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Thank you for standing by. This is the conference operator. Welcome to the ECN Capital Second Quarter 2018 Conference Call. [Operator Instructions] The conference is being recorded. I would now like to turn the meeting over to Mr. John Wimsatt. Please go ahead, Mr. Wimsatt.
Thank you, Ariel. Good afternoon, everyone. Thank you for participating in our conference call to discuss ECN Capital's 2018 second quarter results announced earlier today. Joining us are Steven Hudson, Chief Executive Officer; Jim Nikopoulos, President; and Grier Colter, Chief Financial Officer.A news release summarizing the second quarter results was issued this afternoon, and the financial statements and MD&A for the 3-month period ended June 30, 2018, 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 in the webcast as well as 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'll refer you to the Cautionary Statements section of the MD&A for a description of such risks, uncertainties and assumptions. Although management believes that the expectations reflected in these statements are reasonable, we can obviously give no assurance that the expectations of any forward-looking statements 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 our 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. All figures presented are in U.S. dollars unless explicitly noted.With these introductory remarks complete, I'll now turn the call over to Steven Hudson, Chief Executive Officer.
Thank you, John, and thank you for taking time to join us this afternoon.Before we turn to the operating results for the second quarter, I want to take a moment, just a moment, and reflect upon the completion of our transition. Under Slide 6 in the deck that you have in front of you, we've had a number of questions about the definition of ECN, given that we've gone from being a direct lender into a business service provider. And we thought we would post our outline of basically who we are, what do we do and who our customers are. These slides will form the basis for an enhanced website that you'll see this coming Monday.On Page 6 of the deck, you'll see that we have 90 banks and credit unions. They represent two-thirds of the second quarter's revenue. That's still a small part of a very big market. There's over 10,000 banks and credit unions in the U.S. We think we're just scratching the surface, very successfully.At the end of the second quarter, we now manage $28 billion, manage and advise on credit portfolios. We've given you some summary of some of who are -- how significant we are to some of the larger players in the U.S. I don't want to leave you the impression that we're just focusing on large money-center banks. We have very deep partnerships with regional banks and smaller banks and credit unions throughout the U.S.Exactly who is our customer? Our customer is the head of a retail bank who has long deposits and seeking high-quality, risk-adjusted portfolios to match the deposit base. Why do they turn to ECN and its companies? Because we provide attractive portfolios with embedded risk diversification, cycle-tested portfolios and aligned and proven management teams.Turning to Slide 7, you'll see the composition of the revenue, the two-thirds of the revenue for the second quarter. A chunk of it is origination income. An important chunk is advising. And then there's a management portion for the $28 billion of managed assets. Important that the average term of those management relationships exceeds 5 years.Jim Nikopoulos will be speaking to a significant management portfolio that we've just undertook this quarter shortly.When we walk into a bank, our menu has 3 services. We can offer you unsecured consumer loans, secured consumer loans and consumer credit card portfolios, all of a prime and super prime nature.Turning to Page 8, our solutions. Our first offering, all equal, is to offer you an unsecured consumer loan portfolio. It is in the form of a RIC and it can be secured if the bank or credit union chooses to file UCC lien, entirely up to them. These loan portfolios are originated through our partners at Service Finance. They sell those portfolios and manage them to 15 banks. Average FICO, 365. They have a very attractive return to our bank customers, of 5%-plus. An important distinction, this, like all our portfolios, are nonrecourse to the loan performance, including credit losses, but as well as prepayment speeds and yields.Turning to our second solution on our menu, that is one of secured consumer loans portfolios, offered through our partners at Triad. FICO of 750. It has a yield of 5.5%, slightly higher than that of the Service Finance portfolios, but a longer term. Again, nonrecourse to the performance, including that of credit losses, prepayments and yields.Finally, our third offering on our solution menu is that of credit card portfolios that we offer to 25-plus U.S. financial institutions, where we provide management and advise portfolios on their behalf.All 3 of these -- and that particular business has over half of its revenue coming from a manage basis. Jim will speak more to that in a second.Suffice it to say, when you get to Page 11, ECN as an active manager on behalf of its partners, both in terms of our experience, expertise and use of our balance sheet, has driven additional growth and incremental value for our 3 platforms and, more importantly, for our 90-plus banks and credit unions.4 good examples about how ECN operates with its investment platforms. We provide for rapid launch of foundation products. What the heck does that mean? It means in Triad's case that within 90 days we launched a comprehensive Floorplanning platform, a business that we've been in for over 2 decades, and that has driven the 20% incremental origination growth.When you turn to Service Finance, we created a compliant PACE loan program, a little [ million ] of $50 million of product. That was an additional loan that Mark wanted to offer his home improvement dealers. That portfolio was created, and has now been under contract to a financial institution who's purchasing that portfolio.Third, we are now beginning to cross-market our 1 through 3 solutions to our various banks. We completed 2. We take 2 products and they're in the midst of completing 3. We're happy that the theory of being able to cross-sell is actually becoming a practice.And finally, but not least, the ability to use the balance sheet and investment-grade rating has allowed our partners at Service Finance, Triad and Kessler to reach out and grab new origination share and take market share, more importantly.And finally, the legacy business has been historically an important business to us. It is in a run-off prudent basis. We are providing -- these businesses provide stable cash flows, predictive stable cash flows. And as you know, when this capital is harvested we either reinvest it organically into our 3 core businesses or we return it to our shareholders, like we've done in the past.I do want to conclude this section that there is not a fourth leg coming. These are our 3 core investment platforms. And our business -- our only plan is to grow them, redeploy capital within them and return excess capital.Turning to operating highlights, specifically on Page 14, simply put, Service Finance had a great quarter. Some would say exceptional. A highlight of that quarter would be we now have a $0.5 billion annual funding relationship with a new bank partner that is in place and funding. We have 15 banks in total. We have an additional 3 banks and credit unions. We've been able to transfer credit unions from Triad into the Service Finance platform, an additional 3 that are in the due diligence process.And we've had 60%-plus growth in originations, our managed book and EBITDA. I think some would remark that our $55 million was aggressive as a target for this year. I think this team will prove it, and we're quite proud of Mark and his partners' success in this field.We continue to add approximately 170 dealers a month. So we're comfortable that we're not only gaining share, but we're servicing our existing client base.And we're maintaining our guidance for this business in 2018.With respect to originations, on Page 15, you see the very strong month-over-month growth. As you know, this is the -- Q2 and Q3 are the strongest quarters for Service Finance.Jim?
Thank you very much, Steve. If I could turn you to the next 2 slides, I wanted to cover the manufacturing housing vertical for ECN. Triad had a very strong quarter of originations, of $150 million. This represented an almost 20% increase year-over-year. Backlog that I reported from the temporary industry, in fact, in Q1 have been normalizing and working their way through. This has resulted in a strong quarter that we experienced in the second quarter. We remain on pace for our full year originations guidance of $530 million. Triad's nearly 60-year focus on providing prime high-quality manufactured housing loans is also leading to a steady increase at our funding partners. In the first half of 2018, Triad added 6 new bank/credit union funding partners. The breakdown was 3 banks and 3 credit unions, in that case.Triad continues to focus on its managed book, focusing increased penetration on full servicing for the entire portfolio, nearing nearly 30% of all outstanding loans today.The launch of the on-balance sheet Floorplan program that Steve mentioned earlier has been exceeding our expectations. We did an opportunistic portfolio purchase of $43 million in the second quarter that added over 150 new dealers to the Triad relationship. And for the quarter end, we are at nearly $65 million, with 200 approved dealers. The success of this program -- this program is successful in and of itself, averaging about 7.5% yield per loan, but it also has contributed, as Steve mentioned earlier, to increase originations for the core business.So in short, we're very pleased for the performance of Triad in the second quarter, and the efforts through Don and his team contributed to very strong results, including over 100% year-over-year growth in EBITDA. As I mentioned, we remain highly confident that Triad will achieve its full year guidance.If you turn to the next slide, Slide 18, I just wanted to cover our newest investment, which is in the Kessler Group. As you recall, we announced this strategic investment into Kessler Group on May 10. And thanks to the outstanding efforts of both the Kessler and ECN teams, we were able to close that transaction at the end of May. As a reminder, we initially invested $221 million for an 80% equity stake in the Kessler Group. Subsequent to that transaction close and as part of the previously announced stock purchase program for senior management, we sold a 4% equity interest to a member of senior management at the same valuation. As a result, ECN's equity investment in the Kessler Group currently stands at 76%.In terms of operating results, we only have 1 month to report, the month of June, and our adjusted operating income before tax for the business was $2.5 million, of which ECN's shares represent $1.9 million. I'll note in this area that that does not include -- that result in June did not include any M&A transaction fees, and we expect to earn the majority of those fees in the latter half of the year.I also want to highlight a transaction that was very publicly disclosed in the past few weeks, and that's the transaction under which Walmart's private-label, general-purpose, co-branded credit cards moved or are in the process of moving from Synchrony Bank to Capital One. This was announced at the end of July. This transaction was very complex, obviously, and had a lot of pieces to it. Kessler Group advised Capital One on the transaction.This is an excellent example for us that we'd like to let you know about Kessler's role in a complex transaction, moving a lot of assets from one party to another, helping Capital One structure the new program, a new card program for those clients and ensuring the best outcome for the banking partners, for the partner itself and for the ultimate customers. Kessler doesn't normally highlight their roles in transaction because according to them they operate on behalf of the deal. But this one, given its high exposure and high press and the fact that Kessler was mentioned, there's a good reason why we're raising it for purposes of this call.This longstanding partnership is going to contribute both upfront fee when the back book moves to Capital One. It's in the process of being negotiated [ as we speak ]. The plan is for that to occur next year. And it also will allow for a 10-year annuity program for fees based on outstanding receivables of that program over the next 10 years.So this is an excellent example of the transaction and also contributes to not only the upfront fees but the 70%-plus of multiyear contracted revenue streams of the business that Steve discussed on an earlier slide.So at the end of the day we continue to expect Kessler to be accretive, as we announced earlier, to our net income per share, and will contribute approximately $0.03 in 2018. And as I previously mentioned, we expect performance to be heavily weighted to the fourth quarter when Kessler [ is expected to ] earn the majority of its M&A transactions fees.So just turning to the next few slides of what we're calling our legacy businesses, rail and aviation, let me start with the rail slide, on Slide 20.As we've previously stated, and as good stewards of capital, we remain highly focused on a prudent wind-down of these legacy businesses in order to release capital that can be redeployed into our 3 core businesses or returned to shareholders. To this end, there were no new real originations in the second quarter, and we do not expect any origination volume during the second half of the year.EBITDA improved on a sequential basis due to a small portfolio sale that we completed in the normal course during the quarter that generated just under $1 million in syndication income.So during the wind-down process, we will continue to remain focused on the operations and orderly wind-down of the rail business. I now turn you to Slide 21, dealing with aviation. We've been very pleased with the wind-down efforts of the aviation book in quarter. We've been highly focused on it and achieved great results in the second quarter. Our average earning assets for the quarter reduced to $389 million, down from $645 million in Q2 of 2017. This included the successful sale of 2 global aircraft in the quarter, for gross proceeds of $[indiscernible] million. Sales activity to date including the second quarter have been tracking well ahead of our plan, and our pipeline for the remainder of '18 remains robust. As a result, I'm pleased to update that we are now revising our year-end forecast for the portfolio of aviation earning assets from the $420 million previously communicated to our new year-end target of $250 million to $300 million of earning assets.As we look back to the start of the wind-down, which we initially announced in the fourth quarter of 2015, we have brought the book down by over $600 million and released over $200 million of equity, which we redeployed into more profitable business segments.With that, I will turn the call over to Grier.
Thanks, Jim. So turning to Page 23 and first looking at our consolidated operating highlights, managed and advised portfolios increased to $28.1 billion, primarily because of our investment in the Kessler Group completed in Q2 and also due to portfolio originations at Service Finance and Triad.Originations for the quarter were $505 million, versus $349 million in the prior quarter and $379 million versus Q2 2017 on a pro forma basis, reflecting exceptional quarters from our Service Finance and Triad businesses in a historically strong quarter seasonally.Adjusted EPS was $0.04, including the results from 1 month of our Kessler Group investment. Before the contribution from Kessler and the impact of the SIB, EPS was still $0.04 and in line with our original guidance.Turning to Page 24, we have provided a summary of our balance sheet. Total assets were up versus the prior quarter, reflecting our investment in the Kessler Group. And accordingly, our leverage increased as we drew from our senior line to fund this transaction as well as a substantial issuer bid. Total finance assets also increased compared to Q1, due to the temporary warehousing of home improvement loans at Service Finance, the addition of Floorplan loans at Triad and the addition of a short-duration senior loan to finance a portfolio of credit card receivables.Shareholders' equity has declined in the quarter due to share repurchases made under our recently completed SIB, of approximately CAD 115 million.On Page 25, a summary of our income statement is shown. Please note we have reorganized our income statement to better reflect our current business model with a focus on portfolio origination services, portfolio management services and portfolio advisory services line items. We will no longer present our income in a net interest margin format.Portfolio origination and management services income were both up significantly versus prior quarter, due to strong performance both at Service Finance and Triad and the inclusion of 1 month of Kessler results. Portfolio advisory service revenue represents 1 month of results from our investment in Kessler.Interest income and net rental revenue, which is primarily from our rail and aviation businesses, was consistent with prior quarter.Operating expenses were higher, primarily as a result of the addition of Kessler Group operating results. And as in prior quarters, as we move to Page 27, we've provided the expense detail by business segment. So on Page 27, as expected, our corporate operating expenses remain elevated as a result of M&A activity, and we remain on track to meet our previously disclosed cost reductions as we now wind down the M&A process.Moving to the chart at the bottom of the page, and similar to prior quarters, we have shown a base corporate line which represents targeted ongoing corporate costs of $20 million to $21 million. The $890,000 represents corporate costs that will be reduced over the next 2 quarters and appear in SG&A expenses currently. Finally, the $2 million in costs at the bottom of that chart represents amounts that were expensed as part of business acquisition costs in connection with Kessler and represent legal, accounting and travel expenses.Also note that we remain committed to reducing the size of our senior credit line, from $2.2 billion to $1.5 billion, by the end of the third quarter, resulting in reduced standby fees and previously disclosed savings of approximately $2.4 million on an annual basis and also $500,000 in annualized savings with regards to commitment fees.And that concludes my comments. At this time, I'll turn it back to the operator for Q&A.
[Operator Instructions] Our first question comes from Geoffrey Kwan, of RBC Capital Markets.
Just on the Capital One-Walmart transaction, are you able to provide any even ballpark numbers on what it might impact on terms of EPS? I know it's not going to be an event for this year, but more next year. And then also, too, is are there other opportunities with that relationship to try and grow it beyond what they're inheriting and any sort of other, say, broader activity in the sector that might benefit Kessler?
We can't talk about the specifics of the fee arrangement. That being said, there will be a component of an upfront fee, a basis point fee, based on the back book receivables that get transferred over mid next year. And then on the forward flow business, Kessler would continue to help advise and help oversee the program on a go-forward basis. So we'll recognize and earn a basis point fee on outstanding receivables over the next 10 years. So they have a forecast on what they think the outstanding receivables will be, and what they'll actually be depends on what occurs, but they're very bullish on it. We will as we update guidance for '19 on behalf of the businesses, Geoff, make sure that we capture the benefit of the program as we report our '19 guidance at the end of the year.In terms of a go-forward basis, one of the strengths of the Kessler Group is their ability to work on the deal, their knowledge of deal flow on these types of transactions. They know every deal that's happening before it happens. And they represent a magnitude of partners, a magnitude of retailers, a magnitude of banks on all these transactions. So one of the reasons why they are gun shy about announcing themselves as an adviser on one transaction is they tend to represent the other side on the next transaction. So we think there's a lot of deal flow that's happening in the marketplace. We're bullish they're actively involved on many files; this one being a very big one, as you know. But this is a perfect example of a type of transaction that they do a lot of throughout the course of the year.
I would just add, too, as consistent with past years, management will be providing 2019 guidance on the third quarter call, which is slated for early November. And I think you'll see the impact of the Walmart transaction when we provide the guidance for '19 at that time.
Okay. Perfect. A second question was on the Service Finance, and apologize if you had mentioned this earlier, but those loans that got warehoused and not sold to -- the loans that were warehoused, was there something specific about them why they weren't sold kind of according to your allocation matrix to your existing funding partners?
On the PACE product, in particular, Geoff, that was sold under contract to an institutional investor who wanted that paper and provided a very attractive return to us.On the solar, as you know, we have a bank partner that's in a separate fund for that and is proceeding along as planned. We now have had interest from other partners for the solar paper who are going to participate in that fund, and I think will increase the returns to Service Finance as a result. As you know, solar has a longer duration than nonsolar paper. So it's going as planned. I would comment that the PACE stuff is an institutional product and very attractive returns, and that's being sold as we speak. So it will be gone at the end of the third quarter, although we'll continue to originate on behalf of that investor, Geoff, and the solar will be gone in the same time frame.It's incumbent upon us that we use our balance sheet when prudent, when prudent, that we be able to expand the type of products that Service Finance can offer and we only use our balance sheet when we're highly confident that there is a home for those assets. And that's what we've demonstrated with these 2 particular products.
Okay. Thanks for that. And just last question I had was talking about the winding down of the rail business. Does that have any implications from the credit rating perspective? Because initially with the spinoff, that was one of the things why you were planning to keep the rail, was to keep that investment-grade credit rating. Or is it, the current business mix would satisfy those agencies?
So as you know, this a balancing act. I think as we look to the increased cash flow generation of the businesses, it will balance us out. This was all well thought out in advance, and there's no issue in that regard. Keep in mind also the leverage is coming down quite a lot as we do this.
Our next question comes from Paul Holden, of CIBC.
So want to go back to the on-balance sheet financing. I guess, first, on the home improvement loans that, Steve, you've already talked a little bit about. I guess what I want to understand is the economics while they sit on your balance sheet and then also any kind of credit risk or other risks you may be taking in that window while they're on your balance sheet.
The 2 components. The PACE loans are a state-approved product in U.S. It is a loan that ranks senior to that of the mortgage. It's a unique product. It actually forms a tax lien. So there's almost no chance of credit -- there's zero chance of credit loss because of where it ranks on the capital structure on a home.During the period that we are accumulating those assets on behalf of an institutional investor, the accumulation is hedged into interest rate changes. So we're not naked on interest rate exposure. And we have an agreement with respect to how the purchase price is calculated with the institutional buyer. So on the basis that we're originating is the basis they're buying, and then we're hedging in any movement in that basis during the hold period.The same applies to solar, that we are hedging in the book on the basis which we buy and the basis which we sell.And again, as I mentioned to Geoff, both of these were conducted after doing a lot of due diligence, both with the origination and credit methodology behind ECN and discussions and agreements with the buyers of the paper.
Okay. So in other words you're very comfortable that your expected returns are locked in.
Correct. Those returns, Geoff, will be at or higher than the traditional home improvement business.
Okay. Good. And then you also bought or funded a very small credit card portfolio transaction in the quarter. Just want to understand that a little bit better, maybe the rationale behind it and the expected duration on that book.
On that one, just as we were moving through the Kessler transaction, an opportunity came up for us to opportunistically fund a small portfolio that was for sale. That book is in run off. Most of that book runs off over the next year to 2 years. That's not a big nature of our business on a go-forward basis, but that partnership for us opened up some additional relationships, and that was in addition to the kind of return on the portfolio, a basis under which we undertook that investment. But on a go-forward basis, the managing, the originating, the advising side of Kessler is where our focus will be.
I think, Paul, just to add back into that, as we get into the next quarter you will see that we have expanded the buyers of the fixed income paper, including credit card books, into institutional investors; by that, I mean life insurers and fixed income funds. And we think that's an important growth factor for the company. We are very, very supportive of our banks and credit unions, but we are going to continue to diversify the bases of buyers of this type of paper. So the PACE paper is going to an institutional investor who wants long-dated, high-quality paper.The same thing is happening with the credit card manager. We're introducing new partners into credit cards who want to own it, where we can manage and advise and structure on their behalf. In this case, we're able to help facilitate their entry into the marketplace in exchange for becoming a partner for managing and advising. But it's not our core business to use our balance sheet. It's used strategically when we need to launch new institutional investors.
Got it. Understood. Okay. Next question is related to the aviation book. It looks like something has changed that has allowed you to sell assets more rapidly than you thought previously. So that's a positive. Wondering what that change is in the marketplace. And based on the math, it sounds like you expect another $50 million to $75 million to be sold second half of the year. Maybe you can confirm if my math is right there.
The sales that occurred in the second quarter, the globals, if you remember a quarter or two ago we announced that we took back some globals as a result of a lessee that went through a bankruptcy process. So we claimed those globals and moved rapidly to sell them. Those assets, as you know, the globals are high-quality assets. There's demand in the marketplace for business jets. And because of the nature of them these are big ticket aircraft. So moving those really helped moved the needle down further than we expected. Because when we first put out our forecast at the end of last year we obviously don't expect a bankruptcy to occur. The great news is we got in there quickly, we reclaimed them quickly, we brought them back to Toronto quickly, and we put them on a program to get them sold. And happy to report that the sales team did a phenomenal job finding those and for the right hands.Our focus, obviously, with the wind-down as much as possible is to sell aircraft. To refi them or to put them on long-term leases is not really part of our core focus. So having done that and finding opportunistic buyers is a big basis for that.So to your second question, you're right. On the last call we tied it to having about $420 million of earning assets kind of at the end of the year. Our pipeline looks strong. We've got some sales activity as we go, some assets under LOIs that we're currently negotiating. So we'd expect the number to be closer to $275 million to $300 million at the end of the year.So we think that's great. Kudos to our aviation group. I'm extremely proud of their contributions over the past quarter and really over the past couple of years moving a lot of assets out from aviation, releasing tremendous capital. Because as we know, on these a typical advance is 65%. So a lot of equity is tied into the assets. And enabling those, that released equity to be redeployed into these 3 profitable businesses is a great [ outcome ].
Okay. And then in terms of the redeployment of capital, it sounds like the tone you have this quarter is a little bit different than last quarter. Last quarter you kind of said you'd contemplate all opportunities, including potential acquisitions. Now it sounds like you've pulled back on that. Is my impression of your tone correct? And sort of what's changed in your thinking, if I am right?
Well maybe I'll start, Paul, and I'll let Grier pick up. But we are still looking for tuck-in deals within our 3 core businesses, but there was a rumor floating around that we're going to add a fourth business line to ECN. So I wanted to hit that nail on the head and say it's not going to happen, that we are still looking for tuck-in deals within our 3 core businesses.I think I'll let Grier speak to [indiscernible].
I would say we've got -- there's sufficient liquidity to support the organic growth of our businesses and look at other capital allocation alternatives. As you probably know, we have filed another NCIB. So we have that plumbing in place and that tool. And consistent with our strategy, we'll continue to look at that as an option. But no formal commitments, but we'll continue to be careful capital allocators, as we've been over the last 2 years.
I would say with the stock at $3.53, it looks very attractive.
Our next question comes from Vincent Caintic of Stephens.
2 questions. First, on Service Finance. So good growth trend. It seems like both you and your direct competitor have shown pretty good growth here on the revenue side. If you could update us on the pipeline and the conversations you're having with the manufacturer relationships? And then also the progress you're having on the penetration rates with the contractors at the existing relationships you have.
We don't publicly announce. I'm sure that that competitor that you mentioned is on this call. We don't publicly name names, but we have large -- we have landed an exclusive for a very large home improvement manufacturer and distributor, greater than the size of Lennox. But don't expect that to roll out any meaningful way until late this year, most likely in '19. So we are -- not we. Mark and his team are continuing to have significant wins in the marketplace.With respect to existing dealers, we're still going through and pulling in dealers at 170 a month under existing programs. So it continues to be a story of taking share, but as well as organic growth. And with respect to the competitor you mentioned, yes, we both do home improvement, and obviously they've had a very successful IPO. But I would comment to you that our model is different, in that we have a lot more revenue from management fees and our banking relationships are very, very clear. They are nonrecourse with respect to credit losses, prepayment or yield maintenance. They are whole loan sales, full stop. But congratulations on their IPO.
Great. We only have their word to get the valuations aligned there in terms of the multiple we see with your competitor, but that's great color. So next question, on the Kessler Group. So as an expert in the affinity card space, if you can kind of give us an overview maybe of the pipeline? It seems like there's a lot of competition amongst the affinity card players, so between the retailers and the banks. Maybe if you could outline the size of the opportunity you're looking at and how you see the environment playing out with this competition in this space?
So I will not profess to be an expert in the affinity space. That's Mr. Kessler and the people at Kessler Group. That being said, we are seeing through the Kessler Group just a lot of activity across the board. There are certain bank issuers and, Vince, you've obviously written a lot about this, but there's a lot of banks that are looking to grow their own branded cards. There's a bunch of other banks that are looking to partner and do co-branded cards. And it really is a bit of a hodgepodge of both, we would say.And the good news about somebody like a Kessler is you remember at the beginning of the slide presentation we talked about relationship with banks, relationship with issuers and relationship with partners. Kessler is strong across all those boards. Having established the first affinity card and establishing over 6,000 partner programs gives you a lot of credibility in the marketplace. And those partner programs and the partnership relationships are so strong that when that partner is looking to augment a program, institute a program, move a program, restructure a program, the good news is that that life cycle with a Kessler continues through all of those transactions. So obviously, the pipeline there continues to be strong.At the same time, the bank emphasis on increasing their own receivables under the bank brands are also very strong. And again Kessler's strong relationship with those banking partners, the product managers, the C-suites, puts them at the front and center across all those.So we really believe they have a unique model where, unlike a traditional banking relationship where you come in and get represented and get retained on a transaction to buy and sell, Kessler tends to work through the life cycle of a transaction. And their corresponding fee structure, taking a lot of their fees under kind of long-term annuity programs where they tell a partner, they tell the bank, we're in it for the long haul. You won't pay us up front; pay us over the long term. That's the better method.
Our next question comes from Mario Mendonca of TD Securities.
If we could go back to the balance sheet stuff, the growth in the finance receivables. On the manufactured housing, my sense there with the Floorplans is that you were going to add -- you were going to lend to some dealers over time and this would gradually get to, I think it was, I forget what the target was. Was it $65 million? Or $100 million? Or something like that?
Mario, $65 million at the end of the year.
So you added $43 billion (sic) [ $43 million ], or so, in 1 quarter, but it doesn't sound like it was to individual dealers. It sounds like it was 1 big deal. Could you just describe how that happened? Because it's different from the way I understood this to work.
So the transaction that generated that $43 million portfolio purchase actually was various Floorplan facilities with 150 dealers. And so the benefit of this transaction for us, twofold, right? One, the Floorplan loan in and of itself with a 7.5% yield and zero credit losses historically is compelling. More compelling is the new dealer relationships that were established with these dealers that would augment some of the growth. We've already seen those dealers refer business to Triad, and we continue to track that, because our ultimate goal is to do Floorplan, Mario, to get the benefit of the referrals for the originations and the loans, as opposed to the product in and of itself.
So were these dealers all new to Triad?
The vast majority of them were new.
And just so we're perfectly clear, the seller, was the seller like a bank or a credit union? Was that bank or credit union a bank or credit union that was in the syndicate?
Yes and no. It was a financial player. It's not a current funding partner.
So under no circumstances was this a loan that was somehow or a series of loans that were put back to Triad from someone in the syndicate?
No. This was just us being opportunistic to look for opportunistic tuck-in portfolio buys, and we continue to look for opportunities, whether it's on the core manufactured housing or on the Floorplan side, Mario.
Okay. And then on Service Finance. The fairly significant increase there in finance receivables. Again, I just want to be clear that we're not talking about loans in any way that are being put back to Service Finance or anyone. I want to understand the nature of these loans. Because although I think you would suggest that this is consistent with your strategy, it is different from how I understood this ECN would operate. So is there anything special about these loans being put back from any facility?
These are all new loans. They are not loans being put back from any one of our banks who are purchasing loans. As I mentioned in the last call or the call before that, Mario, we've launched a PACE product. PACE loans are approved by the state of California and Florida. They are senior to that of a mortgage. They are longer in duration. So the duration makes them not of interest to a bank. So we have been accumulating those PACE loans on behalf of an institutional investor. And we are completing our first sale of those PACE loans to that institutional investor, as we speak this afternoon.With respect to the solar loans, which are new loans, not loans being put back by anyone, as I mentioned before, those have a longer duration. They are interest -- 1 of our banks has spoken to them. Since then we've had other banks and 1 lifeco come and say they would like to participate in that, as well. And we are in the midst of closing that sale.
Okay. So, the solar loans, and that's where I was going to go next, they're not automatically transferred to that 1 bank you referred to in the past.
We do sell solar loans. Last year, 12% of our originations were solar loans, and we do sell them through to our core banks. We've had 1 bank in particular that would like more solar because they have a need for longer duration and a higher yield. And we are forming a specific pool for them, in addition to selling solar through to our existing banks.Since that bank has expressed an interest and arrived at a term sheet, we've had other institutions express interest in those long-duration solar.
Okay. And then the PACE loans, how material is this going to be? What proportion of the $355 million in originations were the PACE loans?
Pace loans average anywhere from $4 million to $5 million a month.
What I'm getting at is the increase in the finance receivables was fairly significant this quarter.
Right.
So the $355 million...
We've been underwriting PACE loans now for 3 quarters, Mario. So it's been averaging about $4 million to $5 million per month. We have a buyer for those PACE at $50 million. We are now at $54 million. We're executing on that sale, as we speak. Going forward, think of $4 million to $5 million as a run rate, and that institution will buy the go-forward flow, as well.
Okay. So maybe to put this, to just wrap it all up then, because this growth in the balance sheet is not something that I expected and I think by the nature of the questions you're getting there are probably a few of us that didn't see it coming, how much larger do you expect the [indiscernible] loans to get? And I'm not interested in what's going on with rail or aviation. I'm just talking the 3 core verticals.
The Service Finance book will shrink because, going forward, the PACE will be sold on a flow basis and solar will shrink. So think of Service Finance having $75 million of outstandings, maximum.
And then Triad? $65 million makes sense there. That's what you told us.
We put that forecast out at the beginning of the year. We're actually ahead of it. We'll continue to look at a few additional dealers as they come on through the course of the year, Mario, but we've essentially hit our year-end targets. So don't expect a big increase in that this year.And then, going forward, for planning purposes, as Steve mentioned, when we forecast we'll continue to provide updates on things like Floorplan for that business every year.
And I would just add 1 comment, which is all of these 3 categories are driving the core growth in our loan originations and sales, the 60%-plus at Service Finance and the 20% at Triad.
Our next question comes from Brenna Phelan, of Raymond James.
So I just wanted to start on the aviation asset sale. Did that come out of your inventory? And the charge-off of $4.6 million, does that relate to the carrying value of the $70 million of proceeds you received?
Combination. Obviously, the largest -- the example I gave with the globals, one of them was in inventory coming off the bankruptcy that we discussed earlier. So it's really a combination, Brenna. At the end of the day, obviously we focus on the complete wind-down of the portfolio. If things are in inventory, we're looking to move those quicker. That being said, even the earning assets as we continue with the wind-down we'll be opportunistic.So we don't distinguish. We are looking for opportunities on all of the assets, whether they're earning or inventory, because I think our primary focus is a prudent wind-down of the strategy. So every quarter that combination will change, but it will tend to be from both inventory and from -- but mostly from earnings assets.
So can I think of the $4.6 million charged off from your allowance as relating to that $70 million sale?
Given the larger ticket nature, that's fair.
Okay. Then on the Kessler Group, the sale of that noncontrolling interest, do you still expect to sell the remaining portion to get to the 10% sale? Or is that finished now?
We've talked about 10%. Having closed the transaction and actually being extremely busy at Kessler with the Walmart deal, amongst other things, we're still talking to senior members about the buy-in. So I would expect 10% over the next short while to be sold to senior management as we promised them. [indiscernible] we'll report, obviously, that that's the case because that impacts, obviously, ECN of the earnings of the entire company that we report on.
Right. Okay. And then moving on to Service Finance, would these PACE loans that are currently on balance sheet, when they're sold will the origination and management fee yields be similar to the rest of your portfolio? Are these higher or lower? As you move into potentially more institutional buyers, are you pricing your management fee the same?
They will be sold at a margin slightly above our traditional home improvement margin.
And same management fee?
They're longer-duration assets. So over the term you'll have the same management fees. In essence, these are -- they are 9- to 12-year duration loans. So you'll get to the same economics as you would in home improvement when you look at both origination and management.
Okay. And then last one for me, can you just give us your thoughts on the GreenSky-AMEX partnership that was announced earlier this week? Is this something you'd be interested in pursuing? Can Kessler help out with that?
We don't understand more than what was in the press release. We don't use the credit card rails to originate transactions. As you know, we originate them through RICs and sell them directly to the banks. So it's not a method of origination that we have chosen, and that's by design. So I can't comment.I would say that the Kessler relationship has helped us by opening up banks who they currently manage credit card portfolios that we are now in due diligence with to have them buy either Service Finance or Triad portfolios. So that's been the big opportunity.
But my understanding was that this partnership allows merchants that accept AMEX to offer GreenSky financing options at the point of sale. So that's not necessarily using credit card rails either, right?
We do not use credit card rails or credit card issuers or merchants, at all. Full stop.
Our next question comes from Jaeme Gloyn, of National Bank Financial.
I just want to go back to the balance sheet questioning. The increase I guess isn't necessarily a surprise for me, but I guess the pace of the increase was a little bit quicker. You did speak about increasing and using the balance sheet for Triad Floorplan financing. And also around -- and then also on Kessler around the risk-based marketing segment, and that was I guess supposedly supposed to be a growth channel, as well. So I guess the question is, what do you expect the breakdown to be of that sort of $250 million to $300 million in finance receivables a month in the 3 segments?
I think I commented on Service Finance that going forward the PACE product will be sold through to the institutional buyer. So that will be, I wouldn't call it effectively zero, but maybe you've got $5 million, $10 million in monthly flow, but it's de minimis. And solar will be in that $25 million to $50 million range once you get the initial portfolio sold, which is being sold as we speak. You do have some dealer advances. So call Service Finance, as I mentioned earlier to Mario's question, no more than $75 million.
On a run rate.
On balance sheet at any one point in time.When you look at the growth -- you have to relate the on-balance sheet to the overall origination growth. The overall origination growth is over 60% year-over-year. So you need to be able to provide some balance sheet that supports or drives that origination growth, and that's what we've done.
Right. And then Triad, $65 million for now, growing from that base to, what would you think maybe by the end of 2019? And then the same question for Kessler.
As it relates to '19, not sure for '19. For '18, we still have -- having launched it in January, we've still got applications that are in the queue and that we're reviewing dealers to bring on, especially new relationships that are afforded to us. I don't have a number in terms of what to expect for the end of the year, but it won't be much higher than what $65 million today is. Obviously, with that big purchase, [indiscernible] advance and that opportunity that we sourced [indiscernible], we're not looking at it as aggressively as we did at the beginning of the year. That being said, if it makes sense we'll take on a new dealer.As it relates to '19, I'll have to sit down with the experience over the next few months to entertain what we're going to do for '19. Obviously, important for me because those dealers we've signed up and the Floorplan lines we've extended are leading potentially to originations. If that continues, we'll continue to go hard at it and grow it because it makes good business sense.As it relates to Kessler, that was an opportunistic portfolio buy in a run-off book. It's going to run off over the next 12, 24 months. That's not core to us. That's not the nature of our business. I don't see that continuing on a go-forward basis.
Okay. So what exactly is the plan for the risk-based marketing then and the capital that you would expect to put up in that segment to drive growth? What's the plan there?
So for '18, they're going through aggressive growth as we speak. Our first use of deploying capital for those programs is from the business itself. The business is generating cash. The average program for capital is -- the average outlay there is for a 3-month marketing campaign. So the payback tends to happen very quickly on those programs. And historically, Kessler has used its own capital, obviously, to fund those.In '18, we expect them to fund their own programs; going forward, we expect the same thing. What we've told our partners at Kessler is if your growth is stronger than expected, which is good news, we're there to help you finance those programs. But for all intents and purposes, if you think about '18, for example, even though they're going through strong growth, we'd expect it all to be financed internally through their own capital.
Okay understood. And then just in aggregate what would be the debt advance rate, if any, on these receivables?
It's like a 3:1, Jaeme.
Okay. Great. And last one from me, just around the Airbus settlements a couple of weeks ago or maybe a few months ago now. Can you just comment on what that means potentially for your helicopters that are exposed to the same issues around potentially timing for settlement and magnitude of that settlement?
So obviously, we're actively involved on that file. I can't speak too much about it, obviously, because we're in litigation. We filed a claim in the Ontario court, and that's going through its queue. An important event that happened in quarter was the delivery of the Norwegian final crash report that we viewed as -- which kind of outlined the reasons and recommendations for the crash. We view that as favorably. So we hope that between the combination of litigation and [indiscernible], we can have that resolved. We took the reserve against those assets which we were prudent to do. I can't give you an exact indication of timing when this will get settled or whether this could settle commercially or through a court of law. We certainly hope that we can settle it commercially. But I can't, unfortunately, given the uncertainty of this, give you an indication of exactly when that will occur.That being said, as developments happen I'll continue to update you. But again, we're pleased with the findings of the report in terms of the strength of our claim.
Our final question comes from Tom MacKinnon, of BMO Capital.
Just a question with respect to the corporate segment. The interest expense went up quarter-over-quarter. Maybe you could just elaborate a little bit on what's driving that and how that would then come down, as you kind of alliterated before that or reiterated before that your credit facilities will be coming down, as well, and I think that reduction in size of credit facility is completed by the end of the third quarter? So I'm not sure if this is just a temporary jump up in terms of corporate interest expenses, but maybe you can enlighten us on that.
So you're right. The plan is to restructure our credit facility and bring the size down, and I think I alluded earlier to the standby fees and the upfront commitments, which will come down by about $2.4 million, I guess, annually on the standby fees, and then the upfront commitment is about $500,000. So that will be about $3 million a year in savings.With regards to interest costs, when we originally did our plan for 2018, you'll recall we did not have Kessler in our plan. We also did not have the substantial issuer bid in our plan. And accordingly, our capital structure would reflect that. So fast forward from that plan, I think we said it would be in around $100 million or $150 million in draws on the line.So fast forward, we've done the substantial issuer bid. We've executed our investment in the Kessler Group. And accordingly, our draws are much higher now. It's more now like $500 million, plus think of the investments we've put into balance sheet opportunistically to help organically grow these businesses. And you end up with a number about $500 million.So accordingly, the interest cost is higher, and I would expect that to continue as this is kind of our run rate capital structure. Does that help?
Okay. So I think we just kind of look for this rate to continue. And then where do we end up getting -- the benefit of the drawdown in the credit facility, where does that come in? That comes in corporate?
The benefit of the drawdown. So I'm not sure if I understand the question.
The benefit of the reduction in the credit facility, where does that -- we've got 2 things. We've got 1 thing driving interest costs up, and then we've got another thing that's supposed to be bringing them back down. So I'm just a little bit confused as your interest expense in your corporate you're suggesting it remains the same.
So they will go through the corporate segment. That's right. They'll go through the exact same line time. So interest cost, expect that to stay very close to what it is now. That said, we're going to generate cash and there will be other opportunities. But all other things equal, it will be pretty close to where we're at now. What we're looking is to bring the facility down in size, which will take down the standby fees and the commitment fees. They'll come out of the same line item.
So standby fees and the commitment fees are in the interest expense line, right?
That's correct.
So should we expect interest expense in corporate to stay around the same level? Or should it start to come down as a result of the reduction in size of this credit facility?
Firstly, I'd say this. The Kessler acquisition wasn't done until the end of May. The SIB was done halfway through April. So Q2 is not really representative of a run rate quarter anyway on interest expense. Q3 will be more representative, which again I think the draw is about $500 million right now, multiplied by our LIBOR plus 170 is the draw rate.When we restructure the facility at the end of the Q3, the ongoing standby fees will be reduced by $2.5 million annually, and then the upfronts will go down accordingly. But that will all go through that line item on that basis. When we get to Q3 and we introduce our guidance for next year, we'll reflect all that and hopefully give you a clearer picture. But those are the pieces moving around.
Okay. And then 1 final thing. With respect -- we can sort of, with respect to you've got some revisions with respect to aviation in terms of the assets at the end of the year. But if we were looking at just Rail Finance next year, does it just kind of stay around the same or just modestly down? You're calling this a legacy business, but the earnings, I guess, even if we took out the originations, the average earning assets seem to be generally flat quarter-over-quarter. So if this is a legacy business, this rail is running down very, very slowly.
Like I said, we are -- Tom, we look into the marketplace and every couple of quarters we test the market with syndications. We've been doing that since we got into the rail business. And it's just a way for us to test appetite for leases. Those syndication sales activities every couple of quarters generate good returns for us to supplement the interest income for the business.So we'll continue to look opportunistically at opportunities in the marketplace as they unfold. And if there are opportunities to continue to kind of move rail assets, we'll continue to do that. In the interim, they are on our books. They are generating good returns. But look for us to be more aggressive on that syndication front, going forward.
But just in terms of average earning assets in rail, do we just expect those things just to sort of run pretty steady through next year, as well?
I think it's fair to say quarter-on-quarter it didn't move much, but year-over-year or 18 months it's moved a lot. It's down 60%. So to Jim's point, we look for opportunities to sell substantial parts of the portfolio, but we're not running to do it. It's a great portfolio. It's got investment-grade paper behind it. It performs nicely. Stable cash flow. And we will sell this portfolio when we get the right bid. But it will be chunky, Tom. But it will get sold, but on our terms.
And if you didn't sell it, do we just see the average earning assets relatively flat through next year?
That's not the plan, Tom.
There are no 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.