CREDIT OPINION New Issue Denver (City & County of) CO Airport Enterprise New Issue: Moody's assigns A1 to Denver (City & County of) CO Airport Enterprise's Series 2017A and Summary Rating Rationale Contacts Earl Heffintrayer +1.214.979.6860 VP-Senior Analyst earl.heffintrayer@moodys.com Kurt Krummenacker +1.212.553.7207 Senior Vice President/ Manager kurt.krummenacker@moodys.com CLIENT SERVICES Americas 1-212-553-1653 Asia Pacific 852-3551-3077 Japan 81-3-5408-4100 EMEA 44-20-7772-5454 Moody s Investors Service assigned an A1 to Denver (City and County of) CO Airport Enterprise s $276.4 million Airport Revenue Bonds Series 2017A and 2017B (Non-AMT). Concurrently, Moody s affirmed the A1 on the airport's outstanding senior lien revenue bonds and A2 subordinate lien bonds. The outlook is stable. The city and county operates Denver International Airport (DEN). The ratings reflect the airport's monopoly position in the diverse and growing Denver service area that has provided well above average O&D traffic growth in recent years. The ratings are also supported by the airport s geographically central location that leads to diversified airline service, with United Continental Holdings, Inc. (United, Ba2 stable), Southwest Airlines Co. (Southwest, A3 stable) and Frontier (WR) all operating connecting service at the airport. Leverage is expected to increase to around $275 debt per O&D enplanement in 2022, which would put the airport in the middle range of its peer set given announced capital plans by most large hub airports. The enterprise s high proportion of variable rate debt, approximately 22%, weighs negatively on the rating. The A2 rating on the subordinate bonds is based on the subordinate nature of the obligations, as well as the existing hedge and credit facility obligations secured by the subordinate lien.
Exhibit 1 DEN's Airline Cost Per Enplanement will rise consistent with other A1 rated connecting hubs with significant capital plans DEN A1 Median A2 Median Airline Cost per Enplanement ($) 25 20 15 10 5 0 2016 2017 2018 2019 2020 2021 2022 2023 Note: A1 median includes Dallas-Ft Worth, Houston, Phoenix and Seattle. A2 median includes Chicago O'Hare, Miami, and Salt Lake City. Source: Moody's Investors Service 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 on www.moodys.com for the most updated credit rating action information and rating history. 2
The ratings affirmations reflect the ability of the airport to absorb the larger than expected capital expansion expenditures while keeping airline costs competitive with other large hubs, which are also pursuing large capital plans, and the airport s primary airlines ability to absorb the modest increases in costs. The rapid amortization of the airport s existing debt is key to keeping leverage lower than peers and costs competitive. While current projections based on the airport's assumptions show a weakening coverage in later periods of the capital improvement plan, we think the airport is well positioned to outperform the current projected metrics based on the conservative assumptions in their forecast. Credit Strengths» Strong economic growth in the service area provides O&D enplanement strength, with O&D traffic growing 31.4% since 2010» Continued market share growth from Southwest contributes to greater airline diversity away from traditional reliance on United and Frontier» Robust liquidity position» Monopoly position in the growing Denver service area and favorable geographic position for connecting traffic between the southwestern and northeastern United States Credit Challenges» Sizable capital plan will increase leverage and airline costs and reduce DSCR if consultant's conservative forecast is met» Relatively high level of variable rate debt (22%) and high negative mark-to-market value of swaps relative to unrestricted cash balances» Uncertainty regarding long-term Frontier operation levels Rating Outlook The stable outlook is based on our expectation that higher revenue origination and destination (O&D) enplanements will continue to grow despite the loss of connecting traffic that will improve financial performance at the airport and balance higher leverage and construction risk associated with the capital plan. Factors that Could Lead to an Upgrade» Completion of the capital plan within current cost estimates» Continued robust O&D enplanement growth» Sustained growth or stability of Frontier's operations» Total DSCR above 1.75x on a sustained basis Factors that Could Lead to a Downgrade» Total DSCR below 1.15x on a sustained basis» Significant construction cost overruns or delays» Material decrease in service by either United or Southwest 3
Key Indicators Exhibit 2 Key Indicators DENVER (CITY & COUNTY OF) CO AIRPORT ENTERPRISE Enplanement Annual Growth (%) Debt Outstanding ($'000) 2012 2013 2014 2015 2016 0.5-1.2 1.7 1.1 7.9 3,811,910 4,398,110 4,284,025 4,112,490 3,905,640 Debt to Operating Revenues (x) 5.2 5.8 5.2 5.2 4.6 Debt Per O&D Enplaned Passenger ($) 216 245 230 206 188 Days Cash on Hand ('000) 691 741 860 842 764 Senior Lien Coverage By Net Revenues (x) 1.56 1.61 1.56 1.51 1.54 Total Coverage By Net Revenues (x) 1.38 1.41 1.34 1.23 1.17 Source: Moody's Investors Service, DIA Financial Statements Recent Developments DEN is launching a $3.5 billion, 5-year capital improvement plan to accommodate continued growth. The largest projects will include gate additions on all concourses ($1.8 billion) and improvements to the security and concession areas within the Jeppesen Terminal ($1.1 billion, which includes the Great Hall Project ). Approximately $3.9 million of new money debt is expected to be issued to fund the capital plan and required reserves. The city expects the Great Hall Project public-private partnership (P3) with Great Hall Partners LLC (GHP) to reach financial close in early December. The P3 is structured as a hybrid P3 with GHP receiving revenues from the improved retail offerings and from on-going supplemental payments, which are essentially availability payments, from the airport. The airport will additionally fund construction progress payments throughout the four-year construction period from a combination of bond issuances and airport generated revenue. While the P3 provides for significant risk mitigation for the airport by providing for a fixed-price, date certain delivery method, the airport will retain some portion of construction risk that is typical for P3 agreements. Notably, the airport retains the risk of increased costs if security screening protocols change and require alternative construction. The airport will also face the risk of making a termination payment that could range from 80% of GHP s debt in the case of termination for GHP default to all of GHP s debt plus GHP equity return in the case of termination for DEN default. We think that airport has demonstrated sufficient knowledge of the risk it retains and has evaluated how it will fund any cost exposures and therefore view the P3 to be slightly credit positive due to the construction risk transfer of the complex project. The airport continues to see strong enplanement growth in 2017, with enplanements growing 6.3% in 2017 through September over the same period in 2016. Detailed Rating Considerations Revenue Generating Base The Denver economy has posted solid gains through the decade, seeing substantial increases in personal income and strong population in-migration, both of which drive demand for origination and destination (O&D) travel at the airport. Among cities that have connecting hub airports that we rate, Denver s 18.8% increase in per capita income since 2010 trails only San Francisco (20.2%) and population growth of 11.7% since 2010 trails only Houston (13.5%). The region has a strong technology sector and also has a thriving logistics sector that benefits from the airport. In the near term, housing shortages will lead to higher housing costs and erode a historically low cost of living, dampening in-migration. However, Moody s Analytics thinks the region is well positioned to achieve economic growth above the US over the long term. Revenues at DEN are predominantly driven by the significant presence of three airlines. United Airlines (United Continental Holdings Inc., Ba2 stable) is the largest airline at the airport, as measured by enplanements, with 42.0% market share in 2016. According to the Bureau of Transportation Statistics, DEN served the second most domestic passengers in the United network for the trailing twelve 4
months ended July 2017, second only to Chicago (City of) IL O Hare Airport Enterprise (A2 stable). United has been the largest airline at the airport since it s opening in 1995 and also has signed the longest use and lease agreement at the airport that runs through 2035. With the signing of an amended use and lease agreement in 2014, United has renewed its commitment to the airport after roughly 10 years of declining service. Under the amendment, United has committed service at DEN at a minimum of 9.1% of total United system available seat miles. Exhibit 3 Exhibit 4 Exhibit 5 Airport share of United domestic enplanements Airport share of Southwest domestic enplanements Airport share of Frontier domestic enplanements MDW 7% ORD 13% LAS 6% DEN 23% DEN 6% DEN 11% BWI 5% Other 47% PHX 5% Other 52% MCO 10% SFO 10% IAH 10% EWR 9% Twelve month ended August 2017 Source: Bureau of Transportation Statistics Other 71% Twelve month ended August 2017 Source: Bureau of Transportation Statistics LAS 7% ORD PHL 4% 4% Twelve month ended August 2017 Source: Bureau of Transportation Statistics Southwest Airlines Inc. (A3 stable) is the second largest airline at the airport by enplanements, having grown its market share to 29.4% in 2016 from 5.3% in 2007. Though Southwest serves a smaller portion on total enplanements at DEN than United, the airport reports that Southwest 34.0% served of the O&D passengers at the airport to United s 27.0% in 2016. DEN represents the third biggest market in Southwest s system. Frontier Airlines also operates significant operations at the airport, accounting for 12.2% of enplanements in 2016, down from 22.7% in 2007. Passenger levels at DEN represent 23.0% of the airline's traffic, making it the largest airport in its network. Frontier continues to alter its route network as it transitions to an ultra-low cost carrier, and some routes have not even made it a year before they were pulled. The airline announced a plan to increase service at DEN by 50%, however we view that service to be speculative going forward until the airline demonstrates that the routes operate profitably over a series of years. Despite the volatility of Frontier, the airport s position as one of the top three airports in three different airlines demonstrates a diversity of significant airline activity that is unmatched at US airports. We view the significant presence of all three airlines to be a mitigant to the increased leverage in the capital plan. DEN faces little competition for O&D travel. The only competition within the greater Denver area is Colorado Springs (City of ) CO Airport Enterprise (Baa1 stable). While Colorado Springs has seen growth approaching 30% year over year with addition of Frontier service early in 2017, the airport s 788,000 mostly O&D enplanements in the twelve months ending September 2017 pale in comparison to the 18.5 million enplanements that DEN served in 2016. DEN does face competition for connecting traffic from Chicago O Hare and Houston (City of) TX Airport Enterprise (reference rating A1 stable), and several airports for Southwest connecting traffic. We think that even with the increases in cost at DEN, the airport will remain competitive with those other facilities that are also seeing airline cost increases due to capital expansion programs. Operational and Financial Performance Enplanements at DEN increased by 7.9% in 2016 after five years of growth at or below 1.7% growth. The sluggish total enplanement growth between 2011 and 2015 masked the strong growth of 23.1% in O&D enplanements In addition to traditional airport operations, 5
DEN has opened the on-site hotel operated by Westin that has met expected targets for revenue generation in its second year of operations. In 2016, the hotel was able to achieve net operating revenue of $17.2 million, above the $16.2 million projected by the hotel consultant at the time of the Series 2012 bond sale. Based on year-to-date bookings, the city expects net operating revenue from the hotel to increase to $22.1 million in 2017 versus the consultant s projection of $17.6 million. Exhibit 6 O&D enplanement growth at DEN has well exceeded national enplanement growth All US Airports DEN - All Enplanements DEN - O&D Enplanements 140 Enplanements Indexed to 2006 135 130 125 120 115 110 105 100 95 90 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 Source: DEN, Bureau of Transportation Statistics Strong enplanement growth at the airport caused a significant increase in operating revenue in 2016, up 8.0% to $742.5 million from $687.5 million. Increases in concession revenue ($7.7 million, 12.9%) provided the largest gain, followed by facility rentals ($4.4 million, 2.1%) and landing fees ($3.4 million, 2.4%). Parking revenue at the airport declined by $1.5 million (0.9%) as the opening of the commuter rail to the airport, increased usage of transportation network companies (Uber, Lyft, etc.) and full parking garages served to limit revenue. Through the first three quarters of 2017, the airport has seen parking revenue decline an additional 1.9%, however recent months have seen parking increases. The city maintains the ability to raise parking rates to mitigate further parking demand loss. Operating expenses, adjusted for non-cash pension expense, increased 5.6% in 2016, but have fallen 2.2% through the first three quarters of 2017 given lower maintenance expense. We expect that operating expenses will face inflationary pressure given the increasing costs of living in the Denver area and the tight labor market. Debt service coverage ratios by net revenues, adjusted for non-cash pension expense, decreased to 1.17x in 2017 from 1.23x in 2016 as a result in an increase in debt service requirements. Based on the consultant s forecast provided with this issue, will remain above 1.15 times over the forecast period in the base case. We think that consultant's forecast is achievable given cost recovery and conservative assumptions for both enplanement growth (2.2% over the long term) and financing costs. The revenue forecast for the Great Hall Project may prove optimistic, given the lack of comparable spaces in airports that are equally distant from the gate. However, the $10 million revenue from the Great Hall in 2022 represents just 0.02x debt service and is not a significant factor in the rating. 6
Exhibit 7 Total DSCR by net revenue will remain strong in the near term before narrowing in later years ofthe forecast period Actual Projected 1.8 1.7 What could change the rating - UP 1.6 1.5 1.4 1.3 1.2 1.1 1.0 2014 What could change the rating - DOWN 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 Source: Moody's Investors Service Net revenue debt service coverage differs from the airport s bond ordinance calculation because the bond ordinance calculation includes revenues owed to the airlines from revenue sharing and includes all PFC collections as revenues available for debt service, whereas we use net revenues as provided on the financial statements and only include those PFC amounts actually used to pay debt service. The airline agreement is subordinate to the general bond ordinance and any money owed to the airlines from the revenuesharing formula pursuant to the airline agreement is first available to pay debt service if needed. We also exclude CFCs, though they could be used to pay debt service if needed. LIQUIDITY Liquidity decreased to 764 days cash on hand in 2016 from 842 days cash on hand in 2015. The drop represents both the use of approximately $50 million of cash for capital projects and the increased operating expense referenced above. We expect the airport to reduce liquidity to its targets 500 days to fund the current capital plan. In the event that the airport does not generate sufficient revenue to fund cash portions of the capital, we expect that the airport would increase leverage to maintain the liquidity target. Debt and Other Liabilities DEN currently has roughly $2.8 billion in senior lien revenue bonds and approximately $870 million subordinate revenue bonds outstanding. The airport is approaching the final maturity of the debt issued to construct the airport in 1995, and as a result, the airport is retiring a significant amount of principal balance each year. Over the next ten years, the airport is scheduled to retire almost $2.1 billion of principal, while most debt for the current capital plan, which ends in 2018, has been issued. We expect additional leverage associated with a longer-term capital plan that addresses capacity constraints. However, we anticipate that leverage will remain near the current $200 debt per O&D level. In July, the airport announced it selected Ferrovial Airports to reconfigure the security screening areas of the Great Hall and to provide additional concession areas, utilizing a public-private partnership framework. We do not expect the project to significantly alter the credit profile or leverage metrics of the airport. DEBT STRUCTURE DEN currently has roughly $2.8 billion in senior lien revenue bonds and approximately $870 million subordinate revenue bonds outstanding. Over the next ten years, the airport is scheduled to retire almost $2.1 billion of principal, which provide the ability add the approximately $3.9 billion of debt to fund the current capital plan without greatly expanding leverage. 7
Exhibit 8 Declining existing debt service requirements provide capacity to layer in future debt Senior - Existing Subordinate - Existing Senior - Expected Subordinate - Expected Third Lien Annual Debt Service Requirements ($ millions) 800 700 600 500 400 300 200 100 2018 2023 2028 2033 2038 2043 2048 Source: DEN Approximately 78% of total debt is fixed rate and 22% is variable, though 20% of total debt is hedged with interest rate swaps. If the airport completes its capital plan as announced, annual debt service requirements will increase significantly. Exhibit 7 demonstrates how the debt service requirements will increase, however the airport retains flexibility to wrap future debt service around existing debt to minimize annual debt service requirements and airline costs. DEBT-RELATED DERIVATIVES The airport's swap agreements are with several counterparties and were undertaken prior to 2007 in accordance with the City and County of Denver s Master Derivatives Policy. The swaps are not a perfect hedge, and the airport may need to make additional floating rate payments to the extent the tax exempt variable rate on the bonds exceeds the floating rate agreed to in each of the swaps. The airport retains a unilateral option to terminate the swaps; however a payment may be due from the airport if it opts to terminate. As of November 1, 2017, the airport s swap portfolio had a negative mark-to market of $98.8 million across 18 swaps in favor of eight counterparties. All swaps terminate on or before November 15, 2025, with a remaining average life of 4.5 years. The airport could be required to post collateral or the swap counterparties could have the right to terminate the swaps if the airport Senior Lien rating were to fall below Baa2, which could result in a drain on the airports liquidity. Payments, including termination payments due under the swaps, are subordinate to senior lien debt service payments. Given the stability of the airports credit rating, we do not believe these agreements present a significant credit risk to the airport at this time. PENSIONS AND OPEB The airport's long-term defined benefit pension and health care liabilities are not a major factor in our assessment of the airport's credit profile. Our adjusted net pension liability (ANPL) in 2016 for the airport was approximately $326.3 million, compared to its reported net pension liability of $158.0 million. Unfunded pension liabilities are moderate in comparison to other airports and to total debt outstanding of over $3.9 billion. However, increases in pension expense should not significantly impact airline costs going forward. We adjust the reported pension liabilities of entities that report under governmental accounting standards, to enhance comparability across rated issuers. Under governmental pension accounting, liabilities are discounted using an assumed rate of investment return on plan assets. Under our adjustments, we value liabilities using a market based discount rate for high quality taxable bonds, a proxy for the risk of pension benefits. Management and Governance Under the city charter, the management, operation and control of DEN are delegated to Denver's Department of Aviation under the direction of a manager appointed by, and responsible directly to, Denver's mayor. The manager of finance, appointed by the mayor, currently is the chief financial officer and ex-officio treasurer of Denver and is responsible for the issuance of DEN debt and for the investment of DEN funds. In FY14, the airport extended its use and lease agreement with its largest carrier by enplanements, United, from 2025 to 2035. Under the terms of the agreement, airfield revenues are derived on a residual basis while terminal revenues are based on a commercial compensatory basis. With the extension, United committed to service levels at Denver, as measured by Denver's share of total United 8
operations, at FY14 levels and is obligated to pay penalties if service levels dip below the FY14 system share levels. Penalties are generally sized to make the airport whole on lost profit (concessions, net parking, PFC, etc.) from the passengers that would have been using the facility. The other carriers that operate at the airport have shorter tenured agreements that expire in December 2018. Any new agreements would need to match the business terms of the longer term United agreement. Airlines that do not sign a new agreement would operate as a non-signatory and pay rates a premium to those paid by United. Legal Security Net airport revenues on a parity basis with all other senior bonds. The rate covenant requires gross revenues plus other available revenues, including the rolling coverage account, to be sufficient to cover operating and maintenance expenses (O&M) and 125% of senior lien debt service and 110% of aggregate debt service. The rolling coverage account is currently funded at 25% of debt service and debt service reserves are funded at maximum annual debt service. As per the senior bond ordinance, the airports $4.50 Passenger Facility Charge (PFC) is to be allocated as follows: $1.50 (33%) of the PFC will be included in the definition of gross revenue and the remaining $3.00 (67%) will be applied as a reduction in the annual debt service requirement. While not pledged, the airport is currently using the $1.50 portion to pay debt service. This arrangement extends through the end of fiscal year 2018 and the airport intends to apply PFCs in the same manner through 2020. Senior lien bonds are secured by a cash funded common debt service reserve. Subordinate lien bonds are secured by a series specific debt service reserve fund sized at the standard 3-prong test. Subordinate lien bonds have a cash funded reserve. Use of Proceeds Proceeds of this sale will be used to refund Series 2007A, Series 2007C, and Series 2007D bonds and pay issuance costs. The current 2018-2022 CIP contains approximately $3.5 billion of capital spending, which is expected to be funded by $3.9 billion of additional debt that will begin to be issued in 2018. (The amount of bonds issued above the capital plan value reflects debt service reserves and issuance costs.) The largest portion of the plan includes $1.8 billion of spending to expand gate capacity on all three existing concourses. Concourse A, which serves Frontier and other assorted airlines, including international airline will grow to 44 gates from 32 gates. Concourse B, which primarily serves United, will grow to 65 gates from 54 gates. Concourse C, which primarily serves Southwest, will grow to 44 gates from 28 gates. The gate expansion projects will extend existing concourses into near greenfield areas, which should minimize operational risks and limit construction risk from modifying existing facilities. The city has entered into contracts with four experienced contractors and the current estimates reflect contractor input into program pricing. The contracts contain fixed price provisions and also include liquidated damages for late completion. Obligor Profile DEN is owned by Denver, and the power to operate, maintain and control DEN is vested in Denver s airport department. By ordinance, Denver has designated the airport department as an enterprise within the meaning of the state constitution, with the authority to issue its own revenue bonds or other financial obligations in the name of Denver. DEN, the primary asset of the airport system, opened in February 1995, and replaced Stapleton International Airport. The DEN site encompasses approximately 53 square miles located about 24 miles northeast of Denver s central business district. The passenger terminal complex, which encompasses approximately 1.2 million square feet, is reached via a 12 mile dedicated access road from Interstate 70. DENs airfield includes six runways, while the passenger terminal complex consists of a landside terminal and three airside concourses. Other Considerations: Mapping to the Grid The assigned A1 rating is one notch below the grid indicated rating of Aa3. The grid reflects audited information from 2016. The assigned rating reflects both lower liquidity and increased leverage expected from the capital plan. Please see our Publicly Managed Airports and Related Issuers Rating Methodology for information about the limitations inherent to grids. 9
Exhibit 9 Publicly Managed Airports and Related Issuers Methodology Grid Factor Subfactor Score Metric a) Size of Service Area (millions) Aa 3.74 b) Economic Strength and Diversity of Service Area Aa c) Competition for Travel Aa a) Total Enplanements (millions) Aaa b) Stability of Traffic Performance Aa c) Stability of Costs A d) Carrier base (Primary Carrier as % of Total Enplanements) A 42 a)debt Service Coverage by Net Revenues Baa 1.17x b)debt in USD per O&D Enplaned Passenger Aa $188.0 1. Market Position 2. Service Offering 3. Leverage and Coverage 4. Liquidity 5. Connecting Traffic 29.14 Metric Notch Days Cash on Hand 764 1 O&D Traffic 65.1-0.5 6. Potential for Increased Leverage -0.5 7. Debt Service Reserves 0 Scorecard Indicated Rating: Aa3 Source: Moody's Investors Service Methodology The principal methodology used in this rating was Publicly Managed Airports and Related Issuers published in October 2017. Please see the Rating Methodologies page on www.moodys.com for a copy of this methodology. Ratings Exhibit 10 Denver (City & County of) CO Airport Ent. Issue Rating Airport System Revenue Bonds, Series 2017A Rating Type Sale Amount Expected Sale Date Rating Description Airport System Revenue Bonds, Series 2017B (Non-AMT) Rating Type Sale Amount Expected Sale Date Rating Description A1 Underlying LT $255,220,000 11/27/2017 General Obligation A1 Underlying LT $21,175,000 11/27/2017 General Obligation Source: Moody's Investors Service 10
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