Credit Conditions for Airports and Ports

With supply chain concerns easing and travel domestic and abroad much improved, how are the nation's airports and ports faring as the U.S. and global economies are still weathering economic challenges and potential recession?

Transcription:

Beth Coolidge (00:09):

Thank you. I'd like to introduce the next panel, which we'll be discussing, the credit condition of airports, and this will be moderated by Michael Lexton, who is Managing Director and Co-head of our Transportation Group at UBS. So please if we could give them our attention, that would be great. Thank you.

Michael Lexton (00:37):

Thank you Beth.

(00:41)

Everybody gets a little settled here for our panel here on airports. As Beth noted, I'm Co-head of Transportation in P3 at UBS, and very pleased here to have four distinguished panelists. Join me on this session. First off, actually, Kathleen Sharman, who is the CFO of the Greater Orlando Aviation Authority, is going to present a case study of what Orlando went through during the pandemic and how they fared since then as sort of a base case relative to how well airports navigated through the storm of covid 19 and where they are today, and the tailwinds that still support airport credits. Kathleen has spent over 30 years as a serial CFO at many different agencies and was also honored in 2018 as a Trailblazing Woman in Public Finance by the Bond Buyer. So once Kathleen goes through her case study, we'll have some Q&A on the topic with her and the other three panelists.

(01:54)

Ted Chapman, who's with Hilltop Securities, who joined there after 20 years at S&P and has always been recognized as a municipal all-star credit analyst by Smith's research. And Chris Jumper joins us as a director in the public finance department at Assured Guaranty focusing on Utility and Transportation Sectors, and he's had extensive credit experience in the industry as well. And finally, Harvey Zachem, who is a Managing Director in the Public Finance Group at Kroll Bond Rating Agency and specializes in airport and other revenue bond credits. So some real experts here on the topic. But with that, I'm going to start it off with Kathleen to go through the history here of what GOAA went through during the pandemic.

Kathleen Sharman (02:52):

Thank you very much, Michael. It's great to be here with everybody. And Chicago, as Michael said, I'm Kathleen Sharman. I am the CFO of Orlando International Airport. It is the busiest airport in Florida now, the, I think ninth busiest in the country and 17th busiest in the world. And so as we begin to talk about credit considerations, I've been asked to set the stage and I'm going to go through how we got through the Covid pandemic and how it affected our CIP both then and now. Oh wow. It worked. Okay. So every airport pretty much in the world has a slide that looks like this, right? Something like this. We were along with everyone else had the steepest deepest decline in passenger traffic ever. Our covid low point I think was in the middle of April where we had 1,472 passengers through our checkpoint. And just to put that in context last week, which is not a particularly busy time for us in Orlando, we had 70,000. So I mean, it is a really big drop when Disney shut down. We all knew this is serious. So similar to most US airports. Prior for the period from 2015 to 2019, passenger traffic had been growing at a very heavy 7% compact compound annual growth rate except for one year, actually every year, 7% since 2015. One year we only had 5%. That was the year we had three hurricanes.

(04:44)

But prior to that, just prior to that following the 2008 financial crisis, it took MCO seven years to recover from that great recession. So when we found ourselves in this situation, we really took a conservative approach to planning our financial recovery from the pandemic early on, as everyone knows, there was great uncertainty, how quick would air traffic return? We looked at our past history from the Great recession as well as independent sources for traffic recovery scenarios to develop. What we did was a weighted average, and sorry Harvey, I don't have crawl up here, but we took kind of all the rating agencies because one thing about a budget or a forecast, they're always exactly wrong. Usually they're close, we hope. But so that's sort of the reason for the weighted average. I mean, we had the rating agencies a four A projections. We had an economist from UCF as well as our own history to come up with this weighted average.

(05:57)

Again, so very conservative projections providing. And we also provided financial relief to our airlines partners, our concessions and rental car partners as well. Over a hundred million dollars in relief, whether it was waivers or deferrals to our concessions and rental cars, cost cutting measures, we cut the operating budget just like every other airport froze, hiring consolidated operations, cut costs wherever we could. We were very greatly assisted by the Covid relief Funds CARES CRSSA and ARPA, GOAA received over $383 million. And for us, with the exception of about 7 million in eligible expenditures that we use to reimburse from our GA reliever airport, that whole 380 some million dollars was used by us for debt service or debt DFE. And the DFE was I think very successful for us. We realized over 32 million in savings from that. So never let a good crisis go to waste. With respect to the CIP at this time, we were in the middle of building a $3 billion terminal and the largest element of our CIP, and that was nearly 50%, five zero, 50% funded with passenger facility charges or PFC's.

(07:30)

Well remember that earlier slide where there was like 1400 people in the passengers, if there's no PE's, there's no FC's. So we were a little bit sketchy about whether this funding plan was really going to work. So I call it we right-sized. I know there was a little bit of talk here about that's the first thing to cut, but I think it was the right thing to do to right-size the capital program to align our available resources with the new projected demand. We deferred over $372 million from our CIP mostly on terminal C, where we deferred eight out of the 28 narrow body equivalent gates that were under construction at the time. So though, one of the benefits of right sizing that CIP in 2020 is that we have really great shovel ready projects when the FAA issued its first notice of funding opportunity for the airport terminal program under the bipartisan infrastructure law or the investment in Infrastructure and Jobs Act, I guess FAA calls it Bill, but they always have to have a different name for the same thing. Anyway, so we had these two great shovel ready projects and you can see what it looked like. And when we deferred the gates and now you can see the steel going up, it's well underway. We've received nearly a hundred million dollars in bipartisan infrastructure funding. So did we do the right thing?

(09:09)

If we all had a crystal ball, maybe we should have just kept going with the CIP. But given that high level of uncertainty, uncharted waters, our history of the long recovery periods, the heavy reliance on PFCs when we didn't really know when the passengers were going to come back, I really think that keeping keep on going at the pace we were would've been reckless. So that combined with the fact that we were able to restructure our debt and be in a better position to access the capital markets when the demand returns, which it has is the reason I do think we did the right thing. And I don't have any regrets about right sizing both our CIP and our debt portfolio.

(09:56)

So this is a snapshot of the bill statistics, and I just saw my email, they just released the NOFO for the next year. So we'll get busy when we get home working on the 24 application, but GOAA has been very successful. We received probably more bipartisan infrastructure funds than any other airport in the United States. And I'd love to say it was because I'm like the most fantastic grant writer in the world and I have the greatest political connections and all, but we just had really good shovel ready projects. And that's the key I think, to being successful in that program. So fast forward to now three years, MCOs recovered much faster than expected and we were one of the earliest airports to fully recover from the pandemic we're back to 2019 levels and growing. We benefited from being in Florida. Florida was open for business the whole time and while other regions in the country were not, people love to visit Florida, warm weather, our awesome attractions and a really good business environment there.

(11:15)

And we don't see the trend subsiding for 23. Our passengers are exceeding the 2019 levels and budgeted to continue to increase. So we believe we were extremely well positioned with our right-sized debt service profile growth in our regional economy and changes in travel habits with the advent of leisure. We no longer have the busy weekends and dead during the middle of the week. It's busy all the time. People are traveling, they can work remotely. I mean, how many people maybe even here are going to hang around a little more and do some work and check out Chicago? So I know I have a lot of rating agency friends in the room and on the panel as well, often in discussions with me anyway, that rating agencies have seen exposure to leisure as a credit weakness. And I don't see it that way. I mean, I believe our leisure, and I know some of the recently, I think the thoughts are changing, but I think that really leisure kind of saved us. And so I think it's growing and it's continuing to grow.

(12:28)

There's just a snapshot of our strong fundamentals, not withstanding the exposure to leisure. I mean, we have quickly recovered through the pandemic. We managed the Covid well, right-sizing our capital program, restructuring our debt, cutting our operating budget. We really pushed through and delivered the construction of our major terminal expansion during the pandemic successfully opening Terminal Sea, which is a 2 million square foot 20 narrow body equivalent gate facility. And we opened that just about a year ago, September of 2022. So that really mitigates our construction risk in the future. This is what our CIP looks like today, but pretty much the big difference is a lot more reliance on grant funding. But otherwise that we've added back the eight gates as well as other expansion projects. And just summarizing, we've always taken a conservative approach to financial planning. We've opportunistically taken advantage of federal and state grants to strengthen our financial position.

(13:39)

One of the things I worked on a project with ACI where some of the large hub airports visited the rating agencies. It was December of 2019, and I'd like to think, I don't know what you all think some of you're out in the audience, that that helped a little bit as we educated without having to go for a credit rating. The real essentiality of airports and most rating agencies did not. While they did put the sector on negative outlook, they didn't really downgrade. Most of them didn't do that right away. So the airport sector was supported by the government in the short term with CARES, CRSSA and ARPA in the longer term with the bipartisan infrastructure law. Orlando is objected or listed here. They're similar to other airports and who provide needed infrastructure to support one of the country's most essential services. And I really do believe airports are an essential service and an extremely credit worthy investment. The pandemic was kind of the ultimate stress test, and I think at least in Orlando, I think we passed. So thank you very much. I'm looking forward to the discussion.

Michael Lexton (14:58):

I think Kathleen hit on a couple of key points that are in her conclusion. In particular, the essentiality of the airport sector to the nation's mobility and economy. The UBS CIO Chief Investment Office just released a report highlighting the value in airport revenue bonds to investors since airport spreads tend to be wider than other services that have in the past been viewed as essential services like water, sewer and power. And yet the pandemic proved the essentiality of the airport sector. Again, the largest test, real life test one could go through and not a single airport went into default. And in fact, as most of the panelists will go through today, have gone through it with significant tailwinds. So just like investors who put their money on the line to invest in airport bonds, so do bond insurers put their money on the line. So Chris, clearly the pandemic was one of the greatest challenges that the sector had ever faced. As a bond insurer who provides Assured Guaranty for the term of the bonds. How did you look at the pandemic? How were you able to look at writing insurance through that time?

Chris Jumper (16:23):

Am my mic on? Do I have to do something? First of all, I want to thank you Michael, and thank the Bond Buyer for the opportunity to speak to you all. Just to put it all in reference, assured guarantee has about 6.2 billion of airport sector exposure. So when the pandemic hit, we were very focused on it. Let's put it mildly. First thing we did, because again, we are buy and hold investors, we're like buy and hold investors. Once we write our policy, it's on there for the term of the bonds. We can't trade out of it. So we just by our very nature, are extremely conservative. When it hit, everyone was kind of taken back as far as how long it was going to last, and we tried. We needed to get a handle on it, we needed to box that. So the first thing we did, we started reaching out to the airports, the airports that we've insured and getting their ideas on the length of it and the impact on them.

(17:33)

We also talked to a lot of consultants in the industry just to get a sense of what their thoughts are. The general consensus that was coming back to us was, oh, it's going to be a year event, maybe a year and a half event. So by virtue of being conservative, we doubled it just to make sure that we overcompensate it. And then we also said, it's not just going to bounce right back. It's going to be a gradual recovery over the remaining four or five years. So using this, it also became very clear that it became a function of liquidity. What did their balance sheets look like? Historically, we'd focus on debt service coverage and we'd focus on other interesting ratios. This really came down to did they have the liquidity? Did they have the access to short-term capital lines of credit, letters of credit reserves in order to work through the darkest days of it.

(18:35)

When there was travel restrictions going on, we developed a pandemic model that we were able to then start applying to different credits based on where their in employments were and based on the different scenarios that we come up for recovery to see did they have the wherewithal, did they have the access to liquidity? And by virtue of that, we were able to continue to write secondary policies. And again, once primary policy started coming around, a lot of scoop and toss refunding's were being done, which normally we don't like to see those, but in this case, it was the right thing to do at the right time and give yourself a little bit of a holiday and put it off until they could recover. So just by again, taking kind of a deep breath and putting together a model and trying to be as conservative as possible, we were able to keep writing business.

Michael Lexton (19:43):

No, that's good to hear. For sure. So switching to you, Harvey, when comparing now, so we've gone through the biggest stress tests as we've said for airport credits. Where do you think airports are today versus where they were pre pandemic in terms of credit quality?

Harvey Zachem (20:03):

Well, I think airports have come back very well and under the pandemic reaction, and that's attributable to a number of factors, foremost was the federal recovery monies that were in the three programs that were very substantial. And I don't think anyone expected kind of the magnitude of those kind of programs. Also, the flexibility that they granted you basically could replace any revenues lost and that wasn't really the case for some other sectors that were much more restrictive. I think we've always put a high premium on airport management as sophisticated and knowledgeable, and they reacted very well in making the expenditure reductions that were available to them for savings. Also, in terms of deferral of capital projects that weren't essential at that point. And as Chris mentioned, that the restructuring of debt was critical also as a practice that we again don't like to see. But the thought was that it's really an extraordinary circumstance, which requires an extraordinary action. I think in terms of the cost, they've always benefited also from really robust cost recovery mechanisms in terms of their use and lease agreements that allow them to mean coverage itself and as needed. Those type of actions really were prime to that.

(21:39)

I think you look at the recovery and if you look at TSA throughput data on some days you're really exceeding 2019 levels. Also noteworthy, Kathleen mentioned leisure's destinations, and we do take a view that's relatively positive towards legion's destinations. We find that the revenge travels really helped them. There was always the question of whether it's sustainable, but these locations tend to be areas in the country that are undergoing population economic growth and where a lot of individuals and families relocated during the pandemic, which generates travel also. So you're looking at numbers that in some cases that are significantly above the 2019 levels business conference meeting haven't really come back to the same degree. But I think we're still monitoring that, and that's sort of in those cases where employment activity hasn't quite reached what it was in 2019. And to a lesser extent as far as the rebound international travel, particularly in Asia and that's affecting west coast airports. I think the concern would be, I think in areas and there was some movement during the pandemic to a secondary airports in a metropolitan area where there was some shifting from the carriers to the primary airport itself. And whether that remains becomes more of an issue because you're really diminishing employments at those airports. But overall, I would say it's come back very well. And on average, I would say it's at least at the level where it was prior to 2019 with some upside.

Michael Lexton (23:32):

I think you make a very good point there that we've talked about all the federal aid that went to airports, several hundred million dollars to Go Air, for example, and other airports around the country as being a nice lifesaver event, but it shouldn't be ignored that also several hundred million dollars went to the airline industry as well. The nature of airport credits resiliency has to do with its cost recovery capabilities and the ability to pass through its cost to the airlines users. And obviously the airlines benefited from the federal aid as well, and no airlines went out of business as a result of covid, which I think also helped the overall credit quality of the airport sector as well. So Ted, turning to you, I'm wondering whether you might take a look into your crystal ball and let us know what you see ahead for airport credits over the next couple of years.

Ted Chapman (24:34):

Yeah, and I think first of all, if you look at all of the infrastructure sectors that we're going to talk about over the next couple of days, I think if you compare mass transit, surface transportation, utilities, airports probably were the big winner. I mean, if you look at kind of holistically, and then I guess just first of all, since it's sort of right after lunch and the first day, and because I'm that guy, a quick show of hands, anybody have anybody recently within the last couple of years become parents? No. Okay. First of all, congratulations. Second of all, how dedicated are you to the industry that you may be named your child Bill or IRA maybe CARES? All right, fair enough. My kids are a little bit older yet one in college, one in high school, my high school age daughter, she seems to think she knows everything.

(25:27)

She actually helped me with this presentation, but unfortunately she sent me all of her notes via snap. So I'm going to probably have to translate for you guys a little bit. But I think broadly speaking, if you look at airports, you could probably, again, very generically put it into three different buckets because it's infrastructure and we'll talk about buckets. The first one, she called that the whatevs. So she said, okay, FAA authorization no change in the PFC cap, which hasn't been changed for the last 20 years. So she said, IDK, I don't know. And then, yeah, okay, yeah, after a huge run up post pandemic ticket prices have been falling in few the last few months. Certainly, yes, that helps revenge travel, pent up demand, however you want to call it, is that sustainable. So second column, the second category, she said she called this one sketch, not sketchy, but it's one that doesn't sound so good, but certainly absolutely not catastrophic.

(26:31)

So she sent me the eye roll emoji and she said, thanks teams, meaning how much business travel is completely cannibalized gone forever. We know some of it is, and that used to be a pretty important part to not just the airlines, but also the airports. Then she mentioned Davis Bacon, Bob, Bob waivers. She said it helped a little kind of, I guess, I don't know, whatever if you know. And then headline risk, that's probably not material and measurable, but I mean it's still something that we hear about all the time. Pilot shortages, runway incursions, system-wide stoppages for weather disruptions, cybersecurity, antiquated computer systems. And then she just said OMG. But I think my favorite bucket, and I think we'll end this one on a high note, she called this one the Oprah's, meaning you get some money, you get some money, you get some money.

(27:27)

And so you talk about Bill, and Kathleen mentioned it and big picture, there's 25 billion worth of grants. I mean, some of it is for airport improvements, terminals, air traffic control, and then ongoing funding. It looks like that's going to be boosted from a little over 3 billion a year to 4 billion a year over the next five years. There's still some leftover stimulus money of about 2.8, 2.9 billion last year and this year kind of rolling through. And then again, not that there is any drama to the FAA being reauthorized, but oh, by the way, now some of the airport improvement program grants, they're going to make a little bit more flexibility to what might be an eligible project. So as she ended by saying that's totes lit, so obviously that's a good thing mean, again, overall probably the best situated sector. And then she just said TYVM. Thank you very much. So that's all I got. That's all my daughter has, Michael, thank you.

Michael Lexton (28:28):

Well, no, thank you. Appreciate those perspectives, Ted. For sure. And in the name game, my colleague Chris Bergstrom, who by the way was just elevated to be Co-head of Transportation with me at UBS had you beat because he named his son Austin after his client Austin Bergstrom Airport.

Chris Jumper (28:51):

Is Bergstrom the middle name?

Michael Lexton (28:52):

There you go. So Chris, this Chris, with the passenger recovery now near or exceeding pre pandemic levels, what headwinds do we see? And I'll attest to my six hour delay in getting here last night being one of those.

Chris Jumper (29:12):

There we go. Okay. And again, just to build off some of the topics that Ted brought up, I'll do just a show of hands, just a show of hands. Over the past two days, how many people flew here? How many people had delays, how many had delays over two hours? It gets a little smaller. Okay,

Michael Lexton (29:35):

Do I need to stand up?

Chris Jumper (29:36):

Me too. I always, I just flew in from LaGuardia and wearing my arms tired because it was six hours of a lot of fun. But again, the employments are back, no doubt, the vengeance, revenge travel is happening. A lot of the premises that we thought were important kind of got turned on their head, things like we would rely more on passenger travel than cargo. And the covid proved that. No, that's actually the one bright spot during the covid pandemic. But things are returning. There are still a lot of challenges with a shortage of pilots, a shortage of air traffic controllers. My flight was delayed this morning initially because they couldn't get a copilot. And then when they got that, there were some residual storms. Climate change, I know it may or may not be a popular topic depending on which side of the aisle you're on, but it's happening.

(30:46)

The storms are becoming more frequent. The delays caused by storms are becoming more frequent and the storms are bigger. So it's a concern in addition to storms, you've got sea level rise, you've got storm surge that could impact coastal airports. You have heat that heat waves that require a longer runway because the air is thinner and you can't take off. It's going to require a lot of additional funding and capital improvements that are going to need to be done. Some of the biggest problems that I've seen, I mean again, over the past year, how many people got caught in the January shutdown of the aircraft? I was flying in the FAA in January, basically just shut down the airspace for not a long time, but still that hadn't happened since nine 11.

(31:53)

It was because they had a glitch in their aircraft monitoring devices, the thing that tracks the aircraft, which was technology from the fifties that they were still using. So those are the kind of things that are going to need to be upgraded. We're seeing airplanes that airlines are using, they're opting for larger airplanes now because, and again, to deal with congestion, to deal with the shortage of pilots, get more people on a flight. Well, what's happening on some of the secondary and tertiary airports is that they're being the major airlines, the four major that now cover 80% of domestic flights are avoiding certain cities since 2020. They've cut out about 68 cities that they were formally serving. So those are some of the challenges that again, it it'll work itself out. I think it's a very, don't get me wrong, the US airports are the safest in the world. They are the best. The airlines are the safest, but still it's not, I always get a little bit nervous because they still have a ways to go as far as training people and getting the staffing right. There was a lot of people that were let go during the pandemic when it first started. And yes, they've replaced them, but the experience still needs to be acquired.

Michael Lexton (33:40):

I appreciate that. And Kathleen, I don't mean to put you on the spot, but as we look at some of these potential headwinds, and you mentioned in your talk that budgets are, they hopefully are close, but never a hundred percent accurate. What level of conservatism do you try and put into your budgets relative to not knowing what we see out there in the future?

Kathleen Sharman (34:01):

Well, we definitely are conservative. We want to be, what can I say, conservative based on our track record. We like to over, what am I, I'm going to say it wrong. Under promise and over delivery. Yes, exactly. Last year in 2023, we budgeted 2019 levels. Well, we blew that out of the water by 10%. So the terminal area forecast is for our region is like 2.3%. So that's what the FAA says we're going to grow. So we usually go by that, but we've always kind of exceeded that. So that's how we are. I think that's the way it should be mean. But it's interesting you bring up that point because as I do this longer and longer, you don't want to be too conservative because then you maybe don't do important projects that need to get done. So this whole, the bipartisan infrastructure and all the new grants and the federal money that is even getting passed through the states that states are trying to figure out how are they going to use it.

(35:20)

There's so many projects, so many, all the airports infrastructure, not just ours. I mean, everything was built like 30, 40 years ago. So we're all going to need to start improving that now. And I think you're seeing that even cost and plane passenger where it was for us, we're a low-fare market, so we like to keep that low, but it's being less and less problematic as the airlines and everybody really and just was evidenced by the panel even just prior to ours too. It's important. Infrastructure's important kind of what makes the world go around. It generates economic development. So I think people are seeing more and more that prices have to go up. A lot of times when I do the budget and consult with the airlines, I'm like, oh my God, it's going to be a big percentage increase. And this year it was 10.6% increase in our operating budget and nobody blinked. I mean, it was what it cost and it's what their union contracts are even increasing higher than that. And it's the cost, as was said here earlier of trying to get good people to do work experience work, retaining and attracting talent as well as the supply chain and all that. So that was a long-winded answer of saying, yeah, we budget conservatively.

Michael Lexton (36:45):

I think your points about needing to spend money is important as well. For sure. And your point about CPE is an interesting one as well. It's one I've been on the soapbox about relative to the importance different CPE than the CPE eligible that this panel brings with it cost per employment to the airlines, which has been ubiquitous in the airport sector. Certainly the airlines, whenever they're negotiating, they pound their table over their costs. But as a rating analyst, Harvey, where do you see CPE and its importance and where it falls into the rating spectrum?

Harvey Zachem (37:23):

Well, we review CPE and we publish information on it because it's really what the industry expects to see, and it's become a sort of a standard that way. But it's only one of several metrics that are considered. And when you look at it, it could try to compare it between airports. It's really not an apples to apples comparison. It really depends on what the airlines are responsible for and what the airport is responsible for. If it just includes, let's say, landing fees and terminal rents, it's different than if the airline, let's say, owns the baggage system or is responsible for and own loading bridges or the airports issued special facility bonds that they're responsible for. You would kind of lose that in a sense, if you're making a comparison that way. Also, in terms of CPE, when you see a high CPE, it's not necessarily bad. Maybe some of the improvements that were financed with the debt resulted in lower.

(38:37)

Basically the efficiency has improved. Its flow turns at the gate have improved. The airfields are better that way, and that conceivably ends up in more profit for the airlines, so they may benefit from that. So if you look at a number in isolation, you're really not going to get that benefit. Also, the fact is that it's a collaborative process, these capital projects, and in many cases, majority and interest approval is needed. So airlines really know what they're getting into, the kind of costs involved and when they approve these type of programs. So they're willing to take on those type of costs, I think. And finally, basically if you look at it in terms of airline costs, it's lower than their labor costs. They're fuel costs. It's a small component overall in terms of overall costs. I know they're very sensitive to it and they bring it up in terms of negotiation. But again, they wouldn't go forward with the project if the project didn't make economic sense and produce better efficiency and potentially more profit for them.

Kathleen Sharman (39:50):

I think they make a big deal of it because it's a cost they control or they perceive they can control. So they can't really control fuel prices and they really can't control labor either. It's market driven, so they have their little thing that they can control. Right.

Michael Lexton (40:09):

Well, it's also a metric they can measure as well. So I mean it makes it a little easier in that regard for them to point to the dollar amount and haggle over it. But I don't think there's been a single airport in this country that's lost an airline due to its CPE going up from $12 to $15. Right?

Harvey Zachem (40:32):

I mean, it doesn't really not reflected in yield that the airlines really gain from service.

Kathleen Sharman (40:38):

Right. And each airline's CPE, I mean airports report their CPE as an average, right? But I have 40 airlines operating in Orlando, and I can tell you their CPE, their real CPE, it's all different. It depends on how efficient they are and other stuff like that.

Michael Lexton (40:57):

Although admittedly, in reading some airline research, while it is a airport, costs are a small percentage of the overall cost of an airline. It has been ticking up in recent years with again, the needed capital improvements that have made customer service more efficient for the airlines as well as aircraft movement on taxiways and items like that that have reduced their fuel costs because they don't have to idle as much. So I promised Kathleen I wouldn't have her address any of the next topic because she's a Florida issuer, but it's impossible to ignore ESG, which has dominated the universe, but also the airport sector as well. So Harvey, as a rating analyst, again, putting the burden here on you for some of these questions, how do you evaluate ESG? Do you feel the risks influence ratings and what specific factors are most important to evaluate?

Harvey Zachem (42:03):

Yeah, I'll begin by saying that we believe that ESG factors that influence the risk of default and recovery are much less than the ESG factors that are considered important by a lot of stakeholders. So given that kind of approach, we think the way to distinguish between those relevance ESG factors and those who aren't relevant is by a credit analysis itself and not to use the collection of irrelevant data and scoring systems, which kind of don't really reflect credit quality overall. What we're looking at is how it affects credit quality of the issuer, not so much a whole scoring system that has positives and negatives and maybe averages out. And then just conflates what really is going on for that particular airport. So we believe the role of the analyst is focused on ESG factors that only material to credit and relevant to ESG risks. And we see ESG risks as pretty unique to each issuer itself.

(43:27)

We believe scoring methods, scorecards, weighing of ESG factors are subjective and non meaningfully credit relevant. And really in a sense, by quantifying it, you're, you're creating false precision as far as the outcome. Our belief is that the development weighing and ranking of these factors is best led to investors rather than to rating agency analysts. We consider that ESG factors that including climate risks, cyber risk, reputational risk, and stakeholder preferences really are the ones that have the highest likelihood of being credit relevant factors. And what we do is we analyze these factors through the lens of how they're identified and managed by issuers. So for us, in our methodologies, assessment of management is a significant role it plays, and we base that on the premise that detailed management really doesn't gloss over just headline numbers or ratios or scoring. Our focus is on management.

(44:52)

So first awareness of the ESG issues as it affects their operations, their finances, capital. Next in terms of how their strategies reflect their assumptions in terms of financial planning. And finally, how affordable are these risks if they do have to be capitalized. So we present all of that if it's relevant in our individual credit reports. And we also have an ESG management section that just lays out the issues that an airport may face. But the short answer is that if it doesn't affect credit quality directly, in a sense, it's not really reflected in terms of our ratings.

Ted Chapman (45:43):

Can I amplify a couple of things? No, absolutely. So I mean, as somebody that was also a rating agency analyst for two decades and now as somebody that's an MA, yes, a hundred percent yes. If you can basically, okay, let's say that you don't like the term ESG, but I mean you heard Harvey say the word risk several times. That's ultimately what it is meant to be. It's not politicization. Setting that aside. Are you thoroughly identifying risks and are you reasonably trying to ameliorate them if those are things that you can demonstrate to the rating agencies, because obviously you cannot mitigate every single risk, but if you can reasonably do so and thoroughly identify those, that's what we're telling our clients to do. And as somebody who sat in and chaired many, many rating committees over the years, that can make a difference.

(46:32)

If you're for those entities, for those rating agencies at least, maybe that use scorecards as an example, if you're sort of scorecard indicated outcome, you're sort of a one, a two, well, maybe you get the benefit of the doubt because you have demonstrated to the rating analysts that come visit you who then represent you in the rating committee. You know what, they're really thorough. Risk management here is really comprehensive. Again, you're probably not going to be able to address every single risk. I mean, raise your hand if you've got enough money to do everything in your budget, no.

Harvey Zachem (47:04):

It's all about priorities.

Ted Chapman (47:04):

But to the fact that you have not just conservative financial management, but that you're tying operations together and you've got the C-suite staff, the board, if city council needs to be involved, et cetera. If everybody's on the same page, that will go a long way towards getting your deal done. That will go a long way towards, I mean, that almost markets itself. So I mean, yes, those are things that we tell our clients. So absolutely, a hundred percent yes.

Michael Lexton (47:30):

I think that's interesting. Again, for someone who puts their money on the line, climate change issues, you mentioned it before, rising sea levels, heat waves, et cetera. How does bond insurer evaluate those risks and effectively cost them out?

Chris Jumper (47:48):

Yeah, we don't take them into, no, I'm only kidding. This has become almost like a central focus. It's almost like you have to check this and make sure that it's okay before you even get started. So it, it's an important feature for us because again, we're signing on for 20 years, 30 years of a bond, and we want to make sure that we thoroughly understand it. We've spent a lot of time with consultants, we have environmental consultants, we've hired people that have expertise in the field, in the property casualty field. We've actually created our own subsidiary assured analytics to monitor this and develop our own database. We, we've come up with various stress cases that we run through, and again, just try to quantify the risk. What is the risk to the population? What is the risk to the assessed value of a county or a city?

(48:56)

How is it going to be impacted if some event happens? And then the other flip side of that though is we also spend a lot of time with resiliency and how are they, and it gets to management. How did they respond to it? What are they doing? Ben Watkins was talking earlier about the resiliency office in Dade County and the resiliency office in the state. They're spending millions of dollars to address climate change, to incorporate things like building codes and whatnot to manage it. And do they have the wherewithal to replenish it? How many more times are they going to be able to go to FEMA? And again, we feel very confident with the work that's going on there. Same with New Orleans, where scary place, and they've Army Corps of Engineers spent 14 billion there. So those are the kind of resiliency efforts that we focus on to kind of balance the climate change, but it's real. And again, we focus on environmental risk monitoring and assessment, but things like governance do come in because that's management. That's also how does the state respond and the federal and the local, the regional governments, how do they contribute? Is there a coordinated effort or is everybody just out for themselves? And then how management works that into their response. So we do spend a lot of time, more and more time discussing environmental and governance and resiliency. And I think it's just a trend that's going to continue.

Michael Lexton (50:58):

I think you make a good point, Chris, and even again related to the prior panel, the importance of infrastructure overall, not just for airports. We talk about the need for expansion, need to build new facilities, new gates and terminals, but we also talk about the need to upkeep state of good repair maintenance, but there's another significant cost out there that governments are going to have to bear, which is the decarbonization of infrastructure and weighting that and what that cost is, which is in some ways still unquantifiable in many cases is another factor that will ultimately impact credit quality as expenditures have to go up to address that. I mean, every single major airline in the country has a net zero plan by 2040 or 2050 that comes as a cost. The reason they put those plans out there for the public is so that their investors know that this will ultimately be an added cost that the airlines are going to have to bear.

(52:02)

They're going to have to recycle their fleets entirely and look at other ways. Sustainable aviation fuel is a much more expensive fuel than traditional fuel. So all those things impact how we look at things. And I think going forward, this issue, and again, Harvey, I thought you made a good point too, relative to probably should be more on top of mind of investors rather than the rating analysts. And I think we're seeing that now as we know a number of investors that we deal with at UBS who have defined quantitative models and how they look at the various ESG risks. And therefore that begs the question, what metrics do they want? What are they looking at? Is greenhouse gas emission an important metric for airports to supply to investors? And so we're sort of working through that now as it's still a work in progress.

(53:02)

But what's important to investors is they look at ESG considerations. What specific metrics do they want? I mean, we're in a world now of data analytics. I mean, any sports fan here sitting in the room knows how data analytics has just gone through the roof relative to how teams evaluate what players they have, what their opponents have. We all saw Moneyball or read the book. And so that is clearly being applied more and more to the municipal bond industry as well. And so what are the metrics that are important that's still a work in progress. And then finally, for those issuers out there, how do you disseminate that information? Is it only periodically when you sell a bond issue and put it in your offering documents or do you need to have an annual report or some other mechanism of disclosure relative to these issues? So again, depending on what side of aisle you're on, it can be a good or a bad topic, but it's a topic that needs to be addressed in some fashion. So with that, I think we have about five minutes or so for any questions from the audience. And dutifully, I see my colleague Beth here raising her hand. Do we have a microphone anywhere? There we go.

Beth Coolidge (54:28):

Thank you. I know the other panel talked a little bit about ai. Is there any consideration when doing some of these large terminal renovations as to what that could look like, incorporating AI either through how people board or D board or anything with baggage handling? Would love to hear your thoughts.

Kathleen Sharman (54:52):

That's me. We're constantly looking at technology improvements. I can't speak to AI specifically. I mean, increasingly customer service is not just a nice to have or customer experience. It's an expected to have, right? So with that comes a lot of technological innovations. We just recently, we've, Orlando hired a CEO about a year and a half ago who has restructured our organization and one of the positions he created was a Chief Creative Officer. And that person is in charge of customer experience and it as well as innovation. So I can't speak to specific AI stuff that's being incorporated in our expansion projects, but I know technology will be there. So if that's what is appropriate, it will be there. And we're certainly looking at it.

Michael Lexton (55:53):

Yeah, I would add two things to that. And I don't have a crystal ball, otherwise I wouldn't be sitting here.

Michael Lexton (56:03):

But one of the things I constantly say is that technology is going to impact mobility much more significantly than I think most people think. And what that is and how that relates and whether it incorporates ai a hundred percent sure it will, but how it impacts that. In fact, we ran out of time on last panel, but one of the questions I have about AI generally speaking, and even from a credit standpoint is do you view it as a potential job replacer or a job enhancer? And the answer to that question is still unknown, but how that answer turns out will have a dramatic impact on demographics. And we are still waiting to see what that means.

Harvey Zachem (56:51):

I think we're seeing since the pandemic also accelerated use of biometrics now going forward too, too. And that's going to speed things through, I think in some more efficiency itself. So that may have implications also from what you're referring to.

Michael Lexton (57:06):

I've already boarded a Delta flight where they just looked at my face.

Kathleen Sharman (57:10):

We have a hundred percent biometric entry and almost and about, I don't know, 40% biometric exit. So yes, that is absolutely being incorporated into, and I'm not the only one.

Michael Lexton (57:25):

And again, this is an airport panel, but broadly speaking in infrastructure, since this is an infrastructure conference, technology will have an impact everywhere from automated vehicles to Robotaxi's to whatever mobility will be impacted by technology. And we have to be able to adjust to it both as bankers and as issuers and just keep our eye on the prize or whatever the right metaphor is.

Kathleen Sharman (57:55):

Can I make, I guess almost a personal, as a self-proclaimed transportation finance geek, right? Who's been in this industry for over 30 years answering the question, technology and technology change, yes, there'll be replacement jobs, but there'll be different jobs and new jobs. I was heavily involved in implementing the E-ZPass system in the northeast back in the nineties, and everybody was really upset because, oh, toll collectors will lose their jobs, but there were more jobs and higher paying jobs because there was the customer service centers and all this other stuff. So whatever this next wave of AI is going to be, I don't have the crystal ball either, but it's going to be different and there's just going to be different jobs. They're not the same, but it's still going to be good or I have hope anyway.

Michael Lexton (58:45):

Great. Any other questions? Okay,

Audience Member 1 (58:52):

Just drill them down on one, these metrics.

Michael Lexton (58:54):

Hold on, DJ one second.

Audience Member 1 (58:59):

Just wanted to drill down a little bit on one more metric. You talked about CPE, but I've always been blown away by the US having 32 trillion and still keep effectively keeping a aa. And when I started many years ago, airports had eight or 10 billion a year, and now they're up to about twice that. So I guess maybe for you, Chris, and how do you look at this leverage? Does it constrain you or is there some kind of sub metric that you look at or are you open to it? I'm an airport banker, so I like the leverage. But is it a reflection of the essentiality is kind of one of my questions also. And is it inevitable I see some of these even medium and small hubs with really big programs now. So maybe when you're approving something, Chris, how do you look at leverage?

Chris Jumper (59:55):

Yeah, no, and again, it's a big concern. It's a big focus. It's not a concern. It's a big focus. The same municipal, most of the airports are publicly owned. There's only, I think one, maybe two privately owned airports, one's in Puerto Rico and the other one I'm not even quite sure where. So they're publicly owned, they're financed by tax exempt bonds. They have a low cost of finance. So all that in perspective, yes, we focus a lot on leverage. We focus a lot on things like debt to net plant debt per employment coverage ratios, those kinds of things. And again, nothing is a yes or no binary decision. It's usually if the leverage ratios are high, it's a discussion. Why are they high? Did they just complete a massive capital improvements plan that's going to double their revenues? What are the financial projections say? Discounted? Can they still support it if you stress their in employments and their revenues? So that's kind of how we approach it. Again, we are very conservative. We don't usually take any growth projections and cut them in half and that's our base case and then go down from there. So I don't know. Harvey, do you want to.

Harvey Zachem (01:01:22):

Yeah, I would say we also look at those type of metrics. I think for us, we're looking for factors as to how much sense does this project make given employment trends here or the growth of the area itself to support that. Will it create more efficiency in terms of throughput, in terms of turns by the airlines, less runway congestion. Those are all factors. I think if we're looking at, let's say an airport that may be at risk of let's say having two or three carriers and one carrier potentially pulling out there, and I guess I'm looking at more of a mid-size or a smaller size airport. There's concerns there, but I think the expectation is that there's a lot of inflation in terms of both labor and costs of capital costs itself. And there's an understanding and it's like a new normal from what it was, let's say 10 or 15 years ago. And I think you have to look at it in the context itself of how essential and what is the payback for investing in these type of facilities.

Chris Jumper (01:02:37):

And yeah, Harvey, that's a huge thing. What are they using the money for? Is it for safety purposes for maintaining the important critical infrastructure or are they building some sort of, yeah.

Harvey Zachem (01:02:54):

And I would add debt structure is very important also as to is this assuming that you're deferring the repayment of the debt, so you're going to grow into this and if it doesn't grow into this, it becomes a much larger burden. So that would be a factor also.

Michael Lexton (01:03:11):

Great. Well thank you. I think we've come to the conclusion of our panel. I'd like to thank Chris, Harvey, Ted and Kathleen for an excellent session. And I think there's a break now, or Beth will let us know what's going on next.