OREANDA-NEWS. Fitch Ratings has affirmed the Issuer Default Ratings (IDRs) and long-term debt ratings at 'A' for Caterpillar Inc. (CAT), Caterpillar Financial Services Corporation (CFSC), and certain of CFSC's subsidiaries. Fitch has affirmed the companies' short-term ratings at 'F1'. The Rating Outlook is Stable. A full list of rating actions follows at the end of this release.

KEY RATING DRIVERS

The ratings for CAT incorporate a high degree of cyclicality in the company's construction, mining, energy and transportation markets. Credit metrics for CAT's manufacturing business, which consider CFSC on an equity basis, have deteriorated due to cyclical downturns in CAT's mining, energy and construction end markets. Demand for machinery and engines in these markets is in the midst of an extended decline due to low prices for mined commodities and oil, and slower growth in emerging markets. As an example of the weak end markets, Fitch's Leveraged Finance forecast for metals & mining defaults in 2016 is 20%, the highest of any industry Fitch covers.

Fitch expects credit metrics could weaken further through at least 2016, and the timing of an eventual recovery is uncertain. Fitch estimates free cash flow (FCF) will be lower but still positive in the near term, and debt/EBITDA could increase to approximately 2.0x or slightly higher during the next one to two years assuming CAT uses available cash to repay scheduled debt maturities. Fitch views these levels as weak for the ratings but within expected ranges during a cyclical downturn.

Rating concerns include support that could be required for CFSC in the event that credit quality in CFSC's receivables portfolio deteriorates materially or if CFSC has diminished access to funding sources. Fitch views CFSC's credit profile as strong and believes support from CAT is unlikely to be needed in the near term. However, if low commodity and oil prices lead to substantially higher delinquency rates and asset write-downs, CFSC could experience lower liquidity, and dividends from CFSC to CAT could be reduced or eliminated. These concerns are mitigated by CFSC's focus on its captive portfolio and CFSC's effective management of its residual risk exposure.

Other rating concerns include litigation with the IRS which has proposed taxes and penalties totaling approximately $1 billion for the 2007-2009 period related to profits at a CAT subsidiary in Switzerland. The amount of an eventual resolution is uncertain and the process could be lengthy which would allow CAT to generate additional cash flow to help fund any payments if they are required. There are also investigations into conduct at CAT's Progress Rail business regarding business practices and potential violations of environmental laws that could result in penalties or fines.

Rating strengths include CAT's liquidity, operating flexibility, global presence, strong competitive positions, broad product lines, diverse customer base, and an established and well-capitalized independent dealer network. The dealer network is a core part of CAT's strategy as it supports the company's market share for both original equipment and aftermarket business. Continued R&D spending of approximately $2 billion annually through the downturn should help protect CAT's competitive position when end market demand recovers.

CAT and its dealer base have reduced inventory significantly which helps to control costs and limits the risk of holding obsolete inventory when demand eventually recovers. During the past three years, CAT has reduced inventory by $5.8 billion and CAT's dealers have reduced inventory by approximately $5 billion. Additional reductions are possible in 2016. The severity of the current down-cycle presents some risks to dealers in hard-hit regions, and to certain smaller suppliers which may be challenged to cope with an extended downturn.

Fitch estimates CAT's manufacturing FCF in 2016 will remain positive but could decline toward $500 million compared to $1.8 billion in 2015. FCF does not include dividends from CFSC which Fitch classifies as investing activities. Dividends from CFSC were $600 million in 2015. FCF also is adjusted to exclude the impact of changes in receivables sold to CFSC. During the past few years, FCF has benefited from lower working capital requirements, including significant inventory reductions. An additional inventory reduction is possible in 2016 but at a smaller level as industry demand gets closer to trough levels. Significant FCF has supported large share repurchases that have totaled $8.3 billion since 2013, but Fitch expects repurchases will be minimal until demand recovers.

CAT's manufacturing revenue fell 30% during the past three years, including the negative impact of currency movements, and Fitch estimates sales could decline more than 10% in 2016. The sales decline reflects a persistent decline in capital spending since 2012 by mining companies, the negative impact of low oil prices on demand for engines and construction equipment, and weak global economic growth. Mining production remains elevated, but widespread bankruptcies in the coal industry indicate the widespread pressure within the mining industry to cut costs and preserve cash.

A demand recovery is unlikely before 2017. Excess mining capacity created during the previous expansion cycle suggests that an eventual recovery could be relatively moderate compared to earlier recoveries and would be driven by maintenance and replacement spending rather than on expansion projects. Sales in some of CAT's markets are well below replacement levels, so sales should turn up eventually, although the timing is uncertain.

CAT's profit margins are being pressured by low sales, primarily in the Resource Industries segment that is centered on mining equipment. Segment revenue was down 64% over the three year period between 2012, when demand peaked, and 2015 when the segment generated a small loss. The decline in CAT's total sales during the past three years has been large but relatively gradual, permitting the company to effectively reduce inventory and implement comprehensive restructuring.

In late 2015, CAT announced a $2 billion restructuring program that is expected to reduce costs by $1.5 billion annually when completed, including $750 million in 2016. The company expects to incur $400 million of restructuring costs in 2016 compared to $908 million in 2015 and $441 million in 2014.

CATERPILLAR FINANCIAL SERVICES CORPORATION (CFSC)

CFSC's ratings are equalized with CAT's ratings, reflecting Fitch's view of CFSC as a core subsidiary of CAT based on the 100% ownership, shared brand name, importance of CFSC to achieving CAT's strategic objectives and the Support Agreement between the two entities. The Support Agreement requires CAT to maintain 100% ownership of CFSC, maintain CFSC's net worth at not less than $20 million, and maintain CFSC's fixed-charge coverage at not less than 1.15x or higher on an annual basis.

Beyond these support-driven considerations, Fitch also considers CSFC's solid operating performance and very strong asset quality performance counterbalanced by elevated leverage levels relative to stand-alone finance companies, but consistent with similarly rated captive finance peers, as well as its reliance on wholesale funding sources.

Asset quality metrics remain strong, despite a modest uptick in write-offs during 2015. At year-end (YE) 2015, delinquencies greater than 30 days past due amounted to 2.14% compared to 2.17% one-year prior. Retail net write-offs (net of recoveries) as a percentage of the retail portfolio were 0.57% in 2015 compared to 0.34% in 2014. The increase in net write-offs was driven by the mining and marine portfolios. While overall asset quality metrics are expected to remain strong in the near-term, Fitch expects mean reversion in delinquency and write-off performance over the medium- to longer-term. The allowance for credit losses amounted to $338 million, or 1.22% of net finance receivables, as of Dec. 31, 2015. Given strong asset quality performance over the last several years and direct CAT support, Fitch believes CFSC's loss reserves are sufficient to cover potential losses on its receivables.

Operating performance remained strong in 2015, albeit weaker than 2014. CFSC reported FY 2015 revenues of $2.67 billion, a 7.3% decrease from the same period last year. The drivers for full-year revenues include unfavorable impacts from lower average earning assets and lower average financing rates. Pretax income was $619 million, or an 18% decrease. Pretax income was impacted by a decrease in net yield on average earning assets, reflective of a shift in geographic mix and currency impacts from CFSC's international operations, as well as the impact from lower average earning assets. Net income amounted to $460 million, or a 14% decrease year-over-year. Despite year-over-year volatility and weakness in certain of CFSC's markets, Fitch expects overall operating performance will remain relatively stable and the company will remain solidly profitable in the near to medium term given the company's consistent financing share and conservative risk appetite.

CFSC's balance sheet leverage, which is calculated by Fitch as debt-to-tangible equity, was above its historical range of 7.0x-8.0x at 9.97x as of Dec. 31, 2015. However, covenant leverage, defined as consolidated debt to consolidated net worth (including preferred stock but excluding accumulated other comprehensive income and non-controlling interests), was lower at 7.93x. Fitch expects the company to manage leverage with sufficient cushion relative to the maximum leverage level permitted by this covenant of less than 10x (measured at all times as the average of the last six-months or as of the last day of the current quarter). Further, it is important to note that leverage, although high, remains consistent with other captive finance peers but higher than many stand-alone finance companies. Fitch does not anticipate any significant changes in CFSC's overall capital structure over the Outlook horizon. Should funding requirements increase, Fitch believes CAT would inject additional capital into the finance arm, as necessary, to manage CFSC's overall leverage profile.

CFSC relies on the global debt capital markets and various bank funding programs to provide liquidity for its operations, as well as support from CAT. The company's ability to consistently access the global capital markets demonstrates the strength of CAT's brand and franchise. Fitch believes CFSC's comprehensive funding platform, in combination with the financial strength of its parent, is consistent with other captive finance companies.

KEY RATING DRIVERS - Caterpillar Financial Australia Limited (CFAL), Caterpillar International Finance Limited (CIF) and Caterpillar Finance Corporation (CFC)

CFAL, CIF and CFC are wholly-owned subsidiaries of CSFC. The ratings of the subsidiaries reflect the unconditional and irrevocable guarantee provided by CFSC for full repayment of obligations under the subsidiaries' various borrowing facilities. The guarantee is viewed as the strongest form of parental support, which in Fitch's view, enhances the rating linkages between CFSC and its subsidiaries. As a result, the IDRs and issue ratings of the subsidiaries are linked to those of CFSC.

KEY ASSUMPTIONS

Fitch's key assumptions within the rating case for CAT's manufacturing business include:

--The cyclical downturn continues through 2016 in CAT's mining, energy, and international construction equipment markets; a significant recovery does not occur until 2017 or later.
--EBITDA margins decline in 2016 due to the impact of lower revenue on operating leverage and an unfavorable sales mix.
--Planned restructuring contributes to cost savings of $1.5 billion annually when restructuring is completed, of which almost half could be realized in 2016.
--FCF declines toward $500 million in 2016 due to lower sales and smaller benefits from working capital reductions, primarily inventory.
--Cash deployment for share repurchases will be minimal after 2015 until CAT's performance improves although some repurchases are possible to offset dilution from stock compensation.
--CAT repays scheduled debt maturities to reduce the impact on leverage from weak operating results.
--CAT maintains its market share through the current industry downturn.

RATING SENSITIVITIES

Future developments that may, individually or collectively, lead to a downgrade include:

Caterpillar Manufacturing Business

--Credit metrics are consistently weak for more than a few quarters during mid-cycle periods, including funds from operations (FFO) adjusted leverage well above 2.0x or debt/EBITDA above 1.5x. During periods of cyclical weakness, credit metrics could exceed these levels for two to three years. At the long end of this timeframe, Fitch expects metrics would be only slightly outside the mid-cycle range. Fitch expects mid-cycle FFO adjusted leverage will be near 2.0x or below and debt/EBITDA will be near 1.25x or below;
--Market share declines materially in key product lines or geographic regions;
--Margins remain permanently lower after end market demand improves;
--CAT experiences poor execution on its operating strategies including restructuring and inventory and supply chain management;
--CFSC requires support from CAT due to asset write-offs or difficulty accessing debt markets.

Cyclicality in CAT's machinery markets limits the potential for a positive rating action. However, developments that Fitch would view as positive for CAT's credit profile include:

--An increase in the company's geographic and product diversification and in the proportion of relatively stable parts and services revenue;
--Meaningful market share growth in emerging markets;
--Lower peak financial leverage during down-cycles (debt/EBITDA well below 1.5x) and stronger FCF through the business cycle;
--Effective product development.

CFSC and Designated Subsidiaries

Positive rating momentum would be limited by Fitch's view of CAT's credit profile, as CFSC's ratings and Outlook are linked to that of its parent. Fitch cannot envision a scenario where the captive would be rated higher than its parent.

Conversely, negative rating actions for CFSC could be driven by a change in the perceived relationship between CAT and CFSC. For example, if Fitch believed that CFSC had become less core to CAT's strategic operations and/or adequate financial support was not provided to the captive finance company in a time of need. In addition, consistent operating losses, a material change in balance sheet leverage, and/or deterioration in the company's liquidity profile, any of which alters CFSC's perceived risk profile and/or requires the injection of regular financial support from CAT, could also drive negative rating actions.

The ratings of CFAL, CIF and CFC are linked to the ratings of CFSC, and therefore, are sensitive to changes on CSFC's ratings.

LIQUIDITY

CAT's liquidity (excluding CFSC) at Dec. 31, 2015, as calculated by Fitch, totaled $7.6 billion, including manufacturing cash of $5.3 billion and credit facility availability of approximately $2.75 billion, offset by $517 million of current maturities of long-term debt and $9 million of short-term debt. Slightly more than 80% of CAT's $6.5 billion of consolidated cash was held overseas. CAT estimates a portion of its overseas cash would be subject to U.S. taxes if repatriated.

Long-term debt is well-distributed, with annual maturities not exceeding $900 million during the next five years. Other cash requirements include pension contributions that CAT estimates at $150 million in 2016. At the end of 2015, pension plans were underfunded by $4.8 billion (76% funded; down from 79% at the end of 2014).

Credit facility availability of $2.75 billion as of Dec. 31, 2015 is the internal allocation of CAT's consolidated $10.5 billion of facilities to the equipment business. CAT can revise the allocation of these facilities between CFSC and its equipment businesses at any time. The facilities were amended in September 2015 and consist of a $3.15 billion 364-day facility that expires in September 2016, a $2.73 billion facility that expires in September 2018, and a $4.62 billion facility that expires in September 2020.

Under intercompany agreements, as of Dec. 31, 2015, CAT may borrow up to $1.29 billion from CFSC ($490 million outstanding) and CFSC may borrow up to $2.28 billion from CAT ($1.1 billion outstanding) on a short-term basis. In addition, CFSC provides a $2 billion committed credit facility to CAT which expires in 2019.

CFSC also purchases, at discount, dealer and customer receivables from CAT. Outstanding receivables balances purchased by CFSC totaled $2.6 billion at Dec. 31, 2015. Fitch classifies changes in these amounts as financing cash flows at CAT's manufacturing business.

FULL LIST OF RATING ACTIONS

Fitch has affirmed the following ratings:

Caterpillar Inc. (CAT)
--Long-term IDR at 'A';
--Senior unsecured bank credit facilities at 'A';
--Senior unsecured notes at 'A';
--Short-term IDR at 'F1';
--Commercial paper (CP) at 'F1'.

Caterpillar Financial Services Corporation
--Long-term IDR at 'A';
--Short-term IDR at 'F1';
--Senior unsecured notes at 'A';
--Senior unsecured bank facilities at 'A';
--CP at 'F1'.

Caterpillar Financial Australia Limited
--Short-term IDR at 'F1';
--CP at 'F1'.

Caterpillar International Finance Limited
--Long-term IDR at 'A';
--Senior unsecured notes at 'A';
--Senior unsecured credit facilities at 'A'.

Caterpillar Finance Corporation
--Long-term IDR at 'A';
--Senior unsecured notes at 'A';
--Senior unsecured credit facilities at 'A'.

The Rating Outlook is Stable.