Kansas City's $851M of airport makeover bonds hit the runway next week
Kansas City International Airport officials are conducting a full court press with investors as they prepare to sell $851 million of airport special obligation debt to finance a $1.5 billion terminal modernization program.
The city-owned airport previously privately placed $98.5 million for some initial work. The tranche tentatively scheduled to price on June 12 will provide the funding needed to begin the work in earnest. Demolition has begun. Investor meetings are set for later this week in Philadelphia, Boston, and New York.
With a final borrowing in the $600 million range is expected in 2021, the airport is looking at potential hedging options to manage its exposure to potential increases in interest rates.
The project is years in the making. The current horseshoe terminal layout established in 1972 grew worn and failed to accommodate the larger aircraft, routes, and security requirements of current air travel.
The present terminal setup requires multiple security checkpoints in each terminal, making the airport a difficult place to make connecting flights and limiting options for post-security dining and shopping.
The city and airlines agreed in 2016 to overhaul the terminal layout, and voters approved it in 2017.
“Forty-seven years later this design is no longer efficient,” Justin Meyer, deputy director for marketing and air service development at the airport, said in an investor presentation. “Future growth is constrained by gate size, baggage infrastructure and roadway limitations.” The shuttered terminal A is the site for new terminal.
A local firm pitched a public-private partnership and the city began exploring that option. The city decided to open up the P3 to competition and, after some fits and starts, settled on a private investor group led by Edgemoor Infrastructure & Real Estate LLC to lead the design, construction, and financing.
The city shifted gears on the financing after exploring its options through Edgemoor and finding they would cost more than a city financing. In the end, the city settled on a more traditional airport bond financing. There was one hiccup. Voters had not approved a general airport bond sale as would be required under state law, so the city and airport turned to a special obligation security structured with some similarities to a general airport bond.
Repayment is built into the airport’s lease agreement with the airlines, and the master bond ordinance governing airport debt has been revised. The plan calls for a 39-gate terminal with room to expand to replace two operating ones and one shuttered terminal and 6,300 parking slots.
“It is the most efficient, most cost-effective deal we could do,” the airport’s chief financial officer John Green said in an interview. He said the partnership was limited to the "design-build” phase of the project. After that the project uses a “traditional financing structure," with the exception that the city and airport are using a conduit borrowing agency in the form of the development authority.
The decision to forgo private financing has other benefits. The city retains financing control going forward, limiting the relationship with the private builder once the airport opens, Green said. “The equity was coming in higher and would have created a longer term relationship with developer,” Green said. Though the relationship with the developer is good, he said, the city financing permits more flexibility going forward.
In its investor presentations, the finance team is highlighting the security strengths, Kansas City’s history of honoring its appropriation pledges, and Federal Aviation Administration restrictions on the use of airport generated revenues.
Green said the airport hopes investors look beyond any headlines and identify the bonds as being in-line with traditional general airport bonds.
Green said the marketing effort wasn't driven by the tarnish on Missouri-based appropriation credits stemming from Platte County’s decision not to appropriate funds to make up a shortfall in sales tax revenues to fully cover debt service on a $32 million deal issued through its development authority.
The deal carried an annual appropriation pledge under a financing agreement. A local court last week agreed with the county that it’s only obligation on debt service is for its auditor to submit an appropriation request that the county commission can either approve or not. The county lost its investment grade rating over the decision last year.
“The key point is the FAA restricts the use of airport revenue,” Green said. “We have a contractual relationship with the airlines that provides for debt service and the use is restricted to cover the appropriation of debt service so there are some pillars” that support repayment and there’s no incentive not to appropriate.
City finance director Randall Landes stressed the city’s policies prioritize appropriation debt and it’s funded unless the City Council passes an ordinance specifically eliminating it.
One investor who asked not to be named said he intends to forgo any Missouri-based special obligation credit.
Matt Fabian, partner at Municipal Market Analytics, which has been following the Platte County issue closely, said investors will need to closely look at the security features outlined in the offering statement, but the transaction benefits from federal restrictions on revenue use, and Kansas City has a deep understanding of the bond market and consequences of non-appropriation.
“Is this as strong of an obligation as a real GARB or even an appropriation in a different state? No. But it’s a materially safer profile than” other local Missouri governmental appropriation credits, Fabian said.
“Given the incentives and process for appropriation for city debt, Fitch does not view the distinctions in the forms of airport debt to differentiate the ratings,” Fitch Ratings wrote.
“Federal legislation that limits to the use of airport derived revenue from being used for non-aviation related purposes also eliminates the potential that the city not appropriate and use funds for other general purposes,” Moody’s Investors Service wrote.
The deal selling through the Industrial Development Authority of the city of Kansas City offers a $788.6 million series of airport special obligation bonds that is subject to the alternative minimum tax and a $62.7 million non-AMT series. Morgan Stanley has the books with nine other firms rounding out the syndicate.
The bonds mature in 2055 and are secured by payments from the city to the authority under a financing agreement subject to the annual appropriation by the city council, with airport revenues serving as the source of repayment.
Proceeds will fund the project costs, debt service reserves, and capitalized interest through construction with the new terminal targeted for a 2023 opening.
Hilltop Securities Inc. and Moody Reid Financial Advisors are advising the city. Kutak Rock LLP, the Hardwick Law Firm LLC, and Martha E. Schach, owner of Attorney at Law LLC, are co-bond counsel. Lewis Rice LLC and Fields & Brown LLC and Schach are co-disclosure counsel.
The bonds carry an A rating from Fitch Ratings and S&P Global Ratings and an A2 from Moody’s Investors Service. All assign a stable outlook. S&P downgraded the airport’s general airport rating in conjunction with the deal by one notch to A due to the level of new debt.
“It’s an absolute necessity” so was worth the downgrade,” Green said of the project, adding that the airport probably faced a downgrade whether or not it went with a private financing structure or public.
The airport has all necessary environmental approvals.
Southwest Airlines is the top carrier at Kansas City International, accounting for 51% traffic, followed by Delta Air Lines, American Airlines, and United Airlines. Parking is the top revenue source followed by airline revenues.
Passenger levels rose by 5.9 % to nearly six million in fiscal 2019 compared to 2.8% the previous year and a five year average of 3.7%. Some positive momentum was slowed this year by the grounding of Boeing’s 737 Max8 planes after two crashes led to questions over potential design flaws.
The city’s growing population, income levels, and jobs support ongoing traffic growth, Landes said in the presentation. The airport has a separate $234 million, five-year capital improvement program, but no debt is planned.
Fitch said its rating reflects “a favorable revenue risk profile, supported by a broad traffic base and a strengthened cost recovery framework, offset by the size of the upcoming terminal-focused capital program” that “has resulted in a marked increase to airline costs and higher sustained leverage metrics.”
The local market supports nearly six million passengers traveling annually and has a solid origination/destination demand profile. “The airport's renegotiated airline use and lease agreement will transition rate setting to a full residual methodology following terminal opening, ensuring all debt service and operating costs are recovered,” Fitch added.
Though the project does introduce execution risks to the airport’s credit profile, it benefits from strong public and airline support. The bonds benefit from a conservative fixed-rate structure and senior lien position and flat debt service. A downside is the long maturity of 2057 accounting for the 2021 issuance.
Moody’s rates the new bonds one notch lower than the airport’s $110 million of general airport bonds.
“The A2 rating on the senior lien appropriation obligations is based on the conditional lien that the obligations will have on net revenue, weaker than the unconditional claim provided for senior lien airport revenue bonds that are rated A1 and the large amount of debt expected to fund the terminal modernization project,” Moody’s said.
The increased debt will raise adjusted debt per originations and destination passenger to near $285, high for an airport of its size, Moody’s said.
"The downgrade reflects the significant impact from these issuances and additional debt plans in the near term because of financing the terminal-modernization plan," said S&P analyst Kevin Archer said.
The rating’s strengths include the airport’s market position, service area economic fundamentals, low industry risk relative to that of other industries and sectors, and very strong management and governance.