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 Third Quarter 2018 Conference Call. [Operator Instructions] I would now like to turn the meeting over to Mr. John Wimsatt. Please go ahead, Mr. Wimsatt.
Thanks, Ariel. Good afternoon, everyone. Thank you for participating in our conference call to discuss ECN Capital's 2018 third quarter results announced earlier today. Joining us are Steve Hudson, Chief Executive Officer; Jim Nikopoulos, President; and Grier Colter, Chief Financial Officer.A news release summarizing the third quarter results was issued this afternoon, and the financial statements and MD&A for the 3-month period ended September 30, 2018, have been filed with SEDAR. These documents are also available on our website at www.ecncapitalcorp.com. Presentation slides to be referenced during the call are accessible on 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. 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 are presented in U.S. dollars unless explicitly noted.With these introductory remarks complete, I will now turn the call over to Steven Hudson, Chief Executive Officer.
Thanks, John, and good afternoon. Let's start with Slide 6 if we can. People have seen this before. Just 2 things. Jim will speak shortly to our successful transition of rail, which is a big step forward for the company and its evolution. And I just note that we're now at $29 billion of managed and advised credit assets on behalf of 90 banks, and the banks are our customers. Turning to Page 7. I'd like to draw your attention to 3 items: First, the $325 million of 10-year annuity backlog. Jim will speak to that, but that is committed revenue. That will be earned over the next 10 years by our partners and colleagues at Kessler Group. It's a very substantial asset. We're proud to have it and really smooths out the source of revenue. Second of all, the chart just to the right of that shows the percentage of operating income that comes from our business service group versus our legacy business. We're happy to report that this is effectively done. And finally, on the slide, management and advisory services, we think an important distinction of the quality of our business model is that we have approximately 50% -- 52% that's the form origination fees and 48% that comes through advising and management fees. We think that's an appropriate mix and increases the sustainability and durability of our business model.Turning to Slide 8. I'm very proud of the team's success in maintaining our book value, and we are good stewards of capital over the last 2.5 years. It's gratifying to see that we maintained it. An equally important point is the ownership by the insider group at 13% currently. I think it's safe to say that when we clear blackout here on Wednesday morning, you'll see that increase as we're able to buy stock. A second comment I would make, second bullet on this page, is that we now have 3 great businesses that are balance sheet light, scalable high return, are high growth but high growth with dramatically less leverage. That's important, and we'll speak to that in a second. And finally, we replaced our historical earnings with ones that are accretive and are more attractive.On Page 9, I want to highlight 4 things in our growth strategy, which we believe is now -- are now gaining traction 2 years later in our transition. We think that we have both take and make share strategies of that are gaining traction, the most recent win on the Beacon Roofing contract, which is exclusive for next 5 years, as example of that. We've been able to go back with our partners with a strong balance sheet, lots of liquidity, investment-grade ratings and are able to secure clients who may not have signed up in the past.On foundation products -- and what I mean by foundation products are products that we can put in our balance sheet, very, very modest investments, and those drive incremental loan origination on behalf of our bank partners. An example of that would be Triad's floor plan, which puts up about $15 million of equity to drive substantial increase in our core loan programs being sold to our bank and credit union partners.The third is the new loan products where we incubate, if you will, loan products that, we believe, our banks have indicated they would like to purchase. We're happy to report that the first success was the sale -- the arrangement to sell our solar portfolio in the fourth quarter to one of our large bank partners; and equally important that our bank partners have now committed all of them to buying solar as part of the core flow in 2019. We think that's a great outcome evidencing our ability to use a modest amount of balance sheet and to drive new loans within our core area of expertise.And then finally not least is the cross-sell opportunity where we've taken our banks and our 90-plus banks and instead of offering them 1 product, are now starting to begin to offer them 2 and 3 products. We think those 4 pillars are the strength of our growth strategy.In terms of our business model on Page 10, I just want to highlight 5 features of our bank model. You'll hear a little bit -- a little more about this in a second as our bank partnerships are truly that they are not recourse agreements and we have no liability with respect to the origination and the management of those assets, more to come in a moment. Where sole focus is on super and prime originations; we don't have FICO creep down to lower quality -- lower categories of credit, and we don't allow creep into other areas of consumer credit assets. We have 12,000 dealers between Service Finance and Triad, and we're quite happy with those dealers and our national network of manufacturers. In terms of the sustainable and durable model I referred to earlier, it's important to our manufacturers and dealers that -- not to use our balance sheet but be able to become their partner to undertake sales finance on their behalf. And they rely upon the investment-grade rating, the $800 million of liquidity we have, the 50-50 match of management advisory fee versus origination fees, and the annuity backlog of $325 million helps a lot. And finally but not least is our strong regulatory framework. We don't come through a third party. We do not lie on bank pre-emanation. We are directly licensed in all 50 states, and we enjoy positive relationship with all regulatory agencies.As I mentioned, on Page 11, we're happy to report that we've entered an arrangement to sell our solar loans to a key bank partner, which will close in the fourth quarter and that the bank partners as a group, in 2019, have agreed to buy solar in the normal course. And finally, Grier and his team were successful in extending our senior line to 2021, and we've rightsized that from $2.2 billion to $1.4 billion and have reduced the fees associated with that rightsizing.Page 12. We've noted that we've bought approximately 20% of our stock. We think that's a prudent way of reinvesting back in the business. And then we're going to -- as you'll note in a moment, we have lots of fire power to both pursue organic growth and to repurchase shares.Turning to the individual businesses. Let me turn you to Page 14 if I can. And let me pause for a second. And at the risk of being redundant, I want to take a moment and reflect on the strengths of our business model. First and foremost, we have noncore -- nonrecourse origination fees, which are earned without risk to adjustment for loan performance, i.e. yields and margin, interest rates and prepayments. There is no liability associated with our recourse -- with our origination model on behalf of our bank partners, 0. We have recurring and high-margin servicing revenue. I mentioned amongst all of our 3 businesses, we have about a 52-48 mix. We think that's a strength of our business. Going forward, we have a very efficient and scalable business model with very high EBITDA margins. As I mentioned, we're directly licensed in all 50 states. We're not relying upon someone's license to operate. And finally, we think our model is very scalable provided we stay within our very expertise of home improvement for Service, manufacture housing for Triad, and we can scale within products in that sector such as solar.On Page 15. 15 bank partners, we have several other banks and we now have a life insurance company in our due diligence funnel. We think that's a testament to the strength of our business model. We're not walking away from our banks, but we think adding life insurance companies as funders is additive to our mix of bank partnerships; significant growth whether it's originations, managed portfolios and EBITDA. You have to remember that 1.5 years ago, this business was a little under $20 million of earnings. To Mark Berch and his team, congratulations. This has been a dramatic result, but we're not done. As I mentioned, solar has now been successfully dealt with both in '18 and '19 going forward.If I turn to the origination updates. We've had a modest and temporary impact on volumes. Two things that we've been able to address: First and foremost is Sears bankruptcy, which has impacted the volumes at Sears Home. Effectively, those volumes are down to 0. That's not news to us. It was rumored for a long time. We've been able to deal with that without loss to our bank partners, which is critical. Now the contractors that are part of the Sears network are now moving to other platforms, and they're going to take our software and sales finance with them so we'll see that recover over the next few quarters. Unfortunately, Lennox, an exclusive partner for us in HVAC, suffered a tornado. A tornado closed their facility in Iowa. That was significant. It's now coming back online late in the fourth quarter and Q1. We'll see those volumes recover. And as a result, operating income will be $51 million, not $55 million. That said, it's important to note that we've seen a 53% increase in originations, a 63% in operating income. And these temporary circumstances are just a temporary setback. The growth will continue into '19.I wasn't planning to highlight the monthly originations. And at this point, I'll pass it over to Jim Nikopoulos.
Thank you very much, Steve. If we turn to the next slide, Slide 18, I just wanted to highlight a few of the highlights for the third quarter results for Triad Financial. First and foremost, Triad funded originations of $147 million in the quarter, which represented a 14% growth year-over-year, a number that we're proud of. That resulted in an overall growth on the bottom line and EBITDA line of 86% year-over-year. That was through a combination of the increased originations and the introduction of the floor plan program, which Steve earlier defined as a foundation product. With the floor plan, we also saw uptick on the increased originations from dealers that we've extended the floor plan lines to. That's a very important metric for us to continue to monitor because even though floor plan is a great product in and of itself with a 7.5% yield and a loan that's fully backed by the manufacturers, not just the dealers, the purpose of that, obviously, is to see the increased originations, and we are seeing early signs of that increased penetration.As it relates to the funding partner side, Triad added 8 new banks and credit unions year-to-date. So this year, thus far, 43 funding partners have purchased manufactured housing loans from Triad. And that's about an equal split between banks and credit unions.As it relates to the portfolio itself, the full-service portfolio now stands at 33%. That's a 7% increase in penetration from the beginning of the year. That's another metric that we monitor closely, and Don and team at Triad have done an excellent job further penetrating the loans and the portfolios that they sell through to their banking partners.The managed-only program has also been very successful for Triad. These are deals that get originated on behalf of what we call REIT communities. And Triad continues to sign more and more REIT community partners to its program and now has 8 of the top 10 REIT communities in the U.S. Examples of that would be entities such as Sun Communities and RHP communities. So well done on that front.And the last point I'd make just on this is that we just want to kind of confirm that we're going to maintain the full year guidance that we put to The Street earlier this year for 2018.If I can now turn you to Kessler on Slide 20. We're obviously very pleased with the results of Kessler for the -- just as a reminder, this was an investment that we made at the end of May. So this -- we reported 1 quarter -- 1 month of results in the last quarter. So this is really the first full quarter of Kessler results. The pretax operating income of $20.7 million, our share being $16 million because of the ownership, us having 76%, was ahead of plan for us. It was based on revenues of $33 million. And the main emphasis on that is the business was strong right across its key segments, strategic partnerships, portfolio advisory and marketing. The portfolio advisory side generated $16.6 million of fees in the quarter, which is again higher than we expected. So kudos to Howard, Scott and the team there for driving those transactions a quarter earlier than what we would have expected.I think the most important thing for us is what we're calling the advisory backlog that now totals $325 million. These are, as Steve mentioned, contractual annuity programs that, on average, pay out fees on a transaction over a 10-year period based on a fee structure that is a percentage of basis points against the outstanding receivables of a certain program traditionally over a 10-year cycle. So these have -- these are based on transactions that have already occurred and are pent up in Kessler's annuity backlog. This is an important metric for us because it adds a lot of certainty to the revenue streams that are expected to come off the Kessler business year-over-year and really distinguishes The Kessler Group from a traditional investment bank that's highly reliant upon deal flow to generate its revenues and its earnings every year. So the point I would make here is we certainly hope to continue to see that number growing as transactions get added. In addition to that, today, 70% to 75% of the revenues that Kessler generates are through these multiyear, contractual annuity programs. So there really isn't a reliance upon any one particular deal to help with the numbers. As we go through our guidance for next year, we'll highlight the percentage of the book that has been earmarked under that advisory backlog number. So with all that being said, we now expect to exceed the 2018 guidance that we put out when we announced the transactions that we had announced that Kessler would contribute an incremental $0.03 in adjusted EPS to ECN on a consolidated basis and now expect with this great result to achieve another $0.02 in the fourth quarter for a total of $0.05 contribution in 2018. So kudos to the team at Kessler for those great results.If I could now turn to the rail, aviation legacy. We issued a news release. As part of the earnings news release, we also announced a transaction with GATX to sell 3,100 railcars to them for total proceeds of $229 million. Coupled with the ERL I deal that we announced earlier and closed in October, those 2 transactions produced book value of 0.9x and, more importantly, released $140 million -- or will release $140 million of equity capital for redeployment. That represents over 95% of the remaining rail assets. So happy to report that the cars have come to the end of the line, so to speak. So as a reminder there, on that, we started obviously at the end of 2016 with $5 billion of legacy assets. With these transactions, we are now down to approximately $450 million today. And as we highlighted on an earlier slide, 9, we've done all this work and all these transactions while preserving book value, which was important to us. The remaining $36 million of railcar assets will be disposed in due course. There's about 330 cars left. So that's great news on rail, and particular thanks to James Barry and Loreto for leading the charge to make sure that, that deal was consummated. And lastly, on the aviation front, the average earning assets, as you see, decreased from approximately $390 million in the second quarter to $340 million, so by approximately $50 million. That was through a combination of sales, some early buyouts and some natural expiries. So with the accelerated wind-down plan last quarter, we indicated that we're targeting ending the year with aviation earning assets of $275 million to $300 million of assets. And we reconfirmed that we will be on track to achieve that. And again, like with the rail transactions, the released capital, because a lot of capital was tied into the aviation assets, continue to be redeployed into our core businesses and used for purposes of share repurchases. So all in all, we're very extremely happy with the wind-down of the legacy assets.With that, I'll turn it over to Grier Colter.
Thank you, Jim, and turning to Page 24. Let's have a look at the consolidated operating highlights. Originations for the quarter were $509 million versus $505 million in the prior quarter, reflecting exceptional quarters from our Service Finance and Triad businesses in a typically strong quarter seasonally. Adjusted EBITDA and adjusted earnings per share were $51 million and $0.07 per share, respectively, including the first full quarter results from our investment in Kessler Group.Turning to Page 25. We have provided a summary of our balance sheet. Total finance assets declined versus the prior quarter, reflecting our divestitures in rail assets subsequent to quarter end. These assets have been presented as available for sale pending the close of these transactions. This decline was partially offset by an increase in the warehousing of home improvement loans that are expected to be sold in the fourth quarter. Proceeds from the sale of the rail assets will be used to repay debt and further reduce our leverage in Q4. Shareholders' equity and tangible book equity declined in the quarter due to share repurchases made under NCIB as well as the comprehensive loss due to our rail sales.On Page 26, a summary of our income statement is shown. Consistent with Q2, we have presented our income statement to align with our current business model with a focus on portfolio origination services, management services and advisory services line items. Portfolio origination and management services income were both up significantly versus prior quarter due primarily to the first full quarter from Kessler and continued strong performance from Service Finance and Triad. Portfolio advisory service revenue was up significantly due to very strong M&A advisory revenue at Kessler Group. Interest income and net rental revenue, which is primarily from our rail and aviation businesses, was in line with prior quarter. Operating expenses were higher primarily as a result of the first full quarter of Kessler Group operating results. And if we move to Page 28, as in prior quarters, we have provided the expense detail by business segment. Corporate operating expenses for the quarter were $6.7 million and remain elevated as we incur costs associated with our head office relocation to the United States. The work is not done, but we remain confident that we will achieve our targeted annualized run rate of $20 million to $21 million by Q1 2019. The chart at the bottom of the page, which we've shown in prior quarters, shows base corporate, representing targeted ongoing corporate cost of $20 million to $21 million. The incremental $1.6 million are expenses that we intend to cut for the coming months. In early October, we extended the maturity and reduced the size of our senior credit line, as expected, from $2.2 billion to $1.4 billion, which resulted in an ongoing standby fee and commitment fee savings of over $3 million on an annualized basis. And we will continue to assess whether this level of capacity is appropriate for the needs of our business going forward with the potential to further reduce these commitments in further quarter -- in future quarters.With that, I'll turn back to Steve for a few closing comments.
Thanks, Grier. Let me just highlight a few comments and then open the call to questions.Pretty amazing quarter, $50 million of EBITDA, I believe, proves up our business service model. We are confirming 2018 consensus estimates in this call. Transition is complete. At our Investor Day on December 6, which we welcome everyone to attend, we'll be talking about some plans to accelerate the divestiture of aviation on the 6th. Insider ownership has been increasing through the transition and more to come in the next few weeks. We believe the growth continues at a very significant pace and will continue through '19. We see no evidence of a slowdown of the U.S. economy. We're mindful that we underwrite these loans on a prudent basis on behalf of our bank funding partners, but we've seen no deterioration in the credit quality with respect to arrears or losses. Approximately 90% of our Q4 adjusted income is from our new business, our business service model going forward. We welcome you again to December 6, and we're providing guidance on that at that time. And I'm very excited by the growth opportunities that will continue into 2019. We have expected firepower of approximately $350 million. Management notionally sets aside $150 million of buffer. It's really for comfort, but $350 million is in place at the end of '19, which is firepower for both organic growth opportunities and to reinvest through share repurchase.With that said, operator, we would open the call to questions now.
[Operator Instructions] Our first question comes from Geoffrey Kwan of RBC Capital Markets.
My first question was just on the Kessler. So if I'm understanding it right, the -- I think I'm guessing it was the Capital One deal. The -- it came in earlier in terms of falling into Q3 then, let's say, Q4. And then based on your guidance, I guess it seems to imply that the Q4 number is going to be kind of a more nominal-ish looking number to beat that guidance. Is that the way to think about it?
Yes. So Geoff, it's Jim here. So the first one, the first comment you made, it wasn't that transaction that triggered the gains. Kessler obviously has a lot of transactions in the queue, and they land at particular points of time. So there was 3 separate transactions that were completed that Kessler was working on, obviously had in their pipeline and completed a quarter earlier than we expected. If you remember on the last call, I indicated that a lot of that revenue should be coming in the fourth quarter because those transactions were scheduled to be done before the end of the year. The Capital and Walmart transaction is something that will close next year. So it will contribute to Kessler earnings in 2019 and beyond. And in terms of the second part, yes, in terms of the fourth quarter, we expect kind of -- we forecast more of a kind of a regular quarter, and that's why I indicated that we still expect $0.02 of contribution from Kessler in the fourth quarter.
Okay, thanks for that. And then on the Service Finance, are you able to say like how much was Sears in originations? And on the Lennox -- or I guess on both of them, it sounds like you think that Lennox will come back to where it was pre levels, call it, early next year. Do you have an estimate on when you think you'll kind of be at the, call it, pre-issue levels at Sears? Is that like -- maybe like a later '19-type timing or...
The -- yes, so the Lennox one is specific to this tornado and their plant in Iowa, which was their high-efficiency -- the manufacturer, high-efficiency equipment there, which is important to us because that has the buy-down support, which is a big part of our program with Lennox. They didn't wait for the plant to be rebuilt. They transferred some of the production into other plants. So it will start to come back in -- we saw an improvement in October and continue in November and December, but it will be back in full force and effect in January. Lennox is going to -- with that plant fully back online, is going to announce a special sales finance program. I can't get into the details for you, but it's going to be very, very -- it's going to be great for us. So we feel very good about Lennox coming back in a little bit in Q4 but mostly in Q1. With respect to Sears, Sears was really an amalgam of a bunch of independent contractors under the Sears brand, and they all carried -- they're all vetted by us as approved dealers. They carried our mobile app. And as they start to move to other platforms, most of which has happened, we'll see that come back. Will it come back to the $150 million that we did with Sears the year before? Probably not, but we'll probably get back at least half of those. It doesn't matter much because the growth is so strong in other areas, whether its landing beacon has an exclusive contract going forward or a growth elsewhere. It's literally a road bump, important to us but it's not that important or material to our 2019 numbers.
Okay. And if I can sneak in one last question. I know they're kind of smaller amounts but I noticed the Stage 3 ticked up $1.5 million, and the 61 to 90 day on the arrears was up $6 million quarter-over-quarter. Just wondering if there's anything specific that you can flag on that.
Well, I'd say that these are legacy assets left over from our commercial and vendor business, but they're going through a process. It's important that we classify them this way, but we feel fully confident that we'll have full recovery on these assets.
Our next question comes from Vincent Caintic of Stephens.
First question is on the bank partnerships, the deeper penetration you've been getting there. So you talked about that you've got now 2 partners and 2 products and another 3 maybe coming up. Just wondering if you could discuss the significance of that and how many more in the pipeline we could see and what that will do to earnings going forward.
Yes, it's -- we're starting to see -- one of the thesis we had last year was being able to provide cross-marketing between the platforms. So Kessler identified 2 banks that we're very keen to get unsecured consumer loans and the prime -- super prime category of those 2 are now in the pipeline at Service, and they are significant. I can't mention the names mentioned, but they're in excess of $200 million per year. And we had one prior to that, and we're starting to continue to add them, I would say, for '19. And we are fully sold out in terms of bank partnership for Service and for Triad. I don't want to like just come back and highlight the lifeco. The life insurance participation is hugely important because that will bring NAIC, which is a regulatory voice in the life industry, into our fold. We think that's a big step forward. That launch will be about $200 million for that lifeco. But subject to success of that, it could be expanded up to $800 million, Vincent. Not to take anything away from our bank partnerships because we like them a lot, but we think the life industry diversification is important. Again, the life partnerships is exactly like the bank partnerships. There is no recourse with respect to credit losses, prepayments, yield or maintenance. But it's important to me and also important to the board because as you know, our history, our DNA goes back to the life industry.
Okay. That's really helpful and in a way that touches on my next question. So one of your competitors with Service Finance, in particular, has been struggling. They talked about marching impressions from credit concerns. I'm just wondering maybe if -- you can't talk particularly about the competitor but if you can talk about the industry and how you are differentiated from the rest of the industry.
Yes, so that's a good question. I'm not going to talk about the competitor but maybe I can talk about what we are. And the first I would draw your attention to is the nonrecourse bank partnerships where we do not provide direct or indirect support on credit losses nor prepayments nor yields or margins. As a result, we don't have a liability. It takes a typical bank about 9 to 12 months to enter into a partnership with Service and Triad. That's because you are participating in all the ups and downs of a portfolio without support from us. I think the second observation I would draw is that we focus just on prime and super prime, home improvement and manufactured. We have not expanded into other credit markets. We don't believe them to be a good risk-adjusted return for our bank partners. And then 2 quick points. We think the balance between origination and management fees is hugely important, that 50 -- almost 50-50 mix. And that really draws to our last point. I don't want to talk about the other company, but we have an investment-grade rating, which is hugely important to our bank partners and to our origination platforms. It denotes sustainability, durability and the ability to take up significant share. And if I could touch upon one other thing, Vincent, just on interest rates. We don't guarantee yields or bank margins. We are proactive with our banks. We have passed along increase. We did change our mix to broader, attractive risk-adjusted yields. That's always in consultation with them but no guarantee.
Our next question comes from Jeff Fenwick of Cormark Securities.
Maybe just a follow-on from the last question there, Steve, in terms of the nature of the contracts that you have with your liquidity providers there. What sort of risk is there here for you to see some fee erosion when they come back and say, "Well, maybe we want to take a few basis points off the origination piece?" How should we think about that risk?
Yes, these are contractual arrangements that go for 3 years. You're committed to the program. You're also committed to reinvest capital through the pool. We don't provide a guarantee. We do have conversations with you about where the market's going and what our plans are, but we have seen 0 movement on our origination fees and our management fees, to answer the question for you, and don't see any in our '19 forecast that we'll present on December 6.
And then maybe a bit of color on the solar program now that you've got it up and running this year. What are the tips and advices that you need to bring on your balance sheet in season before you roll them out to your bank partners? How should we think about that?
Yes. There'll be no requirement for seasoning. We did our incubation, if you will, on this first $150-ish million. We proved to the banks the portfolio works. So going forward, it will flow through on everyday just like a financing for a furnace or air conditioner. So there won't be a season requirement. We don't fund the loan until the solar project is finished. So we'll approve it, but it could take 3 or 4 months for permitting and installation. But it gets funded at the end when the consumer -- every one of our loans gets -- or RICs gets a phone call to make sure the consumer is happy with performance on time and on budget. And at that point, it gets funded.
Okay. And can you just remind me the economics with regard to...
We like solar because it's a high-quality asset with a long-term management fee, and our banks like it because of yield and credit quality. Average credit quality on solar for us is 700 -- it's FICO 780, and it performs exceedingly well. And our incubation test has proven that to our bank partners. So we're happy to have done it for them. We committed a very modest portion of capital to our balance sheet and we're very, very happy that it's become part of the core program in '19 and that we have one of our larger bank partners purchasing this particular portfolio in Q4.
And will this be on a sort of similar economics as the rest of the finance flow that you've seen?
Yes, it's a good question. The only thing differs on this is that because solar is a longer term, the average duration here is 7, 8 years. You're in about 50 basis points per annum on management fees, but if you PB back that management fee it's the same economics as a 3-year financing on a furnace or air conditioner. Management fee, a dollar is a dollar, and we like the 8-year profile of these management fees.
And then maybe just one last one if I may. I noticed that you had about $1 million of -- $1.5 million, I think it was, of corporate expenses for M&A that didn't happen. So what's the -- what sort of things are you looking at strategically here with respect to M&A? Is this just a stuff that would be complementary to you guys?
Jeff, it's Grier. The slide where we're showing the $1.5 million, it's really just illustrative in trying to show that 5.125, which we feel is our ongoing run rate once we've come through the other side of our cost reductions. The $1.5 million is really representative of cost we need to cut over the coming months. So it's really -- it's not specifically for transactions that we're looking at or anything like that. It's really just a bogey for us in trying to demonstrate the cost that we're going to run out of this business.
And I guess part of that question was, is there going to be a fourth leg to this business. There's not going to be a fourth leg to this business. We're very comfortable and happy with the results of our 3 businesses. We would look at tuck-ins where we could put additional origination flow through our 3 businesses, but we're not going to create a fourth business.
Our next question comes from Paul Holden of CIBC.
So first question, you mentioned in terms of the receivables past due is related to some leftover C&V business. So maybe you can just give us a magnitude for how much C&V business still sits on the balance sheet and how that should roll off over time.
Paul, it's Grier. This -- the balances that are left, I mean, you can see them in the corporate section of our MD&A in terms of the balance sheet assets. There's amounts that we have as available for sale. That would be the net number. We're talking about a very small number here. This was one of the larger assets that we held. It's in a bankruptcy process, and we feel fully confident we're going to get the full return. That would be my comments on it.
Yes, Paul, we took an appropriate mark maybe -- and we took a very conservative mark on these assets when we split from -- when we sold C&V to Canadian Western Bank, and another way of saying you're not going to see a loss on these assets.
Okay. And then next question would be related to the originations coming from Service Finance. So previously, your guidance included growth from existing vendors versus new vendors, and you made a comment in your MD&A you're going to change that guidance, which is fine. But just kind of trying to get a sense of why you're changing the way you're thinking about that guidance and then maybe what the year-to-date origination growth has been from those 2 buckets.
Yes, first of all, we did change the guidance that's in the deck, and the reason for the changes were specific to 2 topics, which was the closure of the Lennox plant. So there's lots of disclosure on Lennox on the impact of that plant closure and what it means to them, and the supply partners were one of those in Sears bankruptcy. We've seen growth inconsistent between existing vendors and new vendors in line with management's expectations. This was a one-off issue with Sears and with Lennox. Everyone else is either at or above our expectations for growth, whether it be an existing or new vendor channel.
And I guess that's exactly what I was trying to get at, to get a sense of whether the new vendor growth is hitting your expectations. And given that's the case, maybe you can give us some commentary regarding, I think, a new vendor relationship you referred to, Steve, last quarter. Sort of maybe give us a sense when that actually launches and when we can see some origination growth from that vendor.
So that one, Paul, would be Beacon Roofing and now acquired Allied, which is the largest roofing company in the U.S. That's now an exclusive program for 5 years. It will go through a formal launch. It's now been signed, a 5-year exclusive we're launching it as we speak, but you'll see the impact in '19. And at the December 6 Investor Day, we'll walk you through new sources and existing sources. We -- there's obviously been some disruption in the home improvement market here. We have been able to take share because we are stable, predictable to our dealers and our manufacturers. So we think we're in line to have an exceptional 2019 on the take-share strategy. Manufacturers don't like a sales finance partner that has unpredictability. We are not that.
Got it. Next question regarding Service Finance. You've talked a little bit about the solar loans on balance sheet. I want to ask you about the PACE loans that were on balance sheet as of last quarter, see if those are still on balance sheet or if that transaction has closed.
Well, a good question. So solar has been committed to. It's been priced, agreed, documentation underway. Everything's been done. On PACE, we have 3 parties who are bidding on the final round of this. We would anticipate taking one of those bids here in this quarter, Paul, and closing it late this year. At the same -- these are kind of December closings. The PACE, as you know, is a AAA-rated security because it primes the mortgage security. It's a product that we've offered to be competitive with our competitors -- competitive with our competitors, to be competitive, but it's not a significant -- it's about a $60 million book for us. That said, it's important that we show liquidity in that asset category.
And would you also expect those to close in Q4? Is that looking more like a Q1 transaction at this point, Q4?
Yes, late Q4. It might be in January but -- 1st week of January, but it's going to close.
And then final question from me is given the types of growth rates you're putting up and the valuation of the stock, have you been approached by any third parties regarding any of your operating subsidiaries in terms of expressing interest in participating or a wholly owned ownership way?
I think that we are very happy with the way the businesses are coming together. We have been approached by a number of investors who want to -- who would like to acquire more stock. And John deals with them. And these are large U.S. players who would like to acquire stock, and that due diligence process is underway but we're not -- this is -- and this is not like a box of donuts where you can buy 1 and leave 2 behind. They are integrated together, but if you're an investor and can see value at a stock that's at CAD 3.20, then we'd love to talk to you as management has been buying personally as well as reinvesting cash into the shares.
Our next question comes from Tom MacKinnon of BMO Capital Markets.
Just given the big bump up in the advisory fees in the quarter in The Kessler Group and the fact that you're talking about being -- Q4 kind of being more of a -- I guess, a normal quarter, how should we be thinking about 2019 in that regard? Should we be thinking of those as continuation of a Q4-type quarter? Or when do we, here and there, throw in $16 million or $17 million in advisory fees?
We'll provide to the '19 guidance on the -- when we're together, Tom, on December 6. The -- as I kind of said before, if you think about the nature of the business and the fact that 70% to 75% of the revenues are through these longer-term advisory backlog contracts together with some marketing spend, the only portion -- the portfolio advisory is a little lumpier. So what we do is predict it as best as possible at the end of the year for the forward year. And sometimes, some of those revenues come in a little bit earlier. Sometimes, they come in a little later. But they don't represent the kind of biggest portion of the revenue. So the way Kessler works is they have -- and we'll walk you through as well -- we'll walk through the targets we have for the business and the pipelines. But the predictability, whether it's one quarter or the next, will be a little fluid through the process. So we'll guide to the annual numbers as it relates to all facets of the Kessler business.
Okay. And just sort of continuing maybe a little bit on that. In terms of originations for Service Finance for next year, are we kind of still looking into a solid double-digit growth in originations for next year? I mean, just preliminary before we get into the -- your Investor Day guidance.
Tom, we'll be -- we'll pass the -- it will be a significant double-digit growth. The strategies that we've embedded within Service that are now coming to fruition, this company is not growing at 10%, 20% per annum. It won't happen.
Okay, something north of 20%?
Well, I wouldn't -- I'm not going to get into Investor Day today, but let me put a double negative. You won't be unhappy.
Okay. And then with the $275 million to $300 million in aviation assets left at the end of the year, how much equity would be supporting those?
Tom, it's Grier. Just rough numbers, end of the year aviation equity is probably between $225 million and $250 million.
Okay. And then the final thing is the tax operating. The operating tax rate is 15%, I think, this quarter and maybe something like 16% the quarter before. How should we be thinking about that? I thought maybe the guidance was somewhere around 21%, but I can't -- what should we be thinking about for an operating tax rate?
Yes. Tom, it's a great question. It's Grier again. I -- the rate obviously is coming in lower than we originally had guided, and there's a whole host of reasons. One is, our investment in The Kessler Group enabled us to drive the rate down a little bit. And ultimately, that's -- that really is the key driver here. I think as we close in to the end of the year, I think we originally, right, said 20%? I think this is what I would say as between 15% and 20% will be the overall rate. And it's probably closer to the midpoint if not the lower end of that range. With regards to 2019, I think we're still tumbling the numbers. I think in fairness, we'll probably just want to wait until we get into that discussion to talk about the 2019 rate. But it's a fair comment. The tax rate is, for sure, coming in lower for 2018. It's largely because of the investments that we've made this year.
Our next question comes from Jaeme Gloyn of National Bank Financial.
I just want to approach some of these previous questions a little bit differently. In terms of the on-balance sheet assets for Service Finance, that $180 million in Q3, by the sounds of it, you've got the flow for the solar and the PACE loans are coming off at the end of the year. So should we expect that to be pretty much 0 at Q4? And then as a run rate, there shouldn't be too much on balance sheet related to Service?
Yes, you're always going to have what we call progress payments, which is part of that business, where you all have contractors who have a longer-term installment process. So it's probably in the $25 million range. That's always been there since we've owned the business. But you are, to your point, going to see a substantial reduction with the elimination of solar in PACE.
Okay, great. On the Kessler business, the $16.8 million -- or sorry, the $16.6 million, $17 million, is that -- that's the fair sort of recurring revenue in this business primarily coming from the advisory? Is that the right way to think about that as well?
No, that's the piece -- it's Jim, Jaeme. That's the piece -- that's the lumpiness. So when the transactions closed, they collect those fees.
Yes, I mean excluding that $16.6 million...
Yes, excluding that, yes. If you take the $33 million and you back out the $16 million, the remaining $16 million is the longer-term annuity programs.
Okay, perfect. On the -- sorry to jump back to the Service. But on the Sears and Lennox, are you able to give us a breakdown of the $150 million between the 2?
We haven't, but it's sort of 70%, 80% Lennox, and the rest was Sears. Sears had already come down pretty significantly because we've been managing Sears down in the last year because of the potential for Sears to fail.
Okay. And still with Service, you said you communicated -- consulted with the bank partners, and you've obviously increased interest rates but you also changed the mix. Can you give us a little more color about...
Yes, part of the mix is just change in promotional loans. You can have a 6-month promotional or 12-month promotional. You can toggle that back and forth. Solar provides higher yield, but longer duration, so how much solar do you want to push duration out? So we've got agreement on that. It's a combination of both. But again, there's no guarantee on the yield nor margin on the go-forward business nor in the back book.
Right, okay. The last one from me and I'll turn it over. The size of the credit facility being reduced to $1.4 billion, can you just sort of talk us through your thought process in arriving at that $1.4 billion? And when I look at the assets that should be on the balance sheet to be funded going forward, it seems like that $1.4 billion is still pretty high. So just your thought process there.
Sure. It's Grier, Jaeme. I would say that really is -- there's no right answer to this. I mean, the way we look at this is in order to provide our businesses with appropriate backstop or alternative funding source to make sure that we're able to fund these originations. And we've set a target. We've said at least 6 months is kind of what we want to have there. And we'll continue to look at that. And point taken, we have this dialogue here about this. And it's just important for us to have these alternative funding sources available for us. So that's kind of the driver of it and why it sits at $1.4 billion. To the extent that we continue to delever through the rail transactions, you're going to have another look at it, but that's kind of the way we drive that.
Our next question comes from Brenna Phelan of Raymond James.
I just wanted to go back to the commentary around the margin expectation at Service Finance. Your competitor cited one other issue in the form of labor shortage, somewhat related to the hurricane and some weather events. Just your thoughts on how your vendor partners are dealing with getting the contractors to work. Are they seeing pressure in the form of labor shortages? How should we think about that?
We've seen no evidence of labor shortage. Hurricanes, unfortunately, are bad things for families but good things for home improvement because there needs to be a fair amount of replacement done, which will occur over the next 3 to 6 months, but no shortage of labor. We don't -- it's not -- it's a non-issue for us. I'm sure it's an issue for them as labor cost increase but not for us.
Okay. That's helpful. And then just with Triad, any thoughts on the development of some of the programs that Fannie Mae and Freddie Mac are expanding their loan purchases, what that does to demand and/or supply for your manufactured housing product?
Yes, really -- it's Jim here. Really, it won't impact the shipments that we're anticipating in the marketplace, Brenna. Overall, if you think about where we are, we're expecting manufactured housing shipments to go up about 10% a year, and we represent 10% to 15% of that flow that comes off of that. So that's clearly within our expectations on a go-forward basis. I won't go to too much details, but we have had discussions with those parties as well about potentially assisting them with certain projects. So it's early days, nothing to discuss. But I think we're covering the topic on all fronts, our continued core origination flow, which is going up with floor plan and just natural penetration, some portfolio buys, plus we're having discussion with those players. So that's kind of my view on that.
Okay. And then just the loss on sale of assets, most of it coming from the rail. Was there about $9 million loss on sales or moving or early prepayment of aviation assets?
Brenna, it's Grier. So you're referring to the $98.9 million. So $90.9 million of that relates to the previously announced transactions with ERL I and the unencumbered that was announced today. The other $8 million, on a pretax basis, is associated with assets that we have on our balance sheet with basically as a proactive reduction and the carrying value of those assets.
And that's within rail or aviation?
All rail, Brenna.
Our next question comes from Mario Mendonca of TD Securities.
Can we just go back to solar for a moment? Is there -- to me it sounds, Steve, that we could see that balance shrink to as little as $25 million maybe in the Q4 or, I mean, perhaps early Q -- I mean, early in 2019. Is that -- I thought the intention there was to build it up over time, let it grow to a larger amount and then sell it. Or is it your intention to keep it to that nominal amount going forward?
Yes, I think there are 2 types of loans on Service balance sheet. There are, what I call, the new loan products, which are solar and PACE and the markets always have my commitment to test those, incubate them and sell them. So those are underway and will be sold in Q4. PACE might be the first week at Q1. The -- what I call the foundation products that drive the business and the best I can give you is progress payment, where John Wimsatt, as a contractor comes in, he's got a bath remodel and it's a $40,000 RIC. We may advance $10,000 against that RIC once we have a RIC signed. And we have recourse to draw on that progress payment part will always stay as part of the business. And call it $25 million, it could be $30 million, it could be $35 million, it could be $20 million. It's a relatively short-dated loan; it typically lasts no longer than 15 to 30 days.
Okay. So that has nothing to do with solar and PACE. So those loans, what do you expect those balances to look like over time?
So they're being -- our bank group has committed to buy all of solar in 2019. So it's permanently gone. It will flow through under the commitments to fund -- sorry, to purchase. So solar is now gone. You won't see solar pop up on our balance sheet.
Okay. They're going to be solar on origination?
Correct. They will take some time, yes. So that's a big win for Mark and his team, and we're happy that's happened. I think it's proof of concept that we can incubate an on-message, on-market loan product and get liquidity on it and anticipate the same thing will happen with PACE.
And what do you -- there are differing views on PACE and solar loans generally. There are some folks that really don't like this business because of some of the issues around the contractors and predatory lending. Is your experience or Mark's experience been that this business is a nice, clean, tidy business that doesn't have reputational risk attached to it?
Yes. So I don't want to talk about competitors, Mario, but we follow -- as you know, we follow -- we're a fully compliant lending organization. One of those is TILA, truth in lending. So all of our consumers know the exact cost of credit, whether it's a solar, a furnace, an air conditioning unit. So we're happy that we're compliant. Complaints from consumers in solar are actually a little lower than the complaint level coming through our other business lines. And I think the proof in the pudding here is our bank group taking time to re-underwrite this business. We do increase the FICO on this business for the longer duration. So it goes from a 760 now close to a 780, but we're happy to have it. More importantly, our banks are happy to have it. But there's a big difference between being a licensed organization and someone who relies upon someone else's charter to conduct business. We're in that former group. So all the stuff that we got to do on covered banks, whether it's TILA, Freddie Mac, anti-money laundering, all of that's performed by Service. We're happy to be in the business, provide the solar loans, conform to our bank's credit criteria.
Okay. And just one final question ON 2018 guidance. So Service Finance, for very sensible reasons, you're taking that from $55 million to $51 million, but the overall guidance for the year hasn't changed. And is the logic there simply that Kessler is delivering better-than-expected numbers?
Yes, that's right. You've got it, Mario.
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.