Fitch Rates LAX (CA) Airport Sub Rev Bonds 'AA-' & Affirms Outstanding Debt; Outlook Stable

NEW YORK--()--Fitch Ratings has assigned a 'AA-' rating to the Department of Airports of the City of Los Angeles' (the department) $347.2 million subordinate revenue bonds issued on behalf of the Los Angeles International Airport (LAX, or the airport). Fitch has also affirmed its 'AA' rating on $3.63 billion senior revenue bonds, and its 'AA-' rating on LAX's $797.3 million parity subordinate revenue bonds. The Rating Outlook for all bonds is Stable.

KEY RATING DRIVERS

The ratings reflect LAX's superior credit characteristics, including a strong underlying air trade service area, significant operational activity of more than 36 million enplanements supported by an expanding and diverse mix of domestic and foreign-flag carriers, favorable rate agreements with airlines, and very strong track record of favorable financial metrics. However, the scale of the capital program is significant and additional borrowings will be required to provide portions of the funding. These concerns are well mitigated by the airport's strong and resilient market position in the Los Angeles region and favorable fiscal position. Peers include Massachusetts Port Authority (Boston) and San Francisco airports, both of which are strong performing international gateway, large-hub facilities.

Revenue Risk - Volume: Stronger

Large Gateway Airport with Expanding Traffic Base: LAX exhibits extremely strong market economics, reflected in its status as the nation's largest origination and destination (O&D) airport as well as one of the largest (#3 ranking) international gateway airports. The airport benefits from a strong and well-developed diversity of domestic and foreign-flag air carriers. While alternate airports are within the Los Angeles metropolitan area, growth constraints at competing facilities allow LAX to capture over 70% of the domestic market and almost the entire international market.

Revenue Risk - Price: Stronger

Sound Rate Agreements: The airport operates under carrier rate agreements established in 2013, which is resulting in substantive progress towards greater equalization of its rates and charges using compensatory methodologies. These agreements with LAWA's terminal tenants have also enhanced LAWA's control of most of the terminal spaces. Airline cost levels are estimated at $16.50 per enplanement for fiscal 2016, remaining moderate for an international gateway airport while similarly providing financial flexibility.

Infrastructure Development and Renewal Risk: Midrange

LARGE-SCALE CAPITAL PROGRAM: The airport is undertaking an ambitious $5.9 billion capital program (ending in FY2022) with a focus on a rebuilt international terminal as well as additional airfield and terminal projects. Delivery on projects completed has been successful; however, the capex plan is expected to result in a higher leverage position in the near term and ultimately lead to rising CPE levels.

Debt Structure: Stronger (senior bonds); Midrange (subordinate bonds)

CONSERVATIVE CAPITAL STRUCTURE: All of the existing senior and subordinated long-term airport debt is in fixed-rate mode, thus minimizing the risk for fluctuations in debt interest costs. Future debt issues are expected to remain in similar form. Covenants for rates and additional borrowings are relatively standard for the sector while all of the debt service reserves are cash-funded.

STABLE FINANCIAL METRICS

Current financial metrics such as debt service coverage (2x aggregate senior and subordinate debt) and liquidity remain solid. Leverage metrics are moderate at under 6x on a net debt-to-cash flow available for debt service basis while debt-to-enplanements is competitive at $114. As the full costs of the capital program, including an additional $2.4 billion in future debt borrowings phased-in over the next five years, the projected coverage and leverage ratios is still projected to remain close to historically strong levels but could be pressured in the event the airport underperforms on traffic and revenues.

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FACT Tool: U.S. Airports

PEER ANALYSIS

Comparable Fitch-rated peers include Massachusetts-Boston ('AA'/Stable Outlook) and San Francisco (SFO; 'A+'/Stable Outlook) airports. Both are international gateway, large-hub facilities having strong revenue risk profiles supported by large enplanement levels and competitive airline costs coupled with strong financial metrics. LAX has stronger coverage levels and a lower leverage compared to SFO but are slightly weaker compared to Boston, which has a very low debt burden for a large-hub airport enterprise.

RATING SENSITIVITIES

Negative: Given the commitment to the extensive capital program currently underway, a material downward trend in airport traffic as a result of economic factors or general adverse conditions in the aviation sector could pressure the airport ratings.

Negative: Trends that indicate weaker than expected financial metrics including aggregate debt service coverage, leverage, and liquidity.

Positive: Unlikely in the near term in light of the size of the capital program underway with additional borrowings expected.

TRANSACTION SUMMARY

The airport intends to issue approximately $347.2 million in subordinate revenue bonds for the purposes of funding various portions of its ongoing capital programs. The bonds are expected to be issued in fixed-rate mode with a final maturity in 2046.

LAX continues to demonstrate industry-leading traffic and financial performance. As expected with an international passenger and cargo gateway airport, LAX is served by a diverse mix of nearly 100 domestic, foreign-flag and all-cargo carriers. The largest passenger carrier, American Airlines, accounted for just 18.8% of the airport's total enplanements in FY2015. This level of diversity is a particular strength of the credit. FY2015 traffic levels, at 36.1 million enplanements, continued to climb 5.2%, a rate well above most U.S. airports. Year-to-date FY2016 results through February indicate that international traffic grew 11.1% over the same period in fiscal 2015, while domestic traffic grew 7.5%. Traffic growth is supported by new domestic and international services.

A current terminal rate-setting framework for carriers serving at LAX began its implementation in phases at the start of calendar year 2013, establishing an equalized and uniform rate schedule using a commercial compensatory methodology. This approach also enhances the recovery of most of LAX's operating and capital financing costs at the terminals (other than American's preferential-use Terminal 4 facility). Furthermore, those carriers entering into 10-year rate agreements under the revised terminal tariff framework have been entitled to discounted terminal rates over an initial period of years while also receiving revenue-sharing credits generated from terminal concessions. The airport has also established a Terminal Renewal and Improvement Fund (TRIF), with deposits up to $125 million per year, although the balance is currently at zero following recent draws.

LAX's updated capital improvement program (CIP) is significant in size, even for a large-hub airport, having a current estimate of $5.9 billion. The largest project includes a new 11-gate midfield satellite concourse at a cost of approximately $1.57 billion. The remaining CIP comprises other terminal and airfield projects. Capital expenditures for the entire program, which runs through 2021, are expected to be funded at nearly 60% with debt (including up to $2.4 billion of future senior and subordinate bonds) supplemented by LAX funds, grants, and passenger facility charge (PFC) pay-go receipts.

Longer term projects, including a new car rental center and automated people-mover system may add an additional $4.5 billion to $5.5 billion in costs, although the plan of finance is not developed at this time. Fitch notes that management has demonstrated a solid history of executing on its capital plan while controlling costs at budgeted levels. To the extent the program costs migrate higher, and are unable to be passed on to carriers or necessitate more leverage, the rating could be pressured.

LAX's recent financial performance has been largely stable with coverage of total debt service at 2.54x based on indenture-derived fiscal 2015 audited results. Fitch's calculation of coverage, treating PFC receipts as revenue rather than debt service offsets, generated a still healthy 2x. Both passenger growth and solid increases in non-aeronautical operating revenues have allowed for financial performance to remain at very high levels over the last several years even with the growing debt burden to support the capital plans underway.

LAX leverage metrics had been somewhat elevated for the 'AA' category on a historical basis; however, Fitch notes that the net debt-to-CFADS has steadily evolved to a lower 5x-6x range over the past two fiscal years and should remain in that range over the Fitch rating case scenario even with the increased level of gross debt. In Fitch's view, a combination of the rate-setting methodology, strong cash balances, as well as growth in airport concession revenues should collectively help stabilize the airport's fiscal and leverage position in the coming years.

LAX's liquidity position in excess of 400 days cash on hand is viewed as strong taking into consideration the substantial unrestricted revenue fund balances supplemented by PFC and maintenance reserves.

The latest sponsor traffic and financial forecasts assume the full implementation of the capital program. Fitch reviewed the underlying assumptions, including moderate traffic growth that averages at 2.6% through 2022 coupled with operating revenues and expenses growing at 7.3% and 6.2%, respectively, to be applied as the Fitch base case. Under this scenario, CPE is expected to be around $24 in 2022 as debt costs are incorporated into the airline rate base. However, airline costs at these levels would not be a credit concern. Leverage is also expected to remain moderate in the 4x-6x range through the forecast period.

Considering the history of some traffic losses in past recessions, Fitch's rating case assumes a nearly flat average traffic growth rate through 2022 by assuming a 5% reduction in 2017 followed by phased-in modest recovery. The results indicate that CPE levels will peak at slightly over $26 while total debt service coverage levels remain at 1.7x or higher when treating PFC receipts as revenue in lieu of debt service offsets. Airport leverage is not expected to be materially different than the Fitch base case.

The 2015 settlement agreement letter of intent between the Cities of Los Angeles and Ontario, which is intended to transfer the ownership and control of the Ontario International Airport (ONT) from Los Angeles back to the City of Ontario, through the Ontario International Airport Authority (OIAA), should resolve a longstanding dispute and ongoing litigation over ONT's governance and operations. At the current time, Fitch does not expect this action to have a material impact on either the operations or finances of LAX. In Fitch's view, the change in ownership is not likely to in itself create any significant shifts in its traffic profile. Given its location, the degree of regional competition, and the underlying economy of its air trade service area, bringing in more airline services will be an ongoing challenge for ONT. Ontario is a reliever airport for the Los Angeles metropolitan region, serving a traffic base primarily in the Inland Empire region.

SECURITY:

The senior revenue bonds are secured by the net revenues of the Los Angeles International Airport. The subordinate revenue bonds are secured by subordinate net revenues. The airport expects to use both lien levels to address future capital developments.

Additional information is available on www.fitchratings.com

Applicable Criteria

Rating Criteria for Airports (pub. 25 Feb 2016)

https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=877676

Rating Criteria for Infrastructure and Project Finance (pub. 28 Sep 2015)

https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=870967

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Contacts

Fitch Ratings
Primary Analyst
Seth Lehman
Senior Director
+1-212-908-0755
Fitch Ratings, Inc.
33 Whitehall Street
New York, NY 10004
or
Secondary Analyst
Jeffrey Lack
Director
+1-312-368-3171
or
Committee Chairperson
Scott Zuchorski
Senior Director
+1 212-908-0659
or
Media Relations:
Elizabeth Fogerty, New York, +1 212-908-0526
Email: elizabeth.fogerty@fitchratings.com

Contacts

Fitch Ratings
Primary Analyst
Seth Lehman
Senior Director
+1-212-908-0755
Fitch Ratings, Inc.
33 Whitehall Street
New York, NY 10004
or
Secondary Analyst
Jeffrey Lack
Director
+1-312-368-3171
or
Committee Chairperson
Scott Zuchorski
Senior Director
+1 212-908-0659
or
Media Relations:
Elizabeth Fogerty, New York, +1 212-908-0526
Email: elizabeth.fogerty@fitchratings.com