Hertz is issuing another $634 million of bonds backed by its rental car fleet, according to rating agency presale reports.

The transaction, called Hertz Vehicle Financing II LP, Series 2018-1, is a master trust, and the notes share collateral on a pari passu, or equal basis, with Hertz’ other outstanding series of notes.

The collateral ultimately backing the notes is a fleet of vehicles; these vehicles are owned by a special purpose entity and leased back the Hertz in a single lease. The issuer repays the notes with funds generated from a combination of lease payments from the sponsor, sale of vehicles, and/or refinancing proceeds.

The rental fleet vehicles in the pool include both program and non-program vehicles. Program vehicles benefit from repurchase or guaranteed depreciation agreements from eligible manufacturers.

The primary risk to investors, according to Moody’s Investors Service, is that Hertz, a heavily indebted company with a below investment grade rating, may default on its obligation to make its required lease payments to the issuer. However, Moody’s believes that Hertz would have a strong incentive to affirm the lease in the event of a Chapter 11 bankruptcy, because the collateral represents the majority of its U.S. rental car fleet and so is critical to its operations. And if Hertz reorganizes under Chapter 11 and does affirm the lease, Moody’s assume that noteholders would not experience a loss.

Should Hertz default, however, there is a secondary risk the market value of the vehicles could depreciate as the entire portfolio is liquidated, reducing the amount that investors could recover.

Fitch Ratings cites as the primary risks the diversity of the rental fleet and the fluctuation in the rate at which the vehicles depreciate. In its presale report, it noted that Hertz’s fleet depreciation has been volatile since 2014 for certain types of vehicles and remains elevated due weaker residual values, particularly for compact cars. Despite this, vehicle disposition losses have been minimal. Fitch has taken recent performance into account and adjusted the risk depreciation assumption higher to 2.0%.

Both rating agencies cite the financial health of the manufacturers of the vehicles, and the fact that the rental fleet is concentrated among a few manufacturers, as a rating driver. Fitch noted that all of the manufacturers with program vehicles have improved their financial performance in recent years and are “well positioned” to meet their repurchase agreement obligations.

Both Moody’s and Fitch expect to assign a triple-A rating to the senior tranche of notes to be issued; there are also four subordinate tranches, three rated only by Fitch and a fifth tranche that will be retained by Hertz to satisfy risk retention rules. All of the notes have an expected final distribution date of February 2023.

Bank of America Merrill Lynch is the structuring lead; BMO Capital Markets, BNP Paribas Securities, and Mizuho Securities are joint bookrunners.

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