OREANDA-NEWS. Fitch Ratings has upgraded Commonwealth Ports Authority (CPA), Commonwealth of the Northern Mariana Islands' (CNMI) approximately \$12 million of outstanding senior series 1998A airport revenue bonds to 'B+' from 'B-'. The Rating Outlook has been revised to Stable from Positive.

RATING RATIONALE

The upgrade reflects steady improvement in the airports' operating profile resulting in high coverage, increased liquidity, and low leverage, notably stronger than the distressed financial profile that began in 2006. The airports' ability to apply full PFC collections as revenues has helped contribute to a substantial reserve build-up and provides a critical buffer in the case of a future significant economic downturn. In addition, traffic rebounded substantially in fiscal 2012 and appears to have stabilized.

KEY RATING DRIVERS

Revenue Risk-Volume: Weaker
--Highly Volatile Enplanement Base: The airport system is an essential enterprise, serving as the gateway to and within the Mariana Islands. The enplanement base of 542,744 passengers is relatively small taking into account the overall population base and the island's more limited, weaker economy. Traffic performance is potentially vulnerable to underlying economic stresses given the significant component of traffic tied to the tourism industry.

Revenue Risk-Price: Weaker
--Limited Cost Recovery: Rate setting practices with airlines are not clearly established and have been observed to be more reactive, based on financial pressures, than proactive. In Fitch's view, the airports' limited pricing power could constrain financial flexibility under an adverse operating environment. Recent approval by the Federal Aviation Administration (FAA) to allow the airports to utilize 100% of passenger facility charge (PFC) collections for debt service provides enhanced cushion to manage revenue levels to support financial obligations while keeping airline costs stable.

Infrastructure Development & Renewal: Midrange
--Moderate Capital Plan: The authority's capital improvement plan is modest at \$51 million through fiscal 2019 and predominantly funded through FAA grants with no future anticipated debt issuances. To the extent that a significant portion of PFC revenue is needed for debt service, it could hamper the airports' ability to provide required matching funds and thus limit grant receipts. However this risk is partially mitigated by a substantial build-up of liquidity.

Debt Structure: Stronger
--Conservative Capital Structure: The authority maintains 100% fixed-rate, fully amortizing debt. Annual debt service payments are essentially level and final maturity on the bonds is in 2028.

--Improving yet Volatile Financial Metrics: CPA generated a robust coverage ratio of 5.7x (4.2x without 100% PFCs as gross revenues) for fiscal 2014 (unaudited figures). Still, coverage levels have greatly fluctuated over time and failed to meet the financial rate covenant test (1.25x) as recently as fiscal 2008. The authority has reserves in excess of debt outstanding such that leverage is presently negative. The ability to treat all PFCs as revenues provides further stability and has helped grow Days Cash on Hand (DCOH) significantly over the past five years to 712 days in fiscal 2014.

--Peer Analysis: Harrisburg (PA), rated 'BB+'/Outlook Stable, serves as a comparable peer in terms of a small hub with weaker revenue characteristics and high CPE in-line with CPA's. Harrisburg has a more stable enplanement base than CPA due to a stronger MSA workforce, while CPA demonstrates higher coverage and significantly lower leverage.

RATING SENSITIVITIES

Positive:
--A more favorable rate setting mechanism as a result of the Ricondo rate study that ensures adequate financial stability independent of traffic performance;
--Continued improvements in the underlying service area economy and the airports' ability to maintain or grow its current traffic base;
-- Sustained favorable trends in balance sheet liquidity and strong financial ratios (independent of the use of 100% of PFCs as gross revenues).

Negative:
--Material declines in enplanement volume or in coverage, resulting from increased operating expenses and/or the CPA Board's failure to sufficiently apply the full collection of PFCs as gross revenues;
--Identified longer-term capital projects that would rely on significant debt issuances for funding.

CREDIT UPDATE

The CPA airports are heavily reliant on tourism and leisure travelers, creating an elevated degree of vulnerability to economic recessions both within its narrow local market as well as to the larger, neighboring Asian markets. As a result, enplanements have shown elevated fluctuations over time. In fiscal 2014, enplanements decreased marginally (approximately 1%). However, year-to-date fiscal 2015 enplanements (through 5 months ended February) are showing strong growth, up nearly 12% as a result of new charter flights from China and Russia. Saipan airport, the authority's strongest and busiest airport retains demand from international passengers and increased utilization.

Collectively, Delta Airlines and Asiana Airlines maintain their dominance representing approximately half of the total air traffic. However, this is down from a combined 58% for fiscal 2013 with Delta's market share falling an estimated 5% in 2014 and Asiana's falling by 2%. Fitch notes that carrier demand for service at the airports exists as seen in growth from Chinese and Russian markets and from several existing and new airlines increasing their market share. Overall, service remains essential to this island economy and management indicated that multiple airlines are looking to begin or increase service levels.

The airports set rates under a residual methodology with its carriers. However, the CPA has shown a history of reluctance to consistently pass through the full cost requirements given the fragile economy and nature of the airline industry, negatively impacting financial flexibility and resulting in past covenant violations. Management's actions in fiscal 2009 to increase airline rates have resulted in improved net revenues with coverage increasing well above the 1.25x requirement. Unaudited fiscal 2014 coverage is expected to be close to 5.74x following 4.26x coverage in the prior year, based on pledged revenues inclusive of all PFC collections. Providing somewhat of a consistent revenue stream to help service debt, non-airline revenues have been relatively stable over time and management continues to try to expand those sources.

Management is currently engaged with Ricondo and Associates to complete an airlines rate study, expected by 2016, which will be necessary to implement new rates and file an application for further PFC collection beyond the current authorization level. Fitch views this as a credit positive to the extent it brings further stability to the operating profile and coverage levels.

Cost per enplanement (CPE) is estimated by Fitch at around \$16.46 for fiscal 2014 and is expected to remain in that range barring any wide swings in enplanements or changes to airline rates. Fitch notes that this level is similar to the new baseline CPE established when airline rates went up in fiscal 2009.

CPA's overall leverage is reasonable given the operational profile of the airports; however its net debt-to-cash flow available for debt service (CFADS) is very low at -0.7x taking into account its growing liquidity (712 DCOH), reserves, and ability to use all of its PFCs as cash flow. As a result of the airports' improved operations, conservative capital structure, and flat debt service profile, Fitch projects coverage to remain well above covenant through a five-year forecast period, even when only the eligible portion of PFCs for debt service are applied.

CPA's capital improvement plan through 2019 is modest at \$51 million and 95% of the funding comes from FAA grants. The largest project is a \$17 million Regional ARFF Training Facility that could be a revenue-generating project for the airports. Other projects include: rehabilitating the 30 year old runway, repair of the taxiway, Tower and Airport Fire Station, and various renovations to the international and commuter terminal. These are in addition to several future anticipated projects. Management indicated that no future debt issuances are currently planned.

SECURITY

The series 1998A bonds are secured by a pledge of gross airport revenues generated by the operations of the airports, including Passenger Facility Charges eligible for payment of debt service. Fitch notes that CPA Board Resolution No. 2011-01 now designates all PFC Revenues as gross airport revenues.