Fitch Ratings has upgraded the Issuer Default Rating and long-term debt ratings for Textron Inc. (TXT) and Textron Financial Corporation (TFC) to 'BBB-' from 'BB+'. The Rating Outlook is Stable. TXT's short-term ratings have been upgraded to 'F3' from 'B'. TFC's subordinated debt rating has been upgraded to 'BB' from 'B+'. A full rating list is shown below.
TFC's ratings are linked to TXT's ratings through a support agreement and other factors. The support agreement requires TXT to maintain full ownership, minimum net worth of $200 million and fixed charge coverage of 1.25 times (x). Other factors supporting the rating linkage include a shared corporate identity, common management, and the extension of intercompany loans to TFC.
The upgrades of TXT's and TFC's ratings largely reflect material progress toward liquidating TFC's non-captive portfolio and diminished concerns about TXT's ability to support TFC in the event of losses or a lack of liquidity. Fitch previously viewed TXT's credit profile as consistent with a low investment grade rating when excluding required support for TFC. The ratings for TXT continue to be constrained by TFC, although to a lesser degree than in the past. Fitch estimates debt/EBITDA at TXT's manufacturing business was approximately 2.0x as of Dec. 31, 2011 compared with 2.35x at the end of 2010.
Since late 2008 when TXT decided to exit its non-captive portfolio, the size of the non-captive managed portfolio has declined from more than $7 billion to less than $1 billion at the end of 2011. Cash collections on liquidated receivables have supported a reduction in debt used to fund the receivables portfolio. At the same time, TFC's leverage improved to 4.5x at Dec. 31, 2011 as estimated by Fitch, compared to 4.8x at the end of 2010 and 5.6x at the end of 2009. Also, TFC's liquidity has been sufficient to limit the amount of net cash advances needed from TXT.
Risks related to TFC's portfolio have been reduced but not eliminated. Asset quality and cash conversion are generally weakening as the highest quality assets amortize or are sold. A large portion of the nearly $1 billion non-captive portfolio consists of long term golf mortgage and timeshare receivables of which nearly half were classified as non-accrual as recently as Sept. 30, 2011. If cash generated from the liquidation of TFC's non-captive portfolio is less than expected due to higher credit losses or discounting, TXT would need to provide further support for TFC which would reduce TXT's liquidity. The impact would be limited, however, due to the reduced size of the non-captive portfolio and TXT's cash balances and operating cash flow which provide sufficient capacity to support TFC at moderate levels.
Near-term debt maturities at TFC before 2013 are not significant, but the amount and timing of some of TFC's subsequent debt maturities and asset liquidations could be mismatched, possibly requiring support from TXT, at least temporarily. TFC relies on TXT for short-term funding as it does not have a bank facility. TFC repaid and terminated its bank facility in October 2011. In the medium term, TFC's ability to repay debt will partly depend on the cash conversion of its non-captive portfolio. Concerns about liquidation will decline further as the non-captive portfolio shrinks.
TFC's captive portfolio totaled $1.9 billion and consisted primarily of aviation receivables. Non-accrual accounts were 5.9% of total captive receivables at Sept. 30, 2011 compared to 7.2% at the end of fiscal 2010. Although the level of non-accrual accounts is relatively high, potential concerns about credit quality in the captive portfolio are mitigated by an improving trend in the level of accruals, TFC's expertise managing aviation receivables, and the beginning of a recovery in the business jet market that should support collateral values.
Future positive rating actions could result from the eventual completion of TFC's non-captive portfolio liquidation, a material recovery in Cessna's business jet market, TXT's ability to adjust to potentially lower defense-related revenue at Bell and Textron Systems, and further progress in addressing pension liabilities. The ratings could be negatively affected by material losses at TFC, lower revenue and margins at TXT's manufacturing businesses associated with an economic downturn, large declines in defense revenue, or production cuts at Cessna if the business jet market weakens from its current level.
TXT's support for TFC includes capital contributions and intercompany loans to TFC. Losses at TFC require TXT to contribute capital under a support agreement, but TFC's liquidity was sufficient in 2011 to pay an offsetting amount of dividends to TXT. TFC's operating profit could improve to a break-even level in 2012 as the non-captive portfolio is liquidated and loan losses decline. At the end of 2011, non-accruals fell slightly to $566 million before an adjustment to reclassify the Golf Mortgage portfolio as held-for-sale. Non-accruals totaled $321 million after the adjustment, or 11% of the book value of TFC's total receivables portfolio, excluding held-for-sale. Future capital contributions from TXT, net of dividends, may be nominal and intercompany loans to TFC could begin to decline from approximately $500 million at the end of 2011. However, loans may still be required for short periods depending on the timing of TFC's scheduled debt maturities and cash conversion from the liquidation of receivables.
TXT's manufacturing free cash flow in 2011 was $319 million after $642 million of pension contributions and $22 million of dividends. Operating cash flow in 2011 was stronger than usual due to timing and one-time items and is likely to moderate to a more sustainable level in 2012. Fitch estimates free cash flow in 2012 could improve to $500 million as slightly lower operating cash flow associated with higher spending for product development is more than offset by lower pension contributions. TXT's $642 million contribution to its pension plans in 2011 was substantially above its initial plan of $250 million. The company plans to contribute $200 million in 2012. At the end of 2010, the net pension obligation was $1.3 billion. The funded status at the end of 2011 is not yet available, but the large contributions in 2011 will mitigate the negative impact on TXT's pension obligation from the decline in discount rates and assumed asset returns.
TXT's ratings are supported by steady operating cash flow at the manufacturing businesses, solid performance at Bell, effective cost controls which are contributing to improved margin performance at the manufacturing businesses, and a nascent recovery in Cessna's business jet market. The market for large business jets is recovering sooner than the light and midsize segments where Cessna has its strongest presence. Margins at Cessna remain low but could rise slightly in 2012 if orders at least hold steady to support current production levels. The backlog is lower than usual following the deep downturn in demand for business jets, and future production cuts represent a risk if demand falters. Cessna's operating margin of 2% in 2011 reflected a gradual improvement during the year. By comparison, the margin in 2010 was negative 1.1%.
Bell's military business represents a core strength. H-1 production has been steady while V-22 aircraft production rates are likely to ramp up through 2012 before stabilizing. Bell has a substantial installed base which could benefit from aftermarket spending and modernization programs. Conditions in the commercial helicopter market are beginning to recover from trough levels in 2010. Commercial unit sales, excluding foreign military sales, increased to 120 units in 2011 from 103 aircraft in 2010, and volume could increase further in 2012 based on the backlog and a potential ramp up in production for the 429 helicopter which is still at an early point in its life cycle. Bell's margins in 2011 increased 160 bps to 14.8% and exceeded initial expectations due to higher U.S. military deliveries and effective execution. In 2012, margins could decline modestly due to an increase in lower-margin commercial helicopter volumes and higher R&D spending.
Rating concerns at TXT include low unit deliveries and margins at Cessna, pension contributions, the risk of slower economic growth in Europe and Asia, and pressure on U.S. defense spending that is an important part of the Bell and Textron Systems businesses. In the Industrial segment, sales volumes are generally stable as demand for automotive fuel systems at Kautex mitigates weak conditions in the segment's construction, turf and golf markets.
At Dec. 31, 2011, TXT's liquidity included manufacturing cash of $871 million and a $1 billion four-year bank facility that expires in 2015. The facility includes a maximum debt to capitalization covenant of 65% and a requirement that TFC's leverage not exceed 9:1. Fitch calculates these covenants were well within compliance at Dec. 31, 2011. Debt maturities at TXT are modest in 2012, at less than $200 million. Maturities are larger in 2013, at approximately $600 million, but do not exceed $350 million annually after 2013.
The narrowing of the notching on TFC's subordinated debt reflects an improvement in the unencumbered asset mix, as the non-captive portfolio has continued to decline in size, and an overall improvement in asset coverage.
Fitch has upgraded the ratings for TXT and TFC as follows:
TXT
--Issuer Default Rating (IDR) to 'BBB-' from 'BB+';
--Senior unsecured bank facilities to 'BBB-' from 'BB+';
--Senior unsecured debt to 'BBB-' from 'BB+';
--Short-term IDR to 'F3' from 'B';
--Commercial paper to 'F3' from 'B'.
TFC
--IDR to 'BBB-' from 'BB+';
--Senior unsecured debt to 'BBB-' from 'BB+';
--Junior subordinated notes to 'BB' from 'B+'.
Approximately $4.4 billion of debt outstanding at Dec. 31, 2011 (on a preliminary basis) is affected by the ratings, including nearly $2.5 billion at TXT and nearly $2 billion at TFC.
Additional information is available at www.fitchratings.com'. The ratings above were unsolicited and have been provided by Fitch as a service to investors.
Applicable Criteria and Related Research:
--'Corporate Rating Methodology', Aug. 12, 2011;
--'Global Financial Institutions Rating Criteria', Aug. 16, 2011;
--'Finance and Leasing Companies Criteria', Dec.12, 2011;
--'Rating Linkages in Nonbank Financial Subsidiary Relationships', Nov. 29, 2011;
--'2012 Outlook: Global Aerospace and Defense', Dec. 20, 2011.
Applicable Criteria and Related Research:
Corporate Rating Methodology
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=647229
Global Financial Institutions Rating Criteria
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=649171
Finance and Leasing Companies Criteria
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=659834
Rating Linkages in Nonbank Financial Subsidiary Relationships
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=656583
2012 Outlook: Global Aerospace and Defense
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=660209
ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: HTTP://FITCHRATINGS.COM/UNDERSTANDINGCREDITRATINGS. 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.
Contacts:
Textron Inc.
Primary Analyst
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
Michael Paladino,
+1-212-908-9113
Senior Director
or
Textron Financial
Corporation
Primary Analyst
Katherine Hughes, +1-312-368-3123
Associate
Director
Fitch, Inc.
70 W. Madison Street
Chicago, IL
60602
or
Secondary Analyst
Mohak Rao, +1-212-908-0559
Director
or
Committee
Chairperson
Nathan Flanders, +1-212-908-0287
Managing Director
or
Media
Relations
Brian Bertsch, +1-212-908-0549
brian.bertsch@fitchratings.com
