Fitch Upgrades San Jose, CA's Airport Revs to 'A-'; Outlook Stable

CHICAGO--()--Fitch Ratings has upgraded the ratings for San Jose, CA's approximately $1.38 billion of outstanding general airport revenue bonds (GARBs) to 'A-' from 'BBB+'. The Rating Outlook is Stable.

Fitch has also upgraded the underlying 'BBB' rating to 'BBB+' on the bank note associated with subordinated commercial paper notes series A-1 (non-AMT), A-2 (non-AMT/Private Activity), B (AMT) and C (Taxable). The bank note rating is aligned to the senior lien rating.

The Rating Outlook is Stable.

RATING RATIONALE

The upgrade on the GARBs reflects an overall improved financial position driven in part by growth in demand as seen in 29 consecutive months of year-over-year enplanement growth. Fitch's near-term expectations for financial flexibility have improved as compared to prior analysis. The airport's above-average leverage compared to peers is partially mitigated by management's historical ability to prudently contain costs and limited future capital needs, given the large, recently completed capital program and no future planned debt. Increases in non-airline revenues, as well as uses of airport fund balances have collectively allowed the airport to manage its cost per enplanement (CPE), estimated $9.61 in FY 2015 (FY, ended 6/30), well under management's goal of $12. Despite debt service coverage from current cashflows remaining narrow at about 1.1x, the increasing fund balances and revenues due to passenger growth will improve performance.

The 'BBB+' rating on the bank note associated with the subordinate commercial paper is aligned to the senior lien rating.

KEY RATING DRIVERS

Revenue Risk - Volume: Midrange

Competitive Airport Region: The airport's traffic base is over 98% origination and destination but is exposed to competition from nearby San Francisco and Oakland. As a result, enplanements have historically been volatile through cycles in the economy and aviation sector. The airport also has a moderately concentrated carrier base with Southwest ('BBB' Stable) accounting for over 50% of traffic. San Jose (rated 'AA+' /Stable Outlook by Fitch) has benefitted from its strong tax base and employment growth in having a third consecutive year of operational surplus and solid revenue growth.

Revenue Risk - Price: Midrange

Airline Pricing Sensitivity: The airport's hybrid use and lease agreement allows for adequate cost recovery. However, the airport is reliant on the solid performance of volume sensitive parking, passenger facility charge (PFC), and customer facility charge (CFC) revenues to maintain airline costs competitive for the region. The airport also utilizes unspent bond proceeds to subsidize a portion of debt service costs to airlines to keep the CPE under $12. This practice is expected to remain in place until the proceeds are expended in 2017.

Infrastructure & Renewal Risk: Stronger

Limited Near-term Capital Needs: San Jose has a recently completed terminal complex, rental car facility, and other airfield and roadway improvements allowing for very limited capital needs in the near term. This is important as there will be limited funding generated from revenue over the next five years given the full allocation of PFC, CFC and concession revenue to offset airline rates and charges.

Debt Structure: Stronger (revised from Midrange)

Moderate Debt Structure: The airport's long-term debt is senior lien in fixed rate mode. Other obligations include $38 million in subordinate commercial paper notes. The debt structure has some higher than average risk characteristics for the airport sector with partially back-loaded payments including a significant jump in annual debt service payments after 2033. A more favorable restructuring is possible following a 2017 call date.

Elevated Leverage, Limited Operating Flexibility

San Jose has leverage of approximately 11x as a result of the previously completed $1 billion terminal area improvement plan (TAIP) and leverage is likely to remain elevated for some time. The airport's FY 2014 liquidity is high with 530 days cash on hand. Under modest growth assumptions, the airport's legal calculation for debt service coverage reaches a nearly 2.0x level, the coverage from current cashflows is much narrower at closer to just 1.1x.

PEER ANALYSIS

Comparable rated airport peers include Port of Oakland, CA (rated 'A+/A-'/Stable Outlook) and Broward County, FL (rated 'A'/Stable Outlook) which both operate in a market with a large hub nearby. San Jose and Oakland have similar CPE and while San Jose has the highest leverage of the peers, it also has the most days cash on hand.

RATING SENSITIVITIES

Negative - Either rising air traffic volatility or declines that stress financial or cost flexibility.

Negative - Debt service coverage falling under 1.0x from current cashflows, and expected to persist in that manner.

Positive - Further traffic growth leading to higher operating margins and fund balances resulting in higher debt service coverage and reduced leverage.

CREDIT UPDATE

Enplanements increased 5.7% through 11 months of FY 2015 following a 6.7% rise in FY 2014. Growth in demand and a thriving Silicon Valley economy has spurred new service by air carriers. Hainan Airlines started non-stop service to Beijing, China on June 15, 2015, operating five days a week. Southwest added daily flights to Dallas Love Field (due to expiration of the Wright Amendment) in April 2015, the frequency will increase to twice daily in November 2015. Alaska Airlines announced daily service to Eugene, OR commencing on November 2015. Delta began service to Seattle in early 2014 and added additional flights to both Seattle and Los Angeles in 2015.

The airport operates under a hybrid rate setting airline use and lease agreement, which expires in 2017. This cost recovery approach passes through 26% of the total debt service to the airlines through rates and charges. In light of a competitive market for air travel, management is also cognizant to maintain CPEs at or below $12 per enplanement. This target seems achievable under the current improving operational conditions.

Total revenues increased 2.3% to $127.7 million in FY 2014 due to parking and roadway revenues (37% of total) growing by 1.2% and general aviation/other revenue increasing 29.8%.

Operating expenses increased 2.1% to $66.3 million in FY 2014 following five consecutive years of declines. The airport has proven to prudently manage costs to maintain adequate coverage and liquidity through recent downturns in traffic but expenses are expected to increase going forward as they track enplanement growth.

The commercial paper notes series A-1, A-2, B, and C have an authorized maximum $60 million aggregate principal amount at any given time with an irrevocable direct-pay letter of credit (LOC) provided by Barclays Bank PLC (rated 'A/F1', Stable Outlook). The LOC provides coverage for the principal amount of the notes and interest on the maturity date. Any principal portion of an unreimbursed LOC draw becomes a term loan and must be repaid by the 3rd anniversary of the LOC draw date. The bank note rating supporting the commercial paper reflects the subordinated nature of the obligation.

SECURITY

The senior airport bonds are secured by a first lien of net revenue of the airport, including operating grants, facility rents, and other non-airline revenues. The commercial paper notes are secured by a lien and pledge of advances pursuant to the letter of credit facility, proceeds of the sale of notes, and surplus revenues subordinate in lien to the senior bonds. To the extent term loan bank notes were to be issued, such notes would be secured by surplus revenues held in the subordinated debt account of the surplus revenue funds, established in the master trust agreement.

Additional information is available on www.fitchratings.com.

Applicable Criteria

Rating Criteria for Airports (pub. 13 Dec 2013)
https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=725296

Rating Criteria for Infrastructure and Project Finance (pub. 12 Jul 2012)
https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=682867

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https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=988595

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Contacts

Fitch Ratings
Daniel Adelman, +1-312-368-2082
Associate Director
Fitch Ratings, Inc.
70 W Madison Street
Chicago, IL 60602
or
Secondary Analyst:
Scott Monroe, +1-415-732-5618
Director
or
Committee Chairperson:
Chad Lewis, +1-212-908-0886
Senior Director
or
Media Relations:
Alyssa Castelli, +1-212-908 0540
New York
alyssa.castelli@fitchratings.com

Contacts

Fitch Ratings
Daniel Adelman, +1-312-368-2082
Associate Director
Fitch Ratings, Inc.
70 W Madison Street
Chicago, IL 60602
or
Secondary Analyst:
Scott Monroe, +1-415-732-5618
Director
or
Committee Chairperson:
Chad Lewis, +1-212-908-0886
Senior Director
or
Media Relations:
Alyssa Castelli, +1-212-908 0540
New York
alyssa.castelli@fitchratings.com