SAN FRANCISCO--(BUSINESS WIRE)--Fitch Ratings has affirmed Department of Airports of the City of Los Angeles, Ontario International Airport's (ONT) $63.4 million of fixed-rate revenues bonds outstanding at 'A-'. The Rating Outlook has been revised to Negative from Stable.
Negative Outlook Rationale
The Negative Outlook reflects ONT's ongoing transition from a strategic reliever airport serving the greater Los Angeles, CA, service area into a more limited service, regional hub airport, as reflected by continuing declines to its primarily origination and destination (O&D) traffic base. Cost per enplanement (CPE) is very high in comparison to peer secondary/regional hub airports at above $12, more on par with large hub airports such as Los Angeles International Airport (LAX). It also reflects continued uncertainty as to ownership of the airport going forward.
The need for further cost-containment whilst holding airline costs no higher than current levels remain the primary concern, as the enplanement base is potentially susceptible to further decline, reflecting acute competition from neighbouring airports. The airport's strong liquidity position and low leverage somewhat mitigates the airport's operational challenges; nevertheless, further traffic declines and increasing CPE would reflect weakening franchise strength no longer consistent with an A-category rating.
KEY RATING DRIVERS
Revenue Risk- Volume: Weaker
SECONDARY AIRPORT IN COMPETITIVE REGION: ONT is in transition from being a strategic reliever facility to a smaller regional hub in the highly competitive southern California air service market. The airport's traffic profile has shown six years of consecutive declines with enplanements in fiscal 2014 expected to fall to 2.0 million from 3.5 million in fiscal 2008. The airport is dominated by Southwest Airlines, which accounted for approximately 56% of air services in fiscal 2013.
Revenue Risk- Price: Midrange
COMPETITIVENESS CONSTRAINED BY HIGH CPE: The airport operates under a long-term residual use and lease agreement expiring in 2024, which provides the basis for strong cost recovery. As at April 1, 2014, all airlines had indicated commitment to the agreement. While the airport's ability to pass costs on to airlines is not limited by an elevated CPE of $12.73, its competitiveness in relation to lower cost airports in the region is reduced.
Infrastructure Development/ Renewal: Midrange
MANAGEABLE CAPITAL PLAN: ONT's infrastructure is in adequate condition with only routine maintenance comprising the CIP of $67.6 million for FY 2015-2019. Fitch takes the view that the airport has limited flexibility to defer certain identified maintenance projects required to bring certain parts of its asset base back up to standard. No additional debt is anticipated to fund the airport's capital plan, which is largely expected to be funded with AIP Grants, PFCs and cash.
Debt Structure: Stronger
CONSERVATIVE DEBT STRUCTURE: The airport's outstanding debt profile consists of entirely fixed rate, fully amortizing bonds with final maturity in 2026. Its debt service schedule is relatively flat with annual debt service payments ranging from $7.0 million to $7.3 million.
LOW LEVERAGE, STRONG LIQUIDITY: The airport's debt service coverage ratio (DSCR) of 1.44x provides adequate financial cushion. Unrestricted cash of $96 million in fiscal 2013, equivalent to 574 days cash on hand, was greater than the amount of debt outstanding at that time, resulting in a net debt to cash flow available for debt service (CFADS) ratio of -4.3x.
PEERS: Amongst its peers at the 'A-' rating level, such as Long Beach (CA) airport, ONT demonstrates weaker DSCR and significantly higher CPE, although these features are somewhat offset by its strong cash position, resulting in very low leverage. Analysis of ONT in comparison to peers in the greater Los Angeles region such as Burbank (CA) and John Wayne Airport (CA) yields a similar conclusion.
--Continued traffic declines that result in a significantly lower enplanement base, further weakening the airport's franchise strength.
--Operating Cost Management: Inability to strategically manage costs, resulting in increases to the already high CPE;
--Liquidity Balances: Significant erosion in the airport's strong liquidity position leading to an increase in leverage;
--Continued uncertainty with respect to ownership of the airport that further affects its operations.
--Unlikely at present given current traffic trends.
The airport continues to experience traffic declines as a result of a weak local economy and competition from nearby airports. Enplanements decreased by 6.3% to 2.08 million in fiscal 2013 and continue to show declines in fiscal 2014 (11 months through May) of 4.1%. All services offered at ONT are also available from LAX, the primary airport in the region, and usually at higher frequencies and capacity. Fitch is of the view that further enplanement decreases to levels below 2 million enplanements followed by sluggish growth are possible - a scenario that would reflect significantly weakened franchise strength of the airport.
CPE was reported to be $12.73 in 2013, an increase from $11.12 in 2012. The department continues to cut costs in all areas of operations in response to recent traffic declines, especially reductions in staffing levels. Operating expenses in 2013 were 0.4% lower than in the previous year, and are currently 24% lower than expenses in 2008. Management has already realized cost reductions in 2014 through passing certain cost centers to airlines themselves, such custodial and airline equipment maintenance functions effective July 1, 2013. Given the prospect of stagnant traffic growth at the airport, Fitch believes that further cost control remains critical to avoid an increase in CPE which could result in service retrenchment. Fitch notes that the airport has managed to moderate CPE in fiscal 2014 and will continue to monitor ONT's longer-term CPE management.
DSCR remained strong at 1.44x in 2013, similar to the 1.48x coverage resulting in 2012. The airport has historically generated DSCRs of 1.4x - 1.5x through expense reduction initiatives and the pass-through of costs to carriers. It also has a strong liquidity position, with 96 million of unrestricted cash, which reflects the insurance trust, revenue fund, and O&M reserve.
Fitch's base case scenario assumes continued traffic declines from 2014 to 2016 to 1.8 million enplanements. The 9% expense decline in 2014 is attributed to the airline consortium cost savings followed by slight expense growth thereafter. In order to maintain DSCR of 1.5x under such scenario, CPE in 2014 would need to return to 2010 level of $13 and increase to around $15.50 by 2018. The rating case assumes a 15% traffic shock in 2015 followed by 2.5% annual recovery. Fitch assumes a 5% decline in 2015 expenses similar to historical declines when enplanements fell, resulting in similar CPE levels as the base case. Absent any further cost reductions, CPE is expected to remain elevated. Although the airport is able to apply PFCs to eligible debt service, the PFC rate is not expected to be raised above the current $2.00 in the foreseeable future given the need to keep rates low to incentivize carriers.
In 2011, the city of Ontario offered to assume control of the airport in consideration of a transaction payment of $50 million, assumptions of the airport debt outstanding, and repayment of $125 million of PFC revenues previously transferred from LAX for the construction of the two terminals at ONT. In September 2012, the city administrative officer of Los Angeles issued a report recommending LAWA to decline the offer but also to negotiate with the city of Ontario and the newly formed Ontario International Airport Authority, with the goal of determining the most effective and appropriate ownership and management alternative and to determine the fair market value of the airport. To date, LAWA has initiated actions consistent with the recommendations, but has not endorsed any sale of the airport. As part of the process, a valuation report was prepared by Leigh Fisher which estimated the value of the airport to be in a significantly higher range than the amount proposed by the city of Ontario. There have been no further developments since, though LAWA has expressed it is still open to potential transfer of the airport only for a reasonable value.
The bonds are secured by a net revenue pledge of the airport and exclude passenger facility charges (PFCs) and consolidated facility charges (CFCs).
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria and Related Research:
--'Rating Criteria for Infrastructure and Project Finance' (July 11, 2012);
--'Rating Criteria for Airports' (Dec. 13, 2013).
Applicable Criteria and Related Research:
Rating Criteria for Infrastructure and Project Finance
Rating Criteria for Airports