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Fixed-Income Insights

Here’s a primer on general airport revenue bonds, and what analysts look for in evaluating their credit standing.

By Yeida Reyes, Research Analyst

[Note: This article is from the forthcoming issue of The Muni Quarterly.]

Commercial airports have been a crucial part of aviation in the United States since the first one (Minneapolis-St. Paul International) opened in 1920. Back then, commercial airline travel was an emerging form of transportation; now, it is a critical artery of economic activity. According to the Federal Aviation Administration (FAA), there are currently more than 500 commercial service airports in the United States, representing a $100 billion segment of the $3.8 trillion municipal bond market. We thought it would be helpful to give investors some background on one widely held category of airport bonds, and the factors used to assess their creditworthiness.

Airports often issue General Airport Revenue Bonds (GARBs) to fund long-term projects as transportation needs expand around the country and outdated infrastructure requires upgrades. These bonds are secured broadly by all sources of revenue an airport receives from its operations. This revenue is generated from fees that generally come from two major sources. First are fees received from the airlines, which are typically landing fees for runway use and rental charges for use of gates and terminal space. The second category of fees is passenger-derived revenue from food and retail concessions, parking, and rental car operations.

Because GARBs are tied to all the revenue an airport brings in, the health of the bonds depends only partially on a particular airline using the facility as a hub.  While airline fees constitute about 40%–60% of total airport revenue, these fees only make up roughly 5% of an airline’s total expenses. Thus, even against a backdrop of high-profile airline bankruptcies and consolidation over the last 20 years, GARBs generally have been lower-risk investments, experiencing few defaults. Some of the largest GARB issuers are highly trafficked facilities in large markets such as Chicago O’Hare, Dallas Ft. Worth, Miami, Los Angeles, and San Francisco International Airports.

Critical Factors
When evaluating the credit profile of airports and GARBs, we look at several key factors. The first critical factor is market position and service area. An airport serving a large, diverse market is generally more creditworthy than a smaller facility with lower traffic serving a less diverse economic base. The nature of traffic at a facility is also critical. Some airports are classified as origination and destination (O&D) where the majority of passengers begin or end their trip at the airport.  O&D traffic has historically been more resilient than connecting traffic, which is more exposed to the strategic operating decisions of individual airlines. For example, if traffic at a facility is mainly connecting (i.e., the airport serves primarily as a hub for one carrier) the airport could run into financial trouble should the carrier decide to downsize or move connection operations elsewhere.

We also look at the amount of airline revenue generated relative to enplanements (“cost per enplanement”) as a measure of how attractive the airport is from an economic perspective to the airlines. Every dollar that comes from McDonald’s or Jamba Juice is a dollar that doesn’t have to come from the airlines, which means a lower overall airport cost, making it more favorable for a new airline to come in if a hub carrier leaves or shuts down.  All else equal, a lower cost per enplanement makes for a more favorable credit profile. 

A final factor we look at closely is financial performance and leverage. Higher debt loads and expensive capital plans are risk factors to consider. Cost recovery methods are also important, and guide our expectations for financial performance. Some airports operate under a compensatory structure, whereby the airlines pay only the costs allocable to the premises they use (mainly, airfield and portions of the terminal), and the system bears the risk for the costs of all other spaces (concessions, public circulation, parking, and/or vacant spaces). In this structure, the airport must charge market rates for non-airline cost centers and retains the upside if these centers become more profitable with growing traffic. Other airports utilize a residual structure that requires the airlines to pay all of the costs of running the airport net of other revenues collected from non-airline centers—essentially a form of revenue sharing.

Compensatory airports tend to generate higher levels of free cash flow and liquidity, but are subject to greater downside in the event of traffic declines. Residual airports typically operate with narrower margins but less volatility.

Other Models
Increasingly, airports are adopting hybrid cost recovery schemes whereby a combination of residual and compensatory structures is used, depending on the cost center. We find that hybrid agreements tend to be more favorable for bondholders because they generate more flexibility under financial covenants and allow for the airport to have more control over gates and other operating decisions.

While this primer has focused on GARBs, it is important to note that there are other types of airport bonds that carry a higher level of risk and account for the vast majority of defaults in the sector. Such bonds tend to be project-based and secured by a narrow and specific asset or fee such as a hotel or car rental facility or backed solely by the financial strength of a private airline (Special Facility Bonds). Though such bonds carry more risk, many have done well—specifically, issues that have other redeeming credit qualities in strong economic centers.

In today’s world, airport infrastructure has become a linchpin of both the U.S. and global economies. And while it is critical to understand the subtleties and specific narrative underlying each individual credit, we continue to find this sector to be an attractive place to selectively allocate capital in the tax-exempt market.

 

IMPORTANT INFORMATION

This commentary may contain assumptions that are “forward-looking statements,” which are based on certain assumptions of future events. Actual events are difficult to predict and may differ from those assumed. There can be no assurance that forward-looking statements will materialize or that actual returns or results will not be materially different from those described here.

This material is provided for general and educational purposes only. It is not intended as an offer or solicitation for the purchase or sale of any financial instrument, or any Lord Abbett product or strategy. References to specific asset classes and financial markets are for illustrative purposes only and are not intended to be, and should not be interpreted as, recommendations or investment advice.

References to specific securities and issuers are for illustrative purposes only and are not intended and should not be interpreted as recommendations to purchase or sell such securities. The securities referenced may or may not be held in portfolios managed by Lord Abbett and, if such securities are held, no representation is being made that such securities will continue to be held. This is not a representation of any securities Lord Abbett purchased or would have purchased or that an investment in any securities of such issuers would be profitable.

 

A Note about Risk: The value of an investment in fixed-income securities will change as interest rates fluctuate and in response to market movements. As interest rates fall, the prices of debt securities tend to rise. As rates rise, prices tend to fall. Investing in the bond market is subject to risks, including market, interest rate, issuer, credit, inflation risk, and liquidity risk. The municipal bond market may be impacted by unfavorable legislative or political developments and adverse changes in the financial conditions of state and municipal issuers or the federal government in case it provides financial support to the municipality. Income from the municipal bonds held could be declared taxable because of changes in tax laws. Certain sectors of the municipal bond market have special risks that can affect them more significantly than the market as a whole. Because many municipal instruments are issued to finance similar projects, conditions in these industries can significantly affect an investment. Income from municipal bonds may be subject to the alternative minimum tax. Federal, state and local taxes may apply. Investments in Puerto Rico and other U.S. territories, commonwealths, and possessions may be affected by local, state, and regional factors. These may include, for example, economic or political developments, erosion of the tax base, and the possibility of credit problems.

The information provided is not directed at any investor or category of investors and is provided solely as general information about Lord Abbett’s products and services and to otherwise provide general investment education. None of the information provided should be regarded as a suggestion to engage in or refrain from any investment-related course of action as neither Lord Abbett nor its affiliates are undertaking to provide impartial investment advice, act as an impartial adviser, or give advice in a fiduciary capacity. If you are an individual retirement investor, contact your financial advisor or other fiduciary about whether any given investment idea, strategy, product or service may be appropriate for your circumstances.

 

The opinions in this commentary are as of the date of publication, are subject to change based on subsequent developments, and may not reflect the views of the firm as a whole. The material is not intended to be relied upon as a forecast, research, or investment advice, is not a recommendation or offer to buy or sell any securities or to adopt any investment strategy, and is not intended to predict or depict the performance of any investment. Readers should not assume that investments in companies, securities, sectors, and/or markets described were or will be profitable. Investing involves risk, including possible loss of principal. This document is prepared based on the information Lord Abbett deems reliable; however, Lord Abbett does not warrant the accuracy and completeness of the information. Investors should consult with a financial advisor prior to making an investment decision.

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of our discussion with Dan Solender, partner and director, research analysts Kari Gauster and Yeida Reyes, and moderator Erik Britt, about opportunities in the municipal bond market.

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