Fitch Rates San Francisco Int'l Airport (CA) Revs 'A+'; Outlook Stable

CHICAGO--()--Fitch Ratings has assigned an 'A+' rating to the Airport Commission's, City and County of San Francisco, San Francisco International Airport (SFO) approximately $582 million series 2016B second series revenue bonds, $169 million series 2016C second series revenue bonds, and series 2016D second series revenue refunding bonds. Fitch has also affirmed the 'A+' rating on approximately $4.2 billion of parity SFO second series revenue bonds. The Rating Outlook for all of the bonds is Stable.

KEY RATING DRIVERS

Summary: The rating reflects SFO's strong operational and financial performance within the healthy, yet competitive air trade market in the San Francisco Bay Area. The airport's fully residual airline agreement and proven management team provide a solid framework for stable and competitive results; however, its elevated leverage profile and additional borrowing needs create some pressures on the rating. Leverage is forecast to double, but moderate to less than 10x by 2021, while CPE will increase to more than $23. These results are reasonable for an international gateway airport and should remain competitive relative to peers and the 'A+' rating level.

Revenue Risk-Volume: Stronger

STRONG OPERATING PROFILE AND POSITIVE TRAFFIC TRENDS: SFO serves as a major international gateway airport with a dominant market share of passenger traffic within the San Francisco bay region (70% in fiscal year [FY] 2016). The airport has a well-balanced traffic profile, with 79% origination & destination (O&D) traffic in 2016, the remainder being a mix of domestic and international connecting traffic. United Airlines Inc. (United; 'BB-'/Outlook Positive) maintains a sizable presence at SFO, with a 44% share of the passenger market. United's share has fallen in recent years despite its increased seat capacity as growth at SFO has been largely driven by the increasing presence of low-cost carriers (20% in FY2016) and service expansion by foreign-flag airlines.

Revenue Risk-Price: Stronger

FAVORABLE RATE-SETTING FRAMEWORK: The current airline use agreement (AUL), in place through 2021, is fully residual and provides for strong cost recovery with respect to all operating and debt service requirements. Airline charges were $16.53 per enplanement in FY2016 and have been relatively stable in recent years, although they are expected to rise in the medium term due to additional projected costs associated with the airport's capital improvement program (CIP).

Infrastructure Development/Renewal: Midrange

LARGE, DEBT-FUNDED CAPITAL PLAN: Airport capital needs are well managed, but substantial infrastructure improvement is planned for the near-to-medium term. Recently completed terminal improvements together with planned development projects are considered necessary to allow the airport to adequately serve its growing user base. The 10-year CIP totals $6.1 billion and is expected to be predominantly funded through revenue bonds. The program has been accelerated with more projects occurring in the five-year horizon such that approximately $5.7 billion in new money issuance was factored into the forecast period through fiscal 2021, in addition to the 2016BC bonds.

Debt Structure: Stronger

STABLE DEBT PROFILE: SFO has reduced its variable-rate exposure from nearly 20% of outstanding debt in 2008 to approximately 11% in 2016 (all synthetically fixed) and has eliminated its mandatory tender exposure. Further, SFO's percentage of variable-rate debt will continue to decline as new, fixed-rate bonds are issued to fund its CIP. Covenant and reserves are sufficient, with the debt service reserves now nearly 100% cash-funded and funded in excess of the maximum annual debt service (MADS) requirement.

STRONG FINANCIALS, ELEVATED LEVERAGE METRICS: SFO's debt level is high at $4.2 billion ($164 per enplanement in FY2016) and contributes to the airport's high fixed-cost structure. The airport's current net debt-to-cashflow available for debt service (CFADS) ratio is similar to that of peer large-hub airports at 7.4x. Additional borrowings to support capital spending will cause debt metrics to rise, but they should remain reasonable for an international gateway with stronger assessments for both revenue risks (volume and price). Nevertheless, the airport has a good liquidity position (332 days cash on hand for FY2016) and stable coverage levels, demonstrating it can adequately meet its debt service obligations. Fitch forecasts the debt service coverage ratio (DSCR) to remain in the 1.36x - 1.55x range through FY2021 including permitted transfers (1.09x - 1.14x without).

PEERS: SFO's Fitch-rated peers include Los Angeles International Airport ('AA/AA-'), Miami International Airport ('A'), and Atlanta International Airport ('A+/A+') given their similar prominence as large-hub, international gateway airports. All also have elevated leverage related to large capital needs in support of their on-going operations. SFO benefits from the most positive enplanement trends over the last five years while LAX benefits from the highest DSCR given its hybrid AUL. Cost per enplanement (CPE) is expected in the $20 range for all but Atlanta, although SFO's CPE is projected to rise above $20 after FY2019.

FACT Tool: U.S. Airports (Opens in an Excel worksheet)

RATING SENSITIVITIES

Negative: A larger capital program size or additional borrowings above current forecast parameters may lead to rating pressure.

Negative: Changes in the airport's traffic profile given the sizable presence of United and the presence of competing airports in San Jose and Oakland.

Positive: Upward rating migration is unlikely at this time given SFO's elevated leverage and large additional borrowing needs over the next 10 years.

TRANSACTION SUMMARY

SFO is expected to issue $582 million series 2016B and $169 million series 2016C second series revenue bonds to refund $343 million of outstanding commercial paper and to pay costs associated with its capital program. The bonds will be fixed rate and fully amortizing with a 30-year final maturity. SFO is also expected to issue approximately $129 million of series 2016D second series revenue refunding bonds for debt service (DS) savings. The bonds will be long-term, fixed rate bonds and will not extend the final maturity of the refunded bonds. NPV savings are estimated at more than $12 million. The bonds are expected to price around September 15, 2016.

SFO's traffic has continued to perform extremely well in recent years (5.3% CAGR between FY2011 - FY2016), with strong enplanement growth every year. Most recently, enplanements grew by 6.7% in FY2016 (compared to the 1.9% growth forecast by the airport consultant) to a record 25.6 million enplanements, and are up another 7.1% for the first month of FY2017. SFO is benefiting from international passenger traffic growth in addition to strong domestic performance driven by low-cost carrier expansion and United's increased service. United remains the dominant carrier with 44% of enplanements, though the share of low-cost carriers increased to 20% in FY2016 from 6% in FY2007. Since the recent economic downturn, SFO's passenger traffic market share has increased relative to competing Oakland and San Jose airports, now comprising approximately 70% of the Bay Area.

Estimated debt service coverage in FY2016 was 1.34x, taking into account permitted contingency fund transfers of approximately $94 million as well as the use of designated passenger facility charge (PFCs) as revenues. On a stand-alone basis, excluding contingency rollover funds, coverage was 1.12x. This coverage level is in line with performance in recent years and is not unusual given SFO's residual rate-setting methodology.

The airport commission utilized $43 million of PFC revenue to cover debt service in FY2016, down slightly from FY2015, and down notably from the $73 million and $87 million used in FY2012 and FY2011, respectively. However, PFC utilization is forecast to return to historic levels ($85 million) by 2020 and grow to as much as $255 million by 2021 as the commission uses this revenue stream to offset new debt service attributable to the CIP and as a tool to manage costs passed on to airlines.

SFO's airline CPE continues to grow, rising to $16.53 in FY2016, up from $16.00 in 2015, as debt service obligations ramp up, but remains in line with expectations and reasonable for an international gateway. Continued growth in enplaned passengers as well as large increases in non-airline revenue sources and usage of PFC receipts as offsets to debt service payments together contribute to the recent stabilization of airline costs. Even with a quintupling of PFCs designated as revenues, CPE is forecast to exceed $23 by 2021 under a scenario of modest traffic growth. This level is reasonable for an international gateway and should remain competitive relative to peers.

SFO is implementing a sizeable, 10-year CIP of around $6.1 billion, with a main focus on modernizing terminals 1 and 3, increasing safety and security, and enhancing passenger experience. The program is demand-driven and has been accelerated due to the consistent outperformance in enplanement growth over the last few years. While projects have been moved forward to meet current and projected demand, should enplanements fall, a portion of the program could be deferred. The program will be nearly all bond-funded.

SFO's leverage, in terms of net debt-to-CFADS, is moderate for a large-hub airport at approximately 7.4x for FY2016. This will, however, increase as a result of the magnitude of the CIP despite the rapid amortization of existing debt. Through the forecast period, leverage will peak at approximately 15x, but fall to less than 10x by 2021 as new principal begins to amortize and the additional debt service enters the rate base charged to carriers. This elevated leverage level is mitigated by SFO's strong franchise strength and cost recovery framework demonstrated by its stronger assessment for revenue risk in terms of both volume and price.

The commission is still completing its airport development plan (ADP), which may be integrated as early as the FY2017 capital plan (subject to environmental approval and demand) and is additive to the current CIP. To the extent additional borrowings for either the current CIP or forthcoming ADP materially weaken the airport's financial profile, the rating may be pressured at its current level.

Fitch's base case assumes 1.9% average enplanement growth through 2021, in-line with the airport consultant and notably lower than that observed in recent years. Total revenues are expected to grow at 7.9% driven by airline revenue growth of 8.2% and a massive increase to PFCs designated as revenues. Operating expenses are forecast to grow at an average of 4.6% annually over the same period, which is just below historical levels. Under this scenario, CPE is likely to reach $23-$24 by FY2021. Net debt-to-cashflow averages 12x but falls to below 10x by 2021. Under this base case, DSCR is expected to remain stable at around 1.36x - 1.55x range (including permitted transfers) given the fully residual AUL.

Fitch's rating case assumes a weaker 0.2% average enplanement growth through 2021, taking into account an 7.6% loss in 2018 with recovery in future years. Total revenues are expected to grow at 7.9% driven by airline revenue growth of 8.9% while operating expenses are forecast to grow at the same 4.6% average annually as the base case through 2021 despite the lower enplanement volume. PFCs designated as revenues remain unchanged from the base case. Under this scenario, CPE is likely to reach the $27 range; however, net debt-to-cashflow and DSCR levels are expected to remain comparable to the base case given the AUL framework.

Even with continued growth in the airport's enplanement base, Fitch expects the average CPE to increase over the next few years to service rising annual DS payments resulting from additional borrowings. Fitch believes that rising airline costs will affect SFO's overall financial flexibility, although it notes that such higher airline costs are supported by a relatively large component of high-yielding international and long-haul domestic travel. In addition, these costs facilitate necessary improvements to support the continued growth experienced at SFO and should remain in-line with and comparable to peer airports with similarly sized capital needs.

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
Jeffrey Lack
Director
+1-312-368-3171
Fitch Ratings, Inc.
70 West Madison Street
Chicago, IL 60602
or
Secondary Analyst
Emma Griffith
Director
+1-212-908-9124
or
Committee Chairperson
Seth Lehman
Senior Director
+1-212-908-0755
or
Media Relations
Sandro Scenga
+1-212-908-0278
New York
sandro.scenga@fitchratings.com

Contacts

Fitch Ratings
Primary Analyst
Jeffrey Lack
Director
+1-312-368-3171
Fitch Ratings, Inc.
70 West Madison Street
Chicago, IL 60602
or
Secondary Analyst
Emma Griffith
Director
+1-212-908-9124
or
Committee Chairperson
Seth Lehman
Senior Director
+1-212-908-0755
or
Media Relations
Sandro Scenga
+1-212-908-0278
New York
sandro.scenga@fitchratings.com