DBRS Assigns Issuer Rating of BBB (low) to ECN Capital Corporation, Stable Trend

DBRS, Inc. (DBRS) has today assigned an Issuer Rating of BBB (low) to ECN Capital Corporation (ECN or the Company).The trend on the rating is Stable. The rating action follows an in-depth review of the Company’s fundamentals, operating performance, and future prospects.

The rating reflects the Company’s solid franchise as a leading commercial lender and lessor in North America with strong origination platforms and sound risk management across multiple asset classes. The rating also considers the solid earnings generation derived from the franchise, producing more than sufficient pre-provision earnings to absorb the cost of credit with a solid cushion to absorb potentially higher losses that would be expected through the cycle, as well as unexpected losses. Funding is appropriate and aligned with the asset base, while leverage is considered low compared to peers. The Company’s reliance on secured forms of wholesale funding and execution risks associated with the Company’s evolving strategy to become more “asset-lite”, as well as the potential for entry into new business activities currently constrain the ratings.

The Stable trend reflects DBRS’s expectations that ECN will successfully separate from Element Fleet Management Corporation with no material operational-related charges, and continue to generate solid returns while retaining capital to support new activities. Moreover, the trend considers DBRS’s expectations that the slow but steady economic growth in the U.S., as well as in Canada, will continue to provide the Company with sound growth opportunities in its chosen markets.

ECN’s franchise is an important consideration in the ratings. Across the Company’s three verticals, Rail Finance (Rail), Aviation Finance (Aviation), and Commercial and Vendor (C&V), ECN has leading platforms with a sound and growing market presence in North America supported by a well-established senior management team that has deep knowledge of their industries. Overtime, ECN endeavors to evolve to a more “asset-lite” strategy in which assets the Company originates would be placed into funds for investors that the Company would continue to manage and service for a fee. While this strategy is potentially a positive as certain risks would be removed from the balance sheet, DBRS sees execution risks in transitioning to the strategy, including potential disruption from stress in capital markets or shifting investor appetite. Also, DBRS considers the proposed acquisition of INFOR Acquisition Corporation (IAC) in an all-stock transaction that is expected to close later in October 2016, as having no immediate rating impact on ECN. In acquiring IAC, ECN will be gaining access to approximately C$220 million of cash to support the acceleration of ECN’s growth, while also gaining senior management members with deep expertise in the Canadian financial services market.

ECN’s earnings are expected to develop and strengthen as the franchise grows. Revenues are largely derived from net interest income generated from earning asset growth, but DBRS expects fee-related income to gradually become a more important contributor to revenues as the Company advances its ‘asset-lite” strategy. DBRS would view a higher proportion of revenues from non-transactional oriented fees such as servicing and management fees more favorably. For 1H16, ECN generated C$94.3 million of pro-forma adjusted pre-tax income, excluding share based compensation as well as transaction and integration related costs, compared to C$86.6 million in the year ago period. Importantly for the rating, ECN generates solid levels of income before provision for credit losses (IBPT). Indeed, in 1H16 the Company generated C$104.3 million of IBPT, of which provision expense absorbed 9.6%.

The ratings also consider ECN’s risk profile, which DBRS views as well-managed supported by strong credit underwriting discipline and sound servicing capabilities across the Company’s verticals. Within ECN’s railcar portfolio, losses have been minimal to date, benefiting from a young, well-diversified railcar portfolio backed by a high-quality customer base. Further, DBRS notes that ECN has minimal exposure to tank car retrofitting resulting from the FAST regulations introduced by the U.S. DOT related to tank cars carrying flammable liquids. DBRS considers asset risk as manageable within the run-off Aviation Finance vertical, which will comprise 18.9% of net earning assets, pro-forma to the separation. While ECN has exposure to CHC Helicopter (CHC), which filed for bankruptcy protection in June 2016, DBRS notes that CHC affirmed the leases on two helicopters while returning five helicopters, which ECN anticipates having the majority of back out on lease in the near-term. ECN’s C&V’s portfolio continues to perform well, benefiting from its relationships with manufacturers and the absence of sourcing business from third-party brokers, which DBRS views positively.

From DBRS’s perspective, ECN’s balance sheet strength is solid, supported by a funding profile that is properly aligned with the asset base reducing potential capital calls and liquidity that is appropriately managed. However, DBRS views the reliance on secured forms of wholesale funding as limiting financial flexibility and a constraint on the ratings. Liquidity is largely comprised of unrestricted cash and capacity under its bank facilities, which DBRS considers more than sufficient to fund expected originations over the next year.

Capitalization is considered acceptable given the risk profile of the balance sheet. Tangible equity-to-tangible assets was a very solid 24.1% at the end of June 2016, on a pro-forma basis. Tangible leverage, on a pro-forma basis, was 3.0x at June 30, 2016, which is better than the peer average, and within maximum covenant limits of 4.0x.

RATING DRIVERS
While near-term upward ratings migration is unlikely, over the medium-term, ratings could be positively impacted by a successful execution on the “asset-lite” strategy while maintaining asset quality within expectations and balance sheet leverage at current levels. Sustained earnings expansion that is supported by a more balanced mix of revenues would also be viewed positively by DBRS. A more balanced funding profile and lower asset encumbrance resulting in improved financial flexibility would be viewed favorably. Conversely, a noteworthy increase in leverage, sustained deterioration in operating performance, or indications of miss-steps in the execution of the “asset-lite” strategy evidenced by loss of key customers or operational-related charges could result in negative ratings pressure. Ratings could also be pressured by a material acquisition that DBRS views as outside of ECN’s core verticals and capabilities.

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

The applicable methodology is Global Methodology for Rating Finance Companies (October 2015), which can be found on our website under Methodologies.

The primary sources of information used for this rating include company documents and SNL Financial. DBRS considers the information available to it for the purposes of providing this rating was of satisfactory quality.

Lead Analyst: David Laterza
Rating Committee Chair: Michael Driscoll
Initial Rating Date: October 3, 2016
Most Recent Rating Update: October 3, 2016

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