OREANDA-NEWS. June 16, 2015. Fitch Ratings has affirmed the 'A+' rating on the State of Alaska's Alaska International Airport System (AIAS, or the system) approximately \\$487.3 million of revenue bonds. The Rating Outlook for all bonds is Stable.

KEY RATING DRIVERS

The rating reflects AIAS's moderately strong cargo position and air service monopoly supported by a modestly sized traffic base, conservative debt structure, and management continually prepaying debt. Cargo volume continues to be volatile but is somewhat mitigated by a more stable passenger enplanement base of over 3 million, modest operating revenue growth, and controlled operating expenses. AIAS's liquidity position remains strong with over 450 days cash on hand (DCOH) and leverage (net debt to cash flow available for debt service, CFADS) has dropped to 7.46x.

STRONG MARKET POSITION: REVENUE RISK - VOLUME: MIDRANGE
Air travel is essential in Alaska due to a lack of alternatives which provides a stable origination and destination (O&D) base. Two major airports, Anchorage (ANC) and Fairbanks (FAI), are strategically located for air cargo along the great circle route, and cargo provides over half of total operating revenues but remains vulnerable to global economic conditions as well as changes in trade policy and fuel costs.

FAVORABLE RATE SETTING APPROACH: REVENUE RISK - PRICE: STRONGER
Carriers operate under a full residual operating agreement which allows AIAS to set and adjust rates to ensure sufficient revenues for operating and maintenance, reserves, and the rate covenant. The operating agreement was renewed for an additional 10 years under similar strong cost recovery terms. Cost per enplanement (CPE) was \\$10.82 in fiscal 2014, slightly above peers.

LARGE CAPITAL PROGRAM: INFRASTRUCTURE DEVELOPMENT & RENEWAL: STRONGER
The airport has a large \\$448 million capital program through 2023 funded through grants, rates and fees, and internal reserves. No new near term debt is anticipated. The largest project is resurfacing the ANC airfield which is expected to last several years. Relatively new terminal facilities are in good condition.

CONSERVATIVE DEBT STRUCTURE, DEBT STRUCTURE: STRONGER
The system has a reasonable amount of debt outstanding given its size with approximately 90% of debt fixed rate. AIAS used available cash to pay-down debt and lowers annual debt service.

SOUND FINANCIAL METRICS
AIAS's healthy balance sheet helps manage financial metrics of 7.46x leverage, \\$165 debt per enplanement, and over 450 DCOH. Fiscal 2014 debt service coverage was 1.25x with PFCs included as revenues.

PEER ANALYSIS
Louisville and Memphis are Fitch-rated peers dual dependency on cargo operations and passenger traffic. Louisville maintains higher coverage, better liquidity, smaller capital improvement plan (CIP), and less debt obligations but has a smaller passenger enplanement base. Memphis has around the same CPE and debt obligations as Alaska but slightly lower enplanements and weaker liquidity.

RATING SENSITIVITIES
Negative - Significant cargo and passenger enplanement volatility and material changes in internal liquidity could pressure the rating.

Negative - Management's inability to continue to successfully control operating costs causing narrower financial margins could also pressure the rating.

Positive - None considered at this time due to the airport's enplanement size and cargo dependence.

CREDIT SUMMARY

Despite historic volatility, air cargo is central to AIAS' operational and financial strength, and Fitch expects AIAS will continue to bring activity from different carriers. FedEx recently started using aircraft between the continental U.S. and Asia that can bypass refuelling in Alaska, which caused Fedex's Cargo Certified Maximum Gross Takeoff Weight (CMGTW) to drop 23% from fiscal 2013 to 1.9 million or 10% of the airport's total cargo for fiscal 2014 (down from 13%). However, other large cargo carriers rely on refuelling in Alaska, and UPS still processed the most (16%) of the airport's cargo for fiscal 2014. Cathay Pacific and China Airlines both increased CMGTW 15% and 10%, respectively, over fiscal 2013, which have helped to offset losses from FedEx.

AIAS has maintained a stable passenger enplanement base between 2 million and 3 million since 1999 which has grown at a compounded annual growth rates (CAGR) of 1.3% since 2004 and 0.8% since 2009. Management expects enplanements to grow at 2%-3% in the near future, and Fitch expects fiscal 2015 enplanements to be above fiscal 2014 based on partial year numbers. Alaska Airlines continues to retain over half (58%) of AIAS' market share, and while carrier concentration is not an immediate credit concern, sustained single-carrier dominance could pose future challenges to pass costs to passenger carriers to cover cargo revenue shortfall in future years.

Fiscal 2014 total operating revenues increased 14.9% to \\$123.8 million due to significant increases in landing fees to offset decreases in landed weight which are expected to again bring around \\$80 million of revenue fiscals 2015-2016. The landing fee increase grew fiscal 2014 airfield revenues 22.2% over fiscal 2013 and brought 66% of total operating revenues. Landing and terminal fees will each increase again (4%) July 1, 2015 to cover capital projects instead of issuing new debt. Cargo and passenger airline revenues represented 79.5% of total operating revenues for fiscal 2014. Non-airfield revenues grew 2.9% from slight increases in concessions and parking which offset decreases in terminal/land rents. Cargo revenues grew 19% to \\$65.4 million and passenger airline revenue grew 16.9% to \\$33.1 million from fiscal 2013 both from increased landing fees. Operating expenses increased 6.4% due to increased field and equipment maintenance costs.

AIAS maintains a fully residual airline use and lease agreement (AUL) and started a new 10-year agreement effective fiscal 2014 materially unchanged from the prior AUL. The residual rate setting mechanism allows AIAS to set and adjust rates mid-year to ensure sufficient revenues to pay O&M, fund reserves, and satisfy the rate covenant. Debt service coverage for fiscal 2014 was 1.25x applying bond document calculations.

In prior fiscal years, 2012 and 2013, the system used excess construction fund cash to support debt service which differed from earlier years when construction funds were used to defease principal. The AIAS recently submitted a Violation Closing Agreement Program filing with the IRS regarding inadvertent prohibited transactions involving tax exempt debt. AIAS management believes the financial impact of the matter to be inconsequential. Fitch will continue to monitor the situation.

AIAS has a revised eight year CIP for fiscals 2016-2023 that totals \\$448.4 million and includes airport grants, IARFs, and rate based funding sources. No near-term debt issuances are planned, and it has been represented to Fitch that no significant projects are deferred or being contemplated for deferral. The most significant project is repaving ANC runways.

The Fitch base case enplanement growth assumptions were 2% (slightly less than the sponsor's assumptions of 3%), sustained airfield revenue increases from increased rates and charges, nonairline revenue growth in line with enplanements, and operating expenses following inflation. Under this scenario, CPE would grow to \\$11.88 to meet 1.25x DSCR, drop leverage from 6.84x to 4.99x as debt decreases, and keep DCOH in the 400s.

The Fitch rating case tested double year enplanement declines per historicals of 3% and 4% drops, volatile airline revenues from cargo fluctuations, nonairline revenue growth in line with enplanements, and operating expense growth higher than inflation at 3%. Under this scenario, AIAS would need to raise CPE to \\$12.75 to meet the required 1.25x rate covenant. Leverage would still drop from 6.84x to 6.44x as debt decreases, and DCOH remains in the 400s.

Fitch expects management to raise CPE in a stressful situation to meet required rate covenants and has historically been proactive raising CPE as well as rates and charges. Fitch believes a CPE around \\$11-\\$12 is manageable and airline-acceptable for an airport of this size. Volatile cargo traffic and revenues remain a concern as cargo companies improve aircraft alongside economic rollercoasters. If necessary, the airport will have to pass more financial burden onto passenger carriers in light of continued cargo declines.

SECURITY
The bonds are secured by a pledge of net airport system revenues. The state also applies PFC funds to pay debt service.