Fitch Affirms San Jose, CA's Sr. Airport Revs at 'A-'; Sub CP at 'BBB+'; Outlook Stable

SAN FRANCISCO--()--Fitch Ratings has affirmed the ratings for San Jose, CA's approximately $1.31 billion of outstanding general airport revenue bonds (GARBs) at 'A-'. The Rating Outlook is Stable. Fitch has affirmed the underlying 'BBB+' rating on the bank note associated with subordinated commercial paper notes series A-1 (non-AMT), A-2 (non-AMT/Private Activity), B (AMT) and C (Taxable). The bank note rating is aligned to the senior lien rating. The Rating Outlook is Stable.

The ratings reflect the San Jose Airport's (SJC) almost entirely (98%) origin & destination traffic base and its status as a medium-to-large hub in a competitive market space. The ratings are further supported by SJC's recently upgraded facilities, manageable CIP needs, and sizeable yet decreasing debt levels. The airport's high leverage of 10.86x has stepped down, while current debt service coverage ratio (DSCR) grew marginally to 1.09x. Increases in non-airline revenues, limited use of airport funds, and adequate cost recovery from a hybrid airline use & lease (AUL) agreement, have allowed the airport to manage its cost per enplanement (CPE), still under management's goal. Though SJC faces competition from nearby hubs, the airport remains competitive with proven cost management and healthy cash balances. The airport's peers include Port of Oakland, CA (rated 'A+/A-'/Stable Outlook) and Broward County, FL (rated 'A'/Positive Outlook) which both operate in a market with a large hub nearby.

KEY RATING DRIVERS

Revenue Risk - Volume: Midrange

Competitive Airport Region: The airport's traffic base is over 98% origination and destination but is exposed to competition from nearby San Francisco and Oakland. As a result, enplanements have historically been volatile through cycles in the economy and aviation sector. The airport also has a moderately concentrated carrier base with Southwest ('BBB'/ Stable Outlook) accounting for 49% of traffic.

Revenue Risk - Price: Midrange

Airline Pricing Sensitivity: The airport's hybrid use and lease agreement allows for adequate cost recovery. However, the airport is reliant on the solid performance of volume sensitive parking, passenger facility charge (PFC), and customer facility charge (CFC) revenues to maintain airline costs competitive for the region. The airport also utilizes unspent bond proceeds to subsidize a portion of debt service costs to airlines to keep CPE competitive. This practice is expected to remain in place until the proceeds are expended in 2016.

Infrastructure & Renewal Risk: Stronger

Limited Near-term Capital Needs: San Jose's future capital needs are manageable, with a five-year CIP totalling $244 million. The airport has recently completed a terminal complex, various upgrades, and added a new fixed-base operator facility. The airport does not require additional debt to fund its CIP.

Debt Structure: Stronger (Senior lien), Midrange (Sub lien)

Moderate Debt Structure: The airport's long-term GARBs are entirely senior and fixed rate debt. Other obligations include $34.7 million in subordinate commercial paper notes. Although debt service on the senior bonds is scheduled to spike in 2033, SJC plans to refinance for a smoother debt service structure, which Fitch views as favourable. The midrange score on the commercial paper reflects the subordinated lien on excess revenues.

Financial Metrics

San Jose has leverage of approximately 11x and leverage is likely to remain elevated for some time. The airport's FY 2015 liquidity is high with 606 days cash on hand. Fitch calculated coverage from current cash flow is much narrower compared to airport calculations, at just 1.09x.

Peers

The airport's peers include the Port of Oakland, CA (rated 'A+'/'A-'/Stable Outlook) and Broward County, FL (rated 'A'/Stable Outlook) which both operate in a market with a large hub nearby. San Jose and Oakland have similar CPE, and while San Jose has the highest leverage of the three, it also has the most cash at 606 days cash on hand.

RATING SENSITIVITIES

Negative- Either rising air traffic volatility or passenger declines that stress financial or cost flexibility.

Negative: Debt service coverage falling under 1.0x for sustained periods.

Positive: Due to the large amount of debt, high leverage and CPE, positive rating action not likely in the near term.

SUMMARY OF CREDIT

Enplanements increased 5.5% in FY 2015, followed by a 6.8% rise in FY 2016. Traffic has recovered year-over-year since 2013 and is nearing pre-recession levels. Rising enplanements are spurred by a thriving Silicon Valley economy as well as San Jose's steadily growing population. Since 2015, SJC added five new international routes to London (British Airways), Vancouver (Air Canada), Frankfurt (Lufthansa), Beijing (Hainan Airlines), and Shanghai (Air China). Alaska began services to Eugene, OR, and American Airlines, Southwest, and JetBlue each announced adding an additional route which starts later this year.

The airport operates under a hybrid rate setting airline use and lease agreement, which expires in 2017. This cost recovery approach passes through 26% of the total debt service and 34% of costs to the airlines through rates and charges. In light of a competitive market for air travel, management is also cognizant to maintain CPEs that is competitive with the other regional airports. This target seems achievable under the current improving operational conditions.

2015 operating revenues increased a net of 0.3%. This was a result of a 7.7% drop in airline revenues (caused by a decreased landing fee rate and the application of surplus revenues from the prior year), offset by an 6% increase in non-airline revenues (due to a higher concession rental rate and passenger activity). Estimated FY2016 Airline Revenues grew 16.6% due to fewer revenue sharing and increased terminal rents from traffic growth, and non-airline revenues grew 12.4% due to the continued growth in enplanements. The airport has proven to prudently manage costs to maintain adequate coverage and liquidity through recent downturns in traffic but expenses are expected to increase going forward as the airport plans to add additional staff.

The commercial paper notes have an authorized maximum $38 million aggregate principal amount at any given time with an irrevocable direct-pay letter of credit (LOC) provided by Barclays Bank PLC (rated 'A'/'F1'/Stable Outlook). The LOC provides coverage for the principal amount of the notes and interest on the maturity date. Any principal portion of an unreimbursed LOC draw becomes a term loan and must be repaid by the 3rd anniversary of the LOC draw date. The bank note rating supporting the commercial paper reflects the subordinated nature of the obligation.

SECURITY

The senior airport bonds are secured by a first lien of net revenue of the airport, including facility rents, and other non-airline revenues. The commercial paper notes are secured by a lien and pledge of advances pursuant to the letter of credit facility, proceeds of the sale of notes, and surplus revenues subordinate in lien to the senior bonds. To the extent term loan bank notes were to be issued, such notes would be secured by surplus revenues held in the subordinated debt account of the surplus revenue funds, established in the master trust agreement.

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

Additional Disclosures

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https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=1011201

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Contacts

Fitch Ratings
Primary Analyst
Scott Monroe
Director
+1-415-732-5618
Fitch Ratings, Inc.
650 California Street
San Francisco, CA 94108
or
Secondary Analyst
Seth Lehman
Senior Director
+1-212-908-0755
or
Committee Chairperson
Astra Castillo
Senior Director
52-81-8399-9100
or
Media Relations:
Sandro Scenga, +1-212-908-0278
sandro.scenga@fitchratings.com

Contacts

Fitch Ratings
Primary Analyst
Scott Monroe
Director
+1-415-732-5618
Fitch Ratings, Inc.
650 California Street
San Francisco, CA 94108
or
Secondary Analyst
Seth Lehman
Senior Director
+1-212-908-0755
or
Committee Chairperson
Astra Castillo
Senior Director
52-81-8399-9100
or
Media Relations:
Sandro Scenga, +1-212-908-0278
sandro.scenga@fitchratings.com