Past Session:

Proceedings of the Special Senate Committee on the

Pearson Airport Agreements

Appendix A

Transport Canada

Associate Deputy Minister

September 27, 1993

MEMORANDUM

To: Mr. Morris Rosenberg, PCO

Mr. Alan MacGillvray, PCO

Mr. M. Capp, Treasury Board

Mr. Bill Cleevely, Treasury Board

From: Wm. A. Rowat

Subject: T1T2 Redevelopment Project - Citizen Articles

For your information:

Modified Media Line
Point by point responses to the Citizen articles.

Please provide any comment if appropriate, to Keith Jolliffe, 998-4811 (Fax 998-4837). We could have a conference call if necessary.

Response to points raised

in the

Greg Weston

Citizen articles of

Saturday, September 25, 1993

Sunday, September 26, 1993
(both attached)

Note: A number of other newspapers have picked up and responded on the Citizen articles.

September 28, 1993

Allegation:

1. The documents show the new owners plan to charge already cash-strapped airlines higher fees for using the air terminals. Those increases are almost certain to be passed along to air travellers.

Facts:

Minister Corbeil announced in a news release December 7, 1992 that "the government must be satisfied that a realistic plan, consistent with the airlines' present economic environment is worked out in the marketplace as a prerequisite for this project and the significant job creation it brings to Southern Ontario."

No matter who undertakes development at Pearson, the costs of such development would be charged to the airlines. By international convention, ICAO, these fees are cost based for the airlines, i.e they only pay to the developer their share of Operating and Maintenance, Capital Expenditures an a reasonable rate of return on investment.

Typically, airport costs represent 3%-5% of an airlines total operating costs.

Air Canada, indicated at the August 1993 news conference that "an upgraded and expanded Pearson translates into a stronger international airport and a better overall facility for Air Canada and - by extension - for our customers."

Allegation:

2. The confidential papers also warned Campbell's cabinet that if the airport's new owners run into financial troubles, the result "would impace severely on the operation of Pearson" leaving Canadian air travel in chaos and probably putting the airport back in the government's lap.

Facts:

The deal takes into account many eventualities.

If the developer goes bankrupt the facility will be taken over by the lender's receiver and continue to operate it as long as the lease is kept in good standing. The receiver will be free to find another investor to take over the project, of return the facility to the Crown.

In any event, the operation of the terminals would continue without disruption, although a delay in the development program could occur.

In the event of failure by the developer or receiver to operate the terminals according to the terms of the lease, the operator would be in default of its obligations under the lease, and the government would be able to assume control of the facilities and proceed with the operations and development itself, or find another developer.

Allegation:

3. Patrice Miron, press secretary to Transports Minister Jean Corbeil, says the deal was pushhed through to help create jobs in Toronto's beleaguered construction industry. But there is no mention of job creation anywhere in the cabinet documents obtained by the Citizen and no estimates on how many new positions - if any - might be generated by the Pearson project.

Facts:

The redevelopment of Pearson will result in 14,000 person-years of employment over the course of the project.

Job creation estimates were provided to the government in the proposals received in response to the RFP.

Job creation and the need for a "quick start" was discussed by cabinet on a number of occasions.

In fact, the March 1992 news release gives this estimate of jobs being created. Also, the December 1992, Economic Statement indicates TlT2 and a number of other projects will be undertaken to create employment.

Allegation:

4. The Transport Minister has publicly justified the deal by saying the rents £rom the developer's 57 year lease of Pearson will put more money in the government's coffers each year than it would make by continuing to run the airport itself.

Facts:

This is true.

The deal provides for a guaranteed base rent commencing in Year 1 of $28 million. This guaranteed base rent escalates for inflation and passenger growth over time.

The deal provides for the developer to pay the higher of a guaranteed base rent or a participation rent. The participation rent also provides for a higher return to the government as total revenue increase over time.

The government currently earns a new revenue of $23.6 million (i.e. after deduction of operating costs, etc.) Given the age of the facilities this net revenue would decrease over time, as operation and maintenance costs increased (more repairs, etc.).

The deal provides for the developer to expend $686 million redeveloping T1T2, roads, aprons, central heating facilities, administration building, etc. All of these facilities are in need of upgrading/replacement that the government can no longer afford to provide.

Allegation:

5. Far from saving money, Corbeil's own internal figures project taxpayers could actually lose tens of millions a year.

Facts:

This allegation is false.

Years 2, 3, 4, and 5 reflect the rent deferral of $ll million per year, (which will be paid back with interest over the following 10 years. It is clear that the first 5 year time horizon will not be financially positive compared to the years beyond that because of the rent deferral clause, work force adjustment policy costs which dampen the government's return in the early years. However, over the long term this deal nets the government more than would be received under current projections had the government decided to continue to operate the terminals.

Allegation:

6. Those same figures indicate profits the government should have earned would have amply financed the $682 million in long term improvements to Pearson.

Facts:

The requirement to invest $686 million in redeveloping terminals could not be financed out of the current net earnings at Pearson of $23.6 million per year without severely impacting other airports in the system. These airports are cross-subsidized from the net revenue from Pearson as a contribution to finance their needs such as safety and other operational requirements not financed by their own revenues.

The government could have used public funds to finance this development, but this would have increased the public debt at a time when efforts are being made to reduce this debt load.

Private sector development will permit project financing without increasing the public debt and will transfer the risk of any cost overrun to the private sector, while maintaining for the government a stable return on Pearson operations - better than its current return of $23.6 million.

Allegation:

7. Serious doubts are raised as to the urgency of any development at all at Pearson. The existing three terminals are only half full and the government is not projecting any major growth in air travel before the end of the century.

Facts:

Growth occurs over time, and doesn't just happen in one year.

Pearson's passenger traffic is forecast to grow on a year by year basis, such that the capacity of the existing three terminals would be surpassed in 1999. Thus new/expanded facilities are required before this time if congestion is to be avoided.

In addition, the developer, based on its forecasts of passenger/traffic growth is willing to take the risk of assuming responsibility for the existing terminals and for providing for future needs through its proposed development program. Airlines in turn will pay for the new facilities through rental charges when they take possession of these facilities.

In addition to the above, phasing of construction at an existing operating terminal is a complex matter and requires sufficient lead time.

The existing passengers and growth over the development period have to be served from a facility under construction, which has to be adequate to serve the demand.

In order to develop Pearson, Terminal 1 has to be closed. The airlines in this terminal and their passengers must be accommodated in some other facility. This other facility has to be developed first.

Allegation:

8. As part of the plan, Air Canada and the government agreed on a deal that would ultimately hand over $570 million in public funds to the privately-owned airline and some foreign companies using terminals 1 and 2.

On July 21, Air Canada reached an agreement with the government and the developers. Kim Campbell's cabinet approves a side-deal that will give the Air Canada and foreign airlines using Terminal 2 15% off their annual rents at Pearson - an estimated subsidy of $70 million - starting when their current leases expire in 1997.

Facts:

The original Paxport proposal would have increased airline charges immediately and would have recovered capital costs at at faster rate.

Given the current state of the airline industry, the government has recognized that the rate of increase and the overall level of charges to airlines must be in balance with charges for similar facilities in North America.

Therefore the government has negotiated a number of changes which will delay and reduce in total the charges to the airlines. This has resulted in the government accepting less rent than would have been payable under the original Paxport proposal. However, this revised level of rent still provides a good return to the Crown.

Thus in order that the overall TlT2 cost-competitiveness remain in the same range as T3 and terminals at other major North American hubs, PDC agreed to drop their rate of return and the government agreed to reduce its ground rent expectations from the leasings of the terminal complex at Pearson. This decrease in rent expectation was 15% of the airline portion of the ground rent that was proposed by Paxport in its submission to the government.

This 15% has a net present value over 57 years of approximately $70 million.

Even with this "deal", the return to the Crown is greater ($800 million NPV over 57 years) than if Transport Canada had undertaken the redevelopment itself.

All airlines at TlT2 will benefit from this reduction in expected rent.

Allegation:

9. The government has agreed to pay $5.5 million in severance benefits to its 160 employees at Pearson, even though their jobs are guaranteed with the new owners for at least two years.

Facts:

The government's work force adjustment policy requires this payment.

Allegation:

10. The only year the government will actually make money out of the deal is this year - by selling all the airport furnishings and other assets to the new owners at much less than what taxpayers paid for them .

Facts:

The sale of chattels is at "net book value" which is the cost minus depreciation .

In fact any other type of sale could end up with the government achieving lesser value as a large part of the items are "airport specific" and not marketable off airport.

Over the 57 year lease, the government will make money and the net cash flow is positive. (See earlier question and answer to no.5)

Allegation:

11. The federal government has allowed the developers to structure the deal in a way that allows the developer to avoid an estimated $lO million in land-transfer taxes to the province of Ontario.

Facts:

There is no regulation at any level of government that precludes a business from organizing its affairs such that taxes are legally avoided.

This issue relates to the option to lease for a period of 20 years beyond the initial lease term of 37 years.

Allegation:

12. The developers originally agreed to make $30 million in repairs to the aging Terminal 1. The government has now agreed to pay a third of any costs over $15 million.

Facts:

Even though expected maintenance costs are only $10 million, the developer has agreed to expend 100% of any costs up to $15 million on the passenger processing portion of T1 if necessary.

The government has agreed that if more than $15 million is required in the passenger processing facilities, it will fund one third of the extra cost subject to approval of the developer's expenditure plans by the government.

Allegation:

13. The Tories promised taxpayers would not be financing the deal. Yet the government has agreed to cut the developers' lease payments by $33 million over the second, third and fourth years as a loan to help the consortium finance the first $96 million in improvements to Terminal 2.

Facts:

The RFP stated that the government would give no guarantees.

The government agreed to a $33 million rent deferral to ensure that airlines, given the current weakened state of the industry, would not have to pay increased rents until such time as they had use of the first stages of the new development.

The rent deferral will be paid back over the following 10 years with interest.

Allegation:

14. The deal turns over Canada's most vital transportation link to the private consortium on a 57 year lease with annual rents starting at $528 million. In return, the group gets to keep the lucrative fees from the airlines, terminal concessions and parking, now totalling close to $77 million a year.

This is blatant misrepresentation. The numbers are not comparable. The fact is that there is around $23.6 million in net revenues as present after deduction of ongoing operating and maintenance costs.

The deduction of these legitimate expenses from gross revenues yields a net revenue to the Crown of $23.6 million compared to the $28 million in the first year of the lease.

Allegation:

15. And, even allowing for $682 million in long-term improvement costs, the government documents indicate the consortium is forecasting profits from Year 1, rising to $70 million a year by the 20th year.

Facts:

The return on equity to the developer over the term of the lease is around 14% which is about 2% higher than the returns earned by public utilities.

The slightly higher rate was considered to be a reasonable rate of return by financial advisors, Deloitte Touche and Finance and Treasury Board officials due to the developer's risks that would not be associated with a public utility.

Allegation:

16. An assessment of the plan by accountants Touche Deloitte shows Transport Canada said it could not run the airport as cost-efficiently as private developers, estimating it would cost the government an average of about $12 million more a year in operating costs.

The same assessment points out that the government can borrow money for the required capital improvements to the facilities at much lower rates than the consortium - a saing that would more than offset the higher operating costs.

Facts:

This arithmetic does not compute. The private sector is expected to operate the terminals more economically, effectively and efficiently and overall less expensively.

While there is savings in borrowings, this would not offset the extra costs if government were to develop and operate the project.

In any event, the government took the decision that it could not afford an investment of this magnitude ($700 million) and resulting increase in the deficit.

Allegation:

17. The promised improvements to Pearson may be a long time coming. The documents show the developers are only committed to $96 million in immediate improvements to the airport terminals, a third of which is being financed by a government loan.

Future phases of the development will only take place as increased air passenger traffic warrants - possibly not within the next five years. Even then, redevelopment is planned in stages which could span another decade.

Facts:

The developer is also committed to commence $96 million of construction within 30 days of signing the agreements.

The developer is also committed in commencing another $236 million within 19 months of signing of the agreements.

The following two stages are subject to passenger triggers of 22.4 million and 24.6 million passengers in all three terminals. These triggers are projected to occur in 1996 and 1998 respectively.

Allegation:

18. But the three terminals at Pearson are sitting half-empty and the confidential cabinet documents show the government is not expecting any major expansion in air traffic before the turn of the century.

Facts:

T1/T2 and T3 are not currently at capacity.

The growth in traffic is expected to result in the capacity of the terminals being exceeded at the turn of the century.

Growth is projected to occur annually, not in major increments.

The redevelopment is contingent upon keeping the airport operational and servicing passengers at a reasonable level of service.

The redevelopment requires that accommodation for the airlines be available while space is being demolished and redeveloped. Thus a current "excess" capacity is needed to accommodate this movement, and allow the airlines using T1 and T2 to continue to grow during the period of redevelopment. (See question and answer #7).

Allegation:

19. In the end, Canada is about to become one of the only countries in the world with its major international airport in private hands and all that could mean to the future of the nation's transportation system.

Facts:

Several large international airports are owned and operated by the private sector including London Heathrow and London Gatwick - BAA plc., Manchester, England.

Several countries are examining private sector participation in their major airports;

Germany (Berlin-Templehof)

Athens

Hong Kong

Besides, is there any reason why Canada can't be the first to do something innovative?

Allegation:

20. In September 1990, the government announced it was putting Terminals 1 and 2 up for grabs to private business interests .

At that point, the bureaucrats were already well into negotiations with community business groups across the country to turn over control of major airports to them as non-profit "local airport authorities." That, after all, had been the government's official policy following the federal task force's recommendations in 1986.

Facts:

The 1987 government policy on airport transfers entitled "A Future Framework for the Management of Airports in Canada" states:

"The exact form of organization accepting a transfer could vary according to suit local circumstances and interests. Options in this regard would include provinces, municipalities, local authorities or commissions authorized by federal or provincial legislation. In addition, private sector leasing would be considered".

The private sector participation in TlT2 meets all the guiding principles outlined in the policy.

T1T2 were not the first pprivate sector lease of a terminal in Canada. Tenminal 3 was completed in 1990.

Allegation:

21. At the same time, the environmental assessment board concluded that with the slump in air traffic and projections of only modest growth ovet the next decade, new runways at Pearson wouldn't be needed at least until the next century, nor was there any immediate threat of overcrowding in the terminals, either.

Facts:

The environmental assessment panel made no recommendations concerning terminals.

Allegation:

22. The precise monopoly situation that Paxport had been warning could lead to higher prices and lower service at the airport was not well on its way to fruition - with Paxport's participation.

Facts:

The RFP did not preclude the current operators of T3 from bidding and this had been envisioned as a possible outcome of the RPP process. Safeguards were also built into the process to protect against monopoly abuse, including review of the deal by the Department of Consumer and Corporate Affairs (Bureau of Competition Policy).

Airlines are protected under the agreement to pay only cost-based fees for their leased space (pursuant to ICAO an lnternational contention on airports to which Canada is a signatory).

Pearson Airport Agreements (Special)

Proceedings of the Special Senate Committee on the

Pearson Airport Agreements

Appendix A