NEWS

WIRES

OTHER

Fitch Affirms $2.0B Houston Airport (Texas) Sub Lien Revs 'A+', Outlook Revised to Negative

NEW YORK - (BUSINESS WIRE) - Fitch Ratings affirms the 'A+' rating on the city of Houston, TX's outstanding $2.0 billion airport system subordinate lien revenue bonds. The Rating Outlook is revised to Negative from Stable. The bonds are secured by a subordinate lien on the net revenues generated from the operations of the airport system that includes the two primary commercial aviation facilities Houston Intercontinental (IAH) and William P. Hobby (Hobby) airports. The airport also recently sold approximately $450 million of series 2009A senior lien revenue bonds. Fitch does not rate the airport's senior lien revenue bonds.

The Negative Outlook reflects the expectation of lower coverage levels on total debt obligations and the reduced annual funding of surplus net revenues into the Airport Improvement Fund (AIF) over the next two to three years due to the effects of lower passenger levels and additional leveraging. In fiscal 2009, the combined traffic at IAH and Hobby airports declined by 8.3%. Further traffic reductions are likely given the continued stresses in both the economy and aviation industry. While financial projections indicate that airline cost levels should remain largely unchanged under reasonable traffic assumptions, the debt service coverage levels on combined senior and subordinate lien revenue debt are expected to be considerably weaker at or below the 1.40 times (x) level as compared to a more healthy 1.80x to 2.0x range in most recent years. These forecasts reflect some softness in operating revenue performance under the airport's compensatory rate-setting methodology as well as the greater use of debt service offsets from recently enacted passenger facility charges (PFC). With tighter operating margins the airport will likely see reduced annual transfers into the AIF that is generally available for pay-go capital spending and reserves. Fitch will look to the upcoming traffic trends over the next one to two years as well as monitor revenue performance and management actions on budget and debt that will together serve as key drivers to the airport's prospective financial position and cost profile. Should traffic levels fall below expectations or margins remain depressed, further rating action is likely. The high airport fund balances coupled with the available PFC capacity above the current $3 per passenger rate level at both commercial airports provide additional measures of flexibility if utilized in a prudent manner.

The 'A+' subordinate lien revenue bond rating reflects the broad economic base of the primary service area supporting 24 million annual enplanements, strong historical demand for air carrier service at both IAH and Hobby airports, and the moderating future debt requirements following the planned airport revenue bond issues through 2010 to support the capital program. Historically, the airport system also exhibited consistently strong financial results evidenced by high coverage levels, sound reserve balances, and rising but relatively competitive airline costs. Credit concerns include the dominant positions held by Continental at IAH and Southwest Airlines (Southwest) at Hobby and the likely declines in margins and coverage levels in the near term projection period. Continental is rated 'B-' with a Stable Outlook and Southwest is rated 'BBB', with a Negative Outlook by Fitch.

IAH serves as the primary commercial airport for the metropolitan area and Houston-based Continental operates its largest hub at the airport, accounting for 87% of enplaned passengers. Reflecting the strength of the economy and Continental's increased operations at the airport, enplanements at IAH increased at a 3.4% average annual rate between 1999 and 2008. After five consecutive years of robust traffic growth totaling 30%, enplanements at IAH for fiscal 2009 experienced an 8.2% decrease. Hobby serves as the market's secondary commercial airport and features mostly low-cost carriers providing point-to-point domestic service. Southwest, which considers Houston as one of its 'focus cities,' accounted for 89% of enplanements. Through 2008, enplanement base at Hobby had grown at a slower 0.4% throughout the past decade, primarily reflecting the maturity of Southwest's service at the airport. However, Hobby is expected to post an 8.8% traffic loss in fiscal 2009. On a combined basis, the Houston airport system realized an 8.3% decline in traffic over the past year with some of declines attributed to the effects of Hurricane Ike that shut down airport operations for up to four days in September 2008 and the swine flu pandemic in spring 2009. While the very high airline concentration at each airport is a relative weakness in the carrier mix profile, this risk is somewhat mitigated system-wide as Continental represents approximately 72% of total system enplanements, while Southwest represents 15% of enplanements. Still, Fitch views both Continental and Southwest's ongoing commitment to the Houston market as an important credit consideration. Any significant service reductions or departure by either anchor carrier would most probably have substantial adverse effects on the airport's connecting traffic and financial profile, and would likely result in a lower rating to the airport revenue bonds.

The airport system's use and lease agreements utilize a strong compensatory methodology for setting fees and charges in the terminals and airfield facilities which have resulted in sound financial operations during years of traffic expansion. The compensatory terminal agreements have allowed the airport to control most concession revenues, thus providing the system to build high debt service coverage levels and substantial liquidity balances. However, Fitch notes that approximately 60% of total operating revenues are derived from airline charges, a level generally high for a large-hub airport. Concession revenues contribute approximately 28% of airport revenues but have increased by over 30% since 2005. PFCs have only recently been introduced to both airports; Hobby in November 2006 and IAH in December 2008. Both airports charge $3 per enplanement, a level that is low relative to PFC rates charged at most other major U.S. airports. An increase to the current maximum $4.50 per passenger level would be a notable revenue addition particularly since the combined airports rank among the largest markets in the nation with 24 million enplanements. While the PFCs are not pledged to the payment of the airport revenue bonds, PFCs are being used as debt service offsets and provide for additional funding sources for capital spending requirements.

Taking into account the large capital programs that have been implemented for terminal and airfield improvements in recent years, the cost per enplanement (CPE) at both airports has trended upward. The fiscal 2009 CPE is estimated at $9.37 at Hobby and $11.74 at IAH, slightly higher than the average for comparable facilities. Even with an updated $526 million capital improvement plan (CIP) through 2014, the CPE's at both airports are expected to remain close to current levels but are dependent on a growing use of PFCs to cover over 40% of new debt service obligations for the CIP and a steady recovery in traffic starting in 2011. In addition to the $450 million series 2009A bond issue, of which over $250 million of proceeds will fund capital projects, the airport intends to issue a modest $100 million of additional new-money bonds in 2010. A $1.0 billion Terminal B expansion program at IAH is also under consideration but much of the proposed projects have been deferred due to the current traffic trends. Fitch's assumptions on future airport leveraging consider the expectation that Continental would self-finance a majority share of the Terminal B capital costs.

For the period between fiscal year (FY) 2004-2008, the airport's financial profile was consistently strong. Coverage levels of outstanding subordinated revenue debt were 1.90x or higher. Estimated FY2009 results show minimal changes to the coverage levels, with senior and subordinate coverage ratios at 1.94x and 1.88x, respectively, after using unpledged PFCs and LOIs as direct debt service offsets. Treating these offsets as revenues, total coverage levels were at a lower but still healthy 1.65x. Airport cash reserves have remained notably strong with nearly $517 million of unrestricted fund balances in fiscal 2008, equivalent to 852 days cash on hand. For fiscal 2009, unaudited figures indicate unrestricted reserves of $282 million and total fund balances of $758 million, translating to an amount greater than 30% of total long-term debt. Portions of the series 2009A bonds will be used to reimburse the airport and increase the reserves; however, some use the airport's internal liquidity will be drawn on for capital spending in upcoming years.

The financial projections, which assume reasonable additional enplanement losses of 2.7% in fiscal 2010 followed by modest recovery rates in subsequent years, show net revenues available for debt service dropping from $256 million in 2008 to below $185 million over the next two to three years. In turn, debt service coverage levels for the combined senior and subordinate lien obligations are projected to fall into a range of 1.36x to 1.51x taking into account the PFCs and federal accounts as debt service offsets. Assuming these funds as revenues rather than debt service offsets results in coverage levels ranging between 1.28x to 1.40x. Should debt coverage ratios fall below and remain flat due to weakness in traffic and revenue performance, negative rating action would be warranted.

Fitch's rating definitions and the terms of use of such ratings are available on the agency's public site, 'www.fitchratings.com'. Published ratings, criteria and methodologies are available from this site, at all times. Fitch's code of conduct, confidentiality, conflicts of interest, affiliate firewall, compliance and other relevant policies and procedures are also available from the 'Code of Conduct' section of this site.

Fitch Ratings, New York
Seth Lehman, +1-212-908-0755
Mike McDermott, +1-212-908-0605
Media Relations
Cindy Stoller, +1-212-908-0526
cindy.stoller@fitchratings.com