Fitch Ratings downgrades to 'BBB' from 'BBB+' its rating on the city of Pensacola's (Florida) approximately $35.2 million in outstanding series 2008 airport capital improvement revenue bonds issued on behalf of Pensacola International Airport (PNS or the airport). The Rating Outlook remains Negative.
The downgrade reflects an increased risk profile to the airport's financial flexibility and airline cost stability which is likely to continue under conditions of stagnant traffic levels. In Fitch's view, the airport's debt burden remains elevated relative to its net cashflow which contributes to dependency on fund balance transfers to maintain its covenanted debt service coverage requirement levels. The overall tight liquidity position may limit the ability to continue this practice and therefore place more reliance on growth in non-airline revenues or raising airline rates and charges. The lack of a structured airline agreement indicates some uncertainty to rate setting flexibility to recover airport costs.
The Negative Outlook reflects the likelihood of continued narrow coverage and liquidity levels absent an improvement in operating revenues supported by traffic growth. Should financial performance remain in the current range, further rating action could be warranted.
KEY RATING DRIVERS
--Narrow Airport Role with Uneven Performance: PNS serves a relatively small local market enplanement base of 781,000 supported by a mix of business (50% of traffic), tourism (25%), and a strong military presence (25%). Enplanement performance has been uneven in recent years, reflecting the economic environment and could be influenced in future years due to the presence of some competition at other regional airports. PNS's direct air service is somewhat limited to serving traffic into connecting hub markets. Carrier concentration remains elevated with Delta Airlines accounting for nearly half of total enplanements.
--Limited Cost Recovery Framework: The airport operates under monthly extensions of its hybrid compensatory agreement since its previous expiration in 2008. The execution of a longer extension is uncertain. Meanwhile, airline CPE was moderate at $6.43 in fiscal 2011 (ended Sept. 30). Airlines provide for only 30% of operating revenues which lends to dependency on both non-airline revenues and capital fund transfers to support operations and annual debt service obligations.
--Moderate Debt Structure: PNS's capital structure includes 82% fixed rate debt outstanding (which includes a recently awarded $6.1 million State Infrastructure Bank loan) and 18% synthetically fixed rate bonds with BBVA Compass Bank (IDR rating 'BBB'; Negative Outlook by Fitch). Aggregate debt service levels are generally flat-to-declining through final maturity.
--Constrained Finances: Airport leverage is elevated at 13.6 times [x] net debt/cash flow available for debt service. Low debt service coverage of 1.4x (including capital fund transfers) coupled with low balance sheet liquidity of 63 days cash on hand remain credit concerns.
--Minimal Capital Expenditure Needs: PNS recently completed its 2008 expansion and renovation program ($36 million) and its upcoming capital program is modest through fiscal 2017. Spending needs are demand driven and should be primarily defrayed by federal grant funds. A $6.1 million SIB loan was awarded in 2011 and is expected to be applied for capex needs beginning in fiscal 2012.
WHAT COULD TRIGGER A DOWNGRADE
--A lack of stable to improving passenger traffic levels that would support growth in operating revenues;
--A continuation of the airport's narrow financial metrics, with a focus on debt service coverage ratios generated from net operating revenues;
--Inability to manage its operating expenses which may pressure airline costs.
SECURITY
The bonds are secured by the net revenues of PNS's
operations and certain funds under the bond resolution.
CREDIT UPDATE
PNS's enplanements which were nearly 781,000 in fiscal 2011 have experienced moderate fluctuations over recent years. Traffic rebounded by a combined 11.2% in fiscal 2011 and 2010 after realizing a reduction totaling 16.5% in the two previous years. Recent activity indicates that capacity reductions by the carriers have resulted in monthly declines in year-over-year enplanements for seven of the latest eight month period ending May 2012. As a result, enplanements dropped 3.6% over this most recent period. Fitch notes that management projects 3.5% traffic growth over the next five years which is very optimistic when considering the continuing uncertainty in the economy and aviation industry.
Competition risk is a potential concern given the presence of nearby Panama City Airport but Southwest is currently transitioning service at PNS which may be a catalyst for near-term growth. The enplanement base remains small and some degree of carrier concentration exists with Delta maintaining a nearly 50% market share. This leaves PNS vulnerable to fluctuations in carrier air service decisions and yields.
The airport continues to operate on a month-to-month basis under an extension of the prior airline use and lease agreement (which expired in September 2008). The hybrid agreement is compensatory in terminal fees and residual on landing fees. Historically, airline revenues have accounted for only 30% of operating revenues, leaving PNS more susceptible to non-airline revenues that are related to enplanement volume. Parking is the largest component of the non-aero revenues, accounting for nearly 37% of non-airline revenues (26.8% of total operating revenues).
Management has historically worked to control rates and charges to the airlines and maintain a competitive cost per enplanement (CPE); however, due to a combination of decreased capacity and enplanement volatility and the terminal expansion projects, CPE has modestly risen in recent years and is expected to continue to increase. CPE for fiscal 2011 rose to $6.43 from $5.70 in fiscal 2007 (or 12.8%). Fitch expects CPE to be at some risk for steady increases in its base case of traffic and financial assumptions to over the $9.00 level through the next five years. This level of CPE is slightly elevated relative to Fitch rated peers and may impact the airport's pricing competitiveness. Further, Fitch believes that the airlines may be reluctant to agree to these increases given the precedent of low and shrinking rates in prior years.
Managing greater stability in operating costs will be key for improving airport financial margins. Past years were highlighted by double-digit expense growth even in periods of enplanement declines. More recently, operating expense growth tempered to just 1% in fiscal 2011 as a result of cost cutting measures while fiscal 2012 expenses are estimated to grow 2.8%. The airport's updated forecasts indicate a 1.5% growth per annum which Fitch views to be aggressive. Therefore, Fitch assumed 3% annual expense growth in its base case scenario.
Operating margins have been depressed in recent years resulting in the airport's DS coverage becoming increasingly dependent on PFC collections and capital fund balance transfers to meet its 1.25x rate covenant test. PNS's DS coverage ratio (DSCR) on all parity airport debt for fiscal 2011 was 1.42x (including capital fund and PFC transfers as revenues) and 1.16x (including PFCs as revenue but without capital fund transfers). These coverage levels did improve from fiscal 2010 (1.37x and 0.71x, respectively), but were primarily attributable to a decrease in DS obligations manipulated through a refunding bond issue. Coverage ratios are forecasted to remain tight as annual DS obligations increase. In turn, the airport may again show dependency on capital fund transfers and/or increases to airline rates and charges to meet its covenant based on existing traffic levels.
PNS's modest liquidity position and above-average leverage is likely to constrain financial flexibility over time. The airport's unrestricted cash position is low relative to its operating expense base, and for fiscal 2011 the airport only had 63 days cash on hand. The airport's debt/enplanement is $79.59 and its net airport revenue debt/cash flow available for debt service is 13.6x. While leverage is expected to drop under 10.0x by fiscal 2013, this is still above average and restricts financial flexibility.
Beyond the 2012 SIB loan, no additional airport revenue debt is expected to be issued in the near- to medium-term given the recent airport modernization and relatively small CIP.
Additional information is available at www.fitchratings.com. The ratings above were solicited by, or on behalf of, the issuer, and therefore, Fitch has been compensated for the provision of the ratings.
Applicable Criteria and Related Research:
--'Rating Criteria for
Infrastructure and Project Finance' (Aug. 16, 2011);
--'Rating
Criteria for Airports' (Nov. 28, 2011).
Applicable Criteria and Related Research:
Rating Criteria for
Infrastructure and Project Finance
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=648832
Rating
Criteria for Airports
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=656970
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