U.S. Markets open in 7 hrs 43 mins

Edited Transcript of ECN.TO earnings conference call or presentation 7-Nov-19 10:30pm GMT

Q3 2019 ECN Capital Corp Earnings Call

TORONTO Nov 8, 2019 (Thomson StreetEvents) -- Edited Transcript of ECN Capital Corp earnings conference call or presentation Thursday, November 7, 2019 at 10:30:00pm GMT

TEXT version of Transcript

================================================================================

Corporate Participants

================================================================================

* John B. Wimsatt

ECN Capital Corp. - Head of Corporate Development & IR

* Michael Lepore

ECN Capital Corp. - CFO

* Steven K. Hudson

ECN Capital Corp. - CEO & Director

================================================================================

Conference Call Participants

================================================================================

* Brenna Phelan

Raymond James Ltd., Research Division - Equity Analyst

* Geoffrey Kwan

RBC Capital Markets, Research Division - Analyst

* Jaeme Gloyn

National Bank Financial, Inc., Research Division - Analyst

* Jeffrey Michael Fenwick

Cormark Securities Inc., Research Division - MD & Head of Institutional Equity Research

* Paul David Holden

CIBC Capital Markets, Research Division - Executive Director of Institutional Equity Research

* Tom MacKinnon

BMO Capital Markets Equity Research - MD & Analyst

* Vincent Albert Caintic

Stephens Inc., Research Division - MD & Senior Specialty Finance Analyst

================================================================================

Presentation

--------------------------------------------------------------------------------

Operator [1]

--------------------------------------------------------------------------------

Thank you for standing by. This is the conference operator. Welcome to the ECN Capital Third Quarter 2019 Conference Call. (Operator Instructions) And the conference is being recorded. (Operator Instructions)

I would now like to turn the meeting over to Mr. John Wimsatt. Please go ahead, Mr. Wimsatt.

--------------------------------------------------------------------------------

John B. Wimsatt, ECN Capital Corp. - Head of Corporate Development & IR [2]

--------------------------------------------------------------------------------

Thank you, operator. Good afternoon, everyone. Thank you for participating in our conference call to discuss ECN Capital's third quarter 2019 results announced earlier today.

Joining us are Steve Hudson, Chief Executive Officer; and Michael Lepore, Chief Financial Officer. A news release summarizing these results was issued this afternoon and the financial statements and MD&A for the 3-month period ended September 30, 2019, have been filed with SEDAR.

These documents are available on our website at www.ecncapitalcorp.com. Presentation slides to be referenced during the call are accessible on the website as well in PDF format under the Presentations section of the company's website.

Before we begin, I want to remind our listeners that some of the information we are sharing with you today includes forward-looking statements. These statements are based on assumptions that are subject to significant risks and uncertainties. I will refer you to the cautionary statement section of the MD&A for a description of such risks, uncertainties and assumptions. Although management believes that expectations reflected in these statements are reasonable, we can, obviously, give no assurance that the expectation of any forward-looking statement will prove to be correct.

You should note that the company's earnings release, financial statements, MD&A and today's call include references to a number of non-IFRS measures, which we believe help to present the company and its operations in ways that are useful to investors. A reconciliation of these non-IFRS measures to IFRS measures can be found in your MD&A.

You should also note that as of January 1, 2018, the company changed its presentation and functional currency from Canadian dollars to U.S. dollars. In addition, readers should note that legacy operations have been discontinued and classified as held for sale as of the fourth quarter 2018. All figures are presented in U.S. dollars unless explicitly noted.

With these introductory remarks complete, I'll now turn the call over to Steve Hudson, Chief Executive Officer.

--------------------------------------------------------------------------------

Steven K. Hudson, ECN Capital Corp. - CEO & Director [3]

--------------------------------------------------------------------------------

Thank you, John, and good afternoon. Starting with Slide 8. Our third quarter results are in line with management expectations, and we are reiterating our full year 2019 guidance. If you look to our origination growth of approximately 30% in Q3 or 35% excluding pace, both are very strong and demonstrate both our make and take share strategies are working, as well as our strong EBITDA growth of approximately 33% in the quarter.

Turning to Page 9. Lennox volume continues to be strong, Q3 volume accelerated after an unseasonably cool weather in May and June. With respect to solar, as we discussed in Q1, the Service Finance management, proactively and prudently raised FICO scores and pricing on solar loans, which was not mandated by our bank partners, but of our -- protecting our yield for our bank partners.

Solar represents 17% of the third quarter originations compared to 24% in the prior period -- prior year's period. Originations were at -- excluding pace and that of one of our origination partners that went bankrupt. We were up approximately 38%, and we continue to forecast $1.6 billion to $1.8 billion originations for 2019.

Turning to Page 10. It's -- with respect to our banks and lifeco who purchased our loans, I think it's interesting to note that of our top 10 partners purchase commitments have increased by 70% since our January Investor Day. We've also added a large life insurance partner in the first quarter of '19 and added a new bank partner in Q3.

As we enter 2020, we will need to allocate loans amongst our partners. This is a case where demand for service finance loans, actually, RICs, is greater than our ability to originate, notwithstanding very strong origination numbers.

Page 11, assets held for trading, an update on that, a decline from $273 million in Q4 to $75 million as forecasted in the earlier quarter. Our complementary program -- our complementary flow program is working. As a reminder, these are similar credits, average FICO 760 and performed -- and performance similar to our core program, but fall outside of the core program due to one criteria or another, principally due to loan size.

We executed a $44 million sale complementary flow to partner -- bank partners wishing to acquire these loans. Originations on Page 12 reflect the strong growth that I mentioned earlier.

Turning to Kessler Group on Page 13. Third quarter results were in line with expectations. We are also reiterating our guidance for 2019 for this business. EBITDA margins of approximately 57%, reflect both improved expense management and better revenue performance. We continue to explore our long-term strategy to develop credit card syndicated investment, loan platform, and Kessler Group partnered with several institutional investors to originate, syndicate and manage on 4 portfolios totaling a little under $1 billion.

Kessler Group has retained a modest investment of $90 million with an 18-month average life. That investment is on a pari passu basis, i.e., not subordinate.

Turning to Page 14. On business mix or revenue mix, Scott Shaw and his team executed and provided great leadership from Scott. We've seen the material shift in the nature of the revenue, moving from 66% of annuity-based revenue at the date of our investment to 87% this quarter and decreasing our reliance on one term -- onetime M&A fees, hereby classified as portfolio advisory fees revenue from 34% to 13%.

We like the annuity revenue because it provides a higher margin on longer-term revenue, driving more predictable and better profitability. And we have a strong robust pipeline across all business lines for the remainder of 2019 and entering into 2020.

Turning to Page 15. And Triad results were ahead of management expectations. We are reiterating our 2019 forecast, approximately 16.5% year-over-year Q3 growth and 33 -- 32%, sorry, growth in EBITDA. Floorplanning continues to do what it's supposed to do, which is to drive more loans to our banks and credit unions, with outstanding so approximately $100 million over 236 active dealers. And as we mentioned earlier, Floorplan dealers drive 3x the revenue growth or loan origination growth to that of non-Floorplan dealers.

We had a modest assets held for sale of $16 million, which will be accumulating on behalf of 2 bank partners who wish to purchase in certain bulk size. This will be sold by year end.

16 reflects the originations that I spoke to earlier. And with that, I'll pass it to Michael.

--------------------------------------------------------------------------------

Michael Lepore, ECN Capital Corp. - CFO [4]

--------------------------------------------------------------------------------

Thank you, Steve. Turning to the consolidated operating highlights on Page 18. Total originations were $639.1 million in the quarter, up over 25% compared to Q3 2018, again, reflective of the strong year-over-year growth at both Service Finance and Triad.

Q3 adjusted EBITDA of $34 million was down slightly compared to the $38 million in the same prior year quarter, largely due to lower transactional revenue at the Kessler Group. Adjusted operating income before tax of $26.4 million was up compared to Q3 2018 due to the impact of the buyout of the 20% noncontrolling interest in the Kessler Group in Q1 2019.

Adjusted earnings per share applicable to common shareholders was $0.08 per share, which was in line with our guidance of $0.07 to $0.08 per share. The debt-to-equity ratio was 0.51:1, consistent with the prior quarter, and down from 0.751 at Q3 2018.

Turning to the balance sheet on Page 19. Total assets were up $19 million from the prior quarter, primarily due to a new investment in a syndicated credit card portfolio and an increase in risk-based marketing receivables at the Kessler Group, partially offset by the sale of legacy held for sale assets. Managed and advisory assets were up to $32.6 billion, reflecting $27.9 billion at Kessler, $2.3 billion of Service Finance and $2.4 billion at Triad Financial Services. Debt was up slightly compared to the prior quarter, primarily due to the increase in assets referenced above.

Turning to the income statement on Page 20. Q3 adjusted EBITDA of $34 million was down slightly compared to the same prior year quarter. Primarily due to the lower transactional M&A revenue at the Kessler Group as noted earlier, partially offset by the year-over-year growth in EBITDA, both Service Finance and Triad Financial Services.

Adjusted operating income of $26.4 million was up 15.6% compared to Q3 2018 as the impact of the buyout of the 20% noncontrolling interest in Q1 of 2019, more than offset the decline in Kessler Group operating income. Operating expenses decreased in the third quarter compared to 2018, due to lower cost at the Kessler Group.

Turning to Page 21, which provides a breakdown of the operating expenses. This page illustrates the breakdown of operating expenses and highlights that the overall decrease is being driven by the lower Kessler operating costs as a result of the expense reductions initiated in Q1 2019, and lower incentive compensation due to the impact of lower revenue.

Lower operating expenses at the Kessler Group were partially offset by the increase in operating costs of Service Finance and Triad Financial services, which were driven by the year-over-year growth in revenues.

Corporate operating expenses were up slightly compared to our normalized run rate for 2019 of $5 million to $5.5 million per quarter due to higher costs in the quarter related to the pursuit of strategic tuck-in M&A and other growth opportunities.

Turning to the legacy business update on Page 22. I just want to highlight that, again, that the legacy -- the wind down of the legacy business assets remains on track. And in the quarter, we were able to sell 8 aircraft for proceeds of approximately $40 million, which was in line with their book value.

And with that, I will turn it back to Steve for the closing summary.

--------------------------------------------------------------------------------

Steven K. Hudson, ECN Capital Corp. - CEO & Director [5]

--------------------------------------------------------------------------------

Thank you, Michael. On Slide 24, in the way of closing. We're quite pleased with the third quarter EPS of $0.08, which is the high end of our guidance of $0.07 and $0.08. We are confirming our 2019 EPS guidance of $0.25 to $0.28 as well as maintaining our $0.35 to $0.40 for 2020. We'll provide additional detail and color on that EPS at our January Investor Day.

This represents, I believe, another solid and clean quarter. I want to thank all of my partners at ECN and employees as well as at Service Finance, Kessler Group and Triad. And we have no onetime charges. So I would like to think that we've delivered on online, inline results for this quarter.

Service Finance had a solid third quarter, Lennox volumes accelerating, balance sheet use declined to $75 million, Kessler Group was on plan, revenue mix continues to strategically shift to more predictable recurring revenue, and Triad was on plan with the floor plan initiative driving the results that we're seeking, and we continue to take market share in that particular sector.

With respect to capital management, we're pleased to announce that quarterly dividend increased by $0.25 (sic) [25%] to $0.025 per quarter or $0.10 annually. And 2019-2020 NCIB has been reauthorized.

With those comments, operator, we would open the call for questions.

================================================================================

Questions and Answers

--------------------------------------------------------------------------------

Operator [1]

--------------------------------------------------------------------------------

(Operator Instructions) Our first question comes from Jaeme Gloyn with National Bank Financial.

We appear to have lost him. Our next question is Vincent Caintic with Stephens.

--------------------------------------------------------------------------------

Vincent Albert Caintic, Stephens Inc., Research Division - MD & Senior Specialty Finance Analyst [2]

--------------------------------------------------------------------------------

Just wanted to talk about pipelines at each of the different businesses, and if you could give an update there. So I appreciate the 2019 call -- the 2019 confirmation of guidance, but kind of wanting to look a little further.

And then, specifically, with 2 of the businesses. So when I think about service finance and weakness at a competitor that has been around for about a quarter already. Has that benefited you in terms of signing more partners?

And then on Kessler, nice to see that there's more recurring revenues. Is that still sort of where we would need to look at more credit card portfolio partnerships there for that to see growth? Or is there another way we should be thinking about growth there?

--------------------------------------------------------------------------------

Steven K. Hudson, ECN Capital Corp. - CEO & Director [3]

--------------------------------------------------------------------------------

We are -- I'll speak to -- I guess I'll speak to Service Finance, and then I'll let John speak to Triad, and I'll come back to Kessler. But on service, it's Mark Berch and his team, Ian and Eric and Steve Miner and the rest of the management and employees have done an exceptional job of 35% organic growth in the quarter is very strong.

We look at the approvals we get funded originations and those continued strong in October and November. And I can't say it's a function of just take or just make share. Take share is competitive shift. It's just not from a competitor, it's also from revolving credit cards that are offered by banks. We think our installment base programs are superior.

I don't talk about competitors a lot. We do originate prime and super-prime home improvement loans. However, our business model's materially different than that we originate and manage without providing recourse. And I think that's a model, I don't know -- I don't think is a model with Service Finances set in place, and we continue.

In terms of what 2020 looks like. We'll speak to it in detail in January at the Investor Day, but we're seeing -- continue to see strong growth in our business. We have a bigger number to lift each year, but I think the growth is extremely strong. And we're not seeing a consume -- a consumer that's fatigued in the U.S. Many consumers are electing to stay in their home and improve it. And so I think it's not a northeasterly wind. It's a nice wind out of the south, and I think we'll continue very strong growth in service, both from take share and make share.

We are looking at some tuck-in deals inside of service. Don't think of us changing the model. We're not going to change the model. But there are some opportunities that we'll speak to at our Investor Day. I'll let John chat about Triad.

--------------------------------------------------------------------------------

John B. Wimsatt, ECN Capital Corp. - Head of Corporate Development & IR [4]

--------------------------------------------------------------------------------

Yes. I mean, as you can see, Triad continues to grow mid-high teens, which we've seen throughout most of the year. Shipments in the industry have actually been down a little bit. Now there's some reasons for that. But all things equal, we're very excited. We've very clearly been taking market share within the manufactured housing space. And I think a lot of that has to do with our proprietary Floorplan product that we've introduced really effectively over the last over the last year or so.

So as far as the future, obviously, we'll get into that at Investor Day. But what we've seen this year is a really nice pickup in market share across Triad.

--------------------------------------------------------------------------------

Steven K. Hudson, ECN Capital Corp. - CEO & Director [5]

--------------------------------------------------------------------------------

And with respect to Kessler group, the growth is being driven by the mandate of being able to assist our bank partners with what programs they really want to be into with respect to credit card world, and we've been able to successfully move those portfolios, driven by factors such as CECL and other risk factors, and accounting factors. And we've been able to place those. And the good news is when we place them with our partners, we're picking up long-term annuity fees. And that's been a big driver of growth here. We're happy to take the onetime M&A fees. But we really want to improve the quality of the revenue and earnings in Kessler. And we think the longer-term fees will hold us in good stead.

And it isn't one particular source. I can't say it's credit card investment or others. It's across the board at Kessler, and it's strong going into 2020.

--------------------------------------------------------------------------------

Vincent Albert Caintic, Stephens Inc., Research Division - MD & Senior Specialty Finance Analyst [6]

--------------------------------------------------------------------------------

Okay. Great. Very helpful. Just maybe one follow-up. So as we're looking into the fourth quarter, I appreciate you have guidance. But just what are you seeing in terms of your retail partners and your bank partners? Are they -- is there any difference in appetite for the retail partners? Are they doing more or different types of programs? Just kind of wondering if there's any change to this holiday season.

--------------------------------------------------------------------------------

Steven K. Hudson, ECN Capital Corp. - CEO & Director [7]

--------------------------------------------------------------------------------

Yes. No, we speak to the service, but we -- in service, we've tended to see, historically, things slow up as you get into the holiday period with Thanksgiving starting the holiday period.

And home improvement tends to decline because people don't want to open up their homes for improvement, but it's remained strong, stronger than you would otherwise think given that seasonality in the holiday.

In terms of bank partners, it's very significant because a lot of our bank partners are -- have had great results on risk-adjusted basis and with yields coming down significantly for them. This is an asset category that really works. So I think coming into 2020, one of the nice issues to have is that Mark will have to focus on how to allocate amongst partners. We need to satisfy all the demands, but I don't think we'll be able to satisfy 100% of loan demand in 2020, given the growing.

As I mentioned on that slide, we've had 70% growth in commitments from existing banks. So it's -- I think it speaks volumes to the quality -- the risk-adjusted quality of the Service Finance product.

--------------------------------------------------------------------------------

Operator [8]

--------------------------------------------------------------------------------

Our next question is from Jaeme Gloyn with National Bank Financial.

--------------------------------------------------------------------------------

Jaeme Gloyn, National Bank Financial, Inc., Research Division - Analyst [9]

--------------------------------------------------------------------------------

So first question is just on the Kessler Group. I'm looking at the recurring revenues, just backing into it based on your disclosure of percentage that was recurring in Q3 and Q2. It looks like 17% quarter-over-quarter growth in those recurring revenues. Can you speak to the sustainability of that growth rate? Or will it just level off?

--------------------------------------------------------------------------------

Steven K. Hudson, ECN Capital Corp. - CEO & Director [10]

--------------------------------------------------------------------------------

Yes, I think what you're seeing, Jaeme, as we renewed a large bank partner relationship. We spoke about it on Investor Day, as part of that renewal, we were able to increase the scope of our relationship to cover portfolios that bank partner may be divesting of, and that has begun.

And as they divest those portfolios, we sell them to other banks or institutions who are paying us in M&A fee, but more importantly, are allowing us to grow on the management advisory annuity fees.

And I think that will pick up pace as we move into 2020. So strong growth. And whether that's a large bank partner, making room for a very large business they acquired or whether it's a bank partner, having to deal with CECL and looking to get some reserves released. So the pipeline of credit card trades is up significantly.

And as a result of those trades, you'll see the growth in the managed and advisory/what you're referring to as the annuity fees grow on a corresponding rate.

--------------------------------------------------------------------------------

Jaeme Gloyn, National Bank Financial, Inc., Research Division - Analyst [11]

--------------------------------------------------------------------------------

Okay. So if I can just summarize then the -- the $15.6 million of recurring revenues earned in Q3, we'll see that continue to grow at close to double-digit growth rates into 2020?

--------------------------------------------------------------------------------

Michael Lepore, ECN Capital Corp. - CFO [12]

--------------------------------------------------------------------------------

Jaeme, yes. It's Mike Lepore. Yes, we think of those recurring revenues, as we said, it's a focus for us to grow those segments. So we look to grow the recurring revenue stream in double digits through 2020.

--------------------------------------------------------------------------------

Steven K. Hudson, ECN Capital Corp. - CEO & Director [13]

--------------------------------------------------------------------------------

And then, Jaeme, obviously, we'll give a lot of detail around that and guidance when we get to Investor Day, like last year. So you'll get a lot done.

--------------------------------------------------------------------------------

Jaeme Gloyn, National Bank Financial, Inc., Research Division - Analyst [14]

--------------------------------------------------------------------------------

Okay. And still on that Kessler. I just want to square the performance in the quarter. So on an EBITDA margin basis, it looks like the margin went down by a percentage point. The disclosure in the MD&A suggests that recurring revenue has higher margins? I'm just wondering what went on there to have the margin decline?

--------------------------------------------------------------------------------

Michael Lepore, ECN Capital Corp. - CFO [15]

--------------------------------------------------------------------------------

Yes. Jaeme, it's Michael. Overall income went down, right? So whenever you have income going -- we have less transactional revenue. So even though it's lower margin, it's still good margins. So the margins came down slightly, but not materially.

--------------------------------------------------------------------------------

Steven K. Hudson, ECN Capital Corp. - CEO & Director [16]

--------------------------------------------------------------------------------

And for what it's worth, they're materially higher than they were previously. I mean, we've really worked to rationalize that platform and take out expenses. So all things equal, the margin for the business as a whole is up materially year-over-year.

--------------------------------------------------------------------------------

Michael Lepore, ECN Capital Corp. - CFO [17]

--------------------------------------------------------------------------------

Yes. But there's still a fixed base of expenses. So as income comes down, you'll see a little bit of margin decrease.

--------------------------------------------------------------------------------

Jaeme Gloyn, National Bank Financial, Inc., Research Division - Analyst [18]

--------------------------------------------------------------------------------

Second question is, is this related to the discontinued operations? Seeing a bigger loss there, and it looks like it's comp and benefits driven. I'm wondering, can you just speak to what's driving that increase in the discontinued operations?

--------------------------------------------------------------------------------

Michael Lepore, ECN Capital Corp. - CFO [19]

--------------------------------------------------------------------------------

Yes. Sorry. So as you know, we're -- as we're almost a year into the wind down. So we sold over $100 million in assets this year. So -- and we've got to keep that team in place and keep them going and keep them motivated.

So to the extent, as we get to the end, we're -- have to pay performance bonuses to those people. So that's driving comp up a little bit. And then the other factor on the loss on disc ops was revenue was down slightly quarter-over-quarter, just to, again, as some leases roll off and the assets move into inventory. So that was the 2 factors impacting the higher loss in disc ops.

--------------------------------------------------------------------------------

Jaeme Gloyn, National Bank Financial, Inc., Research Division - Analyst [20]

--------------------------------------------------------------------------------

Okay. So really just performance-based comp driven on the asset sales. Okay.

--------------------------------------------------------------------------------

Steven K. Hudson, ECN Capital Corp. - CEO & Director [21]

--------------------------------------------------------------------------------

And decline in revenue, Jaeme. We took back a bunch of equipment we want to sell. So we took it off-lease. When you take it off lease, you lose the lease stream. So we took it off-lease in order to sell it. We're pretty focused, as you know, on returning that capital as quickly as possible because we'd like to redeploy that capital in accretive tuck-in M&A deals.

And for -- lousy term, but that legacy portfolio is, kind of our piggy bank to fund that -- those tuck-in deals. So we're aggressively going after it.

--------------------------------------------------------------------------------

Operator [22]

--------------------------------------------------------------------------------

Our next question is from Paul Holden with CIBC.

--------------------------------------------------------------------------------

Paul David Holden, CIBC Capital Markets, Research Division - Executive Director of Institutional Equity Research [23]

--------------------------------------------------------------------------------

So when I think about the increased demand on the part of your lenders. Steve, you highlighted a 70% increase in demand for product. And then, kind of, comment you just made on wanting to pursue M&A deals and the extra corporate expense you saw in Q3 related to pursuit of M&A. Like do all those 3 kind of tie together? Or this is -- you feel more encouraged to pursue M&A today because of the demand on the part of the lenders?

--------------------------------------------------------------------------------

Steven K. Hudson, ECN Capital Corp. - CEO & Director [24]

--------------------------------------------------------------------------------

Yes. I think that's a good question, Paul. We've been brought a couple of opportunities by our bank partners who are originating loans to other platforms. They buy them from the other platforms, and they manage them through business model without recourse. So those relationships are entirely consistent with our business model.

And we're looking at those opportunities with our bank partners. We're not going to originate credit assets to put on our balance sheet. That's the old, old model. We're not going back there. So but I think you can read into that, that we have a heightened level of tuck-in discussions with our bank partners who are already buying these assets.

And given the results they've had, the favorable results they've had on the Service Finance and Triad, risk-adjusted returns, they're bringing us opportunities. And on the risk-adjusted yield works for them, Paul.

So yes, I think you can read into that, a heightened level of tuck-in deals. Don't read into that, that we're going to go out and do a $400 million or $500 million deal, because we're not. But we are going to pursue these deals that are within our capital structure and our ability to fund them with on balance sheet assets -- on balance sheet capital.

--------------------------------------------------------------------------------

Paul David Holden, CIBC Capital Markets, Research Division - Executive Director of Institutional Equity Research [25]

--------------------------------------------------------------------------------

All right. Got it. And then, I guess, the second part of that, would M&A tuck in be contingent on your ability to execute on noncore asset sales? Or would you consider a different sequence, i.e. if you think you can close a tuck-in M&A before completing the asset sales, you would do so? And maybe just bridge the financing.

--------------------------------------------------------------------------------

Steven K. Hudson, ECN Capital Corp. - CEO & Director [26]

--------------------------------------------------------------------------------

Yes. We have a lot of -- we have $1 billion of credit line to your facility. We're only using less than half of that. Also we have lots of free capital. I just look at the cash and the legacy assets as being permanent funding.

So we've got 2 sources for it. So we are engaged in these tuck-in conversations and opportunities. And funding is not -- they're not slowing down. We have the capital to execute.

--------------------------------------------------------------------------------

Paul David Holden, CIBC Capital Markets, Research Division - Executive Director of Institutional Equity Research [27]

--------------------------------------------------------------------------------

Okay. And maybe one more for me. Just -- you increased your dividend this quarter based on the midpoint of your 2020 guidance. I get to expect a payout ratio of roughly 20%. Do you view that as a good level in the medium term? I.e., will you continue to increase your dividend with earnings growth? Or do you see capacity to grow that payout ratio over time?

--------------------------------------------------------------------------------

Steven K. Hudson, ECN Capital Corp. - CEO & Director [28]

--------------------------------------------------------------------------------

Yes, it's -- we increased the dividend this quarter because we're very confident in our business model and the cash flows that are being -- we've completed the transition, our business partners at the 3 businesses more than provided or more than delivered, so we are -- we're confident in that cash flow.

We -- just don't worry into that, that we haven't got the opportunity to deploy the capital in other business growth, whether it's a tuck-in M&A or a program, which we'll do. But I think that the Board was very comfortable with that in terms of payout ratio.

Well, I think that's something the Board will visit sort of midpoint of 2020. And I think there's room to grow it. But I think we've got some -- there is room to grow it, but we've got some work to do on some tuck-in M&A deals in the interim.

--------------------------------------------------------------------------------

Operator [29]

--------------------------------------------------------------------------------

Our next question is from Geoff Kwan with RBC Capital Markets.

--------------------------------------------------------------------------------

Geoffrey Kwan, RBC Capital Markets, Research Division - Analyst [30]

--------------------------------------------------------------------------------

Just the first question I had, and I apologize if I missed it earlier, the increasing of the FICO score on the solar stuff. Was it something you were seeing within the book that you'd already originated? Or was there other reasons for that?

--------------------------------------------------------------------------------

Steven K. Hudson, ECN Capital Corp. - CEO & Director [31]

--------------------------------------------------------------------------------

The market -- some of the competitors offering solar financing, were dropping rates, and we didn't see that, that was a great trade on the risk-adjusted basis. So we weren't going to follow it down. We're also cognizant that solar loans have a very long -- have a longer duration of some 7 to 8 years versus our average 2.5 to 3.5 years on our other product.

So you just have to be cognizant of that as where you want to sit on the credit. So it wasn't anything we're seeing in the book. It was proactive. We treat these credit assets as if they're ours. They're not because they're nonrecourse, but we underwrite them as if they are. And that our view on that downward drift in pricing, it wasn't warranted. It wasn't acceptable to us. So we focused on core solar origination that we thought was priced appropriately.

--------------------------------------------------------------------------------

Geoffrey Kwan, RBC Capital Markets, Research Division - Analyst [32]

--------------------------------------------------------------------------------

Okay. And just the second question, just clarifying...

--------------------------------------------------------------------------------

Steven K. Hudson, ECN Capital Corp. - CEO & Director [33]

--------------------------------------------------------------------------------

To be clear, it was not initiated by any bank partners. It was our recommendation to the bank group, and they accepted it.

--------------------------------------------------------------------------------

Geoffrey Kwan, RBC Capital Markets, Research Division - Analyst [34]

--------------------------------------------------------------------------------

Okay. Just a second question I had was just clarifying. On Slide 10, where you kind of talk about that increase from the top 10 bank partners. It sounds the way you've been describing it is, it's the top 10 at each point in time? In other words, this is not the same 10 banks at the start of the year that have increased the commitments by 70%, but it's just the top 10 as it stands today, in aggregate, would be 70% higher than the top 10 you would have had at the top -- at the beginning of the year?

--------------------------------------------------------------------------------

John B. Wimsatt, ECN Capital Corp. - Head of Corporate Development & IR [35]

--------------------------------------------------------------------------------

Geoff, it's John. Yes, I mean, that's right, right? It's the top 10 lenders at this point in time or at that point in time. Obviously, we've added a large partner with an insurance company. A number of our banks have upsized their commitments. We've added some new banks. So at any given time, the top 10 might not be exactly the same.

I think the point we were trying to make was, we're certainly not -- we are certainly adding capacity, and we've been consistently adding capacity over the entire year, and we're just trying to make sure that it's clear to people that, that is, in fact, the case, and we've got more than enough capacity to fund our origination profile through 2020.

--------------------------------------------------------------------------------

Operator [36]

--------------------------------------------------------------------------------

Our next question is from Brenna Phelan with Raymond James.

--------------------------------------------------------------------------------

Brenna Phelan, Raymond James Ltd., Research Division - Equity Analyst [37]

--------------------------------------------------------------------------------

Could you talk a little bit about the economics that you're going to see come from the credit card portfolio structuring, the management fees and potential incentive fees, and the potential for capital appreciation?

--------------------------------------------------------------------------------

John B. Wimsatt, ECN Capital Corp. - Head of Corporate Development & IR [38]

--------------------------------------------------------------------------------

Brenna. Again, the credit card portfolio or credit card investment portfolio of business is something that were in process and in progress, right? It's -- we're still exploring the long-term strategy. As a result, we're not at this point prepared to discuss, sort of, economics and fees and other things, other than to say we'd expect on our capital invested to earn adequate returns. But in addition to that, and the reason, the strategic reason behind this is really to create management fees, which we also anticipate happening over time. I would anticipate that we're going to get more into this business and what we're doing with it at Investor Day.

But right now, because we're actively looking at various types of transactions, et cetera. We're just not in a position where we want to talk about pricing, et cetera.

--------------------------------------------------------------------------------

Steven K. Hudson, ECN Capital Corp. - CEO & Director [39]

--------------------------------------------------------------------------------

The only other thing I would add, Brenna, is that the -- where we're doing advisory business on behalf of these syndicated books. That advisory business has similar margins to that of our regular adviser business. And well, this has been an initiative by us by not to take undue risks, which we haven't. And to get this business ready for its formal rollout in the January Investor Day.

--------------------------------------------------------------------------------

Brenna Phelan, Raymond James Ltd., Research Division - Equity Analyst [40]

--------------------------------------------------------------------------------

Okay. And are these institutional investors new relationships for Kessler, that can eventually be leveraged to purchase other types of assets that you originated?

--------------------------------------------------------------------------------

Steven K. Hudson, ECN Capital Corp. - CEO & Director [41]

--------------------------------------------------------------------------------

Yes. Yes. These are large institutional investors who could -- I can't get to names, but think of the pension industry, in particular. So we've noted a pension discussion we're having at Service Finance and I've had the strategic initiative to see if we can cross-sell services from Service, to Triad, to Kessler. And I think that's beginning. So yes, there is commonality.

--------------------------------------------------------------------------------

Brenna Phelan, Raymond James Ltd., Research Division - Equity Analyst [42]

--------------------------------------------------------------------------------

And just on the potential for tuck-in M&A. Is that in verticals, asset classes that you already have a presence in? Or is there a potential to expand the types of things that you're financing?

--------------------------------------------------------------------------------

Steven K. Hudson, ECN Capital Corp. - CEO & Director [43]

--------------------------------------------------------------------------------

Yes. They are -- we're not going to leave that prime, super prime consumer financing market where we have expertise. So we're not going into sub-prime or near prime. So we're sticking with our knitting. And we're letting our banks initiate the conversation where they're seeing opportunities where they have an origination and management relationship with a partner that might be better managed within the ECN world, that's where this flow is coming from. So we're not adding a fourth leg. We're sticking with our knitting.

--------------------------------------------------------------------------------

Brenna Phelan, Raymond James Ltd., Research Division - Equity Analyst [44]

--------------------------------------------------------------------------------

Okay. And within Kessler, understand that you're focusing on the more recurring type nature of the revenues. But within the portfolio advisory universe, is there anything big out there that's in progress? Or you're actively pursuing that you see presenting material opportunity?

--------------------------------------------------------------------------------

John B. Wimsatt, ECN Capital Corp. - Head of Corporate Development & IR [45]

--------------------------------------------------------------------------------

Well, as we described at Investor Day last year, Brenna, there's always a significant opportunity, meaning that there's always credit card portfolios that are moving around one way or the other, and Kessler is a lot of the time involved in that. So as you can imagine, there's a pretty robust pipeline of things that we are working on and looking to participate in as an adviser or structure manager of that process.

That said, we're obviously not going to talk about potential future transactions until we have -- until we actually have something to announce, but we'll give you an update at Investor Day of how we feel about those businesses going into 2020. But what I can say is we still feel really good about the pipeline.

I think the point is, what we're trying to do. It's not that we're deemphasizing transaction fees and other things that are core businesses for Kessler and have been for a long time. What we're really trying to do is emphasize those really long-term recurring revenues, because ultimately, those are easier to understand. So that's where I'd leave it.

--------------------------------------------------------------------------------

Operator [46]

--------------------------------------------------------------------------------

Our next question is from Tom MacKinnon with BMO Capital Markets.

--------------------------------------------------------------------------------

Tom MacKinnon, BMO Capital Markets Equity Research - MD & Analyst [47]

--------------------------------------------------------------------------------

A couple of questions just with respect to the Corporate segment. I think at your Investor Day, you said you were looking to get your corporate expenses -- you expected them to be under $20 million in 2020.

How should we be thinking about that now that you're talking about all this tuck-in stuff? And I've got a few follow-ups.

--------------------------------------------------------------------------------

Steven K. Hudson, ECN Capital Corp. - CEO & Director [48]

--------------------------------------------------------------------------------

Yes. So I think, Tom, the -- I think the range we gave, the guidance we gave was $19 million to $20 million. We're not far from that range. And if we happen to be at $21 million, and we do a tuck-in deal, I think that's a good trade for us. So it's not going to be materially off that, and we'll wait to see what we can produce in the tuck-in deal for you.

If I can provide -- if I can deliver -- or the team could deliver accretion of x for $1 million of expense, I think that's going to be a good trade for us.

--------------------------------------------------------------------------------

Tom MacKinnon, BMO Capital Markets Equity Research - MD & Analyst [49]

--------------------------------------------------------------------------------

Okay. With respect to the debt that increased, like overall, in the company, it went up $13 million, but in the corporate segment, it seemed to go up more. How could Corporate gets allocated with debt? And why is the cost seem to be in the 7- to 8-ish percent range, if I'm figuring it correctly here?

--------------------------------------------------------------------------------

Michael Lepore, ECN Capital Corp. - CFO [50]

--------------------------------------------------------------------------------

Yes, Tom, it's Michael. The way we allocate the debt is based on the usage. So to the extent that we're making investments. Typically, we keep it at corporate to the extent that these subsidiaries are using our balance sheet to generate on balance sheet assets, then that's what goes -- gets allocated to those segments.

In terms of the cost, I don't have the map right in front of me, but -- so the cost underline are, generally, the variable costs are generally around 4%. But then there's -- we have amortization of costs and then there's standby charges. But I don't think it's quite as high as 7% or 8%. I -- we can get back to you on that.

--------------------------------------------------------------------------------

John B. Wimsatt, ECN Capital Corp. - Head of Corporate Development & IR [51]

--------------------------------------------------------------------------------

If you want, I can take it offline with you. We can run through your -- run through it.

--------------------------------------------------------------------------------

Tom MacKinnon, BMO Capital Markets Equity Research - MD & Analyst [52]

--------------------------------------------------------------------------------

Okay. And then, finally, depreciation and amortization was kind of running in the 600, 700-ish range. And now it's like double that this quarter. Is there anything funny happening in this quarter? Or...

--------------------------------------------------------------------------------

Michael Lepore, ECN Capital Corp. - CFO [53]

--------------------------------------------------------------------------------

Yes. And if you're -- the accounting rules have changed in 2019, and you're not required to capitalize your leases -- all leases. So for us, it's mostly the office space that we have, obviously, for the corporate office and other operating subsidiaries. So those lease costs now get capitalized and expensed through interest and depreciation expense. That's where you're seeing that jump.

--------------------------------------------------------------------------------

Tom MacKinnon, BMO Capital Markets Equity Research - MD & Analyst [54]

--------------------------------------------------------------------------------

That jump is just in the third quarter because...

--------------------------------------------------------------------------------

Michael Lepore, ECN Capital Corp. - CFO [55]

--------------------------------------------------------------------------------

So we -- yes, we pushed it. It wasn't usually material. So we had to do the work in the first 2 quarters, and we pushed it in the change in Q3.

--------------------------------------------------------------------------------

Operator [56]

--------------------------------------------------------------------------------

Our next question is from Jeff Fenwick with Cormark Securities.

--------------------------------------------------------------------------------

Jeffrey Michael Fenwick, Cormark Securities Inc., Research Division - MD & Head of Institutional Equity Research [57]

--------------------------------------------------------------------------------

Maybe just to circle back on to the Kessler Group questions there. Just with the build of your capital behind those opportunities. How are you feeling in terms of how large you'd like the debt funding to be in behind that? And do you start to think about maybe finding some other vehicle you could structure alongside of it that might replace that?

--------------------------------------------------------------------------------

John B. Wimsatt, ECN Capital Corp. - Head of Corporate Development & IR [58]

--------------------------------------------------------------------------------

I'm sorry, Jeff, are you asking how large we think the credit card investment platform opportunity is for -- on ECN's balance sheet?

--------------------------------------------------------------------------------

Jeffrey Michael Fenwick, Cormark Securities Inc., Research Division - MD & Head of Institutional Equity Research [59]

--------------------------------------------------------------------------------

Well, more how much debt are you willing to put behind it? I mean, we saw it step up from just a little over $60 million up to $94 million. Like is the sky the limit if the opportunity is right? And is that...

--------------------------------------------------------------------------------

John B. Wimsatt, ECN Capital Corp. - Head of Corporate Development & IR [60]

--------------------------------------------------------------------------------

No. No. No. Look, like -- if you think back to what we did with -- think back to what we did with solar, right? I mean, we had to add assets to the balance sheet for a period of time to develop a solar business so that we could ultimately turn it into a flow program, so it kind of came off-balance sheet and became more of that fee -- core fee business at Service Finance.

I would think of it similarly here in the sense that we're using some capital and some balance sheet to invest alongside some of these partners to create a platform where, in the future, we can just syndicate these out to partners and earn management fees, where we're not actually putting up more capital.

I think we've said previously that the limit that we would do on balance sheet for that business is around $100 million, and I don't think that's changed at this point.

Now remember, these are very short duration assets, meaning less than 18 months, so they roll over relatively quickly. So if we wanted to, we can, obviously, reinvest some of that capital that's coming back to us, but we don't think it's going to get much larger from here.

--------------------------------------------------------------------------------

Steven K. Hudson, ECN Capital Corp. - CEO & Director [61]

--------------------------------------------------------------------------------

We're not going to go out -- yes. We're not going to go out and buy a credit card portfolio and put it on our balance sheet. We're happy to put up, up to 10% in a pari passu basis, prefer it to be 5%, but up to 10%. And we're going to -- $100 million mark, it might be $105 million or $95 million real numbers. That's a real mark in our mind. Be our limiter.

So we understand we're going to allocate our capital very, very carefully.

--------------------------------------------------------------------------------

Operator [62]

--------------------------------------------------------------------------------

Our next question is from Jaeme Gloyn with National Bank Financial.

--------------------------------------------------------------------------------

Jaeme Gloyn, National Bank Financial, Inc., Research Division - Analyst [63]

--------------------------------------------------------------------------------

I just want to come back to the tuck-in M&A and the expenses related to that. Is this -- it sounds like it's bank-driven or partner-driven in terms of what you're looking at. So maybe just a comment on how active you are? And these expenses that popped up in Q3, would you expect them to continue? Is this something that you're actively searching for, a tuck-in M&A in the portfolio? Maybe a little more color on that.

--------------------------------------------------------------------------------

Steven K. Hudson, ECN Capital Corp. - CEO & Director [64]

--------------------------------------------------------------------------------

Yes. It's -- we're actively pursuing them because our bank partners have presented them to us. And in the past, we've seen several from them that we just didn't think met the -- met -- didn't meet our credit requirement. We saw one for financing collector cars and antique automobiles, which was an easy no go. We're now seeing ones that have got real teeth that fit clearly within our silos, and we're spending money and time on it with the real opportunities. But I can't guarantee you that if any result will happen, we think we're confident, but it's all a function of due diligence. And it's a function of making sure the banks are there for a committed period to fund the loans.

So it's temporary in nature. It's relatively modest, this increase in expense. And I think it's an important part of doing effective and deep due diligence.

--------------------------------------------------------------------------------

Jaeme Gloyn, National Bank Financial, Inc., Research Division - Analyst [65]

--------------------------------------------------------------------------------

Yes. Fair enough. Is the right way to think about it then just that the level of expenses in Q3 will sort of continue until you announce a deal or you announce that you're done looking at tuck-ins?

--------------------------------------------------------------------------------

Steven K. Hudson, ECN Capital Corp. - CEO & Director [66]

--------------------------------------------------------------------------------

Yes, I can't -- I can't tell you that if we stop today, then you'll see them come down. But these underwritings, Jaeme, they take some time, right? You've got to go deep on the credit performance, the loan performance tapes, the management team, all that stuff, and we underwrite these. As you know, we looked at $80 billion in opportunities to settle on the 3 businesses that we bought. So we're pretty good at this, but we get extremely deep, so we don't hit a land mine.

--------------------------------------------------------------------------------

Jaeme Gloyn, National Bank Financial, Inc., Research Division - Analyst [67]

--------------------------------------------------------------------------------

Okay. And one more then, just on the divestitures of the aircraft in the quarter. Can you talk about the fair value that you're getting on those sales?

And if I recall correctly, there's a provision related to the sale of those assets. How much is left in that provision as you're winding down?

--------------------------------------------------------------------------------

Steven K. Hudson, ECN Capital Corp. - CEO & Director [68]

--------------------------------------------------------------------------------

Yes, I think it's adequate to deal with the portfolio. And we don't give individual valuations because we have people on this phone who are looking to buy those aircraft.

So we have a value in which we'll sell them, and we'll have a value -- we'll value their advertising in a value that we'll sell it at, which is within our provision.

--------------------------------------------------------------------------------

Michael Lepore, ECN Capital Corp. - CFO [69]

--------------------------------------------------------------------------------

I'd say in the sales that took place, we're within -- we're very close to our provisional values.

--------------------------------------------------------------------------------

Operator [70]

--------------------------------------------------------------------------------

There are no more questions registered at this time. This concludes today's conference call. You may disconnect your lines. Thank you for participating, and have a pleasant day.