DBRS Morningstar Downgrades HTZ to CCC (high) and Maintains Under Review with Negative Implications

DBRS, Inc. (DBRS Morningstar) has downgraded the ratings of The Hertz Corporation (Hertz or the Company), including Hertz’s Long-Term Issuer Rating to CCC (high) from B (high). The Company’s ratings remain Under Review with Negative Implications.

KEY RATING CONSIDERATIONS
The downgrade and the maintenance of the Under Review with Negative Implications considers the significant impact that the Coronavirus Disease (COVID-19) is having on Hertz’s balance sheet and credit fundamentals. Overall, the Company’s highly pressured bottom line and cash flows, along with its high level of obligations, including the possibility of having to make credit enhancements to support asset backed securitization investors, is placing severe pressure on the Company’s liquidity position, which has limited options. Although The American Car Rental Association, a trade group for the sector has reached out to Congress for support, there has not been any strong support from Washington to date.

Although the Company has approximately $1.0 billion in liquidity, and only a moderate level of corporate debt coming due in 2020, the unprecedented decline in travel volumes at airports has materially impacted revenues and cash flows. As a result, DBRS Morningstar sees the Company’s interest and lease expenses, as well as potential need for future incremental credit enhancement for the ABS notes and other working capital needs as potentially straining the Company’s existing liquidity in the near term. Additionally, with its high level of ABS funding, Hertz maintains a highly encumbered balance sheet, which limits its financial flexibility, especially in stressful periods. The Company’s high level of encumbered assets as well as its weakening credit fundamentals results in the two notch differential between the Long-Term Issuer Rating and Long-Term Senior Debt rating.

As guidance to the impact of the coronavirus on Hertz’s future credit fundamentals, DBRS Morningstar utilizes the moderate scenario as described in DBRS Morningstar’s Sovereign Group’s commentary “Global Macroeconomic Scenarios: Implications for Credit Ratings”. In this scenario, DBRS Morningstar assumes some success in containment of the virus within the second quarter and then a gradual relaxation of restrictions, enabling economies to begin a gradual economic recovery in the third quarter. Within this scenario, DBRS Morningstar sees the recovery in the global travel industry as being very slow across both leisure and business travel, which will result in meaningful headwinds through 2020 for rental car companies. Indeed, these headwinds will impact the Company’s second and third quarters, which are typically when it generates the majority of its revenues, further pressuring the bottom line. DBRS Morningstar notes that coronavirus related headwinds also continue to severely pressure Hertz’s global vehicle rental volumes and fleet utilization rates, as well as used vehicle values.

Historically, Hertz has generated approximately 66% of its U.S. business from on-airport rentals. With a large share of North American flights having been cancelled due to federal, state and local travel restrictions, passenger volumes have declined dramatically leading to a meaningful drop in rental demand and fleet utilization. We expect that these conditions are having a considerable impact on Hertz’s revenues and cash flow generation. To offset the negative impact of the coronavirus headwinds, Hertz continues to focus on selling vehicles to better match its fleet with rental demand, cutting capital expenditures and prioritizing sales and marketing strategies. However, sales volumes in the used vehicle market remain very challenged given the restrictions on non-essential businesses, consumers being required to shelter-in place, and the pace of rising unemployment, all of which will curtail Hertz’s ability to sell cars at reasonable prices. To address the challenging revenue environment, the Company is managing its operating costs, and has cut its North American workforce by approximately 10,000 employees, or 26% of its total year-end 2019 headcount.

Within the rental car sector, declining used vehicle values could not have come at a worse time, especially as the sector looks to reduce fleet to better match demand. Indeed, J.D. Power, in its recent COVID-19 Valuation Services Update, noted that it expects used vehicle prices to decline 8% - 11% through June 2020 before beginning to recover. That said, DBRS Morningstar notes that used vehicle prices are currently hard to assess, especially given that most physical auctions are closed due to the coronavirus (albeit the auction houses are focusing on simulcast sales), and used vehicle sales at dealers are very limited due to government restrictions on operations.

Hertz funds its vehicles with ABS structures that include certain provisions intended to protect investors from market value declines with respect to risk vehicles. Among these provisions are a mark to market test whereby the fleet’s net book value is compared to industry guides and a disposition proceeds test that also compares sales proceeds to the fleet’s net book value. DBRS Morningstar notes that any observed shortfalls with respect to either of these tests could result in increased credit enhancement requirements under the ABS transaction documents. Given the size of the Company’s securitized rental fleet, the potential increase in credit enhancement could be significant, and further strain the Company’s corporate liquidity.

During the review, DBRS Morningstar will focus on Hertz’s ability to offset the pressure on its liquidity position as well as the impact of the current environment on its financial performance. We will consider the Company’s actions, including reducing the size of the fleet, managing costs, and reducing capital expenditures. Additionally, the review will consider the impact of any potential European or U.S. governmental support for the rental car industry.

The Under Review with Negative Implications status is generally resolved with a rating action within three months. However, if heightened market uncertainty and volatility persists, DBRS Morningstar may extend the Under Review status for a longer period of time.

RATING DRIVERS
Given the Under Review with Negative Implications, an upgrade in the near term is unlikely. Meanwhile, if the Company’s liquidity position were to deteriorate further or were the Company to seek to restructure its debt with creditors, the ratings would be downgraded. Conversely, should rental demand meaningfully return and Hertz demonstrates progress in aligning its fleet to demand while reducing potential liquidity pressure, the ratings could return back to a Stable trend.

ESG CONSIDERATIONS
A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework and its methodologies can be found at: https://www.dbrsmorningstar.com/research/357792.

Notes:
All figures are in U.S. dollars unless otherwise noted.

The principal methodology is the Global Methodology for Rating Non-Bank Financial Institutions, (September 24, 2019), which can be found on our website under Methodologies & Criteria: https://www.dbrsmorningstar.com/research/ 350802/global-methodology-for-rating-non-bank-financial-institutions.

For more information regarding rating methodologies and Coronavirus Disease (COVID-19), please see the following DBRS Morningstar press release: https://www.dbrsmorningstar.com/research/357883.

The primary sources of information used for this rating include Company Documents. DBRS Morningstar considers the information available to it for the purposes of providing this rating was of satisfactory quality.

The rated entity or its related entities did participate in the rating process for this rating action. DBRS Morningstar did not have access to the accounts and other relevant internal documents of the rated entity or its related entities in connection with this rating action.

This rating was not initiated at the request of the rated entity.

Generally, the conditions that lead to the assignment of a Negative or Positive trend are generally resolved within a 12-month period. DBRS Morningstar’s outlooks and ratings are monitored.

For more information on this credit or on this industry, visit www.dbrsmorningstar.com.

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