NEW YORK--()--Fitch Ratings affirms the outstanding 'A+' rating on the city of Houston, TX's $1.9 billion in airport system subordinate lien revenue bonds. The Rating Outlook on all subordinate lien bonds remains Negative.
The airport also has approximately $450 million of series 2009A senior lien revenue bonds outstanding; Fitch does not rate the airport's senior lien revenue bonds.
The Negative Outlook reflects concerns that net revenues may stagnate as enplanement growth moderates, leading to declines in debt service coverage ratios (DSCRs). While Fitch recognizes the improvements seen in fiscal 2012, Fitch looks to see continued stabilization in operating margins and DSCRs to levels consistent with or better than historic averages in order to remove the Negative Outlook. If these levels do not recover it could reflect a longer lasting shift towards levels not consistent with the 'A+' rating level.
KEY RATING DRIVERS
STRONG SERVICE AREA: Houston's broad economic base supports over 25 million annual enplanements, with strong demand for air carrier service at both Houston Intercontinental (IAH) and William P. Hobby (Hobby) airports. O&D traffic accounts for 55% of system enplanements, partially mitigating the dominant positions held by United/Continental at IAH and Southwest at Hobby. Revenue Risk Resilience - Stronger.
HYBRID USE AGREEMENT WITH MODERATE AIRLINE COSTS: The airport system's hybrid agreement has allowed Houston to maintain relatively competitive costs at both airports. However, airline revenues declined in 2011 and 2012, in part reflecting the limited revenue protection provided by the compensatory nature of the system's largest cost center when traffic growth is flat or negative. Use and lease agreements cover approximately 43% of total costs at Hobby and 59% at IAH. Revenue Risk Price - Midrange.
MODERATE CAPITAL PROGRAM: The system has a moderate capital improvement program. The plan is largely airport improvement fund (AIF) and grant funded, with the possibility of some bond financing, though financing decisions are still being finalized. Southwest's investment in five new international gates at Hobby will increase capacity without increasing airport leverage levels. Infrastructure Development/Renewal - Midrange.
CONSERVATIVE DEBT STRUCTURE: The airport system has a relatively conservative debt structure, with a majority of debt in fixed- rate mode (83%) and no swap exposure. The amortization profile is flat, with rated debt maturing in 2032. Rate covenants of 1.25 times (x) for senior debt and 1.1x for subordinate debt are somewhat low but adequate, and the airport system has a history of greatly exceeding these levels. Debt Structure - Stronger.
ADEQUATE COVERAGE, ELEVATED LEVERAGE: Historically the airport system had debt service coverage in excess of 1.75x. 2011 and 2012 saw lower coverage at 1.58x and 1.62x respectively. Fitch expects lower margins and coverage levels in the near term projection period, in part due to increasing debt service requirements. The airport system has relatively elevated debt levels compared to its peers, with 10.2x net debt/CFADS and debt per enplanement of $93 in 2012. However, the airport system has a strong liquidity position (694 days cash on hand through December 2012) and the ability to increase its passenger facility charge (PFC) collections from $3 to $4.50. Debt Service - Midrange.
--Maintenance of healthy margins and coverage levels as senior lien debt service comes online will be integral in maintaining the current rating. Should additional borrowing be undertaken on the senior lien, the rating may be pressured.
--Fitch recognizes that recent changeovers in management bring considerable experience and knowledge to the Houston Airport System, and expect that the airport will continue to manage its cost profile while executing on its current capital plan.
--The ability to maintain service and traffic levels despite route rationalization by the system's two biggest carriers will also affect the rating going forward.
The bonds are secured by a subordinate lien on the net revenues generated from the operations of the airport system that includes the two primary commercial aviation facilities, IAH and Hobby airports.
As a system, the Houston airports combined have shown reasonable resilience through the economic downturn. After exhibiting average growth rates of 3.2% through the decade leading up to the downturn, in fiscal 2009, both IAH and Hobby lost passengers (declines of 8.2% and 8.8% respectively). Since that low, system enplanements have increased 5.3% overall through 2012. For fiscal 2012, the system overall saw 1.4% growth in enplanements, with IAH decreasing by 0.1% and Hobby increasing by 8.2%. At IAH, the recovery of international enplanements has been more robust than that of domestic enplanements, growing 12.2% since 2009 vs 1.5% for overall IAH enplanements. For the first six months of fiscal 2013 (July 2012 - December 2012), Hobby enplanements are up 4.9% over the same period a year prior; IAH enplanements are down 2.8% over the same period a year prior, making system wide enplanements down 1.2%. Given ongoing route rationalization processes for both United and Southwest following their respective mergers, Fitch expects enplanement growth to be moderate at both airports in the near to medium term.
Fiscal 2012 operating revenues grew 1.7% over the prior year, and were derived from airline charges (58%), commercial/concession revenues (36%), and other operating revenues (6%).
2012 Airline Fees dropped 1.8% year over year, with landing fees down 4.7%, and terminal revenues down 0.2%. Concession revenues performed strongly, increasing 6.8% in 2012 over the prior year, compensating for the modest declines in airline revenues. For the first six months of fiscal 2013, airline revenues are 1.9% above budget levels, while terminal concessions are 5.6% above budget and auto rental concessions are 13.2% above budget. Net of PFCs, the use and lease agreement at Hobby is expected to recover 43% of costs in 2013, while IAH's agreements are expected to recover 59%.
Operating expenses dropped 2.7% in fiscal 2012, driven by a substantial WIP write-off in 2011 that did not occur in 2012. Operating margins were 41%, an improvement over the year prior but below margins of 50% in 2008 and prior. For the first six months of fiscal year 2013, total operating revenues are 2.3% over budget, and annualized are up 5% over 2012. The increase is largely due to higher airline revenues, retail concessions, parking, and car rental revenues. On the cost side, operating expenses are 10.8% below budget for the first six months, and annualized are 8.3% below 2012 operating expense levels. Based on budget figures, margins are expected to remain at the 40% level in 2013.
Airport unrestricted cash reserves have remained strong with $505 million of unrestricted fund balances in December 2012, equivalent to 694 days cash on hand based on 2012 operating expense levels and covering 21% of total long-term debt. Some use the airport's internal liquidity will be drawn down for capital spending in upcoming years. The airport system also maintains some flexibility in the form of its PFC rate; both Hobby and IAH currently charge a $3 PFC, below the allowable limit of $4.50. However, management indicates they intend to maintain the PFC at $3 at both airports in the near to medium term. The airport system plans to use between $43 million and $57 million in PFCs annually to offset debt service obligations through 2015.
Coverage ratios improved slightly in 2012, rising to 1.62x on an indenture basis (1.44x when offsets are treated as revenues) from 1.58x on an indenture basis a year prior (1.37x when offsets treated as revenues). Based on airport system projections for 2013, coverage will be largely flat. However, DSCRs remain below historic levels, and are sensitive to drops in net revenue that may result if enplanement growth stagnates. Leverage is somewhat high at 10.2x, though is expected to fall in coming years as debt is repaid.
The five-year capital improvement program for 2013 through 2017 totals approximately $983 million, slightly up from the previous year's plan. The plan consists largely of infrastructure rehabilitation, upgrades, and lifecycle replacements, and is expected to be funded through airport funds, remaining bond proceeds, FAA grants, and PFC charges. Financing decisions are still being finalized.
In May 2012, Houston City Council approved a deal to have Southwest Airlines build a new international facility at Hobby (5 additional gates and an FIS) that would allow the airlines to operate international flights at Hobby starting in 2015. Southwest will finance and construct the improvements, turning over ownership of the improvements to the airport system, which will then maintain and operate the facility. The airport system will then lease four of the gates preferentially to Southwest for 25 years, with the fifth gage available on a common use basis. The facility will be constructed so that it can be mixed use (international and domestic flights). The Southwest construction will also modify the existing security checkpoint to expand its capacity to 14 lanes. The airport system will undertake the conversion of an existing surface lot into a 3,000 space garage and associated roadway improvements.
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' (July 12, 2012);
--'Rating Criteria for Airports' (Nov. 27, 2012).
Applicable Criteria and Related Research
Rating Criteria for Infrastructure and Project Finance
Rating Criteria for Airports