Category: Market Action

DBRS has announced:

upgrades the credit ratings of Element Fleet Management Corp. (EFN, or the Company), including the Company’s Long-Term Issuer Rating and Long-Term Senior Debt Rating to A (low) from BBB (high), its Short-Term Issuer Rating to R-1 (low) from R-2 (high), and its Perpetual Preferred Shares Rating to Pfd – 2 (low) from Pfd – 3 (high). At the same time, the trend on all credit ratings were revised to Stable from Positive. The Intrinsic Assessment (IA) for the Company is A (low), while its Support Assessment is SA3. As a result, EFN’s final credit ratings are equalized with its IA.

KEY CREDIT RATING CONSIDERATIONS
The credit rating actions consider EFN’s sustained improved earnings generation capacity which reflects a diverse set of revenue streams, including increasing levels of net financing revenues and net servicing income, along with more moderate revenue contributions from its syndications platform. The credit rating actions also take into account the Company’s sustained progress in diversifying its funding position, including increased levels of unsecured funding. EFN’s credit ratings reflect its leading commercial fleet management franchise in North America and Australia – New Zealand, and its sound risk profile with very modest credit losses through the cycles and moderate residual value exposure. Although acceptable, the Company’s credit ratings do reflect higher tangible leverage relative to its large industry peers. Importantly, it is our view that credit fundamentals will remain sound over the near-term, despite economic uncertainties and still elevated interest rates.

CREDIT RATING DRIVERS
Over the longer term, lower tangible leverage and reduced asset encumbrance as well as sustained stronger earnings generation would result in a credit ratings upgrade. Conversely, a persistent and material decline in the Company’s earnings and/or a significant weakening of its balance sheet fundamentals would result in a credit ratings downgrade. Sustained materially higher tangible leverage outside of the Company’s target range would also result in a credit rating downgrade.

CREDIT RATING RATIONALE
Franchise Building Block (BB) Assessment: Good
EFN maintains the leading commercial fleet management franchise in its chosen geographical markets. The Company provides a broad array of products and services to a diverse customer base, while utilizing its significant scale of operations to attain preferred pricing on vehicles from OEMs and discounts from various other vendors and suppliers which it passes onto its fleet customers. Founded in 2007, the Company maintains strong institutional and industry knowledge. Positively, the commercial fleet management sector continues to benefit from a secular shift with more companies seeking to outsource their fleet needs.

Earnings Building Block (BB) Assessment: Good
The credit ratings consider EFN’s sustained improved earnings generation capacity, which reflects its diverse and growing revenue streams, including net financing income, net servicing income, and net syndications revenue. Positively, the Company’s earnings performance metrics including its ROE and ROA ratios have tracked upwards since the end of its Transformation program (YE20), reflecting its strong business model and the mission critical nature of the vehicles that it manages and finances.

For the six month period ending June 30, 2024 (1H24), earnings totaled $196.5 million, or an ROE metric of 12.7%, as compared to $168.1 million, or 11.9%, for 1H23. Improved 1H24 earnings, on a year-on-year (YoY) basis, reflected increased levels of net servicing income, net financing revenues, and net syndication revenues, partially offset by higher operating expense. Overall, higher revenues were driven by solid originations, earning asset growth, and improved servicing penetration rates. Reflective of its diverse revenue mix, net servicing revenues represented 53.4% of total net revenues in 1H24, followed by net financing revenues at 42.8%, and net syndication revenues at 3.8%. These results followed full-year 2023 earnings totaling $345.6 million, up from $314.9 million for full-year 2022, reflecting higher levels of net servicing income and net financing revenue.

Risk Building Block (BB) Assessment: Strong/Good
EFN’s sustained sound risk profile reflects its conservative and well-managed credit risk and residual value risk policies, and is supportive of the credit ratings. Levels of net charge-offs (NCOs) remain very modest underpinned by EFN’s significant level of investment grade clients, conservative underwriting, and the mission critical nature of the financed vehicles to the customer. Specifically, NCOs totaled a very low $0.05 million in 1H24, while for full-year 2023, NCOs totaled just $0.75 million. The Company’s allowances for losses are considered sufficient at $5.4 million, or 0.07% of gross finance receivables at June 30, 2024, as compared to $5.5 million, or 0.08%, at December 31, 2023.

Meanwhile, the majority of the Company’s clients’ leases in the U.S. and Canada are open-ended, limiting EFN’s residual value exposure. For open-ended leases, it is the client, not the Company, that is exposed to declines in used vehicle values upon disposition. Lastly, we view operational risk as a relevant risk with the significant amount of client data that EFN holds across its operating platform. We view operational risk to be well-managed.

Funding and Liquidity Building Block (BB) Assessment: Good/Moderate
The Company has made solid progress in diversifying its funding profile, including the periodic issuance of unsecured funding. Indeed, at June 30, 2024, 44.4% of EFN’s total debt was unsecured compared to 22.1% at year-end 2020. We note that the Company’s funding mix is also diverse by lender and investor base. EFN also maintains an established syndication platform that provides liquidity as well as reduces potential client concentrations while providing an additional revenue stream. Overall, funding remains well-aligned with the asset base. Lastly, the Company’s liquidity position is sound, anchored by $5.0 billion committed undrawn liquidity, including $2.05 billion of availability under its senior revolving unsecured credit facilities, $2.87 billion under its vehicle management asset-backed facilities (if collateral is available), and unrestricted cash of $0.08 billion, as of June 30, 2024.

Capitalization Building Block (BB) Assessment: Moderate
EFN has demonstrated sound capital discipline. Although somewhat higher than its large commercial fleet management peers, the Company’s tangible leverage ratio is acceptable at 6.50x, at June 30, 2024, up from 5.99x at year-end 2023. Overall, EFN targets tangible leverage in the 6.25x to 6.75x range. Finally, the Company continues to simplify its capital base by retiring costly preferred shares which now represent just 3.2% of total equity compared to 13.5% in year-end 2020.

EFN.PR.E was issued as a FixedReset, 6.40%+472, that was announced 2014-6-2 but not immediately tracked by HIMIPref™ as it was unrated. Coverage commenced in September, 2015 after the company’s preferreds were rated Pfd-3 by DBRS. The extension was announced 2019-8-27. The issue reset at 5.903% effective 2019-9-30. I recommended against conversion and there was no conversion. The company announced its intention to redeem this issue in November 2023 and the issue has been called for redemption 2024-9-30. The issue is tracked by HIMIPref™ and is assigned to the Scraps – FixedReset – Discount subindex.

PerpetualDiscounts now yield 5.96%, equivalent to 7.75% interest at the standard equivalency factor of 1.3x. Long corporates yielded 4.77% on 2024-9-20 and since then the closing price of ZLC is unchanged at 15.51. Therefore, the pre-tax interest-equivalent spread (in this context, the “Seniority Spread”) has remained constant at the 300bp reported September 18.

A day enlivened by the mostly unexpected extension of TD.PF.A, and the consequently horrible performance of both it and TD.PF.C.

The long awaited FOMC rate cut announcement came out today:

Recent indicators suggest that economic activity has continued to expand at a solid pace. Job gains have slowed, and the unemployment rate has moved up but remains low. Inflation has made further progress toward the Committee’s 2 percent objective but remains somewhat elevated.

The Committee seeks to achieve maximum employment and inflation at the rate of 2 percent over the longer run. The Committee has gained greater confidence that inflation is moving sustainably toward 2 percent, and judges that the risks to achieving its employment and inflation goals are roughly in balance. The economic outlook is uncertain, and the Committee is attentive to the risks to both sides of its dual mandate.

In light of the progress on inflation and the balance of risks, the Committee decided to lower the target range for the federal funds rate by 1/2 percentage point to 4-3/4 to 5 percent. In considering additional adjustments to the target range for the federal funds rate, the Committee will carefully assess incoming data, the evolving outlook, and the balance of risks. The Committee will continue reducing its holdings of Treasury securities and agency debt and agency mortgage‑backed securities. The Committee is strongly committed to supporting maximum employment and returning inflation to its 2 percent objective.

In assessing the appropriate stance of monetary policy, the Committee will continue to monitor the implications of incoming information for the economic outlook. The Committee would be prepared to adjust the stance of monetary policy as appropriate if risks emerge that could impede the attainment of the Committee’s goals. The Committee’s assessments will take into account a wide range of information, including readings on labor market conditions, inflation pressures and inflation expectations, and financial and international developments.

Voting for the monetary policy action were Jerome H. Powell, Chair; John C. Williams, Vice Chair; Thomas I. Barkin; Michael S. Barr; Raphael W. Bostic; Lisa D. Cook; Mary C. Daly; Beth M. Hammack; Philip N. Jefferson; Adriana D. Kugler; and Christopher J. Waller. Voting against this action was Michelle W. Bowman, who preferred to lower the target range for the federal funds rate by 1/4 percentage point at this meeting.

Reporters at the New York Times commented:

Michelle Bowman, the one committee member who wanted a smaller cut, seemed concerned about a resurgence in inflation as recently as last month. “I still see some upside risks to inflation as supply conditions have now largely normalized and any further improvements to supply seem less likely to offset price pressures arising from increasing geopolitical tensions, additional fiscal stimulus, and increased demand for housing due to immigration,” she said in remarks to the Alaska Bankers Association.
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The real problem when it comes to housing, Powell says, is the lack of supply — a long-term problem that is outside of the Fed’s control.
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Federal Reserve officials agree that Wednesday’s rate cut is unlikely to be their last. They are much less united on how far or how quickly they will decide to lower rates moving forward.

The chart below, known as the “dot plot,” helps tell the story. Each dot represents one Fed official’s forecast for where interest rates will be at the end of each year.

In 2024, for example, nine of the central bank’s 19 officials expect rates to end the year at about 4.4 percent, half a point below where they stand after the jumbo rate cut on Wednesday. That suggests those officials expect to make more modest, quarter-size cuts in each of the two meetings they have scheduled for the rest of the year.

But seven policymakers expect just one more cut this year, and two officials expect none. At the other end of the spectrum, one official expects the Fed to cut rates by another three-quarters of a point this year, suggesting another supersize reduction in either November or December.

All 19 officials expect rates to be lower at the end of next year than they are now. But their estimates of how much lower vary widely, from about 2.9 percent (two full percentage points below where they are after Wednesday’s action) to 4.1 percent (just three-quarters of a point below where they are now). There is an even wider range of views in 2026 and 2027.

Eventually, most officials expect interest rates to settle between 2.5 percent and 3.5 percent. That’s higher than in the decade before the pandemic, when the Fed’s target interest rate never topped 2.5 percent — suggesting we may not soon return to the era of ultralow rates that prevailed after the Great Recession.

Fed Dot Plot, 2024-9-18

PerpetualDiscounts now yield 5.98%, equivalent to 7.77% interest at the standard equivalency factor of 1.3x. Long corporates yielded 4.77% on 2024-9-13 and since then the closing price of ZLC has changed from 15.55 to 15.51, a decrease of 26bp in price, implying an increase of yields of 2bp (BMO reports a duration of 12.46, but don’t disclose whether this is Macaulay or Modified; I will assume Modified) to 4.79%. Therefore, the pre-tax interest-equivalent spread (in this context, the “Seniority Spread”) has narrowed to 300bp from the 310bp reported September 11.

So, good news today on Canadian inflation:

The year-over-year inflation rate of 2 per cent in August is precisely in line with what the Bank of Canada wants to see. So why will no one be celebrating outside the downtown Ottawa offices of the central bank?

Reason One: Food inflation is still running a bit hot. Prices at grocery stores and restaurants came in at 2.7 per cent in August.

Reason Two: Shelter inflation hit 5.3 per cent last month, a reminder that mortgage interest remains a big contributor to overall increases in the cost of living. Mortgage rates have been falling steadily, though.
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Now for some inflation positives: In the Statistics Canada report on the job market for August, hourly wages were up 5 per cent on a year-over-year basis after a 5.2-per-cent gain in July.

So, the markets reacted a bit:

The Canadian dollar fell to 73.42 cents US as the 830 am ET inflation report was released, from 73.63 prior. Canada’s two-year bond yield eased a little bit – by a couple basis points. That’s relatively stable, and may have also been influenced by a stronger-than-expected U.S. retail sales report released at the same time.

The swaps market, which captures market bets on future monetary policy moves, suggests roughly 50/50 odds on whether it will be a 25 or 50 basis point cut by the BoC on Oct. 23, according to LSEG data.

Regardless, almost 75 basis points of rate cuts are priced into the market by the end of this year. By December of next year, the overnight rate is seen by markets as reaching 2 per cent.

Swaps market pre-announcement

Swaps market post-announcement