Rightsize or Capsize

The car rental industry is in the midst of an unprecedented maelstrom.

Just as the industry survived the thrashing it took in the used car market last year, the recession hit and weakened travel and rental car demand. With the collapse of the securitization and bond markets and lenders pulling back, the major rental companies down to the independents were left scrambling to find financing. They’re getting squeezed on the back end too, as consumers and other commercial buyers of rental fleets suffer the credit crunch. It’s all costing much more.

And then Chrysler and General Motors, two of the biggest suppliers of rental fleets, declared bankruptcy.

The mandate: Right-size or capsize. The following is a compendium of the industry’s recalculations and adjustments to stay on course. Brace yourself—that could be bright skies on the horizon, or just the eye of the storm.

A Major Scramble
Like many other industries dependent on large amounts of capital to run, the major car rental companies are trimming fat as they work to replace funding lost in the wake of the securitization market implosion.

There was no disaster in car rental; no one had to liquidate entire fleets. But with a virtually insolvent bond market, the backstop to securitization is gone—as is 4 percent financing.

Hertz was able to raise close to $1 billion recently through debt and equity offerings, which will be used to help in debt refinancing and lower fleet interest expense. Hertz cut its U.S. car rental fleet in the first quarter by 15 percent year over year.

Avis Budget says it will need to raise $1–$1.5 billion for fleet needs over the next year. The company ended the quarter with its fleet down 22 percent from the year earlier.

Dollar Thrifty reduced debt by $490 million in the first quarter, while reducing its investment in fleet by about 43 percent, or more than $1.1 billion from the year earlier.

Enterprise has paid down $3 billion worth of debt in the first nine months of its fiscal year (ending July 31, 2009) while purchasing more than $10 billion worth of cars in that time.

“We have paid down debt this year, we haven’t borrowed and we have not drawn on our lines of credit,” says Bill Snyder, CFO and executive vice president for Enterprise Rent-A-Car, National Car Rental and Alamo Rent A Car.

With the demise of securitization, the majors investigated government TARP (Troubled Asset Relief Program) money and TALF (Term Asset-Backed Securities Loan Facility) loans. But TALF terms require a AAA rating and 60 percent equity in the deal. This is a difficult proposition for car rental.

Nonetheless, Avis Budget remains optimistic about accessing TALF funds.

“We are actively working through the logistics of issuing debt under this program and we hope to issue TALF eligible asset-backed securities in the coming months,” said David Wyshner, executive vice president and CFO, in the company’s first quarter earnings call. “Early indications are that costs under this program will be in line with our current conduit facility costs.”

“By being unsecured we believe that the flexibility in how we manage our fleet more than offsets any potential interest savings that we would get by being a securitized borrower,” says Snyder.

However, Enterprise says it will not need financing any time soon.

“We are totally internally financing vehicles right now,” says Snyder. “We have sufficient liquidity such that we will not need to go to the debt markets through our fiscal year-end. Actually, as we look out, unless we start seeing significant fleet growth, we would be fine through fiscal year-end 2011.”

Independents Follow Suit
Like the majors, licensees and independents are trying to pay down debt, run tighter fleets and keep funding in place. “I’ve taken the value of my fleet and cut it almost in half in the last eight months,” says Michael Jones, a National franchisee in Bentonville, Ark. “I’m working aggressively to show my bank that there will not be a problem on my end to pay the money back.”

“We’re getting into lower cap cost cars and are increasing the amortization on them,” says Monty Merrill, a Dollar and Thrifty franchisee in Austin and Killeen, Texas. “We’ve lowered our lending needs by 30 percent. We’ve battened down the hatches.”

Financing is still tight, as RACs regroup from the virtual pullout of GE Capital from the market and banks shorten up on credit lines.

“We lost GE, our largest lender,” says one operator. “I still have 100 cars on that line and I’m gradually selling them down. We have 12 months to deal with this, which is reasonable.”

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“Our problem is not so much the cost of funds but bankers deciding either to get out of a certain region or get out of car rental altogether,” says Craig Parmerlee, director of business development for Ace Rent a Car, an affiliate system. “We have markets where we could do four to five times the number of rentals if we could get funding for the fleets.”

“There aren’t enough sources out there at this point,” says Jim Anderson of Boca Raton, Fla., who sells vehicles to rental fleets. “People may have lost a funding source and are going back to their [remaining] bank and asking them to increase their line, and there isn’t a whole lot happening there.”

Even as primary credit lines hold stable, seasoned operators are paying closer attention to secondary lines, just in case.

“My second bank, whom I’ve been with only a couple of years, did renew my lines, but I don’t think I’ve ever spent quite as much time answering as many questions,” says Sharon Faulkner, a Thrifty licensee in Albany, N.Y. “Anyone that is applying or reapplying should be prepared to take the time and not take offense to any of the questions they may ask or materials they want you to produce.”

“When we had some excess lines, we made a mistake by not using them,” says Merrill. “And when the crunch came, they said, ‘We’re not renewing.’ We had to go back and kind of grovel and say we’ll take a smaller piece of the pie and commit to using it. Get something on those lines; don’t let them go dormant.”

“Everyone is looking at more due diligence,” says Kent Boskovich of Union Leasing, a lessor to rental and commercial fleets. “We’re requiring credit on a regular basis. We’re pulling back on some credit lines.”

“I feel like a circus bear with the unicycle and the pink tutu,” says Dino Joyce about complying with banks’ more stringent policies. Joyce’s Focus Transportation Group consults with and sells vehicles to rental car companies.

The Middle Age Fleet
As fleet size constricts, fleet age is increasing to unprecedented levels. With the cost of funds going up and manufacturers cutting production, rental companies are holding onto vehicles from older, cheaper credit lines. In car rental, “40,000 is the new 20,000.”

Manheim data shows that through March, rental risk units sold with an average of 34,000 miles, compared to 27,000 in 2008 and 24,500 in 2007.

Hertz stated that as of March 31 the average age of risk cars sold—now 75 percent of Hertz’s total fleet—was about 20 months compared with 14 months a year earlier.

Pam Nicholson, president and COO of Enterprise, National and Alamo, says the company has increased the average age of risk cars sold to 13 months compared with 12 months last year. “The 2008 buy was not great for anybody in the industry, and everybody bought a lot of them. So we needed to run those a little longer because the economics weren’t good, and they still aren’t good. With manufacturers cutting production they’re not going to be selling as many to rental fleets. So for that reason too, we’ll want to run them a little longer.”

Franchisees are under similar pressures.

“You start with the credit crunch, and then what the heck do you buy right now in which you can reasonably forecast what the residual will be?” says Merrill. “We’re going to run these cars until something changes. We’re holding back on selling.”

In some situations, corporate is quietly looking away from mileage restrictions stated in the franchise agreement. “My original licensee agreement said I could not do that,” says one licensee. “I think they’re admitting there is no choice.”

As mileage soars past warranty caps, operators are paying closer attention to maintenance and repairs.

“I’m doing more brakes, brake pads, tires and tire rotations,” says Faulkner. “I spent $2,000 on maintenance at one Goodyear dealer. It used to be $300.”

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Supply Issues in the Used Car Market
Longer hold times, combined with manufacturers shutting factory lines, have helped to firm up the used car market. Residual values are up, though it’s due more to a constriction of supply rather than strong demand. This is becoming an issue for independents that rely on the auctions to fleet up.

“[Operators] in the North and Midwest are looking at cars for their summer needs, but they’re finding that it’s hard to find good, low-mileage used cars,” says Anderson. “And the prices on those that they can find are quite high.”

“I think going to the used car market in the fourth quarter is typically a good move, but I don’t think there will be enough product,” says Merrill, who hasn’t seen many teen mile units lately. “The pricing won’t be what we’re used to seeing.”

“Over the last three months, the used car market has gotten hotter,” says Jason Manelli, communications director for Rent A Wreck and Priceless Car & Truck Rental. Rent A Wreck franchisees use the auctions almost exclusively to stock their fleets. “But we’ve got a savvy group of franchisees that can identify opportunities market by market to fleet up.”

OEM Bankruptcies – Two “Non Events?”
The specter of Chrysler’s and GM’s bankruptcies seemed to have been a much larger issue before the bankruptcies actually took place. A week after Chrysler filed, ALG devalued the Chrysler line by six points. RACs had concerns about whether they’d get paid for repurchase vehicles.

The bankruptcy courts subsequently ruled that RACs will get paid, and ALG now says it may have cut residuals too sharply. As of the middle of June, Chrysler’s bankruptcy had yet to have a significant impact on used values, according to Kelley Blue Book. GM’s bankruptcy is expected to produce a similar market response in the short term.

“We are particularly pleased that the sale process was handled in such a timely way that we have not experienced a negative impact on the residual values of Chrysler products,” said Scott L. Thompson, president and chief executive officer of Dollar Thrifty Automotive Group in a statement.

If anything, the bankruptcies are hastening the industry’s move away from the domestics, which started three years ago as a residual value protection initiative by the manufacturers.

Rental fleet sales numbers back this up, as market share for Chrysler, Ford and GM collectively has dropped from 67 percent year to date through May 2008 to 48 percent this year. Some of this supply is being supplanted by the Korean manufacturers.

Hertz is further diversifying its fleet with cars from Toyota, Hyundai and Kia, according to public statements.

Nicholson says Hyundai and Kia have been a greater part of Enterprise’s 2009 buy.

On the wholesale side, Manelli says 2008 Kias have been a good buy, especially Kia minivans, over the last three months.

Domestic manufacturers are continuing to make deals with the majors, but in smaller numbers.

“If they’re the right price and we get our residuals right, then we are not afraid of buying their [domestic OEMs’] product,” says Nicholson. “In fact, we plan on continuing to buy Chrysler and General Motors products as we have in the past. We are actually buying some 2010 Pontiacs as we speak.”

Dollar Thrifty continues to buy from Chrysler and has made a secondary supply agreement with Ford Motor Company. “We look forward to continuing our relationship and expect to be working closely with Chrysler Group in the near future,” said Thompson.

Smaller car rental companies give a mixed bag of reactions these days when it comes to American product.

“I’m happy with American product, especially Ford and Chrysler,” says Matthew Holowinski of Greenberg Rent A Car in Norridge, Ill. “My customers like those cars. With the price I’m paying and the car I’m getting, to me it’s a really good deal. The Dodge Journey is a lot of car, and I can rent it for more than an Accord.”

Yet as domestic residuals hold up in the short term, the future is cloudy.

“Today, you have to buy your cars with the idea of selling your cars,” says Merrill, a former GM dealer. “Purchasing Chrysler may not be the way to go, even if you’d like to be the good American. I have to make money on the back end of these cars. Most of us are buying foreign product.”

While there are some deals to be had, the smaller independents are not reporting any “too-good-to-pass-up” deals on GM or Chrysler product, yet.

“I was hoping bankruptcy would allow us to get more cars from the dealers that have to close,” says Courtney Milford of Courtney Leasing, a lessor to smaller rental fleets. “I haven’t seen that yet.”

“I was offered $2,500 off a Dodge Caravan, which is not much,” says Anderson. “They’re not really giving anything away, so far. I’m not finding any fire sales.”

On the Horizon
While there was some worry that the manufacturer bankruptcies may have a domino effect into a major car rental company bankruptcy, the threat has waned.

“Dollar Thrifty’s situation seems to have stabilized,” says Betsy Snyder of Standard & Poor’s. “They may have been the most vulnerable, but the Chrysler bankruptcy seems to have been a non-event as an impact on them.”

“The industry should be fine over the next year,” Betsy Snyder says. “Avis Budget conduits will need to be renewed later this year and Hertz has several billion of debt coming due in 2010, but we’re seeing them take steps to replace that now.”

Though revenues are not robust, Wall Street apparently appreciates the industry’s ability to right size. Stock prices have migrated north in the last six months, brought back from the dead since December 2008.

Independents and smaller companies are benefitting from the constriction in fleets, as customers turn elsewhere during sold-out times.

“Our call center volume for Rent A Wreck has been up consistently since January by 20 percent,” says Manelli. “And our Internet volume is up 15-20 percent.”

Travel portals are looking to independent brands to replace volume lost from their normal source of supply.

“Every month for the past seven months has been a record number of bookings for us,” says Parmerlee of Ace, who recently signed an agreement with Expedia. “Our strategy now is to focus on giving the best customer service.”

The travel outlook remains cloudy, but rates are up, as fleet size is balanced with demand. As leading indicators show the recession is easing, the mood, overall, seems “cautiously optimistic.”

“Even though rental demand remains under pressure, pricing has improved and we continue to see some improvement in the used car market. Hopefully things have leveled out at this point,” says Nicholson.

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A New Way to Finance?

Marty Young and Tom Pernsteiner of Loughlin Meghji + Company, who specialize in corporate strategy and debt restructuring, believe that auto rental financing will come from two other sources—asset-based loan (ABL) facilities and the OEMs themselves.

Asset-based loans have not shown up yet in car rental, but they’re coming. (Hertz finances part of its equipment fleet through ABL.) “This is a position that the traditional banks are very comfortable with,” says Young.

ABL works if you can run an efficient liquidation. Hence, a nice fit with rental fleets. “With its capital raise, Hertz started to position itself for asset-based loan financing down the road,” Young says.

In terms of financing source number two, the OEMs, two recent developments give some indication of where the industry might be going.

Hertz recently announced it is working a deal with two “investment grade” manufacturers (read: non American) to lease as much as 20 percent of its fleet. Avis Budget has completed a similar, yet much smaller lease deal.

Unlike a traditional risk sale or repurchase program, in these new lease deals, the manufacturer will hold title to the car. This allows for better financing terms, as some of the risk burden is alleviated for the manufacturer because it has the right to yank the cars immediately without an official repossession.

And with manufacturers holding onto titles, they’re better able to control mileage and term. “There is some wisdom in a metered approach, especially with the market the way it is right now,” Young says. “Regardless of industry, if you can move to some form of metering, you may pay more for it, but you should be able to pass cost onto customers or else just turn it off.”