ECN Capital Corp
TSX:ECN
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ECN Capital Corp
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Thank you for standing by. This is the conference operator. Welcome to the ECN Capital First Quarter 2020 Results 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.
Thank you, operator. Good afternoon, everyone. Thank you for participating in our conference call to discuss ECN Capital's First Quarter 2020 Results Announced earlier today. Joining us are Steven 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 March 31, 2020, have been filed with SEDAR. These documents are available on our website at www.ecncapitalcorp.com. Presentation slides to be referenced during this 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 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 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. All figures are presented 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 good afternoon. Turning to Page 7. The disaster recovery plans have ensured that all of our businesses and operations and functions have performed remotely. Given our Florida locations, ECN has robust capabilities and protocols in place due to our necessary preparedness for hurricane season in a seamless transition. ECN and each of our subsidiaries are fully open for business, albeit on a remote basis, with complete functionality, servicing capability and our full suite of core product offerings. The most important fact to take away from these opening remarks are that each of our businesses has shown strong resilience through this unprecedented time with performance substantially improving through May, and we'll speak to that shortly. Turning to Page 8. I'd like to touch upon 4 areas of particular focus. First of all, the resilient businesses. We produced strong results in the first quarter, as you noted, $0.06, including we've expensed off business development that we've curtailed and will not be pursuing. After initial pullback from the virus, improving trends in place over the past several weeks, we'll walk you through those shortly. Servicing and partnership income provides stability with financial institutions and our counterparties. And finally, but not least, the quality of our credit assets have demonstrated exceptional performance to our funding partners. And I'll be providing details shortly on each of our businesses. ECN's proven model has liquidity to fund originations. Committed funding remains in place, both from our bank, credit union and institutional partners, who are purchasing loans as committed in addition to the liquidity we have in our balance sheet. Demand for prime and super prime assets remain strong. Our corporate liquidity remains high. We -- as you know, we have a $4 billion -- 4-year, $1 billion committed line with major banks, which was recently extended to '23. We have significant positive cash flow. We have, I think, we believe a material corporate expense reduction program in place, which we will review shortly. And we've done a deep dive in all our on-balance sheet assets to ensure there's no impairment. And finally, we believe this is a significant period to take share. We're well positioned to take share during this economic disruption. And we believe the franchise value as we support our partners and customers will increase. Although it's difficult to provide the short-range outcomes due to the virus, I strongly believe, although, we're withdrawing guidance for now and we're refreshing at the end of Q2, that our baseline for this company is the $0.27 that we produced in 2019. And by that, I mean, the low end. And I believe that we have a line of sight through to at least $0.36 of earnings for this company. Turning to Page 10. Service Finance had an extraordinarily strong first quarter. Operating income was up 43% year-over-year. Originations with excluding PACE were up 29%, and we have robust dealer growth. By all accounts, it was a strong quarter. So everyone's asking, "What's happened since the end of the first quarter?" On Page 11, you've seen a 3% growth year-over-year with shelter-in-place orders. In fact, you've seen strong HVAC growth of almost 30% in Q1 and almost 45%, 46% in April. Lennox volumes were very strong. I think the 2 charts on the right-hand side of the slide tell the story, as after an initial drop in April, you've seen an increase in both the approvals and applications. Those beget fundings or originations in our world, and you began to say that as May 13 with respect to the applications and approvals increasing. The one negative has been solar finance decision to limit solar production. We did that -- we had undertaken that before the crisis. It's not new. And if the shelter-in-place orders have stayed in place, our installers have not been able to put solar rays on the homes of consumers. But that was already part of our plan for 2020. Turning to the credit quality of our portfolios. On Page 12, we're happy to report that our portfolios are performing better than almost any credit asset. We've seen limited impact of payment deferments. Deferments debt at 1.7%. And you'll see the line on increases for additional request. We believe deferments have bottomed. At the same time, the performance on arrears and credit losses has been exceptional. I think you have to stand back and say to yourself, "Why is this happening?" And I would make 3 observations for you. The first, our portfolio is one of super prime and prime credits. We're not in the near prime or subprime business. Our consumer profile are people who make more than $40,000. As you know, a large chunk in the unemployment in the U.S. has been focused on households under $40,000 of annual income. And we are not in urban locations. Neither of our businesses are in Manhattan or Chicago or Dallas or L.A. We are a suburban and urban model with respect to Triad. And finally, I would note that secured and amortizing nature on loans puts us in a better position to outperform. So I'm happy to say that our portfolios are performing extremely well on behalf of our investors who have purchased these portfolios. Turning to Page 13. Assets held for trading, down from $274 million in Q4 of '18 to $99 million. There was a rise during this quarter. These assets on our balance sheet have the same credit quality and characteristics as those in our bank portfolios. And the moment people come back to the phones with our bank counterparties, these assets will be sold. Page 14, summary of originations we've had, I think, for at least 2 years. No new change there, strong originations for Service through each quarter. Turning to Kessler Group. I'd like to note on the first line that partnership revenue is up 32% year-over-year. That reflects the results of the strategic shift we made in Kessler away from one-time M&A-type revenue to annuity-based revenue. We're happy that, that strategy is working. We saw marketing services decline, which is no surprise. People are taking time to reorientate their marketing programs. We believe that's a timing and a deferred issue. It's not a lost revenue. We'll walk you through that in a second. And the transaction revenue year-over-year, you have to note that in Q1 of 2019, there was a onetime large fee from the sale of the Walmart credit card portfolio. Turning to 16. You see the evidence of the shift away, as I mentioned earlier, from onetime to recurring revenue. We're happy with that shift. We believe in the marketing services business that, that business will not be lost. That will be moved into late 2020 and early '21. I think it's really important to note the transaction service business had the best year that KG ever had was just after the post-global financial crisis of 2010, 2011. And we know the pipeline is building quite nicely as credit card owners look for new opportunities. Turning to Page 17. With respect to our on-balance sheet credit card investments, we have the opportunity as part of our deep dive across our entire balance sheet that we stress this book to the levels of the great credit crisis, the great financial crisis. I'm happy to report that because of the structures in place, whether it's the management fee structure, loss caps or other protections that we will recover 100% of our invested capital, and we continue to expect a positive return. We're obviously not proceeding with additional investments of this type at this time. And as you know, these investments were made with partners in order to drive core revenue from our service business. Turning to Triad on Page 18. Again, strong results, I believe, in line with expectations, both on originations and earnings. I think a really important point to speak to the quality of the portfolio here in Service is that 5 new credit union partners were signed up year-to-date, 3 in the first quarter, 1 in April, 1 in May. I think that speaks volume to the quality of the assets that Triad is originating. We saw loan receivables in the Floorplan increase. That was principally due to homes that have been manufactured sitting at a manufacturer site with approved contract and funding in place, and they're awaiting delivery to the site. The site has been restricted due to the shelter-in-place. That backlog will clear and that balance will come down. Again, this was subject to a detailed credit scrub, and we see no loss whatsoever in the Floorplan business. Turning to what's happening post March on Page 19. Applications were down materially in April year-over-year. Happy to report that they've rebounded in May, and we've seen improving traffic. Manufacturers temporarily closed 50% of the plants in response to quarantines. Most of those plants have reopened by this period. Most dealers remained open and have seen improved foot traffic in the last 3 to 4 weeks. Turning to Triad's portfolio of credit terms. On behalf of the credit unions and banks who purchased these, we implemented short-term deferment programs approved by our banks. It's typically a 2- to 3-month extension, which added the end of the loan. As similar to Service, you see that those deferment requests have come down. If you contrast the level of deferments on this portfolio versus traditional mortgage book, you'll see it's fared much better. And the 30-day delinquency is up to 1%. I would note that in May, those delinquencies, in fact, are improving. We have no changes to loan losses. Page 21, originations remain strong through the first quarter. Michael?
Thank you, Steve. Turning to Page 23 and the consolidated operating highlights. Total originations of $509 million were up over 21% compared to Q1 2019, reflecting growth of over 29% at Service Finance and over 13% at Triad. Adjusted net income applicable to common shareholders of $0.06 per share is in line with our internal budget, reflecting the strong start we had to the year. Turning to Page 24 and the balance sheet highlights. Total assets were down slightly compared to year-end, but finance assets were up by approximately $50 million, reflecting growth at Service Finance and Triad, as Steve noted earlier. Our plan remains to continue to reduce on-balance-sheet assets. Portfolio sales that were in the queue for March got delayed due to the COVID-19 pandemic, but we have begun to reengage with buyers this week as people start to return to their desks. Debt was up approximately $64 million, largely due to the increase in finance assets. Now turning to Page 25 and the income statement highlights. We have provided a detailed breakdown of the income statement. Key highlights of the growth in origination and management services revenue, again, reflecting the shift in our business to more recurring revenue streams, partially offset by the decrease in transactional revenues, as noted at KG. Adjusted EBITDA was in line with Q1 2019, while adjusted operating income was up approximately $1.7 million compared to the prior year due to lower interest expense and lower noncontrolling interest expense, which reflects the buyout of the remaining noncontrolling interest in KG at the end of 2019. Turning to Page 26. Operating expenses were up at Service Finance and Triad, which was in line with the increase in revenues. This was partially offset by lower operating expenses at KG due to the impact of cost reductions implemented in Q1 2019 and lower compensation costs due to lower revenue. Corporate operating expenses of $7.5 million were up compared to the prior year and our normalized run rate due to the nonrecurring business development and other expenses related to the pursuit of our growth opportunities that Steve noted earlier. Finally, turning to Page 27. In response to the COVID-19 pandemic, we launched a comprehensive expense reduction initiative, including reductions to executive salaries, a 25% reduction in Board of Director fees and significant reductions to business development, travel and entertainment and professional fees. As a result, we expect corporate operating expenses to be in the $4 million range for the remainder of the year. We also have an ongoing review underway at each of our operating companies. And with that, I will turn it back to Steve.
Thanks, Michael. Just on Page 28, highlighting our discontinued operations. These are also subject to the same detailed credit review. The rail business is in good shape. The aviation business is fine, as you would note that our aviation business is largely that of civil aviation being corporate aircraft and helicopters. We'll see what happens with corporate aircraft. The helicopter market, we actually had some sales of assets in the first quarter and sales in the second quarter, so that market is, strangely enough, coming back. We'll see where the value of business jets lie. But I have a view that those jets will actually be in larger demand. Right now long-haul jets are not flying, but think post the crisis, there will be a demand. And we'll wait -- we'll look at the valuation of those in the second and third quarter. Turning to the -- to my closing remarks. I'd like to highlight, going back to the forecast, that although we withdraw in guidance, it's still my strong view as CEO that we have a lower end -- a baseline at the lower end of $0.27 for the path through to growth for 2020. We've got to get to the lower end of that, and we'll see what the virus brings us. But I think I've been very comforted by the rebound in our businesses, both through -- in both Service and in Triad. And we have high-quality products and services. I think the note I want to make to on that is that we're not a restaurant, we're not an airline, we're not a hotel. None of our business is lost. It's deferred. And I think the reflection of that is, as you saw the rebound in April in the businesses, we have resilient and recurring businesses with strong growth opportunities. And you see that evidence, whether it's manufactured housing or HVAC or roofing, we think we're well positioned. We have robust liquidity. And I believe our prime and super prime assets have performed exceptionally well through a stressed period. I wish we hadn't gone through the stress test, but we have, and I'm very happy with the credit quality of our portfolio. And obviously, our dividend is maintained. There's no question about our dividend. And with that, operator, I'm happy to open the call to questions.
[Operator Instructions] The first question is from Geoff Kwan of RBC Capital Markets.
My first question was on Service Finance. So if we look at the 2019 revenues, like roughly how much of that would have been revenues driven out of necessity, like an HVAC unit breaking down and needing to be replaced, versus revenues that may have been arguably a little bit more discretionary like an upgrade or renovation?
Yes. Geoff, the -- I would say, I'll get you the precise number. But approximately 70% of services businesses, items like HVAC, roofing, foundation repair, electrical and plumbing, all of that was deemed essential. We did see other areas like windows and doors contract, but important to know that windows and doors has come back in the last 3 to 4 weeks. So it's -- overall, the numbers speak for themselves. And there's been some deferment, obviously, and people not wanting their kitchens or their bathrooms remodeled, but the growth in the other areas has more than made up for it. We've had some significant competitive dislocation. I don't want to go into individual competitors, but some competitors are not with us today. And that's helped us with our growth.
Just to remind you, Geoff, last year, we had about 24% of our originations in the solar area. As we've noted, obviously, what's gone on, solar, what's going on with solar. But what's to take away with that is the growth we have is in all those other areas. So just keep that in mind.
Okay. And then on Kessler, I'm just trying to make sure I understand this right in terms on the managed assets. I mean if we see a decline in consumer spending, that would presumably also be a bit of a headwind on Kessler's revenue base? Is that correct?
Yes. Well, balance -- yes, you would because we get -- as you know, Geoff, on the annuity stuff, we get basis points on the gross balances, not with respect to credit losses. But we haven't seen that. We've seen balances slightly up. And time will tell. I can't -- I haven't got a crystal ball, but we haven't seen that contraction. Again, our revenue is based upon gross outstanding, not with respect to credit losses.
Okay. And just my last question is staying on Kessler. The credit card M&A you were talking about coming out of global financial crisis. Just in general, like in that type of environment, like what are the reasons that would drive increase kind of M&A? Is it companies that are seeking to extract more economics from their financial services partner or -- to kind of improve the bottom line? Or what would be the kind of the key factors?
Geoff, I just think when you go into periods of stress like you have during the financial crisis or when credit losses spike as you go into recessions or things, you have owners of these assets that rethink their strategy. And as part of that rethinking of the strategy, typically, what happens is you see portfolios moving around, might have a total rethink of the strategy and exit the business or you might just be thinking about moving this portfolio or that portfolio. When you have periods of stress that typically will create the opportunity for that rethinking of strategy. And that's what we've seen pretty consistently over the years.
And those conversations have begun, Geoff.
The next question is from Tom MacKinnon of BMO Capital.
Just a couple of questions. Maybe, Steve, just starting with your comment about a line of sight to at least $0.36 and a $0.27 baseline. Maybe just what -- you talked about a broad range of outcomes when you decided to take away guidance. So I'm just wondering what is involved in a baseline assumption of $0.27 and a line of sight to at least $0.36? How long of a shutdown, the likelihood of second wave? If you can just share with us a little bit of color that went into each one of those statements you made.
So Tom, obviously, I haven't got a view of how long the shutdown occurs. We have been insulated. As I mentioned earlier, our customers are a suburban rural model. So we -- and you've seen the smart recovery in both Triad and Service Finance. I can't predict that there's going to be a second wave, Tom, so hence, my caution on the forecast here. I think we'll know that by the end of the second quarter. But if you look to the recovery that you've seen in May, then I can get back to my origination numbers for 2019. And if that recovery continues and the competitive -- the competitors have gone away, then I think we have an opportunity to grow our share. But I can't predict, Tom. I have a view of -- a personal view about the second wave. I think we'll handle it, but we'll wait and see.
Yes. And Tom, we went through all exercise internally. Obviously, we worked with each of the businesses to come up with forecasts under various different scenarios, and I think we feel pretty comfortable that we did a real thorough job there and really kind of understand what the puts and takes could be here for this year. So I think when -- Steve is fairly confident what he's talking about.
Okay. And with respect to Service Finance, I think the comments were -- based on results in April and early May in terms of originations, you said you're in line with the second quarter '19. But does that mean -- I assume that means the second quarter of month -- or quarter-to-date 2019 in terms of originations is similar to quarter-to-date in 2020 to Service Finance?
No, I think what I said, Tom, is on Page 11 that applications and approval we're up 30% -- 35% year-over-year. And if you use the approval number, it begets fundings, right? So I think you can assume that funding is for that period. They take some time, right? If I'm approving a roofing job today, I won't turn into an origination of funding for 30 or 45 days. But that 35% year-over-year increase on applications and approvals gives you the confidence you're hearing in my voice with respect to originations. It's the top end of the funnel, Tom.
What we'd say was that in April, even in April, where we saw whatever -- the adversity that we saw, we still had 3% growth year-over-year in originations at Service Finance. Month-to-date in May looks roughly similar. These -- like Steve said, these originations, these applications come in, and there's a bit of a delay between the application and approval and then the actual origination because we don't fund until the job is complete to the satisfaction of the customer.
Okay. And the final thing is in Service Finance, what percentage of the services that you do there are deemed essential? I thought it was somewhere in the area of 55%, is it 70%? Is it all of it?
No, Tom. We -- I mentioned earlier in a taped interview that we are approximately 55% to 60%. The part that's come back in the last 3 to 4 weeks has been the windows and doors business that's now up. Those businesses are 70% and are extremely strong. I think what you're seeing is that super prime and prime credits are staying home, and they're not spending money on vacations. They're not spending money on dinners out. They're spending money on improving their homes. And you're seeing that elsewhere in the home improvement sector. And our contractors have found workarounds to how to deal on a safe basis and social distancing. We're doing the consultations in the backyard, and we've learned how to be -- they've learned how to perform the services on a safe basis. A lot of learning process.
So there's nothing to suggest that the business that Service Finance does right now would be deemed nonessential?
Correct.
The next question is from Jeff Fenwick of Cormark Securities.
Steve, you mentioned the deferment levels at Triad and SFC. Can you just speak to what do the economics look like in terms of the impact on those 2 businesses?
Right. So these are -- as you know, Jeff, good question. We -- these are the banks portfolios we've already been paid for originating it. We get to pay to service it. Our servicing contracts allow for a little more revenue. We spend more time on it. In the U.S., deferments are a little different than Canada, these are actual deferments. You can't call them arrears. They get stuck on the end of the contract, and you collect them then. And we get paid on -- you've got a small lengthening of the contract, so you can probably expect Service revenue to be up a bit. And we get paid a little more for the work on it. But right now to be clear, Jeff, all you're allowed to do is to call the consumer and ask how they're doing. And whether they're employed and things like that, you cannot aggressively pursue a collection activity. However, we haven't seen a degradation in arrears. So we feel very good. If you could talk to our funding partners who buy these assets, they're very happy with the quality of these portfolios versus other portfolios. And you see that in the net additions in Triad to new buyers coming on board.
And I was thinking in terms of the added fee revenue, you might pick up in that extension of the life of the book -- the contract of the book.
Yes. Yes. Fair enough, Jeff. We haven't had a chance to model through that. We're kind of dealing with this live. But there's probably an opportunity there. We just haven't had a chance to turn our mind to it yet. Making sure those portfolios are safe and sound for our bank investors and credit unit investors is the first priority.
And I guess maybe you could speak a little to the conversations you're having with those partners today and how are they feeling at both of you. And are they signaling anything to you in terms of either their appetite or their view on pricing, et cetera?
Well, on pricing, you're given by -- prime and super prime credit in the U.S. is not capped out. And our competitors, whether it be nonbank or Wells or Synchrony have increased pricing. And so the pricing is the pricing. But obviously, these yields are attractive compared to other investments that our buyers can get. I think the performance speaks for itself, Jeff. They're happy with the quality of these assets.
And maybe speak to...
No, go ahead. Sorry, Jeff.
In terms of the Complementary Flow program and what you're holding on your balance sheet there, I think that's principally one funding partner you're working with. So is there anything -- any change in the status of that program?
No, it's 2 or 3 buyers who buy those paper. They'll buy the paper. There's no one -- they're not sitting at their desk at the other end, so we've made sure the underwriting requirements are -- haven't changed. We made sure we did a review of both the performance of the bank portfolio assets in these and they're exact -- they're right on top of each other as you should expect. There's no -- we're not taking lower-rated credits or changing our underwriting standards. And now the people in the last -- today was a busy day because people have come back to their desks, and they're now picking up their pens again. So I'm comfortable -- confident we'll sell these assets.
And then I did note the added spend on corporate development this quarter. And certainly, it seems like we're in a period where there's going to be some dislocations. How are you thinking about being positioned to be opportunistic here?
I think everything that we had in Q1, we killed. So just walked away from any conversations, which is the appropriate and prudent thing to do. We'll watch. Now both of our businesses, all 3 of them are able to onboard existing customers from the existing challenges. You've seen the growth in dealers from Service. You've seen growth in Triad. I think we've had some -- I don't think we've had significant competitors leave both those businesses, and our focus has to go after those dealers, and we can do that without spending any money.
The next question is from Vincent Caintic of Stephens.
First question is if you could talk about the conversations you're having with the customers or your dealerships at the different segments. So for Service Finance, how are the conversations? And what are they asking for from the dealers and the manufacturers? Same thing for Triad and then when you talk to your retail and bank partners on the Kessler side, any help or specific discussions that are going on there? Just trying to get a sense of maybe what sort of opportunities or topics are on?
Yes. Well, as we -- as you know, Vincent, in a period of recovery, sales finance plays a disproportionate role in getting back revenue. And we're in the conversations with our major manufacturers and dealer networks about promotional programs that will secure that revenue. So those conversations are underway with those partners. What are the promotions we're going to add in the summer and in the fall to get consumers come back, and I would say the consumers have come back based upon the numbers we have in front of us. We continue to -- with manufacture support in Triad, they're offering 90 days, don't pay; first payment on 90 days. That's all backed by the manufacturing, not by us. So those programs have been launched. So a series of programs and buy downs have been launched.Others are in conversation. This is not -- this is a chance for -- sales finance has always been sort of 30% of the revenue pie, if you look at credit cards and cash in a recovery. And I haven't got my numbers in front of me, but it tends to grow to 40%, 50% of the pie. So we're going to aggressively pursue that. However, we're not going to pursue it at the expense of credit quality. We're going to maintain our underwriting standards, so we're not providing lesser credit quality into our portfolios.
Okay. Great. It was great to see that April and May growth was pretty strong. And it seems like from the charts on the deck that there was an inflection point on April 15. I'm wondering how much of the growth is maybe driven by U.S. government stimulus to U.S. consumers? And would it be a good number to expect a 35% and 25% growth you're seeing in Service Finance and Triad? Is that something that we should be expecting going forward?
Yes. I don't -- well, the vast, vast majority of our customers would not qualify for U.S. stimulus of the super prime and prime nature and employment and their income levels. I think what you're seeing, Vincent, is just the return to work that we found a way to offer our services on a safe basis. And again, people are sitting home, want to improve their home. Maybe John, do you want to add to that?
Yes. I would say, I mean, a lot of places in the country really started to clear in mid, late April. Not that everything was clear. It wasn't like you're necessarily going out to restaurants or anything like that, but people were getting back to work. In addition to that, I think you're talking about prime or super prime customers. They probably had plans to do other things that they're probably not going to do right now, which is vacations or whatever it is, and they've come back and they've decided to do some of the work around the house that they're looking at. So for various reasons, I mean, in the first week or so, we saw it in both companies, I mean, that was when you were deep into -- the lockdowns were new, and people are trying to figure it out. And I think as that loosened up a little bit in different areas of the country, you really start to see a rebound.
Okay. That's helpful. Yes. So that's great that -- it sounds like you aren't over-earning for the stimulus. That's great. The last one, and I appreciate your confidence in the baseline expectations, even though, you've pulled guidance. So I guess when I'm thinking about what's the worst, I guess, sort of worst-case scenario or bare tree scenario you can think of? Because it seems like it's just that maybe your origination slowed down because it's deferred and that comes back later? Or are there other risks that we should just be thinking about?
I think it's the latter, Vincent, that you could have -- it could be later to recover. We'll see what happens in this "second wave." But even during the first wave in the heart of it, we were flat. We were flat to [ $19 million ] in the depth of this, right? We were renewing bank commitments in the depth of this. So I think its one-off timing. I know its one-off timing, that if you're in Arizona and your air conditioner breaks and the heat is on in Arizona right now, it's going to be fixed. If you've got a leaky roof, it's going to be done, right? If you'd sold your home and waiting for delivery of your manufactured home, it's going to be delivered, subject to it loosening up. So the risk is one-off timing.
The next question is from Mario Mendonca of TD Securities.
Just quickly, on the home improvement and manufactured housing, the expense lines look sort of light there relative to the reasonably strong revenue. Was there anything specific on the expense side, particularly in home improvement that would have driven expenses lower?
It's Michael. No. Nothing. No worthy in the quarter to drive expenses lower. They just -- I think each of those platforms have very good strong operating leverage. So as we grow the top line, that -- those margins increase.
They just -- we can dig into it, Mario. I suspect that there's been almost no travel by the field force that we have almost 90 people in the field. They've been working from home. So they haven't been traveling. They haven't been entertaining clients. We've had efficiencies on that front. We did do -- it wouldn't be in March. In April, we did do a little bit of reduction of head count at the various operating units without cutting into the muscle. Anyone we reduced, by the way, we put them on health benefits with the right to recall them. So -- but that would be an April issue, but I suspect most of it has been in travel and entertainment, those businesses.
Okay. Going dealer advances in both home improvement and manufactured housing, what would your argument be for why we may not -- we will not see -- I think that was your point, that we will not see any major issues with the quality of those loans and collections? What arguments would you make, Steve, to suggest that those are high-quality loans?
Yes. So let's deal with dealer advance, i.e., home Floorplanning at Triad. That's the similar thing. So the home -- the Floorplan at Triad, we have secured registered interest in each one of the homes, and we will repurchase obligation by the manufacturer. So Algis, who's the Chief Credit Officer has scrubbed the repurchase counterparty, and we're comfortable with that. We had 2 homes in total that totaled $100,000, where the dealer got in troubled, and the manufacturer repurchased the homes. So we've rescrubbed all our collateral, our secured interest and our repurchase obligations. And any one new coming on to the Floorplan book, a new customer gets a double scrub on their onboarding. And you did see -- to your point, we saw a modest increase in floor planning. Most of that relates to homes that have been manufactured, sitting at the manufacturer facility where we have approved the customer, we have sold the loan through to a credit union, but are waiting for someone to deliver that to a lot. If you kind of turn the dealer advance at the counter the same asset at Service Finance, dealer advances at Service Finance is where we have a registered RIC. We have an obligation from the dealer. We've seen no degradation in the quality of that. We monitor it very closely. We watch the aging on it. And we haven't seen any -- again, we went through an account-by-account review on it. Mario, we've obviously capped dealer advance limits by individual dealers, not because we've seen a change in their quality, but we just want to be prudent on the management. So I feel good after Algis and his team's work that we're not going to see a material -- we're not going to see an impairment or a credit loss in those 2 books.
So I can see how the dealer advances in Floorplanning would be secured. I didn't -- honest, I didn't know that they were, but they're secured by the home. I can't see how anything in home improvement could be secured. Is that fair?
So let's just use a lot of examples. So if we're putting -- if we put an air conditioner into your home, right, the -- it's all been completed except the thermostat hasn't been delivered. The RIC is registered and it's effective, right? Until that thermostat is delivered, we can't sell it through to a bank. But the job is complete, and you as a consumer have signed off and the RIC is enforceable. The RIC, as you know, is a -- RIC is a registered lien on the home. It's not a lien at which you can accelerate, but it's a UCC filing, and it's filed at that point. So we filed our UCC and we're waiting for that thermostat to come in or whatever it is. As you know, we don't sell through a single loan to a bank until the consumer is 100% happy.
The next question is from Paul Holden of CIBC.
So first off, those weekly stats you provided are very helpful. And I wanted to turn to Slide 12, particularly on Service Finance and want to make sure I understand the chart at the bottom right because it says -- the title on it is Percentage of Loans Making Payments. How do I understand that -- those 4% and 3.9% stats there?
Paul, that chart, it's actually interesting. That's a chart that banks and other credit lenders look at quite a bit. What that's telling you is you're not seeing any really different behavior among your consumers and your loan portfolio year-over-year. What that's showing you is as a percentage of UPB or unpaid balances, which reflects the growth, right? So it's actually apples-to-apples year-over-year. You're seeing basically the same amount of payments coming through, right? So it's not like you're witnessing there a materially different payment pattern from what you would have seen in any given month or at least year-over-year. So it's important to understand. So not only do we have actually a situation where 30 -- where delinquency in all buckets has actually fallen for Service Finance throughout the year, actually each month. Deferment requests, they spiked a bit. They came back down, but we're actually not even seeing any difference in payment patterns at Service Finance.
I think, Paul, just a little bit of color on John's, is before you get in arrears, you see a reduction in the payment activity. So we -- all these payments come through lock boxes in the U.S. That's where this data is extracted day by day. We're not seeing a reduction in the payment activity, which ties into the low level of arrears. It was just -- it was a forward indicator over and above the arrears number.
Got it. That's helpful. So next question then is going back to the Service Finance held for trading. So in the slides, you say you anticipate sales to resume as counterparties come back online, like I'm not exactly clear why they went off-line given the payment performance, and let's say, your core flow products. Maybe you can expand a little bit on that, why those parties went off-line?
Well, I mean, Paul, as you know, at the beginning of March or middle of March, a lot of people were sent home or quarantined or worried about other things. I mean these portfolios were dealing with the same banks, but sometimes they were dealing with different teams inside those banks, people who buy these portfolios, et cetera. We had a sale teed up for the end of March. It just got delayed. And so now what we're seeing is people coming back to work, they probably had some other issues they had to deal with what's going on. They weren't necessarily buying assets. They were worried about other things in their portfolios for a couple of weeks. Now they're coming back to reengage. We're starting to talk again, and we think we'll start resuming the sales process here over the next couple of months.
And Paul, it's Mike. I'll just add one other thing. I think a lot of them as well, given the dislocation in the market, were chasing a lot of other opportunities that are created as a result of that and now are coming back.
So my impression in that is, let's call it again, your core flow business, as we've learned in the past, is more automated. It sounds like this held-for-trading business that's then sold is less automated? Is that what I'm hearing?
That's 100% correct. They get sold in blocks of 25 -- 10 to 25. And the people buying these blocks aren't the automated core flow business. It's someone on the whole loan sales desk at ABC Bank, who did take 3 or 4 weeks off and does want to come back. And we had 2 today. On these conversations, the person has literally come back. It's one person. It sounds like a derivative of trading desk in a big bank.
Got it. I understand. Okay. The aviation sales you put through in the quarter, the $19 million, it doesn't look like there's any loss on sale, at least from what I can tell. Is that correct? They were sold in line with last reported carrying value?
Correct. I'll just -- was saying yes.
That's good. And then last question I had, there is a slide in there where you mentioned you've done some head count reduction, and some employees have been furloughed. But then, again, when we highlight the fact that the flow is coming back and quite strongly in May, I'm a little bit surprised to see that. So are you bringing that head count back up? Or have you found new efficiencies in the business that kind of require less people?
Yes. No, they were furloughed in April as we've -- and not everyone was furloughed. Some people were moved over to the services side of the business. Obviously, in April, the origination level wasn't -- historically, it stepped up for high levels. So there were some furloughs. Some of those people are now returning to work.
Okay. So we should expect FTE, roughly to be where would it being back in February, March?
Correct.
The next question is from Jaeme Gloyn of National Bank Financial.
First question in Service Finance, just thinking about the April decline in originations, given that lag between application and approvals of 30 to 45 days, most of that would have been applied for and approved back prior to any COVID dislocation. So were there some deals or transactions that might have been canceled in April as well that dragged that number down to be flat year-over-year as opposed to still up from pre-COVID volumes?
The duration of the book has changed materially, Jaeme, because now we're into -- HVAC is a big part of the book. And HVAC isn't weeks or 2s, it's a couple of days. And air conditioner can be a day. A furnace, if it's cold, anywhere, it's still cold north, it can be 2 or 3 days. So the duration is quite short. So you don't have -- and because solar has come down, you don't have that long duration between what is an approval and a funding.
Okay. So the approvals that we're seeing pick up in April and May should translate to Q2 originations.
Right.
Okay. The $150 million cap on dealer advances, is that new? And then the follow-on is why the cap? I thought the idea of having the line of credit and that flexibility was to use the balance sheet in these times of stress.
Yes. The cap is an internal mechanism to -- it's a point at which Algis looks at capital allocation around the business, right? We don't -- we will review the cap and make the case to the internal credit community. We want to go past it. But it's a stop and pause basis about where we're at. It's normal course.
So it's not new. It's been in place since Service Finance was acquired, and this is just the first time that we're kind of talking about it, I guess?
Correct.
Okay. On Triad and thinking about that 1% delinquency rate, and granted, it's trending in the right direction now. But can you refresh me and just remind me how the reserve account works with Triad? And what level of delinquency or loss would be required for a bank to recapture some of that reserve account that you would have earned into income?
Well, the reserve account is set up by the bank or paid for by the bank upon the sale of the asset, right? So we sell the loan to the bank. We book our piece of income, the transaction fee, and the balance of it is then set up as a reserve. Under no circumstance do we have any recourse to ever have to put any more capital into the reserve. So the way it works typically is over the life of the loan, that reserve is set up to protect the bank against prepayments and losses. And we have, for years, recovered against that reserve. The primary use of that is against prepayments because there's very low losses inside of Triad. Losses, if they picked up, they would have to pick up very, very materially before you do something like run through that reserve. But to the extent that you did, remember, it's not -- we would not be on the hook for any of that. It goes to the bank.
Yes. I guess my question is just more around that you're generating a return off of that reserve account assuming a certain loss experience? And I was hoping you could just refresh us on what that loss experience would be? Is it anything above 0% losses they can recapture from that reserve account? Or is there a threshold?
Yes. I mean the reserve itself is used for any losses or any prepayments.
Yes. If the reserve is there, any losses or any prepayments so -- but obviously, there's a built-in assumption in terms of what the loss rates are. And we've always operated well below those loss rate assumptions so that...
Even in the middle of a financial crisis.
Even in the middle of a financial crisis.
The financial crisis losses peaked at around 115 basis points. So -- and that's losses. What we were referring to in the slide deck was delinquencies.
Okay. And just one more on that. How much of the reserve account would drive revenue in a quarter or on an annual basis, for example, just so I can understand the sizing of what the importance of that reserve account is to revenues?
It's about 10% to 15% of the origination revenue.
Okay. That's great. Just moving to the -- and still on the finance receivables, I guess, have you -- are you able to share any delinquency experience post quarter end in April and May? Has that evolved any differently than what's been reported for the quarter?
I think we went through and shared with you the deferments. The credit quality is the same in April, and you don't do arrears mid-month, but it's exactly the same at the end of March. We've seen no degradation.
Okay. Great. And a question for Michael on the cash flow hedge loss this quarter. Can you just walk me through the mechanics there? And then I noticed a large increase in derivative liabilities. Just wondering what kind of transactions are going on there? And just help me up with that one.
Sure. We have 2 hedges in place for a while, one related to our senior line, which is a floating rate liability. So we've got a hedge on that. And obviously, as rates came down, that's moved into a liability position. Similarly, we hedge our -- the stock price moved in on a share-based compensation. And the decrease in share price, late March, obviously, moved that into a loss position from an asset position at year-end.
Okay. That makes sense. Two more here from me. First, on corporate expenses, the guide is now for $4 million. But I mean under the assumption that things start to normalize here pretty soon, should we expect that to trend back up to the $5 million range in the second half of the year, assuming things normalize?
Well, it depends how long the virus -- the COVID continues. We have a commitment for the salary reductions as long as that virus is in place. We'll look at, when the virus ends or the period of crisis ends, going back to regular salary levels. But this -- we're going to align our interest with shareholders, and we're not -- so this run rate is, I would see it being at least the next 2 quarters.
Jaeme, why don't I follow up you with -- for the rest of your questions. We still have a couple of people in the queue and only a couple of minutes left.
The next question is from Vincent Caintic of Stephens.
Sorry, just a quick one. Does the economics of the business change with market conditions? Are they contractual? So for example, when I think about Service Finance, gain on sale, is that set? Or does that fluctuate?
No, that's all -- the yield to the consumer has not changed, I mentioned earlier. So it hasn't changed.
The next question is from Tom MacKinnon of BMO Capital.
Just on the salary reductions for the executives. What was the thinking behind that? And when will these be put in place? And are these -- are we to expect -- and how long would these reductions sort of hold in place as well?
So it was my program, Tom, so I let it. And I think it's important that we align ourselves with the interest of our shareholders. There's been a lot of pain here. And I think that it's important that management align itself and the Board came on site. In terms of how long, it's for the period of crisis until we see recovery in our business. Our share price is depressed. And I feel the pain personally, and large shareholders, but I'm sure one feels the pain. So it was our method of aligning our interest with our shareholders.
And it was put in place in the first quarter? When was it put in place?
It started in the second quarter, now. I can't remember the payroll date, but I've certainly seen it in my take-home pay, Tom.
The next question from Mario Mendonca of TD Securities.
Steve, I appreciate that the next question is probably not -- this is not the most appropriate time to be thinking about this. But I want your overall general big picture view on what the ROE of your business, what you've accumulated and what you've put together here? What do you really believe the long-term ROE potential of this business is? And I know this isn't the right time to ask it because everything feels so different, but I'm asking the question because I wonder if you think that this pandemic has eroded the long-term earnings power of the company in any way.
Yes. No, that's a question I ask myself a lot, Mario. And I look at the franchise value, if you will, and I'll get back to you in precise ROE. But I look at what our yields are originated at and what we're selling paper through because that really is the model. And the volume is second part. But I haven't seen degradation on either side. I think the quality of these assets is of interest. If you look to people who are wanting to come into our programs now Mario, in terms of funders, you're seeing institutional investors pop up and more credit unions of size. I'm not too sure you're going to see regional banks in the short term in the U.S. pop in. They have their own set of issues. But the product is demand. I think as long as it performs the credit side, you won't see degradation of the yields. We're not seeing yields to the customer. We're not seeing degradation to the investor. I do think -- and it's not the time to talk about it, Mario, but I think there is a significant opportunity to capture share here. And we've seen major competitors either go away or substantially reduce operations. And you have to grow in the context of available capital to buy your loans and in the context of prudent credit underwriting. But I think that Mark's business, with the right partners could be a $3 billion or $4 billion year business next year. You're going to say that sounds crazy. And it probably does sound crazy on this call, but I think that's the opportunity.
And the long-term ROE of the business?
Well, we're not going to be capital intensive. You look to Mark's business in terms of invested capital of $310 million, then you got to put some equity against the on-balance-sheet assets, so call it $350 million, Mario. I think Mark's business is capable of producing $100 million to $120 million on a run rate basis when we get through this. Not today, obviously. In Triad, we paid $110 million for it. If you take -- add equity on-balance-sheet assets, so call it $125 million. I think Triad has a line of sight to being $40 million a year. These are on pretax numbers, Mario. And Kessler, the same. So I think we put our head down, we continue to execute, we keep focus on the credit quality and make sure our bank partners are getting the performance they expect, and I think we'll be in good shape.
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.