Fitch Rates City of San Jose, California, Airport Revs ‘A+’; Revises Outlook to Negative

Fitch Ratings has assigned the City of San Jose, California’s $835,995,000 airport revenue bonds, series 2007 an underlying ‘A+’ rating as follows:

–$589,095,000 series 2007A (AMT);

–$187,025,000 series 2007B (Non-AMT) ;

–$50,700,00 series 2007C refunding (Non-AMT) ;

–$9,175,000 series 2007D refunding (AMT).

The series 2007 bonds’ Rating Outlook is Negative.

The bonds are scheduled to sell on August 14-15, 2007, via a syndicate led by Lehman Brothers. Expectations are that the bonds will carry bond insurance from a monoline insurer, whose claims paying ability is rated ‘AAA’ by Fitch.

Proceeds of series A&B will finance phase-I capital development at the Norman Y. Mineta San Jose International airport (the airport), which includes remodel and expansion of Terminal A, completion of the new North Concourse, the first half of a new Terminal B and removal of the old Terminal C, related parking and roadway work, and a consolidated rental car facility. Furthermore, the series A&B bonds will be used to refund outstanding commercial paper ($38 million), fund capitalized interest ($129 million) and provide for a debt service reserve fund. Series C is an advance refunding of a portion of series 2001 and series D refunds series 1998A. The Series 2007 bonds are issued on parity with $485 million in outstanding airport revenue bonds, whose underlying ratings are affirmed at ‘A+.’ The Rating Outlook for all bonds is revised to Negative from Stable.

The revised outlook reflects the airport’s continued enplanement volatility coupled with development of a large and complex capital plan. During 2001-2006, due to the dot-com bust, events of 9-11, and American Airlines’ service reductions, the airport’s enplaned passengers declined 28% overall. The enplaned passenger declines occurred in fiscal 2002 and 2003, but since then traffic has grown at only 1-2% annually. Current estimates for 2007 indicate further erosion of enplanements (2.1%), but with American Airlines’ service stabilized, the airport expects enplanements to increase at a 2.5% compound annual rate through 2015. In terms of the capital plan, 79% of the total $1.3 billion cost of phase-I will be developed through a design-build contract with Hensel Phelps Construction Company creating construction processes and efficiencies. However, with only parts of the project at 30% design, the risk of future cost escalation is present. Under the airport’s base-case forecast, the cost per enplaned passenger increases to $11.82 in fiscal 2011 from $4.79 in fiscal 2006, which is high for an airport of this size. Furthermore, with the addition of $776 million of bonds, the leverage ratios increase substantially to $215 of debt per enplaned passenger and long-term debt to net revenue available for debt service at 14x in fiscal 2011.

The ‘A+’ rating reflects the strength of the airport’s service area, which includes the City of San Jose (rated ‘AA+’/Stable Outlook by Fitch), the third largest city in California and the 10th largest in the US. The airport is located in the competitive Bay Area region with San Francisco International Airport and Oakland International Airport nearby, but it benefits from its proximity to the Silicon Valley, which is home to 150 companies with greater than $1 billion of market capitalization, and closer to the population growth occurring in the counties of Santa Clara and San Benito. Additional strengths include the airport’s very high origination and destination orientation of 96%, and decent airline market share diversity led by Southwest Airlines (rated ‘A’/Negative Outlook by Fitch Ratings) accounting for 41% of the service in fiscal 2006.

Experienced and fiscally conservative airport management consistently produces strong debt service coverage and cash balances under the existing residual methodology. Starting in fiscal 2008 the airport’s airline rate-making methodology changes to hybrid, which should minimize airline costs, generate decent debt service coverage, increase airport profitability, and enable the airport to generate excess money for development or reserves.

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