New Issue - Philadelphia · FY 2010 was linked to the global economic slowdown and airline industry...

INFRASTRUCTURE AND PROJECT FINANCE

CREDIT OPINION6 December 2017

New Issue

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Myra Shankin [email protected]

Kurt Krummenacker +1.212.553.7207Senior Vice President/[email protected]

Adena Schmidt +1.212.553.6871Associate [email protected]

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Philadelphia (City of) PA Airport EnterpriseNew Issue: Moody's Assigns A2 to Philadelphia PA AirportRevenue and Refunding Bonds Series 2017A & B; outlook isstable

Summary Rating RationaleMoody's Investors Service has assigned an A2 rating to the Philadelphia (City of) PAAirport Enterprise's Series 2017A (Non- AMT) and Series 2017B (AMT) Airport Revenue andRefunding Bonds. Moody's has also affirmed the A2 rating on all outstanding parity bonds.Total debt outstanding is $1.68 billion after issuance. The city owns and operates PhiladelphiaInternational Airport (PHL) and Northeast Philadelphia Airport (PNE).

The ratings reflect PHL's strong market position for travel in the Philadelphia metropolitanregion as well as the airport's maintenance of moderate leverage levels though its newly-rationalized capital plan. Leverage is expected to increase over time as the airport completesits plan, which will also increase airlines costs above the current levels, but both leverageand costs will remain moderate for a A2 rated international gateway airport. The ratingalso considers that the very low liquidity and heightened competitive environment ismostly offset by a large, robust service area that provides sufficient demand to support aninternational hub. The combination of low liquidity, comparatively low coverage metricson a net revenue basis and the construction risk of the capital program positions the ratingweakly within the A2 category and any further deterioration in liquidity, failure to achievethe enplanement forecast by the airline consultant, or increases in the project cost duringconstruction would place negative pressure on the rating.

Exhibit 1

PHL Historical Enplanement Trends & Forecast

-10.0%

-8.0%

-6.0%

-4.0%

-2.0%

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

-

2,000,000

4,000,000

6,000,000

8,000,000

10,000,000

12,000,000

14,000,000

16,000,000

18,000,000

2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018F 2019F 2020F 2021F 2022F 2023F

PHL Domestic Enpax PHL International Enpax PHL Total Enpax Forecast YOY% PHL Total Enpax YOY% Natonal Enpax

Source: Moody's Investors Service and 2017 Report of the Airport Consultant

https://www.surveygizmo.com/s3/1133212/Rate-this-research?pubid=PBM_1102371

MOODY'S INVESTORS SERVICE INFRASTRUCTURE AND PROJECT FINANCE

Credit Strengths

» A revised capital program that focuses on PHL's more pressing needs, demonstrating management's understanding of the airport’sevolving requirements and targeting its resources accordingly

» Large, stable service area with an improved economy, forming the base for O&D demand

» Growing service offerings to domestic as well as international destinations in North America and Europe bolstered both by theairport's position as a hub for American Airlines Group, Inc. (Ba3 stable) and a diverse portfolio of low-cost carriers

Credit Challenges

» Though liquidity is below historical norms due to a deferred recovery of expenses, it will remain weak even at the targeted levelswhen compared to other international hubs and similarly-rated airports

» Competition from nearby airports in the New York and Baltimore metropolitan areas lowers passenger utilization rates

» Large scale of capital improvements introduce construction risk

Rating OutlookThe stable outlook reflects our expectation that the airport will see stable enplanements, liquidity will continue to improve, and debtassociated with capital spend will be issued on the schedule indicated in the offering documents.

Factors that Could Lead to an Upgrade

» Liquidity improving to more than 600 days cash on hand

» Above average enplanement growth on a sustained basis, demonstrating a stronger market position

Factors that Could Lead to a Downgrade

» Unexpected, unrecovered expenses that further decrease liquidity

» Capital plan results in substantial increases in debt above currently projected levels in the mid-term

» Leverage exceeding $300 debt per O&D passenger

» Enplanement growth trends below the 1% consultant forecast

Key Indicators

Exhibit 2

PHILADELPHIA (CITY OF) PA AIRPORT ENTERPRISE

2012 2013 2014 2015 2016

Enplanement Annual Growth (%) -1.7 -0.8 0.7 0.0 2.4

Debt Outstanding ($'000) 1,366,920 1,315,455 1,295,965 1,361,515 1,314,605

Debt to Operating Revenues (x) 4.6 4.1 3.7 3.9 3.5

Debt Per O&D Enplaned Passenger ($) 147.5 143.2 139.7 143.9 126.8

Days Cash on Hand ('000) 207 165 94 103 177

Total Coverage By Net Revenues (x) 0.98 1.07 0.91 0.95 1.12

Source: Moody's Investors Service Municipal Financial Ratio Analysis Database

This publication does not announce a credit rating action. For any credit ratings referenced in this publication, please see the ratings tab on the issuer/entity page onwww.moodys.com for the most updated credit rating action information and rating history.

2 6 December 2017 Philadelphia (City of) PA Airport Enterprise: New Issue: Moody's Assigns A2 to Philadelphia PA Airport Revenue and Refunding Bonds Series 2017A & B;outlook is stable


Recent DevelopmentsTotal enplanements were 14.8 million as of FY 2017, down 5.6% from FY 2016, linked to changes in American Airlines operations.Airline management specifically points to three factors: fleet transitions, pilot shortages and dropping Air Wisconsin as a regionalpartner. American has stated they are confident that they have addressed these issues, and the losses will be mitigated for FY 2018.After the FY 2018 recovery, airport management has factored in a basically steady-state level enplanements, at under 1% annuallythrough FY 2023. Enplanements for the first quarter of FY 2018 were down 4% from the same period in the prior year.

PHL had a long-term Capital Enhancement Program (CEP) in place since January 2011, which was focused on enhancing airfieldcapacity in order to address delays. As part of the CEP, in September 2011 the FAA awarded PHL a $466.5 million Letter of Intent (LOI)to provide some funding for certain airfield elements. In the meantime, a combination of factors has lead to fewer aircraft operations,diminishing the need for capital improvements to enhance capacity on the airfield – the new runway – and shifting priorities towardsterminal, gate capacity, landside, and cargo needs instead. With this in mind, PHL and the FAA agreed to close the LOI in October 2017,refocusing FAA Entitlement and future Discretionary Grant funding for other airfield improvements. The airport formally replaced theCEP with a Capital Development Program (CDP) this year which reflects PHL’s shifted focus. It includes $2.4 billion of projects approvedby the Signatory Airlines. In general, the primary focus of the CDP is terminal development.

Detailed Rating Considerations

Revenue Generating BaseThe city of Philadelphia (A2 Negative LT GO) is the economic center of the large, multi-state Delaware Valley region, and has begunto grow after decades of decline. Philadelphia is the sixth-largest city in the US by population, and is at the center of the sixth-largestmetropolitan area. The city underwent a protracted decline in the post-industrial era, with population falling 26% since 1950. Thatsaid, the metro area economy is experiencing its strongest growth since the late 1990s. The area is not only outperforming the stateand region, but for the most part, the U.S. as well. The population is growing with higher education levels, and personal income in thecity has increased 21% since 2009. We attribute the city's growth to national demographic trends, as well as the appeal of the city'ssubstantial mix of universities, hospitals, and other employers. The city's strong nonprofit sector provides some underlying strength tothe economy that is not reflected in socioeconomic statistics. An estimated 155,000 college students live in Philadelphia, and about295,000 people commute into the city daily. The traditional measures of tax base strength understate the city's economic resilience,although persistent poverty and weak income indices remain a challenge.

PHL is the only commercial airport in the Philadelphia CSA. The closest commercial airports in the area are Trenton-Mercer Airport(TTN) and Atlantic City International Airport (ACY), both with limited levels of air service as compared to PHL. At 90 miles to thenortheast, Newark Liberty International Airport (EWR) is the closest true competitor to PHL. EWR is within a two-hour drive ofPhiladelphia’s city center, but also benefits from hourly Acela non-stop high-speed rail service to the airport from Philadelphia’s 30thStreet Station. Philadelphia is also less than a two-hour drive from Baltimore–Washington International Airport (BWI), 110 miles tothe southwest. Though these competing hubs benefit from a broader service offering, the competitive risk to PHL is partially mitigatedby capacity limits and slot restrictions of the New York-area airports, leaving them unable to serve as true connecting hubs to smallercities. Additional mitigation of the competitive risk comes from the improved local economy, which is generating increased organiclocal demand for air service, as well as PHL’s competitive pricing.

As of September 2017, PHL was served by 26 passenger airlines: five mainline carriers (American, Alaska, Delta, United and VirginAmerica), four low-cost carriers (Frontier, JetBlue, Southwest and Spirit), twelve regional airlines and five foreign-flag carriers. FedExand UPS provide cargo service. PHL has non-stop service to 86 domestic destinations, which is expected to grow to 92 by Spring 2018.PHL also service 34 non-stop international destination, focused on the Caribbean, Europe and the Middle East. Additional service toEurope is expected in the Spring and Summer of 2018. Looking ahead, the airport hopes to expand to business centers in Asia and LatinAmerica.

Operational and Financial PerformanceTotal enplanements were 14.8 million as of FY 2017, down 5.6% from FY 2016, linked to changes in American Airlines operations.Airline management specifically points to three factors: fleet transitions, pilot shortages and dropping Air Wisconsin as a regionalpartner. American is in the midst of a fleet modernization program, where several aircraft widely used at the airport (Dash 8s, MD-80s,



Embraer 190s, Airbus A330s) were phased out in FY 2016 and FY 2017, to be replaced with larger, more efficient aircraft awaitingdelivery. American has stated they are confident that have addressed the other points by increasing pilot salaries and managing AirWisconsin’s exit, and the losses will be mitigated for FY 2018. After the FY 2018 recovery, airport management has factored in abasically steady-state level enplanements, at under 1% annually through FY 2023.

Enplanements have hovered in the range of 15 million since 2005, though it saw some volatility in that period. Enplanements wereup slightly in FY 2008 as US Airways dehubbed Pittsburgh International Airport (PIT), shifting service to PHL. The dip in FY 2009 andFY 2010 was linked to the global economic slowdown and airline industry consolidation, and the slight uptick in FY 2011 is linked to abroader recovery and the start of service from Frontier Airlines. That said, Southwest - the second largest airline in terms of passengermarket share – began a large, multiyear shift of capacity from PHL to other markets in FY 2011, which extended through FY 2016. Thispullback was partially mitigated by the addition of service by JetBlue, Spirit, Frontier, Qatar Airways and American, but led to somewhatstagnant enplanement growth through FY 2016 when compared to national trends. FY 2016 was the first year since FY 2011 where PHLshowed more solid growth, up 2.4% over FY 2015, though still lagging behind the nation. Though American pulled back slightly, mostother airlines added seats to the market, including Southwest.

PHL operates under a residual rate-making methodology, where airline rates and charges are calculated to fund annual net expensesof the airfield and terminal facilities after taking into account non-airline revenues generated. The residual rate making allows for thecollection of shortfalls in the next year, but the airport has reached an agreement with the airlines that stabilized rates by drawing onthe balances in the O&M reserve account. The deferral helps to smooth airline costs. The airlines' pledge to repay the drawn reservesapplies outside of the recently agreed to use and lease agreement. PHL will recover all of these draws through FY 2018.

Debt service coverage on Moody’s net revenue basis was 1.12 times at FY 2016. We expect this to remain near 1.0 times as it hashistorically. The airport's residual agreement does not allow coverage to range far from 1.0 times as it limits revenues to cost recovery.On a bond ordinance basis, debt service coverage is calculated two ways. Under Test 1, which defines funds available for debt serviceas pledged amounts less operating expenses, FY 2017 coverage is 2.83 times, and is projected to stay above 2.67 times through 2023,while factoring in additional issuance of approximately $385 million in FY 2020. Test 2 defines funds available for debt service aspledged amounts less operating expenses and debt service on GO bonds issued for airport improvements, where FY 2017 coverage is1.88 times, which is the minimum projected coverage through FY 2023.

Airline cost per enplanement (CPE) increased slightly to $15.59 in FY 2017 from $14.97 in FY2016. The increase is attributed toa decrease in enplanements rather than an increase in airline costs. Given the expense increases and relatively flat enplanementtrajectory, management expects CPE to rise to $18.57 though FY 2023, with the largest bump expected in FY 2021 due to capitalspend. While the increase is high, airlines have visibility to these increases and projected amount compares favorably with reportedvalues for international airports in New York and Washington, D.C.

LIQUIDITYPHL has historically had weak liquidity. In FY 2014, the airport’s operating expenses were elevated due to union contracts and snowremoval expense, dropping cash to below historical levels to 94 days. The airport allowed the airlines to spread the recovery of thoseexpenses, though FY 2018. FY 2016 saw cash improved to 177 days, and it grew further to 185 days in FY 2017 based on unauditeddata. The airport expects, as the repayments are completed, cash levels should recover to its target of 200 days. That said, even attargeted level, the airport’s cash levels are well below the FY 2016 medians for hubs of any size or A2 airports broadly.

Debt and Other LiabilitiesIn addition to the new money portion of the current offering, management plans to add an additional $385 million from a 2020issuance of airport revenue bonds and $434 million from debt to be issued after FY 2023. PHL has maintained its currently low levelof leverage ($126 of debt per O&D enplanement in FY 2016) and its generally declining annual debt service requirements provideopportunity to increase leverage while avoiding large increases in airline costs. Leverage is expected to remain below $160 debt perO&D enplanement through 2023, which compares approximately to the FY 2016 median for hub airports of $157.

PHL had a long-term Capital Enhancement Program (CEP) in place since January 2011, which was focused on enhancing airfieldcapacity in order to address delays. It included projects addressing runway length, airfield geometry, runway capacity, in addition to



expansion and reconfiguration of the existing terminal complex. As part of the CEP, in September 2011 the FAA awarded PHL a $466.5million Letter of Intent (LOI) to provide some funding for certain airfield elements.

For the last decade, the FAA implemented some improvements to air traffic control and the airport completed some airfieldimprovements separate to those contemplated by the CEP. At the same time, PHL saw a decrease in aircraft operations linked to a shiftaway from smaller aircraft by the airlines. The two factors reduced delays, diminishing the need for capital improvements to enhancecapacity on the airfield – the new runway – and shifted priorities towards terminal, gate capacity, landside, and cargo needs instead.With this in mind, PHL and the FAA agreed to close the LOI in October 2017, refocusing FAA Entitlement and future DiscretionaryGrant funding for other airfield improvements.

The airport formally replaced the CEP with a Capital Development Program (CDP) this year that reflects PHL’s shifted focus. It includes$2.4 billion of projects approved by the Signatory Airlines. In general, the primary focus of the CDP is for the terminal developmentand rehabilitation, airfield improvements and pavement rehabilitation, apron improvements, land acquisition, ground transportationprojects, security and information technology enhancements, support facilities, and improvements at the Northeast Airport, the city’sreliever airport. Approximately $370 million of projects have been completed to date. Of the approximately $2.0 billion of project tobe completed, the airport expects approximately $341 million to be funded by PFC monies and other grants, $320 million from CFC-related funds, $95 million from existing bonds funds, $431 million from the current bond offering, $385 million from a planned 2020issuance of airport revenue bonds and $434 million from debt to be issued after FY 2023. That said, timing and scope of the projectsare evolving and are based on the airport’s operational needs.

DEBT STRUCTUREAll general airport revenue debt is currently on the senior lien. Series 2005C, with $110.7 million outstanding, is in variable-rate modesupported by two letters of credit and is hedged with a swap. This variable-rate liability represents less than 7% of the airport’s longterm debt. After issuance of the current offering, debt service is level at approximately $125 million through 2021, when in increases toMADS of $147 million for five years. After 2025, debt service begins a stepped decline to final maturity in 2048. The modest spike indebt service is not common in airport debt profiles, and there is capacity to further fund the capital program in the out years.

Exhibit 3

PHL Debt Profile After Issuance of Series 2017

-

20,000,000

40,000,000

60,000,000

80,000,000

100,000,000

120,000,000

140,000,000

160,000,000

2018 2019 2020 2021 2022 2023 2024 2025 2026 2027 2028 2029 2030 2031 2032 2033 2034 2035 2036 2037 2038 2039 2040 2041 2042 2043 2044 2045 2046 2047 2048

2005C 2007A* 2007B* 2009A* 2010A 2010C 2010D 2011A 2011B 2015A Taxable Loan Series 2017A** Series 2017B**

*To be refunded by current offering**PreliminarySource: 2017 Report of the Airport Consultant

The airport also has a commercial paper program authorized to $350 million through three providers through 2019. After the refundingassociated with the current offering, $141.2 million will be outstanding.

DEBT-RELATED DERIVATIVESThe Series 2005C variable-rate bonds are hedged with a floating-to-fixed rate swap, provided by JPMorgan Chase Bank. The swap has anegative mark-to-market of $8.7 million as of November 2017.



PENSIONS AND OPEBMoody’s adjusted net pension liability (ANPL) in FY 2016 was about $370 million, compared to its reported net pension liability of$223 million. This ANPL represents approximately 28% of PHL's total debt outstanding of $1.3 billion.

We adjust the reported pension liabilities of entities that report under governmental accounting standards, to enhance comparabilityacross rated issuers. Under governmental pension accounting, liabilities are discounted using an assumed rate of investment return onplan assets. Under our adjustments, we value liabilities using a market based discount rate for high quality taxable bonds, a proxy forthe risk of pension benefits.

Management and GovernanceThe Philadelphia Airport System is owned by the city of Philadelphia and operated by the city’s Division of Aviation. It is comprised ofPhiladelphia International Airport (PHL) and its general aviation reliever airport, Northeast Philadelphia Airport (PNE).

The most recent airline use and lease agreement began July 1, 2015 and runs through June 30, 2020, after which it can be subjectto two one-year extension options. The city has executed the agreement with the following 14 airlines at the airport: Air Canada,Alaska Airlines, American Airlines, British Airways, Delta Air Lines, FedEx, Frontier Airlines, JetBlue Airways, Lufthansa, Qatar Airways,Southwest Airlines, Spirit Airlines, United Airlines, and UPS.

The airport operates under a residual rate-making methodology, where airline rates and charges are calculated to fund annual netexpenses of the airfield and terminal facilities after taking into account non-airline revenues generated.

Legal SecurityThe bonds are secured by a pledge of net revenues. Bondholders also benefit from a rate covenant of 100% of O&M and 150% of debtservice on GARBs in a given year or 100% of O&M, debt service on GARBs, debt service on GO bonds issued for airport improvements,and subordinate obligations secured by amounts available for debt service. There is also a debt service reserve fund, funded to thestandard three-prong test.

Use of ProceedsThe current offering is a mix of new money and refunding. The city plans to use the proceeds to (1) pay for a portion of the airport’sCapital Development Program; (2) Currently refund Series 2007A, 2007B, 2009A and certain outstanding commercial paper notes;(3) fund the related Sinking Fund Reserve Requirement for the outstanding bonds, including the current offering; (4) fund capitalizedinterest on a portion of the current offering; and (5) fund cost related to issuance of the current offering.

Obligor ProfilePHL is located approximately eight miles southwest of downtown Philadelphia and is classified by the FAA as a large hub airport basedon enplanements. It has operated as an American Airlines hub since the merger with US Airways in 2015, which had been the dominantcarrier since the 1980s.

PHL’s terminal complex is located north of the two main runways and includes seven terminals, each with a concourse; a landsidebuilding for ticketing, check-in, and security; and a separate baggage claim building. The complex is approximately 3.3 million squarefeet and contains 126 aircraft gates. Approximately 150,000 square feet of terminals have been developed for concessions. PHL’sairfield consists of four runways – two main, parallel runways, a shorter crosswind runway and a commuter runways – as well astaxiways and apron parking. The runways system is capable of handling the largest commercial aircrafts operated by the signatoryairlines.

The Philadelphia Parking Authority (PPA) owns and operates five parking garages at PHL (11,800 spaces), as well as a number of remotesurface parking lots (7,100 spaces) served by shuttle buses. PPA leases the land from the city through the Aviation Department in aground lease that goes through 2030. The ground lease provides for a payment to the airport equal to gross receipts less O&M, debtservice on PPA bonds issued to finance capex at the airport and reimbursements to PPA for capex and prior year operating deficitsrelated to airport operations. An agreement between the FAA and PPA caps PPA’s administrative costs at 28% of its total administrativecosts across facilities, located on and of airport.



Other Considerations: Mapping to the GridThe assigned A2 rating is above the grid indicated rating of A3. The assigned rating reflect our expectation that the airport willsuccessfully manage it capital program within the bounds of the additional debt currently contemplated, which would remove thatnotch.

Note: The grid is a reference tool that can be used to approximate credit profiles in the airport sector in most cases. However, the gridis a summary that does not include every rating consideration. Please see the Publicly Managed Airports methodology report for moreinformation about the limitations inherent to grids.

Exhibit 4

Regional Position: National

Rate Making Framework: Residual

Factor Subfactor Score Metric

1. Market Position a) Size of Service Area (millions) Aaa 7.2

b) Economic Strength and Diversity of Service Area Aa

c) Competition for Travel A

2. Service Offering a) Total Enplanements (millions) Aaa 15.7

b) Stability of Traffic Performance Baa

c) Stability of Costs Ba

d) Carrier base (Primary Carrier as % of Total Enplanements) Baa 70%

3. Leverage and Coverage a)Debt Service Coverage by Net Revenues A 1.12x

b)Debt in USD per O&D Enplaned Passenger Aa $126.79

Metric Notch

4. Liquidity Days Cash on Hand 185 -1.0

5. Connecting Traffic O&D Traffic 67.3% -0.5

6. Potential for Increased Leverage -0.5

7. Debt Service Reserves 0.0

Scorecard Indicated Rating: A3

Source: Moody's Investors Service

MethodologyThe principal methodology used in this rating was Publicly Managed Airports and Related Issuers published in October 2017. Please seethe Rating Methodologies page on www.moodys.com for a copy of this methodology.



Ratings

Exhibit 5

Philadelphia (City of) PA Airport EnterpriseIssue RatingAirport Revenue and Refunding Bonds, Series2017A (Non-AMT)

A2

Rating Type Underlying LTSale Amount $145,210,000Expected Sale Date 12/14/2017Rating Description Revenue: Other

Airport Revenue and Refunding Bonds, Series2017B (AMT)

A2

Rating Type Underlying LTSale Amount $577,580,000Expected Sale Date 12/14/2017Rating Description Revenue: Other

Source: Moody's Investors Service



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MJKK and MSFJ also maintain policies and procedures to address Japanese regulatory requirements.

REPORT NUMBER 1102371


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Americas 1-212-553-1653

Asia Pacific 852-3551-3077

Japan 81-3-5408-4100

EMEA 44-20-7772-5454


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