Fitch Affirms Navistar at 'CCC'

Fitch Ratings has affirmed the Issuer Default Ratings (IDRs) at 'CCC' for Navistar International Corporation (NAV), Navistar, Inc. and Navistar Financial Corporation (NFC). A full list of rating actions follows at the end of this release.

KEY RATING DRIVERS

The ratings reflect ongoing risks related to NAV's liquidity due to operating losses and negative free cash flow (FCF) while the company completes the transition to Selective Catalytic Reduction (SCR) emissions technology. As of July 2014, NAV had introduced all of its major SCR products, and the company has made material reductions to its cost structure which should improve its financial performance over the long term. In the near term these positive developments are offset by the slow recovery in NAV's market share and high seasonal working capital requirements that could reduce NAV's liquidity in the first quarter of fiscal 2015. Despite this concern, Fitch expects NAV will maintain sufficient liquidity through the next two to three quarters, assuming operating performance continues to improve and there are no material unexpected cash requirements. Beyond early 2015, the realization of further market share recovery, lower warranty expenditures, and stronger margins could lead to stronger FCF and liquidity and potentially support a positive rating action.

Concurrent with the transition to SCR emissions technology, orders in NAV's traditional markets (Class 6-8 trucks and school buses) have increased, but market share has not recovered as quickly as anticipated. NAV estimates its share of retail deliveries in its traditional markets could increase to 19%-20% in fiscal 2014, lower than 21% originally expected, and compared to 18% in 2013. Customer acceptance, and the pace of orders, may improve as trucks with SCR engines demonstrate a record of performance. NAV's retail market share of heavy duty trucks is improving sooner than medium duty and severe service trucks. The timing reflects the later phase-in of SCR emission equipment on medium duty and severe service trucks that was only recently completed.

Warranty charges have been high due to the complexity of emissions-compliant technology, particularly for EGR-only engines. Warranty expense is declining as older EGR engines exit their warranty period and as the mix of installed higher-performing SCR engines increases. In addition, NAV does not incur engine warranty expense for trucks sold with Cummins engines installed. Gross adjustments to pre-existing warranties through the first nine months of 2014 declined to $124 million ($65 million net of reversals) compared with $252 million in the year-earlier period. However, warranty cash costs are likely to remain materially higher than accrued expense, reflecting high prior-period adjustments of more than $800 million in aggregate in 2012 and 2013.

EBITDA margins have improved on a quarterly basis and should increase further as NAV continues to restructure and streamline its manufacturing and engineering operations. In addition to cost savings in 2013, the company estimates it will realize incremental savings of $300 million in fiscal 2014, not including manufacturing cost reductions of $50 million - $60 million. NAV could generate additional manufacturing cost reductions after 2014 and expects to reduce the cost of its engines by removing unnecessary EGR emissions content once SCR technology is fully implemented.

NAV's efforts to rebuild its operating performance are supported by strong cyclical demand in its North American heavy and medium duty truck markets where NAV's business is concentrated. Higher industry production could continue through 2015 due to a strong economy, high truck fleet utilization, and an aging fleet. Risks include driver shortages and weak demand in overseas markets, primarily Brazil where NAV has a sizeable engine business.

Manufacturing free cash flow (FCF) was negative $403 million in 2013 as calculated by Fitch and is likely to be substantially negative for all of 2014 (negative $350 million in the first nine months). FCF typically is weak early in the fiscal year, but year-to-date results also reflect operating losses due to lower revenue, costs to implement SCR emissions technology, warranty cash costs, and pension contributions. Fitch expects FCF in fiscal 2015 will be positive and could approach $100 million, depending on market share gains and industry demand. To preserve cash, NAV has exited the majority of its material non-core operations and limited capital spending which should be less than $150 million in 2014.

Pension contributions represent a recurring use of cash. NAV expects to contribute $164 million in 2014 ($98 million contributed through July 31, 2014) and at least $100 million annually between 2015 and 2017. NAV reduced its estimates following passage of the Highway and Transportation Funding Act of 2014 which extended relief from funding rules. NAV's net pension obligations were $1.4 billion at FYE Oct. 31, 2013 compared to $2.1 billion at the end of 2012.

Liquidity at NAV's manufacturing business as of July 31, 2014 included cash and marketable securities totaling $1,050 million (net of BDT and BDP joint venture cash and restricted cash). NAV also has an undrawn $175 million ABL facility. Liquidity was offset by current maturities of manufacturing long term debt of $254 million. The company has maintained solid cash balances above $1 billion during the past two years which Fitch expects will remain stable through the end of fiscal 2014. Cash balances could decline well below $1 billion in early fiscal 2015 due to seasonal working capital requirements and ongoing cash warranty charges.

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 Fitch expects the loan would 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's dealers. The relationship is formally governed by the Master Intercompany Agreement, as well as a provision referenced under NFC's credit agreement requiring NAV or Navistar, Inc. to own 100% of NFC's equity at all times.

NFC's operating performance and overall credit metrics are viewed by Fitch to be neutral to NAV's ratings. The company'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 for the first nine months of 2014 (9M14), resulting from the continued reduction of NFC's retail portfolio balance and lower wholesale financing volume to dealers. The average finance receivables balance declined modestly to $1.3 billion at July 31, 2014 compared to $1.6 billion one-year prior.

Asset quality of the underlying receivables portfolio remains stable, reflecting the mature retail portfolio, which continues to run-off. Charge-offs and provisioning volatility has also been stable as NFC continues to focus 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 tangible equity, was 2.8x as of July 31, 2014, which is well below the five-year average of 5.3x. Fitch believes NFC's leverage is appropriate and consistent with peers. NAV has utilized the strength of NFC's balance sheet to enhance liquidity at the parent company, including re-establishing dividends and intercompany borrowing between NAV and NFC.

Fitch deems NFC's liquidity to be adequate, with $19.2 million of unrestricted cash and approximately $464 million of availability under its various borrowing facilities, as of July 31, 2014. During 9M14, NFC completed a $100 million trade receivables securitization and extended the maturity date of the revolving note of a wholesale receivables transaction. Fitch views favorably NFC's ability to refinance a portion of its borrowing facilities and access the capital markets at reasonable terms, which should mitigate some potential near-term liquidity concerns.

The rating of NFC's senior secured bank credit facility is equalized with the IDR to reflect the level of secured debt in the overall funding profile, as well as the modest level of unencumbered assets on the balance sheet. Fitch would view positively a greater proportion of unsecured debt in the funding profile, as it would enhance the company's financial flexibility in a stressed scenario. The Recovery Rating of 'RR4' reflects average recovery prospects of creditors under the credit facility following default in a stress scenario.

NAV RATING SENSITIVITIES

Fitch could take a positive rating action if:

--NAV's traditional market share recovers to a level around 20% or higher;

--FCF improves sufficiently to support a meaningful reduction in debt;

--Consolidated EBITDA margins reach NAV's target of 8%-10%. The margin was approximately 5% in Q3 2014.

Fitch could take a negative rating action if:

--Manufacturing cash and marketable securities balances decline by more than one-third for more than a short period from the current level near $1 billion;

--Manufacturing EBITDA margins fail to improve materially from approximately 3.75% in Q3 2014 as calculated by Fitch;

--FCF is materially below a break-even level in 2015;

--There is an adverse outcome of the SEC's investigation into the company's accounting and disclosure practices.

NFC RATING SENSITIVITIES

NFC's ratings are linked to those of its parent. Therefore, positive rating momentum will be limited by Fitch's view of NAV's credit profile. However, negative rating action could be driven by a change in the perceived relationship between NFC and its parent. Additionally, a change in profitability leading to operating losses, a material change in leverage and/or deterioration in the company's liquidity profile could also yield negative rating actions.

The rating of the senior secured bank credit facility is sensitive to changes in NFC's IDR, as well as the level of unencumbered balance sheet assets in a stress scenario, relative to outstanding debt.

Fitch affirms the ratings for NAV and its affiliates as follows:

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 facility at 'CCC'/'RR4'.

As of July 31, 2014 debt at NAV's manufacturing business totaled $3.2 billion, including unamortized discount, and nearly $2.1 billion at the Financial Services segment, the majority of which is at NFC.

Additional information is available at 'www.fitchratings.com'.

Applicable Criteria and Related Research:

--'Corporate Rating Methodology' (May 2014);

--'Parent and Subsidiary Rating Linkage' (May 2014);

--'Global Financial Institutions Rating Criteria' (January 2014);

--'Finance and Leasing Companies Criteria' (December 2012);

--'Rating FI Subsidiaries and Holding Companies' (August 2012);

--'Recovery Ratings for Financial Institutions' (September 2013).

Applicable Criteria and Related Research:

Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=749393

Global Financial Institutions Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=732397

Finance and Leasing Companies Criteria

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

Recovery Ratings for Financial Institutions

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=717538

Rating FI Subsidiaries and Holding Companies

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=679209

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=888114

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