Fitch Affirms Navistar's IDR at 'CCC'; Removes Negative Outlook

CHICAGO--()--Fitch Ratings has affirmed the Issuer Default Ratings (IDR) for Navistar International Corporation (NAV) and Navistar Financial Corporation (NFC) at 'CCC' and removed the Negative Outlook on the ratings. The removal reflects Fitch's view that immediate concerns about liquidity have lessened, although liquidity remains an important rating consideration as NAV implements its selective catalytic reduction (SCR) engine strategy. Other rating concerns are already incorporated in the 'CCC' rating. A full list of ratings is shown at the end of this release.

NAV's manufacturing cash balances of $1.5 billion at Oct. 31, 2012 were above the high end of the range anticipated by Fitch. The improvement resulted from NAV's issuance of approximately $200 million of equity near the end of its fiscal year in October, lower inventory, and the collection of defense receivables sooner than anticipated. However, the improving liquidity trend could reverse during the first part of fiscal 2013 due to seasonal and one-time factors before NAV's fundamental operating performance recovers.

NAV's liquidity includes $1.5 billion of manufacturing cash and marketable securities and a $175 million ABL facility. This level of cash should be sufficient to offset negative FCF while NAV introduces its heavy duty diesel (HDD) SCR engines. Fitch expects manufacturing free cash flow (FCF) to be negative through at least the first half of fiscal 2013 due to seasonally low FCF; possible delays in deliveries due to the depletion of emissions credits; and expenditures related to warranties, non-conformance penalties (NCPs), and ongoing pension contributions.

Liquidity and FCF could be pressured if industry demand for trucks does not improve, the company's market share does not recover, or the transition to SCR technology is delayed. Current maturities of manufacturing long term debt were modest at $172 million as of Oct. 31, 2012, but debt maturities exceed $1.5 billion in 2014, including $570 million of 3% convertible notes. The remaining 2014 maturities could be extended if NAV pays down or refinances the majority of the convertible notes.

NAV finalized a supply agreement with Cummins Inc. in October 2012 for SCR engines and emissions technology. NAV's transition to SCR emissions technology appears to be on track within the expected time frame and cost. However, it involves execution risk related to integrating the technology with NAV's engines, and integrating Cummins' 15-liter engine in NAV's trucks. Execution risks are mitigated by NAV's familiarity with Cummins engines. In December 2012, NAV launched on time the ProStar with the Cummins ISX 15-liter engine, and is scheduled to phase in 13-liter SCR engines beginning in April 2013, followed by medium duty engines later in 2013 or 2014. NAV will require approval by the EPA of its reconfigured emissions compliant engines.

Other rating concerns include the availability and use of emissions credits which NAV estimates will be depleted during 2013 for its heavy HDD engines. In addition, NAV is still working to achieve on-board diagnostics (OBD) certification in 2013 for certain engines. As a result, there could be occasional gaps in deliveries while NAV implements its revised engine strategy. Such delays could slow a recovery in the company's market share, at least temporarily. NAV's share in its traditional heavy and medium truck and bus markets was 23% in fiscal 2012 and remains well below the peak level of 36% in 2009. Emission credits are a particular concern in 10 states that use California Air Resources Board (CARB) standards which do not allow the use of NCPs. There are sufficient emissions credits to support medium duty engine sales into 2014.

EBITDA in 2012 was negative due to higher warranty costs, a decline in military vehicle sales, lower engine sales related to truck volumes and demand in South America, and higher material costs. Warranty expense more than doubled in 2012 to $895 million, mostly related to complexity surrounding engine emissions regulations. The charges included more than $400 million of adjustments to pre-existing warranties. As NAV incorporates improvements in newer engines, warranty expense should decline in 2013, barring additional unexpected quality problems. However, cash charges are likely to increase in the near term as NAV makes repairs related to accrued warranty liabilities.

Fitch estimates EBITDA could turn positive during 2013 if NAV executes its revised engine strategy on time and begins to rebuild market share. In order to improve its operating performance and preserve cash, NAV plans to limit capital spending, cut back on investments associated with NAV's global expansion, and redirect product development to its engine strategy. Restructuring should also help control NAV's cost structure over the long term, including workforce reductions. NAV estimates these actions will reduce its cost structure by $175 million beginning in 2013.

Pension contributions represent a recurring use of cash, but required contributions during the next few years should be slightly lower than originally anticipated due to MAP-21 legislation passed in 2012. The legislation allows a portion of required contributions to be temporarily deferred, but the total obligation is unaffected. NAV estimates it will be required to contribute $166 million in 2013 and at least $200 million annually between 2014 and 2016. NAV contributed $157 million in 2012. NAV's net pension obligations increased to $2.1 billion at the end of fiscal 2012 from $1.8 billion in 2011.

Fitch could take a positive rating action if manufacturing FCF returns toward a sustainable breakeven level during 2013, the SCR engine strategy is implemented on time, the company's market share begins to recover, and earnings improve steadily.

Fitch could take a negative rating action if NAV's transition to SCR emissions technology is delayed or requires substantial cash expenditures, or FCF and liquidity do not begin to recover after the middle of fiscal 2013. If sales volumes are low or margins remain pressured, FCF could be impaired, making it difficult to fund capital expenditures, pension contributions and higher interest expense associated with increased debt levels. In addition, five investors have accumulated, in aggregate, more than 50% of NAV's common shares, which introduces uncertainty about long-term operating and financial policies. The ratings could also be negatively affected depending on the outcome of the SEC's investigation of the company's accounting and disclosure practices.

The Recovery Rating (RR) of '1' for Navistar Inc.'s $1 billion term loan supports a rating of 'B', three levels above NAV's IDR, as the loan can be expected to recover more than 90% in a distressed scenario based on a strong collateral position. The RR '5' for NAV's senior unsecured debt results in a rating of 'CCC-', one notch below the IDR, and reflects poor recovery prospects in a distressed scenario. The RR '6' for the senior subordinated convertible notes reflects a lower priority relative to NAV's senior unsecured debt.

Fitch believes NFC is core to NAV's overall franchise, and the IDR of the finance subsidiary is directly linked to that of its ultimate parent due to the close operating relationship and importance to NAV, as substantially all of NFC's business is connected to the financing of new and used trucks sold by NAV and its dealers. The linkage also reflects the potential that, under a stress scenario, NAV may seek to extract capital and/or unencumbered assets from NFC. The relationship between NAV and NFC is formally governed by the Master Intercompany Agreement. Also, there is a requirement referenced in NFC's credit agreement requiring Navistar, Inc. or NAV to own 100% of NFC's equity at all times.

Fitch views NFC's operating performance and overall credit metrics as neutral to NAV's rating. NFC's performance has not changed materially compared to Fitch's expectations, but its financial profile remains tied to NAV's operating and financial performance. NFC's profitability declined further in 2012 due to the lower net interest margin earned from the continued reduction of NFC's retail portfolio balance.

NFC's asset quality has remained stable, reflecting the mature retail portfolio, which is in run-off. Charge-offs and provisioning volatility has declined as NFC focuses on its wholesale portfolio, which historically has experienced lower loss rates relative to the retail portfolio.

Absent material dividends to the parent, Fitch expects NFC's leverage to improve and stay below historical levels due to reduced financing needs. Balance sheet leverage, as measured by total debt to equity fell to a historical low of 3x in 2012. Management believes NFC can more effectively operate with a leverage target between 5x and 6x, which is consistent with other Fitch-rated captives. The company may also reestablish dividends from NFC to NAV in efforts to maintain adequate asset coverage and leverage, as well as to enhance liquidity at NAV in the medium to longer term.

In June 2012, NFC completed a securitization of roughly $500 million and used proceeds to repay outstanding borrowings on a previous securitization and a portion of its revolving bank credit facility. In addition, NFC refinanced a $750 million wholesale facility in August 2012. Fitch believes the refinancing of NFC's debt facilities may help to mitigate potential near-term liquidity concerns at NFC.

The RR of '5' for NFC's senior secured credit facilities support a rating of 'CCC-', one notch below the IDR, which reflects poor recovery prospects in a distressed scenario.

As of Oct. 31, 2012, Fitch's ratings covered approximately $3 billion of debt at NAV and $1.9 billion of outstanding debt at the Financial Services segment, the majority of which is at NFC.

Fitch has affirmed the following ratings:

Navistar International Corporation

--Long-term IDR at 'CCC';

--Senior unsecured notes at 'CCC-'/'RR5';

--Senior subordinated notes at 'CC'/'RR6'.

Navistar, Inc.

--Long-term IDR at 'CCC';

--Senior secured bank term loan at 'B'/'RR1'.

Cook County, Illinois

--Recovery zone revenue facility bonds (Navistar International Corporation Project) series 2010 at 'CCC-'.

Illinois Finance Authority (IFA)

--Recovery zone revenue facility bonds (Navistar International Corporation Project) series 2010 at 'CCC-'.

Navistar Financial Corporation

--Long-term IDR at 'CCC';

--Senior secured bank credit facilities at 'CCC-'/'RR5'.

Additional information is available at 'www.fitchratings.com'. The ratings above were solicited by, or on behalf of, the issuer, and therefore, Fitch has been compensated for the provision of the ratings.

Applicable Criteria and Related Research:

--'Corporate Rating Methodology' (Aug. 8, 2012);

--'Parent and Subsidiary Rating Linkage' (Aug. 8, 2012);

--'Finance and Leasing Companies Criteria' (Dec. 11, 2012);

--'Global Financial Institutions Rating Criteria' (Aug. 15, 2012);

--'Recovery Ratings and Notching Criteria for Non-Financial Corporate Issuers' (Nov. 13, 2012);

--'Recovery Ratings for Financial Institutions' (Aug. 15, 2012).

Applicable Criteria and Related Research:

Corporate Rating Methodology

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=684460

Parent and Subsidiary Rating Linkage

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=685552

Finance and Leasing Companies Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=696720

Global Financial Institutions Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=686181

Recovery Ratings and Notching Criteria for Non-Financial Corporate Issuers

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=693773

Recovery Ratings for Financial Institutions

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=686295

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Contacts

Fitch Ratings
Primary Analyst (Navistar International Corporation)
Eric Ause, +1-312-606-2302
Senior Director
Fitch, Inc.
70 W. Madison Street
Chicago, IL 60602
or
Secondary Analyst
Craig Fraser, +1-212-908-0310
Managing Director
or
Committee Chairperson
Sharon Bonelli, +1-212-908-0581
Managing Director
or
Primary Analyst (Navistar Financial Corporation)
Johann Juan, +1-312-368-3339
Director
or
Secondary Analyst
Katherine Hughes, +1-312-368-3123
Associate Director
or
Committee Chairperson
Nathan Flanders, +1-212-908-0827
Managing Director
or
Media Relations
Brian Bertsch, New York, +1-212-908-0549
brian.bertsch@fitchratings.com

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Contacts

Fitch Ratings
Primary Analyst (Navistar International Corporation)
Eric Ause, +1-312-606-2302
Senior Director
Fitch, Inc.
70 W. Madison Street
Chicago, IL 60602
or
Secondary Analyst
Craig Fraser, +1-212-908-0310
Managing Director
or
Committee Chairperson
Sharon Bonelli, +1-212-908-0581
Managing Director
or
Primary Analyst (Navistar Financial Corporation)
Johann Juan, +1-312-368-3339
Director
or
Secondary Analyst
Katherine Hughes, +1-312-368-3123
Associate Director
or
Committee Chairperson
Nathan Flanders, +1-212-908-0827
Managing Director
or
Media Relations
Brian Bertsch, New York, +1-212-908-0549
brian.bertsch@fitchratings.com