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

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 the Company’s top-tier commercial fleet management franchise, including leading market shares in North America, Australia - New Zealand, as well as its diverse product offering which helps to maintain strong client retention levels. Despite headwinds, including OEM vehicle production constraints and ongoing Coronavirus Disease (COVID-19) pandemic concerns, the Company’s earnings and operating performance remain sound, supported by the successful completion of its Transformation Plan (the Plan) in 2020, that actioned $208 million of pre-tax annual run-rate profit improvements. Although originations have declined with OEM production issues delaying vehicle order fulfilment, a growing backlog of vehicle orders telegraphs solid levels of future originations and earnings. EFN’s risk profile remains solid, evidencing strong credit metrics and low residual value risk, despite the uncertain operating environment. The ratings also consider the Company’s reliance on secured forms of funding with a growing level of unsecured debt. Finally, tangible leverage is acceptable.

RATING DRIVERS
Sustained improvement in annual profitability reflecting solid origination levels and performance metrics, while maintaining sound credit performance would result in a ratings upgrade. Continuing improvement in funding diversity which results in higher levels of unencumbered assets would also result in an upgrade. A sustained material decline in the Company’s bottom line and/or a significant weakening of its credit profile would result in a ratings downgrade. Additionally, deterioration in the franchise, evidenced by higher than expected client attrition, or a reversion to a higher sustained level of tangible leverage, would also result in a downgrade.

RATING RATIONALE
The Company maintains a strong commercial fleet management franchise, underpinned by solid market shares in the U.S., Canada, Australia - New Zealand, and Mexico. The franchise benefits from a solid management team, which has capably navigated the Company through the ongoing coronavirus pandemic, and successfully executed and completed the Plan, which we view as having augmented the Company’s operating platform.

As anticipated, the Company’s earnings have improved, primarily driven by the non-recurrence of substantial charges and costs as well as benefits associated with the Plan. The Company’s earnings totaled $176.4 million in 1H21, up 28% from $138.0 million in 1H20, primarily reflecting the non-recurrence of transformation costs and disposition losses, along with improved net revenues, and lower operating expenses. On a core basis, excluding these non-recurrent costs/charges, income before taxes increased 14% year-on-year (YoY) to $235.2 million. Despite lower originations and the strengthening Canadian dollar, net revenues in 1H21 improved 2% YoY, driven by a 12% increase in net financing revenues and relatively stable syndications revenues, partially offset by a 5% decline in net service income. Overall, originations totaled $2.5 billion in 1H21 as compared to $3.3 billion in 1H20, reflecting the aforementioned OEM vehicle production constraints, spurring EFN’s vehicle order backlogs to record levels. Lower funding costs outpaced the decline in finance revenues, driving higher net finance revenues. Meanwhile, operating expenses were well-managed, down 5%, YoY, driven by lower levels of costs across most line items, including a 3% decline in salaries, wages and benefits expense, and a 12% decrease in general and administration cost.

The Company’s risk profile remains sound, reflecting highly manageable residual value risk and low credit risk. Additionally, operational risk is well managed, especially considering the significant volume of client data that the Company holds. Residual value risk is modest with the overwhelming majority of EFN’s clients’ leases open-ended, where the Company’s clients, not EFN, are exposed to declines in used vehicle values at disposition. Meanwhile, credit risk remains modest, reflecting net charge-offs (NCOs) totaling a very low 0.01% of finance receivables for 1H21, 0.01% for 1H20, and 0.02% for the full year 2020. Overall, EFN's low NCOs demonstrate its conservative underwriting, well collateralized client exposures, and significant level of investment grade fleet management clients. Low NCOs also reflect the mission critical nature of the leased vehicles to the lessee, which has historically resulted in most leases being affirmed in bankruptcy, leading to low loss severities. We note that the Company has some industry and client concentrations, which we regard as manageable, especially given the high credit quality of the client base.

Although EFN is reliant on secured sources of wholesale funding, we view its funding to be diverse by investor and channel, and is well-aligned with the asset base. A constraint on the ratings, a large component of the Company's assets are encumbered, even with the issuance of unsecured debt over the last two years, along with the December 2019 amendment to its senior term facility, which released the facility's general lien on the Company’s non-securitized assets. The Company’s available liquidity remains sound, totaling $4.1 billion, consisting of $1.6 billion of availability under its revolving unsecured credit facilities, and $2.5 billion under its vehicle management asset-backed facilities, at June 30, 2021. EFN’s liquidity position also benefits from its solid cashflows from operations, which totaled $1.5 billion in 1H21.

Capital remains acceptable, given its modest risk position and sound earnings generation. Important for the ratings, EFN's tangible leverage position has improved, reflecting the Company’s use of syndications, sound retention of earnings, and its lower level of originations, which resulted in lower levels of vehicle-backed debt. Specifically, EFN's tangible leverage position was 5.6x at June 30, 2021, down from 6.8x, at June 30, 2020.

ESG CONSIDERATIONS

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/373262.

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, 2021): https://www.dbrsmorningstar.com/research/383936/global-methodology-for-rating-non-bank-financial-institutions. Other applicable methodologies include the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (February 3, 2021): https://www.dbrsmorningstar.com/research/373262/dbrs-morningstar-criteria-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings.

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.

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