DBRS Confirms ECN Capital’s BBB (low) LT Issuer Rating Following Strategic Investment Announcement

DBRS, Inc. (DBRS) has confirmed the BBB (low) Long-Term Issuer Rating and Pfd-3 (low) Preferred Shares rating of ECN Capital Corp. (ECN or the Company) following the Company’s announcement that it has agreed to make a strategic investment in the Kessler Group (Kessler or the Group) for approximately $221.2 million in cash. The transaction is subject to customary closing conditions and is expected to close in 2Q18. The trend on all ratings is Stable.

Rating Considerations
The confirmation of the ratings considers the benefits to ECN’s franchise, earnings and risk profile that are expected from the strategic investment in the Group. With Kessler, Service Finance Company (SFC) and Triad Financial Services (Triad), the Company has three businesses that enjoy leading market shares in niche markets, while providing healthy revenue diversification underpinning the appropriate earnings generation power that is consistent with the ratings. The ratings confirmation also considers the benefits of the investment to ECN’s overall risk profile. Specifically, Kessler is an advisory business to credit card issuing banks, as well as to affinity and co-brand partners, with no lending activities resulting in very low credit risk added to ECN’s balance sheet. With no lending activities, funding requirements to support Kessler are very modest contributing to ECN’s lower liquidity risk profile. DBRS sees these considerations as partially offset by execution risks, as well as operational risk becoming a larger component of the Company’s overall risk profile.

Rating Drivers
Over the medium-term, ECN’s ratings could be positively impacted by the successful integration of the recent acquisitions and investments as evidenced by continuing growth in originations and further diversification of volumes by vendor. Further, ratings could benefit from sustained earnings growth and returns consistent with that of higher-rated peers supported by anticipated revenue diversification, while maintaining a consistent risk appetite. Conversely, a material charge or loss resulting from integration missteps or a significant increase in credit costs demonstrating that ECN’s risk appetite has increased could result in a ratings downgrade. A noteworthy and sustained increase in leverage or an inability to access the capital markets to fund the business at reasonable costs could also lead to ratings pressure.

Rating Rationale
ECN anticipates that the Kessler investment completes the Company’s transformation of the franchise and redeployment of capital generated from the sale of several businesses and asset portfolios following a strategic review in late 2016. DBRS considers the strategic investment in Kessler as strengthening the overall ECN franchise through its market leading business in a niche market.

Formed in 1979, Boston, MA-based Kessler is a leading advisor and manager of credit card portfolios for over 20 U.S. banks, including six of the 12 largest card issuing banks in the U.S. The Group’s activities include advising on the design and optimization of co-brand and affinity relationships for credit card clients, advising on credit card portfolio acquisitions and sales, multi-channel marketing and providing alternative financing for new account acquisition. Since inception, the Group has structured, advised and managed over 6,000 strategic partnerships with balances in excess of USD 1.0 trillion. Integration risks are expected to be very modest, as the integration of Kessler with ECN’s other businesses is limited to only back-office functions. Nevertheless, as with any acquisition, execution risks are present. Positively, like with ECN’s other recent acquisitions, the day-to-day management team of Kessler will remain in place, partially mitigating key man risk and execution risks that could potentially arise from ECN’s management team overseeing three acquisitions within a twelve-month period.

Further, the acquisition of Kessler will provide revenue diversification and support earnings growth. Indeed, the acquisition is expected to be immediately accretive to ECN’s earnings. Moreover, Kessler provides a stable source of fee revenues for ECN as approximately 70% of revenues are based on long-term contracts and relationships, with several in place for more than 20 years. These sound, long-dated revenues combined with the appropriate scale of the business underpins the Group’s strong operating margins.

Consistent with ECN’s previous two transactions, SFC and Triad, Kessler creates minimal credit risk on the Company’s balance sheet. While SFC and Triad originate loans that are sold on a flow basis to FDIC-insured financial institutions, Kessler undertakes no lending activities resulting in reduced credit risk on ECN’s balance sheet as compared to its pre-transformation business model.

Following these transactions, DBRS notes that operational risk exposure is becoming a larger component of ECN’s overall risk profile. Consumer lending in the U.S. continues to face heightened regulatory and compliance scrutiny. Moreover, given that both Triad and SFC finance originations through partnerships with FDIC-insured institutions, while Kessler advises FDIC-insured credit card issuing banks, any operational missteps by ECN could potentially be damaging to the franchise’s reputation and result in the loss of financing partners or material revenue generating partners. Given these concerns, DBRS takes comfort that to date, each of the businesses have demonstrated sound credit and operational risk management. Also, DBRS recognizes that risk management has been a focus of each of the businesses with the procedures and processes of each entity reviewed by their bank partners.

Given the lack of lending activities, the Group will add very little to ECN’s funding requirements. ECN intends to maintain the well-established funding platform developed by SFC and Triad for their businesses through their partnerships with FDIC-insured institutions. Finally, ECN maintains its senior credit facility as a “back-up” line in the event there were to be a material disruption to the funding of originations through the bank partnerships, which DBRS considers as prudent liquidity management.

The confirmation of the ratings also considers the relatively modest impact to leverage expected from the investment. Indeed, ECN expects debt-to-tangible net worth to increase to 0.8x at year-end 2018, from 0.53x as of March 31,2018.

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

The applicable methodologies are Global Methodology for Rating Finance Companies (November 2017) and DBRS Criteria: Preferred Shares and Hybrid Security Criteria for Corporate Issuers (December 2017), which can be found on our website under Methodologies.

The primary sources of information used for this rating include company documents and SNL Financial (and other sources such as bank regulators etc). 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 Financials, Global FIG
Rating Committee Chair: Michael Driscoll, Managing Director, Head of North American FIG, Global FIG
Initial Rating Date: October 3, 2016
Last Rating Date: October 31, 2017

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

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