DBRS Morningstar Confirms ECN Capital at BB (high), Stable Trend, Following its Announced Sale of Kessler Financial Services LLC

DBRS, Inc. (DBRS Morningstar) confirmed the ratings of ECN Capital Corp. (ECN or the Company), including the Company’s Long-Term Issuer Rating of BB (high) and Preferred Shares Rating of Pfd-4 (high). The trend for the ratings is Stable. The rating actions follow the Company’s announcement that it has entered into a definitive agreement to sell its Kessler Financial Services LLC (KG) business to funds managed by Stone Point Capital LLC. The Intrinsic Assessment (IA) for ECN is BB (high) and the Support Assessment is SA3, resulting in the Company’s Long-Term Issuer Rating being equalized with the IA. The transaction is subject to customary regulatory approvals and closing conditions and is anticipated to close late in the third quarter or early fourth quarter of 2022.

KEY RATING CONSIDERATIONS
ECN’s ratings consider the impact of the sale of KG, a manager, adviser and structuring partner to credit card issuers, banks, credit unions, and payment networks, on ECN’s credit fundamentals. With the sale of KG, the Company and its management team will be exclusively focused on a more streamlined asset - light business model, focused singularly on secured consumer financing. These businesses include Triad Financial Services, Inc. (Triad), ECN’s manufactured housing finance business, as well as Source One Financial Services, LLC (Source One) and Intercoastal Financial Group, LLC (IFG), both of which provide consumer lending programs to the marine and recreational vehicle (RV) industries. The ratings action considers the loss of earnings contribution from KG, that is expected to be offset by the higher growth nature of the earnings generating capacity of ECN’s remaining businesses.

We see the Company’s risk profile as sound, especially given the limited credit risk on the balance sheet, reflecting the asset-light business model as well as the historically low loss nature of floorplan lending. Although operating risk is well managed, integration risk is somewhat elevated, given the execution risk associated with the Company’s recent tuck-in acquisitions of IFG on July 1, 2022 and Source One on December 21, 2021. ECN’s ratings also reflect a sound funding profile, as originations for Triad, Source One, and IFG are funded on a flow basis with their Funding Partners (Partners), which consist of numerous banks and credit unions. Finally, capital is acceptable for ECN's rating level.

The Stable trend, reflects our view that ECN’s credit fundamentals will remain acceptable, despite the uncertain economic outlook and rising interest rate environment. We expect continuing moderation in housing demand in 2022. However, we anticipate that Triad’s operating performance will continue to benefit from solid demand for manufactured housing underpinned by the notable affordability issues in the U.S. housing market. Additionally, the Company’s Source One and IFG’s marine and RV business performance should benefit from solid but contracting demand, and tight supply.

RATING DRIVERS
Sustained improvements in adjusted profitability and statutory earnings, while maintaining disciplined capital management and risk aversion, would result in an upgrade of the ratings. Should credit risk on the balance sheet become more pronounced, cash flow leverage track upwards for a sustained period, or if there were Partner funding disruptions, the ratings would be downgraded.

RATING RATIONALE
Upon the close of the KG sale, ECN’s focus will be entirely on secured consumer financings. Triad is a leader in the manufactured home financing business while Source One and IFG, combined, provide marine and RV financing on a nation-wide basis. All three businesses are asset - light businesses that focus on customers with super prime and prime credit profiles. We note that over the near term, the Company anticipates acquiring several more moderately sized tuck-in acquisitions to further strengthen its marine and RV business segment. ECN's ratings also consider the Company's solid management team, which has considerable experience and industry knowledge.

Despite the loss of KG’s earnings contributions, offsetting is the higher growth nature of ECN’s secured consumer segment businesses. Overall, we expect the Company’s future earnings to remain acceptable with solid growth potential. During 1H22, ECN generated earnings totaling $14.7 million, down from $25.7 million in 1H21, reflecting the non-recurrence of $22.9 million of net income from discontinued operations, specifically related to the sale of its Service Finance Company, LLC’s (SFC) business on December 6, 2021. On a continuing operations basis, net income totaled $14.7 million, up from $2.8 million, year-on-year (YoY). Improved earnings reflected solid performance from the secured consumer businesses, including higher levels of loan origination revenues (up 89.5% YoY to $62 million), servicing revenues (up 60.4% to $9.9 million), and interest income and other revenue (up 56.5% to $13.5 million). Meanwhile, revenues related to KG totaled $52.9 million in 1H22, compared to $41.3 million, YoY.

Overall, ECN’s risk profile is well managed. Credit risk is limited to the Company’s moderately sized but growing manufactured housing floorplan portfolio ($280 million at June 30, 2022) and its loans held for trading portfolio ($100 million). Providing comfort, floorplan loans are secured by first priority, fully perfected liens in the underlying manufactured housing units that are financed by Triad. Meanwhile, the held for trading portfolio represents commitments, as well as regular flow business of manufactured housing loans to large institutional buyers that prefer larger transaction sizes. Loans purchased by ECN’s Partners are non-recourse purchase arrangements. Specifically there is no recourse beyond fees to Partners for charge-offs or prepayments typically within the first 12 months. Finally, we see operational risk as a key risk for the Company, given that its consumer businesses have considerable compliance and regulatory oversight, and many of its Partners are FDIC-insured institutions. We view integration risk to be somewhat elevated given its recent acquisitions, but see it as being well managed.

The Company’s ratings reflect its solid funding profile. Indeed, its secured consumer segment is funded on a flow basis by its Partners, including banks, and credit unions. Liquidity is satisfactory, as the Company recently upsized its revolving credit facility, but has increased the utilization of the line for acquisitions and its growing floorplan loan portfolio.

Capital is acceptable. Going forward, we would expect the Company to maintain appropriate levels of capital to match its risk position. Given ECN’s moderate credit risk, we view cash flow leverage to be a more appropriate measure for leverage. We note that the Company’s cash flow leverage is elevated and would view sustained lower levels favorably.

ENVIRONMENTAL, SOCIAL, GOVERNANCE CONSIDERATIONS
There were no Environmental/ Social/ Governance factors that had a significant or relevant effect on the credit analysis.

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/396929/dbrs-morningstar-criteria-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings.

Notes:
All figures are in U.S. 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, Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (May 17, 2022): https://www.dbrsmorningstar.com/research/396929/dbrs-morningstar-criteria-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings.

The primary sources of information used for this rating include Morningstar, Inc. and Company Documents. 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.

The conditions that lead to the assignment of a Negative or Positive trend are generally 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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