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This Time Is Different: An Anemic And Uncertain Passenger Recovery Will Challenge U.S. Airports' Credit Quality


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This Time Is Different: An Anemic And Uncertain Passenger Recovery Will Challenge U.S. Airports' Credit Quality

The entire aviation industry continues to face significant disruption caused by the COVID-19 pandemic, which S&P Global Ratings believes will dramatically reshape the U.S. airport sector landscape, adding uncertainty and potential variability to operations, along with comparatively weaker financial performance and competitiveness. It is clear this is unlike previous downturns in severity; likely duration; its effect on the rise of virtual meetings and decline of business travel; and, most notably, the tremendous industrywide transformation required to address consumer health and safety issues on a global scale. We view this precipitous decline not as a temporary disruption with a relative rapid recovery, but rather as a backdrop for what we believe will be a period of sluggish air travel demand that could extend for a prolonged period. Our ratings incorporate downside risks, but not to the degree airport operators are currently experiencing or for the possible duration of this downturn.

We revised our sector outlook in mid-March (see "U.S. Transportation Infrastructure Sector Outlook Update: Now Negative For All Sectors," published March 16, 2020, on RatingsDirect); revised all individual long-term airport issuer and issue-level debt rating outlooks to negative (see "Ratings Outlooks On U.S. Transportation Infrastructure Issuers Revised To Negative Due To COVID-19 Pandemic," published March 26, 2020). Subsequently, on Aug. 7, 2020, we placed all U.S. not-for-profit airports on CreditWatch with negative implications (see "U.S. Airport Ratings Placed On CreditWatch Negative On Severe Passenger Declines And Weakening Credit Metrics"). We also lowered ratings on airports globally, with rating actions in the U.S. not-for-profit airport sector thus far limited to downgrades of one notch, reflecting diminished credit quality caused by factors outside of management's control, which include activity levels we believe will be materially depressed, unpredictable, or volatile .

We are currently applying our April 2020 baseline and downside passenger activity estimates for U.S. not-for-profit airports to benchmark and evaluate management-provided forecasts against our criteria and financial metrics. Based on the best data available, U.S. systemwide activity is approximately 70%-75% lower than 2019 levels for the month of July. This is approximately in line with our baseline recovery estimate; however, recent airline capacity reductions put this at risk, with systemwide passenger activity trending to our downside.

The June 25 S&P Global Economics forecast did not alter our April baseline or downside activity estimates, but this could change with updated information. Our current April baseline estimates assume a passenger recovery to 2019 levels by 2024. (See "Activity Estimates For U.S Transportation Infrastructure Show Public Transit And Airports Most Vulnerable To Near-Term Rating Pressure," published June 4, 2020.)

Most current U.S. airport ratings are high investment-grade and we expect the sector will have a greater ability to weather adverse credit conditions than largely speculative-grade sectors such as airlines. While we have taken rating actions in the airport sector and will continue doing so, at this time we generally expect them to be less severe because of the sector's important infrastructure-provider role, access to the capital markets, and financial flexibility. Nevertheless, we expect to maintain a negative outlook on affected entities until we have better visibility into the shape of the recovery.

U.S. Airports Face Weaker Markets And Financial Metrics

S&P Global Ratings acknowledges a high degree of uncertainty about the evolution of the pandemic and its effect on the economy and air travel.   Our current economic forecasts anticipate a slower recovery beginning in third-quarter 2020, ending at a negative 5.0% real GDP growth rate in 2020 and rebounding to 5.2% growth in 2021, a full percentage point weaker than our previous 2021 estimate of 6.2%. With this summer's national virus transmission rates rising to new peaks, uncertainty is elevated again. Several states have shut down parts of their economies and instituted new quarantine restrictions, which could erode the bounce-back in the third-quarter 2020 real GDP growth of 22.2% (annualized). The recovery remains fragile--in particular, because of uncertainty about the timing of an effective vaccine being readily available, fears of another wave of COVID-19, and the reluctance of surviving businesses to quickly rehire workers. Our economic forecasts and macro credit implications associated with the pandemic assume a vaccine or effective treatment is widely available in the second half of 2021. (See "U.S. Economic Update: A Recovery At Risk As COVID-19 Surges," published July 22, 2020.)

Against this backdrop, accurate estimates regarding the timing and pace of a recovery have been fleeting.   By definition, the unprecedented nature of the pandemic on global aviation has complicated the collective industry response and development of financial forecasts, among the many challenges faced by airport operators. Time horizons and predictions regarding the evolution of the coronavirus pandemic and related impacts remain highly uncertain and we believe current airport financial forecasts based on estimates of passenger recovery scenarios at this time are subject to considerable uncertainty.

The return of passenger activity will not be uniform.   We believe many airports may recovery more quickly, while others will face a much longer road. Some airports might not reach past peaks for a decade or longer. Currently, our view is that U.S. airport operators' market positions as defined in our criteria have weakened for the foreseeable future. Our market position assessment typically focuses on the role and importance a transportation infrastructure provider plays in its respective industry, activity level trends (including customer diversity and volatility), and rate-setting flexibility (legally, economically, and politically).

Individual airports will demonstrate variable financial recovery to sustainable-but-lower levels of financial performance as measured by our key metrics.   We anticipate financial sustainability will be achieved partially based on airport hub size and location (including population growth); the business strategy and relative success of an airport's dominant airline; the domestic, international, leisure, and business passenger mix; cost structure; and the ability of airport management to navigate evolving business conditions. However, risks remain to the downside with airport operators potentially experiencing materially lower, uncertain, or anemic activity, hampering cash flow generation and translating to likely lower DSC, weakening financial profiles compared with pre-COVID-19 levels.

COVID-19 Will Reshape The Airport Industry Landscape

In mid-February 2020, the U.S. airport sector was well down the path of a renaissance in airport construction and reinvestment of aging infrastructure, with most airports reaching all-time highs in enplanement activity. U.S. enplaned passengers reached a record level of 1.05 billion in 2019, including 241 million international passengers, buoyed by a long economic expansion, increased population, and mobility and tourism worldwide. Airports have a long history of resilience to past economic cycles and demand shocks, and operators confidently proceeded with ambitious, multiyear capital programs, overwhelmingly financed with debt. U.S. airports currently have approximately $7 billion in debt service annually and about $100 billion in total debt outstanding.

Since 2002, U.S. domestic traffic has experienced only two years of decline, following the Great Recession, at 4.0% and 5.2% in 2008 and 2009, respectively, with international traffic at U.S. airports increasing since 2002 at 4.3% annually, with only one meaningful decline of 5.3% in 2009. Demonstrating its long-term resilience, the U.S. aviation industry has only experienced eight instances of passenger activity declines since 1971, before recovering and resuming longer-term growth.

We believe the COVID-19 pandemic and resulting global recession are unlike any previous disruption.   The severity of the current decline highlights risks previously not observed during past activity declines, including 9/11, SARS, and the Great Recession beginning in 2008. Never before have operations been so acutely affected with the likelihood of a prolonged recovery set against the backdrop of a weakened and contracting airline industry grappling with an evolving global health crisis and significant longer-term challenges. In addition, risks remain that future pandemics could have a similar acute negative effect on activity without health and safety innovations throughout the industry.

For the airline and airport industries alike, this uncertainty is compounded by the uncoordinated and still-evolving operational challenges regarding how best to meet--and pay for--consumers' health and safety expectations as well as how to coordinate the myriad of governments and regulators that oversee the global aviation network. Developing and implementing international health protocols for health emergencies like the current pandemic will take time and could prove comparatively difficult relative to the aviation industry security standards established post-9/11.

We believe current scenarios or projections necessitate epidemiological and human behavior assumptions that exceed the predictive abilities of industry experts.   Passenger recovery forecasts in the current environment are fraught with the challenges of predicting human behavior and consumer choice when people might not respond rationally to economic incentives or update their beliefs based on new, evolving information and act accordingly. Rather, until there is a widely held view that the entire air travel experience is safe, many consumers will likely seek alternatives. Still unknown are longer-term implications for business travel, the explosive growth of remote and virtual meetings, macro changes in consumer behavior, existing and future travel restrictions (including quarantines), and capital investment to reconfigure airport terminals for social distancing and passenger processing. And of course, the ultimate timeline to implement an effective, widely available, and broadly accepted vaccine and treatment regime is currently unknown.

Weakened U.S. Airlines Will Get Smaller

When CARES Act money runs out by the end of September, U.S. airlines are expected to downsize by 20%-30%, reducing employees and flight operations to better align with fare revenues. This will have a direct impact on airport operators, which, to date, have at least been able to collect landing fee revenues for largely empty flights. Much like the airport sector, the airline industry has been buoyed by the $50 billion in government aid, which provided a combination of cash grants and unsecured and secured loans. Five airlines have signed letters of intent with the U.S. Treasury for additional loans permitted under the Act, including American Airlines Inc. (B-/Negative), Spirit Airlines Inc. (B/Negative), Frontier Airlines (not rated), Hawaiian Airlines Inc. (CCC+/Negative), and SkyWest Airlines (not rated). The other major U.S. airlines-- Delta Air Lines Inc. (BB/Negative), United Airlines Inc. (B+/Negative), Southwest Airlines Co. (BBB/Watch Neg), Alaska Airlines Inc. (BB-/Negative), and JetBlue Airways Corp. (B+/Negative)--have not closed the door on seeking federal loans.

Although additional debt improves liquidity and buys time (and boosts market confidence enough to attract additional investment), it further burdens balance sheets. We see domestic and leisure travel recovering before international and business, although a second wave of COVID-19 would set back the recovery and, if it is on the scale of the first wave, multiple airline bankruptcies are likely. While airlines have cash now, they typically don't wait until liquidity is depleted before filing for bankruptcy (see "Industry Top Trends Update: North America Transportation," published July 16, 2020).

What We Are Seeing

U.S. airport management teams we have contacted have taken action to adapt to the sudden and severe activity decline and resulting revenue contraction. Examples of such actions include:

  • Expense reductions including consolidating landside terminal space, closing parking garages, and reducing activity-linked services like ground transportation;
  • Significantly reducing other discretionary expenditures (but not reducing headcount as a condition of receiving federal CARES Act money) and hiring freezes;
  • Deferring deposits to pension benefit programs;
  • Reducing annual capital expenditures and deferring multiyear programs;
  • Refinancing or paying down debt or near-term debt maturities to improve near-term flexibility and meet rate covenant levels;
  • Issuing debt to pay debt service requirements, often in the form of private placements or direct bank lending;
  • Issuing bond anticipation notes to provide funding for capital needs on an interim basis; and
  • Adding to or extending lines or letters of credit to improve cash positions.

At many airports, growth in cargo activity has been the only bright spot as online and overnight shipping increased during the pandemic.

Key Airport Risks From Weaker Demand

A key risk is operators' airline use and lease agreements.   These agreements typically include some cost-recovery mechanisms, requiring airlines to pay higher landing fees and/or terminal rentals when activity levels decline. These work well in benign or moderately stressed operating environments, but are untested in the current severe market downturn. A few of the issues we have identified are:

  • How will airports manage the continued pressure to keep airline costs low? Are airlines willing and able to pay higher fees to help make the airport financially sufficient for as long as the severe downturn continues?
  • Will additional requests for rent and rate relief by the airlines and airport tenants be accommodated?
  • How will the airline industry change structurally and what are the operational and capital investment implications for airports including a significantly reduced airline footprint?
  • Under a bankruptcy scenario, will airlines affirm all their leases and continue to pay airport operators as they have in the past?

We believe airport operators have less flexibility to increase airline fees among fewer major airline tenants to compensate for declining passenger volumes. Although some non-aeronautical revenues are often shared with airline tenants to lower their rates and charges, many airport operators are fully responsible for certain cost centers supported by non-airline revenues derived from concessions such as food and beverages, retail and duty free, parking, rental cars, and ground transportation. As a result, airports with compensatory-style airline use and lease agreements dependent on traffic and concession revenues could be more exposed to weaker DSC and debt capacity metrics.

Rising accounts receivable in the form of rental credits, deferrals, lease extensions, waivers of minimum annual guarantees, write-offs or renegotiation of revenue-sharing provisions are other risks. Strong airport liquidity in the form of CARES Act money and other federal sources combined with the healthy unrestricted and restricted cash position, has enabled airport operators to offer temporary rate relief. In some instances, entire concession agreements are subject to renegotiation or cancellation due to provisions linking payments to traffic levels.

While they're unavoidable, we believe rent and concession agreement relief measures taken by airport management combined with the steep drop in non-aeronautical revenues will weaken airport finances, particularly if airlines or concessionaires file for bankruptcy protection or otherwise default. Retail and activity-based non-airline revenues, which have risen in recent years to 45%-50% of most airports' revenue mix, will likely be even more heavily hit than aeronautical revenues from the passenger declines and global recession reflected in lower renegotiated revenue-sharing agreements. (For other potential effects, see "When The Cycle Turns: U.S. Airport Balance Sheets--And Exposures--Increase With Traffic" published July 9, 2019.)

S&P Global Ratings' Analytical Approach

S&P Global Ratings' criteria for evaluating not-for-profit airports focus on two fundamental elements: an enterprise risk profile and a financial risk profile, each with separately weighted factors. The market position is a primary credit factor within our enterprise risk profile that incorporates activity level trends; passenger volatility; rate-setting flexibility; and additional considerations outside of the operator's control, including health scares. This market position assessment is the highest-weighted factor (60% weight), followed by industry risk (20%), economic fundamentals (10%), and management and governance (10%). Within our overall financial risk profile, we consider such factors as financial performance (55% weight), debt and liabilities capacity (35%), and liquidity and financial flexibility (10%).

Given the current and anticipated aviation industry conditions, our analytical approach thus far has been to likely weaken an individual airport's market position assessment under our criteria, reflecting a change in the sector and decline in each airport's passenger demand of unknown duration. We believe this change in market position and, if necessary, other qualitative adjustments, is appropriate to accurately reflect airport creditworthiness (such as general airport revenue bonds) or airport-related debt (such as passenger facility charge-secured ratings; airport parking ratings; and special facility ratings, including consolidated rental car facilities and airline fuel systems).

We view current rate-setting flexibility as severely constrained in the near term, contributing to an overall weaker credit profile.   We could further weaken the market position assessment or make other qualitative adjustments if the rate of recovery in activity levels remains notably below our expectations. Conversely, if activity levels rebound faster than we estimate, and we believe such a rebound is sustainable, our market position assessment could improve and we could raise ratings.

Reliance On Cash Reserves Reflects Weaker Credit Profiles

Although airport operators have resources to ensure timely payment of debt service, our criteria give weight to sustainable financial operations from recurring revenue sources.   In our view, reliance on cash reserves to support operations reflects a diminished capacity to service obligations and suggests a user base unable or unwilling to support facility costs. If recurring revenue sources do not recover quickly enough and non-recurring sources or actions are exhausted or limited, we believe an obligor's chances of making timely payments is less certain, indicating a weaker rating.

Going forward, we expect to evaluate management actions to mitigate the effects of revenue declines and expense increases to reach financially sustainable operations.   Our focus will be on each airport operator's forward-looking financial risk profile, including key financial metrics (S&P Global Ratings-calculated DSC, debt to net revenues, days' cash on hand, and unrestricted reserves to debt). Specifically, we expect to focus on operators' fiscal year 2021-2023 estimates along with supporting assumptions to provide a clearer picture of probable financial metrics as activity levels recover or stabilize. Their ability to mitigate financial pressures and navigate an evolving landscape will inform our prospective view to determine if financial metrics are achievable, sustainable, and align with current rating levels. To ensure comparability across airports and consistent with our criteria approach for grants, coverage accounts, etc., we will include only operating revenue in our DSC calculations (excluding CARES Act funds and other non-reoccurring revenues under our criteria), recognizing that in 2020 at a minimum, DSC will likely be materially lower. (See "A Review Of Transportation Criteria: Liquidity And Debt Service Coverage In Light Of COVID-19," published April 23, 2020.)

Related Research

This report does not constitute a rating action.

Primary Credit Analysts:Kurt E Forsgren, Boston (1) 617-530-8308;
Joseph J Pezzimenti, New York (1) 212-438-2038;
Todd R Spence, Farmers Branch (1) 214-871-1424;
Secondary Contacts:Paul J Dyson, San Francisco (1) 415-371-5079;
Kevin R Archer, San Francisco + 1 (415) 371 5031;
Scott Shad, Centennial (1) 303-721-4941;
Kenneth P Biddison, Centennial + 1 (303) 721 4321;
Kayla Smith, Centennial + 1 (303) 721 4450;
Sussan S Corson, New York (1) 212-438-2014;

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