Morningstar DBRS Confirms ECN Capital Corp.'s Long-Term Issuer Rating at BB (high); Trend Stable

DBRS, Inc. (Morningstar DBRS) confirmed the credit 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 on the credit ratings remain Stable. 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
ECN's credit ratings confirmation reflects a sound franchise with a focus on providing secured consumer and commercial financing through its three businesses, including Triad Financial Services, Inc. (Triad), ECN's manufactured housing finance subsidiary, as well as Source One Financial Services, LLC (Source One) and Intercoastal Financial Group, LLC (IFG), its marine and recreational vehicle (RV) financing businesses. The credit ratings also take into consideration, the Company's recent earnings volatility, which included a sizable net loss in 2023. We note that earnings were positive for the first six months of 2024 (1H24). Credit ratings reflect ECN's acceptable risk profile given the Company's business model, but also take into account its recent elevated market risk which drove material fair value write-downs. The Company's funding profile remains appropriate as originations for the operating businesses are funded on a flow basis by over 100 institutional partners (the Partners). Finally, cashflow leverage remains high but has improved in 1H24.

The Stable Trend reflects our view that ECN's credit fundamentals will remain consistent with the current rating level, despite the higher for longer base rate environment and economic uncertainty. After a challenging 2023, we anticipate that ECN will generate solid operating results going forward, driven by operational changes, enhanced funding diversification, and improved shipments and solid demand levels for manufactured housing, underpinned by the notable affordability issues in the U.S. housing market.

CREDIT RATING DRIVERS
A sustained improvement in levels of statutory earnings and cash flow leverage while maintaining a sound risk profile would result in an upgrade of the credit ratings. Conversely, an outsized loss or Partner funding disruptions would result in a credit ratings downgrade. Should credit risk on the balance sheet become more pronounced or if cash flow leverage track upwards for a sustained period, the credit ratings would be downgraded.

CREDIT RATING RATIONALE

Franchise Building Block (BB) Assessment: Good / Moderate
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. The businesses provide secured consumer and commercial financing to primarily super-prime and prime credit quality customers. ECN also has a strategic partnership with Skyline Champion (Skyline), a leading producer of factory-built housing and retailer in North America. Additionally, and as part of the partnership, ECN and Skyline launched Champion Financing, a new joint venture (JV) captive finance company with new loan products and floorplan programs for Skyline's retailers. Overall, we expect ECN's partnership with Skyline to benefit the Company's franchise in a growing market while also widening its origination sourcing funnel. Of note, on February 21, 2024, the Company completed the sale of its Red Oak RV and Marine Inventory Finance platform (Red Oak), which operated through Triad Financial Services, to a third-party investor for cash proceeds of $153.3 million, subject to final working capital adjustment. Transaction expenses related to the sale of Red Oak were approximately $4.0 million.

Earnings Building Block (BB) Assessment: Moderate / Weak
Earnings have been volatile over the past eighteen months. Indeed, ECN reported a net loss of $106.7 million in 2023, down from $15.9 million of net income in 2022. The loss reflected a number of headwinds, including lower revenues due to fair value marks in ECN's land home portfolio, driven by a significant prolonged industry backlog in manufactured housing coupled with the steep rise in interest rates. Additionally, the Company's funding reflected a transition in funding Partners from mostly credit unions and banks to a higher proportion of alternative asset manager Partners, resulting in lower premiums. The Company's borrowing expense materially increased due to higher average finance asset balances and a higher average borrowing rate. Additionally, with the completion of its strategic review, substantial restructuring costs including expenses related to the termination of office leases and disposition of its corporate office, negatively impacted the Company's bottom line, but are not expected to reoccur going forward.

The Company's earnings were improved in 1H24 at $1.0 million, up from a $48.2 million loss in 1H23, driven by higher loan origination revenues, normalization of manufactured housing backlogs, the non-recurrence of the negative fair value adjustments, and the non-recurrence of restructuring material costs.

Risk Building Block (BB) Assessment: Good / Moderate
We view ECN's risk profile as acceptable. Operational risk remains a key risk given that the Company's consumer business has considerable compliance and regulatory oversight and many of its Partners are FDIC-insured institutions. We see operational risk as well managed. Market risk is largely comprised of interest rate risk and partially contributed to the write-down on the fair value of the land home loans in 2023. The rapid rise in interest rates, which when combined with extended backlogs of manufactured homes due to supply chain issues, resulted in the aforementioned fair value decline in land home loans. Going forward, the Company has implemented interest rate locks upon approval of the loan as opposed to when it is funded, which should reduce interest rate risk. Credit risk is limited to ECN's moderately sized manufactured housing floorplan business ($175.9 million at June 30, 2024), RV and marine portfolio ($8.1 million at June 30, 2024) and the loans held for trading portfolio ($374.6 million at June 30, 2024). Mitigating the credit risk associated with the floorplan portfolio, the Company also has established a flow agreement with an institutional funding Partner to purchase floorplan loans, providing additional flexibility in managing the overall size of its floorplan portfolio. The held for trading portfolio represents commitments, as well as regular flow business of manufactured housing loans to large institutional buyers that prefer larger bulk purchases rather than a more frequent sales cadence.

Funding and Liquidity Building Block (BB) Assessment: Moderate / Weak
We view the Company's funding profile as appropriate. Indeed, its secured consumer and commercial segment is funded on a flow basis by its Partners. Although, ECN was never unfunded in 2023, the Company's sources of funding were somewhat disrupted as some banks and credit unions pulled back their funding more than anticipated which resulted in an elevated use of ECN's balance sheet. Importantly, ECN has diversified its funding sources by bringing on-board additional funding Partners, with a focus on asset managers and life insurance companies. Overall banks and credit unions have returned in 2024 with increasing commitments. Triad and the RV and marine segments are considered overfunded for 2024, reflecting the attractiveness of its high quality originations. At June 30, 2024, the Company had $723.8 million of debt outstanding, comprised of $565.9 million drawn from its senior credit facility and $157.8 million of outstanding senior unsecured debentures. Of note, the Company utilized proceeds from the sale of Red Oak to repay amounts owed under its senior credit facility. Meanwhile, ECN maintains a moderate level of liquidity, which includes $22.4 million of cash and cash equivalents along with $226 million of available capacity under its long-term senior credit facility subject to available collateral, as of June 30, 2024.

Capitalization Building Block (BB) Assessment: Moderate / Weak
Capital is acceptable and reflects Skyline's C$185 million strategic investment in ECN. At June 30, 2024, cash flow leverage was high at 6.8x, but down from 11.6x at year-end 2023, due to a decrease in outstanding debt. Although cash flow leverage has improved, it is still elevated and we would view sustained lower levels favorably. We do note that the Company is at a tangible equity deficit position as a result of the goodwill and intangibles on the balance sheet due to past acquisitions.

ENVIRONMENTAL, SOCIAL, AND GOVERNANCE CONSIDERATIONS

There were no Environmental/Social/Governance factor(s) that had a significant or relevant effect on the credit analysis.

A description of how Morningstar DBRS considers ESG factors within the Morningstar DBRS analytical framework can be found in the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Factors in Credit Ratings (13 August 2024) https://dbrs.morningstar.com/research/437781.

Notes:
All figures are in US Dollars unless otherwise noted.

The principal methodology is the Global Methodology for Rating Non-Bank Financial Institutions (15 April 2024) https://dbrs.morningstar.com/research/431187. In addition Morningstar DBRS uses the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Factors in Credit Ratings (13 August 2024) https://dbrs.morningstar.com/research/437781 in its consideration of ESG factors.

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

The primary sources of information used for these credit ratings include Morningstar, Inc. and Company Documents. Morningstar DBRS considers the information available to it for the purposes of providing these credit ratings 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.

Morningstar DBRS did have 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. Morningstar DBRS's outlooks and credit ratings are under regular surveillance.

For more information on this credit or on this industry, visit dbrs.morningstar.com.