Fitch Ratings has assigned a 'BBB+' rating to Cleveland, OH's series 2018A and 2018B bonds. Concurrently, Fitch has affirmed the 'BBB+' rating on Cleveland, OH's airport revenue bonds. The airport has approximately $222.5 million in Fitch-rated debt and $454.3 million of outstanding debt not rated by Fitch. The Rating Outlook has been revised to Positive from Stable.
KEY RATING DRIVERS
The rating reflects a midsize airport market which has transitioned from a domestic-focused hub to a more traditional origination/destination (O&D) profile with approximately 4.6 million annual enplanements. Traffic has experienced positive recovery of its O&D in recent years following United Airlines' (IDR 'BB'/Stable) actions to reduce flights several years ago. The airport's financial profile is stable, supported by a residual airline agreement, with indenture coverage consistently in the 1.35x-1.4x range and a strong balance sheet Although CLE's average airline costs rank high relative to most airports of similar operating profiles, United does support its terminal leases and other signatory carriers have competitive airline costs. CLE's current leverage is elevated at 6.2x but is positioned to progressively move lower as debt is amortized and future capital needs have limited borrowings for funding.
Stabilized Regional Airport: Revenue Risk - Volume: Midrange
Cleveland's total traffic base is approximately 4.56 million enplanements, with solid positive growth trends since 2015. United remains the leading carrier at Cleveland, although at much lower concentration levels since its elimination of its connecting-based operations as well as some O&D service. Low-cost carriers continue to grow operations within the market in addition to larger airlines adding new service, which has helped to backfill routes and lower average ticket prices.
Above-Average Cost Profile: Revenue Risk - Price: Midrange
Airline revenues represent a relatively high share of airport operating revenues. The high average airline cost structure (Fitch-calculated at $17.55 CPE for 2017) is substantially a burden on United due to their special facility lease for Concourse D through May 2029. The non-United carriers have more competitive CPE levels with which to operate from Cleveland. The airport's residual airline agreement, which was implemented on Jan. 1, 2017 for a five-year period with additional renewal options, allows for the full adjustment of fees to meet all airport operating and debt costs
Moderate Infrastructure Plan: Infrastructure & Renewal Risk: Stronger
The airport's 2018-2022 capital program (CIP) is modest in size and scope, and totals $148.4 million. The majority of the CIP focuses on airfield improvements/rehabilitation, with terminal enhancements and equipment purchases and replacement representing a minority share. Of the total amount, $34.8 million is expected to be funded with proceeds from the current issuance and $2.7 million is projected to be financed from proceeds of previously issued debt. The remainder will be financed from airport discretionary funds and federal grants.
Conservative Debt Structure: Debt Structure: Stronger
The system's debt is approximately 88% fixed-rate debt and 12% unhedged variable-rate bonds. Debt amortization is rapid as 66.7% of outstanding long-term bonds mature during the next 10-year period. Bond documents provide for solid reserves and adequate coverage requirements.
High Debt and Strong Liquidity: The airport's historical financial profile indicates stable coverage levels, elevated leverage, and healthy reserve balances. The airport's leverage was 6.2x in fiscal 2017 but should trend lower even under Fitch's rating case scenario. A strong balance sheet with reserves equating to 392 days cash on hand helps mitigate potential traffic and operating revenue volatility. Historic debt service coverage has remained stable in the 1.3x-1.4x range, including use of coverage funds.
Peers: The airport's peers include St. Louis, MO (A-/Stable) and Allegheny County, PA (A/Stable). Each airport had previously been a domestic hub and has transitioned to a primarily O&D airport. All airports maintain similar UAL agreement structures and all airports maintain a full cost pass through structure. Cleveland's CPE of $17.55 in 2017 is higher than that of St. Louis ($11.99) and Allegheny County ($12.86).
RATING SENSITIVITIES
Future Developments That May, Individually or Collectively, Lead to Positive Rating Action:
--Continued favorable traffic performance resulting in strengthened airport revenue generation, resulting in average airline costs evolving to a more competitive range.
--Reduction in leverage to a level below 4x on a sustained basis as currently anticipated under Fitch's base case.
Future Developments That May, Individually or Collectively, Lead to Negative Rating Action:
--Material decrease in traffic and/or increase in costs leading to an unsustainably higher CPE.
--Higher borrowings than currently anticipated leading to leverage at or near 8x.
TRANSACTION SUMMARY
The series 2018A bonds will be issued in the amount of $90.3 million to pay a portion of the costs of improvements to the airport system and to currently refund a portion of the city's outstanding airport system revenue bonds, series 2009C. The series 2018B bonds will be issued in the amount of $20.9 million to provide funds to pay a portion of the costs of improvements to the airport system. Bond proceeds will primarily be used to finance airfield projects (taxiway and runway rehabilitation, airfield improvements), terminal projects, and various equipment replacement/restoration projects. Preliminary savings from the 2018A refunding are estimated to be $720,000 annually.
Performance Update
In fiscal 2016 and 2017, enplanements grew by 3.9% and 8.5%, respectively, to 4.56 million. Recent growth represents a recovery following a significant 16.1% decline in 2014, when United reduced service, particularly in connecting operations. Subsequently, several low-cost carriers have begun operating at Cleveland (Frontier, Spirit, and JetBlue) in addition to incumbent airlines adding flights and seats, which has helped in backfilling routes. For the first five months of 2018, traffic growth remained robust, up 9.1% as a result of continued additional services from new carriers serving CLE.
O&D percentage is currently over 97% reflecting the underlying strength of the local market. Since mid-2015, O&D traffic has rebounded at healthy rates of growth. United's market share is down to approximately 26% from 51% in 2014, while American has increased to 16.3% from 7%, and Frontier to 13.1% from 8%.
The airport's current airline agreement was implemented in January 2017. The terms are essentially commensurate with the preceding agreement and rates are set using a residual-based methodology. The agreement has a five-year term, with two two-year options to extend. The average CPE has risen so far from $13.77 in 2013 to nearly $19 in 2016, before reducing to $17.55 in 2017. These levels are among the highest for a domestic-focused airport, although carriers other than United have considerably lower airport costs. To the extent airport traffic remains stable or benefit from small positive growth, airline costs are likely to trend somewhat lower.
CLE's recent financial performance has been largely stable with coverage of debt service at 1.42x based on indenture-derived fiscal 2017 results. Fitch's calculation of coverage, without the coverage account, generated a lean 1.16x ratio. CLE's debt metrics have been historically above average compared to airports with similar profiles, with leverage at about 6.2x; however, leverage should evolve to the mid-4x range in the Fitch rating case over the next five fiscal years, given strong projected revenue performance, the lack of additional borrowings, and ongoing debt amortization.
Fitch Cases
In conjunction with the current issuance, a sponsor forecast was produced by the airport's consultant. The sponsor case projects enplanement activity growing by 6.1% in fiscal 2018, and then averaging approximately 2% annually through 2022. Total airline revenues decline on average by 1% annually through the forecast period given the growth in enplanements and strong non-airline revenue performance, which grows by an average of 5.3% per year in the sponsor case. Under these assumptions, net revenues are expected to produce coverage in the 1.5x range through 2022, with leverage evolving down to 3.7x.
Fitch's base case applied the forecasted 6.1% increase in enplanements in fiscal 2011, followed by an annual enplanement growth assumption of 1% through fiscal 2022. Given more conservative enplanement and operating expenditure assumptions, airline revenue growth assumptions (particularly landing fees) were adjusted annually in an amount that yields debt service coverage of 1.4x annually. Non-airline revenue is projected to increase annually by 3% throughout the forecast. Total operations and maintenance expenses were increased by 3.5% annually through fiscal 2022. Under these assumptions, net revenues are expected to produce coverage averaging 1.4x through 2022, with leverage evolving down to 4.1x. Fitch-calculated CPE under Fitch's Base Case is $15.81 in 2022.
Fitch's rating case applied an enplanement growth assumption of 6.1% in 2018, followed by an 8% shock in 2019. Enplanement traffic experiences a gradual recovery thereafter. Like the Base Case, airline revenue growth assumptions (particularly landing fees) were adjusted annually in an amount that yields debt service coverage of 1.4x annually. Non-airline revenue is projected to increase by 3% in 2018, followed by a 5% decline in 2019 to coincide with the enplanement decline, and 3% growth thereafter. Total operations and maintenance expenses were increased by 3% to 4% annually through fiscal 2022. Under these assumptions, net revenues are expected to produce coverage averaging 1.4x through 2022, with leverage evolving down to 4.1x. Fitch-calculated CPE under Fitch's Base Case is $18.67 in 2022.
Security
The bonds are secured by a senior lien on the net revenues generated from the operations of the airport system.
Asset Description
The Airport System is comprised of Cleveland Hopkins International Airport and Burke Lakefront Airport. The airport is the primary commercial service airport for northeastern Ohio, and is situated approximately 10 miles southwest of Cleveland's downtown. The airport encompasses approximately 2,045 acres of land, with three air carrier runways, a large terminal complex and various cargo maintenance facilities. Based on FAA statistics, the Airport was the 43rd busiest airport in terms of total passengers for U.S. airports in 2017.
A January 2018 district court ruling that dismissed claims regarding payment of Puerto Rico Highways and Transportation Authority debt has raised questions about the scope of protections provided by Chapter 9 of the U.S. bankruptcy code to bonds secured by pledged special revenues. Fitch's rating criteria treat special revenue obligations as independent from the related municipality's general credit quality. The outcome of the litigation could result in modifications to Fitch's approach. For more information, see "What Investors Want to Know: The Impact of the Puerto Rico Ruling on Special Revenue Debt" available at www.fitchratings.com.
