NEW YORK--(BUSINESS WIRE)--Fitch Ratings has downgraded to 'BBB-' from 'BBB' its rating on the city of Pensacola's (Florida) approximately $33.5 million in outstanding series 2008 airport capital improvement revenue bonds issued on behalf of Pensacola International Airport (PNS).
The Rating Outlook is revised to Stable from Negative.
In addition to the 2008 bonds, PNS also maintains approximately $27.5 million of additional parity obligations which Fitch does not rate.
The downgrade reflects the airport's financial underperformance relative to projections in recent years and Fitch's view that PNS's traffic profile through the downturn and airline consolidation environment has become subject to more risk, particularly given the meaningful competition from nearby airports for passenger service already cited as a concern in the past. The credit has had a Negative Rating Outlook since 2010 and was downgraded in 2012 to 'BBB' from 'BBB+'. Fitch considers PNS's financial flexibility in terms of the historical thin operating margins generated, low Fitch-calculated debt service coverage ratios (DSCR), high leverage and low liquidity as more consistent with peers currently rated 'BBB-.'
The Stable Outlook reflects improved financial margins in fiscal year 2013 and enhanced sources of non-airline revenues going forward, both factors which Fitch cited last year were necessary for the airport to retain an investment grade financial profile.
KEY RATING DRIVERS
Revenue Risk - Volume: Weak
-- PNS serves a relatively small local market enplanement base of just over 758,000 supported by a mix of business (50% of traffic), tourism (25%), and a strong military presence (25%). Through the downturn and recent airline consolidation environment, enplanement performance has been uneven and could be influenced in future years due to the presence of competition at other regional airports. PNS's direct air service is somewhat limited to serving traffic into connecting hub markets, with enplaned passengers on regional jets comprising a relatively large 42% of the total base. Carrier concentration remains elevated with Delta Airlines (Issuer Default Rating [IDR] 'BB-'; Outlook Positive) accounting for nearly half of total enplanements to a single destination: Atlanta.
Revenue Risk - Price: Weak
--The hybrid airline use and lease agreement (AUL) provides for adequate cost recovery as costs not chargeable to the airlines on the terminal side can be covered through the residual calculation of landing fees, but historical cash sharing with the airlines points to an unwillingness to impose cost increases back to the carriers to preserve adequate margins. The airport has been operating through this agreement on a month-to-month basis since 2008, which in Fitch's opinion is viewed negatively and causes uncertainty around the medium-to-longer term ability of the airport to recover operational costs and retain increased non-airline revenues above its fixed cost base. The execution of a longer extension is uncertain.
Infrastructure Development & Renewal: Strong
--PNS recently completed its 2008 expansion and renovation program ($36 million), and its upcoming capital program is modest through fiscal 2018. Spending needs should be met by grant funds, with no debt required in the medium term unless demand driven. A $6.3 million loan was extended to the airport in 2012 and is being used to meet capital needs from fiscal 2012 onwards. In addition, PNS was recently awarded an $11.1 million grant from the Florida Department of Transportation (FDOT) for airside improvements.
Debt Structure: Strong
--PNS's capital structure includes 79.3% fixed rate debt outstanding, 14.7% synthetically fixed through an interest rate swap with BBVA Compass Bank (IDR 'BBB+'; Outlook Stable), and 7% unhedged variable rate debt consisting of a $6.3 million loan which assumes a variable rate of interest on Oct. 1, 2017. Covenants are consistent with those of other U.S. municipal airports. The debt service profile escalates slightly to 2019 before dropping off thereafter, which should provide airline cost relief in the medium term.
Strained but Improved Finances: For the airport's size, leverage (net debt to cash flow available for debt service) is elevated at 7.2x above other airports' rated in the 'BBB' category but is down from 9.9x last year, driven by improved operating margins from significant expense savings and improvements to days cash on hand (DCOH). The leverage ratio reduction was key to maintaining investment grade characteristics. Debt service coverage without capital fund transfers remains low for a small hub airport.
Peer Group: Pensacola's closest peers are Harrisburg ('BBB-/BB+', Outlook Stable) and Fresno ('BBB',Outlook Stable) due to the similarly small enplanement bases, higher leverage, and moderate to increasing cost per enplanement (CPE). Fresno's higher rating is driven by Fitch's expectation of higher projected DSCRs and more substantial financial flexibility.
Negative - Longer-term Airline Cost Recovery Framework Still Causes Uncertainty: Fitch still views the lack of a long-term agreement as a concern and a renewed agreement which does not allow for significant retention of non-airline revenues to enhance liquidity would be viewed negatively.
Negative - Diluted Financial Performance: Traffic declines and non-airline revenue generation which lag expectations combined with insufficient cost recovery from the airlines could cause negative rating pressure.
PNS's enplanements have experienced moderate fluctuations over recent years. Traffic rebounded by a combined 11.2% in fiscal 2011 and 2010 after realizing a reduction totaling 16.5% over the previous two years. Capacity cuts of nearly 4% in fiscal 2012 as a result of nationwide adjustments by the airlines, particularly at small-to-mid size airports such as PNS, correlated with a 3.1% enplanement decline to just over 756,000 in that year. The airlines added back capacity in fiscal 2013, but enplanements grew by a modest 0.3%, causing load factors to drop.
Fiscal 2014 year-to-date (YTD) (through May), the airlines have cut back capacity by an aggregate 5.3%, which correlates to a modest enplanement decline of 0.5% despite the improving economic outlook. These capacity figures have improved load factors but come despite Southwest's replacement of AirTran service to Atlanta this past November with mainline flights to Nashville and Houston Hobby. Fitch does note that enplaned passenger performance outpaced that of average traffic performance at small hub airports in calendar year 2013, particularly at neighboring airports, a factor which in Fitch's opinion further supports the Stable Outlook.
Though overall financial performance has lagged projections in recent years, Fitch recognizes the marked improvement in PNS's operating expense profile over the last two years and through May of fiscal 2014 (ends Sept. 30). After expenses increased by a compound annual growth rate (CAGR) of 9.9% since 2000 to address AirTran's expansive service introduction, operating expenses in fiscal 2012 declined by nearly 12% as the airport began outsourcing staff in certain areas and renegotiated existing contracts with service providers. These management actions created enhanced efficiencies compared to previous arrangements for police, janitorial, parking management, and building maintenance services, and led to an additional decrease of 5% in fiscal 2013. Primarily for these reasons, the airport's operating margin rose over the past two years. Through May of 2014, expenses are down a further 2.6%.
In addition to contracted sources of non-airline revenues generated from a hotel on airport property and a new concessions contract with higher minimum annual guaranteed (MAG) revenues, the airport may also enter into a lease with ST Aerospace Mobile (a division of ST Aerospace) in the near term to build and operate an aircraft maintenance facility on airport property. The airport indicates the lease could come with significant additional contracted lease revenue in the range of $200,000-$300,000. Such a lease could serve to further diversify non-airline revenues and help moderate CPE, which has risen to $7.86 in fiscal 2013 from $6.62 in fiscal 2011. The airport previously shared a significant amount of cash with the airlines during the recession which did preserve low to moderate CPE levels but also caused operating revenue coverage of annual debt service to be below other 'BBB' category airports.
The airport's leverage metric at 7.2x on general airport revenue debt is above average for small hub airports, typically closer to 4x, especially of concern given the historically narrow coverage generated on a net revenue basis and low (though improved) liquidity levels compared to other small hubs. Fitch's base case currently projects a modest 1% CAGR for enplaned passengers through fiscal year 2019 leading to modest non-airline revenue gains and in turn a greater reliance on airline revenues to preserve adequate financial flexibility. Under this case Fitch-calculated coverage is expected to improve to approximately the 1.5x-1.6x range in the near term and CPE is expected to rise well above $9.00. In reality the airport could share cash back with the airlines and generate lower operating cash flow coverage, and under this scenario, leverage would remain elevated.
The bonds are secured by the net revenues of PNS's operations and certain funds under the bond resolution.
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria & 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