Fitch Downgrs Susquehanna Airport PA's Sr Bnds to 'BBB'; Removes Sr/Sub Bnds from Watch Negative.

NEW YORK -- Fitch downgrades the rating of Susquehanna Area Regional Airport Authority's (the authority) approximately $133.5 million of outstanding senior airport system revenue bonds to 'BBB' from 'BBB+'. At the same time, Fitch affirms the 'BBB-' rating on the authority's approximately $67.1 million of outstanding subordinate lien airport system revenue bonds. With these rating actions, the senior and subordinate lien bonds are removed from Rating Watch Negative where they were placed on July 7, 2006. The Rating Outlook on all liens is Stable, reflecting Fitch's expectation that a recent gradual, though potentially variable, recovery in passenger traffic will continue through at least the intermediate term, thereby facilitating revenue generation more in line with Fitch's original expectations for this credit and leading to overall improved financial flexibility.

The rating downgrade to 'BBB' from 'BBB+' on the senior lien bonds, which are secured by a net revenue pledge of airport system net revenues and an irrevocable commitment of passenger facility charge receipts, reflects management's decision to circumvent the flow of funds under the master trust indenture and purposely pay a portion of July 2006 scheduled senior and subordinate lien interest payments from debt service reserve funds. This draw was made irrespective of lien status, calling into question the additional protection accorded to senior lien bondholders relative to their subordinate counterparts. While senior lien bondholders still benefit from a first lien and enjoy higher levels of debt service coverage, their vulnerability to future management actions regarding application of revenues and payment of debt service no longer warrant a full two-notch distinction from the subordinate lien rating. Fitch notes that the debt structure calls for management control over the flow of funds, with the trustee serving only as a paying agent.

The purposeful draw on both the senior and subordinate lien debt service reserve fund stemmed primarily from management's attempt to garner control over excess funds released over time from the subordinate debt service reserve account. Under the master trust indenture, management was required to set aside debt service reserve funds for subordinate lien bonds, which are secured by a pledge of subordinate airport system net revenues and an irrevocable commitment of receipts under a $44.2 million Federal Aviation Administration Letter of Intent (LOI), in amount equal to maximum annual debt service. The authority partially funded this reserve with approximately $6 million in LOI monies received during 2005. This LOI was supposed to have been used to pay debt service in Janaury 2006 leading to a shortfall in monies available for debt service going forward.

As subordinate lien bonds matured, and the related reserve fund requirement declined, the authority expected to recover these balances. However, the final legal documents were not consistent with this interpretation. The documents required these funds to flow through the revenue fund and would have reduced airline related payments with no financial benefit accruing to the authority. To deal with this constraint, the authority opted not to subject these excess funds to the flow of funds and instead drew approximately $2 million of this balance from the senior lien and subordinate lien debt service reserves.

Since its action, which was an event of material disclosure under the master trust indenture, the authority, pursuant to the master trust indenture, has begun to pay back 1/12th of the borrowed amount. However, the authority continues to face a shortfall with the upcoming January 2007 debt service payment. The authority plans to solve this problem by replacing a portion of the debt service reserve fund requirement with a letter of credit (LOC) and using the released funds for the January 2007 payment. Once the LOC has been executed and the reserve monies released, the authority expects to eliminate the shortfall and pay debt service when due from originally pledged sources.

Investment grade ratings on the authority's senior and subordinate bonds continue to be warranted by Harrisburg International Airport's (the airport's) highly origination & destination oriented traffic base and economically diversified service area, home to the state capital of Pennsylvania, which provides for a base level of airport traffic, albeit small, over time. Additional factors supporting the investment grade ratings include a hybrid use & lease agreement which allows the authority to raise airport rates and charges to meet bondholder covenants thereby lending a degree of stability to airport financials independent of traffic trends; sound coverage of debt service on senior bonds (1.80 times (x) per the indenture during 2005) and adequate coverage of total debt service (1.16x per the indenture during 2005); and prudent management of operating expenses during a recent period of depressed traffic and revenues. However, these factors are tempered by the airport's very high cost structure and leverage, yielding ratings on both liens which are well below Fitch's average rating range.

Through September 2006, the airport reports approximately 394,000 enplanements, down approximately 22.3% from the approximately 508,000 reported by the airport during the prior year nine-month period. However, based upon strong demand and yields, airlines have begun to add additional capacity, with traffic for October 2006 equaling approximately the same level recorded during October 2005. For the full year 2006, traffic is expected to be down 8.6%, with additional gains in passengers expected in November and December. Fitch views this gradual recovery cautiously, although recently added seats and destinations could signify a longer term trend of improving levels of airline service in the market.

Year to date financial performance shows authority operating revenues at 3.6% below budget at approximately $17.8 million. However, as a result of continued budget tightening, expenses are also below budget by 7.1%, equaling $10.9 million, yielding an operating ratio of 39%, consistent with prior years. Revenue improvement is expected for the remainder of 2006 and into 2007 given the growth in traffic and expected airline rate increases, which the carriers have approved. Fitch estimates the airport's cost per enplaned passenger (CPE) ranges from $12 to $14, which is above average for an airport of this size. However, the favorable airline yield environment helps to mitigate these costs to some degree.

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