Lost Airport Revenue Could Impair Avis' Ability to Fully Draw on Its Revolver; Hertz, Europcar Debt Documents Provide More Flexibility to Withstand Reduced Travel Activity

Relevant Items:
Hertz’s Covenants Tear Sheet
Hertz’s Debt Documents
Avis’ Covenants Tear Sheet, Debt Document Summaries
Avis’ Debt Documents
Europcar Senior 2024
Europcar DXP Full Report Senior 2024

Amid plummeting demand due to fears over the coronavirus, airlines around the world have begun cutting capacity, canceling and/or reducing certain routes and scaling down seating capacity on others. The United States announced Wednesday night that travelers from certain European countries would not be allowed to enter the country for the next 30 days. Not only will the cuts affect airlines - with announcements to date already driving significant selloffs in airline stocks and bonds - but they also stand to trickle down to myriad other industries that rely on a healthy travel industry. One such industry is rental cars, which derive substantial portions of their revenue from airport rentals.

In this piece, we provide an overview of Hertz’s, Avis’ and Europcar’s capital structures and focus on the companies’ liquidity and ability to raise additional debt in order to withstand a sudden and sustained deterioration in their businesses. We find that while Hertz’s and Europcar’s structures provide more flexibility in the form of looser financial maintenance covenants and larger debt baskets that do not condition accessibility on meeting leverage tests, Avis may be more limited in its ability to raise liquidity and weather a period of depressed travel activity.
 
In the last few days, airlines around the world have begun cutting capacity, canceling and/or reducing certain routes and scaling down seating capacity on others. Delta, American Airlines and United have all cut their domestic capacity by about 10% to 20% and international capacity by about 20%.

Internationally, Lufthansa has announced capacity cuts of up to 50%; Air France-KLM is cutting 13% of its long-haul flights, 25% of its European network flights and 17% of its domestic network flights; and Norwegian Air has announced that it is preparing to cancel approximately 3,000 flights, or about 15% of its total capacity, from March through June.

Adding to the pressure, the United States announced Wednesday night that travelers from certain European countries would not be allowed to enter the country for the next 30 days.

In 2019, 66% of Hertz’s revenue and 64% of Avis’ revenue came from their airport locations.

24% of Hertz’s $6.9 billion in revenue in 2019 came from its international segment, while 31% of Avis’ $9.2 billion in revenue came from its international segment.

In a presentation accompanying its 2019 fourth-quarter earnings, France’s Europcar disclosed that it is switching its revenue mix from corporate to leisure and from downtown to airport, to keep fleet utilization high.

In August 2019, the company announced that it would be acquiring Fox Rent A Car to expand its operations into the United States. According to Europcar’s release announcing the acquisition:
 
Decreasing consumer demand could also affect rental car companies if prices for secondhand cars begin to falter.

Through certain securitization transactions, Hertz, Avis and Europcar lease their vehicles from special purpose entities and in addition to monthly lease payments must make payments based on the vehicles’ depreciation to ensure that the value of the special purpose entities’ fleet of vehicles remains above specified thresholds. These companies may also need to provide additional credit enhancement for their securitization facilities, typically in the form of letters of credit.

These companies’ vehicle fleets are split between program vehicles, which are contractually repurchased by the vehicle manufacturers, and nonprogram vehicles, referred to as “at risk” vehicles, which are sold through alternative channels such as auctions.

As of Dec. 31, 2019, nonprogram vehicles made up roughly 88% of Hertz’s U.S. fleet and 62% of its international fleet, 66% of Avis’ total fleet and 14% of Europcar’s total fleet.

In this piece, we provide an overview of Hertz’, Avis’ and Europcar’s capital structures, and focus on the companies’ liquidity and ability to raise additional debt to withstand a sudden and sustained deterioration in their businesses.
 
Each company’s debt documents provide significant flexibility for their securitization subsidiaries to issue debt under securitization facilities to finance the acquisition of vehicles and exclude all such debt from leverage ratio calculations under their corporate debt; the securitization subsidiaries neither guarantee the corporate debt nor pledge their assets as collateral.

Nevertheless, negative covenants under each company’s debt documents provide capacity based on the greater of a fixed amount and a percentage of total assets, which includes the assets under the securitization facilities. As illustrated below, each company has significantly more capacity to incur debt and liens and make restricted payments and investments using a total asset figure that includes their vehicle assets.

Under Hertz’s 2022 senior notes, the company has $515 million of additional debt capacity and $158 million of additional restricted payment and investment capacity than it would have if the notes provided capacity based on its total corporate assets.
 
Avis has $468 million of additional debt capacity and $144 million of additional restricted payment capacity under its credit agreement and its 2023 senior unsecured notes than it would have if capacity were based on its total corporate assets.
 
Europcar has €268 million of additional secured debt capacity and €84 million of additional investment capacity under its 2024 and 2026 senior notes than it would have if capacity were based on its total corporate assets.
   
Hertz’s capital structure and credit metrics as of Dec. 31 are illustrated below for reference.
   
Given the company’s gross total corporate leverage ratio was around 5.8x as of Dec. 31, its first lien leverage ratio under the credit agreement, netting all unrestricted cash, was around 0.5x; the company can currently incur about $1.6 billion of additional first lien debt and remain in compliance with the maintenance covenant, and its EBITDA would need to decline by $540 million, or about 83%, for it to breach the 3x test.

If Hertz’s EBITDA were to decline by $23 million and it were no longer able to meet a 6x gross total corporate leverage test, its first lien leverage ratio, netting $500 million of cash, would increase to 1.1x; the company’s EBITDA would need to decline by $419 million, or about 65%, for it to breach the 3x test.

As such, even if Hertz’s EBITDA were to significantly deteriorate, it would likely be able to remain in compliance with the credit agreement’s financial maintenance covenant.
 
Because each series of Hertz’s unsecured notes permits the company to incur at least $6 billion of secured debt, the company’s ability to incur debt and liens is governed by its credit agreement and 2L notes. Under the credit agreement and 2L notes, Hertz can incur debt and liens under the following baskets:
 
The 2L notes include a credit facilities debt basket that permits at least $3.85 billion of secured debt, although only $2.4 billion of such debt is permitted to be secured on a senior or pari basis. Although the $2.4 billion senior lien basket is the only basket that permits senior lien debt, because the 2L notes also include a secured existing debt basket that does not explicitly exclude the credit agreement, outstanding debt under the credit agreement can likely be attributed to the existing debt basket.

As such, the 2L notes likely currently permit Hertz to incur $2.4 billion of additional first lien debt.

The 2L notes also permit any new-money debt, including debt incurred under a ratio debt basket that requires compliance with a 2x fixed charge coverage ratio, to be secured by pari liens if:
 
Hertz’s 0.22x secured leverage ratio currently permits the company to incur about $2.5 billion of pari leverage liens under the 4x secured leverage test.

As highlighted above, although the company is required to meet a 4x secured leverage test to secure debt under a leverage liens basket, it arguably is not required to meet such test in order to incur liens securing “Refinancing Indebtedness.” Under such an interpretation, the company may not be required to meet this 4x secured leverage test to incur second liens to refinance its outstanding unsecured notes with second lien refinancing debt.

The 2L notes also include a $200 million pari general lien basket and, through a junior lien basket permitting any debt to be secured by junior liens, permit a significant amount of debt secured by liens that are junior to the liens securing the 2L notes.

Taken together, the 2L notes likely currently permit Hertz to incur $2.4 billion of senior lien debt, $2.5 billion of additional pari debt (assuming the company can incur $2.5 billion of debt under a 2x fixed charge coverage ratio) and a significant amount of junior lien debt; the 2L notes may also permit Hertz’s outstanding unsecured notes to be refinanced with pari debt.
 
The credit agreement includes a $2.4 billion credit facilities pari debt basket that currently permits the company to incur about $1.4 billion of additional pari debt after adjusting for the company’s outstanding term loans, $336 million of outstanding letters of credit under the credit agreement and the remaining portion of a $200 million unsecured letter of credit facility that may not be able to be incurred under any other permitted debt baskets.

The credit agreement also permits pari incremental debt, subject to meeting a 2.5x first lien leverage ratio (the agreement also includes a pari leverage liens basket subject to the same first lien test, but there are no other material debt baskets to which such liens could attach). Hertz’s current 0.5x first lien leverage ratio would allow it to incur about $1.3 billion of first lien incremental debt under the 3x test.

Taken together, the credit agreement likely currently permits Hertz to incur about $2.7 billion of additional first lien debt; nevertheless, given the credit agreement’s 3x first lien leverage ratio financial maintenance covenant currently limits the company from incurring more than $1.6 billion of additional first lien debt, the company would likely need to incur $1.1 billion of the $2.7 billion of permitted first lien debt as second lien debt instead (if Hertz wanted to preserve its ability to fully draw on its revolver, it could only incur $1.1 of additional first lien debt).

As such, Hertz is likely currently permitted to incur $1.6 billion of additional first lien debt and $1.1 billion of junior lien debt under its debt documents.
 
Avis’ capital structure and credit metrics as of Dec. 31 are illustrated below for reference.
   
Avis’ credit agreement includes a 2.5x first lien financial maintenance covenant that is calculated without netting unrestricted cash.

Whereas Hertz’ EBITDA could decline by 80% and it would still be able to comply with the first lien maintenance covenant under its credit agreement, if Avis’ EBITDA were to decline by about 37%, assuming constant debt, the company’s first lien leverage would exceed the 2.5x threshold.

More concerning, if Avis’ EBITDA were to fall by just $14 million, it would no longer be able to fully access its revolver.
 
Because each series of Avis’ outstanding senior unsecured notes currently permits the company to incur at least $5 billion of secured debt, the company’s ability to incur debt and liens is governed by the credit agreement. Under the credit agreement, Avis can incur debt and liens under the following baskets:
 
Under the credit agreement, in addition to fully drawing on the revolver, Avis is currently permitted to incur $50 million of additional pari debt using general debt and lien baskets.

The credit agreement permits Avis to incur pari incremental debt, if in compliance with the financial covenant and as long as the aggregate amount of term loans, revolving commitments and any such incremental debt does not to exceed the greater of $3 billion and 350% of EBITDA (which was about $2.8 billion as of Dec. 31). Given outstanding term loans of $1.24 billion and $1.8 billion of revolving commitments, the credit agreement likely does not permit Avis to incur additional pari incremental debt.

It could, however, incur about $3 billion of junior lien incremental equivalent debt under a 4.5x secured leverage test and about $1 billion of unsecured incremental equivalent debt under a 5x total leverage test.

Taken together, Avis can currently fully draw on its revolver and can incur $50 million of pari debt, about $3 billion of junior lien debt and about $1.64 billion of unsecured debt; to the extent the company’s EBITDA materially declines, it could lose its ability to fully draw on its revolver.
 
Europcar’s capitalization and credit metrics as of Dec. 31 are illustrated below for reference.
   
Although Europcar’s senior priority revolver has not been publicly disclosed, according to the offering memorandum for the company’s 2026 notes, the revolver requires the company to comply with a 1.1x ratio of cash flow to total debt service.

The company has disclosed that as of Dec. 31, it was in compliance with the revolver’s financial maintenance covenant.
 
The following chart illustrates the negative covenant packages under the 2024 and 2026 notes.
 
Under the notes, Europcar can incur additional pari second lien debt subject to meeting a 2x fixed charge coverage ratio; although the company’s restricted subsidiaries could also incur debt under the 2x test, such debt would not be permitted to be secured by the collateral.

However, given the €1.1 billion of revolving commitments utilize capacity under the credit facilities debt basket, the company’s ability to incur additional senior priority lien debt is limited to €143 million.

The company could also incur €414 million of debt secured noncollateral assets using capacity under the general debt basket and a general noncollateral liens basket that can be used to secure ratio debt.