EFN: DBRS Places On Review-Positive

Huh. Sometimes I just can’t win. Remember yesterday, when I passed on the news that:

Element Financial, proud issuer of EFN.PR.A, EFN.PR.C, EFN.PR.E and EFN.PR.G, has announced:

that following the completion of a strategic review of each of the Company’s business units that it initiated in October of last year, the Board of Directors has approved plans to proceed with a transaction that will result in the separation of the current business into two publicly traded companies – a $19.5 billion world class fleet management company (Element Fleet Management) to be led by Bradley Nullmeyer and a $7.0 billion North American commercial finance company (Element Commercial Asset Management) to be led by Steven Hudson.

The Company is currently analyzing the most efficient method to implement the separation of the two businesses and further details will be provided to the market as Element completes this analysis with its advisors. The separation transaction that will split the Company into these two publicly traded entities is expected to be completed on a tax free basis before the end of 2016. The allocation of the assets, liabilities and capital structure of the Company, as well as the structure of the Board and the deployment of current corporate services staff between the two new entities will be determined as the details of this separation transaction are determined.

And remember when I went on to say:

We’ll see what happens as details emerge, but I have a hard time envisaging this as being credit-positive for the preferreds!

DBRS has announced that it:

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.

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.

As noted above, affected issues are EFN.PR.A, EFN.PR.C, EFN.PR.E and EFN.PR.G.

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