DBRS Morningstar Confirms Element Fleet Management Corp. at BBB (high); Trend Stable

DBRS, Inc. (DBRS Morningstar) confirmed the ratings of Element Management Corp. (EFN or the Company), including the Company’s Long-Term Issuer Rating of BBB (high) and Short-Term Issuer Rating of R-2 (high). The trend on all ratings is Stable. The Intrinsic Assessment (IA) for the Company is BBB (high), while its Support Assessment is SA3. As a result, EFN’s final ratings are equalized with its IA.

KEY RATING CONSIDERATIONS
The ratings reflect EFN’s top-tier commercial fleet management franchise with strong market shares in North America and Australia - New Zealand. The Company provides a broad set of services to its clients, and is led by a highly capable management team. EFN’s earnings and operating performance remain resilient, despite the difficult operating environment, including sustained but moderating OEM vehicle production constraints which continue to limit vehicle deliveries. EFN’s risk profile remains sound, including modest credit risk and residual value risk. The Company’s ratings also reflect its moderating but still relatively high dependence on secured wholesale funding. Finally, we view EFN’s tangible leverage position as acceptable.

RATING DRIVERS
Lower tangible leverage and reduced asset encumbrance while maintaining similar earnings metrics would result in a ratings upgrade. Conversely, a persistent and material decline in the Company’s bottom line and/or a significant weakening of its credit profile would result in a ratings downgrade. Sustained materially higher tangible leverage would also result in a downgrade.

RATING RATIONALE
Headquartered in Toronto, EFN maintains a top-tier commercial fleet management franchise in its chosen geographical markets. The Company offers a broad set of products and services, which benefits its high customer retention rate. The Company’s management team has deep industry knowledge, and has ably steered the Company through the Coronavirus Disease (COVID -19) pandemic.

The Company’s earnings are solid, benefiting from increasing utilization of services by its clients, including maintenance, tolls & violations, and accident-related services. Additionally, origination levels have improved, spurred by solid demand and moderating OEM production constraints. That said, OEM production constraints remain a headwind, driving an elevated vehicle order backlog, which stood at $2.8 billion in 2Q22, compared to an average of $1.1 billion for 2Q18, 2Q19 and 2Q20. Over the medium term, we anticipate that the Company’s order backlog will recede as OEM production normalizes, which will benefit future earnings. EFN’s earnings in 1H22 improved year-on-year (YoY) totaling $204.7 million, up 16.1% from $176.4 million in 1H21, reflecting solid client demand for services and vehicles and improved pricing of products and services. This follows full-year 2021 earnings of $356.0 million, up 24.0% YoY from $287.1 million in 2020, primarily driven by the non-recurrence of $77.5 million in restructuring and transformation costs and the $13.9 million net loss on disposition of 19th Capital that were recognized in 2020.

EFN’s risk position is sound, including low levels of credit risk and residual value risk. The Company’s net charge-offs (NCOs) totaled a very low $0.1 million in 1H22, $0.9 million in 1H21, and $1.6 million in full-year 2021. The limited level of NCOs reflects the Company’s significant level of investment grade fleet management clients, its conservative underwriting, well collateralized client exposures, and the mission critical nature of the leased vehicles to the lessee. Positively, given the essential nature of the leased vehicles to clients, leases have typically been affirmed in bankruptcy, leading to low loss severities. Additionally, we note that there are only a few modest industry concentrations, but we view these as manageable, given the high credit quality of the client base. Meanwhile, the majority of EFN’s clients’ leases are open-ended, where the clients, not the Company, are exposed to declines in used vehicle values upon disposition, limiting EFN’s residual value risk. Finally, while well managed, operational risk is a key risk given the substantial amount of client data that the Company maintains across its operating platform.

The ratings are somewhat constrained by the Company’s reliance on secured wholesale funding, which encumbers a large portion of its assets, and somewhat limits its financial flexibility. Nonetheless, we view favorably EFN's issuance of senior unsecured debt over the last two years. Overall, the Company’s funding is well-aligned with the asset base. Meanwhile, EFN maintains a sound level of liquidity totaling $2.1 billion, consisting of $1.1 billion of availability under its revolving unsecured credit facilities, and $1.0 billion under its vehicle management asset-backed facilities, as of June 30, 2022. The Company’s liquidity position also reflects its solid cashflows from operations, which totaled $327.3 million in 1H22.

With its sound risk profile and resilient earnings generation capacity, capital is acceptable. EFN's tangible leverage ratio was 6.18x at June 30, 2022, up from 5.86x at December 31, 2021.

ENVIRONMENTAL, SOCIAL, GOVERNANCE CONSIDERATIONS
There were no Environmental/ Social/ Governance factor(s) that had a significant or relevant effect on the credit analysis.

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/396929/dbrs-morningstar-criteria-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings (May 17, 2022).

Notes:
All figures are in Canadian dollars unless otherwise noted.

The principal methodology is the Global Methodology for Rating Non-Bank Financial Institutions (September 2, 2022): https://www.dbrsmorningstar.com/research/402314/global-methodology-for-rating-non-bank-financial-institutions. Other applicable methodologies include DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (May 17, 2022): https://www.dbrsmorningstar.com/research/396929/dbrs-morningstar-criteria-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings.

The primary sources of information used for this rating include Morningstar, Inc. and Company Documents. 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.

The conditions that lead to the assignment of a Negative or Positive trend are generally 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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