Hertz has stepped on the sustainability pedal by announcing its plan to add Tesla electric vehicles to its fleet, thereby pressuring competitors in the rental car industry to join in on the energy transition. The news marks an acceleration towards sustainability in rental car securitization, though questions regarding weakened collateral value and greenwashing remain.
On October 25, Hertz announced that it plans to put in an “initial order” for 100,000 new Model 3 Tesla electric vehicles (EVs) to add to its rental car fleet by the end of 2022.
Hertz has about 420,000 vehicles in its fleet, as of second quarter 2021. With the new Tesla order, 20% of its global fleet will be EVs, according to Hertz.
This is big news for the securitization market, because a majority of Hertz’s funding comes from its ABS programmes, under various titles such as Donlen US ABS and European ABS Programme.
Once the rental car company adds the EVs to its fleet, it is more than likely EVs will be a part of Hertz’s ABS portfolio.
Despite Tesla chief executive officer Elon Musk’s Twitter response on Tuesday that no official contract has been signed yet, ABS market participants are expecting Hertz to follow through with the plan eventually, once details are cleared.
Rising from bankruptcy
Investors said the bold announcement from the rental car company was “pretty surprising”.
“I would say it took me by surprise a little bit, though we have been aware for some time that Hertz was planning to buy vehicles from Tesla, and it does make sense for a couple of reasons,” said one executive at an alternative credit firm based in New York.
Now may be an attractive time for Hertz to announce such news because the company is coming out of a bankruptcy, sources said, which means it has a balance sheet that is in “very good shape”.
“I do think making EVs available to the American public through the rental car experience is great marketing and it will differentiate Hertz from its competition, especially just a few months after they have emerged from bankruptcy,” said David Bondy, managing director at Natixis.
Current market conditions are rosy as well, giving Hertz good access to cash and easy entry into the capital markets for funding.
“If you were ever going to take on risks or try something new like this, now is a decent time to do it,” said one esoteric ABS investor.
It’s also no secret that a rental car ABS including EV collateral will be popular among investors, given the lack of yield opportunity and ESG paper.
“There are just so few opportunities within ABS for green bonds and EV type deals,” said Evan Shay, securitized credit analyst in the fixed income division at T. Rowe Price. “For example, what you saw with Toyota’s last green bond deal was that it ended up pricing 5bp-10bp inside the typical prime auto deal.”
Moving fast may break things
“For auto securitization, it means bigger, better, broader,” said Joseph Cioffi, chair of the insolvency and finance practice at Davis & Gilbert. “However, new technology will come creating new risks and downside as well.”
The most obvious risk is the one of resiliency; not enough volume may be manufactured from Tesla to supply the needs of Hertz and other companies that want to add EVs to their fleet.
Another risk is that batteries could be approximately 20% of the total vehicle cost and batteries and parts may become obsolete quickly, as EV technology evolves at a rapid pace. This will quicken the rate of depreciation, otherwise known as residual value risk.
According to Fitch Ratings, residual value risk for internal combustion engine rental car ABS is typically low, but EVs face higher risk because of its reliance on technology updates. If the manufacturer goes into distress, the residual value risk for EVs becomes amplified, analysts said in a sector comment report on Tuesday.
“One of the risks is the residual values on the EVs. You don’t know how much you should pay and the market is still feeling this out,” said Peter Van Gelderen, a vice-president, senior portfolio manager and senior investment analyst for American Century Investments.
Moreover, investors run the risk of overlooking the ‘S’ and ‘G’ pillars because of the EV label attached to a potential Hertz ABS with EV collateral, sources said.
“It may be a stretch to say a deal like this is ESG friendly, because environmental is just one of three legs in ESG. So the analysis has to consider the social and governance aspects as well,” said Van Gelderen.
Investors may “flock to anything that they think meets their ESG standards,” added Cioffi, but careful consideration is required in figuring out who the issuer and servicer is and whether the social or governance standards are met.
Avis tails behind
Competitors were quick to respond to Hertz’s eye-catching announcement, signalling that they too will soon contribute to the major shift to sustainable driving. In an earnings call on Tuesday, Avis said it is working to absorb EVs at scale.
“We have spent a lot of time over the past 12 months with both our original equipment manufacturer (OEM) partners to optimise a product line for electric vehicles and also our infrastructure partners to tackle logistical hurdles,” said Brian Choi, executive vice-president and chief financial officer of Avis. “But you haven’t heard from us publicly on this because of competitive reasons.”
Market participants are taking Avis’s word for it, but the timing will depend on how Hertz’s announcement and future EV inclusive securitizations are received by investors.
“Another operator we spoke to seemed a little more sceptical about the idea of adding EVs in their fleet, but they may change their mind if they see that Hertz is generating positive feedback,” said Bondy.
