OREANDA-NEWS. Fitch Ratings has affirmed the 'A-' rating on approximately $1.5 billion of outstanding city of Chicago, Midway International Airport's (Midway) second-lien airport revenue bonds (MARBs). The Rating Outlook is Stable.

The city also has approximately $31.5 million of outstanding first-lien MARBs that Fitch does not rate.

The rating reflects Midway's resilient and growing traffic base within the strong Chicago air service area. While significant carrier concentration exists, it is partially mitigated by Southwest Airlines' long-term commitment to serving the airport. Leverage is elevated as a result of past borrowings for terminal and airfield improvements; however, upcoming capital needs are at more moderate levels and leverage should slowly evolve downward. Additionally, the airport's solid cost recovery framework should provide for continued stable financial performance.

KEY RATING DRIVERS

Revenue Risk-Volume: Midrange
CARRIER CONCENTRATION OFFSETS SERVICE AREA STRENGTH: Midway is the second major airport serving the Chicago regional market and is well situated through a growing scale of low-cost domestic services benefiting from an economically strong local air trade service area in a favorable mid-continent location. The airport served 10.6 million enplanements in 2014, of which 61% were origination and destination (O&D) passengers. In recent years, traffic growth has well outpaced that of both the nation and nearby O'Hare International. Total traffic has climbed each year since 2008 and was 3.3% higher in 2014. However, Southwest Airlines/AirTran (Southwest; rated 'BBB', with a Positive Outlook by Fitch) account for over 90% of enplanements between them, and nearly 40% of total traffic is connecting traffic. Air service competition from nearby Chicago O'Hare Airport also lends risks to traffic performance.

Revenue Risk-Price: Stronger
SOLID COST RECOVERY FRAMEWORK: Midway operates under a residual use and lease agreement (AUL) that has provided for stable financial performance in recent years. Further, carriers have signed a 15-year AUL renewal running through 2027, demonstrating their long-term commitment to the airport. Airline costs are currently competitive at $8.48 per enplanement for 2014. Cost per enplanement (CPE) will be rising over the next several years, mainly due to rising debt service obligations related to funding airport improvements agreed to by carriers.

Infrastructure Development/Renewal: Stronger
MANAGEABLE, DEBT-FUNDED CAPITAL PLAN: Midway's capital improvement plan (CIP) for 2015-2021 reflects works totalling $398 million. Approximately 93% of the plan is expected to be funded through bonds, with 37% from prior bonds, and another 57% from future issuances. Key airport facilities are in good condition following recently built terminal and concession areas as well as parking and the completion of the consolidated rental car facility in 2013.

Debt Structure (Second-Lien): Midrange
DECREASED VARIABLE-RATE DEBT EXPOSURE: The airport has taken strides to reduce its variable rate debt exposure to just 17%, of which approximately half is synthetically fixed with swaps. Further, Midway's debt service payment profile has become more level through restructurings and put bond risk has been eliminated. Nearly all of Midway's debt now resides on its second lien with a fully cash-funded debt service reserve fund, but a rate covenant that is lower at 1.10x.

ABOVE-AVERAGE LEVERAGE, WEAKER LIQUIDITY: Midway currently has a higher debt burden and cost profile than peers at $144 debt per enplanement ($236 debt per O&D enplanement) and 17x aggregate net debt/cashflow available for debt service (excluding fund transfers). This should return to the 12x range however by 2019. Liquidity in the form of unrestricted cash and operating reserves is below average at 174 days cash on hand and will likely remain so given the residual airline agreement. All-in coverage for 2014 (including fund transfers) grew to 1.35x from 1.25x in 2013.

PEERS: Fitch-rated comps include Dallas-Love Field (DAL; 'A'/Outlook Stable) and Detroit (DTW; 'A-'/'A-' Senior/Sub, Outlook Stable). DAL similarly serves a strong, metropolitan market with a greater than 90% Southwest concentration and faces competition from a larger, nearby airport. DTW shares an elevated leverage profile with high carrier concentration and similar coverage levels to MDW under its likewise long-term, fully residual AUL.

RATING SENSITIVITIES

Negative: Either a material downshift or volatility in the traffic profile given the Southwest concentration could lead to negative rating action;
Negative: Significant increases to Midway's current plans for borrowings or airline costs as a result of underperforming trends in non-aviation revenues or higher operating expenses could pressure the current ratings.

Positive: Upward rating migration is not likely in the near term given Midway's elevated debt burden.

SUMMARY OF CREDIT
Midway's traffic continues its strong growth following the sharp decline in enplaned passengers in 2008. Traffic grew for the sixth consecutive year, up 3.3% in 2014, to a new peak enplanement level of 10.6 million. Enplanements continue to outperform forecasts as well as capacity additions, indicating organic growth. This trend has continued into 2015 with enplanements up 5.3% year-over-year for the first seven months (through July). Management forecasts enplanements to end the year up 4.5% (versus 3.3% forecast by the airport's consultant).

Whereas most of the airport's recent growth has been derived from connecting traffic related to Southwest's increased hubbing operations, O&D traffic did show positive trends in 2011-2013, growing by a combined 18%. Still, the pace of connecting traffic growth since 2006 has shifted the O&D passenger mix from around 74% of total enplanements at that time to 61% in 2014. Given the expectation of the continued high market share of Southwest/AirTran (currently 91%) and the 39% connecting passenger base at the airport, Midway's future traffic performance and financial flexibility will be heavily influenced by Southwest's scheduling decisions.

Demonstrating its long-term commitment to Midway, Southwest (and the other signatory carriers) executed a 15-year renewal of the residual AUL in 2012. This airline agreement approach has provided for stable airline costs and financial performance, and is expected to continue to do so through the forecast period.

In addition to the fully residual AUL, Fitch views favourably Midway's strides to reduce the risk associated with its debt structure. Midway has now reduced its variable rate debt exposure from approximately 25% down to 17%, with more than half synthetically fixed. In addition, Midway has eliminated its put bond risk, reduced its maximum annual debt service, and smoothed its overall debt service profile.

Midway's expenses have remained relatively stable over the past few years, growing at a modest 3.5% compound annual growth rate (CAGR) since 2009 (normalized for the one-time privatization credit). However, expenses grew 7% most recently in 2014 and are forecast to grow at 4% per annum by the airport's consultant. As the costs of its capital program have come online, CPE rose to $10.21 in 2013 before moderating to $8.48 in 2014 as a result of increasing enplanements and non-aviation revenues as well as the 2013 and 2014 restructurings. Midway's airline costs are likely to rise over the forecast period as debt service obligations and operating expenses ramp up, but should remain largely under control. Fitch's base case projections forecast CPE to remain under $13 through its five-year forecast period. However, as the airport issues additional debt or should non-airline revenues fall short of expectations, Midway's financial profile could be pressured, resulting in higher CPE.

On a purely cash flow basis, without the benefit of fund transfers, total coverage was sum sufficient at 1.02x in 2014. Taking into account the use of cash reserves and non-pledged revenue sources such as PFCs and CFCs, the airport's total debt service coverage ratio (DSCR) was 1.35x, up from 1.25x the year prior. Fitch notes this is well above the 1.10x covenant level and in line with expectations given the residual nature of the AUL. The city anticipates total coverage to remain above its 1.1x rate covenant through the projection period.

Fitch's base case conservatively assumes 1.6% average enplanement growth through 2019, slightly below the airport consultant's forecast. Total revenues are expected to grow at a 4.5% CAGR, driven by average annual airline revenue growth of 4.8%. Operating expenses are forecast to grow at 5% per annum through 2019, which is in line with historical growth and just above the airport consultant's forecast. Under this scenario, CPE is likely to reach the $12.60 range by 2019. Net debt-to-cashflow evolves to 12x, but this could change following the airport's proposed issuance for its capital program. DSCRs are expected to remain stable in the 1.27x-1.32x range (including fund transfers) given the fully residual AUL.

Fitch's rating case assumes a weaker 0.6% average enplanement growth through 2019, taking into account a 5% loss in 2016 with recovery in future years. Total revenues are expected to grow at a 4.4% CAGR driven by airline revenue growth of 5.1%. Operating expenses are still forecast to grow at a 5% CAGR through 2019 despite the lower enplanement volume. Under this scenario, CPE is likely to reach the $13.50 range; however, net debt-to-cashflow will still fall to approximately 12x by 2019 and DSCRs are expected to remain comparable to the base case at around 1.26x-1.32x given the AUL framework.

Given Midway's exposure to Southwest's hubbing operation, Fitch also tested a sensitivity scenario that stressed enplanements with a permanent loss of 25% of connecting traffic in 2016 coupled with a 5% loss to O&D traffic that recovered by 2019. Operating expenses were still grown at a 5% CAGR. The result was a CPE of approximately $15.50 by 2019 or an increase of $2.00 above the rating case. Even under this unlikely scenario, CPE would remain competitive with other large hubs that have taken on sizeable capital programs.

The city's 2015-2021 CIP remains manageable at $398 million, but is up slightly from its 2014-2020 CIP of $275 million. Fitch notes that over 90% of these capital needs will be bond funded, however, 37% has already been issued and 57% will come from future issuances. The primary uses will be for terminal area and airfield projects (approximately 30% each), with the next largest spending on noise projects (20%). Fitch did not have enough information about the future issuance(s) to build them into its forecast at present, but it will monitor the situation and incorporate them into future reviews as information becomes available.

SECURITY
The first- and second-lien bonds are secured by a pledge of the net revenues generated at the airport on a senior and subordinate basis, respectively. The series 2010C second-lien bonds are secured by airport revenues, but the city intends to pay debt service with consolidated rental car facility charges.