The world's first airport securitization to be structured without external guarantees, London City Airport's groundbreaking £100 million ($160 million) securitization closed in November 1999.

While London City Airport, which opened in 1987, took until 1995 to produce an operating break-even, David Thomson, finance director at London City Airport sees a solid future for the airport based on its prime location close to the fastest growing business area in London ? Docklands.

In 1995, 550,000 passengers passed through the airport. In 1999 it was 1.4 million. By 2005 the figure could reach 3 million. This is small fry compared to Heathrow and Gatwick but it represents a remarkable turnaround for an airport that was sold by its original constructor in 1995 for £26 million ? for a snip, in hindsight.

Irish entrepreneur Dermot Desmond bought the airport in 1995 from constructors John Mowlem, who were suffering from the recession. In addition, Desmond bought land from the Port of London Authority. Previously, Mowlem operated the land on a 100-year increasing rent basis. Chartered surveyors Drivers Jonas now calculates the value of the airport at £165 million.

And after a slow start, the airlines are keen to use LCA. In 1992, there were three airlines flying to three routes. Today there are 12 airlines with links to 22 destinations.

LCA markets itself as the premium business airport for routes in Europe. In London, there are three main business areas: Canary Wharf, the City and Westminster. The airport is just 10 minutes from Canary Wharf, 25 minutes from the City and 35 minutes from Westminster.

The airport had a troubled first few years ? a runway that was too short, coupled with the recession and collapse of the property market in the early 1990s, resulted in a tough time for the original owners (see box).

However the airport has undergone a reversal of fortunes, due partly to the improved transport links to the airport and the cementing of Canary Wharf as a viable business centre.

Under its new ownership, LCA reached 1 million passengers in 1997 ? a critical mass for any airport, says Thomson.

Following an internal restructuring in 1998, the airport decided that it was time to raise some money for future investment. ?Our gearing was virtually zero, which is silly if one can find the means to invest money more profitably,? says Thomson.

The deal is a whole business securitization. Some 80% of the cashflow is from aviation revenues, such as landing fees, refuelling charges and passenger load supplements.

The remaining 20% comes from commercial operations: such as duty free and the new £1 million business centre.

From original conception to closure, the deal took around a year. Legal counsel was Simmons & Simmons for the issuer, and Allen & Overy acted for the lead manager Morgan Stanley Dean Witter. Allied Irish Bank provided the liquidity facility and working capital.

The deal was rated triple-B by Standard & Poor's. ?We were slightly disappointed the rating ended with a triple-B,? says Thomson. ?Some investors expressed surprise that the deal wasn't single-A.?

However, the pricing achieved was tight. At 275bp over the 2015 8% Gilt, it was 50bp less than a similar triple-B was trading at the time, the Wightlink whole business securitization, launched the previous month.

The deal was also launched in the same month that two big securitizations ? Merrill Lynch's Bupa deal and Deutsche Bank's Trafford shopping centre securitization ? were both postponed until 2000 due to a lack of investor interest.

Mike Wilkins, an official in the infrastructure finance department at Standard & Poor's, cites several reasons why the deal was rated triple-B. ?The airport is in an exposed competitive position,? he says. ?It is in the shadow of competitors like Gatwick and Heathrow.?

From a ratings perspective, the most important factor in the securitization is the potential for passenger growth. LCA airport passenger growth is overall high ? between 5% and 6% a year, around double the UK GDP. LCA knows that all it has to do to achieve good growth is to continue to steal customers from its larger rivals.

S&P also looked at the company's rapid increase in gearing. The amount of leverage in the company has leapt from 20% to 60%, which makes an impact on the credit profile of the business.

However, Thomson says that, ?we're confident that in five years' time, the annual re-rating will eventually push us up to a single A, because we'll have a longer track record.?

The deal is secured not just by the business revenues, but also by the assets themselves. Thomson says the extra security ?helped us to raise a higher ? and better ? amount than we would otherwise have been able to do.? And as the surrounding area develops, the value of the land looks set to rise.

One rating agency concern was that the bondholders should have as much security as possible, hence, in the last resort, they needed to be able to step in and take control of the entire airport. Other whole business securitizations have been structured this way.

The original 100-year lease between the airport and the Port of London Authority is still in place, and is between two separate companies, Marketspur and City Aviation Properties. There is a sublease between Marketspur and London City Airport Ltd. The Cayman Islands issuer, City Aviation Finance, sits between these two companies.

For the first three years of the deal, there are no capital repayments. After then, the deal is structured as a mortgage-style repayment, with capital and fixed interest payments until maturity. The paper matures in 20 years.

The majority of the cash that LCA has raised will be used for future investment opportunities in the airport sector.

This plan, which is still in its early stages, would be orchestrated by the International Investment & Underwriting (IIU) group in Ireland, which is the corporate finance arm of LCA's owner Dermot Desmond.

Brendan Murphy, executive at IIU says that: ?a minimum requirement for a potential airport purchase is a return on capital employed of 12%.? IIU assists in the financing of Desmond's interests, and was involved in the securitization. It also advises external Irish clients on corporate financing.

Last June IIU hired John Leenane from ABN Amro in Dublin, to head its structured finance department. Leenane will be involved in domestic and cross-border leasing, as well as equity products and other structured financings.

However it is unlikely that LCA will be looking for lease financing. The airport's assets already underpin the securitization, and the airport is too small to be lease financed. Instead, LCA is planning to revisit the capital markets: Thomson says that, ?in three or four years we will probably want to come back and tap the market for a bit more?.

Other financing options were considered before the airport decided to securitize. One idea was a general corporate bond, secured by the assets. Under this plan, however, the airport would have been unable to raise as much as it could with the securitization.

Another idea was to float the company. However, the airport was not large enough, and the owner did not want to lose ownership control.

So securitization emerged as the most beneficial way to raise cash. The question analysts now ask is, how long will it be before other airports copy the technique? In the US many airports have issued revenue bonds, which are tax-exempt and carry a degree of backing from the municipal which owns the airport.

But in Europe, no airports have securitized their revenues. This is partly because most airports are government-owned, and can borrow from the state or issue bonds with a state guarantee.

As airports are privatized and lose this source of cheap funding, securitization will become an option for more and more airports (and not just in Europe).

However, there is only a limited number that would be suited to securitization. An infrastructure specialist at Duff & Phelps outlines three key factors that an airport must consider before deciding to securitize.

First, the size. ?The airport must be small, but not too small ? there's a critical mass point,? he says. If the airport is large then it will probably have a good enough credit rating to issue corporate bonds, for example, Heathrow is owned by the British Airport Authority (BAA) which has a double A rating. If the airport is too small then it will not have enough revenues.

Second, is the age of the airport, and its track record. LCA's deal suffered because it has only been profitable since 1995.

Third, the airport must be in a central location, and have contracts with many airlines to many locations. If not, an airport's revenue streams could be badly affected by the loss of one airline. Linked to this is the necessity for a high proportion of origination and destination flights, rather than connecting flights.

Further airport securitization opportunities are likely to be found in the UK and Australia. In the UK, regional airports such as Manchester or Newcastle are facing increasing demand for flights, and so need increased funding.

A securitization official at Morgan Stanley says it is unlikely that a large regional airport such as Manchester would be interested in a whole business deal. This is because the cash raised from a deal like that could be as much as £700 million ? much more than the airport, which is partly owned by the local authority, would need.

Instead, there could be deals that securitize the most lucrative portions of the airports, for example, the car parks.

In Australia, all the regional airports, except for Sydney, have been partly or wholly privatized. And both Perth and Melbourne have issued deals that are similar to that of the LCA securitization.

However, the Australian deals were just traditional secured bonds, with recourse to the asset. There were no credit enhancement techniques, such as the liquidity facility on the London City deal.

The official at Morgan Stanley says that the bank is in ?advanced talks? with two airports, and clearly other banks are looking at the opportunities too. With the huge cash requirements of the airport sector over the next few years, it is certain that the LCA deal will be replicated ? and soon.