Press release: Fitch Ratings has affirmed Pensacola, Florida’s (the city) ‘BBB-‘ rating on $32.9 million of outstanding series 2008 airport capital improvement revenue bonds issued on behalf of Pensacola International Airport (the airport, or PNS). The Rating Outlook is Stable.
In addition to the 2008 bonds, PNS has approximately $27.5 million of parity obligations that Fitch does not rate.
The ‘BBB-‘ rating reflects the airport’s small regional market with significant competition from surrounding airports, and the continued absence of a long-term airline use and lease agreement (AUL) since 2008. The rating also reflects the airport’s historically weak financial performance, with years of low debt service coverage ratios (DSCRs) and liquidity, though more recent performance has improved and management is developing new non-aeronautical sources of revenue generation. The rating is buoyed by a stronger debt structure and legal covenants, improving leverage levels, and a modestly sized CIP that is predominantly funded with third party resources.
KEY RATING DRIVERS
Revenue Risk- Volume: Weaker
Small, Competitive Regional Market: PNS serves a small 100% O&D passenger market in and around the western portion of the Florida Panhandle. Although traffic is well diversified by a mix of business, tourism and military travelers, overall enplanement performance has been uneven and future performance is susceptible to a significant degree of competition from three other regional airports. PNS serves a limited number of direct markets and has a high level of service level concentration, with Delta Airlines (Issuer Default Rating [IDR] ‘BB’; Outlook Positive) accounting for about 40% of total enplanements to a single destination, Atlanta.
Revenue Risk- Price: Weaker
Rolling AUL Poses Risks: Fitch views negatively the airport’s use of a month-to-month airline AUL since 2008, which casts uncertainty on the airport’s longer-term ability to recover operational costs and retain non-airline revenues above its fixed cost base. The airport is in the early stages of negotiating a longer-term AUL, but the ultimate terms and timing of any such agreement are uncertain. The current hybrid 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 the airport’s unwillingness to impose cost increases on the carriers to preserve adequate financial margins.
Infrastructure Development & Renewal: Stronger
Limited Capital Needs: The airport’s infrastructure was recently expanded and renovated as part of its 2008 capital program, thus limiting the size of its current five-year capital improvement plan (CIP) to just $64 million. The vast majority of the CIP is expected to be funded with grants from the Florida Department of Transportation and the Federal Aviation Administration, and sizeable projects can be deferred, if needed.
Debt Structure: Stronger
Solid Overall Debt Structure & Covenants: The airport’s outstanding debt is predominantly fixed rate (78% by par outstanding) or synthetically fixed (11%) and fully amortizes. Covenants are consistent with those of other U.S. municipal airports and include a cash-funded debt service reserve fund sized to the maximum allowed by the IRS. The debt service profile escalates slightly through 2019 before dropping off thereafter, which should provide airline cost relief in the medium term.
Improving Financial Position: The airport’s financial position strengthened somewhat in fiscal 2014 with DSCR rising to 1.31x from 1.26x the year prior (1.47x and 1.38x, respectively, when discretionary cash transfers to airlines are considered available for debt service). Audited days cash on hand (DCOH) increased to a solid 318 from 208 over the same period. The airport’s financial position had deteriorated to quite weak levels over the past several years, with DCOH falling to just 14 and 18 in fiscal years 2011 and 2012, respectively, and low DSCRs of 1.05x and 1.16x (1.42x and 1.51x, respectively) over the same periods. Improved margins combined with debt amortization reduced net leverage to 6.7x in fiscal 2014 from 7.2x the year prior.
Peer Group: Pensacola’s closest airport peers are Burlington, Vermont (‘BBB-‘, Outlook Stable) and Fresno, California (‘BBB’, Outlook Stable) because of their similarly small enplanement bases, and historically relatively soft financial metrics. Fresno’s higher rating is driven by Fitch’s expectation of higher DSCRs and greater financial flexibility over time compared with PNS.
RATING SENSITIVITIES
Negative – AUL Cost Recovery Framework Uncertainty: Fitch continues to view the lack of a long-term agreement as a concern, and execution of a longer-term agreement which does not allow for significant retention of non-airline revenues to sustain adequate liquidity would be viewed negatively.
Negative – Financial Deterioration: Material financial deterioration to very weak levels, whether caused by traffic declines, new and adverse terms of a modified AUL, or other factors.
Positive – Financial Gains Under a Longer-Term AUL: A track record of solid financial operations under an executed medium- to long-term AUL with a favorable cost recovery framework would likely lead to positive rating action. Fitch views the likelihood of achieving these goals over the next two years as unlikely, however, given the early stages of contract negotiations and the subsequent time required to develop an audited financial track record.
SUMMARY OF CREDIT
PNS’s enplanements increased a moderate 2.1% in fiscal 2014 to 774,003 from 758,158 the year prior. Enplanements have fluctuated moderately over the past several years and are 7% lower than peak levels achieved in fiscal 2007. Based on enplanements to date, management is estimating 3.1% growth in fiscal 2015 and projects 1.5% growth per year thereafter through fiscal 2020. Fitch views management’s projections as realistic given expectations of continued moderate economic growth, announced service expansions, and recent trends toward larger aircraft.
The airport’s financial metrics have improved significantly over the past two audited fiscal years owing to prudent cost-cutting measures, enplanement growth, development of non-aeronautical revenues, and reduced revenue sharing with airlines. Fiscal 2014 operating revenues grew a robust 12% as expenditures increased by a moderate 2.3%, resulting in improved but still below-average financial metrics with a DSCR of 1.31x, unrestricted cash of $10.7 million (318 DCOH), and leverage of 6.7x. Costs per enplanement (CPE) fell to $6.83 from $7.86 the year prior, not including an $856,000 discretionary revenue sharing payment to the airlines. Management estimates that fiscal 2015 (ending September 30) operations will continue the trend of moderate financial improvement, with a DSCR of 1.46x (1.61x when discretionary cash transfers to airlines are considered available for debt service) and reduced leverage of 5.42x. Management estimates enplanements will rise by a solid 3.1% in fiscal 2015.
Financial metrics will likely benefit from management’s continued development of additional non-aeronautical revenues, including the development of vacant land around an on-site hotel, redevelopment of new airport land purchased recently by the city, and construction of a maintenance facility to be leased to an aerospace company. The airport has put in place new financial management practices including a liquidity floor of at least $3 million (about 90 DCOH), and a DSCR target of at least 1.4x. Although these targets are below the medians for small airports, Fitch nonetheless views them as a prudent step towards preventing extreme financial deterioration under stressed enplanement conditions. Fitch acknowledges the airport’s financial condition has shifted materially and positively over the past two years; however, positive rating action is unlikely until the airport can demonstrate a track record of sustained financial stability under a longer-term AUL. AUL negotiations with airlines began earlier this year and management expects execution of a new AUL will occur late in calendar 2016.
Fitch’s five-year base case was derived from the airport’s key assumptions on enplanements and expenditure growth, which Fitch views as reasonable based on economic and enplanement trends and historical data. Enplanements are projected to rise 1.5% annually while expenditures are projected to grow 1.7% in most years. Under these conditions, the DSCR would slowly and consistently rise to 1.60x (1.75x without consideration of discretionary cash transfers to airlines) by fiscal 2020 while leverage would fall to a moderate 3.84x over the same time frame. CPE is projected to rise slightly until late in the forecast when debt service declines.
Fitch’s rating case scenario assumes typical recessionary conditions would result in two years of 5% consecutive enplanement declines, followed by a recovery with three consecutive years of 2.5% growth. The scenario also assumes that management increases its discretionary cash transfers to airlines as needed to prevent CPE from rising above $9.00. Under these conditions, the DSCR would reach a trough of 1.15x in fiscal 2017 (1.39x without consideration of discretionary cash transfers to airlines) and leverage would fall just slightly over the forecast period to 4.79x from an estimated 5.42x in fiscal 2015. CPE would rise to a peak of $9.00 in fiscal years 2016 to 2018 and fall thereafter as enplanements recovered.
SECURITY
The bonds are payable from net revenues generated by the airport and a cash-funded debt service reserve fund sized to the maximum level allowed by the IRS.
Additional information is available at www.fitchratings.com.