Hertz Corp. is tapping the securitization market for $750 million to help finance a costly upgrade of its rental fleet.

The company is more dependent than ever on asset-backed financing because its corporate credit ratings have been downgraded to single-B, making high yield bond financing prohibitively expensive.

Yet this weak financial position also puts the asset-backeds at increased risk, in part because of the unusual way that rental fleet securitizations are structured. Hertz and other car rental firms don't own their vehicles outright; rather they set up bankruptcy remote trusts that issue debt, use the proceeds to purchase cars and trucks, and then lease the vehicles back to their sponsors.

But, unlike bonds backed by car loans or leases, whose performance is tied to the credit of consumers, the performance of rental fleet financing is still closely tied to the performance of the sponsor.

The high cost of unsecured junk debt has made the ABS market more inviting for the B2-rated Hertz.
The high cost of unsecured junk debt has made the ABS market more inviting for the B2-rated Hertz. Bloomberg

The latest offering, underwritten by Citigroup, comes after Hertz Global Holdings reported a net loss of $158 million for the second quarter, partly as the result of falling used car prices and declining rental demand. The poor financial results also reflect large capital expenditures for its turnaround plan engineered by majority investor Carl Icahn through the appointment of new chief executive and president Kathryn Marinello last December.

Moody’s analyst Bruce Clark noted in a May report the rating agency was concerned that the company’s operating performance would remain “well below historic levels through 2018, with pretax operating margins ... remaining near or below the break-even level.” However, Moody's also noted that Hertz is also in a strong liquidity position with more than $2.4 billion in available cash and bank credit lines.

The rating agency cut Hertz's corporate Family Rating to B2 from B1 and its senior unsecured to B3 from B2.

The turnaround involves adding more SUVs into the fleet and reducing the number of compact cars, as well as re-engineering its vehicle procurement and disposition methods, and pouring money into new IT systems and facility upgrades.

That's where the asset-backed financing comes in.

Hertz is offering two new series of senior and subordinate notes sized at $375 million apiece through its Hertz Vehicle Financing II LP (HVF II) master trust. Moody’s Investors Service, Fitch Ratings and DBRS have each assigned preliminary triple-A ratings to the $270.75 million tranche of Class A notes coming out of both the Series 2017-1 and 2017-2 issues.

Fitch and DBRS also assigned ratings to the $63.75 million in Class B notes (A); $19.88 million in Class C notes (BBB) and $20.63 million of Class D notes (BB).

The deal is the first offering from the master trust since a $400 million transaction in June 2016.

HVF II was created in 2013, following Hertz's $2.3 billion acquisition of Dollar Thrifty Automotive Group. The master trust finances both Dollar Thrifty and Firefly-branded rental businesses, as well as that of Dollar Thrifty's former parent, Rental Car Finance Corp.

Since the vehicles are technically purchased and owned by Hertz' legacy rental fleet ABS platform, Hertz Vehicle Financing (HVF), the older master trust has issued variable funding notes that will secure the new HVF II Series 2017-1 and 2017-2 notes. The vehicles to be acquired will be leased to Hertz Corp., DTG Operations (the legacy Dollar Thrifty business) as well as affiliates of HVF, according to presale reports.

The new series of notes have revolving periods — three years for the 2017-1 series and five years for the 2017-2 — during which the sponsor can add eligible program and non-program vehicles to the collateral.

Program cars are vehicles that include repurchase and guaranteed depreciation agreements with manufacturers, which support payment of the notes when the cars are returned. Non-program cars, which lack buyback arrangements and are instead sold off through auctions into the wholesale used-car market, can make up 50% to 80% of Hertz' fleet, depending on seasonal variations.

As of June, non-program vehicles had a net book value of $7.2 billion and accounted for roughly 82% of Hertz rental fleet groups, which had a total net book value of $8.6 billion.

In its presale report, Moody's noted that the primary risk to the deal is that Hertz, which is the primary lessee, may default on its obligation to make its required lease payments. Moreover, in the event that Hertz defaults, the main risk is that the funds that the trust can raise by disposing of the vehicles may be insufficient to make the required payments on the notes, particularly since the bulk sale of a large fleet may itself pressure used car market prices.

Nevertheless, the proposed credit enhancement for the new notes is slightly lower that recent Hertz note issuance, ranging from a minimum of 35.8% to a maximum 40%, levels, based on the shifting mix of collateral as well as underlying ratings of the automakers represented in the pool. Nissan Motor Co., which has the largest mix of vehicles in Hertz’ combined program and non-program vehicle fleets at 30.9%, is rated A2 by Moody’s.

The average age of vehicles in the collateral pool is 9.1 months.

In its presale report, Fitch reported Hertz had a 27% increase in net rental car depreciation per vehicle during the second quarter compared with the year-earlier period. Hertz has a monthly depreciation rate of 2.04% so far in 2017 for its non-program (or non-corporate) fleet vehicles, compared with 1.77% in 2016.

HVF II has 10 other outstanding series of previously issued notes.The HVF platform has been dormant for the past four years, but is still servicing $740 million in outstanding notes.

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