RPT-Fitch Affirms Navistar's IDR at 'CCC' & Upgrades Sr. Unsecured to 'CCC'; Outlook Positive
March 21 () - (The following statement was released by the rating agency) Fitch Ratings has affirmed the Issuer Default Ratings (IDR) for Navistar International Corporation (NAV), Navistar, Inc. and Navistar Financial Corporation (NFC) at 'CCC'. In addition, Fitch has upgraded NAV's senior unsecured notes to 'CCC' from 'CCC-' and NFC's senior secured bank credit facilities to 'CCC' from 'CCC-', based on modestly improved recovery prospects. Fitch has also affirmed the rating for Navistar, Inc.'s senior secured bank term loan at 'B'/'RR1' with the expectation that anticipated changes in covenants for the term loan will not have a significant impact on the loan's priority status in Navistar's debt structure or on recovery prospects. The Rating Outlook is Positive. A full list of ratings is shown at the end of this release. NAV announced earlier this week it plans to reprice and amend its $1 billion senior secured term loan to extend the maturity from July 2014 to August 2017 and amend certain covenants to provide additional operating flexibility. In addition, the term loan would be reduced with proceeds from the issuance of $300 million of unsecured debt to be completed concurrently with the term loan amendments. Lender consent will be required for the term loan repricing and amendments. Key Rating Drivers The Positive Outlook reflects the positive impact of the planned refinancing on NAV's liquidity. Total debt would remain unchanged, but extending the maturity date of the term loan would improve the company's liquidity profile by reducing the large amount of debt maturing in 2014. The shift of $300 million of debt from a secured to unsecured basis would improve recovery prospects for unsecured debt holders. In addition, NAV has made meaningful progress in executing the transition to its revised engine strategy and recently appointed a permanent CEO effective in April 2013. It continues to restructure operations to cut costs and improve efficiency which can be expected to support margins over the long term. Near term concerns remain, however, including declines in the company's market share, high warranty costs, operating losses, negative free cash flow, and tepid demand for trucks that reflects slow economic growth and cost pressures faced by truck purchasers related to fuel costs and driver availability. The ratings also incorporate concerns surrounding the availability and use of emissions credits, which began to run out in the second fiscal quarter of 2013 for some heavy duty engines. In addition, NAV is still working to achieve on-board diagnostics (OBD) certification in 2013 for certain engines. As a result, occasional gaps in deliveries could exacerbate market share concerns while NAV implements its revised engine strategy. NAV's share in its traditional heavy and medium truck and bus markets was 18% in the first fiscal quarter of 2013 compared to 23% in fiscal 2012 and 34% as recently as 2010. 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. Fitch expects manufacturing free cash flow (FCF) to be negative through at least the first half of fiscal 2013 due to seasonally low cash flow; delays in deliveries due to the depletion of emissions credits; and expenditures related to warranties, non-conformance penalties (NCPs), and ongoing pension contributions. FCF could be pressured if industry demand for trucks does not improve or the company's market share does not recover. Liquidity is well above $1 billion which provides a cushion to absorb negative cash flow in the near term. NAV's manufacturing cash and marketable securities declined to just under $1.2 billion at Jan. 31, 2013 from $1.5 billion at Oct. 31, 2012. This level of cash, combined with availability under a $175 million ABL facility, is sufficient to mitigate near-term liquidity concerns while NAV makes the transition to its revised engine strategy. Cash balances could weaken modestly before the company begins shipping heavy duty trucks with its own proprietary MaxxForce 13-liter engines that include Selective Catalytic Reduction (SCR) after-treatment technology by the end of the fiscal second quarter. Current maturities of manufacturing long term debt were modest at $125 million at Jan. 31, 2013. Debt maturities exceed $1.5 billion in 2014 but would decline by $1 billion upon completion of NAV's planned amendments and debt issuance. $570 million of subordinated convertible debt is scheduled to mature in October 2014. Sales declined 12% year-over-year in the first quarter of 2013 due to weak industry demand for trucks and NAV's declining market share. EBITDA was slightly above break-even in the first quarter of fiscal 2013. Results could improve during the year if NAV executes its revised engine strategy on time and begins to rebuild market share. In order to rebuild its operating performance and preserve cash, NAV is limiting capital spending, cutting back on certain investments associated with NAV's global expansion, and focusing engineering efforts on its engine strategy. Restructuring should also help control NAV's costs over the long term, including workforce reductions. NAV estimates these actions will reduce its cost structure by $175 million or more beginning in 2013. 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. However, cash charges are likely to increase in the near term as NAV makes repairs related to accrued warranty liabilities. 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. NAV's revised engine strategy involves combing NAV's advanced exhaust gas recirculation (EGR) technology with Cummins SCR engines and emissions technology. In December 2012, NAV launched on time the ProStar with the Cummins ISX 15-liter engine and is scheduled to phase in its own 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 and CARB of its reconfigured emissions compliant engines as well as approval of on-board diagnostics. Rating Sensitivities 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 market share fails to recover materially as it gradually completes the transition to SCR emissions technology, or if 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 an increase in debt during late fiscal 2012. Five investors have accumulated, in aggregate, more than 60% 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 $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 upgrade to 'RR4' from 'RR5' for NAV's senior unsecured debt reflects better recovery prospects, which are viewed as average in a distressed scenario, due to steady progress in the transition to NAV's revised engine strategy and, to a smaller degree, to NAV's planned refinancing. The RR '6' for the senior subordinated convertible notes reflects a low priority position relative to NAV's other debt. 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 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 first quarter 2013 (1Q13) on continued reduction of NFC's retail portfolio balance and lower wholesale financing volume to dealers. The average receivables balance declined to $1.7 billion at Jan. 31, 2013 compared to $2.5 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. 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 2.5x in 1Q13. 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 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. Liquidity is adequate at Jan. 31, 2013, with $13.1 million of unrestricted cash and approximately $1.1 billion of availability under its various borrowing facilities. In February 2013, NFC completed a refinancing of a portion of its borrowing facilities which Fitch believes mitigates some potential near-term liquidity constraints. The upgrade of the RR to '4' from '5' reflects improved asset coverage for NFC's senior secured credit facilities, which supports a rating equalized with the IDR of 'CCC', reflecting average recovery prospects in a distressed scenario. As of Jan. 31, 2013, Fitch's ratings covered approximately $2.9 billion of debt at NAV and $1.6 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 subordinated notes at 'CC'/'RR6'. Navistar, Inc. --Long-term IDR at 'CCC'; --Senior secured bank term loan at 'B'/'RR1'. Navistar Financial Corporation --Long-term IDR at 'CCC'. Fitch has upgraded the following ratings: Navistar International Corporation --Senior unsecured notes to 'CCC'/'RR4' from 'CCC-'/'RR5'. Cook County, Illinois --Recovery zone revenue facility bonds (Navistar International Corporation Project) series 2010 to 'CCC' from 'CCC-'. Illinois Finance Authority (IFA) --Recovery zone revenue facility bonds (Navistar International Corporation Project) series 2010 to 'CCC' from 'CCC-'. Navistar Financial Corporation --Senior secured bank credit facilities to 'CCC'/'RR4' from 'CCC-'/'RR5'. The Rating Outlook is positive.
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