Trading volumes for Hertz ABS increased to at least $561m last week, a huge jump compared with the $17m of bonds traded in the week before, according to a Wells Fargo research report. Avis, another rental car ABS sponsor, also saw $133m more bonds trade than in the previous week.
The trading frenzy was triggered both by downgrades from rating agencies and by Hertz’s announcement on April 27 that it is bracing for a potential bankruptcy after failing to make lease payments to the respective lessors. The company missed its one week grace period deadline on Monday.
Although the firm released an 8-K filing on Tuesday saying that it has successfully entered into a forbearance agreement with its lenders to buy the company time through to May 22, the impact of the extension has yet to filter through to the secondary ABS market.
Last week, the class ‘A’ notes from Hertz’s transactions traded in the low 90s, while the subordinate tranches traded at a “much lower” price, hovering in the 70s, said a trader at a major bank.
As of Tuesday morning, the ‘A’ bonds are still trading at approximately 91-93, an executive portfolio manager at an investment firm told GlobalCapital.
“This is different from [what I have seen] before and was precipitated by the downgrades,” said the trader, pointing to the rating actions taken by Moody’s, Fitch and DBRS Morningstar. “Hertz’s news that they had missed a lease payment increases the odds of early amortisation and a disposition of vehicles into a very weak market with little likelihood of travel resuming soon, so [people are] really getting to thinking about the underlying valuation of the collateral at this point.”
Moody’s slashed ratings on Hertz and Avis rental car ABS last Thursday, citing weakened corporate credit profiles for both companies. Fitch and DBRS Morningstar also placed all Hertz ABS deals under review with negative implications. Fitch specifically pointed out that Hertz was suffering from an ongoing lack of liquidity, which has led to the failure to make timely payments on its monthly leases.
In the world of Covid-19, investors say they are being forced to recalculate what the rental car ABS asset class is truly worth, particularly because of changing consumer habits and nationally-imposed restrictions around travelling.
“When people are looking at these deals, it’s a lot about the value of the underlying vehicles,” said the portfolio manager. “It looks like in some of the deals, the mark to market value is teetering along the trigger point.”
Used car values have been falling in the past four to six weeks, according to Moody’s, worsened by the closures of the wholesale market across vehicle auctions.
In ABS deals, if the mark to market car values fall under a certain trigger point, the corporate parent typically has to increase enhancements in the underlying deals to support mezzanine tranches, which is a significant risk for both the sponsor and the bondholders, sources explained.
Hertz has been running “just above its mark to market test threshold of 100%,” according to a Wells Fargo research note issued on April 28, but the recent decline in used vehicle prices may put additional pressure on car depreciation rates and “book values going forward”.
“I think folks are definitely concerned,” said an executive at an investment firm. “The corporate [parent] has a lot of debt in the first place. Rental car companies are high capital usage businesses, which is why people are very concerned.”