DBRS Morningstar Confirms ECN Capital’s BBB (low) Long-Term Issuer Rating; Trend Stable

DBRS, Inc. (DBRS Morningstar) confirmed the BBB (low) Long-Term Issuer Rating and Pfd-3 (low) Preferred Shares rating of ECN Capital Corp. (ECN or the Company). The trend on all ratings is Stable. The Intrinsic Assessment (IA) for ECN is BBB (low) and the Support Assessment is SA3, resulting in the Company’s Long-Term Issuer Rating being equalized with the IA.

KEY RATING CONSIDERATIONS
The confirmation of the ratings reflects ECN’s solid operating franchise that is underpinned by its three well-run business segments, each with leading positions within their respective markets. Importantly for the ratings, each of the three businesses share similar characteristics generating good levels of recurring fee income while creating minimal credit risk on ECN’s balance sheet. Loans are originated by ECN and sold on a servicing retained basis to the Company’s broad and deep set of financial institutions (Funding Partners) on a flow basis. This funding was resilient throughout 2020 despite the uncertain operating environment from the Coronavirus Disease (COVID-19) pandemic.

The strength of the three businesses contributes to the steadiness of ECN’s core earnings generation despite the headwinds from the pandemic. Both Service Finance Company (SFC) and Triad Financial (Triad) experienced good origination volume growth benefiting from housing related trends reinforced by the pandemic leading to good top line revenue growth. However, the ratings have been constrained by the elevated level of restructuring and integration related expenses as well as charges related to the exit from legacy assets over the last several years that have impacted reported results. The ratings also consider ECN’s above-average operational risk exposure that is mitigated by the Company’s sound risk management.

The Stable trend reflects our view that ECN’s credit fundamentals will remain sound, notwithstanding the challenging but improving economic environment. The trend factors in the macroeconomic scenarios discussed within the DBRS Morningstar commentary Global Macroeconomic Scenarios: March 2021 Update, with the moderate scenario as our anchor.

RATING DRIVERS
Sustained improvements in earnings as well as convergence between reported and adjusted earnings while maintaining disciplined capital management and a low credit risk balance sheet, would lead to an upgrade of the ratings. On the other hand, a significant weakening of the Company’s operating franchise due to operational missteps would result in a ratings downgrade. Additionally, any significant funding disruptions due to Funding Partner exits, and/or sustained reduction in the Company’s bottom line, would result in a ratings downgrade.

RATING RATIONALE
ECN’s ratings reflect a solid franchise underpinned by three well managed businesses, including SFC, Triad, and the Kessler Group (Kessler). Overall, the Company originates and services unsecured and secured loans to super-prime and prime consumers through its SFC home improvement lending segment and its manufactured housing lending business, Triad. Meanwhile, Kessler offers credit card portfolio advisory and structuring services to financial institutions as well as affinity partner groups. The SFC and Triad segments originate loans and sell their loans on a flow basis to its Funding Partners, while retaining the servicing in most cases.

Ratings reflect the recurrent nature of SFC, Triad, and Kessler’s revenue generation through a number of business cycles. Indeed, the top lines of these businesses are underpinned by large components of annuity-like servicing and management fees. The Company reported strong origination volumes in 2020, reflecting SFC and Triad’s positions as essential service providers, which allows the businesses to remain open through state government mandated shut-downs. Importantly, ECN’s managed and advisory assets remained stable, year-on-year, at $33.1 billion, despite the difficult operating environment. Ratings also consider the Company’s sustained material losses related to its discontinued operations, driven in part by valuation adjustments on legacy assets. Importantly, ECN expects no further material charges against its remaining legacy assets, which total $106.8 million at YE20, including $64.8 million of aviation assets and $32.8 million of rail assets.

The Company reported a $13.5 million net loss in 2020, which was a modest improvement from a $14.7 million net loss in 2019. The net loss for the year, primarily reflected a $37.1 million valuation reserve taken against the Company’s legacy aviation assets ($13.1 million after current tax recoveries and a one-time benefit to corporate tax restructuring), reflecting the severe downturn in the aviation sector for corporate aircraft and heavy-lift helicopters. Given the significant reserve taken against the aircraft assets and the solid performance of the other legacy assets, we anticipate continuing improvement in the Company’s statutory results.

Meanwhile, on an adjusted basis, excluding the impairment of legacy corporate investments, share based compensation, and amortization of intangibles, ECN’s operating income before taxes totaled $102.9 million, up from $97.5 million in 2019, reflecting improved origination and servicing income at both SFC and Triad, partially offset by lower transaction and services and marketing revenues at the Kessler Group.

Overall, the Company’s risk profile remains sound and is well managed. We view ECN's operational risk to be its most significant risk exposure. In general, the Company’s consumer businesses have considerable regulatory and compliance related oversight, and many of its Funding Partners are FDIC-insured institutions. Although not expected, given its strong track record in operational risk management, we note that if ECN were to suffer an operational misstep, which were to damage its reputation, its franchise could be weakened, especially if a number of its Funding Partners were to reduce or pull back from their funding commitments.

Credit risk remains moderate and manageable given the Company’s asset light business model. ECN’s credit risk is limited to Triad’s moderately sized floorplan business, SFC’s advances to select dealers, and Kessler’s support of customer marketing campaigns. Overall, ECN’s credit performance was sound in 2020, notwithstanding some pressure related to solar equipment dealers in California. Specifically, in 2020, the Company charged off $8.2 million of advances to solar equipment dealers, which were negatively impacted by coronavirus induced lock-downs in California. Finally, the Company has reduced its originations for residential solar equipment overall, given ECN’s view that these are riskier credits.

Funding is diversified with more than 100 Funding Partners that include FDIC-regulated institutions, credit unions, a life insurance company, a pension fund, and GSEs. Additionally, ECN maintains a $1.0 billion senior credit facility that is used to fund the origination of certain assets as well as to provide contingent liquidity should Partner funding interruptions occur. At YE20, $473 million was outstanding under the facility. Finally, we consider the Company’s capital position to be solid, given the manageable risk profile of its balance sheet. We view ECN’s cash flow leverage ratio (average debt to adjusted EBITDA) to be manageable at 3.58x.

ESG CONSIDERATIONS
A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework can be found in the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings at https://www.dbrsmorningstar.com/research/373262.

Notes:
All figures are in U.S. dollars unless otherwise noted.

The principal methodology is the Global Methodology for Rating Non-Bank Financial Institutions (September 29, 2020): https://www.dbrsmorningstar.com/research/367510/global-methodology-for-rating-non-bank-financial-institutions. Other applicable methodologies include DBRS Morningstar Criteria: Preferred Share and Hybrid Security Criteria for Corporate Issuers (November 2, 2020): https://www.dbrsmorningstar.com/research/369165/dbrs-morningstar-criteria-preferred-share-and-hybrid-security-criteria-for-corporate-issuers, and DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (February 3, 2021): https://www.dbrsmorningstar.com/research/373262/dbrs-morningstar-criteria-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings.

For more information regarding rating methodologies and Coronavirus Disease (COVID-19), please see the following DBRS Morningstar press release: https://www.dbrsmorningstar.com/research/357883.

The primary sources of information used for this rating include Company Documents and S&P Global Market Intelligence. DBRS Morningstar considers the information available to it for the purposes of providing this rating was of satisfactory quality.

The rated entity or its related entities did participate in the rating process for this rating action. DBRS Morningstar had access to the accounts and other relevant internal documents of the rated entity or its related entities in connection with this rating action.

Generally, the conditions that lead to the assignment of a Negative or Positive trend are resolved within a 12-month period. DBRS Morningstar’s outlooks and ratings are under regular surveillance.

For more information on this credit or on this industry, visit www.dbrsmorningstar.com.

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