After taking a beating in the fourth quarter, the car rental market is looking up-at least among the top tier names-thanks to a rapid reduction in rental car inventory, a faster than expected recovery for the travel industry after Sept. 11, and an economy that is slowly but surely shaking off its first recession in a decade.

The car rental industry, which expected revenues to decline by as much as 15% year-over-year in the first quarter, was down only half that much, according to data provided by car rental companies to Moody's Investors Service. Indeed, the Travel Business Roundtable Index has posted five consecutive months of increases since the lows of September. That, combined with a rapid fleet reduction of about 20% across the industry last fall, has allowed companies to raise pricing, amounting to about $5 more per car per day.

Against this backdrop, Deutsche Bank Securities came to market last week with a $350 million deal - only the second car rental ABS since Sept. 11. (The first was a Budget Group Greyhound Funding deal in November, also led by Deutsche.) The three-year average life transaction from Dollar Thrifty Automotive's Rental Car Finance Corp. priced at 26 basis points above one-month Libor with a six-month controlled amortization. It was rated triple-A with an Ambac wrap. A five-year deal from Dollar Thrifty priced about a year ago at one-month Libor plus 27.

Richard D'Albert, a managing director at Deutsche, noted that Dollar Thrifty's net profit in the first three months of the year - traditionally the industry's weakest quarter - was $12 million, just shy of the $14 million the company posted in profits for all of 2001. "It's a seasonal business and to hear the first quarter was tremendously successful is a real surprise to investors," D'Albert said. "There's a great deal of margin expansion. This deal served to highlight for investors the positive developments in the industry." About 20 investors participated in the oversubscribed deal, he said.

Another major development in the market was ANC Rental Corp.'s victory in U.S. Bankruptcy Court on May 10, allowing it to issue up to $750 million in asset-backed bonds, which will reportedly hit the market sometime this summer (see las week's Whispers). ANC is also permitted to continue using $2.3 billion of existing securitization financing through Sept. 1. Contrary to expectations that those outstanding deals would go into early amortization as a result of the bankruptcy filing last fall, guarantor MBIA granted ANC temporary reprieve (see ASR 2/4/02), though the monoline will receive millions of dollars in fees and other compensation for doing so, according to a report on the car rental market issued May 20 by Lehman Brothers' analysts David Heike and Marianna Fassinotti.

D'Albert argued that the ANC bankruptcy was "a validation of those deals' structure. Rating agencies have scrutinized the structure and found it adequate and capable to provide investor protection. It worked the way it was supposed to." However, Heike countered that while MBIA's credit guarantee "adds stability to these bonds that corporate bonds don't have...the deal didn't work the way investors expected. They expected it to go into early amortization."

These crosscurrents in the car rental industry are precisely what prompted Heike and Fassinotti to issue their report. Heike explained that particularly now, with ANC approved to issue more ABS paper, investors need to study the dynamics of the industry. He pointed out that so far, the travel industry has been buoyed by the leisure sector, which has enjoyed price wars among air carriers. (Car rental companies with an airport presence tend to benefit from carrier price wars since their performance is tied to carrier enplanements, not revenue.) Although Rochelle Tarlowe, vice-president and senior analyst at Moody's, cautioned, "We'll need to see an uptick in business travel before we really see a turnaround in the rental car business."

Indeed, business travel is the great unknown and, until it rebounds, revenue declines will likely persist in the near future for rental car companies. "What we're seeing now is a comparative improvement in business," Tarlowe said. For instance, Avis Group Holdings, a big player in the corporate travel segment, saw rental days decline year-over-year in the first quarter by 7 percent, though that was certainly better than the fourth quarter's 14 percent drop. Even so, D'Albert contends companies well positioned at this point will be at a great advantage when business travel does pick up.

Heike said he expects The Hertz Corporation and Avis, with their leading market share and financially strong parents, to gain steam in a recovery. But the second tier names, such as Budget and ANC's Alamo, are in a more tenuous position. Indeed, while ANC is working through its restructuring, Budget failed to deliver $18.3 million in interest payments to senior note holders in April and warned of possible bankruptcy. These developments lead Heike to predict investors will demand a more robust structure for car rental deals. More ABS deals will be wrapped, and those that have a senior/sub structure "will be a tough sell," he said. Additionally, first-tier names will be much better received than deals from second-tier names. "I would focus on the guys with the strongest market position and best access to financing," he said.

All in all, however, Heike said: "I've been impressed at how resilient some of these companies have been. They've downsized rapidly and made reasonable headway toward a recovery."

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