NEW YORK (July 29, 2014) — Fitch Ratings has affirmed the rating on approximately $62.8 million of outstanding Kenton County Airport Board Cincinnati/Northern Kentucky International Airport (CVG) series 2003B revenue bonds at ‘A-’. The Rating Outlook is Stable.
The affirmation reflects the airport’s stabilizing origin and destination (O&D) traffic profile amidst continued connecting traffic declines resulting from Delta’s ongoing dehubbing. CVG maintains extremely low leverage and high liquidity, and is able to generate stable debt service coverage ratios (DSCR) at the required 1.25x pursuant to the residual airline use and lease agreement (AUL). These features serve to offset operating risk related to competition from neighboring airports for its O&D travel base and the significant carrier concentration that still exists on Delta Air Lines (Delta, rated ‘BB-’/Positive Outlook by Fitch). Fiscal year (FY) 2013 traffic beat Fitch’s previous base case assumption, despite connecting traffic falling below expectations, as a result of O&D traffic outperforming projections by 3 percent.
KEY RATING DRIVERS
— Volume Risk: Weaker
O&D enplanements have remained relatively steady between 2.1 and 2.3 million over the last five years, despite competition from several other airports in the region. Nevertheless, significant carrier concentration exists on Delta, which still accounts for 66 percent of O&D enplanements despite its significant dehubbing activity at the airport.
— Price Risk: Midrange
The airport operates under a strong, fully residual AUL. Currently, high fares at the airport provide flexibility to limit airline subsidies. However, CVG has used fund balances in past years to maintain a more competitive cost structure so this flexibility may not be sustained. With only passenger facility charge (PFC)-backed debt remaining after 2014, no debt service costs are planned to be passed onto the air carriers, only the operating expenses which are not covered by non-airline revenue sources. Annual PFC collections are estimated to be nearly $5 million above annual debt service obligations through the medium term until full authorization is collected. Therefore cost per enplanement (CPE), which migrated above $10 in FY2012 and FY2013, should fall and then stabilize going forward.
— Infrastructure Development & Renewal: Stronger
The capital program running through 2014 has been managed without the use of additional debt and has been funded from a mix of PFCs, AIP grants, and other airport funds. The airport now has a modern terminal that houses all passenger carrier operations with ample capacity for expansion in the long term. Through 2018, Fitch has been advised that any debt-funded capital investment will be demand-driven and mainly focused on the expansion of the airport’s parking facilities.
— Debt Structure: Stronger
Outstanding debt fully amortizes at a fixed rate of interest. A large portion of the airport’s debt has been retired, substantially reducing the airport’s annual debt obligations to $5 million from $23 million.
— Financial Metrics:
The airport has achieved DSCR of 1.25x through the residual agreement and maintains very low leverage, reflecting its significant operating reserves. Fitch-calculated net debt-to-cash flow available for debt service (CFADS) for FY2013 – before the significant debt paydown – equaled 0.27x, and days’ cash-on-hand amounted to 292.
Peer Group: Pittsburgh, St. Louis, and Memphis airports have all experienced recent significant dehubbing activity, and they each act as good comparables for CVG in terms of traffic performance, although CVG’s liquidity and leverage metrics compare favorably. Pittsburgh and St. Louis benefit from slightly more diversified carrier bases, as do some of the neighboring airports with which CVG competes, such as Dayton and Indianapolis. CVG’s CPE compares favorably to these airports but is above average when considered across the ‘A’ category. Fitch does expect the airport to be more competitive in terms of this metric going forward.
Negative – Volatility in O&D Demand: A substantial reduction in the airport’s O&D traffic base below 2 million enplaned passengers.
Negative – Poor Cost Management/Stagnant Non-airline Revenues: A deterioration in the airport’s cost structure or sluggish non-airline revenue growth could push the airport’s CPE upwards, making it a less attractive base for airlines and leading to a fall in traffic.
Negative – Additional Debt Absent Organic Traffic Growth: Issuance of new debt without a corresponding increase in O&D traffic, leaving the airport higher leveraged.
Positive – A sustained trend of positive enplanements supported by carrier diversification.
Despite Delta’s substantial capacity reductions at CVG since 2008, the airline still accounted for 74 percent of 2013 traffic, meaning the airport remains exposed to significant carrier concentration. Airport management projects enplanements to decrease in 2014 by another 9.6 percent due to an additional 41.4 percent cut to Delta’s connecting services. Nevertheless, Cincinnati maintains a sizeable, and relatively stable, O&D base of 2.2 million enplanements which the airport will now primarily serve. Fitch will monitor O&D traffic’s resilience through the cuts and the extent to which low-cost carrier air service serves to backfill losses through Delta. Current airport infrastructure is modern and adequate to serve demand driven from this O&D base for the foreseeable future with limited debt needs. Still, O&D traffic could remain at risk in the event of continuing cuts to Delta’s short-haul services and given significant competition from airports in Dayton, Louisville, Columbus and Indianapolis, all of which offer cheaper air service.
Positive developments for the airport include Frontier Airlines’ introduction and expansion of low-cost carrier service to Denver, ramping up to 12 flights per week by August. Management reports 91 percent load factors on the Frontier flights, which have operated since May 2013. Also, Allegiant recently announced plans to more than double its service offerings at CVG, with increased flights to Phoenix and multiple Florida destinations. Fitch also views positively the expanded presence of DHL, which uses the airport as a major cargo hub and employs 2,200 at CVG, reporting that roughly 92 percent of all DHL U.S. freight volumes pass through CVG. Cargo landed weight grew by 7 percent in 2013 (outperforming the budget by 6 percent), and DHL recently invested $47 million to construct a new sorting facility and renovate existing facilities. Its presence eases the burden of airfield costs placed on passenger carriers and could help stabilize CPE metrics going forward.
Despite Delta’s reductions in connecting traffic over the last eight years, DSCR has remained stable in the 1.25x range pursuant to the CVG’s fully residual AUL. The airport has also managed to maintain CPE between $10 and $11 – below previous Fitch expectations – despite declining enplanements, by holding non-airline revenues steady, controlling operating costs and returning cash held on its balance sheet to carriers. In March 2014, CVG retired the 2002A, 2003C, and 2007B bonds with the use of reserved funds, thereby avoiding having to charge airlines for final-year debt costs.
The only bond series that remains outstanding is the 2003B series, payable from PFC collections, which airport management estimates should allow for coverage of nearly 2.0x above annual debt service going forward without charging any remaining debt costs to carriers. Fitch also notes that CVG raised the PFC rate to $4.50 from $3.00 in 2013. Management projects at this time to collect the full amount of PFC authorization in the next five years, after which point they expect to be able to pay the 2003B debt service as it comes due from these future collections, their current PFC balance of nearly $40 million, and interest earnings thereon. Fitch projects leverage net of unrestricted cash, operating & maintenance and debt reserves to migrate to well below 1.0x by 2018. Even in Fitch’s rating case, which assumes a full loss of connecting traffic and a sustained drop in O&D enplanements below 2.1 million, CPE levels stay within the current range without utilizing fund balances, consistent with other medium and large hub airports rated ‘A-.’
The bonds are secured by a pledge of all funds derived from direct or indirect use of the airport, including all rentals, landing fees, minimum airport use charges, AUL income, concession revenues, motor vehicle parking fees and charges and interest earnings on funds available for operations and on sinking fund and bond reserve funds. The Board may also use PFC monies up to the amount of debt service on the 2003B bonds.