Fitch Affirms Ontario Airport's Rev Bonds at 'A-'; Outlook Remains Negative
OREANDA-NEWS. Fitch Ratings has affirmed Department of Airports of the City of Los Angeles, Ontario International Airport's (ONT) $59.6 million of fixed-rate revenues bonds outstanding at 'A-'. The Rating Outlook remains Negative.
The 'A-' rating reflects the airport's limited traffic activity with exposure to competition from larger airports serving the greater Los Angeles region. While ONT's traffic base is primarily origination and destination (O&D), an elevated cost per enplanement (CPE) may challenge its competitive position to attract new air services. Mitigating these concerns is the sound fiscal position of stable debt service coverage levels, very low debt balances, and solid cash balances. The rating reflects the current debt structure and arrangement for ONT's ownership and operation and does not reflect potential changes to its debt that could take place once the airport's control is transferred to the Ontario International Airport Authority.
The Negative Outlook was assigned after numerous consecutive years of volume declines as annual enplanements approached 2 million. Fitch recognizes that passenger volume levels may have started to stabilize. Enplanements in FY 2015 increased 3.9% over last year's levels, as reported by management. Fitch will continue to monitor passenger enplanement stabilization and cost containment, and the corresponding outlook will be revised if merited.
KEY RATING DRIVERS
Revenue Risk- Volume: Weaker
SECONDARY AIRPORT IN COMPETITIVE REGION: ONT is in transition from being a strategic reliever facility to a smaller regional airport in the highly competitive southern California air service market. The airport's traffic profile has shown seven years of consecutive declines, but enplanements in fiscal 2015 are expected to show positive growth and remain above 2.0 million. The airport is dominated by Southwest Airlines, which accounted for approximately 57.5% of air services in fiscal 2014.
Revenue Risk- Price: Midrange
COMPETITIVENESS CONSTRAINED BY HIGH CPE: The airport operates under a long-term residual use and lease agreement expiring in 2024, which provides the basis for strong cost recovery. As of April 1, 2014, all airlines had indicated commitment to the agreement. While the airport's ability to pass costs on to airlines is not limited by an elevated CPE of $10.78, its competitiveness in the region is reduced
Infrastructure Development/ Renewal: Midrange
MANAGEABLE CAPITAL PLAN: ONT's infrastructure is in adequate condition with only routine maintenance comprising the CIP of $67.6 million for FY 2015-2019. However, there is some uncertainty on planning processes for managing capital needs going forward given the planned handover of ONT's operations from the City of Los Angeles. Currently, no additional debt is anticipated to fund the airport's capital plan, which is largely expected to be funded with federal Grants, PFCs and cash.
Debt Structure: Stronger
CONSERVATIVE DEBT STRUCTURE: The airport's outstanding debt profile consists of entirely fixed rate, fully amortizing bonds with final maturity in 2026. Its debt service schedule is relatively flat with annual debt service payments ranging from $7.0 million to $7.3 million. Bond covenants and reserves are standard for airport credits at this rating level.
LOW LEVERAGE, STRONG LIQUIDITY: The airport's debt service coverage ratio (DSCR) of 1.44x in fiscal 2014, taking into account coverage fund per the bond resolution, provides adequate financial cushion. Unrestricted cash of $99 million in fiscal 2014, equivalent to 666 days cash on hand, was greater than the amount of debt outstanding at that time, resulting in a very favorable negative net debt to cash flow available for debt service (CFADS) ratio.
PEERS: Amongst its peers at the 'A-' rating level, such as Long Beach (CA) airport, ONT demonstrates weaker DSCR and significantly higher CPE, although these features are somewhat offset by its strong cash position, resulting in very low leverage. Analysis of ONT in comparison to peers in the greater Los Angeles region such as Burbank (CA) and John Wayne Airport (CA) yields a similar conclusion.
--Continued traffic declines that result in a significantly lower enplanement base, further weakening the airport's franchise strength;
--Operating Cost Management: Inability to strategically manage costs, resulting in increases to the already high CPE;
--Liquidity Balances: Significant erosion in the airport's strong liquidity position leading to an increase in leverage;
--Unlikely at present given current traffic trends.
The airport continues to experience traffic declines as a result of a weak local economy and competition from nearby airports. Enplanements decreased by 3.3% to 2.0 million in fiscal 2014, but FY 2015 is demonstrating some stabilization with a 3.9% increase. All services offered at ONT are also available from LAX, the primary airport in the region, and usually at higher frequencies and capacity. Fitch believes further enplanement decreases to levels below 2 million followed by sluggish growth are possible - a scenario that would reflect significantly weakened franchise strength of the airport.
CPE was $10.78 in 2014, a decrease from $12.73 in 2013. The department continues to cut costs in all areas of operations in response to recent traffic declines, especially reductions in staffing levels. Operating expenses in 2014 were 10.9% lower than 2013 and are currently 32% lower than expenses in 2008. Management realized cost reductions in 2014 through passing certain cost centers to airlines themselves, such as custodial and airline equipment maintenance functions effective July 1, 2013. Given the prospect of stagnant traffic growth at the airport, Fitch believes that cost control remains critical to avoid an increase in CPE which could result in service retrenchment. The airport managed to moderate CPE in fiscal 2014, and Fitch will continue to monitor ONT's longer-term CPE management.
DSCR remained stable in recent years as noted by strong 1.44x coverage in 2014, unchanged from fiscal 2013. The airport has historically generated DSCRs of 1.4x - 1.5x through expense reduction initiatives and the pass-through of costs to carriers. It also has a strong liquidity position, with $99 million of unrestricted cash, which reflects the insurance trust, revenue fund, and O&M reserve.
Fitch's base case scenario assumes continued traffic declines from 2016 to 2017 to 1.93 million enplanements. In order to maintain DSCR of 1.5x under such scenario, CPE in 2015 would need to return to 2013 levels above $12 and increase to around $14 by 2019. The rating case assumes a 15% traffic shock in 2016 followed by 2.5% annual recovery. Fitch assumes a 5% decline in 2016 expenses similar to historical declines when enplanements fell, resulting in similar CPE levels as the base case. Absent any further cost reductions, CPE is expected to remain elevated. Although the airport is able to apply PFCs to eligible debt service, the PFC rate is not expected to be raised above the current $2.00 in the foreseeable future given the need to keep rates low to incentivize carriers.
A settlement agreement letter of intent between the Cities of Los Angeles and Ontario was recently formed and announced, which is intended to transfer the ownership and control of the Ontario International Airport from Los Angeles back to the City of Ontario, through the Ontario International Airport Authority (OIAA), and should resolve a longstanding dispute and ongoing litigation over ONT's governance and operations. However, the true merits of this settlement will only be evident in the medium and long term.
A number of issues remain from a credit perspective over the longer term as to the operational and financial benefits of the transaction. Similar to Los Angeles International (LAX), ONT is currently owned and operated by the City of Los Angeles, and has been for the past 30 years. However, each airport effectively acts as an independent enterprise, with separate bonding programs and financial reporting. This historical arrangement between the two cities, as public parties, is atypical in the U.S. commercial airport space.
Given the complexity involved with airport ownership transfers, uncertainties remain over the ultimate timing of the transfer, since approval from the Federal Aviation Administration and other units of local governments will be needed. Financial implications remain unclear at this time as the settlement agreement calls for several steps of compensation payments to be made to Los Angeles. The total payments come to $190 million although some of the payments are tied to ONT performance-based schedules, thus an element of uncertainty as to timing of receipt. The source for these payments will be decided at a later time, and making such payments from ONT's funds and reserves could impact ONT's currently very strong liquidity position.
The bonds are secured by a net revenue pledge of the airport and exclude passenger facility charges and consolidated facility charges.