Fitch Rates San Jose, CA Series 2011A Airport Rev Bonds 'A-'; Outlook Negative

NEW YORK--(BUSINESS WIRE)--Fitch Ratings assigns an 'A-'rating to the city of San Jose, California's approximately $150 million series 2011A airport revenue refunding bonds and affirms the 'A-' rating on approximately $1.026 billion of outstanding airport revenue bonds. The bonds are secured by net revenues of the airport, including operating grants and customer facility charge (CFC) collections on rental car transactions. The 2011A bonds will be used to refund outstanding commercial paper which was issued to refund the series 2004 auction-rate securities and cash fund a debt service reserve. The Rating Outlook on all bonds is Negative.

RATING RATIONALE:

The Negative Outlook reflects:

--The airport's elevated risk profile due to the combined effects of multi-year enplanement declines;

--The airport's high leverage driven by the use of debt-financing for the recently completed terminal area improvement plan (TAIP), and the airport's $312 in debt per enplaned passenger, or approximately 22 times (x)-25x in net debt to cash available for debt service, including outstanding commercial paper;

--Future uncertainty regarding traffic recovery given the airport's history of above-average traffic volatility resulting from the highly competitive air service area.

The 'A-' rating reflects the following:

--The airport's nearly 100% origination and destination traffic base but with more limited schedule offerings than nearby competitors;

--The underlying size and strength of the airport's service area which is the 13th largest in the U.S.;

--Modern infrastructure with a recently completed terminal complex, rental car facility, and other airfield improvements allowing for very limited capital needs going forward;

--The highly competitive nature of the air service area, with San Francisco and Oakland airports located approximately 30 miles from the airport, resulting in a volatile enplanement history, and highly leveraged debt position;

--The airport's increasingly high cost structure, which will remain pressured in the near-to-medium term due to the airport's ascending debt profile.

KEY RATING DRIVERS:

--Further enplanement declines or management's inability to achieve revenue growth will place downward pressure on the rating;

--Continued cost controls and reductions - The airport has made significant expense reductions and faces increases in annual debt service payments through fiscal 2014; sustained improvements over the period are necessary to maintain the current rating;

--Successful renewal of the airport's airline use and lease agreement, which is due to expire in 2012;

--Should enplanement levels and passenger driven revenues rebound strongly for a sustained period, resulting in increased financial flexibility, a return to Stable Outlook may be possible.

SECURITY:

The bonds are secured by net revenue of the airport, including operating grants and CFC collections on rental car transactions. The commercial paper notes are secured on a subordinate basis; however, the airport expects to refund the majority of its existing commercial paper with fixed-rate bonds this calendar year. Any remaining commercial paper notes are likely to be refunded into fixed rate bonds during fiscal 2012.

CREDIT SUMMARY:

The airport's cost per enplanement (CPE) remains at above-average levels, reflecting the airport's high leverage. In fiscal 2010 and 2009, the airport reported reasonable CPEs of $11.18 and $9.84, respectively, which was achieved by significant expenditure reductions and the use of airport rate stabilization funds to offset airline costs. In fiscal 2011, the airport estimates its CPE will be $11.67, remaining near 2010 levels despite the increase in debt service obligations from approximately $30 million to approximately $55 million. The airport forecasts its CPE will remain marginally below the $12.00 range through fiscal 2017, consistent with the CPE targets the airport established in 2007 for the TAIP project. The airport expects to achieve this through further aggressive operation and maintenance expense reductions, and the use of fund balances to temper airline rates and charges.

Under Fitch sensitivity analyses, if revenue and traffic trends continue to be pressured and the airport's cost profile is not contained, the airport's CPE could approach the $16 dollar range as terminal related debt is absorbed into the rate base. In fiscal 2014, debt service jumps by an additional 12% and then remains relatively flat through 2028. While annual obligations begin to drop after 2028, they subsequently climb to the $110 million range in 2035-2037, leaving the airport exposed to refinance risk. When including the proposed amortization of the outstanding commercial paper, total debt service reaches the $138 million range in this same period. The airport plans to reduce its outstanding commercial paper from approximately $410 million to less than $100 million and refund the existing commercial paper with fixed-rate bonds during fiscal 2011 and 2012.

The airport expects to issue the series 2011B bonds in September 2011, contingent upon receiving State legislature authority to change its CFC rate to a per-day basis versus the current per-contract structure. The change in CFC revenues is expected to result in considerably higher rental car collections and will be used to pay debt service associated with the relatively new consolidated rental car facility. Forecasted CFC revenues will likely not be sufficient to cover the series 2011B debt service, thus facility rent paid by the rental car companies in the amount of the shortfall will used to pay the remaining debt service. Fitch will continue to monitor this development, ensuring the security pledge is not materially diluted.

Traffic recovery appears to be underway, with fiscal year-to-date traffic up approximately 2.2% from the previous year and consistent with the airport's 2.2% compound annual growth rate forecast through fiscal 2017. In addition, the airport's new terminal, consolidated rental car facility, and expanded concession space will bolster non-airline revenue streams. Financial ratios have not decreased at the same pace as traffic declines, capturing the airport's increase in terminal rental rates and landing fees, new concession agreements generating higher minimum annual guarantees, and the airport's cost-cutting measures. Despite these increases, total operating revenues still fell by approximately 4% in fiscal 2010 from fiscal 2009 while debt service increased by 16%. Year-to-date, the airport's financial performance is tracking well above the adopted 2011 budget, with the airport having reached over 145% of the 2011 estimated net operating income.

Debt service coverage ratios (DSCR) have remained largely sound through the economic downturn. In fiscal 2010, the airport reported (as per the indenture) a DSCR of 2.8x, and a DSCR of 2.75x when including interest costs on outstanding commercial paper. Debt service coverage in fiscal 2010 was down from 3.18x in fiscal 2009, reflecting the smaller passenger base and rising annual debt service obligations. The airport estimates debt service coverage will be 2.75x in fiscal 2011, and will remain above the 1.50x range through fiscal 2017, including amortization of the airport's outstanding commercial paper. Fitch believes DSCRs will continue to trend down and remain pressured in the near-to-medium term given that debt service obligations will likely outpace revenue growth.

Beginning in the fourth quarter of calendar year 2010 airline carriers began restoring seat capacity. The considerable new and/or expanded service offerings announced at the airport during fiscal 2010 and 2011 should serve to cushion some of the increases in the airport's fixed costs. Recently announced new or expanded service includes short-, medium-, and long-haul flights to international destinations such as Cabo San Lucas and Guadalajara, Mexico, and increased domestic service offerings to Boston, Austin, Seattle, Denver, Orange County, San Diego, and Los Angeles. As a result of the new announced service, the airport is estimating a 2.5% growth in enplanements in fiscal 2011.

Additional information is available at 'www.fitchratings.com'

Applicable Criteria and Related Research:

--'Rating Criteria for Infrastructure and Project Finance,' Aug. 16, 2010;

--'Rating Criteria for Airports,' Nov. 29, 2010.

Applicable Criteria and Related Research:

Rating Criteria for Airports

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=578745

Rating Criteria for Infrastructure and Project Finance

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=548345

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