Fitch Ratings has assigned an ‘A’ rating to the City of Philadelphia’s approximately $722 million series 2017A and 2017B airport revenue and refunding bonds issued on behalf of Philadelphia International Airport (PHL). Fitch has also affirmed the ‘A’ rating on the airport’s outstanding parity bonds, excluding its privately placed 2017 taxable bond, which Fitch does not rate. The Rating Outlook is Stable.
KEY RATING DRIVERS
The rating reflects PHL’s role as the main air service provider to a large and stable service area that generates a solid base of origination and destination (O&D) traffic, offset by a high degree of concentration in American Airlines (BB-/Stable) and some connecting traffic exposure. The rating also reflects PHL’s strong residual airline agreement, which provides for full recovery of operating expenses and debt service costs, though the agreement also results in narrow coverage and liquidity levels. Fitch expects PHL’s leverage levels to remain elevated in the medium term, as additional capital-related borrowing comes on line. Fitch views the airport’s levered position as consistent with the current rating level given PHL’s franchise strength. Although airline costs are expected to continue to rise, signatory carriers have approved the airport’s capital plan, signalling their ongoing commitment.
Sizable, Stable American Airlines Hub: Revenue Risk - Volume: Midrange.
PHL’s service area is the large and stable Philadelphia MSA, which provided around 10 million O&D enplanements in FY2017 (10-year CAGR of 0.1%). PHL is a leading connecting hub for American Airlines, which lends to sizable carrier concentration of 70% and connecting traffic exposure of 33%. Service reduction risk is partially mitigated by American’s long-standing presence at the airport, which Fitch expects to persist. Fitch views favorably PHL’s low historical peak-to-trough traffic volatility, reflecting the stability of American Airlines and the Philadelphia MSA.
Strong Cost-Recovery Framework: Revenue Risk - Price: Stronger.
The airport benefits from a five-year, fully residual airline use and lease agreement (AUL) through fiscal year 2020, which effectively provides for 100% recovery of operating expenses and debt service costs. PHL’s rising cost per enplaned passenger (CPE) level, which increases from the current $15 range to $20 by FY2022 under Fitch’s rating case, is mitigated in part by the airport’s franchise strength and airline support for the capital program.
Largely Debt-Funded Capital Plan - Infrastructure Development and Renewal: Midrange
The airport’s seven- to 10-year Capital Development Program (CDP) is sizable at $2 billion and focuses primarily on airfield improvements, terminal redevelopment and expansion, and ground transportation enhancements. Around 62% of the CDP will be funded with commercial paper or long-term debt, including the 2017 bonds. Notably, the capital program’s projects and funding sources are subject to change over time based on the operational needs of the airport.
Sound Debt Structure - Debt Structure: Stronger
PHL benefits from all senior, fully amortizing debt with no material exposure to variable interest rates as all debt is either fix rate or synthetically fixed. Structural features are considered adequate, with a portion of 2017 bond proceeds expected to be used to fully cash-fund the debt service reserve fund. Over the intermediate term, additional debt will cause PHL’s leverage to remain elevated but manageable, while annual debt service will increase but remain generally front-loaded.
The airport has historically managed to debt service coverage levels of around 1x (excluding fund balances) and liquidity of around 100-150 days cash on hand (including interdepartmental charges). These metrics are considered narrow relative to large hub peers yet adequate for airports with residual AULs, as the agreements limit bottom-line cash flow volatility. These narrow levels also limit PHL’s ability to fund its capital plan without affecting the airline rate base. Fitch’s rating case expects leverage to decline from the current 10x-11x level to below 9x by FY2022, reflecting the increased cash-funding of the airport’s reserve fund and slightly improved unrestricted cash compared to historical levels.
Philadelphia’s similarly sized hub airport peers include Miami (A/Stable) and Charlotte (AA-/Stable), which both serve as American Airlines hubs and exhibit carrier concentration and connecting traffic exposure. Charlotte’s higher rating reflects significantly lower CPE and leverage, and stronger liquidity and debt service coverage, despite higher exposure to connecting traffic and American Airlines concentration. Miami is able to achieve the same rating as Philadelphia despite slightly higher leverage and CPE due to its stronger traffic base as a leading international gateway hub.
Future Developments That May, Individually or Collectively, Lead to Negative Rating Action:
- A material reduction in, or elimination of, American’s hubbing activity, which reduces financial flexibility;
- Inability to maintain a minimum of 1x net revenue debt service coverage;
- Inability to maintain leverage levels at or below 10x to 11x on a sustained basis.
Future Developments That May, Individually or Collectively, Lead to Positive Rating Action:
Upward rating movement is unlikely over the near term given PHL’s single carrier concentration and sizable borrowing plans.
The City of Philadelphia is issuing approximately $722 million of airport revenue and refunding bonds for the benefit of Philadelphia International Airport. Approximately $224 million will be used to refund the airport’s series 2007A, 2007B, and 2009A bonds. Remaining uses of proceeds (including bond premium) include approximately $125 million to refund commercial paper, $72 million to fully cash-fund the debt service reserve fund, $41 million for capitalized interest, and $334 million into the project fund to fund the airport’s capital development plan. The bonds are secured on parity with the airport’s outstanding airport revenue bonds, which carry a pledge of airport revenues after payment of net operating expenses. Subject to bondholder approval, the airport is seeking to implement various amendments to the bond indenture, including a revenue release test, in conjunction with the current issuance.
Enplanements declined by 5.6% in FY 2017 to 14.8 million, due to the restructuring of American’s hubbing activity at PHL. Specifically, American eliminated two of its eight connecting banks and reduced departing seats to both domestic and international destinations, resulting in a 15% YoY decline in connecting traffic to 4.8 million enplanements. FY2017 enplanement performance was worse than Fitch’s base case expectations of a 2% decline but did not exceed the cumulative 9.5% shock of Fitch’s rating case. FY2018 published schedules show a 3% increase in departing seats, mostly due to American launching new service and increasing seat capacity on scheduled flights. The restructuring has allowed PHL’s traffic base to reach its highest percentage of O&D traffic since FY 2000, at 67%.
Despite lower than expected traffic performance in FY2017, estimated financial performance generally exceeded Fitch’s expectations. Airline revenues are estimated to be slightly lower than expected due to postponement of the new money issuance to FY2018, and under-budget expenses. Non-airline revenues were higher than expected due to legalization of ridesharing companies (TNCs) in Philadelphia, from which PHL collect fees on pick-up and drop-offs, and also increasing parking system revenue. Resulting net revenues and cash balances are thus slightly higher than expectations, with DSCR (excluding fund balances) of 1.16x compared to 1.02x, and lower leverage of 8.7x compared to 13x.
PHL’s $2 billion capital plan reflects a shift in priorities from airfield capacity to terminal, landside, and cargo development due to observed decreases in aircraft operations over the past decade. The new capital development plan is expected to be slightly longer in nature (seven to 10 years) than PHL’s previous capital plans and is larger as a result. The plan is 62% funded from long-term debt, including the 2017 bonds, $385 million expected to be issued in FY2021, and a $433 million issuance in outer years. Other major funding sources for the CDP include PFCs and grants (17%) and CFC revenues (16%). The new-money portion of the 2017 bonds will primarily finance improvements to the airport’s terminals.
The 2017 bonds will increase total debt from $1.18 billion to $1.68 billion, with an additional issuance in FY2021 that is expected to bring total debt to $1.85 billion. Annual debt service costs rise from $123 million in FY2017 to over $181 million in FY2021. Consistent coverage levels around 1.0x are maintained by an increase in airline revenues (and commensurately, CPE), as majority-in-interest approval under the AUL allows debt service costs to be passed through to airlines.
Leverage is projected to remain elevated but manageable, and gradually decline over Fitch’s forecast period due to increased cash-funding of the reserve fund, and an expectation of improved cash balances maintained by the airport. If savings from the 2017 refunding are not sufficient to fully cash-fund the reserve fund, the airport plans to keep the LOC from TD Bank in place (currently $18.7 million). Assuming the cash-funded portion of the reserve is reduced by the amount of the LOC, leverage remains around 11x in FY2018 but nonetheless falls to below 9x by FY2022, which levels are consistent with the current rating.
Fitch’s base case assumes a gradual recovery from 2017’s enplanement decline through fiscal 2022. Operating expenses increase above the rate of inflation (2016-2022 CAGR of 4.2%), but below the historical growth rate (2012-2017 CAGR of 5.7%). Airline revenues increase at a CAGR of 6.6% to reflect the increased expenses and debt service costs passed through to airlines under the AUL. Base case debt service coverage (including interdepartmental charges and excluding fund balances) averages 1.08x, in line with historical performance. Leverage peaks at 10.7x in FY2018 and falls to below 9x in FY2022, even with additional debt issued in FY2021. CPE averages $17 over the forecast, and peaks at $19.81 in FY2022. Fitch’s rating case incorporates a -3.7% enplanement drop in FY2018 with partial recovery thereafter, higher costs, and more conservative cash balances. In this case, CPE reaches a slightly higher $20.07, while leverage exceeds 11x in FY2018 before falling to below 9x in FY2022.
In comparison to Fitch’s Rating Criteria for Airports, PHL’s leverage levels of 8x to 10x are above the indicative guidance range of 4x to 8x for an airport with a High Midrange revenue risk profile. However, in comparison to other relevant High Midrange peers, PHL’s volume profile is stronger as it benefits from lower historical volatility, less connecting traffic exposure, and a higher percentage of international traffic. While PHL’s revenue risk profile is not viewed as commensurate with Stronger revenue risk peers, which generally benefit from larger, growing traffic bases, the airport’s aforementioned volume strengths and amortizing debt structure are considered mitigants against somewhat elevated leverage levels, making PHL’s credit commensurate with an ‘A’ rating.