Fitch Rates Chicago O’Hare Airport’s 3rd Lien Revs ‘A’

Fitch Ratings assigns an ‘A’ rating, with a Negative Rating Outlook, to the City of Chicago’s approximately $1.5 billion Chicago O’Hare International Airport general airport third lien revenue bonds (GARBs), series 2005, scheduled for negotiated sale on or about Dec. 13 through a syndicate led by Citigroup. Proceeds of the bonds will finance portions of the first phase of the O’Hare Modernization Program (OMP) and refinance a portion of the airport’s outstanding debt. The bonds are secured by the net general revenues generated at O’Hare International Airport (O’Hare, or the airport) on a subordinate basis to the airport’s outstanding first and second lien GARBs. The transaction consists of approximately $1 billion of fixed-rate bonds, and approximately $500 million of variable-rate demand obligations (VRDOs). The series designations and par amounts will be established at the time of pricing. Liquidity support for the VRDOs will be provided by one or more financial institutions. Payments of principal and interest on all series of bonds are expected to be guaranteed by one or more insurance policies to be provided by financial guarantors. Fitch expects to assign short- and long-term ratings to the VRDOs based on the support of the liquidity facilities and insurance policies securing each series of bonds nearer to closing. Fitch also expects to assign long-term ratings to the fixed-rate bonds, based on the insurance policies, at that time.

Fitch also affirms the underlying ‘AA-’ ratings on the airport’s $259.8 million of outstanding first lien GARBs and $926.6 million second lien GARBs; the ‘A’ rating for approximately $2.0 billion of outstanding third lien GARBs; the ‘A+’ rating for approximately $180.7 million of outstanding first lien passenger facility charge (PFC)-backed bonds; and the ‘A’ rating for approximately $672.5 million of outstanding second lien PFC- backed bonds. The lower rating for the third lien GARBs is based on their subordinate payment position and comparatively weak legal provisions, which include a rate covenant and additional bonds test equal to 1.10 times (x) annual debt service or 1.0x including required fund deposits. These relative weaknesses become acute upon the maturity of the outstanding first and second lien bonds in 2018, at which point the third lien becomes the senior operating lien.

The ratings for O’Hare reflect the airport’s central role in the national air transportation system, including major hubs operated by American Airlines (American) and United Airlines (United); a broad and diverse economic base that creates strong local demand for air service that complements the airlines’ hubbing operations; and management’s proven track record of sound financial operations that results in a competitive cost structure. Credit concerns largely relate to two areas: the risks attenuate to the airport’s sizable, though flexible, capital program; and O’Hare’s reliance on its two largest carriers, United and American (issuer default rating of ‘CCC+’ by Fitch). While the airport maintains significant flexibility for the eventual timing of phase two of the OMP, as well as terminal development and other aspects of the overall capital program, Fitch believes the efficient management of this extensive redevelopment program and adherence to the stated budget will be critical to the maintenance of O’Hare’s competitive position relative to other hub airports as well as the airport’s current rating status in light of the scope of planned borrowings over the next five to 10 years. This is particularly true in consideration of the weakened financial position of the airline industry in general and United and American in particular, whose significant connecting traffic exposes the financial performance of O’Hare to changes in their scheduling and operating decisions.

The Negative Rating Outlook for O’Hare is based largely on the continuing bankruptcy proceedings of United and the carrier’s inability to assume the airport use and lease agreement due to ongoing litigation related to its special facility bonds for projects at the airport. While the financial difficulties experienced by the nation’s airlines in general and the rising fixed costs associated with the airport’s capital program also place negative pressure on the rating, Fitch plans to review the Outlook upon United’s assumption (or renegotiation) of the use and lease agreement and the anticipated completion of its bankruptcy proceedings in the first quarter of 2006 due to the diminution of the short-term risks associated with the airport’s largest tenant.

This issue marks the initial transaction for the estimated $7.5 billion OMP (all estimates expressed in 2004 dollars, per the Federal Aviation Administration (FAA)), an extensive capital program designed to realign the airport’s existing intersecting runway system to a modern parallel design and address the increasingly common delays caused by excess demand and the airfield’s inefficient layout in poor weather conditions. In addition to the OMP, the airport’s master plan includes the construction of additional terminal facilities and routine capital investment through 2020, which brings the total estimate of the capital needs at O’Hare to approximately $14.3 billion. The FAA, which issued its Record of Decision regarding the OMP on Sept. 30, 2005, estimates the reconfigured airfield will be able to handle 1.2 million in operations in 2018 (an operation represents one takeoff or one landing), with an average delay of 5.8 minutes. This compares with 922,787 operations in 2004 with an average delay of 9.3 minutes and a forecast of 974,000 operations in 2015 with an average delay of 17.1 minutes without the OMP. The difference in the forecasted average delay in 2015 between the reconfigured and the existing airfield alone achieves an estimated $243.3 million in annual operating savings for the airlines, without consideration for the increase in operations and resultant rise in passenger volume. Fitch also notes this forecast is based on current air traffic control procedures, improvements in which may result in greater capacity gains for the airport at the same level of delay.

The airport’s feasibility consultant projects the airport’s cost per enplaned passenger (CPE) will rise to $16.34 in 2014 from $7.48 in 2004, based on the current construction and financing plans for the first phase of the OMP and the five-year capital improvement program, as well as its assumptions regarding the regional and national economies among other factors. The forecast indicates passenger volume will increase at a 1.6% average annual rate for the period, to 43.4 million enplanements, while debt service coverage remains adequate based on the airport’s residual use and lease agreement. Fitch considers the feasibility study as reasonable, though somewhat preliminary as the project is at its earliest stages, based on the airport’s historical growth trend and the market area’s underlying economic strength. Furthermore, Fitch considers the projected CPE as being in line with the forecasted CPEs for other major airports with extensive capital programs.

While the current feasibility study does not address phase two of the OMP, or the other elements of the airport’s capital initiatives, both the airport and the FAA have considered the financial implications for the entire program in other documents. The FAA, in its recent announcement of its grant of a letter-of-intent for discretionary Airport Improvement Program funds to finance $300 million of phase one projects, indicates O’Hare’s CPE may rise to around $20 under the full OMP, and approximately $30 for the full capital program, in 2015. While these figures place O’Hare at the moderately high to high end of the CPE spectrum based on current forecasts for other airports, they are not out of line with projections for other airports with sizable capital programs. Fitch notes that the final CPE will be influenced by the actual timing and construction of projects in phase two, terminal facilities, and other aspects of the capital program, which remains at the discretion of the airport and will be undertaken after consultation with the airlines and based on actual demand. However, these figures demonstrate the critical nature of the airport’s ability to adhere to the stated budget as even cost variances that are minor in percentage terms may result in significant increases in nominal terms and inflate the airport’s future CPE.

O’Hare consistently ranks among the world’s two busiest airports in terms of both operations and passengers. The airport served a record 37.4 million enplanements in 2004, which represents a 1.5% average annual growth rate from 1995. United is the airport’s largest carrier, accounting for 48.5% of total enplanements in 2004, followed by American at 36.4%. The airport’s residual use and lease agreement results in consistently sound financial operations, with net revenues providing 1.5 times (x) coverage of annual debt service on first and second lien bonds, and 1.1x coverage of third-lien bonds, in 2004. Management’s focus on controlling expenses and improving non-aviation revenues resulted in a decline in the airport’s CPE to $7.48 in 2004 from $8.78 in 2003.

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