Element Fleet Management Corp
TSX:EFN
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Element Fleet Management Corp
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Thank you for standing by. This is the conference operator. Welcome to the Element Fleet Management First Quarter 2020 Financial Results Conference Call. [Operator Instructions] And the conference is being recorded. [Operator Instructions] Element wishes to remind listeners that some of the information in today's call includes forward-looking statements. These statements are based on assumptions that are subject to significant risks and uncertainties, and the company refers to you the cautionary statements and risk factors in its year-end and most recent MD&A as well as the most recent AIF, a description of these risks, uncertainties and assumptions. Although management believes that the expectations reflected in the statements are reasonable, it can give no assurance that the expectations reflected in any forward-looking statements will prove to be correct. Element's earnings press release, financial statements, MD&A, supplementary information document, quarterly investor presentation and today's call include references to non-IFRS measures, which management believes are helpful 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 the MD&A. I'd now like to turn the call over to Jay Forbes, President and Chief Executive Officer. Please go ahead.
Thank you, operator, and good evening to all of you joining us this evening on this call. Before I address our Q1 2020 results, I'd like to make 2 opening remarks. First, on behalf of everyone at Element Fleet Management, I want to express our heartfelt gratitude to the health care professionals and many other frontline workers who are caring for our families, our friends and neighbors affected by COVID-19 as well as providing essential services to the rest of our communities. Second, Vito and I plan to keep our comments brief this evening to afford our analyst community more time for questions and answers. Our published disclosures this quarter effectively contain all that we know about the impacts of COVID-19 and the current economy on our business right now. So we invite you to digest those over the coming days rather than us trying to convey it all to you in detail during our relatively short time together this evening. With that said, let me thank you all for joining us tonight to discuss Element's first quarter results, the continued progress that we're making in advancing our strategic plan and the early impacts of the economic disruption caused by COVID-19 on our people, our clients and our core business. Element's first quarter results demonstrate the progress we have made in strengthening every aspect of our business as we enter the final phase and year of our transformation program. We remain centered on the singular focus we set back in October 2018: To deliver a consistent, superior experience to our clients, day in and day out and, in the process, enhance Element's annual run rate pretax operating profitability by $180 million. And we are well on our way to achieving both outcomes by the end of this year, regardless of the challenges COVID-19 might present. Our transformation efforts positively impacted each of our 3 revenue streams and reduced our operating expenses in Q1 2020. This helped us generate a 10% year-over-year increase in adjusted operating income, equivalent to $0.23 per share for our core business and produced free cash flow of $0.29 per share for our consolidated operations this quarter. These results include a $12 million provision for credit losses recorded in our core net financing revenue this quarter. This brings our balance sheet allowance for credit losses to $20 million or 16 basis points as a percentage of total core finance receivables. By way of reference, the single largest credit loss recorded by our predecessor companies in any given year was 9 basis points. While we haven't experienced any credit or collections issues that suggests that our credit losses would be materially higher than those previously experienced, we also have no knowledge of the depth and duration of the pandemic and the ensuing impacts it might have on our clients' operations. Accordingly, we thought it prudent to increase the provision for credit losses given the potential impact Element might experience. I will let Vito delve more deeply into the details of our provision and its impact on our Q1 results shortly. Against the backdrop of global economic disruption and human suffering that COVID-19 has wrought, we feel incredibly fortunate to be in the position we are at Element. Our people are safe and productive, with 98% of them working remotely as they continue to support our clients. Our clients have been effusive with their thanks, as our teams help them manage their fleet needs through these chaotic times. In Q1 alone, we identified more than $600 million of productivity savings opportunities for our clients. Our operating platform is being transformed at an even faster pace than we had thought possible and, in turn, delivering profitability improvements faster than expected. We hit our original target of $150 million in run rate profit improvement late last week. Our investment-grade balance sheet continues to strengthen, even as we write off the last of the noncore investments, returning the business to its original premise: an industry-leading fleet management company catering to blue-chip organizations with mid- to large-sized fleets. And our liquidity continues unabated with consistent operating cash flows, augmented by working capital releases and backstopped by $5.5 billion of committed undrawn funding facilities. All of this provides us with the conviction and confidence to stay the course on our strategy. As you know, that strategy identifies 3 waves of opportunity for Element. We identified our first wave of opportunities in the fall of 2018, announcing our three-pronged strategy to transform our core business, strengthen our balance sheet and wind down or sell 19th Capital. In the spring of 2019, we launched our second wave of opportunity as we secured Armada as a client and rapidly began to scale our operational and syndication capabilities to serve [ the same ]. And with the nearing prospect of a narrowed strategic focus, a best-in-industry operating platform and a strengthened financial position, we announced our third wave last fall, a planned pivot to growth. We have reexamined these strategic objectives in the context of a post-COVID-19 world and believe them to be even more relevant and viable. In short, we remain focused on the long-term value creation prospects we've identified for Element while remaining vigilant and agile as we grapple with the immediate impacts of the pandemic. While we remain confident that 2020 will be a year of great strategic progress for Element, with the core business transformed, with tangible leverage sub-6x, with 19th Capital sold and with our pivot to growth launched, 2020 will nonetheless be a year of disappointment regarding our planned growth and profits. While we've continued to generate solid profitability this year, our business will not be unscathed by the current circumstances. I can't tell you exactly how our near-term quarterly results will be impacted. Frankly, there are just too many variables at play. We have shared with you all that we know today in our Q1 disclosure materials. And as always, we're striving to maximize transparency for you, our stakeholders. However, because so much remains unknown about the scope and duration of this economic downturn, we have withdrawn our year-end adjusted EPS guidance. We can tell you, Element is fully equipped to endure however long this downturn persists and that we're poised to emerge with momentum when normalcy returns. We can also tell you that we fervently believe Element's value proposition is only being made more compelling by the current environment. Let me say more about that in a moment. But in the meantime, I'll invite Vito to share his views on our Q1 results.
Thank you, Jay, and good evening, everyone. I'm pleased to be with you this evening to talk through what we believe are a solid set of Q1 operating results and expand on what we could expect in the next quarter or 2. As Jay noted, our core adjusted operating income was $0.23 per share or $134.8 million for the quarter, a 10.5% increase over the prior year and a 5.5% decrease from the prior quarter. Given the uncertainty associated with the economic impact of COVID-19 and its potential impact on our clients, we felt it necessary to increase our allowance for credit losses. And these Q1 results reflect a $12.1 million provision or charge for credit losses, bringing our cumulative allowance to a total of $20 million. This is the exclusive driver of the quarter-over-quarter reduction in core AOI. I refer you to Section 2.0 of our supplementary document, which unpacks the quarter-over-quarter AOI change in greater detail. We otherwise had a very solid quarter, building on our continued momentum. We like to look at our assets under management, or AUMs, as one of the barometers of the underlying health of the business. Our core segment finished the quarter with $17.8 billion of AUM, an increase of $1.1 billion from the 2019 year-end and $2.3 billion since Q1 last year. On a constant currency basis, AUM growth was $200 million over prior quarter and $1.9 billion over the prior year. Originations in Q1 were $2 billion, a 9% decrease from last quarter and a 19% increase over Q1 2019. The quarter-over-quarter reduction was primarily a reflection of our model seasonality. Excluding our model, there was strong growth in U.S. originations and in Mexico. Further, as you can see in Section 5.1 of our supplementary, Q1 had had the lowest quarterly origination volume in each of the last 2 years. So for it to be up $300 million over Q1 of last year is a great result for us. This was fueled by strong originations growth in the U.S., including Armada as well as Mexico and Canada. In terms of what we can expect from originations going forward in Q2, given the temporary closures of several OEM production facilities and the economic uncertainty driven by COVID-19, we do expect a meaningful reduction in originations. Turning to core net financing revenue. The provision for credit losses is booked against in this slide, and it was the only driver of core net financing revenue decreasing $4 million quarter-over-quarter and $5.3 million year-over-year. Excluding the impact of the extra provision taken this quarter, net financing revenue performed well, increasing by $7.7 million quarter-over-quarter and $6.5 million year-over-year, benefiting from several factors, including improved working capital management. Our portfolio is blessed with strong credit quality customers in diversified industries and geographies. However, it is difficult at this time to predict the final impact this pandemic will have on our thousands of clients across 5 geographies and over 700 industries. Our $20 million allowance is based on multiple factors: on applying the expected credit loss model, including macroeconomics; the probability of default of our clients; our view of valuations; and the loss that would likely result from default. I refer you to Note 3C of our financial statements, where we discuss our allowance methodology in more detail. Further, the $20 million allowance represents a 16 basis point as a percentage of total finance receivables before the allowance. Based on the information we've been able to gather, the highest level of actual losses to businesses that now make up Element experienced in a similar year was 9 basis points, and that incurred in 2009, the year of the great financial crisis. Let's now turn to net services income for Q1, which fell $2.9 million quarter-over-quarter. The decrease was in part due to lower volumes in March as a result of COVID-19 and in part due to normal seasonal volume reduction from Q4 to Q1. This offset the positive impacts of transformation. On a year-over-year basis, net servicing income improved 7%, with both organic business performance in all geographies and its transformation contributing to growth across multiple product categories. We anticipate a reduction in net servicing income for Q2 due to the broad public health measures implemented to combat COVID-19. Fewer miles driven is obviously a factor, and an oversupply of used vehicles in the U.S. and Canada will delay the utilization of remarketing income. Turning to syndication. The syndication market remains open to Element, and we are successfully expanding our universe of investors. We syndicated $834 million of assets in Q1, $130 million fewer than last quarter and $345 million more than in Q1 of last year. Syndication revenue decreased $1.5 million quarter-over-quarter but actually increased when measured as a percentage of syndicated assets. We are anticipating some level of softness in syndication revenue in the second half of this year as we face a step-down in interest rates. Adjusted operating expenses were effectively flat quarter-over-quarter and down $1.3 million year-over-year. Transformation savings on salaries, wages and benefits were partially offset by merit increases driven by our strong performance last year and the growth of Armada and syndication teams. General and administrative expenses increased with investments in growing our Mexico business and capabilities to serve our model, in addition to professional fees in the quarter. Section 2.1 of our supplementary walks you through our core OpEx quarter-over-quarter. A few more things of note before I turn it back to Jay. We remain on track to achieve sub-6x tangible leverage by year-end. Our tangible leverage was 7.45x this quarter end, an increase of 0.34 from prior quarter due solely to the strong appreciation of the U.S. dollar against our reported Canadian dollar. Excluding FX and the impact of our nonrecourse credit facility, our tangible leverage this quarter end would have been 6.35x. So we continue to strengthen and derisk our balance sheet. Regarding our convertible debentures due next month. You will have seen that we've established a $560 million facility to backstop redemption, if required. As we have indicated, we plan to issue U.S. unsecured bonds in 2020. While market conditions have improved lately, our liquidity profile allows us the luxury of flexibility. We will step into the market at the right time for our inaugural issue. Finally, as you will have seen in our release and as disclosed in our financial statements subsequent event note, in Q2, we closed the book on 19th Capital by selling the assets of the business and settling third-party debt. I'd like to personally thank Heather Tulk, President of 19th Capital, her leadership team and all 19th Capital employees for their commitment and stewardship of these assets and business over the last several quarters. The net impact of these transactions will result in an after-tax and expected after-tax loss of $15 million to be recorded in our Q2 accounts. Finally, allow me please an opportunity to reflect on the undertaking of the last several weeks. Like all businesses all over the world, the leadership and broader team at Element have truly doubled down and rolled up their sleeves. We established cash and client response offices, but I am confident in our best-in-class practices. What are the outcomes of this in my mind? Immediate benefits in our optimal flexibility, a greater understanding of key leaders and ultimately, enhanced confidence in our decision-making. Further, there's a real long-term benefit that it sharpens long-term focus, discipline and competitiveness, which is sustained over time. But perhaps most importantly to me, it's reinforced our confidence in both the resilience of our business and the real value-add we are to our clients. With that, I wish you and your loved ones the best of health as we navigate these uncertain times. And Jay, I'll throw it back to you.
Thanks, Peter. As I've previously communicated, we view the current societal and economic circumstances as an event with an ending as opposed to some new normal. While there will be a long-lasting change as a result of this pandemic, the needs Element addresses in the markets we serve will remain fundamentally the same. Our existing blue-chip client base will still need mission-critical vehicles to sustain their daily operations. Some clients will want larger fleets. Others will want to outsource more responsibility for managing their fleets to Element. Others still are only service clients right now or not Element clients at all. Many companies own their own fleets, and these self-managed fleets represents $2 billion of untapped annual net revenue potential in the U.S. and Canada alone and in the same market segments Element serves today. To the extent current fleet owners, including governments, wish to create balance sheets for budgetary headroom, we have the balance sheet capacity to welcome their vehicles onto our platform. And we have the syndication capabilities to manage any accompanying concentration risks to Element. We also have the liquidity to effect sale-leaseback transactions with current owners and the operating experience to execute a seamless transition of responsibility for those vehicles. In sum, we believe our fleet financing and management services will remain in high demand. We would not be in the fortunate position we find ourselves today without having invested in the last 19 months time and effort into the transformation, the balance sheet strengthening, liquidity improvement, syndication capabilities and the crafting of our growth strategy. Managing through COVID-19 would be an entirely different experience at Element if it were not for everything accomplished since the fall of 2018 in accordance with our strategic plan. As a result, I wish to thank our investors, shareholders and lenders alike for your support of Element then, now and in the future. And I wish to thank our people, my colleagues, for the energy you bring to your jobs every day in delivering a consistent, superior experience and incredible value to our clients. Our business is safe and sound despite these unsettling times, and our future remains bright. With that, it's my pleasure to open the floor to any questions you might have. Operator?
[Operator Instructions] The first question comes from Geoff Kwan with RBC Capital Markets.
Just my first question is on the Q2 service revenue you talked, meaningfully lower year-over-year. Just wondering if you can give a little bit more clarity on that. Is it a range of like mid-single digit, low double digit, that sort of thing? And then how much of your service revenues would be dependent on volume or some other level of activity as opposed to some sort of monthly fee that's charged kind of regardless of what's happening?
Geoff, in terms of service consumption, with a mere global move to work from home, we saw a rather abrupt and material decline in the consumption of maintenance and fuel services, as many of the nonessential fleets that comprise our portfolio were effectively parked. And so we would expect, having seen this materialize towards the end of our first quarter, we would expect that this will have a more pronounced impact as we go through Q2. And as you think about our service revenues and the composition of those revenues, think maintenance, think fuel, think tolls and violations, think collision services, all as being services that we provide that are more attuned to the mileage that the vehicles travel and thus, the fact that many of those vehicles are traveling less and, indeed, a smaller portion of our fleet is effectively parked, I think of a material decline in Q2 service revenues as a direct impact of this pandemic. And maybe just one other point to kind of shape your own thinking around this. In terms of our total fleet, rough, rough, rough, 80% of our fleet would be comprised of service vehicles. The other 20% would be sales vehicles. And we would have expected the vast majority of those sales vehicles would have effectively been grounded as a consequence of shelter in place and people working from home. While the other 80% of the fleet would have varying degrees of utilization, many of those would have been deemed essential services and would have been actively deployed akin to the pace that they were enjoying in the fourth quarter of last year. Others would have been less productive in terms of their utilization. So we're -- the portfolio is, actually by virtue of inherent bias to service vehicles, is more protected in terms of this step-down in terms of service consumption. But nonetheless, we will feel a material deterioration of that revenue in Q2.
And sorry, just -- I mean, I guess, with what you've seen Q2 to date year-over-year, like it sounds like it's -- obviously, it's meaningful. Is that like a 20% reduction that you've seen so far, 30%? I'm just trying to get a sense as to -- even rough ballpark here.
Yes. I think your term meaningful encapsulates it quite well. It was probably the suddenness of this. As a consultant, my colleagues, who have far more experience in the industry than me, no one has ever witnessed this type of pullback in services in the history of fleet management. And again, it -- you trace it back to its core elements, and you come back to this work from home and a sizable piece of the fleet that is operating at suboptimal capacity. So like everything, we've adjusted to that. We shift resources in the organization. And so the surplus resources that we have are actually working to accelerate the transformation of the organization and ensure that we'll be bringing that to the successful close that we had anticipated, both in terms of that consistent, superior client experience but also the realization of the full $180 million of run rate profitability improvement that is actioned.
Okay. And just the other question I had was, is there any commentary that you can provide on what's going on with Armada but also to just any incremental progress with respect to mega fleets?
Sorry, could you repeat the last piece of the question?
Just if there's been any incremental progress around mega fleets, traction trying to get them?
Yes. Yes. So we wouldn't be able to offer any specific commentary on an industry segment or client. And so I'll hold my remarks on Armada, other than to say that the relationship continues to grow and develop. And they, like many other aspects of our fleet or that service component that I referenced earlier, and depending on where you are in that continuum, you may have more than full utilization of one's fleet. And then in terms of the mega fleet strategy, we have actually stood up that group. Tom Peterson, the -- who was our EVP of Mid-Market, has actually taken a lead for us on that market segment, has put together his team, and they are already in the midst of developing marketing plans. So as I say, as we come to grips with the pandemic and the ensuing impacts on our clients, we've been able to actually advance some of our key strategic objectives, not the least of which our transformation and that pivot to growth, as we prepare to take full advantage of the transformed operating model and the strength of the balance sheet to actively grow.
The next question comes from Mario Mendonca with TD Securities.
Quick question on -- sorry, just bear with me here. When you talk about the impairment charge, the $12.1 million, can you offer like what is your best view of the realization of losses? Meaning for every $100, let's say, of impairment, what amount are you contemplating would actually a credit loss? Because I appreciate fully that there'd be a material recovery, that you wouldn't lose 100% of the impairment. But can you help me think through what the recovery would be?
Yes. Certainly, Mario. So a number of consideration points that go into determining what we reference as the gross expected loss. So we'll look at the probability of default for each and every one of our clients. So we assign them a more risk rating. That risk rating is set at least annually for each of our clients. And I should appreciate when you go through events like this, they're refreshed accordingly. So we have that probability of default based on these individual or risk ratings. And against that, we assess our portfolio position. And as I mentioned in the past, our lease has typically kind of average life of 41 months. By the time we hit the 26th month, we're usually in a surplus position in terms of that asset. And so we actually have equity, an equity position in that asset. And as you can appreciate, that equity position, equity surplus builds through to the maturation of that lease. And so when we look at a particular client and the probability of default, we then look at their portfolio position to understand that asset gap and whether we're in the surplus or deficiency. If, for instance, we're in a situation where we see a deterioration or expected deterioration in the credit profile of that client and there is a larger asset gap, very often, we'll ask the client to put up a letter of credit for the difference to ensure that we're not overly exposed in terms of a risk of default and/or an ensuing of loss by virtue of that gap. So that's how we determine the gross expected loss. We then take our experience in managing through worked-out situations, whether it be insolvency or bankruptcy, to determine our net expected loss. And typically, Mario, as Vito has indicated in his commentary, we are single-digit basis points of net expected loss. So while we may have a large default position with an organization, that rarely translates into any meaningful net loss as we work our way through the liquidation or bankruptcy process. And I would cite this last quarter, offering up a perfect example. So you might have seen where we actually had a fairly significant increase in our delinquencies and as well as our impaired assets. When you look at the impaired assets, the quarter-over-quarter increase was actually just 1 client, and it was a client that had gone bankrupt. But we had been working with that client all through the process, had seen the declining credit position and secured letters of credit, such that this client, whose net exposure to us would be in excess of $40 million, actually the net exposure to us is 0 because we were able to secure letters of credit and bridge whatever gap existed. So it is a combination of assessing the probability of default, managing the asset value gap, and then using our past experience in terms of managing in these types of situations to manage our exposure down such that in any given year, our predecessor companies never recorded any more than 9 basis points of net expected loss or effectively credit loss.
That's helpful. My second question is sort of related. The assumptions that any company uses, vis-à-vis when the recovery unfolds and how it unfolds, I imagine are important to the expected loss that you estimate. And it was helpful in your note where you talked about -- I think you make a point that you would expect the reopening of businesses in late September 2020. It was helpful to hear that expectation. But then you also make a point that you expect a return to normal growth in 6 to 9 months. What wasn't clear from reading that note is whether you meant 6 to 9 months from September 2020 or 6 to 9 months from today to see a return to normal.
Thank you for clarifying. So we would -- the 6 to 9 months of return would begin at the end of September, based on our latest view of the world.
The next question comes from Tom MacKinnon with BMO Capital.
Just going to try this service revenue question in a different way. I think on Page 14 in your MD&A, you said that the COVID-19 had a $2 million to $3 million negative impact on core adjusted operating income for the quarter, and that was through reduced service income. So if I pretax that, we'll just call it between $3 million and $4 million, and that's the last 2 weeks, that's about $2 million a week. So just on that math, it's about $30 million for the quarter. Does that seem as a way of looking at the reduction in the service income? And have you seen any -- the pace that you noted in the last 2 weeks of March, have you noted that accelerating or decelerating as we -- at least through May now? And I have one follow-up.
Tom, I'll let you do the modeling. But maybe in response to your second question, we would have seen a rather abrupt and unexpected slowdown in terms of maintenance, fuel, collision type of incidents and thus revenue-generating opportunities for the organization. So we saw it happen very quickly. But having experienced it, there wasn't a material deterioration beyond that. And so the step-down that took place, took place with a degree of immediacy, but there wasn't a significantly pronounced decline thereafter.
Okay. That's great. And then with respect to syndication volume, I think you had talked about -- was it $2.8 billion for 2020. And I was -- and I think you had sort of said that you expected maybe half or maybe slightly more than half to be related to Armada. I think in your latest conversations, you sort of reconfirmed that. Are you still standing by that for 2020? Or just not necessarily standing by that, but would you feel that, that still seems to be a reasonable number?
The indications that we had provided in the past is we thought we would do approximately $2.4 billion a year in syndication, split roughly 50-50 between Armada and the non-Armada piece of the business. And I would say that there will be a bit of a bias here in terms of advancing syndication while the market continues to be as strong in interest and demand, as we have experienced in the first quarter. And so again, the difficulty of working in this COVID-19 environment is it calls into question every single one of your baseline assumptions. There -- it's really almost unfathomable that we're experiencing, as a world, what we're experiencing right now. And as a consequence of enduring the unexpected, as I say, it has caused this leadership team to kind of go right back to the studs and reexamine every aspect of the business and test every aspect of the business to ensure the model that we believe offers the resiliency and the predictability that we have been sharing with you is indeed capable of continuing to do that in a world that has been kind of tossed on us here in the abrupt manner that I've been referencing in this call. And so for us, we're going to have a bias to action here, and we're going to be biased to seize the opportunities when those opportunities are readily available to us. And so when it comes to syndication, recognizing the importance of strengthening the balance sheet and achieving that sub-6 tangible leverage target by the end of the year, recognizing the importance of continuing to manage the concentration risk on certain named clients and recognizing the opportunity to feed that market and to grow that market so that it will be there tough times as well as good times, we may end up going more aggressively on the syndication agenda in 2020 than the $2.4 billion that we would have originally guided you to.
The next question comes from Paul Holden with CIBC.
So first question is regarding scheduled lease payments and collected. Will you give us sort of a breakdown or percentage of what was collected in April and May versus what was scheduled?
Actually, collections is progressing much in line with expectations. We haven't seen a material deviation in terms of our expected cash flows as they relate to billings and collections.
Good. And then second question, Jay, in your shareholder letter, you mentioned that originations in Q2 would be disrupted because of OEM production, facility disruptions. That, to me, suggests that this is largely a supply phenomenon. Now I pretend it's all supply. Does that -- is that fair to characterize based on what you wrote, that this might be more of a supply disruption to originations than a demand disruption?
I'd love to say that's the case. But no, in fact, we have seen a softening of demand. You can appreciate, right now, most organizations are like ours. So again, in all of the contingency planning that we have done, no one envisioned something as disruptive and as pervasive in terms of this disruption as this pandemic has brought. And so most organizations, I think, are like us, and they're going right back to the core. They're making sure that everything is nailed down. Everything is stress-tested, and that the basic business processes are indeed functioning as they were intended to function in times of stress like the one we're in right now. And as a consequence, the notion of placing orders for vehicles just falls low on the priority. So we have been very fortunate. We've seen basically nothing in terms of de-fleeting. We had one client that lost a contract and will be de-fleeting as a consequence, but that's the only instance I'm aware of throughout the 5 countries of any material de-fleeting of fleet. So it's not that people are rushing to decrease the size of their fleets, but they are postponing placing orders. Now in truth, Paul, chicken and egg, are they delaying knowing the OEMs are shut down? Perhaps. But again, I think it is quite secondary to just the operational and logistical issues that these organizations are facing, as they think about ferrying their workers between job sites and keeping them safe and healthy in the process. The other piece, Paul, just if I could, on originations. This is very much a deferral. This isn't a lost opportunity. When we come back to the total cost of ownership, people are originating, ordering new vehicles as a consequence of their existing fleet hitting a certain age in terms of miles driven, years on the clock, that make continued operation of that vehicle more expensive for that organization than retiring that vehicle and replacing it with effectively new technology that's operating at a lower cost. So it's -- this is a delay in originations as opposed to a loss of originations, is the way that we're viewing this, and that would be very much in keeping with the experience back in 2008 to 2010 and the economic downturn and impact it has on originations at that time.
The next question comes from Jaeme Gloyn with National Bank.
First question is related to the net interest margin in this quarter, excluding the PCLs, would have been about 3.7% on your disclosures, primarily on lower interest rates, interest expenses. I'm just wondering if you can give us a little bit more color as to the sustainability of those lower interest expenses flowing through to the NIM in future quarters. And maybe a comment on the impact of gain on sale income in the net interest margin as well.
Yes. Perhaps I'll offer a couple of comments and then ask Vito to provide some additional detail. Jaeme, as you are well aware, the transformation has had multiple focuses, not just on cost-out but, indeed, revenue enhancement. And as we look at that net interest line, it encapsulates a number of different revenue streams and associated costs. We have been actively working to reduce the associated costs as well as to enhance a number of those revenue streams within net financing revenue. And as a consequence, what you're seeing is an expansion of the NIM as a direct consequence of the transformation actions that we've taken. We've also obviously had been rapidly growing out our business in other geographies that offer better yield, which has given us a nice increase in mix and, over and above that, have been more aggressive in the management of our balance sheet and in particular, our working capital position, which has allowed us to lower our risk costs -- or excuse me, our interest costs. And even as you think about that continued journey to that sub-6 tangible leverage ratio, that relief of the associated debt results in a lower interest cost just borne by the organization as well. So a number of different drivers that add to that 3.7% NIM factor that we were able to record for this quarter. In terms on gain on sale, the piece here, much like I mentioned to Paul on originations, we're going to see some delay in the recognition of gain on sale or that it operates in Mexico and Australia. And so by virtue of the virtual shutdown of many of the auction houses, that remarketing channel is readily available to us to sell those vehicles. And thus, the associated gain on sale, the realization of that, is being deferred until those channels open back up and market stability is attained. So again, much like originations, this is more about a deferral in revenue as opposed to revenue foregone. And in terms of timing, we have some indication, by virtue, the OEMs opening mid-May, but the auction houses won't be far behind that. So we're hoping that some degree of normalization takes hold later this month, provides us the facilities to again take those cars to market and realize and record the associated gains on disposition. Vito, did you have some other thoughts in terms of that NIM?
Jay, I think you covered it well. Maybe just 2 additional points there, Jaeme. We're very, very pleased with how NIM is progressing. I wouldn't model a 3.7% for the balance of the year. I think it's a bit of a higher watermark for us. Two additional factors that have contributed to the 3.7%: One is you might recall in Q4, we did have a deferred financing fee write-off in our Q4 results as we had, I'll call it, a onetime charge. So that contributes also to the movement from Q4 to Q1. The additional thing to note is, and we've talked about this a little bit, is syndication reducing NEAs, as you're familiar. But a component of our pricing structure has a fleet management fee. And when we syndicate, of course, we don't sell that fleet management fee. That remains with us. So to that extent, you should get, everything else being equal, a little bit of lift in NIM percentage as you work your way through quarter-to-quarter, as we continue -- as our NEAs -- if our NEAs drop resulting from syndication. And Jay, you've already addressed the gain on sale. We will see obviously reduction in gain on sale here in the short term for reasons Jay has articulated, and that will be a headwind to NIM as we move forward to deal with the short term.
Great. And second question, in a similar vein, just looking at the impact of lower interest rates on the syndication earned rates. Can you give us a little bit more perspective as to the -- how much is interest rate driving syndication revenue? I know there's other factors that drive the price and yield that your -- all those syndicated assets such as duration and credit quality and the size of the pool being sold. But you specifically draw out interest rates in this quarter as being a headwind. So can you give us how your -- how we should expect to see that impact syndication earned rates?
Yes. I think you've called out a number of the contributing factors that are the ultimate determinants of the fees that we earn on the syndication activities that we carry forward. Interest rates, we are going to see its impact work its way into the fee on a couple of dimensions. Firstly, I think it's going to create a higher hurdle rate in terms of a minimum level of acceptable interest return that our syndication investors will be willing to take on a syndication transaction. So as we look to move that volume through those channels that we have established and continue to grow, we're going to find a higher price required to clear the market that will compress some of the fee opportunity that we would otherwise have. Secondly, the depreciation shield that is being purchased is of a lesser value at a lower interest rate. And so the combination of those 2 factors are what's leading us to believe that we will be a bit more bearish in terms of the syndication fee yield that will be available to us as we make our way into the second half of this year.
Okay. And net-net-net, the higher volume of syndicated assets is likely not enough to offset the negative impact of those factors.
Yes. And back to -- one of the big drivers here is, obviously: one, to syndicate all Armada paper to avoid any named concentration risk; and secondly, our continued pursuit of strengthening the balance sheet and achieving that sub-6x leverage -- tangible leverage. So those are kind of 2 overarching themes as it relates to the syndication. And to the extent that the deal economics are still attractive, then happy to put more volume through the channel. But again, to your point, and this takes us back to all of those factors that need to be considered in terms of clients and the credit and the duration, having that, the right mix of factors, is probably much more a determinant of that ultimate fee revenue that is derived versus the fee rate itself.
The next question comes from Geoff Kwan with RBC Capital Markets.
Can you -- Jay, you talked about earlier about that abrupt, unexpected decline on the service revenue side. Can you clarify, was that kind of in that second half of March time frame or was it in April? And if so, when about in April did you see that happen?
More so in the tail end of March.
Okay. And then just my other question was just -- I missed it earlier. Did you kind of stand by kind of around that $2.5 billion on the syndication volume side? And then just adding on. If the mix of vehicles that you're syndicating don't change, is it just a matter of rates going higher that will bring the syndication rate back to where we would have been last year? Or is there some other factor that would do that?
I think that the primary determinant is indeed interest rate, if we hold all else equal. The compression that we anticipate is largely interest rate driven, and we're just being plowed down into levels that we haven't seen in forever. And that is giving rise to certain behaviors and expectations in the marketplace that we think will, again, ultimately lead to a compression in our yields on those transactions for the second half of this year. And in terms of volume, Geoff, again, original guidance that we had provided was somewhere in the neighborhood of $2.5 billion, $2.4 billion of volume. As we sit here at this juncture, with the profile that we have for the business, with our strong desire to strengthen the balance sheet and move to that sub-6 tangible leverage, it feels like we will be north of that $2.4 billion for 2020.
Okay. And sorry, when we're talking rates, are we talking kind of the risk-free rate? Or is it kind of the broader incorporating the spreads in the market?
The underlying risk-free rate. And off of that, then we have our investors setting their minimal acceptable rates of return that they need on their transactions.
The next question comes from Mario Mendonca with TD Securities.
A quick question on the expenditures that the company incurs to generate the $180 million in cost savings. I recall that the expectation is that you'd spend roughly the same amount to generate that $180 million, so $180 million in expenses. By my math, you're at about $177 million now. Is that right? And is the $180 million still an appropriate benchmark to use?
Excuse me. Your ratio is 100% correct. So we have been operating from the very beginning kind of a 1:1 ratio here. For every dollar of run rate profitability improvement actions, we would expect to invest $1 behind that. And to this quarter, we were able to generate $146 million of -- or excuse me, action $146 million of run rate profitability improvement and did so with $145 million worth of investment. So it would be our expectation, Mario, to exit this year with the full $180 million of run rate profitability action and to keep our investment to that same $180 million.
So the $177 million that I was referring to, I guess, maybe is the error that I included Q3 '18 when I perhaps shouldn't have included Q3 '18?
No. That's in there. So if you go to our supplemental and you'll see our -- we're on Page 7, schedule 1.4, you'll see our Q1 results, $146 million of run rate profitability improvement action, $145 million worth of investment and still targeting $180 million worth of investment by the end of the year. So that ratio holds true, and it's our ambition to continue to hold that true straight on through completion of the program.
Thank you. This concludes the question-and-answer session. I would now like to turn the call back over to Mr. Forbes for any closing remarks.
Thank you, operator. And once again, thanks, everyone, for joining us here this evening. Strange times. We appreciate your patience. We appreciate your understanding of our circumstances as, again, we grapple with this rather unforeseen and unexpected pandemic. As always, we'll make ourselves readily available to you by way of follow-up for any additional questions or comments that you might have for me, Vito or Mike. In the interim, wish you and yours very well. Stay safe, stay well, and we look forward to talking in the very near future.
Thank you. This concludes today's conference call. You may disconnect your lines at this time. Thank you for participating, and have a pleasant evening.