Fitch Upgrades Chicago Midway Airport's (IL) Second-Lien Revs to 'A'; Outlook Stable

CHICAGO--()--Fitch Ratings has assigned an 'A' rating to the city of Chicago, Midway International Airport's (Midway) approximately $348 million second-lien series 2016A&B airport revenue and revenue refunding bonds (MARBs). Fitch has also upgraded to 'A' from 'A-' its rating on approximately $1.5 billion of outstanding parity second-lien MARBs. The Rating Outlook for all bonds is Stable.

The city also has approximately $29 million of outstanding first-lien MARBs that Fitch does not rate.

The upgrade reflects Midway's enhanced franchise strength which, taken together with the robustness of the underlying Chicago air service market, offsets its currently elevated leverage. Midway has demonstrated a notably increasing strategic importance to the strong Chicago air service area and emerged as a complementary airport to nearby O'Hare International Airport (O'Hare). Further, solid enplanement growth in recent years has led to a stabilizing cost profile.

The 'A' rating reflects Midway's resilient and growing traffic base within the robust Chicago air trade market. While Southwest Airlines' (Southwest) passenger concentration is considerably above what is seen at most large-hub airports, the carrier has demonstrated the strategic importance of Midway to its network evidenced by its increased utilization and long-term contractual commitments. Fitch believes the airport's residual cost recovery framework provides for continued stable financial performance while maintaining stable airline costs at the current traffic level. Future capital needs should be minimal and flexible in nature, allowing leverage to rapidly evolve downward to the 10x range by 2021. The closest Fitch-rated peer, Dallas-Love Field (DAL), is similarly rated 'A'/Outlook Stable and serves a comparable strong, metropolitan market with a greater than 90% Southwest concentration and competition from a nearby, larger airport, but plays less of a strategic role in the Southwest network, serving fewer passengers and destinations and with less daily seat capacity.

KEY RATING DRIVERS

(Revenue Risk: Volume - Midrange)

RESILIENT MARKET CONSTRAINED BY CARRIER CONCENTRATION: Midway is the second major airport serving the Chicago regional market and is well situated through a growing scale of low-cost domestic services benefiting from an economically strong local air trade service area in a favorable mid-continent location. The airport served more than 11 million enplanements in 2015, of which 61% were origination and destination (O&D) passengers. In recent years, traffic growth has well outpaced that of both the nation and nearby O'Hare. Total traffic has climbed each year since 2008 and was 4.8% higher in 2015. However, Southwest (rated 'BBB+', with a Stable Outlook by Fitch) accounts for over 90% of enplanements, and nearly 40% of total traffic is connecting traffic. While some air service competition may exist from nearby O'Hare, Midway fulfils a complementary role with ample capacity for growth.

(Revenue Risk: Price - Stronger)

SOLID COST RECOVERY FRAMEWORK: Midway operates under a residual use and lease agreement (AUL) that has provided for stable financial performance in recent years. Further, carriers have signed a 15-year AUL renewal running through 2027, demonstrating their long-term commitment to the airport. Airline costs are currently competitive at $9.16 per enplanement for 2015. Cost per enplanement (CPE) will rise modestly over the next several years, mainly due to rising debt service obligations related to funding airport improvements agreed to by carriers, but should stabilize over the medium term and remain below the costs expected at nearby O'Hare airport.

(Infrastructure Development/Renewal - Stronger)

MANAGEABLE, DEBT-FUNDED CAPITAL PLAN: Midway's capital improvement plan (CIP) for 2016-2022 reflects works totalling $458 million. Nearly 95% of the plan is expected to be funded through the combination of previously issued bonds as well as the proposed series 2016 bond issuance. Key airport facilities are in good condition following recently built terminal and concession areas as well as parking and the completion of the consolidated rental car facility in 2013.

(Debt Structure (Second-Lien) - Stronger; Revised from Midrange)

DECREASED VARIABLE-RATE DEBT EXPOSURE: A significant portion of Midway's debt is in fixed rate mode or hedged with swaps, leaving just 7% of debt exposed to variable rates. Further, Midway's debt service payment profile has become more level through restructurings. Nearly all of Midway's debt now resides on its second-lien with a fully cash-funded debt service reserve fund, but featuring a relatively weak rate covenant of 1.10x. The second-lien has been clearly established as the working lien, with the minimal remaining debt on the first-lien maturing in 2024 and the expectation of no further issuance at this level.

HIGH BUT DECLINING LEVERAGE: Midway currently has a higher debt burden and cost profile than peers at $137 debt per enplanement ($225 debt per O&D enplanement) and 16x aggregate net debt/cash flow available for debt service (CFADS; excluding fund transfers), although this should return to the 10x range by 2021. Liquidity in the form of unrestricted cash and operating reserves is below average at 174 days cash on hand and will likely remain so given the residual airline agreement. All-in coverage for fiscal 2014 (including fund transfers) grew to 1.35x from 1.25x in 2013.

PEER GROUP

Fitch-rated comps include DAL and Detroit (DTW; 'A-'/'A-' senior/sub, Outlook Stable). DAL similarly serves a strong, metropolitan market with a greater than 90% Southwest concentration and faces competition from a larger, nearby airport. DTW shares an elevated leverage profile with high carrier concentration and similar coverage levels to MDW under its likewise long-term, fully residual AUL.

RATING SENSITIVITIES

Negative: Given the Southwest concentration, either a material traffic downshift or increased traffic volatility could lead to negative rating action;

Negative: Significant increases to Midway's current plans for borrowings or airline costs as a result of underperformance with respect to non-aviation revenues or higher operating expenses could pressure the current rating.

Positive: Further upward rating migration is not likely in the near term given Midway's elevated debt burden and exposure to carrier concentration.

TRANSACTION SUMMARY

Midway plans to issue approximately $348 million of second-lien series 2016A&B revenue and revenue refunding bonds to fund $308 million of airport capital projects for the existing CIP as well as to currently refund approximately $44 million of second-lien series 2004A&B bonds for present value savings. The DSRF will be cash-funded with bond proceeds. The bonds are expected to price the week of May 23, 2016.

Traffic has continued to experience strong growth following the sharp decline in enplaned passengers in 2008. Traffic grew for the seventh consecutive year, up 4.8% in 2015, to a new peak enplanement level of 11.0 million. Enplanements continue to outperform forecasts as well as capacity additions, indicating natural growth. This trend has continued into 2016 with enplanements up 4% year-over-year for the first quarter (through March). However, management has conservatively budgeted enplanement growth of just 0.6% for 2016 and the traffic consultant (Ricondo) builds off of this budgeted level in its forecast.

Whereas most of the airport's recent growth has been derived from connecting traffic related to Southwest's increased hubbing operations, O&D traffic has shown positive trends since 2011, growing by a combined 24%. Still, the pace of connecting traffic growth since 2006 has shifted the O&D passenger mix from around 74% of total enplanements at that time to 61% in 2015. Given the expectation of the continued high market share of Southwest (currently 93%) and the 39% connecting passenger base at the airport, Midway's future traffic performance and financial flexibility will be heavily influenced by Southwest's scheduling decisions. However, Midway's increasingly strategic importance to the Southwest network serves as a mitigant to this risk. Southwest serves more destinations and passengers from Midway than any other airport in its network, Midway has the greatest seat capacity in the network, and has experienced the greatest growth in destinations, departures, and passengers over the last decade.

Further demonstrating its long-term commitment to Midway, Southwest (and the other signatory carriers) executed a 15-year renewal of the residual AUL in 2012. This airline agreement approach has provided for stable airline costs and financial performance, and is expected to continue to do so through the forecast period.

In addition to the fully residual AUL, Fitch views favourably Midway's strides to reduce the risk associated with its debt structure. Midway has now reduced its variable rate debt exposure from approximately 25% down to 14%, with more than half synthetically fixed. In addition, Midway has eliminated its put bond risk, reduced its maximum annual debt service, and smoothed its overall debt service profile.

The city's 2016-2022 CIP remains manageable at $458 million, but is up slightly from its 2015-2021 CIP of $397 million. Fitch notes that approximately 95% of these capital needs will be bond funded, however, 22% has already been issued and the remaining 72% will mostly come from the series 2016A&B issuances. The primary focus is on routine maintenance and demand-driven, revenue accretive projects, such as parking garage and passenger security checkpoint expansions (at costs of $132 million and $79 million, respectively). The parking garage will add approximately 1,500 new parking spaces, alleviating the capacity constraints that are presently causing the garage to close three to four days a week. The security checkpoint expansion will not only construct an 80,000 square foot (sq. ft) pavilion to accommodate current and future passenger flow, but it will also free up an additional 18,000 sq ft of potential revenue-generating concession space. Leverage is currently elevated as a result of terminal and airfield improvements over the past decade, but is offset by the strength of Midway and the underlying market it serves and should evolve down to 10x by 2021 given the amortization profile and minimal additional borrowing needs post series 2016 bonds.

Midway's expense growth has outpaced inflation, growing at a 4.9% compound annual growth rate (CAGR) since 2010, but in line with the 4.7% enplanement CAGR for the period. Expenses grew more than 6% most recently in 2015 and are forecast to grow at approximately 4% per annum by the airport's consultant. As the costs of its capital program have come online, CPE rose to $9.38 in 2011 before moderating to $8.48 in 2014 as a result of increasing enplanements and non-aviation revenues as well as the 2013 and 2014 restructurings. CPE is estimated to be $9.16 for 2015 and Midway's airline costs are likely to rise over the forecast period as debt service obligations and operating expenses ramp up, but should remain largely under control. Fitch's base case projections forecast CPE to reach the $14 range by 2021 (but remain largely flat on a real basis). However, should non-airline revenues fall short of expectations or operating expenses exceed forecast, Midway's financial profile could be pressured, resulting in higher CPE.

The airport's own debt service coverage ratio (DSCR) calculation for 2015 is not yet available, but is expected to be commensurate with prior years given the residual nature of the AUL. On a purely cash flow basis, without the benefit of fund transfers, total coverage was sum sufficient at 1.02x in 2014. Taking into account the use of cash reserves and non-pledged revenue sources such as PFCs and CFCs, the airport's total DSCR was 1.35x, up from 1.25x the year prior. Fitch notes this is well above the 1.10x covenant level. The city anticipates total coverage to remain above its 1.1x rate covenant through the projection period.

Fitch felt that the sponsor case was reasonable and adopted it as its base case. Enplanements grow at a 2% CAGR 2016-2021, with CAGRs of just under 6% for total revenues and just under 4% for operating expenses. Under this scenario, CPE is likely to reach the $14 range by 2021 and net debt/CFADS evolves to 9.9x. DSCRs are expected to remain stable around the 1.10x covenant given the fully residual AUL.

Fitch's rating case assumes a nearly flat enplanement base (-0.1% CAGR) through 2021, taking into account an 8% loss in 2017 with 2% recovery in future years. Total revenues still grow at a 5.7% CAGR driven by airline revenue growth of 9.7%. Operating expenses are still forecast to grow at a 4% CAGR through 2021 despite the lower enplanement volume. Under this scenario, CPE is likely to reach the $16.50 range ($2.31 more than the base case) by 2021; however, net debt/CFADS will still fall to approximately 10x and DSCRs are expected to remain comparable to the base case given the AUL framework.

Given Midway's exposure to Southwest's hubbing operation, Fitch also tested a sensitivity scenario that stressed enplanements with a permanent loss of 25% of connecting traffic in 2017 coupled with a 5% loss to O&D traffic that recovered by 2020. Operating expenses were grown at a 3.6% CAGR, reflecting some cost containment measures given the enplanement loss. The result was a CPE of approximately $18.65 by 2021 or an increase of $4.56 above the base case. Even under this unlikely scenario, CPE would remain competitive with other large hubs that have taken on sizeable capital programs.

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
Jeffrey Lack
Director
+1-312-368-3171
Fitch Ratings, Inc.,
70 West Madison St.
Chicago, IL 60602
or
Secondary Analyst
Seth Lehman
Senior Director
+1-212-908-0755
or
Committee Chairperson
Saavan Gatfield
Senior Director
+1-212-908-0542
or
Media Relations:
Elizabeth Fogerty, +1 212-908-0526
elizabeth.fogerty@fitchratings.com

Contacts

Fitch Ratings
Primary Analyst
Jeffrey Lack
Director
+1-312-368-3171
Fitch Ratings, Inc.,
70 West Madison St.
Chicago, IL 60602
or
Secondary Analyst
Seth Lehman
Senior Director
+1-212-908-0755
or
Committee Chairperson
Saavan Gatfield
Senior Director
+1-212-908-0542
or
Media Relations:
Elizabeth Fogerty, +1 212-908-0526
elizabeth.fogerty@fitchratings.com