Fitch: Potential Airline Consolidation May Be a Mixed Blessing for U.S. Airports.

NEW YORK -- Recent news stories concerning a possible merger of bankrupt US Airways with America West Airlines (America West, senior unsecured debt rated 'CCC' by Fitch) suggests that the long awaited consolidation of the domestic airline industry may finally be beginning. Many airline industry observers believe such a consolidation, whether through mergers or liquidations, is needed to wring excess seat capacity out of the system, which, along with increased competition, has driven domestic air fares to historical lows and contributed to the industry's sustained weak financial performance.

'While an industry consolidation may or may not completely address the economic issues facing the domestic airlines, such activity may have ramifications for the nation's airports, particularly at the individual level,' said Dan Champeau, Managing Director, U.S. Public Finance, Fitch Ratings. 'U.S. airports may lose service and revenues in the short term; however, a vibrant domestic airline industry remains necessary for long-term growth,' Champeau added.

In the long run, domestic airports stand to gain from a vibrant domestic airline industry so actions that serve to strengthen the economic stature of the airlines should benefit the nation's airports as a whole over time. However, in the short-term, should such a consolidation remove excess capacity and result in increased pricing power for the airlines, airports may experience revenue declines in non-airline sources due to reduced passenger activity stemming from higher airfares and reduced service levels. Fitch believes that a portion of recent gains in passenger traffic exceeds natural growth attributable to the expanding economy but are more a reaction to the price environment that may be vulnerable to a moderate increase in airfares.

Credit concerns become more apparent at individual airports that serve as major operations centers for carriers that may be involved in potential mergers and liquidations. Fitch's 2005 Airport Industry Outlook focused on the possibility of one or more airlines liquidating and the affect on the nation's airports. Fitch believes that large origination and destination (O&D) airports in healthy service areas or airports with a diverse mix of airlines, including some of the more financially stable carriers are likely to fare relatively well compared with second and third tier connecting hubs and certain small-hub airports that may lose service and related revenues. A liquidation would likely result in greater short-term disruption to the domestic aviation network than a merger, as the bankrupt airline's operations would cease and terminal space become dormant, reducing overall service levels. While the surviving carriers would likely backfill this service, it would take time for them to realign their schedules and secure the equipment and manpower to provide such service. Also, the timing of the liquidation, the financial status of the surviving carriers, and the markets that become available would affect the nature of a post liquidation recovery. In addition, valuable terminal space may become subject of prolonged bankruptcy proceedings as the creditors seek to recover as much value as can be salvaged in the liquidation process. While airlines typically do not own their gates at airports, long-term leases are often a transferable asset that may be subject to a court ordered-auction or other assignment in the bankruptcy process.

While mergers may prove less disruptive, as service levels are gradually adjusted as the two entities realign their operations, they still may pose credit concerns for airports. In a situation where one entity is under protection of Chapter 11 of the U.S. bankruptcy code, as is US Airways, the merger partners could use the bankruptcy process in their realignment efforts by possibly rejecting the bankrupt carrier's use and lease agreements regarding unwanted terminal space and implementing other reorganization strategies. This could lead to reductions in service and a realignment of network hubs.

Fitch continues to recognize the inherent economic strengths of the nation's airports, which result in a significant overall differentiation of their industry's credit quality relative to that of the domestic airlines. Should the airline industry eventually undergo significant consolidation, Fitch will evaluate the affect on the nation's airports on a case-by-case basis, with any rating actions reflecting the ramifications on various credit factors, including the economic underpinnings of the air service market, the strength of the airport's balance sheet strength, financial margins and cost structure, status of its capital plan and fixed obligations, and management's ability to quickly adjust to its new operating environment.