Hertz 2008 Annual Report Download - page 121

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (Continued)
MBIA and Ambac provide credit enhancements in the form of financial guarantees for our U.S. Fleet
Debt, with each providing guarantees for approximately half of the $4.1 billion in principal amount of the
notes that was outstanding as of December 31, 2008 under our ABS Program. Under these
arrangements, either MBIA or Ambac will guarantee the timely payment of interest on and ultimate
payment of principal of such notes. An ‘‘event of bankruptcy’’ (as defined in the indentures governing the
U.S. Fleet Debt) with respect to MBIA or Ambac would constitute an ‘‘amortization event’’ under the
portion of the U.S. Fleet Debt facilities guaranteed by the affected insurer. In that event, we would also be
required to apply a proportional amount, or substantially all in the case of insolvency of both insurers, of
all rental payments by Hertz to its special purpose leasing subsidiary and all car disposal proceeds
under the applicable facility or series, or under substantially all U.S. Fleet Debt facilities in the case of
insolvency of both insurers, to pay down the amounts owed under the affected facility or series, instead
of applying those proceeds to purchase additional cars and/or for working capital purposes. An insurer
‘‘event of bankruptcy’’ could lead to consequences that have a material adverse effect on our liquidity if
we were unable to negotiate mutually acceptable new terms with our U.S. Fleet Debt lenders or if
alternate funding were not available to us. See ‘‘Item 1A—Risk Factors—Risks Relating to Our
Substantial Indebtedness—The third-party insurance companies that provide credit enhancements in
the form of financial guarantees of U.S. Fleet Debt could face financial instability due to factors beyond
our control.’’
In connection with the Acquisition and the issuance of $3,550.0 million of floating rate U.S. Fleet Debt,
HVF entered into certain interest rate swap agreements, or the ‘‘HVF Swaps,’’ effective December 21,
2005, which qualify as cash flow hedging instruments in accordance with SFAS No. 133, ‘‘Accounting for
Derivative Instruments and Hedging Activities.’’ These agreements mature at various terms, in
connection with the scheduled maturity of the associated debt obligations, through November 2010.
Under these agreements, HVF pays monthly interest at a fixed rate of 4.5% per annum in exchange for
monthly amounts at one-month LIBOR, effectively transforming the floating rate U.S. Fleet Debt to fixed
rate obligations. HVF paid $44.8 million to reduce the fixed interest rate on the HVF Swaps from the
prevailing market rates to 4.5%. Ultimately, this amount will be recognized as additional interest expense
over the remaining terms of the HVF Swaps, which range from approximately 1 to 3 years. For the years
ended December 31, 2008 and 2007, we recorded an expense of $27.6 million and $20.4 million,
respectively, in our consolidated statement of operations, in ‘‘Interest, net of interest income,’’
associated with the ineffectiveness of the HVF Swaps. The ineffectiveness resulted from a decline in the
value of the HVF Swaps due to a decrease in forward interest rates along with a decrease in the time
value component as we continue to approach the maturity dates of the HVF Swaps. The effective portion
of the change in fair value of the HVF Swaps is recorded in ‘‘Accumulated other comprehensive income
(loss).’’ As of December 31, 2008 and 2007, the balance reflected in ‘‘Accumulated other comprehensive
income (loss)’’ was a loss of $89.6 million (net of tax of $57.4 million) and $45.6 million (net of tax of
$29.0 million), respectively. As of December 31, 2008 and 2007, the fair value of the HVF Swaps was a
liability of $134.5 million and $50.2 million, respectively, which is reflected in our consolidated balance
sheet in ‘‘Other accrued liabilities.’’ The fair value of the HVF Swaps was calculated using a discounted
cash flow method and applying observable market data (i.e. the 1-month LIBOR yield curve and credit
default swap spreads).
In connection with the entrance into the HVF Swaps, Hertz entered into seven differential interest rate
swap agreements, or the ‘‘differential swaps.’’ These differential swaps were required to be put in place
to protect the counterparties to the HVF Swaps in the event of an ‘‘amortization event’’ under the asset-
backed notes agreements. In the event of an ‘‘amortization event,’’ the amount by which the principal
balance on the floating rate portion of the U.S. Fleet Debt is reduced, exclusive of the originally
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