OREANDA-NEWS. Fitch Ratings has affirmed Pensacola, Florida's (the city) 'BBB-' rating on $32.1 million of outstanding series 2008 airport capital improvement revenue bonds issued on behalf of Pensacola International Airport (PNS, or the airport). The Rating Outlook is Stable.

In addition to the 2008 bonds, PNS has approximately $27.5 million of parity obligations that Fitch does not rate.

The 'BBB-' rating reflects the airport's small regional market with significant competition from surrounding airports, and the continued absence of a long-term airline use and lease agreement (AUL) since 2008. The rating also reflects the airport's historically weak financial performance, with years of low debt service coverage ratios (DSCRs) and liquidity, though more recent performance has improved and management is developing new non-aeronautical sources of revenue generation. The rating is buoyed by its predominantly fixed-rate debt structure and legal covenants, improving leverage levels, and a modestly sized capital investment plan (CIP) that is mostly funded with third-party resources. Fiscal year (FY) 2015 (ends September 30) produced a DSCR of 1.84x, an increase from 1.31x in FY 2014 reflecting revenue growth of 12.9%. Compared to peers within the 'BBB' rating category, the airport's metrics are relatively weaker and more vulnerable to operational volatility given the absence of an AUL.

KEY RATING DRIVERS

Small, Competitive Regional Market (Revenue Risk - Volume: Weaker): PNS serves a small 100% O&D passenger market in and around the western portion of the Florida Panhandle. Although traffic is well diversified by a mix of business, tourism and military travellers, overall enplanement performance has been uneven and future performance is susceptible to a significant degree of competition from three other regional airports. PNS serves a limited number of direct markets and has a moderately high level of service concentration with Delta Airlines (Issuer Default Rating [IDR] 'BBB-'/Outlook Stable) accounting for about 40% of total enplanements to a single destination: Atlanta.

Rolling AUL Poses Risks (Revenue Risk - Price: Weaker): Fitch views negatively the airport's use of a month-to-month AUL since 2008, which casts uncertainty on the airport's longer-term ability to recover operational costs and retain non-airline revenues above its fixed cost base. The airport is currently negotiating a longer-term AUL with plans on executing in FY 2017. However, the ultimate terms and timing of any such agreement are uncertain. The current hybrid AUL provides for adequate cost recovery, as costs not chargeable to the airlines on the terminal side can be covered through the residual calculation of landing fees, but historical cash sharing with the airlines points to an unwillingness to impose cost increases back to the carriers to preserve adequate margins.

Limited Capital Needs (Infrastructure Development & Renewal: Stronger): The airport's infrastructure was recently expanded and renovated as part of its 2008 capital program, thus limiting the size of its current five-year CIP to just $83 million. The vast majority of the CIP is expected to be funded with grants from the Florida Department of Transportation and the Federal Aviation Administration and sizeable projects can be deferred, if needed.

Solid Overall Debt Structure & Covenants (Debt Structure: Stronger): The airport's outstanding debt is predominantly fixed-rate (78% by par outstanding) or synthetically fixed (11%) and fully amortizes. Covenants are consistent with those of other U. S. municipal airports and includes a cash-funded DSRF sized at the maximum allowed by the IRS. The debt service profile escalates slightly through 2019 before dropping off thereafter, which should provide airline cost relief in the medium term.

Improving Financial Position: The airport's financial position strengthened somewhat in fiscal 2015 with its DSCR rising to 1.84x from 1.31x the year prior (2.00x and 1.47x, respectively, when discretionary cash transfers to airlines are considered available for debt service). Days cash on hand (DCOH) increased to 285 from 223 over the same period. This is an improvement from several years of weak performance, with DCOH falling to just 14 and 18 in FYs 2011 and 2012, respectively, and low DSCRs of 1.05x and 1.16x (1.42x-1.51x) over the same periods. Improved margins and debt amortization lowered net leverage to 4.3x in fiscal 2015 from 6.7x the year prior.

Peer Group: Pensacola's closest peers are Harrisburg ('BB+'/'BB+'/Outlook Stable) and Fresno, California ('BBB'/Outlook Stable) because of their similarly small enplanement bases, and historically softer financial metrics. Fresno's higher rating is driven by Fitch's expectation of higher projected DSCRs and greater financial flexibility compared with PNS, whereas Harrisburg's lower rating can be attributed to it being significantly more levered than Pensacola.

Fitch Analytical Comparative Tool - U. S. Airports

RATING SENSITIVITIES

Negative

--Execution of a longer-term agreement with a less favorable cost recovery framework or which does not allow for significant retention of non-airline revenues to sustain adequate liquidity would be viewed negatively.

--Material financial deterioration leading to DSCRs consistently below 1.20x, whether caused by traffic declines, adverse terms of a new/modified AUL, or other factors.

Positive

--Sustained solid financial operations under an executed medium - to long-term AUL with a favorable cost recovery framework would likely lead to positive rating action. Fitch views the likelihood of achieving these goals over the next two years as unlikely, given progress of contract negotiations and the time required to demonstrate financial results

SUMMARY OF CREDIT

PNS's enplanements increased a moderate 3.1% in FY 2015 to 798,000 from 774,000 the year prior. Enplanements have fluctuated over the past several years and are 4.7% lower than peak levels achieved in FY 2007. Based on enplanements to date, management projects 1.8% growth in fiscal 2016 and 1.4% compound annual growth thereafter through fiscal 2021. Fitch views management's projections as realistic given expectations of reasonable economic growth, announced service expansions, and recent trends towards larger aircraft.

The airport's financial metrics have improved significantly over the past three audited fiscal years owing to prudent cost-cutting measures, enplanement growth, development of non-aeronautical revenues, and reduced revenue sharing with airlines. Fiscal 2015 operating revenues grew a robust 12.9% and expenditures significantly decreased by 5.7%, resulting in improved financial metrics with a DSCR of 1.84x, unrestricted cash of $9.1 million (285 DCOH), and leverage of 4.3x. Costs per enplanement (CPE), however, increased to $8.07 from $6.83 the year prior. Management estimates slight growth in revenues in FY 2016 but higher increases in expenses as delayed costs in FY 2015 will occur. Based on these estimates, the airport's profile remains stable with a DSCR of 1.46x (1.91x), 346 DCOH, and leverage of 4.91x.

Management estimates enplanements will stabilize and rise by 1.8% in FY 2016. Financial metrics will likely benefit from management's continued development of additional non-aeronautical revenues, including the development of vacant land around an on-site hotel, redevelopment of new airport land recently purchased by the city, and construction of a maintenance facility to be leased to an aerospace company. The airport has financial management practices of maintaining a liquidity floor of at least $3 million (about 90 DCOH) and a DSCR target of at least 1.4x. Although these targets are below the medians for small airports, Fitch nonetheless views them as a prudent step towards preventing extreme financial deterioration under stressed enplanement conditions.

Fitch acknowledges the airport's financial condition has materially improved over the past three years; however, positive rating action is unlikely until the airport can demonstrate a track record of sustained financial stability under a longer-term AUL. AUL negotiations with airlines began last year and management expects the execution of a new AUL in early calendar year 2017. This is, however, subject to delays or changes.

Fitch's five-year base case (fiscal 2016 to 2021) was derived from the airport's key assumptions on enplanements and expenditure growth, which we view as reasonable based on economic and enplanement trends and historical data. Enplanements are projected to rise at a compound annual growth rate (CAGR) of 1.4% while expenditures are projected to grow at a 2.7% CAGR over the same period. Under these conditions, the DSCR would slowly and consistently rise to 1.63x (1.77x without consideration of discretionary cash transfers to airlines) by FY 2021 while leverage would fall to a satisfactory 3.20x over the same timeframe. CPE over the five-year period is projected to rise slightly until late in the forecast, when debt service declines, ranging from $7.20 to $8.73.

Fitch's rating case scenario assumes typical recessionary conditions that would result in two consecutive years of 5% enplanement declines in fiscal 2017 and 2018, followed by a partial recovery with three consecutive years of 2.5% growth. The scenario also assumes that management increases its discretionary cash transfers to airlines in FY 2018 to FY 2021 as needed to prevent CPE from rising above $9.00. Under these conditions, DSCR would average 1.30x (1.54x without consideration of discretionary cash transfers to airlines) throughout the forecast period while leverage would fall to 4.05x from an estimated 4.91x in FY 2016. CPE would rise to $9.00 in FYs 2018 to 2021, assuming that airline rebates are provided. DSCR and leverage metrics in the base and rating cases are well within its 'BBB' rating category, but the rating is constrained due to the lack of an AUL which could potentially provide more security to its financial and operational framework.

SECURITY

The bonds are payable from net revenues generated by the airport and a cash-funded DSRF sized to the maximum level allowed by the IRS.