How Private Activity Bonds Offer Tax-Exempt Funding for Airport Capital Projects

Key takeaways:

• Private activity bonds allow private companies, such as airlines and cargo companies, to borrow at municipal bond-like rates for airport modernization and capital projects.
• For airport-related PABs, the bond proceeds must fund projects directly tied to airport operations; projects outside the airport footprint don’t qualify.
• Because the bonds are issued by local governments, companies must navigate complex regulatory, leasing and tax structure requirements.

Airports act as powerful economic engines that support jobs, attract businesses and spur regional development. Yet the scores of U.S. airports built decades ago are in dire need of modernization and expansion to keep pace with rising passenger traffic and the logistical demands of a global economy. In fact, the Airports Council International—North America estimates that over the next five years, the nation’s airports will need $174 billion in infrastructure investments to address aging facilities and accommodate surging demand.

Government-funded large public projects will only address a fraction of that need, leaving a significant gap—and an emerging opportunity—for private-public partnerships.

While airport projects can be capital intensive, qualifying for private activity bond (PAB) financing can allow companies to tap similar borrowing terms to those that cities get when they issue municipal bonds.

PABs, which are tax-exempt bonds issued by a public authority to finance a private project that serves a public purpose, are intended to fund private capital expenditures that have a public benefit. They give companies access to long-term financing at lower, tax-advantaged rates, making them a compelling option for infrastructure development.

"Governments and nonprofits have access to tax-exempt bonds as a function of who they are," explains Scott Frail, managing director for public finance at Fifth Third Bank. "For companies, eligibility hinges on what you’re doing or where you’re doing it." In the case of PABs, the what and where encompass projects related to public transportation, airports and seaports. Construction on airport property that directly supports operations such as maintaining aircraft, moving cargo or fueling planes are among the activities that qualify.

What are private activity bonds?

Long used by major airlines, PABs are gaining traction with other credit-worthy, airport-based companies such as maintenance and repair operations and fixed-base operators (FBOs) as a funding structure. In a climate of climbing project costs and elevated interest rates, the appeal is straightforward: access to long-term capital — often 20 or 30 years — at lower interest rates that make infrastructure construction, operational expansions or facilities upgrades more feasible. As the interest payments from PABs are tax exempt, the bonds appeal to a deep market of investors.

Depending on market conditions, companies can often realize savings of up to 200 basis points compared with traditional taxable financing over a similar duration. For large-scale projects, that differential can translate into significant long-term savings and faster returns on invested capital.

Are PABs tax exempt?

Similar to municipal bonds, PABs are issued by a public entity, so businesses need to partner with an airport authority or local government, which then issues the bonds on its behalf. Typically, the airport owns the facility where the infrastructure project will take place and leases it to the business. “That leasing relationship is what allows the project to qualify for tax-exempt status,” says Frail, who adds that for company-owned assets, a lease-back arrangement can sometimes be employed for eligibility. “In some cases, a property can be leased to the airport in order to qualify and then leased back to the company.”

For a PAB-financed project at an airport, the business assumes the credit obligation. Once the bonds are sold to investors, funds flow to the project and the business repays the debt over time, as with traditional financing. Qualification rules require that at least 95% of the PAB funds go toward eligible  airport facilities that are directly related to and essential for airport operations. Facilities located near — but not within — the airport footprint typically won’t qualify.

Because PABs represent highly complex and regulated transactions, they are generally reserved for large-scale projects costing in the range of $30 million or more. As a result of the high cost of building infrastructure at an airport, PABs not only make sense for airlines, but also cargo operators or developers handling terminal or maintenance projects.

PAB financing in action

A recent example of how PABs work took place in Hawaii, where special purpose revenue bonds were issued to provide a portion of the financing for the Big Island Center, a 16-acre development at Ellison Onizuka Kona International Airport at Keahole.

A bond issue of $29 million helped finance the acquisition, construction and equipping of two aircraft hangars, an aircraft ramp, an executive terminal and fuel storage infrastructure. The facilities are leased by a Hawaiian corporation called Keahole FBO but are owned by the Hawaii Department of Transportation’s Airports Division. The deal structure allowed the airport to benefit from the improvement of a facility on its footprint without an impact on its debt ratings, while Keahole FBO was able to expand and modernize its facilities with tax-exempt financing.

Similarly, AFCO Airport Real Estate Group was able to finance projects at the Cincinnati/Northern Kentucky Airport and the Austin-Bergstrom International Airport through a $34 million PAB. Capital improvements encompassed modernizing two existing cargo buildings and a maintenance facility, as well as making upgrades to a runway, aircraft parking aprons, warehouse space and other facilities.

Airport facility expansions also act as a cornerstone of local economic development. A good example is the public-private partnership to construct a 337,000-square-foot air cargo facility currently underway at Milwaukee, Wisconsin’s Mitchell International Airport. In addition to streamlining cargo operations and reducing reliance on congested Illinois airports when it opens in 2026, the new facility is expected to generate $1.3 million in landing fees and $1 million in ground lease rents annually.

PABs offer funding flexibility

Flexibility is another advantage of PABs, which allow companies to structure financing around their operational and investment strategies. Most are structured for a 20- to 30-year term, longer than typical commercial loan or corporate bond terms, which eases financial pressure and potential cash flow issues that significant projects can incur.

While most PABs are structured for regular interest payments over the life of the bond and the repayment of principal in one lump sum at maturity, companies can also customize terms, says Frail. “Some want that kind of set-it-and-forget-it solution; others structure a PAB to reset at specified intervals that suit their approach to financing,” he says. “That flexibility allows PABs to fit in with other portions of your capital stack.”

Because of their tax-exempt status, PABs can also enhance the appeal of projects for which companies might otherwise struggle to find financing. “The interest rate is very attractive, but people also like the long duration and the fact that a government entity is sharing in the risk of putting these facilities in place,” says David Izard, managing director, group head of Aerospace, Defense & Transportation with Fifth Third Corporate and Investment Banking. “There are a lot of benefits that encourage private investment.”

How does the PAB issuance process work?

While the benefits are compelling, companies also need to be aware that navigating the PAB application process can be complicated and time consuming. “It requires cooperation with the local government and your airport authority or issuing body,” says Frail. “As with any deal where multiple stakeholders are involved, PABs require some patience.”

Companies should also consult their tax advisors on how the lease structure or tax-exempt status might affect depreciation. The level of scrutiny can be challenging for private companies less accustomed to disclosure requirements, so tax advisors may need to do extensive preparation.

At a time when the case for capital projects on airport grounds is strong, the effort can be worthwhile. Growing airline passenger and cargo volumes are driving demand for efficiencies only possible through new and upgraded airport facilities. Infrastructure projects bring the added benefit of stimulating local economies by fueling both job creation and regional development. Meanwhile, both construction and borrowing costs have climbed, making access to lower-cost, long-term financing especially valuable. By working closely with airport authorities and getting expert advice on deal structure and tax consequences, companies can unlock the capital they need to make strategically critical projects possible — and pave the way for future growth.

With decades of experience and an unwavering commitment to client success, Fifth Third Commercial Bank is thoroughly equipped to help organizations structure and execute private activity bond transactions with confidence. For more information about Aerospace, Defense & Transportation services, visit here.