Fitch Rates Ontario Airport (CA)'s Rev Bonds 'A-'; Outlook Stable

NEW YORK--()--Fitch Ratings has assigned an 'A-' rating to Ontario International Airport Authority's (OIAA or the authority) approximately $52.2 million of fixed-rate Ontario International Airport, CA (ONT) revenue bonds series 2016A&B. The Rating Outlook is Stable. The bonds will be secured by a senior lien on airport net revenues.

The 'A-' rating reflects the airport's history of traffic volatility supported by local demand with exposure to competition from larger airports serving the greater Los Angeles region. While ONT's traffic base is primarily origination and destination (O&D), its elevated cost per enplanement (CPE) may challenge its competitive position to attract new air services on an ongoing basis. Mitigating these concerns is the expectation of a stable fiscal position following the OIAA acquisition supported by sound debt service coverage levels, very low debt balances, and solid cash balances.

The rating also considers the proposed conservative debt structure as well as a stable operational transition for ONT once the airport's control is transferred to the authority. At financial close to this refunding transaction, as well as other conditions met, OIAA will assume ownership and operational control of ONT from Los Angeles. The ONT settlement with Los Angeles includes a series of payments to Los Angeles from the City of Ontario and the authority. A new leadership team for OIAA as well as a staffing plan for ONT should be supportive for the initial transition; however, execution risks remain to manage costs and increase air services during the initial years of OIAA control. Also, formulation of capital spending plan under new management remains an uncertainty, including the program size, priorities, and details of funding sources.

KEY RATING DRIVERS

Revenue Risk- Volume: Weaker

SECONDARY AIRPORT IN COMPETITIVE REGION: ONT is a secondary airport in the highly competitive southern California air service market, with a primary draw of passengers from the Inland Empire region. The airport's traffic profile has shown considerable volatility and declines over the past decade; however, enplanements since fiscal 2015 have shown positive growth and enplaned passenger levels remain above 2.0 million. Airport nonstop services are focused mainly to western region markets and Southwest Airlines is the dominant carrier, accounting for approximately 57% of total enplanements.

Revenue Risk- Price: Midrange

STRONG AIRLINE AGREEMENT CONSTRAINED BY ELEVATED COSTS: The airport operates under a long-term residual use and lease agreement expiring in 2024, which provides the basis for strong cost recovery. All primary passenger and cargo airlines are participants to the agreement. Although the airport has the ability to pass costs on to the airlines, increasing its CPE above the already elevated $11 level could put the airport at a competitive disadvantage to several other airports in the region.

Infrastructure Development/ Renewal: Midrange

MANAGEABLE CAPITAL PLAN: ONT's infrastructure is in adequate condition with only routine maintenance appears to be needed. A multi-year capital budget is not clearly identified at this time and, upon airport transfer, OIAA's new management is expected to develop a forward-looking spending plan. Despite the expectation of limited overall needs, in Fitch's view, the new authority will face limited funding flexibility to defray capital projects as future PFC revenues will be encumbered until settlement payments to Los Angeles are fully paid. Receipt of future federal entitlement grants may also be more limited in light of the recent increase of the passenger facility charge (PFC) rate to the maximum $4.50 level. Still, no additional debt is anticipated to fund the airport's near term capital needs, and debt borrowings may only be done at a subordinate lien level until all LA settlement payments are fulfilled.

Debt Structure: Stronger

CONSERVATIVE DEBT STRUCTURE: The authority's proposed debt profile is expected to consist of entirely fixed rate, fully amortizing bonds with final maturity in 2026. The proposed debt service schedule is intended to be relatively flat with annual debt service payments at or slightly above $6 million per year. Covenants and reserve requirements are expected to be similar to those in the bonds to be refunded and comparable to those utilized at most U.S. airports. No additional senior parity debt may be issued until all settlement payments are paid off.

LOW LEVERAGE, STRONG LIQUIDITY: Heading into the transfer, the airport's debt service coverage ratio (DSCR) of approximately 1.6x (including .25x coverage provided by airport fund transfers) provides adequate financial cushion. Unrestricted cash and operating reserves following OIAA's acquisition will remain sizable and support a near zero net leverage position.

PEERS: Comparable peers include Burbank and Long Beach (CA) airports with both rated in the 'A' category and are secondary airports in the Los Angeles air trade area. ONT is comparable to Burbank with negative overall leverage but has a higher CPE level. Long Beach has higher leverage (4.3x) but a similar 1.5x-1.6x DSCR range.

FACT Tool: U.S. Airports

RATING SENSITIVITIES

Negative:

--Material Traffic Declines: A return to further traffic declines or elevated volatility resulting in a lower enplanement base, further weakening the airport's franchise strength.

--Operating Cost Management: Inability to strategically manage costs resulting in increases to the already elevated CPE;

--Liquidity Balances: Significant erosion in the airport's strong liquidity position, beyond the planned payments to be made to Los Angeles, leading to an increase in net airport leverage.

Positive:

--Unlikely at present given the current airport profile and the near term transitions associated with the ownership transfer.

TRANSACTION SUMMARY OF CREDIT

The series 2016 bonds will be senior lien obligations of OIAA and are being issued to redeem all of the outstanding revenue bonds series 2006A and 2006B issued by the City of Los Angeles Department of Airports on behalf of Ontario International Airport. The new issue is estimated to total $52 million in par and is expected to be issued in fixed rate mode and have a final maturity in 2026. This bond issue is one of several steps required under the settlement agreement between OIAA and the City of Los Angeles to complete the airport transfer of ownership.

The airport has recently shown signs of positive operational activity since 2015 following a lengthy period of traffic declines as a result of a weak local economy and competition from nearby airports. Enplanements increased by 1.1% to 2.1 million in fiscal 2016, which followed a more robust 4.1% increase the prior year. ONT flights are primarily regional in nature and all services offered at ONT are also available from LAX, the primary airport in the region, and usually at higher frequencies and capacity. While the sponsor forecast for traffic is optimistic for future growth, averaging over 3% per year, Fitch believes uneven enplanement performance and volatility could continue in future years, reflecting the economic and competition risks.

Capital needs at the airport are expected to remain modest, with up to $50 million over the next five years, and no additional borrowings are anticipated to cover these costs. OIAA expects to further develop the capital program; however, funding sources will likely be more limited as compared to most U.S. airports as PFC collections will be fully encumbered to cover future Los Angeles settlement payments ($120 million in total from PFC funds with the remainder from airport funds and City of Ontario payments) while entitlement grants will be reduced in future years in conjunction with ONT's recent increase to the maximum $4.50 PFC rate. ONT can pass on pay-go capital costs to the airlines but this approach may be difficult to implement as it will also directly increase airline costs.

Estimated CPE for fiscal 2016 was $11.50, an increase from $10.05 in the prior year but still within the average levels seen over the past five years. Prior cost containment actions were done in response to recent traffic declines, especially reductions in staffing levels. To the extent the airport transfer to OIAA is completed, further expense reductions are anticipated to be implemented based on management discussions regarding the staffing plans during the initial transition period. Given the potential sensitivity of costs to airline services, Fitch will continue to monitor ONT's longer-term CPE management.

DSCR remained stable in recent years as noted by healthy 1.66x coverage in 2016, which is above the historical DSCR 1.4x - 1.5x range. Despite the full residual airline agreement, coverage ratios are sensitive to the level of capital spending passed on to carriers. The sponsor forecast estimates annual DSCR climbing to over 2.5x but this metric appears to be driven by assumptions of $7 million of average annual capital spending charged into airline rates and enhancing coverage. Absent that assumption, DSCR levels would likely average closer to the 1.50x level. ONT's strong liquidity position, evidenced by unrestricted cash and operating reserves, allows for airport leverage to remain in a negative level. Coverage levels should also be protected by OIAA's lack of borrowing needs and the limitations to issue only subordinate obligations until all LAWA settlement payments are completed.

The airport consultants generated sponsor traffic and financial forecasts going out until fiscal 2022. In Fitch's view, the underlying assumptions appear to be optimistic in nature with average passenger growth of 3.1% under a 'low growth' scenario and some expense reductions realized during the initial transition period. The financial results indicate coverage levels to rise dramatically to over 2.5x within two to three years, reflecting both activity growth and additional charges passed to the carriers for capital spending. Fitch notes that without the added capital charges to airlines, DSCR levels would remain at close to historical levels of about 1.5x. Airline CPE remains moderate at below $10 while leverage continues to be negative as airport funds remain robust. Considering the recent history of traffic reductions and the presence of other airports in the region, there is risk for underperformance to this assumed level of growth.

Fitch's base case scenario reflects a lighter increase of annual growth of 1% to 2.26 million enplanements by fiscal 2022. Operating revenues and expenses are assumed to increase at a 2.6% and 3.4% annual rate. Not taking into account additional pay-go capital spending charged to carriers, DSCR levels are expected to remain near the 1.5x level under such scenario while CPE remains in-line to the historical range of $10-$11 per enplanement.

Fitch's rating case assumes an 8% aggregate traffic reduction through 2018 followed by no recovery. Operating revenues and expenses are assumed to increase at a 2.5% and 3.2% annual rate taking into account the changes in traffic levels. DSCR levels are expected to remain at the same levels as the base case given the residual airline agreement while CPE does increase to over $14 per enplanement level. In both the base and rating cases, ONT should be able to maintain a negative net leverage position as preservation of strong cash reserves and amortization of outstanding or refunding debt should support this trend.

Additional information is available on www.fitchratings.com

Applicable Criteria

Rating Criteria for Airports (pub. 25 Feb 2016)

https://www.fitchratings.com/site/re/877676

Rating Criteria for Infrastructure and Project Finance (pub. 08 Jul 2016)

https://www.fitchratings.com/site/re/882594

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Contacts

Fitch Ratings
Primary Analyst
Seth Lehman
Senior Director
+1-212-908-0755
Fitch Ratings, Inc.
33 Whitehall St.
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
Sandro Scenga, +1 212-908-0278
sandro.scenga@fitchratings.com