When you borrow against an asset instead of just projecting future cash flows, you can achieve a lower cost of capital. But a borrower makes not one but rather two bets. The first is that revenues keep flowing, allowing debt to continue to be serviced. The second is that the collateral value remains resilient.
Car rental stalwart Hertz Corporation learns the hard way what happens when both bets go wrong. On Friday night, Hertz filed for Chapter 11 bankruptcy, citing total debt of $19 billion. In another filing Sunday, Hertz said in April, revenue fell 73% year over year.
His biggest problem, unsurprisingly, is that people all over the world aren’t flying. (Interestingly, he also said that since fewer people were driving, there were fewer car accidents and therefore fewer people needed loaner cars, another important customer segment).
© Hertz depot
The vast majority of the company’s debt – $15 billion – took the form of lease obligations to Hertz-owned special purpose entities that had issued bonds to buy cars:
© Hertz depot
© Hertz Depot
But the indebted entities that had bought the vehicles – which charged interest rates between 3 and 5% – were not going to assume the risk of a disproportionate deterioration in the value of the cars. Hertz said that:
When pricing guides show that the company’s non-program leased vehicles have depreciated faster than their book depreciation, the company must pay the calculated write-down to the HVF II ABS program to stay in compliance with its collateral value ratios. . Given the value of the company’s non-program leased vehicle fleet, a 1% decline in vehicle value results in a depreciation adjustment requirement of approximately $75 million to remain in compliance.
According to the company, the car resale market effectively shut down in late March and April, but “pricing guides continued to publish purported market values for used vehicles.” Hertz said JD Power estimated used vehicle prices would drop 7% between March and June.
At the end of April, Hertz owed $135 million to the HVF II ABS program “to maintain compliance with its funding ratios.” The company would normally have been in default by not making the payment, but instead obtained temporary relief from creditors to avoid a liquidation of the fleet. But in the absence of an agreement reached in May, Hertz was forced to file for bankruptcy.
Now comes one of the most interesting redesigns in recent memory. Hertz and its stakeholders need to figure out what a NewCo car rental company should look like, then reset its enterprise value and capital structure accordingly (assuming ABS holders don’t just liquidate the portfolio ). The company has laid off two-thirds of its workforce in the belief that demand will not return soon.
However, with 500,000 cars in the United States, Hertz represents a large part of the industry and the parties must decide how big the new company should be and not just how much debt it should use, but what kind. . Maybe this time they’ll be more careful about using cars as collateral.
Related links:
Hertz bankruptcy case
Hertz car rental group files for bankruptcy – FT
