Fitch Downgrades Susquehanna Airport Authority’s Senior & Sub Bonds

Fitch Ratings has downgraded the underlying rating on Susquehanna Area Regional Airport Authority’s (authority) approximately $133.5 million of outstanding senior airport system revenue bonds (senior bonds) to ‘BBB-’ from ‘BBB’ and downgrades the rating on the authority’s $59.7 million of outstanding subordinate airport system revenue bonds (subordinate bonds) to ‘BB+’ from ‘BBB-’. With these rating actions, the senior and subordinate lien bonds that were previously placed on Rating Watch Negative in January 2007 is resolved. The Rating Outlook on all liens is Stable, reflecting Fitch’s expectation that passenger traffic, while exposed to some volatility has a stable base level of demand with some possibility to grow in the near and medium term.

The downgrade of the senior lien bonds, which are secured by a pledge of airport system net revenues and an irrevocable commitment of passenger facility charge receipts, to ‘BBB-’ reflects Harrisburg International Airport (the airport) exposure to a fundamental change in U.S. airline industry service patterns to small and medium sized airports. With the majority of legacy airlines, notably US Airways (the airport’s dominant carrier), diverting mainline aircraft to larger city pairs, and low cost airlines now deploying assets to proven markets rather than secondary airports, the prospects for material increases in service and/or enplanements at this airport are dim.

While regional affiliates of the legacy carriers, which currently dominate the airport, are expected to maintain a stable schedule to support their respective legacy partners, the airport’s terminal infrastructure, expanded and redeveloped at a cost of $233 million and financed with proceeds of the series 2003 and 2004 bonds, is underutilized as it was designed to support larger passenger volumes. As a result, the airport’s cost structure has absorbed bond debt service without benefiting from increases in passenger related revenues. This structural imbalance has created well above industry average airline costs per enplanement (approximately $16.68 for fiscal 2007) and is a major impediment to attracting a low cost carrier which could potentially generate the traffic volume for which the terminal was built.

An investment grade rating on the senior lien bonds is still warranted due to the stable base of origin & destination demand served by the airport, including passenger traffic generated by state government and area corporations and universities; the ability of airport management in a crisis to raise rates and charges to meet bondholder covenants; and minimal future capital needs, with no additional debt planned. While the subordinate debt remains outstanding (through fiscal 2018), the senior lien position remains significantly over collateralized relative to its subordinate counterpart. Thereafter, coverage of senior lien debt service will likely be driven down and the authority will need to implement timely increases in its rates and charges to meet the 1.25 times (x) rate covenant as annual obligations gradually escalate.

The downgrade of the subordinate lien bonds, which are secured by a subordinate pledge of airport system net revenues and receipts under a Federal Aviation Administration Airport Improvement Program (AIP) Letter of Intent (LOI), to ‘BB+’ is based on the substantial leverage carried by this lien and the significant reliance on LOI payments to meet debt service. This reliance is now further exacerbated by the materially weakened backup pledge of airport system net revenues which would be called upon in the event LOI payments were delayed.

The subordinate lien bonds have always been highly leveraged and dependent on the offset of federal Letter of Intent (LOI) monies. While the authority has generally received LOI monies on or ahead of schedule the significant reliance on these funds, which will run through 2010, makes timely debt service payments highly vulnerable to any delay or interruption in these payments. Subordinate net revenues of the airport system do remain available to meet debt obligations through final maturity. However, as most net revenues will be required to meet operating expenses and senior lien obligations, the strength of the subordinate pledge is substantially weaker than when Fitch first rated the lien in 2003.

In 2006, the authority circumvented the legal requirements of the bond documents when it drew from both the senior and subordinate bond debt service reserve funds without regard to lien position. These draws highlighted structural weaknesses of the documents. Management indicates that all reserves are now fully funded and that authority budgeting practices are better aligned to match document requirements. Fitch’s ratings assume the legal documents will be strictly followed by the authority.

For the nine months ended Sept. 30, 2007, authority operating revenues are outpacing operating expenses, and Fitch views the authority’s budgeted 37% operating margin for full fiscal year as achievable. In addition to prudent expenditure management and timely increases in rates and charges, passenger volumes have increased steadily through November 2007, with total enplanements up approximately 11% over the corresponding time period in 2006; however, passenger traffic is still below originally forecast levels. Fitch views both the operational and financial improvement cautiously, noting that expenses are expected to increase in 2008 and without stable air service and related enplanements, the ability of the airport to generate needed non-airline revenues could be pressured. The authority expects debt service coverage in 2007 to be adequate, equal to 2.74x for the senior bonds and 1.24X for total obligations. Both coverage levels exceed the required rate covenants of 1.25x for the senior bonds and 1.1x for all debt.

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