Fitch Ratings-San Francisco-29 March 2018: Fitch ratings has affirmed the ‘A-’ rating on San Jose Airport’s (SJC) outstanding $1.2 billion of general airport revenue bonds (GARBs) and affirmed the underlying ‘BBB+’ rating on the bank note associated with the airport’s subordinated commercial paper notes. The bank note rating is aligned to the senior lien rating. The Rating Outlook for both liens is Stable.
RATING RATIONALE
KEY RATING DRIVERS
Competitive Airport Region - Revenue Risk (Volume): Midrange
The airport’s traffic base is over 98% O&D but is exposed to competition from nearby San Francisco and Oakland. As a result, enplanements have historically been volatile through cycles in the economy and aviation sector. The airport also has a moderately concentrated carrier base with Southwest (BBB/Stable), historically accounting for ~48% of traffic.
Airline Pricing Sensitivity - Revenue Risk (Price): Midrange
The airport’s hybrid use and lease agreement allows for adequate cost recovery. However, the airport is reliant on the solid performance of volume sensitive parking and passenger facility charge (PFC), revenues to maintain airline costs competitive for the region. Until 2018, the airport utilized unspent bond proceeds to subsidize a portion of debt service costs to airlines to keep CPE competitive.
Moderate Near-term Capital Needs - Infrastructure & Renewal Risk: Stronger
San Jose’s future capital needs are manageable, with a five-year CIP totalling $301.2 million. The airport has recently completed a terminal complex, , and various upgrades. Major projects include an airfield geometric implementation, ramp rehabilitation, a new aircraft rescue and firefighting facility, and a zero emission buses initiative; all of which will be grant funded. The airport does not require additional debt to fund its CIP.
Moderate Debt Structure - Debt Structure: Stronger (Senior lien), Midrange (Sub lien)
The airport’s long-term GARBs are entirely senior and fixed rate debt. Other obligations include $25.5 million in subordinate commercial paper notes. All senior debt service is fixed rate and, although the debt structure is sculpted, debt service peaks in fiscal 2018 and falls to lower levels thereafter. The midrange score on the commercial paper reflects the subordinated lien on excess revenues. Debt service reserve funds (DSRF) are fully cash funded. SJC also maintains a $41 million letter of credit supporting the commercial paper obligations.
Financial Profile: The airport benefits from high unrestricted cash balances and effective expense management. Fitch’s rating case leverage is somewhat elevated, averaging approximately 8.6x over the next five years, but continues to step down. Under typical operating cycles, Fitch expects leverage to be just over 7.0x by 2022. Fitch-calculated rating case all-in coverage is stable, averaging 1.2x over the next five years.
Peers
The airport’s peers include the Port of Oakland, CA (rated A+/A-/Stable Outlook) and Broward County, FL (rated A+/Stable Outlook); both operate in a market with a large hub nearby. Broward is supported by a significantly larger traffic base, while Oakland benefits from additional seaport activities. San Jose and Oakland have similar CPE, and while San Jose has elevated leverage, the airport also benefits from a high level of liquidity at 635 days cash on hand (DCOH).
RATING SENSITIVITIES
Future Developments That May, Individually or Collectively, Lead to Negative Rating Action:
—Traffic volatility or passenger declines that lead to
Fitch-calculated DSCR falling below 1.0x for a sustained period.
Unexpected borrowings that further inflate leverage above current levels.
Future Developments That May, Individually or Collectively, Lead to Positive Rating Action:
Though positive rating action is unlikely in the immediate term due to the competitive environment and current elevated leverage, continued deleveraging and maintenance of DSCR with enplanement growth beyond Fitch’s projections over the medium to long term could lead to positive rating action.
Performance Update
Enplanements increased from 5.1 million to 5.7 million in 2017. Fiscal year-to-date (YTD) 2018 (December 2017) enplanements are up 17% compared to YTD 2017 (December 2016) growth of 11.2%. The uptick in enplanements was induced by airline up-gauging, the consistent addition of new flights, and the thriving Silicon Valley economy. Fiscal year (FY) 2018 is forecasted to have 15% seat growth and is expected to be a strong year according to SJC’s management team.
As of FY 2017, SJC offered 40 non-stop flights, representing an increase from 2016’s offering of 35 non-stop flights; as of YTD 2018 SJC offered or announced 54 non-stop flights. Southwest, Alaska, and Delta remained the three largest airlines by market share, collectively accounting for 74% if enplanements. Air China became a signatory airline recently, and Lufthansa, Aeromexico and Frontier Airlines have engaged in non-signatory operating agreements. Given its historical success, SJC intends to continue committing resources toward its existing new airline incentive program.
SJC extended its hybrid AUL through 2019, and is currently negotiating more favourable terms slated to appear in a new AUL; there has been minimal resistance from the airlines. The new AUL’s target execution date is June 2019.
Total revenues in 2017 exceeded 2016 by 7%, translating to $58 million in airline revenue, $93 million in non-airline revenue and $5 million in other revenue. Airline revenues accounted for 37%, non-airline revenues accounted for 59%, and the remaining 4% was comprised of interest and other income. An increase in landing fees resulted in an 8% increase in airlines revenues, and increases in concessions, airfield revenues, and general aviation fees resulted in a 5.4% increase in non-airline revenues. YTD 2018, the airport’s revenues are up 7.8% compared to the 2018 pro-rata budget and are up 7.2% compared to YTD 2017.
Total expenses increased 6% in 2017 to $77.6 million due elevated staffing requirements. The YTD 2018 rise in expenses was 3.2% higher than YTD 2017.
Higher net revenues and the use of all PFC/CFC revenues toward debt service caused a five basis point increase in total debt service coverage to 1.3x in 2017. Total leverage decreased to 9.6x from 10.2x in 2016, and is anticipated to de-lever down to 7x in 2022 in Fitch’s base case. DCOH and CPE remained stable at 635 and $10.01, respectively.
The airport’s five year (2018 - 2022) CIP amounts to $301.2 million, and will be predominantly funded by AIP grants and the remainder with cash. Some notable projects include an airfield geometric implementation, ramp rehabilitation, a new aircraft rescue and firefighting facility, and a zero emission buses initiative; all of which will be grant funded. Other recent or near term projects include the addition of two bolt-on gates (29 & 30), perimeter security enhancements, ramp reconstruction, FIS enhancements to the meter/greeter area and baggage claim, and security exit doors in Terminal B. All projects in progress have remained on time, on budget, and there have been no changes to the scope of work. The airport does not plan to issue additional debt to fund its CIP.
Fitch Cases
Fitch’s base case haircuts very high year-to-date enplanement growth by 40% to simulate growth moderation, resulting in 10.1% growth in fiscal 2018. Enplanement growth thereafter is assumed at 2.3%. Expenditure growth is assumed at a high 13.8% in fiscal 2018 and settles down to 3.0% thereafter, which is approximately 1% higher than the five-year historical average. Under these assumptions, the Fitch calculated total DSCR over the next five years averages 1.3x and total leverage falls to 7x by fiscal 2022. CPE averages $10.29.
Fitch’s rating case uses the base case assumptions with the following modifications. A hypothetical recession results in a 7% and 3% enplanement loss in fiscal years 2019 and 2020, respectively, followed by 0% annual growth in 2021, and 2% thereafter. In the recessionary years, expense growth is assumed at -5.8% in 2019 and 0% in 2020 based on the airport’s cost containment approach from prior recessions, followed by elevated 3.5% annual growth thereafter. Under these assumptions Fitch-calculated total DSCR averages 1.2x and total leverage falls to 8.2x by fiscal 2022. CPE averages $10.39.
Asset Description
San Jose Airport (SJC) is a medium-sized hub located in the heart of Silicon Valley with an air-trade service area including Santa Clara, San Benito, Santa Cruz and portions of Alameda and San Mateo counties. The airport has three runways, two terminals (A completed in 1990, B in 2010) with 28 gates and two under construction.
The senior airport bonds are secured by a first lien of net revenue of the airport, including facility rents, and other non-airline revenues. The commercial paper notes are secured by a lien and pledge of advances pursuant to the letter of credit facility, proceeds of the sale of notes, and surplus revenues subordinate in lien to the senior bonds. To the extent term loan bank notes were to be issued, such notes would be secured by surplus revenues held in the subordinated debt account of the surplus revenue funds, established in the master trust agreement.
