Navistar International Corp. bond yields are rising while thoseof other U.S. junk-rated truckmakers fall as investors penalize itfor an engine design flaw and Carl Icahn expands his influence inthe industry.

Yields on its notes are up 2 percentage points this year asthose on the 20 most-indebted high-yield automotive companies fall,according to Bank of America Merrill Lynch index data. Icahn, whoowns 14.8 percent of Navistar's shares, is offering $3 billion forOshkosh Corp. after a failed bid last year prompted speculation ofa merger between the two companies.

Navistar, which spent $600 million to design engines that failedto meet emissions rules, is paying Cummins Inc. for replacementtechnology to reverse a forecast $325.4 million annual loss in theyear ended Oct. 31. Liquidity has declined for four straightquarters, and the Lisle, Illinois-based firm sold $200 million ofequity last month to bolster cash.

“Liquidity could get very tight over the next few quarters,”Kirk Ludtke, an analyst at Stamford, Connecticut-based securitiesresearch and brokerage firm CRT Capital Group LLC, said in atelephone interview. “Management just tapped the equity market at afour-year low, which says a lot.”

Navistar's quick ratio, a measure of liquidity, has fallen ineach of the last four quarters since declining below 1 at the endof 2011, meaning it can't pay its current liabilities from cash andnear-cash holdings.

The company had about $3 billion in long-term debt on July 31,it said in a Sept. 6 regulatory filing.

Navistar also took out a $1 billion term loan on Aug. 17, usingpart of the proceeds to repay outstanding loans from an October2011 credit facility. That borrowing increased the net debt by $740million, according to Vicki Bryan, an analyst at research firmGimme Credit LLC. The loan yields 7 percent or 5.5 percentagepoints more than the London interbank offered rate, whichever ishigher. Libor, the rate at which banks say they can borrow fromeach other, was fixed at 0.31 percent yesterday.

Navistar consumed as much as $532 million in cash in its fourthquarter, which ended Sept. 30, after reporting $706 million of cashand equivalents on July 31, Bryan estimated. Navistar needs $500million to $1 billion to remain solvent through next year, shewrote in an Oct. 24 report.

Liquidity Strain

The company's liquidity strain is exacerbated by mandatorypension payments and cash costs associated with the overhaul ofproduct lines and restructuring-related outlays, Bryan wrote in anOct. 25 report. Its unfunded pensions and other postemploymentbenefits exceed the company's market value, she wrote.

Navistar's $900 million of 8.25 percent bonds due in November2021 fell to 94 cents on the dollar to yield 9.25 percent on Nov. 2from 106 cents and a 7.38 percent rate at the end of 2011,according to Trace, the bond-price reporting system of theFinancial Industry Regulatory Authority.

The company's debt is rated B2 by Moody's Investors Service andan equivalent B at Standard & Poor's. The categories denoteborrowers that are likely to be unable or unwilling to pay debts ifbusiness conditions deteriorate.

Yields on each of the 20 other most indebted junk-rated membersof the Bank of America Merrill Lynch High-Yield Automotive and Autoparts index have fallen by at least 0.2 percentage points since thebeginning of the year.

“2012 has been a challenging year,” Steve Schrier, a spokesmanfor Navistar said in a telephone interview. “Our outlook for 2013includes a significant improvement in our performance.”

“We raised more than $200 million in additional capital” throughthe equity offering, said Navistar's Schrier, “which allows us toput to rest the uncertainty of whether Navistar will have enoughavailable liquidity to manage through the current industry downturnand bridge us through our new product launches throughout theyear.”

The company sold 10.6 million shares in a secondary offeringOct. 24, raising money to pay suppliers and to pay Cummins for15-liter engines and to use its technology in future 11- and13-liter Navistar models.

Navistar's shares ended at $20.13 yesterday, up from $18.51 onOct. 26, the lowest closing price since November 2008. That madeits market capitalization $1.61 billion, Bloomberg data show.

Sourcing the after-treatment system from another companyprobably costs several thousand dollars per engine, said CRT'sLudtke. “They've given the market the impression that they'reindifferent between paying the non-conforming penalty and buyingequipment from Cummins.”

Icahn, Rachesky

Icahn and Mark Rachesky's MHR Fund Management LLC each purchased1.6 million additional shares in the company after the newoffering, giving each about a 14.8 percent stake. A so-calledpoison pill provision, adopted by the company in June to prevent“coercive takeover tactics,” would be triggered if a shareholderacquired 15 percent or more. The provision would allow existingowners to buy more stock at half the market price.

The two investors each were given a seat on the Navistar boardand jointly given a third position on the 10-director panel lastmonth, according to an Oct. 8 statement. Rachesky was previouslyIcahn's chief investment officer before striking out on hisown.

Icahn is also the largest shareholder in Oshkosh with a 9.5percent stake. The Oshkosh board rejected his $3 billion offer tobuy the company last month. Icahn said that he doesn't want tocombine the two and that Oshkosh would be worth more in pieces.

“I don't expect any sort of merger in the near term,” BrianSponheimer, an analyst at Rye, New York-based Gabelli & Co., anasset manager with bonds in both companies and stock in Navistar,according to Bloomberg data, said in a telephone interview. “Themandate for Navistar management is very clear, and any discussionoutside of fixing the core business is noise and a distraction thatthe company doesn't need.”

The company said in a regulatory filing last week it was closingits truck factory in Garland, Texas, in “efforts to reduce costsand optimize its manufacturing footprint.” The closing will resultin annual savings of $25 million to $35 million in operating,according to the filing.

Troy Clarke, Navistar's president and chief operating officer,said on a Sept. 6 conference call to discuss third- quarterearnings with analysts and investors that the company will hit the“pause button” on its competing technology that recirculatesexhaust into the engine using high temperatures to reducepollution.

“There is obviously a significant amount of execution risk thatremains” as the truckmaker tries to bring the new engines tomarket, Sponheimer said. If Navistar is successful “there's anopportunity to see a much different company by the 2014 fiscalyear.”

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