Fitch Rates Philadelphia Int'l Airport Revs 'A'; Outlook Stable
KEY RATING DRIVERS
The rating reflects PHL's role in providing air service to a stable and large service area that generates a solid base of origination & destination (O&D) traffic offset by a high degree of carrier concentration in American Airlines/US Airways (American, 'B+'/Outlook Stable) and narrow debt service coverage from net cashflows. The rating also takes into account the expectation that PHL's leverage will remain elevated over the medium term as it pursues additional borrowing associated with its capital improvement plan (CIP) and capacity enhancement program (CEP). Although costs are expected to continue to rise to the high end of the competitive range, signatory carriers provided approval for the capital plan with the recent extension of a fully residual airline use and lease agreement (AUL) signalling their ongoing commitment to PHL.
Revenue Risk - Volume: Midrange
Single Carrier and Hubbing Exposure: As the nation's sixth largest regional market, with over six million people, Philadelphia supports a large enplanement base of over 15 million. Connecting enplanements (43%) remain vulnerable to the operations of PHL's primary carrier, American; the carrier accounts for 77% of total traffic.
Revenue Risk - Price: Midrange
Adequate Cost-Recovery Framework: The residual use and lease agreement (AUL) has resulted in a somewhat competitive cost per enplaned passenger (CPE) level under \\$13 for the last five years (estimated at \\$12.81 in fiscal 2015, ended June 30). The AUL was extended to June 2020 following its expiration in June 2015. As the airport takes out its commercial paper program and issues new money bonds to support the CEP, CPE would increase to \\$16-\\$18 in Fitch's rating case.
Infrastructure Development and Renewal: Midrange
Capital Plan Largely Debt Funded: The eight-year CIP and CEP is large at \\$1.6 billion and it has received MII approval from the airlines under the prior and new AUL. Approximately half of the total plan is expected to be funded by debt and the airport's \\$350 million commercial paper program. The plan also provides for the construction of a new runway should future air traffic warrant it and future airline Majority in Interest (MII) approvals are received.
Debt Structure: Stronger
Moderate Counterparty Exposure: Approximately 11% of outstanding debt is variable rate that is supported by two direct-pay letters of credit (LOC) and is synthetically fixed through swaps. A debt service reserve fund requirement is only partially cash funded (at \\$43 million) and the remainder is supported by several LOCs and sureties. In fiscal 2015, the airport drew \\$167 million of its \\$350 million commercial paper program to fund interim capital expenses associated with its CIP and CEP.
Narrow Financial Margins: The airport's elevated leverage of nearly 11x in fiscal 2015 measured by net debt-to-cash flow available for debt service (CFADS) and low liquidity of about 100 days cash on hand limits PHL's ability to fund its capital plan without impacting the airline rate base. The airport's legal calculation for debt service coverage was estimated at a sound 1.45x (when including all allocable costs); however, this metric is influenced by sizable rolling fund balances (at \\$66 million in fiscal 2015). On net cashflow basis, the airport has historically managed its rates to achieve coverage at or around 1x.
Peer Analysis: Philadelphia's peers include Detroit ('A-'/Outlook Stable) and Minneapolis-St. Paul Metropolitan Airports Commission ('AA-' & 'A'/Outlook Stable) given similar enplanement bases and trends as well as debt amounts. Each airport has carrier concentration greater than 70% but Philadelphia's cash on hand is lower and the airport has a higher CPE.
RATING SENSITIVITIES
Negative: A material reduction in, or elimination of, American's hubbing activity causing CPE to rise and operating margins to weaken.
Negative: Inability to maintain a minimum of 1x net revenue debt service coverage and inability to build up liquidity from net revenue could pressure the rating.
Positive: Given the single carrier concentration and planned additional borrowing for the large CEP, upward rating movement is unlikely at this time.
SUMMARY OF TRANSACTION
The City of Philadelphia intends to issue approximately \\$96.8 million in fixed rate senior lien general airport revenue refunding bonds, series 2015A, to refinance the city's approximately \\$105.9 million in outstanding series 2005A bonds for estimated net present value savings of \\$7.8 million or 7.4%. The refunding bonds maturity in 2035 will not extend beyond the current maturity of the refunded bonds.
The airport's passenger base has been relatively flat since the boost provided by the entry of Southwest Airlines into the market in 2004. Southwest's service peaked in 2009 and has been declining, with a significant reduction in 2012 of 21 flights. The flight reductions have been partially mitigated by the entry of new carriers, including jetBlue, Spirit, Alaska, Qatar Airlines, and Frontier. In fiscal 2015, enplanements at the airport were estimated at 15.3 million and essentially unchanged from prior year. While Virgin America ended service at the airport in October 2014, Frontier saw increased passenger levels. Management projects slow, but steady enplanement growth of about 1.1% annually on average over the next five years.
The airport is one of the primary hubs for the combined American carrier, the dominant airline at the airport. Including its regional/commuter jet subsidiaries, American accounted for approximately 77% of enplanements followed by Southwest/AirTran at 7.5% in fiscal 2015. Despite the merger closing in December 2013 and the carrier's management publicly stating it intends to maintain all hubs, the potential for operational changes at all of the combined carrier's hubs, including PHL, remains. PHL has the advantage of lower costs and less congestion compared to New York City area airports and a robust domestic route network that supports hubbing operations. Still, if American was to measurably restructure its route network and de-emphasize Philadelphia airport as a primary connecting hub, an immediate effect on the airport's operations would likely occur since the timing and possibility for backfill may be uncertain.
The airport's use and lease agreement is based on a residual methodology for setting fees and charges, which has resulted in adequate financial metrics. In July 2015, PHL and the airlines extended the agreement to June 2020 with two one-year extension options. With the prior agreement and this extension, the airlines provided approval for capital expenditures totalling \\$1.6 billion. The rate setting structure has allowed the airport to consistently generate debt service coverage levels above the two rate covenant coverage requirements.
For fiscal 2015, debt service coverage was estimated at 2.35x compared to the covenant of 1.50x (when excluding allocated expense from the city) and total debt service coverage was 1.45x relative to the covenant of 1.0x (when including allocated expenses). Importantly, the airport includes a relatively large fund balance as part of its annual revenues available for debt service (historically at more than 50% of debt service) for compliance with both rate covenant tests. When these funds were excluded from revenue calculation, debt service coverage was a low 0.93x. During the fiscal year, the airport had incurred higher than expected costs largely due to one-time events and in order to avoid a sharp spike in CPE, PHL drew down some of its reserve balances. In turn, the carriers have agreed to reimburse the airports for these draws as well as for deferred operating fund deposits that were not made in the last two years. These reimbursements will be raised through rates and charges over the next three years in addition to the all regularly required fund deposits. While this is expected to contribute to increasing airline costs, the airport's currently weaker liquidity position will likely strengthen as a result.
The airport's leverage was elevated at approximately 10.7x net debt-to-CFADS in fiscal 2015. When taking into account debt service from approximately \\$540 million and \\$370 million in planned bond issuances/CP take-out in 2017 and 2019, respectively, coupled with airline fund reimbursements, management's forecast show CPE in the \\$14-\\$16 range through the forecast period ending in fiscal 2020. Leverage remains at currently elevated levels (around 10x).Although the airport's CFADS and cash position is projected to strengthen, leverage evolves down relatively slowly as the airport issues new money debt. Any unanticipated or sustained declines in traffic would exacerbate the CPE increases and/or lead to tighter financial flexibility.
Fitch base, rating, and alternative cases tested less enplanement growth as well as removing some connecting activity at PHL. In the Fitch base case, enplanements were flat at fiscal 2015 levels and operating expenses increase at above inflation. In this scenario, CPE averages \\$16, days cash grows to around 120, net cashflow DSCR averages about 1.06x, and net debt/CFADS remains at around 10x. In the Fitch rating case, incorporating a 7.5% enplanement drop mid forecast and higher costs, CPE is slightly higher, averaging \\$16.80, while other metrics are not materially different from the Fitch base case. Fitch also ran a sensitivity scenario removing about 50% of connecting traffic mid-forecast. In this scenario the CPE rises to slightly above \\$18 when considering the likely cost containment measures by management.
SECURITY
The bonds are secured by the net revenues generated through the operations of the airport. In addition, the airport may pledge certain passenger facility charge (PFC) revenues for eligible projects.
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