DBRS Morningstar Confirms ECN Capital Corp. at BB (high) Following its Announced Partnership with Skyline Champion Corporation; Trend is Stable

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 all ratings is Stable. The rating actions follow the Company’s announcement that it has entered into a strategic partnership with Skyline Champion Corporation (Skyline). The Company’s Intrinsic Assessment (IA) is BB (high) and the Support Assessment is SA3, resulting in the Company’s Long-Term Issuer Rating being equalized with the IA.

KEY CREDIT RATING CONSIDERATIONS
The ratings confirmation reflects ECN’s sound franchise focused on an asset-light business model centered on secured consumer and commercial financing businesses, including Triad Financial Services, Inc. (Triad), ECN’s manufactured housing finance business. The Company also provides marine and recreational vehicle (RV) financing through its Source One Financial Services, LLC (Source One), Intercoastal Financial Group, LLC (IFG) and Wake Lending LLC (Wake Lending) subsidiaries. The ratings also takes into consideration ECN’s recently announced partnership with Skyline, a leading producer of factory-built housing and retailer in North America. Skyline announced its intent to make a strategic investment of $138 million through a privately placed purchase of common stock and convertible preferred shares. The private placement is anticipated to close in September 2023, subject to certain customary closing conditions, including the receipt of conditional approval from the TSX and the expiration of the applicable waiting period under the Hart-Scott-Rodino Antitrust Improvements Act of 1976.

The ratings also consider the Company’s recent mixed record of earnings generation. Although we see ECN’s risk profile as sound, market risk was elevated in 1H23 reflecting the steep increase in interest rates during 2022 and extended backlogs of manufactured homes in 2022 and into 1H23, which negatively impacted gain on sales. We view execution risk to be somewhat elevated given the partnership’s expectation of creating a captive finance company. The Company’s funding profile remains sound, as originations for the operating businesses are funded on a flow basis by over 100 partners including banks, credit unions, life insurance companies and asset managers (the Partners). Finally, cash flow leverage is considered elevated but expected to be restored to levels consistent with ECN's rating level following the closing of the Skyline share placement.

The Stable trend incorporates our view that ECN's credit fundamentals will remain acceptable, despite the uncertain economic outlook and high interest rate environment. We expect continuing moderation in housing demand for the remainder of 2023 and into 2024. However, we anticipate that Triad’s operating performance will benefit from solid demand for manufactured housing underpinned by the notable affordability issues in the U.S. housing market.

CREDIT RATING DRIVERS
A sustained improvement in statutory earnings combined with materially lowered cash flow leverage while maintaining sound credit fundamentals would result in an upgrade of the ratings. Conversely, should proceeds from the Skyline private placement not be utilized to lower cash flow leverage meaningfully, the ratings would be downgraded. Also should credit risk on the balance sheet become more pronounced, or if there were Partner funding disruptions, the ratings would be downgraded.

CREDIT RATING RATIONALE
ECN has a sound franchise supported by its top tier manufactured housing financing business, Triad, and its more modest position in the marine and RV financing market. All of the businesses are asset – light entities providing secured financings to primarily super-prime and prime credit quality customers. Overall, we expect ECN’s recently announced partnership with Skyline to benefit the Company’s franchise in a growing market and enhance its funnel for sourcing originations and improve its efficiencies of operations.

Upon Skyline becoming an investor in ECN, Skyline will have one representative on ECN’s Board of Directors. Additionally, ECN and Skyline plan to form a captive finance company that will be 51% owned by Skyline and 49% owned by Triad. ECN’s expectation is that the relationship with Skyline and the JV captive finance company will help grow ECN's manufactured housing finance business by streamlining the homebuying experience for ECN's partners and consumers. Key deliverables of ECN’s recently completed strategic review include the simplification of its operating structure, where ECN the parent, will be renamed Triad and integrated within Triad, while alternatives for the RV and marine businesses remain under consideration. The simplification plan also provides Skyline the opportunity to acquire the remainder of ECN in the future.

ECN’s earnings have been mixed over recent periods. The Company reported a $48.2 million loss in 1H23, as compared to $14.7 million of earnings in 1H22. The lower results were primarily driven by a number of items including higher funding costs, lower gain on sale due to the rapid increase in interest rates and the extended industry backlog which extended the time between approval and closing (funding), as well as various one-time charges. On an adjusted basis, net income before taxes totaled $6.0 million in 1H23, down from $21.3 million in 1H22, reflecting a 42% year-on-year (YoY) decrease in loan origination income to $36.0 million, partially offset by a 34% increase in servicing revenue to $13.3 million. Of note, the announced partnership with Skyline will open up access for ECN to the balance of Skyline’s dealers in which it does not currently have active relationships, providing access to retail, as well as floorplan opportunities which should improve revenue generation.

Overall, ECN’s risk profile is sound. However, market risk was elevated in 1H23, reflecting the steep increase in interest rates in 2022 and the extended industry backlog in 2022 and into 1H23 which negatively impacted gains on sale. Going forward, and an offset to this risk, interest rate locks will be placed on loans upon approval. Meanwhile, the Company’s credit risk reflects its moderately sized but growing manufactured housing floorplan portfolio ($320 million at June 30, 2023), RV and marine floorplan loan portfolio ($12 million at June 30, 2023) and the loans held for trading portfolio ($294 million at June 30, 2023). 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. 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. Lastly, we view execution risk to be somewhat elevated given ECN’s just announced partnership with Skyline, including the expectations of creating a captive finance company.

We view the Company’s funding profile as solid. Indeed, its secured consumer and commercial segment is funded on a flow basis by its Partners. In 2Q23, ECN expanded its funding partnership with Blackstone’s Asset Based Finance Group to upsize total funding to $1.14 billion ($840 million for retail loans and $300 million for floorplan loans) with all loans to be serviced on Triad’s platform. ECN also entered into a new funding relationship with the Carlyle Group under which ECN will have access up to $150 million for the financing of both retail and floorplan manufactured housing loans. Meanwhile, liquidity is acceptable, including $46.9 million of cash and cash equivalents as well as $94.3 million of available capacity under its long-term senior credit facility, subject to available collateral as of June 30, 2023.

At the end of 1H23, the Company’s cash flow leverage was elevated at 10.0x and is a ratings constraint. Management did note that it intends to use some of the proceeds from Skyline’s investment to paydown debt, which would improve cash flow leverage.

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 (July 4, 2023) https://www.dbrsmorningstar.com/research/416784/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, 2022):
https://www.dbrsmorningstar.com/research/402314/global-methodology-for-rating-non-bank-financial-institutions
In addition, DBRS Morningstar uses the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings: https://www.dbrsmorningstar.com/research/416784/dbrs-morningstar-criteria-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings in its consideration of ESG factors.

The credit rating methodologies used in the analysis of this transaction can be found at: https://www.dbrsmorningstar.com/about/methodologies.

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 credit rating was initiated at the request of the rated entity.
The rated entity or its related entities did participate in the credit rating process for this credit rating action.
DBRS Morningstar had access to the accounts, management and other relevant internal documents of the rated entity or its related entities in connection with this credit rating action.
This is a solicited credit rating.

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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