Hertz Corp. : Files Chapter 11

On May 22, 2020 Hertz Corp filed for Chapter 11. The BDC Credit Reporter had anticipated as much in our earlier – and first – article about the car rental giant on April 24, 2020. Apparently, despite much back and forth with lenders, the company will be entering bankruptcy without a pre-agreed restructuring deal so the future remains uncertain. Furthermore, some payment relief is being negotiated with asset-based lenders, but that’s not yet resolved. Any number of outcomes remain possible with the travel industry still in a state of high uncertainty. (We avoided saying “unprecedented”).

There is only one BDC with exposure, as discussed in our earliest post: Barings BDC (BBDC). We cannot assess if the (30%) fair market discount taken at 3/31/2020 will be sufficient or whether a further loss – and then a realized loss – will be coming. Certainly, chances are the $0.2mn of annual investment income will be suspended until a final resolution emerges. Given the size of BBDC the impact both in NAV and income terms will not be material.

However, the Hertz story is notable for other reasons. First, this is one of the most high profile BDC-financed companies to file for bankruptcy protection since Covid-19 came along and is undoubtedly a victim of the virus impact. At year end 2019 BBDC and all other lenders valued the debt of Hertz at par or better. The length of time from the initial impact of the virus on business activity has been short – less than 3 months.

Also – as the Hertz press release ruefully mentions – the multitude of programs offered by the Treasury and Federal Reserve to help Covid-19 affected companies failed to do so in this instance. As far as safety nets go there appear to be big holes through which many companies may yet fall.

Finally, to those who claim the government should do nothing to help in these troubled times because bankruptcy is an almost painless transition from one set of owners to another with little other consequence, we note that Hertz will be “reducing planned fleet levels through vehicle sales and by canceling fleet orders“, which will reverberate for years to come across the automotive industry. Also, Hertz will be “deferring capital expenditures and cutting marketing spend” which will hurt a myriad associated businesses.

Most important of all, for a government with the stated goal of minimizing the impact of Covid-19 on employment, Hertz will be “implementing furloughs and layoffs of 20,000 employees, or approximately 50% of its global workforce“. The moral hazard here is not government propping up troubled companies but the fact that the governmental lifeboat is – seemingly randomly – picking up some of those in the water and some not. But we digress.

Hertz Corp: Restructuring Underway

We hear from Reuters on April 23, 2020, in an exclusive, that Hertz is in financial trouble because of Covid-19 and has hired restructuring advisers. All this from the ever reliable “people familiar with the matter”. The publicly traded car rental conglomerate has $17bn in debt, and the burden – given the market conditions – is “unsustainable. The stock price of Hertz has dropped from above $20 as of February 20 to $3.5, close to its low. We believe a bankruptcy filing is possible.

You might imagine that there would be no BDC exposure to a company as huge as Hertz, but the sector is very far from its roots lending to small companies with little access to the capital markets as the Congress first envisaged in 1980. The BDC involved here is Barings BDC (BBDC), which has $5.8mn in Hertz Corp’s 2023 Term Loan which is priced at just LIBOR + 275 bps. When this position was first booked in the IIIQ 2018, the idea was to invest in the safest companies in the leveraged debt markets. Like in the Great Recession what seemed as safe as houses in the expansion does not when the tide goes out.

At 12/31/2019 BBDC valued the investment at a slight premium to par. Now the loan trades at a (30%) discount, according to Advantage Data which tracks prices constantly. This could yet go lower. Moody’s is projecting the company could run out of cash by the end of the second quarter. That’s only 8 weeks away…We are leapfrogging the Hertz Corporate Credit Rating from CCR 2, which is “performing” to CCR 4, where we expect the odds of an eventual loss are greater than that of full recovery. We are also adding Hertz to the Weakest Links list of companies likely to drastically restructure or file Chapter 11 – essentially the same thing.

This is not a major exposure for BBDC and the income involved is modest thanks to the borrower favorable pricing but this story is a useful early reminder that a great deal of companies thought to be unimpeachably reliable sources of interest income may not be. If Hertz is making its way down this slippery hill, who is next ?