Fitch Ratings has affirmed American Honda Finance Corporation's (AHFC) Short-Term Issuer Default Rating (IDR) and Commercial Paper (CP) ratings at 'F1'.

Key Rating Drivers

The affirmation of AHFC's ratings is driven by the affirmation of Honda Motor Company's (HMC) ratings. AHFC's Short-Term IDR is equalized with HMC's Short-Term IDR, as Fitch considers AHFC a core subsidiary of HMC. This is supported by the high percentage of HMC's U.S. and Canada sales financed by AHFC, strong operational and financial linkages between the two companies, shared branding, and a support (keepwell) agreement provided directly by HMC to AHFC.

In addition to institutional support considerations, AHFC's credit profile is further supported by its solid credit performance, strong operating margins, low leverage compared to auto captive finance peers, and a predominately unsecured funding profile. Credit constraints include weaker balance sheet liquidity and coverage of short-term debt maturities.

AHFC's strong asset quality continues to compare favorably to peers, driven by the company's conservative underwriting standards. Industry wide, retail auto credit performance has been strong over the last year relative to historical levels but is expected to begin normalizing in 2022, as some of the pandemic-driven distortions that have been supportive of exceptionally strong consumer credit performance moderate.

Distortions include the unprecedented amount of government stimulus aimed at combating the impact of the pandemic, widespread lender forbearance/deferral programs, a curtailment of consumer discretionary purchases that has resulted in significantly higher savings rates, and a post pandemic surge in used vehicle prices.

AHFC reported a consolidated net charge-off rate of 0.07% on an annualized basis during the first half of fiscal 2022 (1H22; six months ended Sept. 30, 2021), significantly below the 0.29% reported in 1H21. Delinquencies of 60 days or more on finance receivables remained relatively stable during 1H22, amounting to 0.22% at Sept. 30, 2021; down from 0.23% in the year prior.

AHFC has maintained solid profitability over the past several years. In the trailing six months ended Sept. 30, 2021 (fiscal 2Q22) pre-tax income grew 8% compared with the same period a year earlier. The increase was primarily driven by higher gains on lease residual values and gains on foreign currency revaluation of debt. As a result, the company's pre-tax ROA was 3.5% for the TTM 2Q22, compared to the 2.3% ROA for the same period a year earlier.

Fitch believes AHFC's profitability should continue to remain strong in 2022 as loan/lease origination volumes increase towards pre-pandemic levels and elevated used vehicle prices extend into next year due to strong consumer demand and continued supply constraints resulting from the semiconductor chip shortage.

AHFC's leverage, as measured by debt to tangible equity (excluding non-controlling interest), was 2.8x at 2Q22, which was slightly lower than the 3.0x from a year earlier. Fitch believes AHFC's leverage is low relative to auto captive peers, particularly when considering the peer-superior credit quality performance of AHFC's loan and lease portfolio. AHFC pays regular dividends to HMC in order to manage leverage near 3.0x. AHFC paid $956 million of dividends to HMC in the TTM ended Sept. 30, 2021, which was approximately 48% of net income earned during the period, compared to $456 million (38% of net income) over the same period a year earlier.

AHFC's funding profile is predominantly unsecured and includes diverse sources of funding, including U.S. and Euro medium-term unsecured notes, unsecured bank loans, intercompany debt, CP, and asset-backed securitization debt. Unsecured debt represented 83% of total debt at 2Q22, which is higher than peers. The firm has taken advantage of the low interest rate environment and tightening credit spreads to lengthen the maturity of its debt profile in recent years, which Fitch views favorably. CP accounted for 10% of total debt at 2Q22, which is in line with AHFC's historical average and below the peer average.

As of Sept. 30, 2021, AHFC's cash position was $2.5 billion or 3.1% of total assets, which is an improvement from pre-pandemic levels, although weaker than its auto captive peers. However, AHFC's weaker cash position is partially mitigated by solid contingent liquidity sources, which includes $9.6 billion in undrawn bank credit facilities in the U.S. and Canada. At Sept. 30, 2021, AHFC had $20 billion of debt maturing over the next 12 months, including $5.2 billion of CP.

A substantial portion of debt, including the CP program and U.S. and Euro medium-term unsecured notes, are covered by a keepwell agreement with HMC, which requires the parent to ensure that AHFC has sufficient liquidity and funds to meet payment obligations on its debt. Fitch views the keepwell agreement favorably but recognizes it is not a legally enforceable document.

The CP rating is equalized with AHFC's Short-Term IDR, reflecting that it ranks pari passu with the company's other senior unsecured obligations, and is supported by committed third party liquidity facilities from appropriately rated counterparties, which serve to ensure the timely repayment of such instruments.

RATING SENSITIVITIES

Factors that could, individually or collectively, lead to positive rating action/upgrade are limited by Fitch's view of HMC's credit profile. Fitch cannot envision a scenario where AHFC would be rated higher than its parent.

AHFC's Short-Term IDR is linked to that of its parent, HMC, and, therefore, is primarily sensitive to changes in HMC's Short-Term IDR.

AHFC's CP rating is equalized with the Short-Term IDR and would be expected to move in tandem.

Factors that could, individually or collectively, lead to negative rating action/downgrade include a change in the perceived relationship between HMC and AHFC, such that AHFC is no longer considered a core subsidiary of HMC by Fitch. Additionally, a material weakening in AHFC's liquidity profile, asset quality or capitalization could also result in negative rating actions for HMC and, therefore, AHFC.

Best/Worst Case Rating Scenario

International scale credit ratings of Financial Institutions and Covered Bond issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579

REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING

The principal sources of information used in the analysis are described in the Applicable Criteria.

Public Ratings with Credit Linkage to other ratings

AHFC's ratings and Outlook are equalized with HMC, as Fitch considers AHFC a core subsidiary of HMC. This is supported by the high percentage of HMC's U.S. and Canada sales financed by AHFC, strong operational and financial linkages between the two companies, shared branding, and a support (keepwell) agreement provided directly by HMC to AHFC.

ESG Considerations

Unless otherwise disclosed in this section, the highest level of ESG credit relevance is a score of '3'. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. For more information on Fitch's ESG Relevance Scores, visit www.fitchratings.com/esg.

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