DBRS, Inc. (DBRS Morningstar) confirmed the ratings of Element Fleet 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 remains SA3. As a result, EFN's final ratings are equalized with its IA.
KEY RATING CONSIDERATIONS
The ratings consider EFN's strong commercial fleet management franchise, which is underpinned by top-tier market positions in North America, Australia and New Zealand. The Company offers a wide menu of products and services, benefiting customer growth and high retention levels. With its transformation plan almost complete, EFN has strengthened its operating platform and future earnings generation capacity, better positioning the Company to counter headwinds related to the Coronavirus Disease (COVID-19) pandemic. While we expect these headwinds to have a temporary impact on origination volumes and revenues, EFN's risk profile remains solid, including sound credit risk and highly manageable residual value risk. The ratings also reflect EFN's reliance on secured funding along with its elevated but improving leverage position. The maintenance of the Stable trend reflects DBRS Morningstar's expectation that the Company will continue to maintain good credit fundamentals, despite the challenging operating environment presented by the coronavirus pandemic.
RATING DRIVERS
Sustained improvement in profitability driven by solid growth in assets under management and operating efficiency, while maintaining sound credit performance would result in an upgrade. Continuing improvement in funding diversity that results in increasing levels of unencumbered assets, as well as maintenance of tangible leverage below 6.0X would result in an upgrade. If the coronavirus related headwinds were to exacerbate, leading to material pressure on the Company's bottom line and/or weakening credit, ratings would be downgraded. Additionally, deterioration in the franchise, evidenced by a sustained decline in origination volumes and higher than expected client attrition, or a reversion to a higher level of tangible leverage, would result in a downgrade.
RATING RATIONALE
The ratings reflect EFN's strong commercial fleet management franchise, which includes a strong market presence in North America, Australia & New Zealand, along with a growing position in Mexico. DBRS Morningstar considers the Company's management team to be solid, especially given their success in executing the transformation plan introduced in October 2018. Indeed, the executive management team has been successful in fortifying the franchise by taking actions to stem client attrition and improve operating efficiency. We note the Company announced that Vito Culmone, the current Chief Financial Officer, will be departing in early 2021, upon the appointment of a successor. We see this transition as having no impact to the ratings, given the overall strength of the executive management team.
EFN's earnings were pressured in 1H20, due to CAD$13.8 million of non-recurrent costs associated with the disposition of 19th Capital Group LLC, along with a 5% year-on-year (YOY) contraction in originations to CAD$3.3 billion. Lower originations were negatively impacted by the temporary closures of OEM production facilities and dealerships, which resulted in delivery delays of vehicles to EFN's clients, as well as the Company's clients choosing to postpone orders for fleet vehicle replacements while they focused on other aspects of their own businesses. Specifically, 1H20 earnings declined 4% to CAD$138 million, YOY, primarily reflecting the costs associated with 19th Capital, a 7% decrease in net financing revenues to CAD$196 million, a slight decline in service income to CAD$240 million, and a 7% decrease in net syndication revenues to CAD$36 million. These headwinds were partially offset by a 6% YoY reduction in operating expenses to CAD$247 million, reflecting solid progress in realizing the cost efficiencies and productivity improvements that were part of the Company's transformation plan. Overall, Element expects to achieve its goal of CAD$180 million of actioned profit improvements by YE20.
To diversify revenues and manage client concentration exposures, EFN has increased its usage of lease syndications. For 1H20, syndication revenue totaled CAD$36.4 million, or 8% of total revenues, compared to CAD$38.9 million in 1H19. We view the use of lease syndications as a positive, especially if the Company pursues large customers.
The Company's credit performance remains sound, despite the difficult business environment. At June 30, 2020, total delinquencies represented a modest 0.39% of net investment in finance receivables (by contract balance), up moderately from 0.16%, at December 31, 2019. Meanwhile, net charge-offs (NCOs) remain very low, totaling CAD$1.4 million for 1H20, and CAD$2.2million for full-year 2019. Overall, DBRS Morningstar views EFN's modest levels of delinquencies and NCOs as reflective of the Company's high level of investment-grade fleet management clients, as well as the mission critical nature of its leased vehicles. Finally, residual value risk remains moderate and manageable, as the overwhelming majority of the Company's client leases are open-ended.
The Company is reliant on securitization markets for funding, which encumbers the balance sheet, but does provide for solid asset-liability matching. That said, and positively, EFN has taken steps to reduce its dependence on secured funding, including the recent initial issuance of senior unsecured debt to U.S. investors. Liquidity remains sound totaling CAD$4.7 billion (at June 30, 2020) consisting of contractually committed, undrawn liquidity across its revolving unsecured (CAD$1.8 billion) and vehicle management asset-backed (CAD$2.9 billion) facilities.
EFN's capital position remains acceptable, especially given its low risk profile and solid earnings generation capacity. We view favorably the Company's improving tangible leverage, which declined to 6.8x at June 30, 2020, down from 7.1x at YE19, but still above the Company's goal of 6.0x by YE20. Improved tangible leverage reflected continuing usage of syndications, sound retention of earnings, and a lower levels of originations, which resulted in lower vehicle-backed debt.
ESG CONSIDERATIONS
A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework and its methodologies can be found at: https://www.dbrsmorningstar.com/research/357792.
The Grid Summary Grades for EFN are as follows: Franchise Strength - Good; Earnings Power - Good/Moderate; Risk Profile - Good; Funding & Liquidity - Moderate; Capitalisation - Moderate.
Notes:
All figures are in Canadian 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.
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.
DBRS, Inc.
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Ratings
Date Issued Debt Rated Action Rating Trend Issued
i
US = USA Issued, NRSRO
CA = Canada Issued, NRSRO
EU = EU Issued, NRSRO
E = EU endorsed
Unsolicited Participating With Access
Unsolicited Participating Without Access
Unsolicited Non-Participating
01-Oct-20 Long-Term Issuer Rating Confirmed BBB (high) Stb US
01-Oct-20 Short-Term Issuer Rating Confirmed R-2 (high) Stb US
01-Oct-20 Long-Term Senior Debt Confirmed BBB (high) Stb US
01-Oct-20 Short-Term Instruments Confirmed R-2 (high) Stb US
01-Oct-20 Perpetual Preferred Shares Confirmed Pfd-3 (high) Stb US
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ELEMENT FLEET MANAGEMENT CORP. 
