FITCH AFFIRMS CHICAGO MIDWAY AIRPORT'S (IL) SECOND-LIEN REVS AT 'A'; OUTLOOK STABLE Fitch Ratings-Chicago-23 August 2017: Fitch Ratings has affirmed the 'A' rating on the city of Chicago, Midway International Airport's (Midway; MDW) approximately $1.8 billion second-lien airport revenue and revenue refunding bonds (MARBs). Fitch has also assigned an 'A' bank bond rating to the outstanding series 2014C MARBs. The Rating Outlook on all bonds is Stable. The city also has approximately $29 million of outstanding first-lien MARBs that Fitch does not rate. KEY RATING DRIVERS Summary: The rating reflects Midway's established strength as a primary hub location for Southwest Airlines (Southwest; 'BBB+'/Outlook Stable) and the robustness of the underlying Chicago air service market, which collectively offset MDW's currently elevated leverage position. Midway focuses mostly on domestic operations and serves as a solid complementary airport to nearby international gateway O'Hare Airport (O'Hare). Southwest's carrier concentration risk (greater than 90% market share) is partially mitigated by MDW's critical role to the carrier's national network, its increased presence and utilization at the airport, and its long-term contractual commitment. Midway's residual cost recovery framework provides for continued stable financial performance at 1.10x debt service coverage while maintaining relatively stable airline costs. Future capital needs should be limited and flexible in nature, allowing leverage to rapidly evolve downward to the 10x range by 2021. The series 2014C bank bond rating reflects a security pledge that would be on parity with outstanding second-lien revenue bonds. RESILIENT MARKET CONSTRAINED BY CARRIER CONCENTRATION (Revenue Risk: Volume - Midrange): Midway, focused on low-cost domestic services, is a second major airport serving Chicago's economically strong local air trade service area in a favorable mid-continent location. The airport served more than 11.3 million enplanements in 2016, with the percentage of origination and destination (O&D) passengers increasing slightly to 63%. In recent years, traffic growth has well outpaced that of both the nation and nearby O'Hare. Carrier concentration is markedly present with Southwest accounting for 93% of enplanements. While some air service competition may exist from nearby O'Hare, Midway fulfils a complementary role with ample capacity for growth. SOLID COST RECOVERY FRAMEWORK (Revenue Risk: Price - Stronger): Midway operates under a fully residual use and lease agreement (AUL) that provides for stable financial performance. Carriers signed a 15-year AUL renewal in 2012 running through 2027, demonstrating their long-term commitment to the airport. Currently competitive airline costs of around $10 per enplanement for 2016 will rise modestly over the next several years, mainly due to rising debt service obligations related to funding airport improvements agreed to by carriers, but should stabilize over the medium term and remain well below the costs expected at nearby O'Hare airport. MANAGEABLE, DEBT-FUNDED CAPITAL PLAN (Infrastructure Development/Renewal - Stronger): Midway's capital improvement plan (CIP) for 2017-2023 reflects works totalling $428 million and will be nearly entirely funded through previously issued bonds. Key airport facilities are in good condition following recently built terminal and concession areas as well as parking and
the completion of the consolidated rental car facility in 2013. Major projects, including parking, terminal concession redevelopment, and security checkpoint expansions, are demand driven and should be catalysts for non-airline revenue growth. HIGH PERCENTAGE OF FIXED RATE DEBT (Debt Structure (Second-Lien) - Stronger): A significant portion of Midway's debt is in fixed rate mode or hedged with swaps, leaving just 7% of debt exposed to variable rates. All debt is fully amortizing and Midway's debt service profile has become more level through restructurings. Nearly all of Midway's debt now resides on its secondlien with a fully cash-funded debt service reserve fund, but featuring a relatively weak rate covenant of 1.10x taking into account fund balances. This weakness is offset by the strength of the longterm, fully residual AUL that guarantees sufficient revenues to meet all obligations. The secondlien has been clearly established as the working lien, with the minimal remaining debt on the firstlien maturing in 2024 and the expectation of no further issuance at this level. FINANCIAL METRICS: Midway currently has a higher debt burden and cost profile than peers at $159 debt per enplanement ($251 debt per O&D enplanement) and 19x aggregate net debt/cash flow available for debt service (CFADS; excluding fund transfers), although this high leverage is temporary and should return to the 10x range by 2021 as debt service on outstanding obligations rises and is supported by airport revenues. Midway's proven history and strategic importance to both the city of Chicago and to Southwest mitigate against the above average leverage for the given rating level. Liquidity in the form of unrestricted cash and operating reserves is modest at 175 days cash on hand and will not likely increase given the residual airline agreement. All-in coverage for fiscal 2016 (including fund transfers) fell to 1.19x from 1.35x in 2015. PEER GROUP: Fitch-rated comps include Dallas-Love Field (DAL; 'A'/Outlook Stable and Detroit (DTW; 'A-'/'A-' senior/sub, Outlook Positive). DAL similarly serves a comparable strong, metropolitan market with a greater than 90% Southwest concentration and faces competition from a larger, nearby airport, but it plays less of a strategic role in the Southwest network, serving fewer passengers and destinations and with less daily seat capacity. DTW shares an elevated leverage profile with high carrier concentration and similar coverage levels to MDW under its likewise long-term, fully residual AUL. RATING SENSITIVITIES Future Developments that May, Individually or Collectively, Lead to Negative Rating Action: --A material traffic decline or increased traffic volatility given the Southwest concentration; --Introduction of a capital program resulting in a significant increase to borrowing plans; --A sizeable increase to airline costs as a result of underperformance with respect to non-aviation revenues or from higher operating expenses. Future Developments that May, Individually or Collectively, Lead to Positive Rating Action: --Upward rating migration is not likely in the near term given Midway's elevated debt burden and exposure to carrier concentration. CREDIT UPDATE Performance Update Traffic grew for the eighth consecutive year, up 2% in 2016, to a new peak enplanement level of 11.3 million. The five-year CAGR is a relatively strong 3.7%. This growth has reversed year-todate in 2017, however, with enplanements down 1.25% through the first six months. Management indicated that this was due to inclement weather conditions that caused flight cancellations earlier
in the year, but they anticipate that the increased seats in the summer schedule will compensate for this minor reduction leaving enplanements largely flat year-over-year. Given the expectation of the continued high market share of Southwest (currently 93%) and the 37% connecting passenger base at the airport, Midway's future traffic performance and financial flexibility will be heavily influenced by Southwest's scheduling decisions. However, Midway's increasingly strategic importance to the Southwest network serves as a mitigant to this risk. Southwest serves more destinations and passengers from Midway than any other airport in its network, Midway has the greatest seat capacity in the network, and has experienced the greatest growth in destinations, departures, and passengers over the last decade. In addition to the fully residual AUL, Fitch views favorably Midway's strides to reduce the risk associated with its debt structure. Midway has now reduced its variable rate debt exposure down to 14% from 25%, with more than half synthetically fixed. In addition, Midway has reduced its put bond risk and its maximum annual debt service and has smoothed its overall debt service profile. Midway's 2017-2023 CIP remains manageable at $428 million, down slightly from its 2016-2022 CIP of $458 million. The program is nearly 100% bond funded from past issuances (predominantly from the series 2016A&B issuances) with no additional bonding anticipated. Positively, main projects should be revenue accretive. Leverage is currently elevated as a result of terminal and airfield improvements over the past decade, but is offset by the strength of Midway and the underlying market it serves as well as its importance to the Southwest network. Further, leverage should evolve down to 10x by 2021 given the amortization profile and lack of additional borrowing needs. CPE is estimated at around $10 for 2016, up from $9.16 for 2015 as expense growth outpaced that of enplanements and associated revenues. Expenses rose by approximately 9% reflecting increases in deferred salary/wages, repairs and maintenance, and other operating expenses. Expenses are forecast to grow at a more modest normalized rate of 4% per annum by the airport's consultant tied to enplanement growth and inflation. Midway's airline costs are likely to continue to rise over the forecast period as debt service obligations and operating expenses ramp up but should remain competitive at around $14 and well below that of nearby O'Hare. However, should non-airline revenues fall short of expectations or operating expenses exceed forecast, Midway's financial profile could be pressured, resulting in higher CPE. Midway's 2016 debt service coverage ratio (DSCR), taking into account the use of cash reserves and non-pledged revenue sources such as PFCs and CFCs, fell to 1.19x from 1.35x for 2015 but remains above the 1.10x covenant level. The city anticipates total coverage to remain above its 1.1x rate covenant through the projection period. On a purely cash flow basis, without the benefit of fund transfers, total coverage was sum sufficient at 1.02x in 2016. This is largely commensurate with prior years given the residual nature of the AUL. Fitch Cases Fitch's base case holds enplanements flat for 2017 per year-to-date performance and discussion with management followed by 2% growth per annum through 2021. Revenue assumptions for 2017 largely follow that of 2016 actuals given the flat enplanement assumption, but closely follow the airport consultant thereafter. Total Revenues grow at a 6.4% CAGR from 2016-2021, while operating expenses grow at a lesser 4% CAGR. Under this scenario, CPE is likely to reach $14.34 by 2021 and net debt/cfads evolves to 10x. DSCRs are expected to remain stable around the 1.10x covenant given the fully residual AUL.
Fitch's rating case assumes a nearly flat enplanement base (-0.5% CAGR) through 2021, taking into account an 8% loss in 2018 with 2% recovery in future years. Total revenues still grow at a 6.3% CAGR driven by airline revenue growth of 9.2%. Operating expenses are still forecast to grow at a 4% CAGR through 2021 despite the lower enplanement volume. Under this scenario, CPE is likely to reach $16.78 ($2.44 more than the base case) by 2021; however, net debt/cfads will still fall to approximately 10x and DSCRs are expected to remain comparable to the base case given the AUL framework. Given Midway's exposure to Southwest's hubbing operation, Fitch also tested a sensitivity scenario that stressed enplanements with a permanent loss of 25% of connecting traffic in 2018 coupled with a 5% loss to O&D traffic that recovered by 2021. Operating expenses were grown at a 3.9% CAGR, reflecting some cost containment measures given the enplanement loss. The result was a CPE of approximately $18.38 by 2021 or an increase of $4.03 above the base case. Even under this unlikely scenario, CPE would remain competitive with other large hubs that have taken on sizeable capital programs. Contact: Primary Analyst Jeffrey Lack Director +1-312-368-3171 Fitch Ratings, Inc. 70 West Madison St. Chicago, IL 60602 Secondary Analyst Seth Lehman Senior Director +1-212-908-0755 Committee Chairperson Chad Lewis Senior Director +1-212-908-0886 Media Relations: Sandro Scenga, New York, Tel: +1 212-908-0278, Email: sandro.scenga@fitchratings.com. Additional information is available on www.fitchratings.com Applicable Criteria Rating Criteria for Airports (pub. 14 Dec 2016) https://www.fitchratings.com/site/re/891804 Rating Criteria for Infrastructure and Project Finance (pub. 08 Jul 2016) https://www.fitchratings.com/site/re/882594 ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: HTTPS://WWW.FITCHRATINGS.COM/UNDERSTANDINGCREDITRATINGS. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEB SITE AT 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. DIRECTORS AND SHAREHOLDERS RELEVANT INTERESTS ARE AVAILABLE AT HTTPS://WWW.FITCHRATINGS.COM/SITE/ REGULATORY. FITCH MAY HAVE PROVIDED ANOTHER PERMISSIBLE SERVICE TO THE RATED ENTITY OR ITS RELATED THIRD PARTIES. DETAILS OF THIS SERVICE FOR RATINGS FOR WHICH THE LEAD ANALYST IS BASED IN AN EU-REGISTERED ENTITY CAN BE FOUND ON THE ENTITY SUMMARY PAGE FOR THIS ISSUER ON THE FITCH WEBSITE.
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