outlook prior to this Watchlist action. Moody’s said: While the remaining signatories are obligated under the leases to step up to cover operating expenses and debt service expenses, the dominance of US Airways makes that an economically difficult scenario for the remaining carriers. On July 3, 2003, Moody’s downgraded PIT’s rating from Baa1 to Baa2, citing in part, the uncertainty regarding the negotiations to keep US Airways in Pittsburgh and the future viability of the carrier itself. To put the PIT rating of Baa2 into context, the figure below shows the distribution of Moody’s rating as of November 2002 (when PIT was still rated Baa1): Figure 12 Moody’s Airport Rating Distribution Source: Moody’s Investors Service, Industry Outlook, Global Airport Sector, November 2002. Standard & Poor’s also reacted swiftly and said on April 4, 2003: US Airways' decision to reject Pittsburgh International's leases could have far-reaching effects for the airport sector. The outcome of the renegotiations could set a precedent for other teetering airlines serving airports where they account for a lion's share of the traffic. The predicament of the Allegheny County Airport Authority highlights its vulnerability in having a non-diverse carrier mix coupled with a moderately high-cost structure, which limits its financial flexibility in light of potential service reductions or route changes. The outcome of US Airways' negotiations will be watched carefully by other struggling carriers, and if successfully renegotiated by US Airways might test the extent to which individual airports can exercise their John F. Brown Company 35 right to raise rates. If airports have only a limited ability to increase aeronautical charges, then more emphasis will be placed upon the overall facility demand and the resulting level of nonaeronautical charges. It is Standard & Poor's view that Pittsburgh International is vulnerable and any material adverse service/routing decisions by US Airways could have rating implications. More specifically, if Allegheny County Airport Authority cannot maintain debt service coverage levels near the current budgeted level, a rating adjustment could be considered. Although low-cost carriers and the expansion of regional jets have continued to provide stability in some markets, it is the general movement of the mainline carriers that will have the largest near-term effect on credit quality in the airport sector. The airport's heavy reliance on US Airways and ongoing depressed traffic levels continue to be key credit concerns. The airport's outlook remains negative in the near term. On May 19, 2003, S&P issued another report on the PIT situation suggesting far-reaching ramifications for the airport sector by saying: Clearly, the announcement by US Airways was a shot heard throughout the airport sector and has raised the specter that other financially troubled airlines -– where they have the leverage – would look to airport operators to reduce their cost structure by seeking to renegotiate the terms of current agreements that were structured to pay off airline-approved airport infrastructure projects. Most importantly, however, if US Airways were successful in forcing wholesale changes to its payments, this would weaken the profile of all U.S. hubs that have one or two airlines with large market shares. S&P’s rating for PIT is ‘BBB+’ and remains on negative outlook. In anticipation of a potential bankruptcy filing by US Airways, Fitch Ratings place PIT’s “A-“ rating on “Rating Watch Negative” on October 16, 2001, citing the airline’s financially weakened condition, the high concentration of US Airways traffic at PIT, and the airport’s relatively low level of originating passengers. On May 15, 2003, Fitch downgraded PIT from ‘A-‘ to ‘BBB’ “primarily as a result of US Airways’ intention to reject, effective Jan. 5, 2004, its airline agreements with Pittsburgh International Airport (PIT), its second busiest hub airport, as well as the drop in traffic from historical levels.” Fitch also said: Without notice, prior to emerging from bankruptcy protection, US Airways rejected its various leases at PIT, including the use agreement that determines the amount of terminal rental and landing fee payments signatory airlines using the airport must pay each year. It is Fitch Ratings’ opinion that PIT’s particular use agreement, a fully residual lease, which is common in the U.S. airport system, contains the most beneficial financial terms for a hub-based airline at its respective hub airport. Fitch considers the rejection by a dominant carrier of its hub airport’s use and lease agreements a material negative event. After Sept. 11, PIT management proactively and effectively reduced expenses and increased nonairline revenue to protect its financial position. However, the aforementioned actions by US Airways are outside the control of the airport. John F. Brown Company 36 In its review, Fitch noted PIT’s $50 million in cash available for debt service and $60 million in the debt service reserve mitigating the potential impact of US Airways’ lease rejection. Fitch also commented that no general airport revenue bond has ever defaulted and considered PIT’s airline cost per enplaned passenger for 2002 of $7.26 to be reasonable for a large-hub airport with its debt load. On July 21, 2003, Fitch said it considered the forward rejection of the PIT lease to be a “material negative event.” In the same report, Fitch characterized the PIT lease as containing “among the most beneficial financial terms for a hubbing airline at its respective hub airport.” Although the Moody’s and Fitch downgrades in PIT’s credit rating do not affect current costs, it could cost ACAA more in the future if it plans to refinance existing bonds or issue new bonds. As noted earlier, all of the outstanding GARBs at PIT are insured by bond insurance companies. Bond insurance companies would have the right to appoint a receiver to take over operation of the airport in the event of nonpayment on the bonds. John F. Brown Company 37 CASE STUDY LAMBERT-ST. LOUIS INTERNATIONAL AIRPORT This case study was prepared with the assistance of the St. Louis Airport Authority, the owner and operator of Lambert-St. Louis International Airport (STL) and its airport consultant, Unison-Maximus, Inc. EXEUCTIVE SUMMARY Some of the conclusions from this review are as follows: History of bankruptcies. The City of St. Louis has weathered through three separate bankruptcies filings with its hub carrier, TWA. In 1993, as part of TWA’s emergence from its first bankruptcy, the City purchased of all of TWA’s leasehold interests and improvements, and related real and personal property, at or near the airport for a purchase price of approximately $70 million. In return, the City was given the right to take back underutilized facilities from TWA. In the third bankruptcy filing, TWA was granted permission to sell substantially all of its assets to American, which formed a wholly owned subsidiary airline, AMR Sub, on April 10, 2001, to operate as a transitional airline at least through the expiration of the use agreement on December 31, 2005. TWA’s use agreement and other contracts and agreements with the City were assumed by AMR Sub. Connecting passengers. In 2002, connecting passengers accounted for approximately 54 percent of total passengers at STL, nearly all of which were connecting on TWA flights. American service cutback. On July 16, 2003, American announced a major service cutback at STL effective November 1, 2003, as part of its “Turnaround Plan”, reducing its daily departures from 417 to 207 (including American, American Eagle and American Connection carriers). American intends to reduce its mainline daily departures from 213 in July 2003 to 53 in November 2003, with the remaining activity assigned to its American Eagle and American Connection regional affiliates. By contrast, in June 2000, prior to the American acquisition, TWA and American operated a combined total of 356 daily mainline departures and 117 regional departures for a total of 473 daily departures. The airport’s consultant estimates that the connecting passengers would decline over 70 percent (from approximately 6.3 to 1.8 million per year) due to the American pullback. The consultant also projects that STL would not reach FY 2002 enplanement levels, which were already depressed from September 11, until FY 2023. The highest level of enplaned passengers recorded at the airport was 15.3 million in FY 2000. Runway project well underway. The City is in the midst of a $1.1 billion program to construct a new runway will allow the airport to accommodate dual independent aircraft arrivals during bad weather conditions, thereby substantially increasing airport capacity. Annual aircraft operations have declined considerably and almost consistently on an annual basis since the runway project was planned – from 519,156 in 1995 (the year before the master plan was completed) to 437,117 in 2002. As of this writing, the city had awarded contracts totaling approximately 70 percent of the value of construction, land acquisition, and soft costs for the project and feels it must complete the project. The new runway is scheduled to open in early 2006. John F. Brown Company 38 Potential project funding shortfall. Funding for the runway project is to be accomplished through a combination of general airport revenue bonds (GARBs), PFC-backed GARBs, PFC pay-as-you-go revenues (PAYGO), AIP grants, FHWA grants, and internally generated funds. The FAA awarded the City a Letter of Intent (the LOI) to provide $141.4 million of grants-in-aid for the project under the Airport Improvement Program (the AIP) over a ten-year period. In addition, the FAA approved $900 million in PFC revenue for this project of which $428 million is for financing and interest cost and $472 million is for project funding and bond principal.14 PFC-eligible debt service is estimated to be about $20 million per year. The City estimated PFC revenues in FY 2003 to be $53 million.15 On the basis of the revised passenger projections taking into account the American service reductions, annual PFC revenues would decline to approximately $31 million, which would still be sufficient to service the PFC-backed bonds. However, there would be insufficient PFC PAYGO revenues to complete the funding of the project thereby requiring the issuance of more GARBs. In the previous plan of finance, before the American service reduction was announced, the city intended to use commercial paper to cover the PFC cash flow gap but has not implemented a commercial paper program at this time. Therefore, the city has asked the FAA for an additional $100 million in LOI grants for the project for both cash flow and airline rate mitigation purposes. The feasibility study prepared as part of the most recent bond issue included a “low sensitivity” scenario showing debt service coverage levels in the range of 1.28 times annual debt service indicating limited ability to finance more project costs through additional GARBs. This sensitivity was based on the assumption that American would reduce service by 20 percent as compared to the 50 percent service reduction later announced. Airline agreements. The existing airline use agreements date back to 1965 and are set to expire on December 31, 2005. The capital costs associated with the new runway are expected to first enter the airline rate base when the runway opens, shortly after the use agreements expire. Airline rates and charges. Under the existing compensatory rate-making methodology for calculating airline terminal rentals, the City bears the risk of vacant space and bad debt. If American does not restore service levels or if another airline does not establish a major hub operation at STL, it is likely that substantially amounts of terminal space will remain unleased after 2005. American is expected to reduce its gate requirements from 49 currently to 18 gates as a result of the service reductions. Currently, the average airline cost per enplaned passenger is below the national average. However, if STL lost a substantial amount of connecting passengers, its cost per enplaned passenger would increase significantly. In addition, the debt service for the new runway will become payable from airport revenues after the existing use agreements expire, placing further pressure on airline unit costs at that time, especially the landing fee rate, which could become one the of the highest in the nation. Lack of regional airport competition. Although STL does not face competition from nearby major airports -- the closest air carrier airport to STL is 253 miles away (Kansas City) -MidAmerica Airport, which is located across the Missouri River, opened in 1998 with four gates 14. In the City’s primary PFC application for the new runway program, US Airways commented in the Federal Register that because the project was to be financed with PFC-backed bonds, the City would have insufficient PFC revenues to fund the pay-as-you-go projects and PFC debt service in a worst case scenario. 15. The City’s fiscal year ends June 30. John F. Brown Company 39 and has the capacity to increase to 85 gates and accommodate 1.25 million annual enplaning passengers. Credit under review. Although placing STL’s underlying credit under review after September 11 (Fitch Ratings “A-“, Moody’s Investors Service A3, and Standard and Poor’s “A“), none of the agencies downgraded the airport until American announced its service reductions. All three rating agencies reacted quickly after American’s announcement with S&P dropping the rating to “BBB+” and placing STL on its watch list for further negative action. Fitch and Moody’s put the airport on their negative watch lists expressing concern about enplanements levels and associated PFC revenues and financial operations. All three agencies placed STL on a 90-day watch list, meaning that they are considering lowering their credit ratings after that period if the airport finances do not appear to have improved. A downgrade to STL’s credit rating could affect the City’s ability to access the bond market for more GARBs to complete the funding of the runway program in light of the potential shortfall in PFC PAYGO funding for the project. All of the outstanding GARBs at STL are insured by bond insurance companies. John F. Brown Company 40 BACKGROUND Lambert-St. Louis International Airport (STL) is one of the largest airports in the United States in terms of passengers (17th) and operations (15th).16 STL is located in St. Louis County, Missouri and serves the aviation needs of the St. Louis metropolitan area and the surrounding areas of Missouri and Illinois. The airport is a major origin-destination point, and serves as a domestic hub for American Airlines and focus city for Southwest Airlines. The airport is owned by the City of St. Louis and operated as a financially self-sufficient enterprise of the City. The St. Louis Airport Authority was created in 1968 by an ordinance adopted by the St. Louis Board of Aldermen. The Airport Authority is made up of the Airport Commission, the Airport Director, and a personnel complement of approximately 600 full-time employees. The Airport Authority is the organization assigned to overseeing the operation of STL. The airport occupies approximately 2,100 acres of land and upon completion of the land acquisition planned for Phase 1 of the Airport Development Plan the Airport will comprise 3,600 acres, excluding noise abatement-related land. The airport is located 15 miles northwest of downtown St. Louis and ten miles from the population center of the metropolitan area. TRAFFIC TRENDS In Fiscal Year 2002, 12.6 million passengers were enplaned at the Airport, of which 5.8 million (46 percent) were originating passengers and 6.8 million (54 percent) were connecting passengers.17 The Airport is a “system hub” in the route system of American Airlines Inc. (American) as it was for (TWA) in prior years. Enplaned passengers at STL increased from 6.0 million in 1982 to a high of 15.3 million in 2000 and declined each year thereafter. Between 1982 and 2000 enplaned passengers increased at an average rate of 5.3 percent per year with connecting passengers increasing at 6.2 percent per year and originating passengers 4.5 percent per year as TWA steadily built up its hubbing operation at STL and Southwest Airlines entered the market in 1985. In 1993, enplanements declined 5.1 percent as TWA transferred some flights from STL to a “mini-hub” in Atlanta, which was a temporary measure to alleviate financial difficulties. During the following year, enplanements increased 17.3 percent at STL as TWA restored flights to the airport. Subsequently, STL experienced sustained growth in enplanements through 2000, reflecting the longest post-war expansion of the national economy, the continuing decline in the real price of air travel, and the expansion of Southwest’s low-fare operations particularly during the early to mid-1990s. Enplaned passengers at STL declined 12.5 percent in 2001 and 4.3 percent in 2002. These declines reflect the uncertainty accompanying TWA’s bankruptcy (January 2001) and subsequent acquisition by American (April 2001), and traffic declines attributable to the national economic recession and the events of September 11, 2001. From November 2000 through August 2002 16. Preliminary CY 2002 traffic and rankings per Federal Aviation Administration, July 2003. 17. Source: City of St. Louis. John F. Brown Company 41 monthly O&D passengers declined almost steadily relative to the level in the previous year. Monthly traffic from September through December 2002 was below 2000 levels (pre-September 11) by 19.1 percent. Figure 13 Historical Originating and Connecting Passengers Lambert-St. Louis International Airport 18 Connections 16 Enplaned passengers (millions) 14 12 10 8 6 4 2 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 Originations Source: Unison-Maximus, Inc., Financial Feasibility Study, December 7, 1993 and February 5, 2003. Data are for calendar years, except 2002, which is for the 12 months ending June 30, 2002. American Airlines operates major domestic hubs in Chicago and Dallas and an international gateway in Miami. Within the American mainline network, STL ranked 4th in terms of passengers (after Dallas, Chicago, and Miami). On July 16, 2003, American announced a major service cutback at STL effective November 1, 2003, as part of its “Turnaround Plan”, reducing its daily departures from 417 to 207 (including American, American Eagle and American Connection carriers). American intends to reduce its mainline daily departures from 213 in July 2003 to 53 in November 2003, with the remaining activity assigned to its American Eagle and American Connection regional affiliates. Therefore, American’s overall capacity at STL will decline by a greater percentage than the number of departures as smaller regional jets provide an increasing proportion of service. By contrast, in June 2000, prior to the American acquisition, TWA and American operated a combined total of 356 daily mainline departures and 117 regional departures for a total of 473 daily departures. The following table shows the changes in service prior to and since American’s acquisition of TWA in April 2001. John F. Brown Company 42 June 2000 June 2001 June 2002 June 2003 November 2003 Table 11 American Airlines/TWA Daily Departures Lambert-St. Louis International Airport Mainline Regional 356 117 347 147 272 146 271 146 53 160 Total 473 494 418 417 213 Source: Unison-Maximus, Inc., Financial Feasibility Study, February 5, 2003 and American Airlines press release, July 16, 2003. In the AMR Second Quarter Financial Report, American said: "We are going to make it [STL] a smaller hub that will primarily cater to the people who live, work, or do business there," Arpey said. "Our other options were far less palatable, including the extreme of simply making St. Louis a spoke city with service only to our other hubs. Our current plan allows us to provide key services for the local community while strengthening our hubs at Chicago and Dallas/Fort Worth." As the fourth largest city in AA’s system, St. Louis will have nearly the same number of daily flights as Miami, and more total American service than places like Boston, Cleveland, Detroit, Los Angeles, New York’s JFK and Phoenix. The efficiency review also concluded that the airline had too much domestic Reservations capacity, even though it had closed two Reservations facilities earlier this year. Accordingly, the airline will close its St. Louis Reservations office effective Sept. 15. American will maintain its pilot and flight attendant bases there. American (formerly TWA) and its regional affiliates have historically accounted for approximately 78 percent of total passengers since the early 1990s. Southwest is the second largest carrier at STL accounting for approximately 13 percent of passengers in 2002. In the winter of 2003, Southwest announced a planned cutback in service at STL to commence in the spring of 2003. Subsequent to the American service announcement on July 16, 2003, Southwest said that it was considering expanding its operations at STL. As of July 2003, Southwest offered 67 daily departures from STL, down from the 80 flights it operated in July 2001. The Airport’s primary air service area includes the bi-state St. Louis metropolitan statistical area (MSA). The St. Louis MSA consists of the City of St. Louis, six counties in Missouri (Franklin, Jefferson, Lincoln, St. Charles, St. Louis, and Warren), and five counties in Illinois (Clinton, Jersey, Madison, Monroe, and St. Clair). The Airport is the only major commercial airport in the St. Louis MSA. In November 1997, MidAmerica Airport started operations in St. Clair County, Illinois. MidAmerica Airport is intended to be a joint-sue facility in connection with nearby Scott Air Force Base. The passenger terminal at MidAmerica Airport opened in 1998 with four gates, but has the capacity to increase John F. Brown Company 43 to 85 gates. MidAmerica Airport is currently used by the Air National Guard’s 126th Refueling Wing. In April 1998, Langa Air (an aircraft and maintenance company) became MidAmerica Airport’s first commercial tenant. Under its full configuration, Mid America will have the capacity to accommodate 1.25 million enplanements annually. MidAmerica has had scheduled service intermittently since the terminal opened. In August 2003, Great Plains Airlines announced plans to begin service in the fall from MidAmerica to Chicago Midway Airport and Washington Dulles International Airport. STL does not face competition from nearby major airports. The nearest major airports are Kansas City (253 miles), Memphis-Shelby (286 miles), Chicago O’Hare (306 miles) Midway (288 miles), Nashville (320 miles), Louisville (273 miles), and Indianapolis (253 miles). In 2001, there were approximately 2.62 million residents in the STL MSA. The STL service area’s population compares to the state and the nation as follows: Table 12 Average Annual Rate of Increase in Population Actual 1990-2001 Projected 2001-2010 0.4% 0.2% 0.9% 0.3% 1.2% 0.6% St. Louis MSA State of Missouri United States Source: Unison-Maximus, Inc., Financial Feasibility Study, February 5, 2003. The St. Louis MSA has a diverse employment base, including manufacturing, defense, education, telecommunications, transportation, trade, health care and other services. There are 16 Fortune 1000 companies headquartered in the region (including A. G. Edwards & Sons, Anheuser-Busch Companies, May Department Stores) and St. Louis ranked 6th among major metropolitan areas in Fortune magazine’s list of America’s top business locations in 2002. The per capita personal income in the St. Louis MSA was higher than the average for the State of Missouri and the U.S. as a whole in 2000 – per capita personal income in the MSA was $31,354, which was 15.2 percent higher than the state average of $27,206, and 6.4 percent higher than the national average of $29,469. FACILITY OVERVIEW Currently, STL currently has two parallel air carrier runways (runways 12R-30L and 12L-30R), a crosswind runway (runway 6-24), and a converted taxiway that is used only for small aircraft in visual daytime conditions (runway 13-31). The largest commercial aircraft can use the primary runway, 12R-30L18 without restrictions. The 12-30 runways are situated too close together to permit independent arrivals in IFR conditions. The dimensions of the runways area as follows: Runway 12R-30L Runway 12L-30R Runway 6-24 Runway 13-31 11,019 feet long, 200 feet wide 9,003 feet long, 150 feet wide 7,602 feet long, 150 feet wide 6,289 feet long, 75 feet wide 18. The existing Runway 12R/30L will be remarked as Runway 12C/30C when the new runway 12R/30L is completed. John F. Brown Company 44 Terminal facilities include the main terminal, the east terminal, and the international area. The main terminal, including the east connector, contains 544,079 square feet of space on three levels in the terminal building and an additional 590,641 square feet of space in four concourses (concourses A, B, C and D) with 76 aircraft gates in a mixed configuration. AMR Sub19 uses 57 of these gates. The east terminal has 234,000 square feet of building space and 12 narrowbody aircraft gates all of which are leased to Southwest. The international area consists of 69,959 square feet and is situated between the Main Terminal and the East Terminal and includes the Federal Inspection Services (FIS) area and a common boarding area serving three narrowbody (or two widebody) aircraft gates. Table 12 is a summary of the most recently available gate utilization as prepared by the City for its 2002 competition plan update for the U.S. DOT. Currently, public parking consists of a 1,965-car parking structure adjacent to the main terminal and a 980-car parking structure at the east terminal, which provides a total of 2,945 short-term parking spaces. An additional 993 spaces are available for intermediate-term parking in a surface lot immediately behind the parking structure at the main terminal and 3,757 spaces are currently available for long-term parking in remote lots served by shuttle buses. The airport is in the process of developing a 3,200 space long-term parking lot (the Cypress lot), which is scheduled for completion in the fall of 2003. The Cypress lot will replace long-term lots A and B, and result in a net increase of 1,250 spaces. MetroLink, the metropolitan area’s light rail system, currently serves STL with two stations—one at the east terminal and the other at the main terminal. Other STL facilities owned by the City include five cargo buildings, 18 related shop and service buildings, ground service office/hangers for AMR Sub and the office/hangers leased to Midcoast Aviation Services, Inc, a Fixed Based Operator. In addition there are other structures at STL not owned by the City, including office space/hangers for Sabreliner Corporation, a Missouri Air National Guard facility, and certain other cargo facilities. FedEx, United Parcel Service (UPS), Emery Freight, and BAX Global lease space in a privately developed cargo facility situated on a 31-acre site. This complex includes a 100,000 square foot cargo building and a 448,000 square-foot aircraft parking apron. In January 2000, UPS opened a new 18,000 square foot cargo warehouse facility adjacent to a 200,000 square foot aircraft parking apron. 19. On April 9, 2001, Trans World Airlines (TWA) sold all of its assets to a wholly owned subsidiary of American Airlines Inc. (AMR Sub). In connection with the sale, TWA assumed and assigned to AMR Sub all agreements and leases between TWA and the City. John F. Brown Company 45 Table 13 Average Daily Gate Usage ─ February 2002 Lambert-St. Louis International Airport Number of Gates per Airline A10, A12, A14 C1-C38, D2-D36 B2, B4, B6 3 47 3 B7-B16 E29, E31, E33 A9, A16 A2, A4, A6 A3, A5 6 3 2 3 2 E2-E24 A18, A19, A21 A8, A15, A17 12 3 3 87 gates 78 gates 87 78 51 31 87 7 7 6 9 9 12 4 72 9 8 2 1 2 595 426 51 118 7 15 13 16 72 11 13 595 426 17.0 19.7 2.3 7.5 4.3 8.0 6.0 3.7 4.3 6.8 5.5 Total Departures Average per Day, Daily Airline's Departures Gate(s) per Gate 0 279 0.0 6.0 Airline Air Canada (Handled by United) American American (and TWA Airlines LLC) American Connection (TWA Gate) (Chautauqua Airlines, d/b/a) American Connection (Handled by Trans States) (Corporate Airlines, d/b/a/) American Connection (TWA Gate) (Trans States Airlines, d/b/a) City Gates** Comair d/b/a Delta Connection (Handled by Delta) Continental/America West*** Continental Express (Handled by Continental) Delta Northwest Northwest Airlink (Handled by Northwest) (Mesaba Aviation, d/b/a) Southwest United US Airways US Airways Express (Handled by US Airways) (Chautauqua Airlines, d/b/a) US Airways Express (Handled by US Airways) (Mesa Airlines, d/b/a) US Airways Express (Handled by US Airways) (Trans States Airlines, d/b/a) Total Total (excluding commuter gates****) Source: Notes: Gates Airline Departures per Day 2 0 279 Airline Competition Plan Update, Lambert-St. Louis International Airport, March 1, 2002. *During November 2002, American Airlines (AA) transferred all of its flights to Concourses “C” and “D” (previously gates leased by TWA). AA is currently planning internally on reutilizing these gates. However, one of the three gates, A14, is under a Preferential Use Space Permit, scheduled to expire April 6, 2002. After expiration, gate A14 will return to STL for reassignment. **City Gates include Skyway Airlines and regular charter flights. ***Continental and America West each lease 1 gate, however with their synergy agreement they utilized the same facilities. ****This calculation excludes the three American Connection operators and the 9 gates (B2-B16) from which they operate. John F. Brown Company 46 CAPITAL IMPROVEMENT PROGRAM AND FUNDING The City’s capital improvement program for STL includes: (1) the Airport Development Program (the ADP), (2) the 1997 Program, (3) the Part 150 Noise Mitigation Program, and (4) the FY 2002-FY 2006 Capital Improvement Program (the FY 2002-FY 2006 CIP).20 The ADP is based on recommendations set forth in the Master Plan Supplement that was completed in 1996, which includes recommendations for phased airport development over a 20year planning period.21 The major element of the first phase of the ADP is a new air carrier runway to the southwest of the existing airfield. The new runway will be parallel to the existing east-west runways at the Airport and widely separated to permit simultaneous operations during instrument flight rule (IFR) conditions. The new runway project requires acquisition of a substantial number of residential and commercial properties, relocation of a portion of a major secondary road (Lindbergh Boulevard), construction of new roadway interchanges, construction of the runway and related taxiways, and installation of required airfield lighting and navigational aids.22 The new runway will allow the airport to accommodate dual independent aircraft arrivals during IFR or bad weather conditions, thereby substantially increasing airport capacity. Previous studies indicate the new runway should result in savings to the airlines in aircraft delay costs of approximately $50 million a year and have a benefit/cost ratio of greater than 2:1.23 In 1998, the FAA (1) filed its Record of Decision on the environmental impact statement for the ADP and (2) awarded the City a Letter of Intent (the LOI) to provide $141.4 million of grants-in-aid for the project under the Airport Improvement Program (the AIP) over the ten-year period, Federal Fiscal Year (FFY) 1999 through FFY 2008.24 Phase 1 of the ADP is being implemented over the eight-year period, FY 1999-FY 2006. The new runway is scheduled to be operational in the first quarter of calendar year 2006. The total estimated cost for Phase I of the ADP is $1.1 billion. The 1997 Project consists of projects in the Airport’s 1997-2001 capital improvement program, most of which have been completed. The City has been undertaking an ambitious $287 million Part 150 Noise Mitigation Program for the past 15 years of which $226 million had been expended or committed as of June 30, 2002 for property acquisition, purchase of avigation easements, acoustical treatment and relocation of schools, a pilot sound insulation program, and procurement of a noise management (monitoring) system. 20. The City’s fiscal year begins July 1 and ends the following June 30. 21. Leigh Fisher Associates, Final Report--Master Plan Supplement Study, Lambert-St. Louis International Airport, January 1996. 22. The FAA is expected to fund a substantial portion of the costs of the navigational aids required for the new runway from its Facilities & Equipment budget. 23. Source: FAA Benefit-Cost Analysis for Lambert-St. Louis International Airport Capacity Enhancement Project, July 31, 1997. 24. In May 2000, the FAA amended the LOI to increase the amount of discretionary funds to be paid in the early years of the LOI while correspondingly decreasing the amounts to be paid in the later years. John F. Brown Company 47 The City also prepares a rolling five-year capital improvement program (the five-year CIP). The current five-year CIP addresses the period, FY 2002-FY 2006 and consists of various improvement and rehabilitation projects for the airfield, terminal, terminal roadway/curbside, terminal infrastructure, initial security enhancements, public parking facilities, as well as major maintenance projects totaling $231 million. In addition to the approved CIP, the City is undertaking a variety of security measures, including structural modifications to the terminals and parking garages to enhance blast protection, modifications to the security checkpoints, and upgrading of the existing access control system. The Federal Aviation Administration (FAA) has provided significant financial support for these measures through the grants provided to date. The Airport is also evaluating potential structural improvements to the terminals to accommodate proposed new explosive detection equipment, but the cost of such measures is unknown at this time. Once defined, these additional improvements could be added to the current CIP, and federal participation in the costs of such measures is uncertain. In the absence of federal funding from the FAA or Transportation Security Administration (TSA), such additional security measures could likely be funded from the Airport Development Fund (ADF) under the Indenture, provided sufficient ADF funds are available, or from proceeds of additional GARBs. After September 11, 2001, the airport management reassessed the five-year capital needs of the airport, excluding Phase I of the ADP. During this process, only projects deemed essential to the safe operation of the airport, or projects that could improve or create additional revenue opportunities (i.e., long-term parking lot construction and redevelopment of various concession space) were identified for immediate financing. All other non-essential projects were deferred until late FY2004 or later. The City has funded its airport capital program with proceeds of general airport revenue bonds (GARBs), AIP grants-in-aid, PFC revenues, grants-in-aid under the Federal Highway Administration’s highway grant program (FHWA), and monies appropriated from the Airport Development Fund (ADF). There were no capital contributions from the state or local governments to finance the cost of the capital program. The plan of finance for the ADP Phase I and five-year CIP was estimated by the City in May 2003 as follows: Table 14 Plan of Finance for Capital Programs Phase I ADP 5-year CIP AIP Grants LOI Pay as You Go Other Federal Highway Administration Revenue Bonds LOI/PFC Backed (a) Other PFC Pay as You Go Airport Development Fund $11,820 14,436 350,000 169,844 400,118 63,304 $1,109,522 $14,720 176,955 25,051 13,916 $230,642 Source: Unison-Maximus, Inc., Financial Feasibility Study, February 5, 2003. Note: (a) A portion of the LOI installments will be used to make principal payments on bonds. Amount of PFC backed bonds estimated based on level of PFC revenue pledged to payment of bonds. John F. Brown Company 48 The Airport generates cash flow each year from the operation of the Airport. Net revenues generated after payment of operation and maintenance expenses, debt Service on GARBs, and the replenishment of certain reserves flow to the Airport Development Fund (ADF) under the Indenture ADF where they can be appropriated for capital projects. As of June 30, 2002 the Airport had a balance of approximately $54 million in the unappropriated ADF account. Over the years, the City has been successful in obtaining discretionary AIP grants for Airport projects—both general discretionary grants for airfield improvements and grants under the noise mitigation “set-aside” within the AIP. The Airport has received approximately $190 million in AIP grants for both land acquisition and noise mitigation, including grants that have financed a substantial portion of the Airport’s Part 150 noise mitigation program. In addition, in October 1998, the Airport received a letter of intent (LOI) from the FAA to provide $141.4 million of AIP grants for the ADP over the 10-year period FY 1999-FY 2008. The LOI commitment incorporates the Airport’s passenger entitlement funds and establishes a discretionary fund commitment over the 10-year period. This major infusion of federal grant money evidences strong federal government support for the ADP. The LOI is payable in annual installments. The FAA subsequently agreed to modify the payment schedule to provide higher installment payments in the early years of the LOI. The original and revised LOI payment schedule is as follows: Table 15 LOI Payment Schedule Federal Fiscal Year 1998-99 1999-00 2000-01 2001-02 2002-03 2003-04 2004-05 2005-06 2006-07 2007-08 Total Entitlement * $4,202,000 4,313,000 4,410,000 4,506,000 4,601,000 4,695,000 4,789,000 4,882,000 4,973,000 5,063,000 $46,434,000 Discretionary $4,000,000 9,500,000 9,500,000 9,500,000 12,000,000 12,000,000 10,000,000 10,000,000 10,000,000 8,500,000 $95,000,000 Original Total $8,202,000 13,813,000 13,910,000 14,006,000 16,601,000 16,695,000 14,789,000 14,882,000 14,973,000 13,563,000 $141,434,000 Revised Total $7,186,365 21,425,496 17,910,000 12,006,000 14,601,000 14,695,000 12,789,000 12,882,000 14,973,000 12,966,139 $141,434,000 Source: Lambert-St.Louis International Airport Note: * The entitlement portion of the LOI could be reduced as a result of lower passenger traffic depending, in part, upon provisions of future AIP reauthorization legislation. Under the terms of the LOI, the City will remain eligible for additional AIP discretionary grants for the ADP outside the scope of the projects defined in the LOI (and for other capital projects not in the ADP) based on individual project applications to be made in the future. In the City’s primary PFC application for the new runway program, US Airways commented in the Federal Register that because the project was to be financed with PFC-backed bonds, the City would have insufficient PFC revenues to fund the pay-as-you-go projects and PFC debt service in a worst case scenario. The City responded that there would be sufficient PFC revenues since they are only committing 51 percent of expected PFCs to the debt and could issue additional GARBs if needed. John F. Brown Company 49 FINANCIAL FRAMEWORK The City operates STL as an enterprise fund in accordance with generally accepted accounting principles (GAAP) applicable to governmental entities. Financial statements for the airport are prepared each fiscal year based on GAAP and audited by independent certified public accountants. The airport also maintains internal financial statements, which contain more detailed itemization of revenues and expenses. The financial operations of STL are governed in large part by the trust indenture and airline use agreements. Trust Indenture General airport revenue bonds (GARBs) are issued under the terms of the amended and restated indenture of trust dated September 10, 1997, as amended and supplemented (the indenture). GARBs outstanding under the Trust Indenture are limited obligations of the City secured by and payable solely from revenues of the airport consisting of (1) GARB revenues (as defined in the indenture) and (2) pledged PFC revenues (as defined in the indenture) (collectively, the revenues).25 Pledged PFC revenues represent that portion of the PFC revenue stream equal to 1.25 times debt service on the PFC-eligible debt service for the series 2001 bonds totaling $435.2 million. Neither the credit nor taxing power of the City or the State of Missouri is pledged to secure payment of the bonds. The City can issue additional GARBs if (i) bonding authority pursuant to the City’s $1.5 billion referendum exists and (ii) the requirements for the issuance of additional GARBs under the Trust Indenture (the Additional Bonds Test) are met. The Additional Bonds Test requires that projected debt service coverage on Airport Revenue Bonds equal at least 125 percent in each of the three fiscal years immediately following completion of the projects being financed and for any 12 consecutive calendar months out of the 18 calendar months preceding issuance of the bonds. As of April 15, 2003, the principal amount of GARBs outstanding was $966 million. Annual GARB debt service, which was $36.5 million in FY1999, increased to $47.6 million in FY2000, $62.2 in FY2002, and will increase to $78.7 million in FY2007. Figure 14 illustrates the application of airport revenues to the funds and accounts established by the indenture. The revenues are first deposited in the Airport Revenue Fund and then in the Operation and Maintenance (O&M) Fund to pay O&M expenses. The remaining airport revenues are then deposited, in the following order of priority: in the Bond Fund (for payment of aggregate debt service); in the Debt Service Reserve Account (to restore any deficiency and maintain a balance equal to the debt service reserve requirement); in the Arbitrage Rebate Fund (the amount necessary to fund the arbitrage rebate fund in order to pay the rebate amount); in the Renewal and Replacement Fund (to maintain a balance of $3.5 million); in the City General Fund (to pay the five percent gross receipts tax; and the remainder to the ADF. 25. Revenues are also defined to include “…any other available moneys deposited with the Trustee for deposit in the Revenue Fund”. John F. Brown Company 50 Figure 14 Application of Airport Revenues under the Indenture Priority Under Section 504 Revenues Revenue Fund 1 Operation and Maintenance Fund Pay Operations and Maintenance Expenses Bond Fund 2 3 Pay Debt Service on Bonds Debt Service Reserve Account Replenish Debt Service Reserve Requirement Arbitrage Rebate Fund Renewal and Replacement Fund Replenish Balance of $3.5 million 4 5 (GARB Revenues Only) Section 504(A) (6) Subaccount of Revenue Fund (1) Accumulate Funds for City Gross Receipts Tax Transfer Airport Development Fund 6 Deposit all Remaining Revenues Contingency Fund Maintain reserve for contingencies, redemption of Bonds, subordinate bonds and other lawful purposes (1) Referenced in Section 504 (A) (6) of Restated Indenture. Source: Unison-Maximus, Inc., Financial Feasibility Study, February 5, 2003. As shown below, the debt levels at STL are near the median of a sample of U.S. airports on a per enplaned passenger basis but well above the median on a per originating passenger basis, reflecting the debt to finance the ADP and CIP. John F. Brown Company 51 Figure 15 Debt per Enplaned Passenger $180 $167 $160 $140 $120 $100 $80 $60 $40 $20 $0 STL per e.p. U.S. median per e.p. STL per O&D pax U.S. median per O&D pax $76 $70 $88 Sources: Series 2003B Taxable Airport Refunding Bonds (Lambert-St. Louis International Airport) and Moody’s Investor Services, Global Airport Sector, November 2002. Currently, the airport has no special facility bonds outstanding. Airline Use Agreements The basic agreement of the signatory air carriers at STL is the airport use agreement (the use agreement). The use agreements grant the signatory airlines the specified exclusive and nonexclusive uses of the terminal building, concourses, airfield, and related facilities for the business of air transportation with respect to persons, property, cargo, and mail at STL. The City has entered into airport use agreements with all of the major airlines currently serving the airport. The term of the use agreement extends to December 31, 2005 for all signatories except AMR Sub (previously TWA), a subsidiary of American. The use agreement with AMR Sub has a month-tomonth term that renews automatically until December 31, 2005, unless the City exercises its right to terminate the agreement for non-payment of amounts due 30 days after notice or upon cessation of services by AMR Sub for more than 20 days. The original use agreement at STL became effective on August 1, 1965 and has subsequently been amended several times. In addition, there have been amendments applicable only to TWA, including the Asset Purchase Agreement where the City bought TWA's long-term exclusive-use lease rights at the Airport. For those air carriers that were not signatory or successors-in-interest to the 1965 use agreement the City consolidated the 1965 use agreement and the initial three amendments into one agreement and then modernized and simplified the language. This “modern use agreement” has been used since 1982. John F. Brown Company 52 Terminal Facilities. As noted earlier, STL has two terminal buildings: the main terminal and the east terminal. The main terminal has 72 gates of which 56 are leased to American (formerly TWA) on a short-term preferential-use basis. Of the remaining 16 gates, ten are exclusive-use and six are preferential-use and are assigned as follows: America West, one preferential-use; American, two exclusive-use and one preferential-use; Continental, one exclusive-use; Delta, three exclusive-use; Northwest, two exclusive-use; United, three preferential-use; and US Airways Express, two exclusive-use and one preferential-use.26 In 1993, when negotiations converted TWA’s 56 gates from exclusive-use leases to short-term preferential-use leases, recapture provisions were also included for the first time. Those provisions permit (but do not require) the City to take back gates and related facilities from TWA when the air carrier’s usage falls below 3.33 regularly-scheduled daily flight departures per gate. The 1965 use agreement does not include accommodation provisions. The TWA amendments and the modern use agreement do provide for accommodation. The east terminal has 15 gates of which 12 are leased by Southwest on a preferential-use basis. The remaining three gates are common-use gates commonly referred to as the "city gates". Airline Rates and Charges. The use agreements set forth the procedures for calculating landing fees and terminal rents as well as certain other ancillary fees. Airline rates and charges are assessed to the airlines to support the primary activities of the airport—the airfield and the terminal complex (including the main terminal, east terminal, and the concourses). In FY 2002, landing fees and terminal rents for signatory and nonsignatory airlines together accounted for $63.7 million, or approximately 50 percent, of total GARB revenues. Terminal Rentals. The use agreements provide for a “compensatory” approach to setting terminal building rental rates whereby total terminal costs (allocated airport maintenance and operating expenses, depreciation and interest on terminal assets placed in service prior to July 1, 1997, amortization of terminal assets placed in service on or after July 1, 1997) are divided by gross terminal space to determine the airline rental rate per square foot. In this way, the airlines pay only for the space they occupy and use, while the City is responsible for the costs attributable to nonairline and unoccupied airline space. The City pays for these costs out of concession and other nonairline revenues generated in the terminals and in other cost centers (e.g., parking and ground transportation). Nonsignatory airlines are charged terminal rental rates equal to the rates charged to the Signatory Airlines. There is a separate set of terminal rental rates for each terminal and concourse. TWA Asset Use Charge. In 1993, the City purchased certain assets from TWA, including TWA’s leasehold interest in its terminal facilities and other STL support facilities. The agreement that governed this transaction allowed TWA to continue to use these assets on a month-to-month basis, and obligates TWA to pay asset use charges for such use. Under the terms of the use agreement, the asset use charges are established at rates and terms sufficient to recover the City’s investment plus interest costs, based on an amortization schedule tied to the remaining term of the Airport use agreement (which expires December 31, 2005). The asset use charges amount to approximately $7.8 million annually. This charge became the obligation of AMR Sub as a result of the sale of assets by TWA to AMR Sub on April 9, 2001, and the assumption and assignment to AMR Sub of all of TWA’s agreements with the City. Additionally, any other airline that uses 26. US Airways rejected its leases at STL under its bankruptcy and these gates were released to Trans States Airlines, a US Airways Express carrier at STL. John F. Brown Company 53 these AMR Sub assets would be subject to the asset use charges. Also, AMR Sub pays a tenant surcharge of approximately $1.1 million per year for special tenant equipment financed by the City (e.g., loading bridge upgrades, pre-conditioned air, holdroom upgrades). Landing Fees. The signatory airlines are responsible for paying landing fees in the amounts necessary to recover net annual airfield expenses after deducting the fees and charges paid by other airfield users. This method is known as a “cost center residual” rate methodology. Total airfield expenses include allocated airport maintenance and operating expenses, depreciation and interest on airfield assets placed in service prior to July 1, 1997, amortization of airfield assets placed in service on or after July 1, 1997, and interest on the City’s investment in airfield land. Credits against these costs include general aviation fuel, flowage fees and nonsignatory airline landing fees. It is the City’s policy to charge nonsignatory airlines 125 percent of the Signatory Airline landing fee rate. Under the cost center residual methodology, in the event there is a reduction or termination of activity at STL by a signatory airline or other airfield user (whether in the course of ordinary business or pursuant to bankruptcy), the City may reallocate the fees and charges relating to the airfield among the remaining carriers. This protection is not available under the compensatory terminal rental methodology. Majority-in-Interest. Under the use agreements, the costs of certain capital expenditures by the airport may not be included in airline terminal rental rates and landing fees unless such projects receive majority-in-interest (MII) approval from the signatory airlines. MII is defined as signatory airlines that have more than 50 percent of the aggregate landed weight that represent at least 50 percent in number of airlines signatory to the use agreements. Projects in the airfield that would increase the landing fee rate by more than two cents per thousand pounds of landed weight require prior approval of an MII. The City is not required to solicit MII approval if the project (1) is required by a federal or state agency, (2) is of an emergency nature, (3) costs less than $100,000 (and the aggregate of such projects do not cost more than $500,000 in any given year), (4) is the subject of a final court judgment, or (5) is financially self-sustaining and will not increase rates. Generally, MII-approved expenditures have been included in airline rates and charges upon completion of projects. Most of the costs of Phase 1 of the ADP are allocable to the airfield. Phase 1 of the ADP has not been submitted to the airlines for MII approval under the procedures of the use agreement. Without MII approval, the City cannot include any costs related to the project in the airline rate base until after the use agreements expire on December 31, 2005. However, the project is not scheduled for completion until early 2006, after the expiration of the term of the existing use agreements. The City intends that all debt service costs related to the ADP scheduled through Fiscal Year 2006 will be either capitalized from proceeds of bonds or paid from passenger facility charges (PFC) or other airport revenues. Accordingly, no such costs will be charged to the airline rate base prior to the completion of Phase I of the ADP and the expiration of the term of the existing use agreements. The City intends to negotiate new use and lease agreements with the airlines serving the Airport prior to the expiration of the existing use agreements. However, no decisions have been made by the City regarding rate-making methods or other business issues that will be addressed in those negotiations, with the exception that the City will require that costs associated with various completed CIP projects and Phase 1 of the ADP be included in future rates and charges. John F. Brown Company 54 According to the City’s legal counsel, in the absence of new use agreements the City has the authority to establish, charge and collect airport rates and charges by ordinance. Airline Cargo Leases The City has also entered into substantially identical cargo leases with certain airlines at STL granting the airlines the right to use air cargo facilities constructed by the City in connection with their air transportation businesses. These leases extend through December 31, 2005 for all signatories except AMR Sub, which has a month-to-month term that renews automatically until December 31, 2005, unless the City exercises its right to terminate the agreement for nonpayment of amounts due 30 days after notice or upon cessation of services by AMR Sub for more than 20 days. Other Airline Agreements AMR Sub also is party to several other leases with the City for hangar/office, flight training center, and equipment facilities as described in the next section. In addition, there is an air carrier fuel consortium that provides fueling to most of the air carriers. The City's agent provides fuel to those air carriers using the city gates. Currently, there are no special facility leases outstanding. PFC Program The FAA approved the airport’s first PFC application in September 1992 and the airport started collections on December 1, 1992. Through eight applications, the City has authority to collect $1.3 billion of PFC revenues. In the most recently approved record of decision, dated July 18, 2003, the FAA estimated that the PFC charge expiration date would extend to June 1, 2017 on the basis of information submitted by the City. This estimated charge expiration date preceded the recent decision by American to significantly reduce its service at STL. In September 2000, the Airport received approval to apply PFC resources to pay debt service on GARBs to be issued to finance a portion of Phase I of the ADP. Based on that approval, the City issued the 2001A Bonds in the approximate principal amount of $435 million. The plan of financing for that transaction projected that about 50 percent of the then-estimated PFC revenues would be used to pay debt service on the Bonds, with the remainder to be available to fund other elements of the ADP on a pay-as-you-go basis. In September 2001, the Airport received approval to increase the PFC rate from $3.00 to $4.50, and the airlines began collecting at this higher rate in December 2001. The increased PFC rate more than offset the reduction in PFC revenues attributable to the decline in passenger enplanements since the September 11, 2001 events. The additional resources generated by the $4.50 rate are being used to fund a portion of the FY 2002–FY 2006 CIP and provide additional funding for ADP project costs on a pay-as-you-go basis through the completion of the ADP project currently scheduled for the first calendar quarter of CY 2006. PFCs were used as an initial financing instrument for the construction of the east terminal, but the majority of those funds were later reimbursed primarily with GARBs to redirect the PFCs to the runway project. John F. Brown Company 55 The City is currently in the process of submitting a new PFC application to obtain approval for the new PFC projects in the FY 2002-FY 2006 CIP. Airline Bankruptcies In bankruptcy, a signatory airline could seek to reject its use agreement or an unexpired lease pursuant to Section 365 of the United States Bankruptcy Code. In that event, the trustee in bankruptcy or the airline, as debtor-in-possession, might reject the agreement, in which case the airport would regain control of the facilities and could lease them to other tenants, if it were able. Similarly, the airline might seek to reject other leases, if any, with the airport. The rejection of one or more leases might result in a loss of revenue for the airport, which would give the airport a claim for damages as a general unsecured creditor of the airline. The value of any such claim, however, likely would be limited. Over the years, TWA, STL’s major hub carrier, filed for protection under Chapter 11 of the U.S. Bankruptcy Code three times – January 31, 1992, June 30, 1995, and January 10, 2001. TWA’s first reorganization plan was effective August 12, 1993 and included the City’s purchase of all of TWA’s leasehold interests and improvements, and related real and personal property, at or near the airport for a purchase price of approximately $70 million. In addition, the first reorganization plan provided an amendment to TWA’s use agreement to give the City the right to take back underutilized facilities. The second plan of reorganization was effective August 23, 1995. In both instances all of TWA’s leases, licenses, and agreements with the City were assumed by TWA. In the third filing, TWA also filed with its petition for reorganization a motion for authority to sell substantially all of its assets to American or its designees, including AMR Corp., the parent company of American. In connection with the sale, American formed a wholly owned subsidiary airline, AMR Sub, on April 10, 2001, to operate as a transitional airline at least through the expiration of the use agreement on December 31, 2005. TWA’s use agreement and other contracts and agreements with the City were assumed by AMR Sub. TWA also assumed and assigned to AMR Sub the contract with its regional affiliate, Trans World Express. Two other airlines signatories to the use agreement have sought Chapter 11 bankruptcy protection since September 11, 2001: US Airways in August 2002 and United in December 2002. On August 11, 2002, US Airways filed for bankruptcy protect under Chapter 11 of the Bankruptcy Code and announced it would seek to develop a plan of reorganization to return to profitability. The bankruptcy court approved the rejection by US Airways of a gate lease and a cargo lease with the City, effective December 31, 2002, and February 28, 2003, respectively. Its terminal premises were released to Trans States Airlines, a US Airways Express carrier. Currently, US Airways only serves STL through its regional affiliates, Trans States, Chautauqua, and Mesa. UAL Corporation, the parent company of United, filed Chapter 11 bankruptcy on December 9, 2002. United has not yet emerged from bankruptcy, but has indicated it might emerge in late 2003 or early 2004. As of August 1, 2003, the United had not yet accepted or rejected its agreements with the airport. John F. Brown Company 56 AMERICAN AT STL Overview On April 9, 2001, TWA sold all of its assets to AMR Sub. In connection with the sale, TWA assumed and assigned to AMR Sub all agreements and leases between TWA and the City. Beginning in December 2001, AMR Sub integrated substantially all former TWA operations into American. In a letter to the City dated March 28, 2001, American expressed its intent “to continue operating a system hub at the Lambert-St. Louis International Airport…[including] plans to accept TWA’s facility lease at the Airport.” and further indicated that it “does not anticipate any disruption to TWA operations and customers in St. Louis” as a result of the acquisition. In FY2002, revenue from American and TWA ($45.6 million) accounted for 45 percent of total airport operating revenue and 69 percent of total revenues from signatory airlines, consisting of space rentals ($16.2 million), landing fees ($26.2 million), and other fees and charges ($3.2 million).27 American is a signatory to the use agreement and a cargo lease with the airport. Other facilities under lease by American include a hanger/office facility, flight training center, and equipment parking ramp/apron. Airport Use Agreement American is the single largest airline that is signatory to the use agreement measured in terms of enplaned passengers (76 percent), enplaned cargo, aircraft departures, aircraft landed weight, or leased premises. American conducts its passenger operations from the main terminal and concourses B, C, and D where it collectively occupies 389,226 square feet and 56 gates (of the total 87 gates of which nine are commuter gates) on a preferential use basis pursuant to the amended use agreement. The use agreements do not require security deposits from signatory airlines, but the City does require them from nonsignatory airlines. Cargo Lease As noted earlier, AMR Sub has a lease with the City granting the airline the right to use air cargo facilities constructed by the City in connection with its air transportation businesses. This lease has a month-to-month term that renews automatically until December 31, 2005, unless the City exercises its right to terminate the agreement for non-payment of amounts due 30 days after notice or upon cessation of services by AMR Sub for more than 20 days. TWA Asset Purchase Agreement In 1993, the City purchased from TWA all of TWA’s leasehold interests relating to the use of certain gates, terminal support facilities, air cargo facilities and improvements at STL, 27. Revenues from American/TWA do not include PFCs collected and remitted by the airline. John F. Brown Company 57 together with related personal property, leasehold interest in a hangar and office building, and a flight training facility. The agreement governing this transaction allows TWA to continue to use these assets on a month-to-month basis with automatic renewals through December 31, 2005, and obligates TWA to pay asset use charges for such use. This agreement governing this asset purchase became the obligation of AMR Sub as a result of the sale of assets by TWA to AMR Sub on April 9, 2001, and the assumption and assignment to AMR Sub of all of TWA’s agreements with the City. Under this agreement, if during any month AMR Sub has an average of less than 190 regularly scheduled departures, the City has the right to reclaim and redesignate the use of gates and terminal support facilities and equipment to other airlines so that AMR Sub would retain only the number of gates representing an average of 3.33 daily departures per gate. Also, if AMR Sub fails to make a payment of any rentals, fees, or charges, the City may terminate all of AMR Sub’s airport agreements and retain ownership of all assets acquired under the purchase transaction. The City’s purchased of all of TWA’s leasehold interests and improvements, and related real and personal property, at or near the airport for a purchase price of approximately $70 million and financed a portion of this cost with the Series 1993A bonds. The last debt service payment for these bonds occurs in 2005, coinciding with the expiration of the AMR Sub agreements covering its use of these facilities and improvements. AMR sub pays the City an asset use charge of approximately $7.8 million per year for these improvements. Flight Training Center Lease On December 14, 1993, the City and TWA entered into the flight training center lease. The City also purchased TWA’s fee interest in 7.38 acres of land located at 11495 Natural Bridge Road, Brighton, Missouri, which includes a four-story commercial building with 165,550 square feet of gross floor area. The facility contains flight simulators for B-767 and L-1011 aircraft as well as classrooms and office space. AMR Sub uses it as a flight training center. AMR Sub entered into a net lease of the premises whereby it pays all expenses associated with the use, operation, maintenance, repair, and reconstruction of the facility (including taxes, utilities, insurance, etc.) and pays the City rent. Equipment Operating Lease Agreement On November 4, 1993, the City and TWA entered an equipment operating lease agreement and subsequently entered into a series of amendments to this agreement. The City acquired certain equipment, personal property, furniture, machinery, vehicles, loading bridges, baggage handling systems, ground power systems, deicing systems, holdroom seating, office furnishings, counters and millwork, flight information display systems, communications installations, motorized and non-motorized ramp and maintenance equipment, and certain other personal property. Under the equipment lease, the City leases the equipment to AMR Sub on a month-to-month basis, which renews automatically through December 31, 2005 subject to earlier termination by the City. John F. Brown Company 58 HISTORICAL FINANCIAL PERFORMANCE The following table shows historical revenues, operation and maintenance expenses, debt service, and debt service coverage in compliance with the indenture. It also shows airline cost per enplaned passenger. Table 16 Historical Net Revenues and Debt Service Coverage Lambert-St. Louis International Airport (fiscal years ending June 30; amounts in thousands except coverage and cost per e.p.) FY1998 Airline terminal rentals and landing fees TWA asset use charges Concession fees Other operating revenues Interest income Pledged PFC revenues Total Revenues Operation and maintenance expenses Net revenues Debt service Debt service coverage Enplaned passengers Airline cost per enplaned passenger [A] $48,293 7,829 29,091 10,578 7,330 103,121 52,833 $50,288 37,169 1.35 14,347 $3.37 FY1999 $54,101 7,829 33,107 10,560 6,914 112,511 57,736 $54,775 36,469 1.50 14,563 $3.71 FY2000 $58,903 7,829 37,126 11,885 6,533 122,276 56,688 $65,588 47,603 1.38 15,259 $3.86 FY2001 $60,449 7,829 39,532 12,593 8,170 128,573 63,860 $64,713 46,946 1.38 14,984 $4.03 FY2002 $60,552 7,829 33,318 17,912 7,960 21,894 149,465 63,387 $81,078 62,228 1.30 12,637 $4.79 [B] [C] [B/C] [D] [A/D] Source: Unison-Maximus, Inc., Financial Feasibility Study, February 5, 2003. As shown on the figure on the next page, STL’s airline cost per e.p. has been lower than that at the median large hub but is projected to increase significantly when the debt service for Phase I of the ADP comes on line in FY 2006.28 In light of the uncertain airline traffic environment, the airport’s feasibility consultant projected airline costs per enplaned passenger for a base case and a “low sensitivity” scenario, which assumed that American would reduce its service at the airport by 20 percent in addition to the post September 11 service reductions. As noted earlier, American’s service cuts announced on July 16, 2003, would reduce its seating capacity by more than 50 percent over prior levels. Therefore, the low sensitivity scenario may overstate future traffic levels. 28. FY 2007 is the first full year of debt service for the ADP. Interest on bonds for the Phase I of the ADP have been capitalized through FY 2006 to defer debt service costs until after the runway is completed and operational. John F. Brown Company 59 Figure 16 Airline Cost per Enplaned Passenger $10.00 $9.00 $8.00 $7.00 $6.00 $5.00 $4.00 $3.00 $2.00 $1.00 $STL 2002 STL 2007 (projected) base case STL 2007 (projected) low case Large hub median 2002 $4.79 $8.09 $9.29 $5.84 Sources: Unison-Maximus, Inc., Financial Feasibility Study, February 5, 2003 and Standard & Poor’s, Airport Operators Face Uncertainties, June 2002. The following table shows the amount of unrestricted and restricted cash and short-term investments at the end of each fiscal year. Table 17 Cash and Short-Term Investments Lambert-St. Louis International Airport (in thousands) Debt service account Debt service reserve account Renewal and replacement fund PFC fund Airport development fund Construction fund Contingency fund Excluding PFC and construction FY2001 $71,354 70,323 3,500 44,893 46,794 594,975 1,675 $830,514 $193,646 FY2002 $81,372 74,450 3,500 47,496 54,529 447,899 1,857 $711,103 $215,708 Source: Audited Financial Statements, Lambert-St. Louis International Airport, FY 2002. STL retains cash reserves equal to one year’s principal and interest payments on GARB The City must fund and maintain a minimum balance of $3.5 million in the renewal and replacement fund, which may be used for paying the costs of renewal or replacement of capital items for the airport. The City maintains a balance in the contingency fund that, at its discretion, is applied to purchase or redeem bonds, pay debt service on subordinated debt, provide reserves, bonds.29 29. A portion of the debt service reserve requirement on the series 2002 bonds is covered with a surety, the balance of the reserve is in cash. John F. Brown Company 60 or make improvements, extensions, betterments, renewals, replacements, repairs, maintenance, or reconstruction of any airport properties or facilities. All remaining revenues after the payment of operating expenses, debt service, fund deposits, and the City gross receipts tax are deposited into the airport development fund (ADF), which may be used for extensions and improvements to the airport, including acquisition of equipment. AIRPORT INITIATIVES Immediately following the events of September 11, 2001, airport management took the following steps. 1. Analyzed the then current operating budget (FY 2002) and identified all nonessential spending (e.g., vacant positions, materials and supplies, capital equipment, and contractual services) and restructured spending to essential items only. Additionally, an immediate hiring freeze was initiated followed by the first ever layoff of airport staff in May 2003, resulting in the reduction of 51 staff positions (over and above the freeze on 24 vacant positions). Retained all minimum annual guarantees (MAGs) in place with key concessionaires (e.g., food/beverage, merchandise, rental car, specialty, advertising). These MAGs minimized any impact due to the decline in passenger traffic after September 11. In response to a 50 percent decline in parking revenue, increased the parking rate in the long-term lot from $6.00 to $7.00 per day) on August 1, 2002. Nearly 400 parking spaces were lost due to the 300-foot rule. Completed three bond refundings to take advantage of the favorable interest rate environment and partially defeased the series 1997 bonds due to the receipt of unanticipated grant monies. Offered the airlines additional time to repay the underpayment of FY 2002 rates and charges, which the airlines declined. In addition, airport management held in line the FY 2003 operating budget and only increased airline rates and charges nominally. Reviewed the current five-year CIP and deferred approximately $76 million in project costs to FY 2004 or later. As noted earlier, the current CIP does not include funding for security infrastructure, which has not yet been determined. Continued its aggressive air service marketing program, including meetings with various airline on an ongoing basis. More recently, airport management has been actively trying to get replacement service for the service reductions announced by American on July 16, 2003. Reevaluated all risk insurance policies to ensure the airport had reasonable coverage to protect against damage to airport property and injury to individuals on airport property. The premium for general liability insurance increased from $178,500 per year in 2001 to $616,350 in 2002 even after dropping terrorism coverage. 2. 3. 4. 5. 6. 7. 8. John F. Brown Company 61 CREDIT PERSPECTIVE OF RATINGS AGENCIES Prior to September 11, 2001, STL had the following underlying credit ratings on its outstanding general revenue bonds: Fitch “A-“, Moody’s A3, and Standard and Poor’s “A-“. Following the events of September 11, each of the rating agencies placed the credit ratings under review due to the financial difficulties of American and the potential for operational changes at the airline. In February 2003, the last time STL went to the bond market, Fitch and Moody’s maintained negative outlooks while S&P maintained a stable outlook with the expectations that passenger traffic would continue to recover and service level decisions by American would not significantly affect the airport’s cost structure. On April 30, 2003, S&P placed the rating on CreditWatch with negative implications citing an erosion in traffic levels, the weakening financial position of American, and concern by Standard & Poor’s that service cutbacks could be more severe than estimated by airport management under its low sensitivity scenario (20 percent cut in American’s service levels). The rating agencies reacted quickly after American’s announcement that it would dramatically scale back its operations at STL. S&P’s action was the most severe dropping the rating to “BBB+” and placing the credit on its watch list for further negative action. According to S&P: "The downgrade reflects an expectation of financial stress over the near-to-intermediate term and challenges to airport management and the city… A CreditWatch negative listing indicates that the rating could be lowered within 90 days. While a listing does not mean a change is inevitable, it could mean that only the magnitude of the rating change has yet to be determined." Fitch Ratings put the airport’s credit on its rating watch negative list and said: "The operational changes are likely to result in diminished financial flexibility at the airport resulting from lower landing fee collections as the fleet changes from mainline jets to lighter regional aircraft and reduced concession receipts as passenger volume declines.” Moody's also placed STL on its watch list expressing concern that "a decline in enplanements would also directly affect collections of passenger facility charges and federal entitlement grants." Moody’s also said the prospect that another airline would step in and establish a hub at STL is unlikely given the financial struggles of most airlines. Overview of Credit Quality One or more of the rating agencies cited the following risks associated with the general airport revenue bond debt of the airport: ƒ Dominant position of American (at 76 percent of passengers), which uses STL as a compliment to its larger hubs at Dallas-Fort Worth International and ChicagoO'Hare International airports. John F. Brown Company 62 ƒ Financial condition of American and continued economic uncertainty in the airline industry with the potential for further schedule adjustments affecting passenger levels and airport financial operations. High percentage of connecting passengers (54 percent of total enplanements) making the airport more vulnerable to service decisions by American. Need to renegotiate the use agreements, which expire on December 31, 2005. Ambitious airport capital program. Moderately rising airline cost per enplaned passenger associated with the capital plan. ƒ ƒ ƒ ƒ One or more of the rating agencies cited the following mitigating and credit positive factors: ƒ ƒ ƒ ƒ ƒ Central geographic position as mid-continent hub. History of sound financial management. Lack of nearby competing airports. Diversified regional economy and sizable O&D market. Competitive cost structure with low airline cost per enplaned passenger. Bond Insurance All of the outstanding GARBs at STL are insured by bond insurance companies. Bond insurance companies would have the right to appoint a receiver to take over operation of the airport in the event of nonpayment on the bonds. John F. Brown Company 63 CASE STUDY MINNEAPOLIS-ST. PAUL INTERNATIONAL AIRPORT BACKGROUND Minneapolis-St. Paul International Airport (MSP) is the principal commercial service airport serving the Minneapolis-St. Paul area. It is one of the largest airports in the United States in terms of passengers (9th) though it does not rank quite as prominently in terms of cargo (21st).30 The airport’s traffic is approximately equally split between origin-destination passengers and connecting passengers. MSP serves as a domestic hub for Northwest Airlines and has a modest but significant level of international traffic (about six percent). The airport is owned and operated by the Minneapolis-St. Paul Metropolitan Airports Commission (MAC) and is located equidistant (approximately nine miles) south and southwest of the downtown areas of Minneapolis and St. Paul, respectively. It occupies 3,100 acres. Traffic Trends In 2002, 15.6 million passengers enplaned at MSP, of which 7.1 million (46 percent) were originating passengers and 8.4 million (54 percent) were connecting passengers (Figure 17). The airport is a hub in the route system of Northwest Airlines (NWA). For the ten years preceding 2001, the number of enplaned passengers at MSP steadily increased (with the exception of 1998, in which NWA pilots went on strike), then fell back, victim to the national recession that began in March 2001, the September 11, 2001 attacks, and other factors. As shown in Figure 18, enplaned passengers at MSP numbered 15.6 million in 2002, down from 15.9 million in 2001, and from 17.0 million in 2000. NWA operates major domestic hubs in Detroit and Memphis, as well as Minneapolis. Within the NWA network, MSP ranked first in terms of enplaned passengers in 2002. Figure 19 illustrates for the past seven years the dominance of Northwest and its affiliates in serving passengers at MSP, as well as the near doubling of the Northwest Airlink market share, which remains relatively small nevertheless. In 2002 Northwest and its regional affiliates together served 79.4 percent of the airport’s enplaned passengers, while United, American, and Delta Airlines each served approximately two to three percent. The two foreign-flag airlines operating at MSP together accounted for less than 1.8 percent of MSP’s enplaned passengers. The area served by the airport reaches well beyond the MAC’s jurisdiction which itself extends to all areas within 35 miles of the city halls of Minneapolis and St. Paul, and over the Minneapolis-St. Paul “Metropolitan Area” including Anoka, Carver, Dakota, Hennepin, Ramsey, Scott, and Washington counties. At the core of MSP’s service area are the 13 counties of the Minneapolis-St. Paul Metropolitan Statistical Area (MSA). 30. Preliminary CY 2002 traffic and rankings per Federal Aviation Administration, July 2003. John F. Brown Company 64 Figure 17 Total Enplaned Passengers, 1991-2001 Minneapolis-St. Paul International Airport 18 Enplaned Passengers (millions) 16 14 12 10 8 6 4 2 1991 Connecting Originating 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 Sources: DOT, Schedules T-100 and T-3; Air Passenger Origin-Destination Survey, reconciled to Schedules T100 and 298C T-1; Metropolitan Airports Commission; John F. Brown Company, Inc. Figure 18 Enplaned Passenger Trends Minneapolis-St. Paul International Airport (for the 12 months ended December 31) 18,000 16,000 14,000 12,000 10,000 8,000 6,000 4,000 2,000 0 Non-scheduled International Domestic Source: Metropolitan Airport Commission. John F. Brown Company 65 2002P 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002P Figure 19 Enplaned Passengers Served Minneapolis-St. Paul International Airport 100% All Others Northwest Airlink 80% Northwest 60% 40% 20% 0% 1996 1997 1998 1999 2000 2001 2002P Sources: DOT, Schedule T-3; Metropolitan Airports Commission. Note: Because Northwest accounts for most connecting traffic at MSP (94.1 percent in 2002), its share of total enplaned passengers is higher (71.8 percent) than its share of O&D passengers (64.4 percent). In 2002, the Minneapolis-St. Paul MSA was home to an estimated 3,055,000 people, making it the 15th largest metropolitan area in the United States.31 The population has been steadily growing at approximately 1.4 percent per annum on average since 1970. In addition, nonagricultural employment has grown at an average annual rate of 2.5 percent (versus the corresponding national average of 1.9 percent) from 197232 through 2002, although in the three years from 2000 through 2002, employment in the MSA dropped 0.9 percent. Employment in the MSA is concentrated in service industries (30 percent) and wholesale and retail trade (23 percent). Medical technology, printing and publishing, financial services, and machinery and metalworking have reportedly been experiencing strong growth.33 The area’s per capita personal income has risen at an average annual rate of over seven percent, from 114 percent ($4,666) of the overall U.S. per capita income in 1970 ($4,095) to 125 percent ($38,131) of the overall U.S. level ($30,413) in 2001. MSP does not face significant competition from other commercial service airports. In fact, the nearest major commercial service airports are Milwaukee (297 miles away) and Omaha (283 miles away). 31. U.S. Department of Commerce, Bureau of Census website, accessed May 9, 2003. 32. This is the first year for which data are available. U.S. Department of Labor, Bureau of Labor Statistics website, accessed May 9, 2003. 33. Metropolitan Council. John F. Brown Company 66 The economic base of MSP’s air service area, the absence of competition as might be provided by another large airport in the region, and the largest number of originating charter passengers at any U.S. airport together provide MSP with a solid base of relatively high-yield origin and destination (O&D) passengers. Facility Overview MSP has three runways that allow for operations under varying wind conditions and that are capable of supporting operations of the largest commercial aircraft flying today. In addition, the six approaches to these runways are equipped in such a way that operations are possible under almost all weather conditions. The two northwest-southeast runways (Runways 12L/30R and 12R/30L) are 8,200 x 150 feet and 10,000 x 200 feet, respectively, while the crosswind northeastsouthwest runway (Runway 4/22) is 11,000 x 150 feet. The airport’s capital improvement program (CIP) includes development of a new 8,000 foot north-south runway currently scheduled for completion in 2005. Figure 20 Runway Configuration Minneapolis-St. Paul International Airport N Runway 12L/30R Runway 4/22 Humphrey Terminal Source: Federal Aviation Administration. Lindbergh Terminal Runway 12R/30L MSP terminal facilities include the main Lindbergh Terminal and the smaller Humphrey Terminal. The Lindbergh Terminal is a three-story building consisting of a central structure and seven concourses, and includes approximately 2.6 million square feet of space. Distributed across the seven concourses are 117 aircraft loading positions (gates) equipped with passenger loading bridges. The terminal includes a nine-gate international arrivals facility, a ticketing area, a baggage claim area, and a ground transportation center, in addition to concessions areas beyond the TSA security checkpoints. The Humphrey Terminal is a two-story building that includes approximately 389,000 square feet of space and houses nine gates (of which four are international arrival facility gates). The terminal is presently fully utilized six months out of the year, although the two carriers most active at the Humphrey Terminal are charter carriers who operate year-round. John F. Brown Company 67 As of June 3, 2003, there were 15,387 public parking spaces at MSP, of which 13,124 were near the Lindbergh Terminal and 2,263 near the Humphrey Terminal. A light rail connection between downtown Minneapolis and the Mall of America, with two stops at MSP, is under construction and is expected to be completed in late 2004 or early 2005. In addition, the airport is conveniently accessed by car from I-494, which is just south of the airport and runs east-west connecting to I-35E and I-35W (which each run north-south). Capital Improvement Program and Funding The 1989 Minnesota State Legislature established a “dual track” process for planning the future of the airport serving Minneapolis and St. Paul. One option was to relocate the airport to a greenfield site, the other was to modernize and further develop the existing airport. The 1996 legislature made the determination to not build a new airport and to develop the existing one. It is out of this process that the airport’s long-term capital improvement plan—the 2010 Plan—was developed. With an estimated cost of $2.2 billion in 1998, a $200 million contingency escalated through the construction period, and certain scope changes and cost increases, the total estimated cost of the 2010 Plan is $2.8 billion. In addition to other projects, it principally includes: ƒ Airfield projects (construction of a new 8,000 foot north-south runway, holding/deicing pads, and a taxiway, and continuation of the residential sound insulation program); ƒ landside projects (construction of an auto rental/parking facility adjacent to the Lindbergh Terminal, a new parking structure adjacent to the Humphrey Terminal, roadway improvements, and other projects); Lindbergh Terminal improvements; a new Humphrey Terminal, and reliever airport projects. ƒ ƒ ƒ Certain parts of the plan have been completed (for example, the new Lindbergh parking facility and the new Humphrey terminal), while others have been delayed (for example, the new runway). Since the original formulation in 1998, the 2010 Plan has continued to evolve as construction has progressed and other projects have been identified. The MAC’s total capital program consists of the adjusted 2010 Plan projects and the other identified projects. Other capital projects that are not part of the 2010 Plan include an in-line baggage screening facility, additional cargo facilities, a new control tower, and two stations on the route of a light rail system running from downtown Minneapolis to the Mall of America, just south of the airport. Of the approximately $3 billion of the MAC’s total capital program (which includes the 2010 Plan and other projects), approximately $2.1 billion had been completed or had begun construction by June 1, 2003. Each year, in order to determine its funding and operational planning requirements, the MAC reviews and revises its capital projects that are scheduled to begin during the next two calendar years. The current two-year capital program is known as the 2003-04 Capital Improvement Plan (2003-04 CIP) and includes capital projects scheduled to begin between January 1, 2003 and December 31, 2004. In December 2002, the 2003-04 CIP totaled $484 John F. Brown Company 68 million. As it became clear that the economic situation faced by the airline and airport industries was not dramatically improving, the MAC reduced the total plan amount to $316 million. In June 2003, however, the CIP increased to $363 million as a result of adding a $60 million in-line baggage screening project, replacing a $12.9 million project already in the CIP. (The cost of an in-line explosive detection system for the Humphrey Terminal is estimated to be $25-30 million, but no planning is underway regarding this.) It was expected that the Lindbergh explosive detection baggage facility would be funded by a $17.1 million TSA grant, the $12.9 million FAA AIP discretionary grant, and a $23-30 million TSA LOI (which might require up to $7.5 million in matching funds from the MAC).34 In the wake of the September 11 attacks the MAC has reviewed its entire capital program including the 2010 Plan, the 2003-04 CIP, and its other projects. While the total size of the program is still approximately $3 billion, certain projects have been rescheduled or indefinitely deferred as discussed above. Table 18 shows the financing plan for the MAC’s capital program as of June 1, 2003: Table 18 Capital Program Funding Sources Minneapolis-St. Paul International Airport ($000) Source MNDOT Grants AIP Entitlements/Discretion AIP Grants – LOI FAA Noise Mitigation Funds AIP Grants – Noise TSA Grants and LOI PFCs – Pay-as-you-go MAC Funds Bonds Total Expected Amount $ 14,400 115,000 145,000 91,000 10,000 47,100 587,000 280,600 1,709,900 $3,000,000 Percent of Total 0.48% 3.83 4.83 3.03 0.33 1.57 19.57 9.35 57.00 100.00% Source: Metropolitan Airports Commission, Official Statement, June 19, 2003, p.71. In 2002 the MAC received federal AIP grants totaling $33 million.35 In addition, the MAC receives a passenger facility charge (PFC) of $4.50 for each enplaned passenger. The MAC has been authorized to collect PFCs through 2016 up to approximately $1.6 billion. Of this amount, through April 2003 the MAC had received approximately $452 million. The MAC uses the PFC receipts to pay certain of the debt service on its general airport revenue bonds and to fund project construction. The “pay-as-you-go” PFCs that are expected to fund the capital program total $587 million (19.57 percent) of the estimated $3 billion capital program cost. 34. At NWA’s request the project was put on hold while Congress decides on the required level of matching funds, if any. 35. Minneapolis-St. Paul Airports Commission, Official Statement, June 19, 2003, p.75. John F. Brown Company 69 Financial Framework The MAC was created in 1943 by the Minnesota State Legislature. It is governed by 15 commissioners, 13 of whom are appointed by the governor and one each by the mayors of Minneapolis and St. Paul. The MAC exists as an independent entity. Since it is not a part of the state government, the state legislature has little direct control over the MAC’s day-to-day activities. However, certain capital projects of the MAC costing more than $5 million at MSP (or $2 million at reliever airports) must be submitted to the Metropolitan Council for approval. The MAC’s financial operations are strongly influenced by the indentures pursuant to which it may issue debt, and by its airline lease agreements. These and certain other agreements are described below. Indentures Historically, the MAC issued general obligation revenue bonds as authorized by the State to finance its capital construction activities. Since 1998, the MAC has issued its debt as general airport revenue bonds except for refunding of general obligation revenue bonds, which was done with similar bonds. The MAC uses two trust indentures, one for senior lien debt and one for subordinate lien debt, to issue its general airport revenue bonds. General obligation revenue bonds are general obligations of the Commission secured by a pledge of net revenues and, ultimately, by a requirement to levy a tax on all taxable property within its jurisdiction (which the MAC has not done since 1969) should net revenues be insufficient to pay principal and interest currently due. Of the total issued, approximately $344 million is outstanding with final maturities ranging from 2006 to 2022. Senior airport revenue bonds are secured by a pledge of and lien on net revenues on parity with general obligation revenue bonds. Of the total issued, approximately $974 million is outstanding with final maturities ranging from 2016 to 2032. Subordinate obligations are secured by a pledge and lien on subordinate revenues (that is, on net revenues after payment of general obligation and senior lien debt service). Of the total subordinate revenue bonds issued, approximately $366 million is outstanding with final maturities as late as 2032. In addition, the MAC has the ability to issue at the subordinate lien level up to $200 million in commercial paper notes in maturities from one to 270 days. The purpose for establishing the commercial paper program was to finance on an interim basis costs of the capital program. Such issued commercial paper is eventually refunded from proceeds of general airport revenue bonds issued for the purpose. The MAC has covenanted that as long as its general obligation revenue bonds and general airport revenue bonds are outstanding it will establish, fix, prescribe, and collect rates, tolls, fees, rentals, and charges so that its net revenues meet certain criteria related to debt service coverages, debt service funds, reserve requirements, and principal and interest payments. In addition, before new debt can be issued, the requirements of the applicable additional bonds tests must be met. John F. Brown Company 70 Figure 21 Application of Revenues Under the Master Senior Indenture Metropolitan Airports Commission Revenues Passenger Facility Charge (PFC) revenues Operating Fund (Held by Commission) Pay PFCapproved project costs and for other lawful purposes PFC Account (Held in Operating Fund) Maintenance and Operation Expenses of the Airport System (Set aside by the Commission within Operating Fund) Transfer to Senior Trustee Senior Debt Service Funds (Held by Senior Trustee) Transfer to Senior Trustee Commission Debt Service Fund for General Obligation Revenue Bonds (current principal and interest portion) (Held by Commission) Senior Debt Service Reserve Funds Transfer to (Held by Senior Trustee) Senior Trustee Commission Debt Service Fund for General Obligation Revenue Bonds (reserve portion) (Held by Commission) Payment of Commission Debt Service Fund Deficiencies (Set aside by the Commission within Operating Fund) Transfer to Subordinate Trustee Subordinate Obligation Debt Service Fund (Held by Subordinate Trustee) Transfer to Subordinate Trustee Subordinate Obligation Debt Service Reserve Fund (Held by Subordinate Trustee) Transfer to Subordinate Trustee Maintenance and Operation Reserve Account (Held by Commission in a separate account within Operating Fund) Commission Construction Fund (Held by Commission) Health Insurance Trust Fund (Held by Commission) Coverage Account (Held by Commission in a separate account within Operating Fund) Source: Metropolitan Airports Commission. John F. Brown Company 71 Annual debt service on existing MAC debt (excluding its commercial paper notes) is expected to remain in the $119 - $125 million range until 2021 although the MAC’s current plan of finance anticipates issuing additional bonds in 2005. As shown in Figure 22, below, the 2001 total debt outstanding at MSP was higher than the median of a sample of U.S. airports on a per enplaned passenger basis (yet within one standard deviation of the mean, which is not shown), and was notably above the median on a per originating passenger basis (and almost two standard deviations above the mean), largely reflecting the debt related to the 2010 Plan. Figure 22 Total Debt Outstanding per Passenger, 2001 $300 $250 $200 $150 $100 $50 $0 MSP per e.p. U.S. sample median per e.p. MSP per O&D pax U.S. sample median per O&D pax Source: Audited Financial Statements of the Metropolitan Airports Commission for the Fiscal Years Ended December 31, 2002 and December 31, 2001; and Moody’s Investor Services, Global Airport Sector, November 2002. Airline Lease Agreements Northwest and 24 other airlines are signatories to the 2000 Airline Agreements which have an effective date of January 1, 1999 and expire on December 31, 2010. The agreements with Northwest, Mesaba, Air Canada, and Airborne Express, have been amended and expire five years later, and offers to extend have been made to all other signatory carriers. The Agreements establish, among other things, procedures for the annual calculation of rents, fees, and charges for the use of the airport. Terminal Facilities. The two terminals at MSP have a total of 126 gates. Of the 117 gates in the Lindbergh Terminal, 85 gates are leased on a preferential basis and ten are under “shortterm” leases. The remaining 22 gates are on the G Concourse; 12 are leased to NWA on an exclusive-use basis and the other ten gates comprise the International Arrival Facility.36 The Humphrey Terminal is common-use, although two charter carriers have priority use of three of the terminal’s nine gates. The airline agreements provide that under certain conditions, the MAC can reallocate to airlines wishing to provide new service to the airport seven gates then being leased. In addition, the airline agreement with NWA provides, among other things, that the airline 36. Office of the Legislative Auditor, State of Minnesota, Program evaluation report: Metropolitan Airports Commission, January 2003. John F. Brown Company 72 will on an as-needed basis make available one wide-body position and that the airline has exclusive use of the G Concourse except for the nine international arrival facility gates. Airline Rates and Charges. The method for calculating terminal rents and landing fees is set forth in the airline agreements. In 2002, airline revenues, including landing fees for signatory and nonsignatory airlines, and terminal fees from the Lindbergh and Humphrey Terminals totaled $77 million (34 percent of MAC total revenues). Terminal Rentals. The airline agreements specify a compensatory rate-setting methodology for setting terminal building rental rates. Total adjusted terminal building operating costs (including C/D concourse cost deferral/recovery) are divided by total rentable area to obtain the rental rate per square foot. While different rates are charged for janitored versus unjanitored space, there is no rate differential between signatory and nonsignatory airlines. Landing Fees. Landing fees are calculated based on a cost-center residual rate-setting methodology for the airfield. That is, signatory airlines are responsible for paying landing fees in an amount sufficient to cover all annual expenses related to the airfield, net of fees paid by other users of the airfield. (Non-airfield expenses are recovered through mechanisms other than landing fees.) The nonsignatory landing fee rate is 125 percent of the signatory rate. Theoretically, under this methodology, should any airline go bankrupt any shortfall related to airfield operations would be distributed across the remaining airlines with no loss to the MAC. Majority-in-Interest. Proposed airfield capital projects in excess of $1 million are subject to airline review and approval under the airline agreements. The MAC cannot charge airlines for the cost of any such airfield projects that are disapproved by a majority-in-interest of the airlines. As part of the airline agreements, the MAC received approval of the projects comprising the 2010 Plan that require MII approval. The airline agreements define a majority-in-interest (MII) as the signatory airlines who (a) represent at least 50 percent in number of the then-operating signatory airlines, and (b) paid at least 40 percent of the preceding year’s signatory airline landing fees. Specific Project Leases The MAC has constructed various buildings and other facilities including a fueling facility, and hangars and offices. The MAC leases these to Signature Flight Services, Northwest, Federal Express, and Mesaba Airlines. Where the MAC issued bonds to construct the leased facilities, the lessee’s lease payments equal the following year’s associated bond debt service; where bonds were not issued, the lessee’s lease payments equal an amount that would correspond to the following year’s associated bond debt service had bonds been issued. Certain of the Northwest and Federal Express facilities were funded with bonds, and certain of the Signature Flight Services, Mesaba Airlines, and other Northwest facilities were financed from MAC funds on hand. John F. Brown Company 73 For 2002, the total of these lease payments received by the MAC was $35 million.37 Included in this amount are NWA’s payments ($26 million) related to the Series 15 obligations (discussed elsewhere in this study). Other Building and Miscellaneous Leases The MAC collects revenues from other building and miscellaneous leases related to rentals and other fees associated with the Humphrey Terminal, hangars, offices in the West Terminal area, and non-airline tenants in the Lindbergh Terminal. For 2002, these revenues totaled $17 million. Concession Agreements The MAC has concession agreements with concessionaires who operate inside the terminal building and with car rental agencies. The fees from terminal concessionaires are based on various percentages of gross sales with larger concessions guaranteeing an annual minimum payment. For rental car agencies, payments to the MAC are a percentage of gross revenues and special charges. In addition, the MAC receives revenues from an auto parking management contract. For 2002, the total of terminal concessions, rental car concessions, and the auto parking management contract revenues was $71 million. Airline bankruptcies MSP has successfully weathered a number of airline bankruptcies including those of TWA, Sun Country, and Vanguard, and is dealing with the effects and after effects of the US Airways, United, and Air Canada bankruptcies. In January 2001, TWA filed for bankruptcy protection. In April 2001, substantially all of TWA’s assets and certain of its liabilities were purchased by American Airlines. TWA’s lease was assigned over and assumed by American. All pre-petition obligations of TWA have been paid. In December 2001, Sun Country discontinued scheduled passenger service at MSP and filed for bankruptcy protection. Its name and some of its assets were purchased in April 2002 by investors and it now operates charters and limited scheduled service from MSP under the Sun Country name. Sun Country rejected its airline lease agreement. Of approximately $570,000 in pre-petition obligations, approximately $72,000 was recovered from other air carriers through increased landing fees, approximately $46,000 was recovered by re-leasing a hangar previously leased by Sun Country, and $451,392.15 was not recovered.38 In May 2002, Vanguard discontinued operations at MSP before filing for bankruptcy protection in July 2002 and suspending all operations. 37. Audited Financial Statements of the Metropolitan Airports Commission for the Fiscal Years Ended December 31, 2002 and December 31, 2001, Management’s Discussion and Analysis. 38. Minneapolis-St. Paul Airports Commission, Official Statement, June 19, 2003, p.30. John F. Brown Company 74 In August 2002, US Airways (which accounted for 1.4 percent of MSP’s 2002 enplanements) filed for bankruptcy protection from which it emerged in March 2003. It continues to operate from the airport and US Airways has assumed its airline lease agreement. In December 2002, UAL (parent company of United, which accounted for 3.3 percent of MSP’s 2002 enplanements) filed for bankruptcy protection. United continues to operate from the airport. United has neither assumed nor rejected its airline lease agreement, but in June 2003 was required to do so by August 9. In July, the bankruptcy court approved UAL’s request for an extension of the deadline until the earlier of December 15, 2003 or the conclusion of the hearing on UAL’s disclosure statement to accept or reject certain real estate leases. The MAC does not presently hold a security deposit or performance bond from United but is requesting one. In addition, United has paid all pre-petition landing fees, but the MAC and United are currently disputing the categorization of $86,205 of facility rentals under the airline lease agreement, which the MAC considers post-petition and which United considers pre-petition. In April 2003, Air Canada (which accounted for 0.2 percent of MSP’s 2002 enplanements) filed for bankruptcy protection but continues to operate from the airport. By June 2003 no date had been set for Air Canada to accept or reject its Airline Lease Agreement. MAC holds a security deposit of about $19,000 from Air Canada, which owes MAC approximately $5,900 in pre-petition obligations. Northwest at MSP Overview In 2002, NWA provided a significant share of the MAC’s revenue: Table 19 MAC Airline Revenue (for the year ended December 31, 2002; $000) All air carriers' share 69,518 33,609 103,127 26,252 76,875 Operating revenue "Self-liquidating" revenue Interest income Total revenue Less: Series 15 "self-liquidating" revenue Total adjusted revenue "Self-liquidating" revenue detail Series 15 Other Total "self-liquidating" revenue NWA share 51,858 32,658 84,516 26,252 58,264 MAC 170,611 35,290 19,589 225,490 26,252 199,238 26,252 6,406 32,658 951 33,609 26,252 9,038 35,290 100% 100% 100% Operating revenue 30% 41% Total revenue 37% 46% Total adjusted revenue 29% 39% Source: Metropolitan Airports Commission Official Statement, June 19, 2003, p.63. John F. Brown Company 75 NWA is a signatory to MSP’s airline lease agreements and has several other leases with the airport. NWA’s facilities at MSP include space in the Lindbergh Terminal, a tug storage area, Main Base Building B, a 747 hangar and RC Main Base Building C, two deicing centers, a mail sort facility, an air cargo facility, and a fuel system vehicle storage lot. Airline Lease Agreement Measured in terms of enplaned passengers, aircraft departures, aircraft landed weight, or leased premises, Northwest is the single largest airline that is a signatory to the 2000 Airline Agreements at MSP. However, with respect to total cargo handled, Northwest (27 percent) is second to FedEx (43 percent). Northwest conducts its passenger operations from the Lindbergh Terminal where it occupies 416,000 square feet and 101 gates (of the total 117 gates). Twenty-two of the Lindbergh Terminal gates are leased to NWA on exclusive-use leases; 74 are leased under preferential leases; and five are leased under “short-term” leases.39 Table 20, below, outlines the gate allocation at MSP. NWA, along with other airlines, conducts its international passenger operations from the Lindbergh Terminal’s ten international arrival facility gates. NWA, consistent with the 2000 Airline Agreement, is not required to provide the MAC with a performance bond or security deposit (which security would otherwise be equal to three months of estimated rents, fees, charges, and PFC collections) so long as it remains current on outstanding obligations. NWA is current on its rents and on remitting its PFC collections but has asked to give up one of the passenger lounges it currently leases. Table 20 Gate Leasehold Assignments ─ December 2002 Minneapolis-St. Paul International Airport Leased by NWA Lindbergh Terminal Large and regional jet aircraft Commuter jets and propeller aircraft Subtotal Humphrey Terminal Charter/Scheduled service Total 60 41 101 Available Leased by for general others use 16 0 16 0 0 0 Share held by NWA 79% 100% 86% Total 76 41 117 0 101 0 16 8 8 8 125 0% 81% Source: Metropolitan Airports Commission. Notes: The Humphrey Terminal is common-use, although two charter carriers have priority use of three of the terminal’s gates. Although there were eight gates at the Humphrey Terminal in 2002, another is now available. 39. Office of the Legislative Auditor, State of Minnesota, Program evaluation report: Metropolitan Airports Commission, January 2003. John F. Brown Company 76 Other Leases Northwest holds two other major leases at the airport, as well as several other leases for deicing operations, mail sorting, and air cargo operations (see Table 21). The significant leases among these that NWA holds at MSP expire beginning in 2011, with most expiring in 2015, and a few expiring in 2020 and 2026. Table 21 Northwest Airline’s Obligations Other than Airline Agreement Minneapolis-St. Paul International Airport Facility Annual Rent 2003 Former RC Main Base $ 2,947,600 Deicing Operations 746,873 Mail Sort Facility 262,880 Air Cargo Facility 301,174 Lease and Fueling Agreement 9,494 747 Hangar (Series 13) Bond Financing 4,044,919 NWA (Series 15) Bond Financing 21,853,313 Total $30,166,333 Source: Metropolitan Airports Commission. Relations with the MAC NWA has been very active in providing input to the MAC in its management of MSP, and the relationship between NWA and the MAC has at times been contentious even when the state has been attentive to NWA’s circumstances. NWA withholds MAC payments. On September 26, 2001 NWA informed the MAC that it would withhold payment of $5.5 million in airline costs that were owed to the MAC, although NWA was willing to negotiate minimal fees—a proposal acceptable to the MAC as a short-term measure but not as a long-term solution.40 When two days later NWA paid the amount it owed, it indicated that its decision to pay was related to a hope that the MAC would reduce its airport costs in recognition of the airline’s service reductions.41 (Immediately after September 11, NWA had reduced its systemwide schedule by 20 percent.) MAC declines NWA aircraft parking request. Shortly thereafter, on October 1, NWA sought to park 30 to 45 of its idled aircraft in a non-revenue-generating area at MSP for up to nine months. The MAC studied the request and, concerned that approving it might set a precedent of granting fee waivers, on October 9 rejected it.42 Two days later, NWA asked if it could secure parking for 15 of its aircraft, to be activated on a daily basis if necessary.43 On October 29, MAC management met with the airline to discuss a low-cost alternative. NWA continued to ask for free parking. On November 13, the MAC sent NWA a new offer, by which time NWA had already found space at DTW and elsewhere for its aircraft. 40. Toni Coleman, St. Paul Pioneer Press, “Northwest withholding millions in payments for use of Twin Cities airport,” September 26, 2001. 41. Associated Press, “Northwest to make good on payment to airports commission,” September 29, 2001. 42. Minneapolis Star-Tribune, “Northwest, MAC at odds over more airport money issues,” October 4, 2001. 43. Office of the Legislative Auditor, State of Minnesota, Program evaluation report: Metropolitan Airports Commission, January 2003. John F. Brown Company 77 Minnesota Legislature receives report on assisting airlines. Meanwhile, on October 2 a paper prepared by Minnesota’s House Research Department was delivered to the House Taxes Committee. This paper discussed options available to Minnesota related to airline industry relief. It presented an overview of federal legislation enacted in response to the events of September 11; a description of Minnesota tax provisions impacting the airline industry; and a discussion and quantification of options for property tax, excise tax, sales tax, and corporate franchise tax changes to assist the industry. The paper concluded with a brief discussion of loan payment relief measures for NWA.44 MAC refunds NWA debt and delays reappraisal. In January 2002, the MAC refunded its Series 9 obligations, debt it had issued on behalf of NWA to aid the airline in an earlier financial crisis. The lease payments from NWA equal the principal and interest on these obligations. This refunding was calculated by the MAC at the time to save NWA $53 million over the life of the bonds ($37 million on a present value basis assuming a 6.6 percent discount rate). At a Commission meeting in April, Jeffrey Hamiel (Executive Director, MAC) reported that NWA had requested that the MAC defer its periodic reappraisal of the Series 15 collateral until the air transportation market stabilizes. The reappraisal was scheduled to be completed by the end of that month. Mr. Hamiel recommended deferring the appraisal until April 2004 and the MAC agreed to waive the April 2002 appraisal. MAC provides airline subsidy. In December 2002, the 2003 MAC budget included a one-time subsidy ($3.3 million from its 2002 operating surplus) to the airlines to keep their MSP costs at 2002 levels even though new facilities had been completed in the meantime and expenses had consequently increased. In May 2003, NWA indicated to the MAC that more short-term relief was needed from the MAC, over and above keeping airline rates and charges flat in 2004.45 The following month, NWA pointed out in a MAC committee meeting that by limiting operating expense increases to increases in revenue (which was one of the MAC’s 2004 budget goals), actual operating expenses would be reduced by $6.3 million versus their budgeted level, and that since 2002 (the base for the 2004 budget) had a significant surplus, 2004 should as well.46 Thus, by July 2003, the $3.3 million one-time subsidy had grown to $13 million from the MAC’s operating surplus. NWA sues the MAC. In December 2002—in the same month in which the MAC was working to provide airlines serving MSP with a subsidy that would reduce their 2003 rates and charges—NWA “shocked, surprised, and baffled [the MAC] at a time when we’re trying to extend our hand to Northwest”47 when NWA filed a lawsuit in Ramsey County District Court naming the MAC as a defendant. The suit alleged that the rates and charges imposed by the MAC at its reliever airports were too low. The MAC released the following statement in response: Rates and charges to tenants at the reliever airports are established by MAC ordinance. Northwest Airlines had the full opportunity to participate in the development of that ordinance but chose not to do so. We have made clear in recent weeks our intention to review reliever airports financing issues. There is a process in state law for Northwest 44. Joel Michael, House Research Department, Background on and Options for Providing Relief to the Airline Industry, October 2, 2001. 45. MAC Finance Committee, Minutes, May 7, 2003. 46. MAC Finance Committee, Minutes, June 4, 2003. 47. Toni Coleman and Martin J. Moylan, Minneapolis Pioneer Press, “NWA sues airport panel,” December 14, 2002, quoting MAC General Counsel, Tom Anderson. John F. Brown Company 78 Airlines or any other aggrieved party to petition the MAC to reconsider or modify any of its ordinances. It is a waste of time and money for them to file a costly lawsuit at a time they are seeking to reduce expenses.48 The court dismissed the case in April but NWA announced a few days later that it would appeal. In the meantime, the MAC has been searching for ways to reduce the subsidy and by late July had had discussions on that topic with a company that operates general aviation airports.49 NWA reportedly helps amendment reach U.S. House-Senate Conference Committee. In July 2003, discord again surfaced, but this time between NWA and political officials in the Minnesota Legislature and in Washington. NWA reportedly was involved in the introduction of legislation to the U.S. House-Senate Conference Committee that could potentially restrict the MAC’s noise mitigation program.50 This was perceived by some as an effort by NWA to circumvent the local political process in order to restrain MAC spending that would impact NWA. State Representative Martin Sabo described the move as “disturbing,” state Senator Wes Skoglund called the move “a betrayal,” and U.S. Senator Mark Dayton said he was “enraged” by it.51 Historical financial performance The following table shows the MAC’s historical revenues, operating expenses, and debt service coverage for the last four fiscal years. Table 22 Historical Net Revenues and Debt Service Coverage Metropolitan Airports Commission (in thousands except coverage and cost per enplaned passenger) Operating revenues Interest income Operating expenses Non-operating revenue (expense) Net revenue [A] Debt service [B] Debt service coverage ratio /1 [A/B] Source: Note: 1999 $137,985 35,5 (70,922 6,05 $108,698 $ 46,581 2.33 2000 $163,414 35,59 (81,022 7,30 $125,282 $ 64,738 1.94 2001 $170,067 36,03 (90,604 7,47 $122,972 $ 88,595 1.39 2002 $170,611 31,52 (84,325 9,32 $127,127 $ 98,775 1.29 Minneapolis-St. Paul Metropolitan Airports Commission. 1. Excludes Transfer amounts. The MAC’s senior lien debt service coverage in 2002 was 1.42x, while its subordinate lien debt service coverage (including senior lien debt service) was 1.35x. 48. Metropolitan Airport Commission news release, “Response to Northwest Airlines lawsuit, ” December 12, 2002. 49. Dan Wascoe, Jr., Minneapolis Star-Tribune, MAC awaiting proposal from firm to develop small airports, July 28, 2003. 50. Dan Wascoe, Jr. and Greg Gordon, Minneapolis Star Tribune, “Airport noise deal irks [U.S. Sen.] Dayton,” July 31, 2003. In this article, NWA’s involvement is attested by Senators Coleman and Dayton. 51. Dan Wascoe, Jr. and Greg Gordon, Minneapolis Star Tribune, “Coleman: NWA need is real, tactics bad,” August 1, 2003. John F. Brown Company 79 As shown in the following figure, MSP’s cost per enplaned passenger is lower than the median for large hub airports. Through 2010, it is projected to peak in 2007 at $6.37. Figure 23 Airline Cost per Passenger $7.00 $6.00 $5.00 $4.00 $3.00 $2.00 $1.00 $0.00 MSP 2002 MSP 2003 (forecast) MSP 2007 (forecast) Large hub median 2002 $6.37 $4.95 $5.11 $5.84 Source: John F. Brown Company in Metropolitan Airports Commission Official Statement, June 19, 2003; and Moody’s Investor Services, Global Airport Sector, November 2002. The following table shows the amount of unrestricted and restricted cash and short-term investments at the end of each year. Table 23 Cash and Short-Term Investments Metropolitan Airports Commission (in thousands) Operating Restricted Cash and cash equivalents Investments Debt service Construction and other PFC receivable Other Total 2001 $ 76,599 16 243,577 609,877 7,979 0 861,449 $938,048 2002 $ 88,241 12 238,746 258,075 4,792 12,979 514,604 $602,845 Source: Minneapolis-St. Paul Metropolitan Airports Commission. Note: Excludes government grants in aid of construction ($6,440 in 2001, and $14,705 in 2002). Airport Initiatives Even before September 11, 2001, the MAC was coping with lower than expected revenues due to the generally slow economic climate, and with higher than expected expenses due to high utility bills and high snow-clearing costs from the preceding winter. In the aftermath of September 11, the MAC took the following steps: 1. Instituted a hiring freeze on all non-essential positions. The MAC’s 2002 budget continued the hiring freeze on full-time equivalent staff and included a wage John F. Brown Company 80 freeze for its non-union employees, as did its 2003 budget. In addition, its 2003 budget incorporated a headcount reduction to 543 from 567 positions. 2. Ordered a halt to nonessential new projects. In September 2001, the MAC decided to cut $118 million in development projects that had been planned for 2001, and to cut $295 million (of a total planned $371 million) in 2002. In fact, primarily by deferring projects, the MAC decreased its capital budget in 2002 by 80 percent. Deferrals have continued in the 2003 budget. Froze airline rates and charges at 2002 levels. In April 2003, MAC staff recommended that the 2004 budget should continue to freeze airline rates and charges at the 2002/2003 budgeted level of $71.6 million.52 If this recommendation were adopted, this would be the third consecutive year in which airline costs will be held at the 2002 budgeted amount. Provided a $13 million subsidy from its operating surplus to keep airline rates and charges at their 2002 level. Assisted Northwest in 2002 by refunding $286 million in general obligation revenue bonds. The refunding was expected to save NWA $53 million over the life of the bonds.53 The MAC issued its Series 9 bonds in 1992 on behalf of NWA. The Series 15 bonds, which refunded the Series 9 bonds, are secured by certain NWA facilities and equipment that is subject to periodic reappraisal.54 Applied PFC funds to existing debt in 2003 rather than to new debt as had been planned. A larger portion of PFC funds being directed toward terminal projects should lower airline rates and charges since airlines fund approximately half of terminal building charges at MSP.55 Worked to enhance interdepartmental coordination and more closely monitor and review past due balances. In addition, the MAC has become more rigorous with respect to requesting security deposits where circumstances (as defined in the airline agreements) allow. Increased employee parking rates. In March 2003, the MAC decided to increase employee parking rates generating total incremental annual revenue estimated at $293,600. On the second day after the attacks of September 11, 2001, the MAC had closed 7,800 parking spaces (58 percent of the total) in MSP’s newly enlarged garage. The garage lies within 300 feet to the Lindbergh Terminal and this closure was in response to increased security mandates imposed by the FAA. The closure reduced parking capacity to below its preconstruction level. In August 2001, before the events of September 11, the MAC had completed a project in which windows of the Lindbergh Terminal were coated with a protective plastic film to mitigate damage from flying glass shards in the event of a nearby explosion. Despite this, the MAC had to barricade and repaint certain parking areas before being allowed to reopen portions of the closed areas in October 2001. Even so, almost 15 percent of the spaces were not reopened. In spite of these reductions, even at the peak 58 percent reduction level, parking capacity exceeded demand due to reduced air traffic levels. A year later, in 2002, 3. 4. 5. 6. 7. 8. 52. MAC Finance Committee. Minutes, April 9, 2003. 53. Using a 6.6 percent discount rate, the Minnesota Legislative Auditor’s report indicated that the present-value of the $53 million is $37 million. 54. Minneapolis-St. Paul Airports Commission, Official Statement, June 19, 2003, p.56. 55. MAC Finance Committee, Minutes, March 5, 2003. John F. Brown Company 81 revenue from parking ($36,755,000) had dropped to just more than its 1999 level ($36,670,000) and accounted for almost 22 percent of the MAC’s total operating revenues (versus 26 percent in 1999 and 2000). 9. Explored the possibility of levying a property tax. In November 2001 the MAC explored the last-resort possibility of levying a property tax which it has not done since 1969. Calculations showed that doing so could allow it to collect up to $12.5 million for airport operations.56 The contemplated property tax has not been implemented. Eliminated optional overtime except for security. Reduced shuttle bus service.57 Severely curtailed travel. Canceled or deferred planned purchases of capital equipment. 10. 11. 12. 13. In total, budgeted operating expenses for 2002 (excluding depreciation) were six percent below their 2001 levels. According to a report prepared by the State of Minnesota’s Office of the Legislative Auditor, this was lower than 16 of 19 other airports surveyed on this topic.58 In the budget for 2003, operating expenses were set six percent higher than in 2002. In May 2003, MAC staff proposed that 2004 operating expenses should be limited to a 5.8 percent increase from their 2003 level. This proposed increase was based on maintaining facilities that had increased in size over the preceding two years and on replacement due to depletions and deferrals related to budget constraints over the same period.59 The MAC has discussed strategies for reducing this proposed increase to three to four percent. Credit Perspective of Rating Agencies In March 2003, corporate credit of Northwest, the dominant airline at MSP, was lowered by Standard and Poor’s Ratings Group (S&P) from BB to B+. In May, the rating remained B+ on “CreditWatch with negative implications.” This rating, S&P wrote, reflects [Northwest’s] satisfactory competitive position, substantial liquidity, and relatively good operating performance, but is constrained by industrywide risks, an increasing debt and lease burden, substantial unfunded postretirement liabilities, still significant capital expenditure requirements, and a few unencumbered aircraft that could support further secured borrowing. 60 In contrast, the MAC’s rating is quite strong. Following the events of September 11, 2001 S&P placed the Commission’s debt (and that of all major airports in the U.S.) on “CreditWatch” but in March 2002 removed the Commission’s debt from “CreditWatch” and affirmed its ratings of that debt with an outlook of “Stable.” In June 2003 S&P rated the MAC’s June 2003 subordinate airport revenue bond issue as A and listed the credit ratings of the MAC’s outstanding general obligation bonds as AAA. 56. Minneapolis Star-Tribune, “Airports Commission facing deeper budget cuts,” November 8, 2001. 57. MAC Special Finance Committee, Minutes, December 16, 2002. 58. Office of the Legislative Auditor, State of Minnesota, Program evaluation report: Metropolitan Airports Commission, January 2003. 59. MAC Finance Committee, Minutes, May 8, 2003. 60. Standard and Poor’s, Summary: Northwest Airlines Corp., May 16, 2003. John F. Brown Company 82 Fitch, in June 2003, also rated the airport’s Series 2003A subordinate airport revenue bonds as A, and listed the ratings for the MAC’s outstanding general obligation revenue bonds as AAA, its outstanding airport revenue bonds as AA-, and its outstanding subordinate airport revenue bonds A, all with a “Stable Rating Outlook.” One or more of the rating agencies cited the following risks and credit weaknesses associated with the debt of the airport: ƒ Northwest’s large market share (79 percent) at the airport; ƒ ƒ ƒ ƒ the high proportion of connecting traffic at the airport; the 2010 Plan’s increasing debt burden; the decline of debt service coverage levels in 2002 (although the trend is forecast to reverse); the U.S. airline industry’s continuing financial difficulties. One or more of the rating agencies cited the following mitigating and credit positive factors: ƒ The sizeable O&D traffic base (46 percent) generated by a highly-rated diversified local economy; ƒ ƒ ƒ the absence of competition from nearby commercial service airports; resilient traffic at the airport with enplanement trends better than the national average; Northwest’s significant investments at the airport, the nearby location of the airline’s headquarters, and the airline’s pledge to remain in the area in return for past state subsidies; a competitive cost structure as indicated by cost per enplaned passenger (CPE) sustained by significant non-airline revenues, sound management practices, and strong management team; a favorable geographic location making the airport a natural connecting point for upper Midwest passengers. ƒ ƒ John F. Brown Company 83 CASE STUDY SAN FRANCISCO INTERNATIONAL AIRPORT EXECUTIVE SUMMARY Traffic trends. United Airline operates an international gateway, a domestic hub, and maintenance base at San Francisco International Airport (SFO). SFO served as a focus city for the Shuttle by United until United shut down the Shuttle after September 11, 2001. United and its affiliates accounted for 56 percent of domestic passengers and 34 percent of international passengers in FY2003 (the 12 months ended June 30, 2003). Nevertheless, connecting passengers accounted for only 27 percent of total passengers in FY2003, which is well below the average for a connecting hub airport.61 SFO started experiencing significant traffic declines even before September 11 due to the dot-com bust, aircraft delays at SFO, United pilot labor strife, and the loss of service by Southwest Airlines. Low-cost carrier (LCC) service has produced a reallocation of domestic origin-destination (O&D) traffic among the three Bay Area airports over the last ten years. Southwest is the primary LCC carrier in the Bay Area, and OAK and SJC have been the primary beneficiaries of service from Southwest. The reallocation of domestic traffic has worked to the detriment of SFO, which has consistently lost Bay Area market share in short-haul markets since 1991 and has recently lost market share in medium- and long-haul markets. The continuing effect of LCCs and the response they evoke from United is likely to be the dominant theme affecting the allocation of domestic Bay Area traffic for many years to come. SFO recently introduced a landing fee incentive program to attract new service, especially from LCCs. SFO’s enplaned passengers declined from a high of 20.2 million in FY2000 to 14.6 million in FY2003, nearly a 28 percent decline, and are expected to slowly return to FY2000 levels. Recent facility expansion. Implementation of the airport’s Near-Term Master Plan (NTMP) has resulted in the doubling of terminal space with the opening of the new, 21-gate, international terminal in December 2000. The NTMP also included an airport rail transit system linking the terminals and providing access to the consolidated rental car facility. Transition from low to high cost airport. The airport issued general airport revenue bonds (GARBs) to finance most of the cost of the $3 billion NTMP and other infrastructure projects at the airport, with outstanding principal totaling $4.3 billion as of December 31, 2002.62 With debt per enplaned passenger equal to $290, SFO is one of the more highly leveraged airports in the nation. Due to the additional debt service and increase in operating expenses attributable to the NTMP projects, SFO transitioned from being a low cost to high cost airport. The average airline cost per enplaned passenger increased from $6.35 in FY1999 to approximately $20 in FY2003. Declines in passengers and concession revenues also contributed to this increase in unit costs for the airlines. 61. The average percentage of connecting passengers at connecting hub airports was 63 percent in 2002 according to Citigroup, 2003 Hub Factbook, April 16, 2003,. 62. Annual GARB debt service, which was $119 million in FY1999, will be $296 million in FY2004 and will continue to escalate until it reaches approximately $320 million in FY2012. John F. Brown Company 84 New projects put on hold. After September 11, 2001 the airport put on hold numerous capital projects pending a return to certain passenger thresholds and suspended the runway reconfiguration program. PFCs redirected to mitigate airline rates. SFO was one of the last large hub airports to impose a passenger facility charge, starting collections in October 2001. PFCs initially approved for the runway reconfiguration program have been reprogrammed to help pay debt service on NTMP projects and thereby mitigate increases in airline rates and charges. Airline residual lease/use agreement expires in 2011. The 30-year residual airline lease and use agreement expires in 2011. SFO is one of the few airports grand fathered under the revenue retention requirement by this lease/use agreement. Under the agreement, 15 percent of concession revenues are transferred to the city’s general fund, which amounted to approximately $16.9 million in FY2003. Security deposits. SFO may be one of the few airports in the U.S. that requires security deposits from all airlines for rates and charges and was able to use the security deposits for prepetition debt in recent airline bankruptcies (e.g., National, US Airways, United). Airport initiatives. After September 11, the airport undertook a number of initiatives to provide relief to tenants, including: ƒ Deferring capital spending. ƒ ƒ ƒ ƒ ƒ ƒ ƒ Reducing operating expenses, including reducing approximately 100 staff and contract positions and rolling back employee compensation. Redirecting PFC revenue to pay debt service on NTMP projects. Waiving the minimum annual guarantee for certain retail concessionaires until enplaned passengers returned to target levels. Refinancing outstanding debt to take advantage of lower interest rates. Reimbursing itself for capitalizable interest. Increasing parking rates. Implementing a landing fee incentive program to encourage new service. United Airlines default on special facility bonds with continued use. The California Statewide Communities Development Authority (CSCDA) issued approximately $155 million of special facilities lease revenue bonds in 1997 and $33 million of special facility revenue bonds in 2001 for United at the airport, which United used to construct improvements for itself.63 These bonds are payable solely from facility rents payable by United and are further secured by a corporate guaranty of United. United defaulted on its facilities lease payments, which are used to pay principal and interest on the bonds, and has argued in bankruptcy court that the facilities leases supporting the bonds constitute “disguised” financing arrangements and thus a form of prepetition debt. Therefore, United argues that it is not permitted under Bankruptcy Code to make payments on such pre-petition debt without the approval of the Bankruptcy Court. At the same time, United argues that default under the “disguised” financing arrangement is not integral with 63. The airport did not issue the bonds and was not directly involved in either of the CSCDA financings. The airport has no liability to repay the CSCDA bonds. No property of the airport was pledged as security for any of the CSCDA bonds. John F. Brown Company 85 and is severable from the leases with the airport (e.g., ground lease for the Maintenance Operations Center). On this basis, United believes it is entitled to continued beneficial use of the facilities whose rent supports the bonds. The airport has entered into a stipulation with United that it won’t default the airline under the ground lease related to the Maintenance Operations Center for its failure to make facilities lease payments to support the CSCDA bonds. Rating agency actions. Since September 11, the rating agencies have taken the following actions on SFO’s GARBs: Agency Fitch Moody’s S&P Pre-9/11 rating AAA1 A+ Current rating A A1 A Outlook Negative Negative Negative As shown, Fitch downgraded the airport twice, S&P once, and Moody’s has affirmed its rating but kept SFO on negative outlook. In taking its actions, Fitch noted SFO’s “weakening financial margins resulting from lower passenger volumes, increased vulnerability associated with UAL, and significantly increased fixed costs.” Moody’s noted that while the United bankruptcy was “alarming for the airline industry as a whole, we believe that SFO will not be materially affected by the filing in the near term.” S&P commented that “the Chapter 11 bankruptcy filing of United Airlines this week is not expected to result in any immediate changes in ratings or outlooks of current airports with market concentration of the carrier. Specifically, key airport hubs dominated by United Airlines as well as US Airways will maintain their negative outlook until the business plans and operational effects associated with potential reductions in capacity of the respective airlines becomes clear.” BACKGROUND San Francisco International Airport is the principal commercial service airport serving the San Francisco Bay Area, which is also served to an increasing extent by Oakland International Airport and San Jose International Airport. SFO is one of the largest airports in the United States in terms of passengers (11th) and air cargo (17th).64 The airport is a major origin-destination point and one of the nation’s principal gateways for U.S.-Pacific travel. The airport also serves as a domestic hub and international gateway for United Airlines. The airport is owned and operated as a financially self-sufficient enterprise of the City and County of San Francisco by the Airport Commission of the City and County of San Francisco. The airport is located 14 miles south of downtown San Francisco on San Francisco Bay in San Mateo County. It occupies approximately 2,383 acres on a 5,171-acre site; the remaining 2,788 acres are undeveloped tidelands. Passenger terminal facilities include 85 active gates,65 2.6 million square feet of space for domestic operations, and 2.5 million square feet for international operations. International operations are conducted from the new International Terminal Complex (ITC), which opened in December 2000 as the centerpiece of a $3 billion airport expansion program. 64. Preliminary CY 2002 traffic and rankings per Federal Aviation Administration, July 2003. 65. Boarding Area D, which is closed for renovation, is planned for 14 gates when it reopens. John F. Brown Company 86 Airport Traffic Enplaned passengers at SFO increased from 15.4 million in FY1991 to 20.2 million in FY2000 at a compound annual growth rate of 3.0 percent, driven more by increases in international (7.8 percent) than domestic (2.2 percent) traffic. From the FY2000 peak, traffic at SFO has declined each subsequent year: -4.2 percent in FY2001, -19.5 percent in FY2002, and -6.6 percent in FY2003.66 Figure 24 Enplaned Passenger Trends San Francisco International Airport (for the 12 months ended June 30) 25,000,000 International 20,000,000 15,000,000 10,000,000 5,000,000 0 Domestic Source: San Francisco Airport Commission. The initial falloff in traffic reflected the effects of the economic downturn and weak business demand, which were particularly acute in the Bay Area following the collapse of the economic “bubble.” The events of September 11, SARS, the Iraq war, and capacity reductions by United also contributed to more recent declines. These events occurred against a backdrop of underlying circumstances including continuing stagnation in the Japanese economy, fragmentation of international markets, and the increasing service offered by low-fare carriers at OAK. United operates a major domestic hub and international gateway at SFO.67 Within the United mainline network, SFO ranks third in terms of domestic passengers (after Chicago and Denver)68 and second in terms of international passengers (after Chicago) among U.S. airports. United has reduced domestic operations at SFO by –26 percent, from 208 flights per day on average in FY2000 to 148 in FY2003.69 United’s termination of its branded “Shuttle by United” 66. FY2003 traffic is estimated based on traffic reports for the first 11 months of the airport’s fiscal year. 67. United operates from domestic hubs in Chicago, Denver, Washington Dulles, Los Angeles, and San Francisco. United also operates international gateways from U.S. airports in Chicago, Los Angeles, San Francisco, and Washington, D.C. 68. SFO is not a typical domestic hub for United, like Chicago and Denver, partly due to its geography (coastal location) and partly on account of the limited number of short-haul feed markets. 69. FY2003 operations are estimated based on reports for the 12-month period ended March 31, 2003. John F. Brown Company 87 2003E 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 service in November 2001 (mid-FY2002) was a significant factor in the reduction in flights at SFO. Figure 25 Average Daily Jet Departures and Enplaned Revenue Passengers United Airlines at San Francisco International Airport (for the 12 months ended June 30) 250 30,000 200 25,000 20,000 150 Flights 15,000 100 10,000 50 Passengers 5,000 0 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 Flights - Domestic Flights - International Passengers - Domestic Passengers - International 0 Sources: DOT, Schedules T-3 and T-100. Average daily flights by United Express carriers are starting to ramp back up after declining in 2001. (See table below.) Regional jet activity, however, remains a relatively small proportion of the airport’s scheduled flight activity. John F. Brown Company 88 Table 24 Average Daily Departing Flights and Seats1 United Express2 San Francisco International Airport (for the 12 months ended December 31) Year 1999 2000 2001 2002 20033 Source: Notes: Avg. Daily Flights 89 94 80 77 85 Avg. Daily Seats 2,665 2,820 2,427 2,529 3,199 Avg. Seats Per Flight 30.0 30.0 30.4 32.6 37.7 No. of Dest. Served 16 15 15 15 19 Official Airline Guide. 1. Scheduled flights only to domestic and international destinations. 2. Includes Air Wisconsin and Skywest airlines. 3. Data for the first 6 months (Jan-Jun) of CY2003. 4.Flights and seats scheduled to operate as of July 2003 OAG schedule. The shifting geographic distribution of population and jobs in the Bay Area combined with the increasing availability of low-cost carrier service offers at OAK and SJC have caused a shift in the allocation of local domestic traffic among the three regional airports. The SFO share of local domestic O&D traffic declined from 64 percent in 1990 to 42 percent in 2002, while OAK and SJC both increased their respective shares.70 (See figure below.) Additionally, Southwest terminated SFO service (14 daily flights) in March 2001 citing unprofitable operations, congestion delays, and ability to satisfy Bay Area demand through service at OAK and SJC.71 Figure 26 Regional Trends in Domestic O&D Passengers 1990 2002 18.3% 18.1% 31.6% 42.2% 63.6% 26.1% San Francisco International Airport (SFO) San Jose International Airport (SJC) Oakland International Airport (OAK) Sources: DOT, Air Passenger Origin-Destination Survey, reconciled to Schedules T-100 and 298C T-1. 70. Similar trends are reflected in the SFO share of “California corridor” traffic, which has declined from 52 percent in 1990 to 27 percent in 2002. 71. The airline noted “service into and out of that airport produces a disproportionate amount of flight delays rippling across our system.” John F. Brown Company 89 Local O&D traffic accounted for approximately 73 percent of total enplaned passengers at the airport. Airline market shares are concentrated in United and its express carriers, which account for approximately 56 percent of the domestic market and 34 percent of the international market. Low cost carrier (LCC) service was provided by six carriers (America West, ATA, Frontier, National, Sun Country, and Vanguard) and accounted for nine percent of domestic enplaned passengers in FY2003.72 Capital Improvement Program In 1992, the Commission completed the environmental review and approval of projects known as the Near-Term Master Plan (NTMP) projects. The NTMP projects consisted of a new international terminal building and associated boarding areas (A and G), which collectively are known as the International Terminal Complex (ITC),73 an airport rail transit system (AirTrain), elevated circulation roadways to connect the ITC to Highway 101, and various other projects for terminals, parking, cargo, general aviation, police, emergency response, and security. In October 1995, the Commission and the Signatory Airlines entered into a memorandum of understanding, which constituted the Majority-in-Interest approval of the NTMP. The ITC opened December 10, 2000.74 Since September 11, 2001, the airport has discontinued all capital projects except those related to safety and security. Discontinued projects included planned terminal renovations, taxiway improvements for NLAs, and the airport hotel. The airport also opted to discontinue its program to evaluate runway reconfiguration alternatives until passengers reach a certain threshold, noting that neither the political will nor the economics now exist to support the program.75 The airport has issued general airport revenue bonds (GARBs) to finance most of the cost of the NTMP and other infrastructure projects at the airport. (There were no capital contributions from the state or local governments to finance the cost of the NTMP.) The GARBs are secured by and payable from net revenues of the airport and certain other airport funds pledged to such purposes. Neither the credit nor taxing power of the City and County of San Francisco or the State of California is pledged to secure payment of the bonds. As of December 31, 2002, the principal amount outstanding was $4.3 billion. Annual GARB debt service, which was $119 million in FY1999, increased to $252 million in FY2002, and will be $296 million in FY2004. 72. Recently, AirTran announced it would start service at SFO flying to Atlanta beginning November 12, 2003. National and Sun Country are not currently operating at the airport. 73. The ITC is both the largest international terminal and the largest common use terminal in the United States, according to the airport. 74. SFOTEC, LLC, a company formed by all 25 airlines operating out of the ITC, operates and maintains the airportowned common use equipment related to handling flights and passengers at the ITC. This equipment includes baggage handling, flight, baggage and display systems, gate management equipment, passenger loading bridges and preconditioned air and 400 hertz power systems. All such activities and gate scheduling practices are under the oversight of the airport and require its review and approval. The airport maintains all telecommunications and multiple-use flight information displays in the ITC. 75. The airport runway system includes four intersecting runways consisting of parallel east-west runways and parallel north-south runways. During bad weather, one of the parallel runways must be closed because the narrow separation of the parallel runways (750 feet) fails to meet federal requirements. This reduces arrival capacity from 60 to 30 flights per hour and has contributed to substantial delays at SFO over the years. The airport was evaluating the possibility of reconfiguring the runway system to reduce delays during bad weather, reduce noise impacts, accommodate New Large Aircraft (NLAs), and improve the San Francisco Bay. John F. Brown Company 90 Under the current schedule, annual debt service will continue to escalate until it reaches approximately $320 million in FY2012 after which it begins to decline. SFO was one of the last large hub airports to impose a passenger facility charge. The FAA approved the airport’s first PFC application in July 2001 and the second application in March 2002. The moneys are primarily directed to paying a portion of debt service on bonds issued to finance the NTMP projects. Table 25 Approved Passenger Facility Charges San Francisco International Airport Effective Expiration Collection Date Date (in millions) Uses October 1, 2001 January 1, 2004 $112.7 Being re-programmed from runway reconfiguration * January 1, 2004 November 1, 2008 $224.0 Taxiway, apron, ITC equipment No. 1 2 Level $4.50 $4.50 Source: San Francisco Airport Commission. Note: *The FAA originally approved the use of PFC revenues for planning studies related to the runway reconfiguration program. Since the program was discontinued, the airport is coordinating with the FAA to reprogram the use of PFC revenues to pay debt service on eligible portions of the NTMP. The airport recently submitted a third application to continue to impose a $4.50 PFC through November 1, 2018 and to use the receipts to pay debt service on general airport revenue bonds issued to finance certain NTMP projects including Boarding Area A, Boarding Area G, and the International Terminal Building. Airline Agreements As a result of litigation, in 1981, the airport, United, and 14 other airlines entered into a settlement agreement and the 1981 Lease and Use Agreement. The 1981 Lease and Use Agreement, which expires in 2011, provides for a residual cost rate-setting methodology, under which United and the other signatory airlines agreed to pay landing fees and terminal rents in amounts which, when included with other revenues of the airport, would be at least sufficient to pay operating expenses, debt service, and other financial obligations of the airport including the annual service payment to the City.76 Most proposed capital improvements with an estimated cost in excess of $300,000 in 1981 dollars are subject to certain review procedures under the agreements. A majority-in-interest of the signatory airlines may require that the airport defer a capital improvement for six months.77 United and other signatory airlines that operate from the new international terminal (the ITC) have signed amendments to their 1981 Lease and Use Agreements. Most other airlines operate under Lease and Operating Agreements, which are substantially similar to the amended agreements. The amended agreements and the Lease and Operating Agreements provide for 76. The settlement agreement provided, among other things, for payments from the airport to the City consisting of 15 percent of concession revenues (the annual service payment) and additional payments for direct services. The airport is covered by a “grandfather” provision in federal statute permitting certain uses of airport revenue for non-airport purposes. 77. Majority-in-Interest is defined in the Lease and Use Agreements to mean more than 50 percent in number of the Signatory Airlines which, on the date in question, also account for more than 50 percent of the aggregate revenue aircraft weight landed by the Signatory Airlines at the Airport during the immediately preceding fiscal year. John F. Brown Company 91 common-use gates, facilities, and equipment in the ITC and for recapture and reallocation of exclusive-use space in the ITC that is under-utilized and is needed to accommodate new entrants. Although the amended agreements and the Lease and Operating Agreements differ in regard to the use of the ITC, they both incorporate the same provisions with regard to the calculation of landing fees and terminal rents, and the airline review of proposed capital projects. Airline Bankruptcies Since 2000, three of the nine U.S.-flag airlines that were original signatories to the 1981 Lease and Use Agreement have sought Chapter 11 bankruptcy protection: TWA in January 2001, US Airways in August 2002, and United in December 2002. In bankruptcy, a signatory airline could seek an order from the bankruptcy court allowing it to reject its 1981 Lease and Use Agreement as an executory contract or an unexpired lease pursuant to Section 365 of the United States Bankruptcy Code. If rejected by the trustee in bankruptcy or by the airline, as debtor-in-possession, the agreement is deemed to be breached as of the bankruptcy commencement date, and the airport would regain control of the facilities and could lease them to other tenants, if it were able. Similarly, the airline might seek to reject other leases and agreements, if any, with the airport. The rejection of one or more leases or agreements might result in a loss of revenue for the airport, which would give the airport a claim for damages as a general unsecured creditor of the airline. The value of any such claim, however, is limited.78 American acquired most of the assets of TWA, but not TWA’s leasehold at the airport, which consisted of exclusive-use rights on seven gates and associated space in the passenger terminal. TWA rejected its 1981 Lease and Use Agreement, and the leased premises reverted to the airport. US Airways emerged from Chapter 11 bankruptcy on March 31, 2003. As part of its plan of reorganization, the airline assumed its 1981 Lease and Use Agreement with the airport; however, the agreement was modified to reduce the amount of exclusive-use premises. In exchange for agreeing to reduce the amount of premises, the airport obtained the right to require US Airways to relocate its premises in the future. UAL Corporation, the parent company of United, filed Chapter 11 bankruptcy on December 9, 2002 (about halfway into FY2003). Details regarding United’s operations at SFO are discussed in more detail below. In July 2003, the bankruptcy court approved UAL’s request for an extension of the deadline until the earlier of December 15, 2003 or the conclusion of the hearing on UAL’s disclosure statement to accept or reject certain real estate leases including leases at the airport. 78. Claims for real property lease rejection damages are limited to amounts unpaid as of the petition date plus the greater of (1) one year’s rent or (2) 15 percent of the remaining term of the lease, not to exceed three years. John F. Brown Company 92 UNITED AT SFO Overview In FY2002, revenue from United ($126 million) accounted for 27 percent of airport operating revenue consisting of space rentals ($63 million), landing fees ($46 million), and other fees and charges ($17 million).79 United is a signatory to the 1981 Lease and Use Agreement with the airport. It is also a lessee of the airport under three major ground leases and a permittee of the airport for the use and occupancy of various types of facilities. As of July 1, 2003, the airline had not yet accepted or rejected its agreements with the airport. In addition to its airport leases and permits, United has entered into interline agreements with participating airlines covering the operation and maintenance of the fuel storage and distribution facilities at the airport and sharing the cost thereof (including debt service for special facility revenue bonds issued by the airport) on a pro rata basis. United is also a member of a 21airline consortium responsible for the operation and maintenance of systems and equipment in the ITC and sharing the costs thereof on a pro rata basis. United has used the proceeds of “special facility” revenue bonds issued by the California Statewide Communities Development Authority (CSCDA) to finance improvements at the airport. Finally, United has agreements with other airlines covering ground handling services and aircraft maintenance services and with various vendors covering goods and services. Airport Leases and Permits United is the single largest airline that is signatory to the 1981 Lease and Use Agreement measured in terms of enplaned passengers, enplaned cargo, aircraft departures, aircraft landed weight, or leased premises. United conducts its domestic passenger operations from Terminal 3 (T-3) where it occupies 480,000 square feet and 22 gates (of the total 85 gates) on an exclusiveuse basis pursuant to the 1981 Lease and Use Agreement. The airline conducts its international passenger operations from the ITC, which it uses on a common-use basis with other airlines pursuant to the 1981 Lease and Use Amendment.80 79. Revenues from United do not include PFCs collected and remitted by the airline. Rents at SFO are payable in advance. Landing fees are payable based on airline activity reports and subsequent invoices prepared by the airport in a process that can take from two to four months. 80. The ITC provides 645,000 square feet of common-use space and 21 common-use gates. John F. Brown Company 93 Terminal 1 Terminal 2 Terminal 3 ITC Total As % of exclusive As % of total airline Table 26 Airline Terminal Space San Francisco International Airport Exclusive-Use Space Other Joint-Use United Airlines Total Space 245,000 245,000 61,000 480,000 141,000 621,000 89,000 143,000 656,000 54,000 534,000 473,000 1,007,000 717,000 53 31 47 27 100 58 Total Airline 304,000 621,000 799,000 1,724,000 42 100 Source: San Francisco Airport Commission. Note: Terminal 2 closed when the new international terminal opened in December 2000. There are plans to renovate Terminal 2 for domestic use when demand warrants the need. The airport, pursuant to the 1981 Lease and Use Agreement, holds a security deposit equal to approximately two months of landing fees and space rentals.81 United historically satisfied this requirement through a surety bond. In August 2002, however, United’s surety provider notified the airport that it intended to cancel the surety bond. By September 2002, United and its surety provider agreed to deposit cash with the airport in the amount of $24 million to secure United’s performance under the 1981 Lease and Use Agreement and other agreements described below. The security deposit could be applied to satisfy prepetition debt or postpetition debt, if any. As of August 1, 2003, United owed the airport approximately $4 million of prepetition debt. The airport contends United also owes $5.3 million in postpetition debt, covering rentals for the period December 9 (the date of the bankruptcy filing) through December 31 (the so-called “stub rent”). United has refused to pay on the grounds that the stub rent is prepetition debt. The court has not required United to pay. If United assumes the 1981 Lease and Use Agreement, it will have to cure all postpetition claims. If it rejects the agreement, the airport will have an administrative claim for the stub rent. Since the Chapter 11 filing, the airline remains current with remittances of PFC collections and with payments for rents and landing fees. At the time of its bankruptcy filing, United operated major aircraft maintenance facilities at Indianapolis, Oakland, and San Francisco. (See the table below.) At SFO, United had constructed its Maintenance Operations Center on a 129-acre parcel leased from the airport in 1973. The lease, the most current option period for which expired in June 2003, provided for a second ten-year renewal option through 2013 at the airline’s sole discretion, subject to a readjustment in land rents. If United had failed to exercise its final renewal option, the approximately $150 million principal amount of outstanding bonds issued on behalf of United by the California Statewide Communities Development Authority (which financing is discussed 81. Deposits can be in the form of a surety bond, letter of credit, or other security acceptable to the airport. More recent agreements require deposits equal to six months of projected landing fees and space rentals. Concession tenants are required to deposit one-half of the minimum annual guarantee. The airport formalized its accounts receivable policy by resolution of the Commission in 1999. The policy specified collection and reinstatement guidelines for tenants that fall behind in their payments. The guidelines established systematic procedures for the airport to enforce its rights and remedies against delinquent tenants. John F. Brown Company 94 below) would have been subject to mandatory redemption and payment by United. The airline exercised its final renewal option after a negotiating a schedule of escalating land rents with the airport. The negotiations occurred at a time when United was evaluating whether to close one or more of its maintenance bases at IND and OAK. United subsequently decided to close both maintenance bases and retain its maintenance operations at SFO. Table 27 United Airlines Aircraft Maintenance and Overhaul Facilities IND OAK SFO Land area (acres) 300 44 129 Building area (sf in 000's) 1,690 380 3,000 Aircraft hangar docks 12 4 12 Lease expiration year 2031 2007 2003 Source: U.S. Securities and Exchange Commission Form 10-K filing by UAL Corporation for fiscal year ended December 31, 2002. In 1996, the airport entered into a land lease with United covering 11 acres and expiring in 2021. United uses the parcel for an aircraft maintenance hangar. In 1999, the airport entered into a land lease with United covering 16 acres and expiring in 2011. United uses the parcel as a maintenance facility for ground service equipment and a flight kitchen. In addition, United holds space permits cancelable by either party on 30-days notice for various properties at the airport including terminal space, hangar space, aircraft parking, and employee parking. The largest single permit covers 128,000 square feet of space in the Superbay Aircraft Maintenance Hangar, representing annual rents of $2.4 million. As of August 1, 2003, UAL has not moved to assume or reject its leases at the airport. Airport management reports United has expressed an interest in relinquishing relatively insignificant portions of its premises, but has not otherwise attempted to renegotiate the principal business terms of the 1981 Lease and Use Agreement or to seek other incentives as a condition of assuming the leases or maintaining air service levels. Interline Agreement for Fuel Facilities The airport issued special facility lease revenue bonds in 1997 in the amount of $105.61 million and in 2000 in the amount of $19.39 million to finance the construction of a jet fuel storage and distribution system for the benefit of airlines operating at the airport.82 Certain airlines at SFO, including United, formed a special purpose limited liability company (SFO Fuel Company LLC) to lease the airport fuel system including the portion financed with special facility lease revenue bonds. The bonds are payable from charges imposed by the LLC for intoplane fueling at the airport and are further secured by an interline agreement among the participating airlines, including United, under which the participating airlines are obligated to cover the net (residual) costs of the LLC including lease payments to the airport under the fuel system lease. 82. Although the airport issued the bonds, the bonds are not payable from airport revenues or other revenues or assets of the airport, but only from the payments made by the LLC under the fuel system lease. John F. Brown Company 95 Notwithstanding a United bankruptcy, so long as the airlines, including United, continue to make timely payments to the LLC, and the LLC continues to make timely payments under the fuel system lease, the United bankruptcy will not constitute an event of default on the special facility lease revenue bonds. In the event that United terminated operations at SFO, fees to other airlines participating in the interline agreements would increase to cover annual costs. Airline Consortium for ITC Equipment SFOTEC, LLC, a company formed by airlines (including United) operating out of the ITC, operates and maintains the airport-owned common use equipment related to handling flights and passengers at the ITC. This equipment includes baggage handling, flight, baggage and display systems, gate management equipment, passenger loading bridges and pre-conditioned air and 400 hertz power systems. All such activities and gate scheduling practices are under the oversight of the airport and require its review and approval. The airport maintains all telecommunications and multiple-use flight information displays in the ITC. Each member of the consortium is responsible for a pro rata share of the expenses related to the ITC equipment including operating expenses and related debt service. Expenses were about $8 million in 2002 of which United’s share was approximately one-third. In the event that United terminated operations at SFO, fees to other members of the consortium would increase to cover annual costs. Subleases In Connection With CSCDA Bonds The California Statewide Communities Development Authority (CSCDA) issued approximately $155 million of special facilities lease revenue bonds in 1997 and approximately $33 million of special facility revenue bonds in 2001 for United at the airport.83 United used the proceeds of the bonds to construct improvements at the airport. The improvement financed with the 1997 and the 2001 bonds are owned by the airport and are leased to or otherwise used by United pursuant to existing leases and permits. The 1997 bonds are payable from facility rents payable by United under a simultaneous sublease/subleaseback of a portion of the Maintenance Operations Center entered into between United and CSCDA (the facilities leases) and are further secured by a corporate guaranty of United. The CSCDA also granted a leasehold mortgage of its subleasehold interest in the Maintenance Operations Center to the bond trustee. The bonds are not secured by a pledge of any revenues of the airport including without limitation any revenues under the airport’s ground lease with United. The 2001 bonds are payable from and secured by installment payments made by United pursuant to a loan agreement. United has defaulted on its facilities lease payments which in turn are used to pay principal and interest on the 1997 CSCDA bonds. United argues in bankruptcy court that the facilities leases supporting the 1997 CSCDA bonds constitute “disguised” financing arrangements and thus a form of pre-petition debt, and that it is not permitted under Bankruptcy Code to make payments on such pre-petition debt without the approval of the Bankruptcy Court. At the same time, United argues that default under the “disguised” financing arrangement is not integral with 83. The airport did not issue the bonds and was not directly involved in either of the CSCDA financing. The airport has no liability to repay the CSCDA bonds. No property of the airport was pledged as security for any of the CSCDA bonds. John F. Brown Company 96 and is severable from the leases with the airport (e.g., ground lease for the Maintenance Operations Center). On this basis, United believes it is entitled to continued beneficial use of the facilities whose rent supports the bonds. Per its SEC Form 10-Q filing for the quarter ended March 31, 2003, United reports: Section 365 of the Bankruptcy Code requires that the Company timely perform all of its postpetition obligations under unexpired leases of non-residential real property. The Company believes that it is in compliance with all payment obligations under its lease agreements relating to those airports where it has municipal bonds outstanding. However, the Company has not made and does not intend to make debt service payments or any other payment on any of the municipal bond issuances issued on behalf of the Company and relating to domestic airport financings. As a result, under certain of the airport lease agreements, the Company may be considered in default due to the non-payment of the debt and therefore subject to the default provisions of the lease agreements with the airports. Possible consequences could include loss of the Company's status as a signatory airline (resulting in increased rents and landing fees) and loss of the Company's exclusive space agreements. The airport has entered into a stipulation with United that it won’t default the airline under the ground lease related to the Maintenance Operations Center for its failure to make facilities lease payments to support the 1997 CSCDA bonds or installment payments to support the 2001 CSCDA bonds. EFFECTS OF UNITED BANKRUPTCY The confluence of many developments has brought United into bankruptcy court. United offered the following brief explanation of these developments in its Information Brief to the bankruptcy court on December 9, 2002, the day it declared bankruptcy. United Air Lines was determined to avoid this day. The reason it could not is rooted in Economics 101: United’s costs are out of line with the Company’s revenues, which began to collapse in 2001. Indeed, the degree to which United and the other major network carriers were already struggling with unaffordable cost structures before September 11 was laid painfully bare by the tragedies of that day and their aftermath. Despite having the industry’s best work force, assets and route structure, United was unable to stop burning through its cash. United’s revenues have plummeted mostly because Americans simply are not flying as much as they used to, especially not on business trips at full fares. More of the passengers who do continue to fly are opting for low cost carriers at the expense of United and the other full-service carriers. The resulting price competition has been compounded by the emergence of the Internet, which has made it easy for passengers to comparison shop for the lowest available fares. All of this has reduced the value of differentiators among airlines other than price. These shifts in the industry have hit United the hardest. The Company’s passenger revenues have plunged from $16.9 billion in 2000 to $13.8 billion in 2001 and a projected $11.8 billion for 2002. Because of United’s significant presence at SFO, its service reductions and bankruptcy contributed in large part to a number of developments at the airport. The systemwide reduction in passengers and service following September 11 also contributed to these developments as described below. John F. Brown Company 97 Enplaned Passengers. Enplaned passengers at SFO have declined, as described above. The “price competition” United refers to in its Information Brief affected not only the airline but also the airport. Clearly some passengers, who would otherwise use SFO because of its accessibility and convenience, have opted for OAK and SJC instead in order to benefit from the lower fares available at these airports. Judging by the reallocation of traffic among the Bay Area airports, the effects on enplaned passenger levels at SFO has been substantial. Concession Revenues. The declines in traffic (described above) and federal restrictions on the ability of non-ticketed individuals to pass beyond airport security checkpoints caused a falloff in concession sales and consequently in the concession revenue to the airport. The airport waived the minimum annual guarantee for certain retail concessionaires until enplaned passengers for the concourses in which the tenants are located equal or exceed 85 percent of the passengers for the same month in 2000 for two consecutive months.84 Concession revenues have declined from $167 in FY2001, to $119 million in FY2002, to an estimated $115 million in FY2003. Airline Charges. Airline charges began to increase significantly as debt service and operating expenses associated with the $3 billion NTMP were reflected in the airport revenue requirement beginning in FY2000. (See table 28 below.) Under the residual cost rate-setting methodology, the increasing costs in combination with declining traffic and concession revenues pushed airline costs per enplaned passenger (CPE) over $17 in FY2002 from $6.35 just three years earlier. Capacity reductions by United, and the associated declines in passenger traffic and concession revenues, exacerbated the situation.85 In FY2003, it is estimated that CPE will exceed $20.00. 84. As of August 1, 2003, this threshold had been reached on two of the six concourses. 85. Other airlines also reduced capacity after September 11. John F. Brown Company 98 Table 28 Financial Measures San Francisco International Airport (fiscal years ending June 30; amounts in thousands except rates) FY1999 Determination of Residual Airline Charges Debt Service Operation and Maintenance Expenses $119,166 190,207 Annual Service Payment, Equipment, etc. 19,873 Revenue Requirement 329,246 Less: Concession Revenues Other Non-airline Revenues Residual Airline Charges Enplaned Passengers Airlines Charges per Enplaned Passenger Landing Fee Rate (per 1,000 lbs.)1 Average Terminal Rental Rate (sq. ft.)1 140,231 64,435 $124,580 19,604 $6.35 $1.47 $55.01 FY2000 $163,681 198,434 25,800 387,915 152,142 77,776 $157,997 20,174 $7.83 $1.85 $72.25 FY2001 $160,888 247,999 31,311 440,198 167,286 92,485 $180,426 19,434 $9.28 $1.99 $72.31 FY2002A FY2003E $251,759 216,632 26,755 495,146 118,562 102,291 $274,294 15,547 $17.64 $3.85 $102.74 $278,783 237,903 18,246 534,932 112,815 124,395 $297,722 14,615 $20.37 $3.00 $99.29 Sources: Commission Records and John F. Brown Company, Inc. Notes: 1. Rates for FY2001 are revised rates in effect during latter part of fiscal year. A=Actual; E=Estimate. Revenue Collections. Because of the automatic stay that arises upon a bankruptcy filing, it is possible that the airport may experience a delay in collecting landing fees, terminal rentals, passenger facility charges (PFCs) and other amounts due from United which total approximately $12 million per month. However, United has been paying on time. While rents are payable in advance, the airlines generally pay landing fees, utilities and other service fees (averaging $8 million per month) two to four months in arrears based on final reporting data and the standard billing practices of the Airport. PFC Collections. The declines in traffic have adversely affected the level of PFC revenues. The airport extended the collection period by seven months on both outstanding PFC collection authorities. In addition, with the suspension of the runway reconfiguration program, the airport is reprogramming the moneys approved for that project to pay debt service on bonds issued to finance the NTMP. Credit Rating. The airport’s credit ratings, as described more fully below, have been adversely affected by the events of September 11 and the bankruptcy of United. The decline in credit rating has increased the cost of borrowing (or refinancing). Ability to Secure Credit Enhancements. A concern for the airport has been the availability and cost of securing credit enhancements from third-party providers. This has affected the airport principally in two areas; (1) the securing of a continuing letter-of-credit to provide liquidity in support of the airport’s commercial paper program and (2) obtaining a reasonable cost quote for bond insurance in order to issue debt at the highest rating and thus the lowest interest rates possible. To date, the airport has been able to secure such enhancements but John F. Brown Company 99 at an increased cost. The Commission obtained an irrevocable direct-pay letter of credit in the principal amount of $200,000,000 to secure repayment of its commercial paper. Payment of the commercial paper, and repayment to the banks issuing the letter of credit of any amounts drawn thereunder, is secured by a lien on Net Revenues subordinate to the lien of the 1991 Master Resolution securing the Bonds. The expiration date of the current letter of credit is May 9, 2006. Ability to Obtain Tenant Security Deposit. All airlines currently have surety policies or LOCs to meet their security deposit requirement; however, it is reported that there are fewer suppliers and higher bids for this type of security. AIRPORT INITIATIVES Faced with a highly uncertain operating environment, the possibility that a major tenant might liquidate, and a cost structure that was significantly higher than projected, senior management at the airport resolved to undertake the initiatives described below. The initiatives were designed to adapt to current circumstances, to provide relief to concession tenants, and to provide relief to airline tenants without jeopardizing long-term financial operations. Defer Capital Spending. Since September 11, 2001, the airport has deferred spending on various capital projects including, among others, the renovation of Terminal-2, the demolition of old Boarding Area A, and the completion of new Boarding Area A. Terminal-2 (the former international terminal) remains closed pending stronger demand. The runway reconfiguration program was also suspended. However, the airport is now preparing a new 5-year plan, which it expects to complete in the fall of 2003. Reduce Operating Expenses. The airport has taken a number of steps to reduce annual operating expenses including reductions in staff (about 100 positions) and contract positions, a rollback in employee compensation, and other measures. Refund Outstanding Debt. The airport moved to take advantage of low interest rates to refund its debt to the extent possible within the limitations of the tax law. The airport issued refunding bonds in February 2002 ($365 million) and January 2003 ($157 million). The refundings were economic and produced debt service savings at the front end of the schedule where they were most needed. The airport anticipates completing one or more additional refundings to create savings and reduce debt service costs. A significant portion of the airport’s outstanding debt is subject to optional redemption within the next three years. Restructure Outstanding Debt. The airport is evaluating whether to restructure (interest mode and term) or extend selected maturities in order to create near-term relief in debt service costs. Restructuring outstanding debt would enable the airport to better match utilization of the recent terminal improvements with the costs of the improvements. The airport recently adopted a swap management policy and is evaluating the utilization of various financial products to reduce costs or realize other economic benefits. Reimbursement of Capitalizable Costs. The airport was able to reimburse itself from bond proceeds for certain capital costs that had previously been paid from revenues. By financing these costs, the airport was able to offset expenses in the current year. John F. Brown Company 100 Redirect PFCs. The airport redirected PFC capacity from future capital projects to paying debt service on the eligible costs of existing capital projects, thereby reducing the effect of debt service on the airline charges. Relax Restriction on Airport Advertising. To increase concession revenues and help reduce airline costs, the airport relaxed, but did not abandon, long-time restrictions on the place and manner for advertising within the passenger terminals. The restrictions were reduced to allow advertising on passenger loading bridges and on luggage carts and were then further relaxed to allow advertising in the passenger terminal. Increase Parking Rates. To increase operating revenues and help reduce airline costs, the airport increased parking rates in the public parking garages. Rate increases went into effect in April 2003. Renegotiate Work Orders for City Services. The airport sought, but failed, to renegotiate work orders for police, fire, legal, and other services rendered to the airport by other City departments. Implement an Air Service Incentive Program. As an extension of its air service development program, the airport implemented an incentive program designed to encourage air service to new destinations from SFO. Any carrier starting service to a new destination (through April 30, 2004) will be charged a landing fee equal to 50 percent of the current landing fee rate during the first year of the new service. Management also intensified ongoing efforts to market the airport to domestic and foreign flag airlines. Maintain Liquidity. The airport has sought to maintain its liquidity position. The airport has an unrestricted cash balance in its revenue fund that could be used to pay operating expenses and debt service. The airport has restricted cash ($238 million) and surety policies ($79 million) dedicated to the payment of debt service on outstanding GARBs under certain conditions. The airport also maintains a contingency account ($93 million) and may apply moneys in the account to payment of operating expenses and debt service if, and to the extent, moneys otherwise available to make such payments are insufficient. The airport has established a commercial paper program under which it can issue up to $200 million of short-term notes. Monitor United’s Actions in Bankruptcy. The airport has monitored United’s actions leading up to and since bankruptcy. Prior to United’s bankruptcy filing, the airport retained bankruptcy counsel specializing in handling airline bankruptcy matters and, after the filing, the airport secured a non-voting position on the UAL Unsecured Creditors’ Committee. Contingency Planning. The airport continues to study changes within its operating environment and to evaluate its options for responding to current and anticipated circumstances. United’s future is a critical planning variable—whether United will successfully reorganize and, if so, what will be the nature of its business model and the emphasis the airline places on SFO within its network. John F. Brown Company 101 CREDIT PERSPECTIVE OF RATING AGENCIES Before September 11, 2001, Fitch rated outstanding general revenue bonds of the airport AA-, Moody’s rated the bonds A1, and S&P rated the debt A+. Fitch Before September 11, 2001, Fitch rated outstanding general revenue bonds of the airport AA-. In October 2001, Fitch affirmed its AA- rating on airport debt, but changed its outlook to negative from evolving reflecting the “altered state of the airline industry including United Airlines in the uncertain aftermath of the events of Sept. 11, the increased probability of a prolonged downturn in passenger traffic stemming from the U.S. military response and concerns about terrorist activity, and the San Francisco Bay area’s economic decline.” In February 2002, Fitch downgraded the airport debt to A+ citing “weakening financial margins resulting from lower passenger volumes and increased fixed costs.” In December 2002, Fitch affirmed the A+ rating, but changed its outlook to negative citing “weakening financial margins resulting from lower passenger volumes, increased vulnerability associated with UAL, and significantly increased fixed costs.” In May 2003, Fitch, citing the same concerns as in 2002, downgraded the airport debt from A+ to A and retained the negative outlook. Moody’s Investors Services Before September 11, 2001, Moody’s rated outstanding airport revenue bonds A1. In February 2002, Moody’s affirmed its A1 rating but retained the negative outlook. In December 2002, immediately following United’s bankruptcy declaration on December 9, Moody’s affirmed its A1 rating and maintained its negative outlook. The agency noted that while the United bankruptcy was “alarming for the airline industry as a whole, we believe that SFO will not be materially affected by the filing in the near term.” Standard & Poor’s Before September 11, 2001, S&P rated the airport debt A+. After September 11, S&P placed the airport on credit watch. In February 2002, S&P lowered its rating from A+ to A and removed the airport from a credit watch. In December 2002, immediately following United’s bankruptcy declaration on December 9, S&P affirmed it’s A rating and placed the airport on negative outlook. The agency reported that “the Chapter 11 bankruptcy filing of United Airlines this week is not expected to result in any immediate changes in ratings or outlooks of current airports with market concentration of the carrier. Specifically, key airport hubs dominated by United Airlines as well as US Airways will maintain their negative outlook until the business plans and operational effects associated with potential reductions in capacity of the respective airlines becomes clear.” However, the negative outlook reflected concerns that the airport’s high cost structure would limit its flexibility to manage further reductions in service levels by United or disruptions in demand. Overview of Credit Quality One or more of the rating agencies cited the following risks associated with the general airport revenue bond debt of the airport: John F. Brown Company 102 ƒ ƒ ƒ ƒ ƒ ƒ ƒ Relatively high cost structure as indicated by measures of cost per enplaned passenger (CPE) and debt per enplaned passenger (DPE);86/87 Declining levels of enplaned passengers, more severe than the national average;88 Regional airports (OAK and SJC) providing competitive substitute service in certain domestic markets; Uncertainty surrounding the United Chapter 11 bankruptcy filing; Market share concentration in United (47 percent), particularly given United’s financial condition; Reduced levels of mainline and Shuttle service by United; Inadequate airfield capacity (when demand returns) and significant additional costs to remedy the problem. One or more of the rating agencies cited the following mitigating and credit positive factors: ƒ ƒ ƒ ƒ ƒ Strategic position as a domestic hub and international gateway; Preeminent role as one of two international gateways on the west coast of the United States; Relatively high percentage of origin-destination traffic (73 percent) mitigating the risks associated with changes in United service decisions; Relatively modest competition from OAK and SJC for international and longhaul domestic service; Ability of the service area, given its size and wealth, to support high levels of O&D traffic, although the economic contraction had been particularly severe in the Bay Area; Relative attractiveness as a leisure destination for domestic and international travelers; Strong ethnic ties to the Pacific region; Diverse local economy and established center for international business; Relatively high yields earned by airlines at SFO; Ability to accommodate new security requirements while handling future traffic demand; Management initiatives to control costs and reduce CPE including deferral of non-essential capital projects, reductions in operating expenses, and use of passenger facility charges (PFCs) to offset debt service expense. ƒ ƒ ƒ ƒ ƒ ƒ 86. Fitch notes, “This high cost structure is a result of management’s partiality for issuing fixed-rate general airport revenue bonds for nearly all airport projects, preferring to retain control and assume the bulk of the costs.” 87. Moody’s states, “Further sharp increases in airline costs may begin to play a role in future airline service.” 88. “Fitch views the sharp downturn in enplanements at SFO as most likely a fairly short-term phenomenon (3-4 years).” John F. Brown Company 103