Hertz Global Holdings, facing a huge pile of debt paymentsand big bills to upgrade its fleet, is getting the bondmarket's version of sticker shock.

Refinancing costs are surging after more than a quarter of thecar-rental company's market value was obliterated in one week and agauge of its credit risk jumped to the highest since the financialcrisis. Those rising costs could effectively shut Hertz out of theunsecured bond market it has relied on for years to replenish cashand purchase cars. With interest expenses already topping half abillion dollars a year, Hertz may have to pledge more of its assetsto creditors to keep those costs from going even higher.

Some of Hertz's bonds are the year's worst performers in Bank ofAmerica Merrill Lynch's high-yield services index, with yieldshovering near 9%. The junk-rated company needs extra cash toupgrade cars and technology, but it would have to pay heftypremiums — yields of perhaps 10.5% — to get investors to buy anymore unsecured debt, said John McClain, a portfolio manager atDiamond Hill Capital Management. At these levels, creditors have toevaluate the company as if they might own it someday, McClainsaid.

“Effectively we're the equity in the business right now,” saidMcClain, who doesn't currently hold any Hertz bonds. “Getting 9% tobe the equity doesn't feel like a great trade-off, particularlywith an unproven management team with a bad starting hand.”

New Boss

Chief executive Kathryn Marinello took control in Januaryas the third CEO in less than three years. She's trying to turnaround a company that's bleeding red ink, including a secondstraight quarterly loss posted last week.

Selling more second-lien or asset-backed securities will allowHertz to pay a fraction of the interest it'd pay on unsecured junkdebt, since it means pledging specific assets as collateral. But itrisks alienating unsecured bondholders, who will be pushed furtherback in line to get paid if the company defaults, making them waryof new purchases.

“The bondholders could be in a worse and worseposition,” said Joel Levington, a Bloomberg Intelligenceanalyst. “It makes it tough to go to the bond market and issue newdebt.”

There are already warning signs. The cost for an investor toprotect $10 million of Hertz debt against losses usingcredit-default swaps jumped Friday to almost $2 millionupfront, according to data provider CMA. That's more thandouble the price of similar contracts tied to rival Avis BudgetGroup Inc, and means investors see a 62% chance of Hertz failing tomake good on its obligations in the next five years. The stock isdown more than 50% this year, closing Friday at $10.51 in New York,valuing Hertz at less than $880 million. Billionaire Carl Icahnholds a stake of about 35%.

Marinello, 60, is a former director at General Motors. She'supgrading Hertz's fleet by buying sports utility vehicles it canrent out at higher prices and getting rid of unpopular smallsedans.

“The mix of their fleet was not right,” said Mike Kelley, headof global high-yield research at Invesco Ltd, which holds Hertzdebt. “They had too much on the compact side.”

But Marinello's plan is becoming more expensive amid a glut ofused cars that's depressing prices. The lower value cuts how muchHertz gets for old vehicles it sells and also drives up the cost ofnew leases, whose pricing rises if the leasing company assumes thecar will be worth less when the contract ends.

Karen Drake, a spokeswoman for Hertz, declined to comment.

Lower resale values may also weigh on Hertz's ability to paysome of its debt, according to Moody's Investors Service. Hertzdoesn't own its entire fleet of cars outright. Instead, it holdsmost of the vehicles in a subsidiary and leases them back. Thesubsidiary sells investors securities backed by some of the leasepayments.

Hertz's deteriorating credit quality means it's more likely todefault on its lease payments, Moody's analysts wrote in a noteTuesday. The company's $3.2 billion of asset-backed bonds can keeptheir investment-grade ranks for now, since there's still a highchance that Hertz would keep paying even in a bankruptcy, theanalysts said. That's because without the cars, the companycouldn't operate at all.

Hertz carries twice the leverage of Avis, Morgan Stanley analystAdam Jonas said in a May 11 report. To get more breathing room,Hertz persuaded lenders to amend the terms of its loans, the onlycompany Jonas follows that's taken this step. The company still hasample liquidity, including $785 million in cash and a $1.7 billioncredit line, according to Moody's, and Hertz could avoid going todebt markets until after the third quarter, Kelley said.

Nevertheless, the second quarter will also be difficult andHertz may need to renegotiate debt agreements a second time,Citigroup Inc. analysts Manish Somaiya and Sesha Kadakia said in aMay 9 note. While that's doable, the analysts wrote, investors maydecide to “wait for a much better set of company fundamentals tomake it an investable proposition.”

They could be waiting awhile. In April, daily rental car ratesfell $1.87 to $44.26 a day, according to Rental Car News, and Hertzsaid last week that used-car prices will fall faster than it hadbudgeted earlier this year.

“It comes down to how bad the second quarter is,” Levingtonsaid. “It's tenuous.”

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