- The COVID-19 pandemic has led us to lower our stand-alone credit profiles (SACPs) and/or ratings, by one or two notches, on most airports globally. While we believe airports continue to exhibit strong credit fundamentals, we note their inherently higher exposure to unpredictable disruptions compared to infrastructure companies or other rated providers of essential services.
- We believe social factors, including potentially more frequent health and safety emergencies--which we classify as an ESG credit factor given the direct impact on airports and airlines--have become at least as important as environmental risks in their propensity to significantly disrupt airports' operations.
- COVID-19 has also put a spotlight on airports' counterparty exposure. It has brought into question airports' ability to transfer traffic risk to airlines via increasing aeronautical charges, and to commercial tenants via executing minimum revenue guarantees as well as their ongoing viability.
- Increasing exposure to long-term chronic and acute physical climate events requires building resilience into airports' assets. In the short term, we anticipate that ever-greater environmental transition risks (greenhouse gas emissions for example) could affect air travel behavior via potential carbon taxation and government-led climate-friendly policies.
- Strong governance and management is key to anticipating and mitigating climate and social risks. In the post-pandemic world, we believe management teams will aspire to create more variable cost structures for airports to become more flexible to adapt to remote and less visible, but high impact, risks.
Since the onset of the pandemic, we have taken negative rating actions on nearly all airports and airlines. We have lowered SACPs and/or our ratings on most commercial airports (rated under our Corporate Methodology), by typically one (in some cases two) notches (see table 1). We have also lowered our ratings on over 80% of not-for-profit U.S. public airport-related issues, by on average one notch (table 2). This compares to much more severe downgrades of two-to-three notches for rated airlines (table 3).
Airports have shown more resilience than airlines. This reflects their credit strength as infrastructure assets with dominant market positions, and the vital economic and social role they play. In our report, "As COVID-19 Cases Increase, Global Air Traffic Recovery Slows," published Nov. 12, 2020, we highlight that further downside to airport ratings is possible but on a selective basis. Further downgrades will likely be limited to airports unable to demonstrate self-sufficient financial operations and those with more severe cash burn rates and rising debt, especially if this continues into 2021 despite large capital spending cuts. Rating pressure could also keep building for airports whose business or enterprise profiles are deteriorating further (from heightened airline counterparty risk, greater uncertainty about future aeronautical charges, or decreases in air traffic in 2021 beyond our current assumption of 40%-60% lower than 2019). Prolonged uncertainty, or a lack of recovery in profitability and traffic, could weigh on our future assessments of competitive or market positions, volatility of profitability, or even the industry risk itself (see our Corporate Methodology and Global Not-For-Profit Transportation Infrastructure Enterprises: Methodologies And Assumptions or Global Not-For-Profit TIE criteria).
Weaker leverage metrics triggered most of our rating actions on global commercial airports (Corporate Methodology) even when we placed less weight on 2020 ratios in our analysis. For some emerging market operators, liquidity concerns also drove multiple notch downgrades. So far, we have made no outright revisions to airports' business risk profiles (BRPs); they typically remain excellent, strong, or satisfactory. Notably, however, we could revise down airports strengths within the BRP categories depending on the trajectory of the pandemic and the potential for more frequent disruptions in the future. This could lead us to lower ratings, either by selecting a lower split anchor or through adjusting our comparative rating assessment.
For rated not-for-profit airports in North America (Global Not-For-Profit TIE criteria), we lowered our assessment of market positions on nearly all airports by one notch. This in turn resulted in diminished overall enterprise risk profiles (ERPs) for the airports (from extremely strong to very strong; from strong to adequate; and so on). Further credit-specific rating actions are possible (all have a negative outlook, which reflects an approximately one-in-three likelihood of a downgrade) for airports that we believe are exposed to materially lower, uncertain, or volatile activity levels for an extended period. Conversely, modest or no downward rating actions are possible for those transportation entities we believe will demonstrate recovery to financially sustainable levels in the near term.
How long-term ESG credit factors can affect business risk profiles (BRPs) or enterprise risk profiles (ERPs)
Our ratings seek to capture long-term and more remote environmental and social risks where we believe there is a material and relevant likelihood of potential unmitigated consequences. How much these ESG factors influence our analysis depends on how much they affect creditworthiness and may evolve over time as they become less/more material. This impact can be translated into changes in industry scores, including heightened risks of secular change or risks to industry profitability or industry growth trends. For an entity, we can revise our assessment of its competitive position, operating efficiency, comparative rating assessment, or choice of split BRP anchors under our Corporate Methodology on a very forward-looking basis using an extended ratio horizon. Taking such a long-term view is particularly relevant for airports given their long asset lives and investment horizons, as well as largely fixed costs and limited flexibility in adjusting rates.
Similarly, our not-for-profit TIE criteria for transportation infrastructure including airports looks to how ESG factors can influence airports' market positions, industry risk as well as economic drivers and management and governance considerations.
Our recent rating actions reflect our view that the airport sector has become less predictable, notably compared to other highly stable infrastructure assets, such as utilities and, in many instances, ports. Even if pandemics remain remote, the frequency and severity of future disruptions could be higher than we thought before COVID-19. The influence of ESG credit factors on airports' BRPs is rising, noting that ESG factors can equally affect financial risk profiles and/or governance.
Management policies and mitigating actions can offset negative long-term rating pressures. These might include timely capital raising, operational and financial planning, or deferral and reduction in capital investments. Such measures can also include support from regulatory frameworks or other stakeholders. Also, project financing structures tend to have limited flexibility to respond to unpredictable risks or to deliver additional investments by themselves. This is because, unless they self-perform, they often involve long-term financial and operational contracts with limited flexibility to adjust. Mitigating this, in many cases we have seen equity sponsors injecting additional liquidity into the project structure.
Our project finance methodology aims to capture the impact of remote and long-term risks by running a 'BBB' stress or downside scenario. We apply this scenario to the weakest period over the whole project finance term. It tests if the project has sufficient resilience and liquidity resources to meet debt service over a five-year period under stress conditions (a pre-condition to achieving investment grade). Inadequate liquidity or lack of resilience under our downside scenario results in us adjusting down the project finance rating from day one, to capture such long-term or remote risks. Finally, our ratings for global not-for-profit airports incorporate how management teams are building climate change into the planning and operations of airport enterprises. This view is part of our risk and financial management assessment and contributes to our management and governance score.
The pandemic and potentially more-frequent unexpected disruptions signal less stable and predictable revenues and profit
Social risks, notably health and safety, are proving as relevant as environmental risks for aviation. COVID-19 has caused a big deviation in airports' historically very stable profitability trends, with collapses in EBITDA margins (see chart 1). IATA notes that in the six months following the 9/11 attacks--previously considered the most severe aviation crisis--air passenger as traffic measured in revenue passenger kilometres (RPKs) declined by 12%, much less than the 65%-80% drop we forecast for 2020.
Outside the U.S., the most agile airports, such as Gatwick, have managed to cut operating costs by about one-third, primarily by reducing staff and operations. The average decrease in operating spending at European airports has been 10%-25%, according to Airports Council International. Post-pandemic, we expect airport management will focus on making cost structures more flexible and scalable, including through more volume-linked expenses and increased digitalization.
While it has been a century since the previous pandemic, the frequency of unexpected disruptions could increase amid greater globalization. The WHO believes that changes in the way humanity inhabits the planet renders new diseases inevitable, while global connectivity accelerates their spread.
According to a 2004 report by UNICEF/UNDP/World Bank/WHO, "Globalisation appears to be causing profound, sometimes unpredictable, changes in the ecological, biological and social conditions that shape the burden of infectious diseases in certain populations, while also changing the distribution of health and disease both within and across countries and … across continents." (See "Globalisation and infectious diseases: a review of the linkages.) We have seen four global outbreaks this century, all easier to isolate but with higher mortality rates: severe acute respiratory syndrome (SARS) hit in 2002-2003; Swine Flu (influenza) in 2009; Ebola in 2014-2016; and Zika in 2014-2015. Airport operators will need to incorporate the health and safety learnings of the current pandemic into long-term planning and protocols.
The pandemic has caused dramatic financial effects, both in terms of severity and length of recovery. This reflects the difficulty of detecting the virus during incubation and in asymptomatic persons. Reinstating travel confidence, let alone rebuilding shattered economies and airlines' credit quality, may take years. Air traffic might return to 2019 levels only by 2024 (according to the IATA's report "Outlook for Air Transport and the Airline Industry," published Nov. 24, 2020). By comparison, it took only 10-12 months for Hong Kong air traffic to recover from SARS, and 12-18 months for U.S. air travel after 9/11. Some industry estimates suggest it may take up to two decades to return to the pre-COVID passenger forecast trajectory, assuming no structural changes in travel propensity.
The pandemic has also highlighted the difference between essential services (say utilities) and more discretionary services such as air and related non-aeronautical services (retail for instance). Within air travel, the reasons for getting on a plane (ranging from visiting friends and family, going on holiday, and doing business) have different sensitivities. Furthermore, international travel is more vulnerable to health emergencies such as pandemics than are domestic flights, given border restrictions and likely more-rapid border shutdowns in the future. Comparing other transport infrastructure modes, rail has been just as badly hit by COVID-19, notably cross-border services. Commuter usage is less discretionary, although increased home working and virtual meetings could affect rail usage in the longer term. That said, declining rail passenger numbers have been partially mitigated by governments' revenue support or grants/equity packages. By contrast, toll roads saw a much swifter recovery after lockdowns, while ports have been the least affected as they are focused on cargo, with only a 10% volume container drop projected in 2020 (5% drop for bulk cargo).
Why is air travel so sensitive to virus outbreaks?
People avoid taking planes during virus outbreaks for several reasons. The main deterrent is the fear of catching the virus on the flight, while abroad, and/or having to quarantine. Added to this is the unpredictability of potential subsequent travel restrictions between different countries. Quarantine and other social distancing measures introduced by governments can happen quickly and leave passengers stranded.
This fear may not be fully backed by evidence but it has influenced travel behavior. According to IATA, in the nine months to September there were only 44 cases of COVID-19 reported out of some 1.2 billion passengers in which transmission is thought to have been associated with a flight journey (inclusive of confirmed, probable, and potential cases). Still, the idea of being in close contact with other people in a contained space has deterred many people from flying. This is despite research claiming the risk of contracting the virus mid-flight is low thanks to modern airplanes having high-efficiency particulate air (HEPA) filters, the same used in hospital operating rooms, and reassurances that cabin air is replaced every two-to-three minutes. Even with sanitation improvements on aircraft, air travel involves navigating airports and, until there is a widely held view that the entire air travel experience is safe, many consumers will likely seek alternatives.
The pandemic has increased counterparty risk related to weakened airlines, which may complicate future increases in aeronautical charges
Between February and September we downgraded all our rated airlines, on average by two-to-three notches. Some airlines suffered more severe rating transitions, including default (table 3).
Before COVID-19, we would have expected competitors to snap up slots released by defaulting airlines reasonably quickly. Now, we expect airlines will be more selective and focus on the most attractive routes from a demand perspective (short-haul family and friends) or on the most profitable routes (like London to New York).
Future aeronautical charges pose a related risk. This is because financially weakened airlines (and indirectly travellers) may not be willing or able to accept a step increase in unit charges (respectively ticket prices). Lower demand and a structural reduction in business travel will require airports' fixed costs to be spread among a smaller number of travellers.
Under pressure from airlines, many regulatory bodies may not be inclined to immediately pass onto customers the traffic risk for which airports are usually remunerated. In October, the U.K.'s Civil Aviation Authority rejected Heathrow's request for an intra-period tariff formula adjustment to compensate it for the costs of COVID-19. In July, the French regulator rejected Nice Airport's proposal for a 12% increase in service charges and 14.2% increase in landing fees to apply from November 2020. Further, Zurich airport offered a 10% discount to charges for 12 months starting in April in 2021. Ultimately, some solutions may involve accruing lost revenues then recovering them in future regulatory periods. Given the length of the downturn, any such recovery could be far off and spread out, ultimately weighing on airports' medium-term cash flow generation and credit metrics.
In the U.S., airport operators have realized the limitations of their traditional, business-as-usual airline use and lease agreements in the current environment. To limit or prevent what would otherwise be an automatic increase in airline rates and charges to reflect lower activity levels, many airport management teams looked to special federal government COVID-19 relief grants to fill in revenue gaps; deferred fee increases; and returned to the capital markets for debt restructurings to prevent an increase in aeronautical charges as required by bond covenants and the business terms of their agreements with airline tenants. In most instances, this has bought one-to-several years of breathing room until traffic levels return, airlines regain a measure of financial stability, and non-aeronautical revenues recover. Overall, we believe interim measures and reliance on liquidity only is not a substitute for sustainable, self-supporting financial operations commensurate with higher credit ratings. Nonetheless, the collapse of global aviation demand has exposed the weakness of business models designed for more benign market conditions.
Regulatory responses to airports could change our view on the supportiveness of regulation
The drop in passenger volumes amid the pandemic has shown that the volume exposure of airport operators is higher than that of utility providers, for example water companies. This is why we assess airports as having higher industry risk. Supportiveness of regulation, even if it does not protect against traffic risk, is crucial for our assessment of regulated airports' competitive advantage. Regulatory regimes, as they stand now, are designed to protect airlines from airports exerting their near monopoly power. They aim to prevent market abuse. They cap returns, while also providing industry stability and long-term certainty of returns to those who have invested in airport assets.
The regulatory model that caps revenues may not perfectly fit when forecasts are unreliable or excessive deviations in traffic may call for a higher cost of equity. Moreover, charges are difficult to raise substantially given the very competitive environment in which airlines need to restore profitability and balance sheets.
Airports need the flexibility to set capital spending and manage operating costs and revenues in varying traffic scenarios. We are yet to see how promptly regulators will respond to traffic risk, for example by incorporating it in the regulated assets base and providing cost compensation over a longer period, and whether the regulators' decisions will satisfactorily replace market forces. Regulation could eventually move towards allowing commercial agreements that provide more flexibility as well as room for incentive packages to stimulate traffic growth. Gatwick, for instance, has been successfully operating under a set of commitments from the airport. These include a maximum level of airport charges over a seven-year regulatory period and a system of service quality rebates. Operating in a commercial manner may improve equity returns as airports become more agile in responding to airlines' needs. But it raises questions about the stability and attractiveness of returns for long-lead expansion projects.
Protection of non-aeronautical revenues based on minimum revenue guarantees has limited effectiveness
Over the last decade, airports have significantly increased their non-aeronautical activities, now contributing typically to between 40% and 55% of our rated airports' revenues. These are generated by retail, food and beverage, car parks or rentals, and leasing real estate. Real estate income, which tends to be inflation-linked and unrelated to volumes of passengers, and contracts with commercial tenants that incorporate minimum revenue guarantees, have helped airports diversify and reduce their exposure to traffic volumes.
Airports paused execution of minimum revenue guarantees during lockdowns while the entire airport ecosystem fought to survive. Guarantees are now being reinforced as traffic returns, but often significantly relaxed to make the reopening of commercial activities viable. Some guarantees may be more difficult to implement because retail partners could face increased competition from on-line shopping.
The loss of commercial revenue has also exposed differences between airports operating under single till (where both aeronautical and commercial revenues and costs are used to set passenger charges) and those under a dual till (where aeronautical revenues and costs are kept separate from commercial revenues and costs). Single-till airports may need to raise aeronautical charges more than dual tills if there is a smaller revenue contribution from commercial operations.
Changes in travel preferences informed by environmental considerations are a longer term risk
The pandemic has already shown how behaviors can change suddenly. A certain share of business travel is likely to wane in the coming years in favor of virtual meetings due to associated cost, efficiency, and environmental benefits.
The perception that flying is damaging the environment may become ever more central to social resistance to air travel and to expanding air traffic infrastructure. This sentiment caused a 4% decline in passenger numbers in Sweden in 2019. So far, we see this as an exception and probably more relevant to rich countries conveniently connected by rail.
Although we do not foresee a dramatic change in flying behavior in the near future, climate change concerns will likely accelerate, air travel may become more expensive (environmental taxes), and new generations may see the world differently to current users or policy makers. For now, however, factors such as strong pent-up demand for visiting friends and relatives, as well as for leisure, will boost air travel soon after a vaccine becomes widely available. Domestic traffic has already largely recovered in China and Russia, and we expect demand for long-haul flights to and from the U.S., China, and to far-flung places like Australia. Finally, the underlying driver of a growing middle class and increased mobility trends will continue to underpin long-term growth, in our view.
Local communities were already a critical social consideration for airports, even more so for airport expansions
Communities, regulators, and broad political consensus have always been critical considerations for long-term infrastructure investments. Airports need to show politicians and adjacent communities the benefits they bring in terms of economic development while managing and mitigating noise, as well as addressing health considerations such as stress-related illnesses or sleep disruption.
This is particularly so when airports undergo expansions, and even more for new builds. The most prominent case was Mexico City's new airport, the construction of which was cancelled by Mexico's newly elected president at the end of 2018. In the U.K., regulatory and community hurdles to airport expansions have abounded recently. The U.K. Court of Appeal in February 2020 argued that the government's rationale for the construction of a third runway at Heathrow Airport, included in the Airports National Policy Statement of 2018, did not account for the government's commitment to the provisions of the Paris Agreement on climate change. Elsewhere, the impact on quality of life of local communities via noise and traffic pollution, and consequences for local ecosystems, have triggered social resistance. The planned expansion of London City Airport, which primarily caters for business traffic to central London and Canary Wharf, has been heavily criticized for bringing more noise and pollution to local residents who do not tend not to use the airport. Plans to expand Bristol Airport were rejected by the North Somerset Council in February 2019 on environmental grounds. The council left open the possibility for the airport to resubmit its application "when the airline industry has decarbonized and the public transport links to the airport are stronger". By contrast, Gatwick's expansion plans have triggered less social resistance than those of Heathrow, partially because the airport has incorporated community benefits into its strategy, stressing the employment opportunities it generates for local communities and for young people.
Physical climate risks are relevant, both now and longer term
Physical climate exposures may be less material to most rated airports' credit quality than the above social and environmental transition risks, as airports have longer to adapt to chronic climate risks. That said, some are already heavily exposed to acute weather events and, with physical climate risks likely to increase, a forward-looking approach is key.
Given the long-term nature of airports, building in early resiliency is important. This reflects the heavy reputational (and actual) costs of dysfunction, emergency adaptation, or unforeseen revenue losses. Timely investment ensures better predictability of cash flows. Issuers can also demonstrate the benefits of their adaptation measures with more transparency and data and, in so doing, make long-term creditors feel more confident as to the sustainably of their investments.
In our report, "Scenario Analysis Shines A Light On Climate Exposure: Focus On Major Airports," published Nov. 5, 2020, we analyse in detail key physical climate risks under an RCP8.5 scenario. These include:
- Acute extreme weather events, such as storms (including hurricanes, cyclones and typhoons, but also wildfires) and flooding from both heavy rains or overflowing of nearby rivers. While difficult to predict, scientists generally expect an increase in frequency of more intense storms. Following Hurricane Katrina in 2005, we lowered the S&P Underlying Rating (SPUR) on New Orleans Aviation Board (NOAB) to 'BB' from 'A'. Physical damage was limited, but the rating action reflected the uncertain recovery in the regional economy, including in employment and tourism and the impact on air travel demand.
- Chronic long-term increases in temperatures, raising the number of heat days. Increased heatwaves have a direct impact on airlines and therefore on airport passenger capacity, as flights are subject to additional take-off weight restrictions during heat days, while equipment is more prone to damage. Take-off weight restrictions mean that aircraft can carry fewer passengers: a recent study by Pek and Caldecott (2020) for a Boeing 737-800 said a load reduction requirement of 4,536 kg translates into 28% less capacity. Adaptation strategies may include extending runways, improving aircraft technology, and changing flight schedules to cooler times of the day.
- Rising sea levels, a particular risk for U.S. coastal airports notably beyond 2050. San Francisco International Airport last year announced a project to build a sea wall around its 10-mile perimeter at a cost of $587 million. The sea wall will protect against rising sea levels and storm surges, equivalent to those projected to the year 2085. Hong Kong International Airport, build on land reclaimed from the sea, incorporated exposure to physical climate risks in designing its third runway. This runway is bounded by about 13.4 km of sea wall, which is more than 6.5 meters above sea level, and provides protection from extreme tides, storm surge, and flooding.
- Shifting weather patterns may lead to more structural demand changes in both tourism and business traffic. Cooler regions could gain increasing favor in the hotter summer months, but regions with a steep increase in heat waves or hurricanes could suffer.
Strong management and governance and/or supportive regulation are key to mitigating environmental and social risks.
This starts with timely, consistent, and transparent reporting, in our view. The Financial Stability Board's Task Force on Climate-related Financial Disclosures (TCFD) has somewhat improved reporting, but we see it as still insufficient for investors to understand climate-change risks and opportunities. Positively, from March 2021, the EU will make the online publication of sustainability impacts mandatory and the U.K. Financial Conduct Authority will require mandatory TCFD climate-related disclosures from all London-listed companies. Disclosure has been inconsistent to date, making comparisons between companies difficult. Clearer and more comparable information about key ESG risks, and how they translate into financial effects, would allow investors to price opportunities more accurately. It would also provide a more transparent basis for stakeholders to give support, if necessary.
Specific to COVID-19, we have seen some airports taking dramatic steps. Some have raised equity to offset debt increases, while many have accessed markets to bolster liquidity. Management actions have focused on reducing negative cash flows by slashing capital spending, as well as reducing fixed cost operating costs, including tightening executive pay, closing terminals, and preserving operating efficiencies. As airports prepare for a different future, keys to success will be how cost structures can be made more variable, and how airports, airlines, and regulators prepare environmental and climate changes and address issues such as social health and community wellbeing.
- Industry Top Trends 2021: Transportation, Dec. 10, 2020
- Industry Top Trends 2021: Global Transportation Infrastructure, Dec. 10, 2020
- As COVID-19 Cases Increase, Global Air Traffic Recovery Slows, Nov. 12, 2020
- Scenario Analysis Shines A Light On Climate Exposure: Focus On Major Airports, Nov. 5, 2020
- This Time Is Different: An Anemic And Uncertain Passenger Recovery Will Challenge U.S. Airports' Credit Quality, Aug. 7, 2020
- ESG Industry Report Card: Transportation Infrastructure, Feb. 11, 2020
- Infrastructure Seeks A Circular Solution To Sustainability, Dec. 4, 2019
- European Airlines Prepare For Take-Off On Climate Change, Nov. 21, 2019
- Most Rated European Airports Experience Turbulence Due To Common Industry Trends, Sept. 19, 2019
This report does not constitute a rating action.
|Primary Credit Analysts:||Beata Sperling-Tyler, London + 44 20 7176 3687;|
|Tania Tsoneva, CFA, Dublin + 44 20 7176 3489;|
|Kurt E Forsgren, Boston + 1 (617) 530 8308;|
|Karl Nietvelt, Paris + 33 14 420 6751;|
|Secondary Contact:||Julyana Yokota, Sao Paulo + 55 11 3039 9731;|
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