DBRS Places Element’s Issuer Rating Under Review - Positive Following Corporate Separation Announcement

DBRS, Inc. (DBRS) has today placed the ratings of Element Financial Corporation (Element or the Company), including its Issuer Rating of BBB, Under Review with Positive Implications. Today’s rating action follows the Company’s plans to separate into two public companies.

On February 16, 2016, Element announced that following a strategic review of the Company’s business units that the Company’s Board of Directors (BOD) has approved plans to split Element into two separate, publicly traded companies. Under the separation transaction, Element would become Element Fleet Management comprised of the Company’s North American leading commercial fleet management business, as well as the existing assets of the Rail Finance segment. Meanwhile, the Aviation Finance, and Commercial and Vendor Finance verticals, as well as the Company’s rail asset management capabilities would be separated into a second publicly traded company, Element Commercial Finance. DBRS notes that its current rating will apply to the Element Fleet Management entity post-separation. Certain details of the separation including the allocation of assets, liabilities and capital structure will be determined as the separation process proceeds, but completion of the restructuring is expected by end of 3Q16. The separation is subject to customary approvals including the receipt of all required third party approvals and the final approval of Element’s BOD.

The Under Review with Positive Implications reflects DBRS’s view that while the separation transaction will remove some revenue diversity, the transaction will lower the risk profile of Element Fleet Management’s balance sheet. The separation will remove the largest source of credit risk on the current balance sheet (the Commercial and Vendor Finance portfolio), as well as a key source of asset residual exposure (Aviation Finance). Moreover, the key factors that are the foundation of the Company’s ratings, namely, the strong franchise position of the fleet management business and strengthening earnings profile of the fleet business remain intact. Indeed, the soon to be separated commercial businesses accounted for just 23% of total earning assets at September 30, 2015.

The Under Review with Positive Implications also reflects DBRS’s expectations that Element will successfully execute the spin-out of the commercial business, while integrating the GE Fleet business. Moreover, the rating action considers DBRS’s anticipation that the Company’s earnings profile will continue to strengthen as earnings assets grow, and the Company improves its penetration rate within its fleet customers, while maintaining credit costs within historical levels and improving operating efficiency. Conversely, positive rating momentum could stall if there are indications of miss-steps in either the legal separation of the businesses or the GE Fleet integration evidenced by loss of key customers or operational-related charges. Further, leverage outside of fleet management peers would be viewed negatively. DBRS expects to conclude the review once the separation is completed and final details are known regarding Element Fleet Management’s balance sheet composition and pro-forma earnings capacity.

While there are certain execution risks associated with separating business lines, especially at a time when the Company continues to integrate the very sizeable GE Fleet business, DBRS views these risks as manageable in the Element transaction. Indeed, DBRS anticipates minimal disruption to the operating strategy and performance of each business line; as each business currently operates with its own senior management team on a day-to-day basis with oversight from Element’s executive management. DBRS notes that these management teams will remain in place post spin-out. Moreover, there is minimal IT separation required as each of the business lines have dedicated operating platforms owed to the uniqueness of the assets. As a result, while there will be a degree of back-office systems to be separated, DBRS sees IT separation costs and risks as lower in this transaction than in many other separations or spin-outs. DBRS comments that the integration of the GE Fleet business is on target with IT integration expected to be completed in 2016. Importantly, Element’s funding strategy has been to have permanent funding in place for each vertical, which in DBRS’s view should also aid in a smooth separation.

Notes:
All figures are in Canadian dollars unless otherwise noted.

The principal methodology is the Global Methodology for Rating Finance Companies (October 2015). Other applicable methodologies include DBRS Criteria: Preferred Share and Hybrid Criteria for Corporate Issuers (January 2016). These can be found at: http://www.dbrs.com/about/methdologies.

The primary source of information used for this rating include company documents and SNL Financial. 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
Rating Committee Chair: Roger Lister
Initial Rating Date: 24 September 2015
Most Recent Rating Action: 24 September 2015

For additional information on this rating, please refer to the linking document under Related Research.