Key Decisions in Airport Revenue Bond Issuance

Introduction

When an airport decides to issue revenue bonds, the finance team faces dozens of decisions. But not all of these decisions are actually open. Many of the most consequential terms — the rate covenant level, the debt service reserve fund formula, the flow of funds waterfall — were locked in when the airport's master bond document was first adopted, sometimes decades ago.

This distinction matters because it determines what the airport's finance team and financial advisor can control on a new issuance versus what requires amending the bond document — a far more complex process that may require bondholder consent or a supplemental indenture.

This article is organized in two parts. Section 1 covers what the bond document already decided: the provisions that are fixed unless the airport amends its master indenture, trust agreement, or bond resolution. Section 2 covers what the issuer actually decides on each new issuance, with industry common practice data from DWU's database of 57 U.S. airport bond documents.

Section 1: What Your Bond Document Already Decided

The master bond document — whether called a Trust Indenture (California tradition), Trust Agreement (Massachusetts), Bond Order (North Carolina), General Bond Resolution (New York/New Jersey), or Master Resolution — establishes the framework that governs all bonds issued under its authority. These provisions were negotiated at origination and apply to every subsequent series unless formally amended.

1.1 Rate Covenant Level and Type

The rate covenant is the most important provision in any airport bond document. It requires the airport to set rates and charges sufficient to generate Net Revenues equal to a specified multiple of Debt Service. This multiple is fixed in the master document.

The 1.25x standard has become near-universal for new indentures. Rating agencies view 1.25x as the minimum acceptable level for investment-grade airport credits. Some airports have lower covenants (e.g., 1.00x) but compensate with strong coverage type provisions or other structural protections that the rating agencies accept. A few airports have tiered covenants — for example, 1.25x on senior lien and 1.15x on subordinate lien.

Coverage type — hard vs. soft: Beyond the multiple, the bond document specifies what counts toward meeting the test. A hard covenant requires the multiple to be met from Net Revenues alone. A soft covenant permits the airport to add a Transfer from unrestricted cash or reserves to satisfy the test. In the DWU database: 30 airports have soft coverage (59%), 19 have hard coverage (37%), and 2 have dual-tier tests. Soft coverage with Transfer is the dominant modern structure — it provides a safety valve that prevents a technical default during an unusual year while still requiring adequate rate-setting.

1.2 Additional Bonds Test (ABT)

The ABT restricts the airport's ability to issue new bonds that could impair existing bondholders' coverage. It is typically the binding constraint on new issuance — harder to satisfy than the rate covenant because the Transfer mechanism is usually capped (typically at 25% of Maximum Annual Debt Service) for ABT purposes, while it may be unlimited for the rate covenant.

Standard two-part test:

• Historical test: Adjusted historical Net Revenues must cover existing DS + new DS at the specified multiple. Adjustments allowed: approved rate increases not yet effective, full-year impact of mid-year rates. NOT allowed: projected traffic growth or speculative revenue improvements.
• Projected test: A Certified Airport Consultant must project revenues covering all DS for a defined period (typically the first full year after project completion, or 3 years). This is the "Report of the Airport Consultant" (ROAC) found in every OS.
• Completion exemption: Universal. If original bonds passed the ABT, completing the project doesn't require a new test. De minimis exemptions (e.g., issuances below 10% of operating revenues) exist in some indentures.

1.3 Debt Service Reserve Fund (DSRF) Sizing

The DSRF formula is fixed in the bond document. The typical approach is the "three-legged stool" — the DSRF is sized at the lesser of three tests, which also serves as the IRS safe harbor under IRC §148(d) and Treas. Reg. §1.148-2(f)(2) for tax-exempt bonds:

• Maximum Annual Debt Service (MADS)
• 10% of par amount (or issue price)
• 125% of average annual debt service

The three-legged stool is the industry standard because it satisfies the IRS arbitrage safe harbor while minimizing the amount of bond proceeds locked in reserve rather than available for project costs. Some older indentures use MADS alone as the single sizing test, which typically produces a larger reserve. Some airports permit surety bonds or letters of credit in lieu of cash-funded DSRFs, freeing up bond proceeds for project costs but adding ongoing premium expense. Whether this substitution is permitted is a bond document provision — not a deal-by-deal choice unless the document explicitly allows it.

1.4 Flow of Funds Priority

The flow of funds establishes the priority waterfall for applying airport revenues. The standard GARB structure is a net pledge (100% of airports in the DWU database):

1. Operating Expenses (paid first)
2. Senior Lien Debt Service (P&I; deposits)
3. Senior Lien DSRF (maintain required level)
4. Subordinate Lien Debt Service
5. Subordinate Lien DSRF
6. Reserve funds (R&R;, O&M; reserve, maintenance)
7. Discretionary / Surplus fund

The order of priority is fixed. Adding a new tier (e.g., a "junior lien" below subordinate) or modifying the waterfall requires amending the document.

1.5 Definition of Revenues and Operating Expenses

The bond document's definition of Revenues (capital R — a defined term) determines what cash flows are pledged to bondholders. This is not the same as GAAP revenue. Typical adjustments from GAAP include adding unrestricted interest income, excluding construction fund interest, and treating PFC/CFC as designable (opt-in by resolution). Similarly, Operating Expenses excludes depreciation and amortization, and may exclude non-cash pension/OPEB charges (some airports include these in the calculation). These definitions are fixed in the indenture.

Why this matters: two airports with identical GAAP financials can have different trust-basis Net Revenues because their indentures define the terms differently. Every number in a coverage calculation must use the bond document's definitions, not GAAP.

1.6 PFC / CFC Designation Mechanism

Most modern indentures include an opt-in mechanism that allows the governing body to designate PFC or CFC revenues as "Revenues" by resolution. Whether this mechanism exists is a bond document provision. Whether to exercise it is a deal-by-deal decision (see Section 2.9).

Note: Table reflects 49 of 57 airports in the DWU database. The remaining 8 airports either have no PFC-related provisions in their indenture or use structures that do not fit these categories.