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Fitch Affirms Navistar's IDR at 'CCC'; Rates Planned Sr. Sub Convertible Notes 'CC'/'RR6'
October 7, 2013 / 4:28 PM / in 4 years

Fitch Affirms Navistar's IDR at 'CCC'; Rates Planned Sr. Sub Convertible Notes 'CC'/'RR6'

(The following statement was released by the rating agency) CHICAGO, October 07 (Fitch) Fitch Ratings has affirmed the Issuer Default Ratings (IDRs) for Navistar International Corporation (NAV), Navistar, Inc. and Navistar Financial Corporation (NFC) at 'CCC'. In addition, Fitch assigns a rating of 'CC'/'RR6' to NAV's planned $200 million of senior subordinated convertible notes due 2018. Proceeds from the new notes will be available for general corporate purposes and to repay a portion of 3% senior subordinated notes scheduled to mature October 2014. A full list of ratings is shown at the end of this release. Fitch has removed the Positive Rating Outlook on NAV due to uncertainty about the timing of possible future changes in the company's credit profile, particularly as the operating environment remains difficult. Fitch believes NAV's past actions to revise its engine strategy and improve liquidity could support stronger operating results and rebuild financial flexibility over the long term, but the effectiveness of these actions will be subject to near term challenges surrounding the company's market share and industry demand for heavy duty trucks. Key Rating Drivers NAV has made meaningful progress in implementing its revised engine strategy that involves Selective Catalytic Reduction (SCR) emissions technology. The introduction of SCR technology on NAV's heavy duty engines was completed in August 2013 and is currently being phased in on its medium duty engines. NAV also continues to restructure and streamline its manufacturing and engineering operations to improve efficiency and cut costs which can be expected to support margins over the long term. NAV estimates it will reduce its cost structure by $50 million - $60 million in 2014 in addition to $236 million of savings realized to date. Key rating concerns include low sales volumes related to weak industry demand for heavy duty trucks, declines in the company's market share, high warranty costs, operating losses and negative free cash flow. NAV's share in its traditional heavy and medium duty truck markets fell to 14% and 24%, respectively, in the third fiscal quarter of 2013 compared to 18% and 23%, respectively, in fiscal 2012. Orders have recently improved for certain heavy duty trucks which could begin to boost sales in future periods, but orders for medium duty trucks have been especially weak pending NAV's implementation of SCR technology in the medium duty market. NAV recently added the Cummins medium-duty ISB engine to its offerings, but full introduction of SCR in medium duty engines will take place largely in 2014. Concerns about the availability and use of emissions credits are declining as the production of SCR engines increases. Non-conformance penalties totaled $7 million in the third quarter of fiscal 2013 compared to $10 million in the year-earlier-quarter. NAV has received required regulatory approvals of its reconfigured emissions compliant engines and on-board diagnostics, and there are sufficient emissions credits to support sales of medium duty vehicles equipped with non-compliant engines into 2015. Warranty expense more than doubled in 2012 to $895 million and has remained high in 2013, at $594 million through the first nine months. Charges in 2012 included more than $400 million of adjustments to pre-existing warranties. Warranty expenses are largely attributable to complexity surrounding engine emissions regulations, especially for engines produced in 2010. Cash charges could be high in the near term as NAV makes repairs related to accrued warranty liabilities. Manufacturing sales declined nearly 16% in the first nine months of 2013 due to lower industry deliveries, NAV's deteriorating market share, and lower military sales. NAV continues to generate significant operating losses and may not return to profitability until it completes its transition to SCR technology and rebuilds market share. To preserve cash, NAV is limiting capital spending, pruning non-core operations, and expanding restructuring actions. Manufacturing free cash flow (FCF) was negative $383 million through the first nine months of fiscal 2013. Fitch expects it will be negative for the full year and possibly again in fiscal 2014 before the full impact of NAV's revised engine strategy and cost restructuring become evident. NAV's FCF is usually strongest in the last two quarters but is currently pressured by low sales volumes, costs to implement SCR emissions technology, high warranty cash costs, and pension contributions. FCF in 2014 could potentially benefit from higher sales volumes if the growth in orders for heavy duty trucks in the third quarter is sustained, costs decline related to the implementation of SCR, and NAV realizes expected savings from restructuring. NAV's liquidity at July 31, 2013 included manufacturing cash and marketable securities totaling $1,026 million (net of BDT and BDP joint venture cash and restricted cash) compared to net cash of $1,448 million at FYE Oct. 31, 2012. NAV also has an undrawn $175 million ABL facility. Liquidity was offset by current maturities of manufacturing long term debt of $116 million. Liquidity could decline through early 2014 when working capital is typically negative. However, working capital may be less cyclical in the near term due to weak sales levels. In addition, NAV's financial services business is conservatively leveraged, which provides adequate capacity to support a planned $270 million intercompany loan to NAV. Pension contributions represent a recurring use of cash. NAV estimates it will be required to contribute $166 million in 2013 and at least $200 million annually between 2014 and 2016. The company contributed $157 million in 2012 and $86 million through the first nine months of 2013. NAV's net pension obligations increased to $2.1 billion at the end of fiscal 2012 from $1.8 billion in 2011. The favorable impact of higher interest rates on the pension liability calculation could potentially reduce the liability at the end of 2013. Rating Sensitivities Fitch could take a positive rating action if manufacturing FCF returns toward a sustainable breakeven level, the SCR engine strategy is completed successfully, NAV's market share recovers, restructuring and integration lead to further cost savings, and earnings improve. Fitch could take a negative rating action if NAV's market share fails to recover or liquidity declines materially from current levels. If NAV's operating performance does not improve sufficiently in the next several quarters, the company could be challenged to fund capital expenditures, seasonal working capital requirements, pension contributions and interest expense. Several investors have accumulated a material portion of NAV's common shares which contributes to some 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 $700 million 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 'RR4' for senior unsecured debt reflects average recovery prospects in a distressed scenario. The RR '6' for senior subordinated convertible notes reflects a low priority position relative to NAV's other debt. Navistar Financial Corporation 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. Total financing revenue declined in third quarter 2013 (3Q13) on continued reduction of NFC's retail portfolio balance and lower wholesale financing volume to dealers. The average receivables balance declined to $1.6 billion at July 31, 2013 compared to $2.3 billion one-year prior. NFC's asset quality remains stable, reflecting the mature retail portfolio which is running 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. NFC's leverage has remained at historically low levels due to reduced overall financing needs. Balance sheet leverage, as measured by total debt to equity, was 2.36x in 3Q13 compared to 3.98x one-year prior. Management believes NFC can more effectively operate with a leverage target between 5x and 6x, consistent with historic levels and with other Fitch-rated captives. The company is contemplating financing actions, which may include reestablishing 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. Liquidity is adequate at July 31, 2013, with $5.2 million of unrestricted cash and approximately $768 million of availability under its various borrowing facilities. In February and September 2013, NFC completed refinancings of a portion of its borrowing facilities which Fitch believes mitigates some potential near-term liquidity constraints. The 'RR4' for NFC's senior secured credit facilities reflects average recovery prospects in a distressed scenario. As of July 31, 2013 debt totaled nearly $3.1 billion at NAV, including unamortized discount, and $1.7 billion 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'/'RR4'; --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'/'RR4'. Contact: Primary Analyst (Navistar International Corporation) Eric Ause Senior Director +1-312-606-2302 Fitch Ratings, Inc. 70 W. Madison Street Chicago, IL 60602 Secondary Analyst Craig Fraser Managing Director +1-212-908-0310 Committee Chairperson Mark Sadeghian Senior Director +1-312-368-2090 Primary Analyst (Navistar Financial Corporation) Johann Juan Director +1-312-368-3339 Secondary Analyst Katherine Hughes Associate Director +1-312-368-3123 Committee Chairperson Ed Thompson Senior Director +1-212-908-0364 Media Relations: Brian Bertsch, New York, Tel: +1 212-908-0549, Email: brian.bertsch@fitchratings.com. Additional information is available at 'www.fitchratings.com'. Applicable Criteria and Related Research: --'Corporate Rating Methodology' (Aug. 5, 2013); --'Parent and Subsidiary Rating Linkage' (Aug. 5, 2013); --'Finance and Leasing Companies Criteria' (Dec. 11, 2012); --'Global Financial Institutions Rating Criteria' (Aug. 15, 2012); --'Rating FI Subsidiaries and Holding Companies' (Aug. 10, 2012); --'Recovery Ratings for Financial Institutions' (Aug. 19, 2013); --'Recovery Ratings and Notching Criteria for Non-Financial Corporate Issuers' (Nov. 13, 2012). Applicable Criteria and Related Research: Corporate Rating Methodology: Including Short-Term Ratings and Parent and Subsidiary Linkage here Finance and Leasing Companies Criteria here Global Financial Institutions Rating Criteria here Rating FI Subsidiaries and Holding Companies here Recovery Ratings for Financial Institutions here Recovery Ratings and Notching Criteria for Non-Financial Corporate Issuers here Additional Disclosure Solicitation Status here ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: here. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEBSITE 'WWW.FITCHRATINGS.COM'. PUBLISHED RATINGS, CRITERIA AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. FITCH'S CODE OF CONDUCT, CONFIDENTIALITY, CONFLICTS OF INTEREST, AFFILIATE FIREWALL, COMPLIANCE AND OTHER RELEVANT POLICIES AND PROCEDURES ARE ALSO AVAILABLE FROM THE 'CODE OF CONDUCT' SECTION OF THIS SITE. FITCH MAY HAVE PROVIDED ANOTHER PERMISSIBLE SERVICE TO THE RATED ENTITY OR ITS RELATED THIRD PARTIES. DETAILS OF THIS SERVICE FOR RATINGS FOR WHICH THE LEAD ANALYST IS BASED IN AN EU-REGISTERED ENTITY CAN BE FOUND ON THE ENTITY SUMMARY PAGE FOR THIS ISSUER ON THE FITCH WEBSITE.

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