Fitch Ratings placed the ratings for Navistar International (NAV), Navistar and Navistar Financial (NFC) on Rating Watch Positive following the announcement of a strategic alliance between NAV and Volkswagen Truck & Bus (VW T&B). VW T&B is a wholly owned subsidiary of Volkswagen.

The strategic alliance includes an equity investment by VW T&B equal to 16.6% of NAV’s common shares on a pro forma basis that will result in $256 million of cash proceeds to NAV, agreements to collaborate on powertrain and other technologies, a procurement joint venture and the addition of two VW T&B representatives to NAV’s board of directors.

The positive watch reflects Fitch’s expectation that the equity investment and strategic alliance will create benefits for NAV including a moderate increase in near-term liquidity and financial flexibility, $200 million of annual synergies by the end of five years ($500 million cumulative by year five) and opportunities to leverage technology with VW T&B.

Fitch believes NFC is core to NAV’s overall franchise. Thus, 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 dealer inventory and trucks sold by NAV’s dealers. The relationship is formally governed by the master inter-company agreement, as well as a provision referenced under NFC’s credit agreement requiring NAV or Navistar 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 decreased slightly for the first six months of 2016 ended April 30, 2016, resulting from a decline in the average size of the wholesale and retail portfolio partially offset by higher accounts revenue. The average finance receivables balance decreased to $1.4 billion for the first half of 2016, compared to $1.6 billion in the year-earlier period.

Asset quality of the underlying receivables portfolio remains stable, reflecting the mature retail portfolio, which continues to run off.

Charge-offs and provisioning also has been stable as NFC continues to focus on its wholesale portfolio, which historically has experienced lower loss rates versus the retail portfolio.

NFC’s leverage remains relatively low compared to its captive peers but has risen slightly in recent quarters due primarily to the upstreaming of $125 million in dividends to the parent (partially financed by an $80 million loan repayment to NFC) in 2015 and an additional $30 million in dividends in Q2/16. Balance sheet leverage, as measured by total debt to equity, was 3.2x as of April 30, 2016. Fitch believes NFC’s leverage is appropriate and consistent with other captive finance companies. NAV continues to utilize 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.

The ‘B-‘ rating assigned to the existing senior secured bank credit facility reflects Fitch’s view that the addition of a 1.35x collateral coverage covenant in the amended bank credit facility agreement on May 27, 2016 is a credit positive for lenders. The addition of this covenant helps support recovery ratings of ‘RR3’ and mitigates Fitch’s earlier concerns that NFC could securitize all its remaining unencumbered assets, thereby leaving other senior secured lenders in a subordinate collateral position to the company’s securitizations.