OREANDA-NEWS. Fitch Ratings has affirmed American Honda Finance Corporation's (AHFC) short-term Issuer Default Rating (IDR) and commercial paper rating at 'F1'.

The affirmation of AHFC follows today's affirmation of AHFC's ultimate parent, Honda Motor Co. Ltd. (HMC, rated 'A/F1'/Stable Outlook by Fitch). For more information on Fitch's rating rationale, please see 'Fitch Affirms Honda at 'A'; Outlook Stable,' dated Oct. 15, 2015.

KEY RATING DRIVERS
AHFC's ratings are equalized with HMC's ratings, since Fitch views AHFC as a core subsidiary of HMC, as demonstrated by a high percentage of HMC's U.S. sales financed by AHFC, strong operational and financial linkages between the two companies, and a support (keep-well) agreement provided indirectly by HMC to AHFC.

Solid Asset Performance
Robust and conservative underwriting standards have been a testament to AHFC's credit quality performance. The company recorded its lowest-ever net loss rate at 0.18% in 1Q15 (ending June 30, 2014) Delinquencies 60+ days have also remained solid and consistently below 0.20%. The net loss and 60+ day delinquency rates were 0.21% and 0.15%, respectively, for the three months ended June 30, 2015.

Delinquency rates and losses have declined from FYE 2015 (March 31, 2015) primarily due to typical seasonality experienced in the latter part of the year. Fitch expects asset quality performance will continue to remain solid in calendar year 2015 (CY15) and into 2016 but normalize from current levels driven by expected moderation in used car values.

Normalizing Operating Performance; Potential Headwinds
AHFC's overall operating performance continues to normalize after reaching record levels in FY10 and FY11, which was driven by reserve releases from improved credit performance and residual value gains due to unusually high used car values. Pre-tax income, excluding fair value changes related to derivatives and foreign currency revaluation of debt, measured $386 million in 1Q16 (first quarter 2016 ended June 30, 2015), down 9% from $423 million in 1Q15. The decrease was primarily due to a decrease in retail loan and direct financing lease revenues and an increase in early termination losses on operating leases partially offset by an increase in net operating lease revenue and a decrease in interest expense.

Adjusted pre-tax margin was nonetheless still strong at 22.6% in 1Q16, compared to 26.4% in 3M15. Return on equity (YTD annualized) was 8.8% in 1Q16 and reflects the relatively lower leverage and higher capitalization of AHFC compared to its peers. Fitch expects AHFC to be solidly profitable in CY15 given expected expansion in the operating lease portfolio and the company's strong underwriting standards which have helped maintain strong asset quality. However, the company does face headwinds in terms of increased credit related costs, relatively higher interest expense from potentially rising interest rates, and normalizing used car values, which could reduce recoveries on repossessed cars and lease returns.

Low Leverage
AHFC's leverage, measured as debt to tangible equity, was 3.9x at June 30, 2015. Tangible equity to total assets measured 17.5% at June 30, 2015. Fitch believes these ratios are strong compared to AHFC's auto captive peers and other captive finance companies, considering the peer-superior credit quality performance of AHFC's loan and lease portfolio.

Most captives manage their leverage ratios via dividend payments to their parent companies. However, HMC has never taken any dividends out of AHFC, instead choosing to retain earnings at AHFC for growth purposes. Fitch views AHFC's conservative capital strategy positively and believes that its creditors benefit from a higher level of asset coverage compared to its peers.

Diverse Funding Sources
AHFC's funding profile has improved in recent years and includes diverse sources of funding including U.S. and Euro medium-term unsecured notes, unsecured bank loans, intercompany debt, commercial paper (CP), and asset-backed securitization (ABS) debt. Over the past several years, AHFC has lengthened the maturities of its long-term debt, which is improving its liquidity profile and reducing refinancing risk.

AHFC primarily depends on diversified funding sources and cash flow from operations for its liquidity needs. As of June 30, 2015, cash on balance sheet measured $651 million. Contingent liquidity is provided by the company's $8.3 billion undrawn bank credit facility with a consortium of banks and a $0.5 billion committed unfunded asset-backed commercial paper conduit.

Upcoming Debt Maturities
As of FY ended Mar. 31, 2015, AHFC had $19.4 billion of debt coming due within one year. However, a significant portion of this debt is CP and related party debt, which is expected to roll over/refinance. Fitch also finds comfort in AHFC's low leverage levels, high quality of the unencumbered loan/lease portfolio, and lack of dividend distributions to its parent which, to some extent, offset the relatively low level of absolute liquidity.

RATING SENSITIVITIES
AHFC's ratings are linked to those of its parent, HMC. However, negative rating action could also be driven by a change in the perceived relationship between HMC and AHFC such as if Fitch believed that the subsidiary had become less core to the parent's strategic operations or adequate financial support was not provided in a time of need. Additionally, a material weakening in AHFC's liquidity profile, asset quality or capitalization could also yield negative rating action for the HMC and therefore, for AHFC.

Positive rating momentum for AHFC will be limited by Fitch's view of HCM's credit profile. Fitch cannot envision a scenario where AHFC would be rated higher than its parent.

Fitch has affirmed the following ratings:

AHFC
--Short-term IDR at 'F1'
--Commercial paper rating at 'F1'