Fitch Rates Cleveland, Ohio's Airport System Underlying Bank Bonds 'BBB+'; Outlook Stable

Fitch Ratings has assigned a 'BBB+' underlying rating to the city of Cleveland, Ohio's airport system (CLE, or the airport) bank bonds supporting outstanding senior lien $5.975 million series 2008D bonds and $30.2 million 2009D bonds. Fitch also has affirmed its 'BBB+' rating on approximately $692.4 million of outstanding airport system revenue bonds. The Rating Outlook remains Stable.

Cleveland also has $91.3 million in parity series 2013A and 2014AB bonds purchased by U.S. Bank National Association that are not rated by Fitch.

The rating reflects a midsize airport market transitioning from a domestic-focused hub to a more traditional origination/destination profile with approximately 4 million enplanements. Traffic is beginning to see positive recovery following United Airlines's (Long-Term Issuer Default Rating [IDR] 'BB-'/ Outlook Positive) flight reductions several years ago. The rating also incorporates the airport's stable financial profile with indenture coverage in the 1.3x-1.4x range and a strong balance sheet, although leverage is considered elevated at 8.6x. The rating is further supported by the airport's modest near-term capital needs which are unlikely to require future borrowing.

KEY RATING DRIVERS

Revenue Risk - Volume: Midrange

Midsize Market Transitioning: Cleveland's total traffic base is approximately 4 million enplanements and United remains the dominant carrier at Cleveland, although at lower concentration levels since its decision to eliminate its connecting-based operations as well as some O&D service. Low-cost carriers have entered the market, helping to backfill routes and lower average ticket prices.

Revenue Risk - Price: Midrange

Above-Average Cost Profile: Airline revenues represent a relatively high share of airport operating revenues. The high average airline cost structure (estimated at $18.50 CPE for 2015) is substantially a burden on United due to their special facility leases for Concourse C and D through May 2029. The non-United carriers have more competitive CPE levels with which to operate from Cleveland. The existing airline agreement is residual-based rate-setting, and a five-year extension with similar terms is likely, starting in 2017.

Infrastructure & Renewal Risk: Stronger

Moderate Infrastructure Plan: The airport's infrastructure is viewed to be in sound condition and the five-year capital improvement program (CIP) is estimated at $94 million funded through grants, existing bond proceeds, or private investment.

Debt Structure: Stronger

Conservative Debt Structure: The system's debt is approximately 88% fixed-rate debt and 12% unhedged variable-rate bonds. Bond documents provide for solid reserves and adequate coverage requirements.

High Debt and Strong Liquidity: The airport's total net debt-to-cash flow available for debt service (CFADS) is elevated at 8.6x. A strong balance sheet with reserves equating to 438 days cash on hand helps mitigate potential traffic and operating revenue volatility. Debt service coverage is stable in the 1.3x-1.4x range, including use of coverage funds.

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Peer Group: The airport's peers include St. Louis, MO ('BBB+'/Stable Outlook) and Allegheny County, PA ('A-'/Stable Outlook). Each airport had previously been a domestic hub and has transitioned to a primarily O&D airport. All three airports have a high CPE but Cleveland has both the highest leverage and CPE. Allegheny County's low leverage supported by a residual agreement puts it into the 'A' category.

RATING SENSITIVITIES

Negative - Further traffic deterioration going beyond the connecting traffic;

Negative - Changes to the airline rate-setting methodology creating either weaker cost recovery terms or weaker financial metrics;

Negative - Significant uses in airport cash balances to subsidize airline charges or cover capital expenditures may impair financial flexibility;

Positive - Sustained favorable traffic performance as an O&D airport that improves airport revenue generation and allows for average airline costs to evolve to a more competitive range could support consideration for a higher rating.

CREDIT UPDATE

Cleveland intends to replace the liquidity provider supporting the series 2008D and 2009D variable-rate revenue bonds under new remarketing agreements with U.S. Bank National Association (IDRs 'AA-'/'F1+') expiring June 28, 2019. To the extent there are bank bonds under these agreements, the airport's obligation to repay the bank would be on parity with the outstanding senior lien airport revenue bonds.

In 2015, enplanements rebounded by 6.6% to slightly over 4 million, following a relatively sharp 16.1% decline in the prior year. The earlier losses were due to United's reduction in service, particularly those supporting connecting operations. Over the past year, several low-cost carriers have begun operating at Cleveland (Frontier, Spirit, and JetBlue) and, along with all incumbent airlines (except United) adding flights and seats has helped backfill routes. For the first three months of 2016, traffic growth remains robust, up over 9% as a result of continued additional services from new carriers serving CLE.

O&D percentage is currently over 97% reflecting the underlying strength of the local market. Since mid-2015, O&D traffic has rebounded at healthy rates of growth. United's market share is down to 33% from 51% in 2014, while American has increased to 17.7% from 7%, Frontier to 12.3% from 8%, and the 2015 new entrant Spirit at just over 7%.

Negotiations continue on the residual use and lease agreement that expired in 2015 and Fitch does not expect a different rate-setting policy with the new agreement, although average airline costs at CLE are high. The average CPE has risen so far from $13.77 in 2013 to about $18 in 2015. These levels are among the highest for a domestic-focused airport although carriers other than United have considerably lower airport costs. Fitch will monitor any changes in the agreement that could affect the airport's ability to recover costs.

CLE's recent financial performance has been largely stable with coverage of debt service at 1.32x based on indenture-derived fiscal 2015 preliminary results. Fitch's calculation of coverage, without the coverage account, generated a lean 1.05x ratio. CLE's debt metrics have been historically above average compared to airports with similar profiles, with leverage at about 8.6x; however, Fitch notes that net debt-to-CFADS should evolve to a lower 6x-7x range over the next five fiscal years, in both Fitch's base and rating cases, given the lack of additional borrowings and ongoing debt amortization.

Fitch's base case assumes a 1.5% average growth in traffic coupled with operating revenue increases averaging 2.5%. Coverage levels should remain the same, at about 1.30x, while average CPE holds at about the $20 level. The Fitch rating case assumes a flat traffic growth profile, taking into account a 5% loss in 2017 followed by recovery in subsequent years. Given the residual rate-setting approach, the coverage ratios are largely the same as the base case; however, CPE goes slightly higher in each year to maintain the same net cashflow.

SECURITY

To the extent bank bonds were to be issued, such obligations would be secured by a senior lien on airport net revenues, established in the master trust indenture. The senior airport bonds are secured by a first lien on the net revenue of the city of Cleveland's airport system, as well as operating grants, and passenger facility charge collections

Additional information is available at 'www.fitchratings.com'.

Applicable Criteria

Rating Criteria for Airports (pub. 25 Feb 2016)

https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=877676

Rating Criteria for Infrastructure and Project Finance (pub. 28 Sep 2015)

https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=870967

Additional Disclosures

Dodd-Frank Rating Information Disclosure Form

https://www.fitchratings.com/creditdesk/press_releases/content/ridf_frame.cfm?pr_id=1008203

Solicitation Status

https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=1008203

Endorsement Policy

https://www.fitchratings.com/jsp/creditdesk/PolicyRegulation.faces?context=2&detail=31

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