DBRS Confirms ECN Capital’s Issuer Rating at BBB (low), Stable Following Acquisition Announcement

DBRS, Inc. (DBRS) has today confirmed the ratings of ECN Capital Corp. (ECN or the Company), including the Company’s BBB (low) Issuer Rating. The trend on all ratings is Stable. Today’s rating action follows the Company’s announcement that ECN has agreed to acquire Boca Raton, FL-based Service Finance Holdings, LLC (SFH) for approximately USD 304 million in cash. The transaction is subject to customary closing conditions and regulatory approval. The transaction is expected to close in 3Q17.

On June 8, 2017, ECN announced an agreement to acquire SFH, a specialty finance company focused on providing installment loans to prime and super-prime customers to finance home improvement projects. SFH sources its originations through long-dated exclusive national vendor programs in the U.S. While applications are generated by dealers and contractors, DBRS notes that all applications are underwritten and credit adjudication is performed by SFH. The niche market in which SFH operates continues to grow but competition from banks is minimal, creating a solid growth opportunity for ECN. Indeed, for 2017, SFH expects origination volumes to grow 36% from 2016 to USD 742 million.

The confirmation of the ratings reflects DBRS’s view that the acquisition of SFH should strengthen the overall ECN franchise by providing access to a growing market that has no clear market leader. Further, the acquisition will provide revenue diversification and support earnings growth. The confirmation of the ratings also considers the self-funded position of the SFH business and the relatively modest impact to leverage expected from the acquisition. Indeed, ECN expects debt-to-tangible equity to increase to 1.8x at year-end 2017, from 1.3x as of April 3, 2017 (pro-forma to the sale of the U.S. Commercial and Vendor business).

However, the ratings confirmation also factors in the risks present in the introduction of new sources of credit and operational risk to ECN’s risk profile. DBRS notes that SFH is focused on consumer related lending, which elevates execution risk, as this is outside of ECN’s traditional commercial lending focus. In DBRS’s opinion, consumer lending has unique attributes that require a distinctly separate approach to underwriting and servicing compared to commercial lending. Moreover, all consumer lending in the U.S. continues to face heightened regulatory and compliance scrutiny. Given these concerns, DBRS takes comfort that to date SFH has demonstrated sound credit and operational risk management. Also, DBRS recognizes that risk management has been a focus of SFH with its procedures and processes reviewed by SFH’s partner banks, as well as SFH’s registration with the Consumer Financial Protection Bureau (CFPB). DBRS also sees SFH’s primary sourcing of business through national vendor programs as closely mirroring ECN’s go to market strategy in its commercial lending business, which could strengthen the overall franchise by allowing for sharing of best practices by both businesses.

Currently, SFH finances all originations through loan sales to thirteen partner banks at a premium with servicing retained by SFH for a fee. Going forward, ECN intends to maintain these bank relationships while broadening the business’s funding by holding some originations on balance sheet funded through the Company’s senior term facility, as well as eventually through term securitizations or other arrangements. DBRS considers ECN’s option to hold a portion of originations on balance sheet as a potential positive, as it would increase recurring interest income while reducing the reliance on gains on sale revenue.

RATING DRIVERS
Over the medium-term, ECN’s ratings could be positively impacted by the successful integration of the SFH business as evidenced by continuing growth in originations and further diversification of volumes by vendor. Sustained earnings growth supported by anticipated revenue diversification from the acquisition while maintaining historically sound asset quality metrics would be viewed favorably. Conversely, a material charge or loss resulting from integration missteps or a significant increase in credit costs demonstrating that the risk appetite of the business has been increased could result in a ratings downgrade. A noteworthy increase in leverage or an inability to access the capital markets to fund the business at reasonable costs could also lead to ratings pressure.

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

The applicable methodologies are Global Methodology for Rating Finance Companies (October 2016), Global Methodology for Rating Banks and Banking Organisations (May 2017), and DBRS Criteria: Preferred Share and Hybrid Security Criteria for Corporate Issuers (December 2016), 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.

This rating is endorsed by DBRS Ratings Limited for use in the European Union.

Lead Analyst: David Laterza, Senior Vice President, Head of U.S. Non-Bank FIG – Global FIG
Rating Committee Chair: Michael Driscoll, Managing Director, Head of NA FIG – Global FIG
Initial Rating Date: October 3, 2016
Last Rating Date: November 23, 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.