Fitch Ratings has downgraded the Issuer Default Ratings (IDR) for Navistar International Corporation (NAV) and Navistar Financial Corporation (NFC) to 'CCC' from 'B-'. The rating Outlook is Negative. A full list of rating actions is shown at the end of this release.
The rating downgrades and Negative Rating Outlook reflect the company's heightened liquidity risk and negative manufacturing free cash flow (FCF) which could continue into 2013. A significant number of challenges will need to be addressed to avoid liquidity pressures, and FCF could be impaired in the near term by costs related to the implementation of NAV's revised engine strategy, workforce reductions, and possible additional restructuring. Other items that could reduce FCF include lower sales volumes expected in the fourth quarter, and lower margins related to the use of Cummins SCR technology, higher warranty expense for NAV's emissions compliant engines, and the cost of non-conformance penalties (NCPs).
Industry demand and the pace of a possible recovery in NAV's market share are difficult to estimate and could potentially lead to significant negative FCF if economic conditions and customer confidence in NAV's strategy are worse than anticipated. Industry data indicate NAV's market share declined in August. These factors, together with the effectiveness and timing of NAV's transition to its revised emissions technology, will be important in determining the company's near-term financial position and any future rating actions.
Manufacturing sales increased slightly during the first nine months of 2012, but quarterly trends have been weakening through the year due to economic uncertainty and customer concerns about NAV's engine strategy. NAV's heavy-duty truck orders increased through the first quarter of fiscal 2012 but have since declined, consistent with declines across the industry. Medium-duty truck orders have also been weak. NAV's market share was 24% in the third fiscal quarter, including heavy- and medium-duty trucks and buses, and remains well below the peak level of 36% in 2009. Military sales have also fallen as U.S. defense spending declines.
Navistar Financial Corporation
The downgrades of NFC's IDR and bank facility rating reflect the direct rating linkage between NFC and NAV, given their inter-related activities and the core nature of NFC's business to that of NAV. Furthermore, the linkage reflects the potential that under a severe stress scenario, NAV may seek to extract capital and/or unencumbered assets from NFC.
Fitch views NFC's performance, asset quality and leverage levels as neutral to NAV's rating. NFC's performance has not changed materially compared to Fitch's expectations, but its financial profile is likely to be affected over the long term by lower than expected volumes at NAV, and NFC's strong linkage to its manufacturing parent. Profitability continued its slight decline in the nine months ended July 31, 2012 due to the run-off of NFC's retail portfolio. Fitch believes future profitability at NFC will be directly affected by the general operating and financial condition of NAV, as well as the performance of the wholesale receivables portfolio going forward.
Asset quality continues to improve and provisioning has declined as NFC focuses on its wholesale portfolio, which historically has experienced lower loss rates relative to the retail portfolio. Absent material dividends upstreamed to the parent, Fitch expects NFC's leverage to improve and stay below historical levels due to reduced overall financing needs. In June 2012, NFC completed a $501.6 million securitization and the proceeds were used to repay outstanding borrowings on a previous securitization and a portion of its revolving bank credit facility. In addition, NFC completed the refinancing of 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.
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 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.
As of July 31, 2012, Fitch's ratings cover approximately $3 billion of debt at NAV, adjusted for the new $1 billion term loan and ABL repayment, and $2.3 billion of outstanding debt at the Financial Services segment, the majority of which is at NFC.
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