ECN Capital's (ECNCF) CEO Steven Hudson on Service Finance Acquisition (Transcript) – Seeking Alpha


ECN Capital Corp. (OTC:ECNCF) Service Finance Acquisition Conference Call June 8, 2017 7:00 AM ET

Executives

John Wimsatt – IR

Steven Hudson – CEO

Grier Colter – CFO

Analysts

Nick Stogdill – Credit Suisse

Vincent Caintic – Stephens

Tom MacKinnon – BMO Capital

Geoff Kwan – RBC Capital Markets

Jeff Fenwick – Cormark Securities

Mario Mendonca – TD Securities

Stephen Boland – GMP Securities

Victor Dri – National Bank Financial

Operator

Welcome to the ECN Capital Corp. Analyst Briefing. As a reminder, all participants are in listen-only mode and the conference is being recorded. After the presentation, there will be an opportunity to ask questions. [Operator Instructions]

I would now like to turn the meeting over to Mr. John Wimsatt. Please go ahead, sir.

John Wimsatt

Thank you, operator. Good morning, everyone. Thank you for participating on our Analyst briefing to discuss the transaction that ECN Capital announced this morning. Joining us today to discuss this transaction are Steven Hudson, CFO; Jim Nikopoulos, President; Grier Colter, Chief Financial Officer; and Loreto Grimaldi, General Counsel.

A news release summarizing this transaction was issued earlier this morning. A presentation with management’s comments has been posted to our website, ecn.capitalcorp.com and can be accessed during the webcast.

Before we begin, I want to remind our listeners that some of the information we are sharing with you today includes forward-looking statements. These statements are based on assumptions that are subject to significant risks and uncertainties. I’ll refer you to the Cautionary Statement section of our 2017 MD&A for a description of such risks, uncertainties and assumptions. Although management believes that the expectations reflected in these comments today are reasonable, we can obviously give no assurance that the expectations of any forward-looking statements will prove to be correct.

With these introductory remarks complete, I’ll now turn the call over to Steven Hudson, Chief Executive Officer.

Steven Hudson

Thanks, John. And before we start with the formal presentation, let me welcome Mark and our new partners in Florida this morning. We’re extremely excited to have them join the ECN family. I’ve been doing this for over 25 years and I’ve never seen a business like theirs, its growth, scalable; it doesn’t require capital and Mark and his team need to be — they need to get a gold medal for building this business, we look forward to building with them to the next level.

With that introduction, let me start on page three of the presentation. We’ve entered into a definitive agreement to acquire Service Finance for approximately US$300 million or C$400 million. There is also a five-year performance based deferred purchase plans which I’ll just speak to in a moment. We expect the closing in the third quarter subject to conditions.

When you look at this business, it’s all driven by earnings. There is no capital required to run this business. This is our first and major step in transitioning ECN from a balance sheet lender which is book value based to that of an asset manager which is earnings based. We think we’ve done a great deal for us; we think it’s a good deal for everyone involved. The multiples are as presented on page three with respect to earnings.

The transaction will be immediately accretive to EPS and ROE as highlighted on page three. And it marks — more importantly, this marks the first significant step in our divestiture of businesses such as C&V U.S., ECN commercial finance, and transitioning that capital into an asset-light; in this case, no assets, all management fees with superior growth scalability. And we are quite excited by this transaction.

Turning to page four, a little bit on Service Finance, founded in 2004. That is a company with a long history prior to that, actually being in the home improvement business. In 2004, they launched the financing of home improvement. This is a business that we know well that it’s lender based that the financing contracts we refer to them as retail installment contracts, RICs are originated through National Programs on exclusive basis in the U.S.

In 2017, we expect C$1 billion; in 2018, C$1.5 billion. The business is owned 60% by Mark Berch and his partners and other key members of management; 40% by Flexpoint Ford, a private equity investor. The waterfall this purchase price allocates approximately 195 million of that to Flexpoint Ford and a 109 million to Mark Berch and his team; will come to that in a second.

These transactions do not require funding on balance sheet. If you turn to page five, there are three key components of business. The first is the origination, the front-end of business. We originate these financing contracts, these RICs through exclusive manufacturing arrangements; I’ll speak to the manufacturers in a second, on a national basis throughout the U.S.

75% of the originations come through five key exclusive national programs and we continue to grow. We’re adding a 150 dealers per month to this base of customers. The dealers are the ones who represent the manufacturers in the field. The second part of these is that these loans — these financings are underwritten on a prime and super prime basis, very high cycles and average of 760. These are promotional financings from the manufacturers where they offer lower payment structure to interest the customer in purchasing the equipment, relatively short duration of the product and ability to register lien and credit losses that are superior to almost any asset category. And most important part is that these loans are sold to FDIC insured institutions via bank counterparties. The third part is the actual purchase and management. These financings are sold through the 13 FDIC insured institutions, that’s a gold standard. We have new relationships with banks underway, more to come. We are paid a fee for originating and for managing these assets through the successful close. Currently, there is C$1.1 billion. When the assets are paid back, that capital is reinvested into new RICs with Service Finance.

Turning to page six. This is a consistent criterion that you’ve seen for both divesting and redeploying capital. I think you can say that every box gets ticked on this transaction. You see the ability to be partners with banks as a counterparty, profitability that more than exceeds our requirements, a resilient long-term business model and ability to build scale has proven by the historic growth rate and the current and forecasted growth rate and strong asset management business, and the credit risk — we are happy to underwrite these assets, they are being underwritten on behalf of banks without recourse or capital, no first lost arrangements.

Turning to page seven, the side-by-side comparison of the business that we sold, our C&V U.S. business, which is a vendor finance business. To that of Service Finance, the invested equity is approximately equal to that of what we’ve harvested under the U.S. sale. ROE is materially higher than this business; contract yields 10%, will walk to in a second. Duration is shorter because of the promotional loans; most consumers pay-off these loans after the promotional period.

There are no assets on the balance sheet. All these financings, these RICs are sold through to the FDIC insured banks; we manage that book on their behalf. Originations have been strong and continue to grow; and I’ll walk you through the origination profile in a moment. And the credit quality is superior to that of the business we sold. I think it’s safe to assume that this business is superior in all respects to that of C&V U.S., and C&V U.S. was a strong business.

Turning to page eight, with respect to the impact to the profitability of ECN. This business will close late in the third quarter. So, there is a modest $0.04 pick-up thereabouts for our business in 2017. So, there is immediate accretion. I think it’s really important we look to 2019 where we double the earnings. Again, the important part, we double the earnings without putting up capital or recourse to our business, a higher quality revenue in earnings stream for sure.

Turning to page nine, which how do we look at this business, what’s the business valuation from our perspective. The top page part of page nine with respect to the Service Finance model, which is one of an earnings business. And we’ve put some metrics in front of you, how you might value it on the post and pretax basis. The bottom part is the remaining business of ECN, which we are in the midst of harvesting and redeploying; that’s basically a book value calculation. We strongly believe it, we’ve stated for last 18 months that book is book, our investors and analysts are free to put their valuation on book, but we believe it to be at least worth book value.

Turning to the home improvement market on the page 10; this is a $350 billion market. Half of that market is our financed arrangements. Consumers have the ability to pay cash, they have ability to put these home improvements on the credit card and they have the ability to offer installment based credit; we are that provider. We think the installment based credit is a better relationship for the consumer and financing their home improvement. It doesn’t consume credit card capacity; our yields are less than that of the credit card. And we think it’s a longer term relationship that benefits both the financier and the consumer. Installment based credit is the fastest growing market of 12% to 14% and we think that the future is quite clear for this business.

If I turn you to page 11, let me use an example of that. We’ve worked through in the year that we have been working with Mark and his team and last 75 days of extremely deep due diligence. If you think of a family, a husband and wife sitting at a kitchen table in Wichita, Kansas, this afternoon and they’re there with the Lennox dealer, and they’re deciding whether to buy or purchase or finance a new Lennox air conditioner, there is a laptop sitting on the kitchen table, the driver’s license is scanned, the address is — home address is entered and that immediately populates screens in the Florida head office for Service Finance. The underwriting and adjudication of this potential transaction happens in a matter of moments and it’s literally sold through in that same timeframe.

It’s a very impressive system. So, I’ll walk you through the wheel on page 11 is that that second part where the dealer provides the estimate is literally occurring at the kitchen table on a life time basis. The dealer flips around that screen and talks to the husband and wife and says, you can pay cash this morning or this afternoon for that air conditioner; you can put on a credit card or happy to offer you a installment-based program at 2.9%. That last offer is us. We think it’s a superior offer to consumers and that’s seen by the historical and current growth rates; I think it’s being validated as we speak. That application is underwritten real time on behalf of banks, the document is executed, the work needs to be concluded satisfactory, a lot of work. Every single customer, every single consumer gets a touch from Service Finance. Their outbound confirming the work was performed as promised, and the customer is happy with the experience. Upon all of that happening the contract is funded and sold through to an institution and we have receive the fee for it; managing that contract as the contract pays back; that capital from the bank is reinvested into new RICs or new financings in the Service Finance view.

A big part of this business, you will see that Flexpoint Ford analysis of the sales when they talk about this technology enabled business, there is a technology enabled business on the front-end of consumer; there is also the same level and sophistication of technology with respect to the dealers who deal with Service Finance on a daily basis, very select, very robust systems which underpin the, and congratulations again to the team in Florida for developing that.

In terms of how do we find these financings, if you look to page 13, a list of a national vendor program on that page. Lennox, everyone know who Lennox is, the largest number one share in HVAC in U.S. and others. That list is growing; you will see it updated here as new vendors are added. Under each one of these vendors, there are their approved dealers in the field, so we have 7,000 approved contractors. I mentioned we’re adding 150 per month of approved contractors or dealers. And the pipeline for new vendors and dealer relationships is quite robust. Even though we’ve not factored to any material expense, the originations come with the new vendors. The forecasts we are giving you are driven 99% by that of existing vendor relationships.

Turning to page 14, I’ll take a moment to walk you through the origination profile for the last four years, current year 2014, 2015, 2016, 2017. This is a seasonal business; there is lot more done during the summer when people need air-conditioning and HVAC but it’s still a strong business. You will be able to look at the quarter over quarter growth in 2015, 2016, 2017; it’s extremely strong. This business was started in 2004, it’s been a cycle of continuous improvement. Mark and his partners have been able to prove to manufacturers that they can actually increase sales and they increased sales by penetrating the customer base with sales finance. As result, in 2015, Service Finance was awarded the National Program in U.S. for Lennox and others since fall. And without getting into details, the number of vendor conversations of the same yolk are underway; so strong, strong historical growth. The key to this forecasted growth, which you’ll see in a second, that’s based upon existing vendor relationships, new vendor relationships will have proven upside to this.

It’s very rare that I have to actually cut back originations from our partners in Florida. Their originations are — internal originations are higher than what we’re showing this morning. So, we’re comfortable with the originations showing and we hopefully surprise you to the upside.

With respect to 15, the business is Florida based. It shows the ability to offer across the U.S. I’ll just leave that; I’ve stated it.

Credit quality on page 16. These loans are offered to, we refer to as prime and super prime credits. The promotional nature of loans, people take those when they are in a better credit position. As result when the promotional period ends, most people tend to repay the loan, so a very attractive credit pool. Again, we underwrite the loans as if they’re ours, but they are not; these loans are sold through FDIC insured institutions with OCC oversight; there is no recourse; there is no first loss; there is no capital put up by us.

With respect to regulatory oversight on page 17. Service Finance does deal directly with bank counterparties. There is FDIC and OCC oversight. The report card here is what they had without objection or negative comment, which is a very strong statement, speaks to the quality of the business. There is regulation as a consumer lender; they are fully licensed in all U.S. states. They have routine examination by state regulators, and they’ve never had an infraction or license revocation since their founding. It doesn’t sound like it but that’s a gold standard.

With respect to 18, how do I manage the risk in the field with contractors and installment credit. There is a series of each. Even though there is a vendor relationship with the likes of Lennox, Rinnai and others, each individual contract in the Lennox family and Lennox dealer is underwritten with respect to their financial capacity, their credit reports, better business bureaus, a lot of work to make sure that consumer has a very positive experience with that Lennox dealer, or others this morning. A lot of work done with respect to verifying income, with respect to the quality of that consumer, all of which are things that you would understand that a bank needs to purchase those loans, those are put in the second box on page 18; and finally, how do we work with the credit side of the house. This is a model that’s been perfected over the past 14 years.

With respect to originations on page 19, we show both historical, current and forecast originations which are strong and the management — the managed portfolio growing in a corresponding basis. So, they came for a second, flip to 20, which is a reason why we believe that it could surprise for the upside here. There is very little in this forecast given to new vendors.

If you look to 2017, Mark and his partners and the employees in Florida funded US$77 million in May alone. So, it tells you that we feel confident about that $1 billion number for 2017 and in 2018 and 2019 a little bit a very little bit given to the new vendors; we obviously hope to surprise you on the upside. When you see rapid growth like this in financing, what are the mitigants to this; the mitigants are this has been laser focused with respect to what it does to provide vendor financing to prime and super prime customers through these vendor origination channels on behalf of FDIC insured institutions.

We could put all of these assets on our balance sheet or not. This business model is strong, it is proven, we’re just staying on focus with Mark and his team; we’re going to help them to grow. Someone said why they’re selling? Well, the selling takes some money off the table; the deferred purchase price has a lot of money, in the comments will talk about. But the other part of the sale is that I think Mark and his partners realized early on that evolution was occurring and having a counterparty us who was investment grade credit would allow additional vendor partners to join. If you are vendor and you are outsourcing your vendor finance business to Service Finance, it is nice to have investment grade counterparty that you know will be there for 20 years. We are not putting up capital, but we need to be there to originate and finance your originations over the next 20 years through thick and thin. We think that investment grade rating that we’re extending to Mark and his organization will allow to track on additional vendors looking for that counterparty, the quality.

We will be in investing in IT. We’re quite happy with the IT system. It’s strong, robust; it processes tens of thousands of transactions. We will however make capital available to the team in Florida for continuous improvement in IT, so the business is extremely scalable. We have budgeted for US$4 million, thereabouts in the numbers in the forecast; we’ll see how much is required but we’ve put that allocation and to invest in the systems. And funding the five-year deferred purchase price plan has the significant backend value that I think that will drive — need to drive the right behavior, believing they are on mark with that program, we’ll reinforce the focus and execution this business model staying as it is.

With respect to 21, it shows you the forecast that net income of the business and the ROE again, and the EBITDA which is estimate of pre-tax income, this business does not require capital. It doesn’t have a recourse; there is no first lost. This is nothing that — this is a business where we clearly sell. We expect financing this morning and we manage them on behalf of the banks. So it’s a very strong growth and earnings and ROE.

Let me just summarize on page 22 if I can for you that this is a market that we think that we’ve invested the right time. It’s a very successful and proven platform. We think the vendors are back with respect to originations that the home improvement market is strong and growing that we’re seeing more consumers expect installment based financing over cash or over credit cards and the ability for us to penetrate additional vendors with an investment-grade counterparty, i.e. ECN providing that 8Service Finance will grow the vendor base. What we have here, again very little of that put into the forecast.

We believe that the healthy originations, managed assets and EBITDA growth are superior without capital being provided. This is a sector that we know well. We understand vendor financing. I would suggest you that Mark and his partners have created a far better mousetrap by having a relationship with bank counterparties to sell and manage on their behalf. Those robust funding relationships are very important with respect to this model.

And finally, this transaction confirms ECM’s transition to primarily an asset-light, asset management model and something that I’ve personally promised investors over the last 18 months, we’ve delivered on the first step this morning. It is an earnings business, it’s not an on balance sheet business and that’s an important higher quality of earnings with less risk, in this case no risk to the business. Management and Board are committed to harvesting and redeploying capital. I’m sure there will be a question on what’s the right size of capital. We have a commitment to you, we’ll honor that commitment but we’ll get through this harvesting and redeployment. I suspect that we will be back together as a team before we announce second quarter results to update you on some of our harvesting activities.

With that operator, we’re happy to open the call for questions.

Question-and-Answer Session

Operator

Thank you. [Operator Instructions] And our first question comes from Nick Stogdill from Credit Suisse. You may go ahead.

Nick Stogdill

Hi. Good morning. Congratulations on the transaction. Steve, maybe you could talk a little bit about how you identified this business? Was it a competitive bidding process? And then, you mentioned that you’re bringing an investment grade balance sheet to add on to Service Finance. But is there anything else or what else are you bringing to the table in this acquisition? Is it your bank relationships to help extend that or maybe on the vendor side, maybe you can just elaborate a little bit on that please?

Steven Hudson

So, Mark and his brother Ian and Eric are individuals I’ve known for over a year. All three of them are legendary in the home improvement finance space. I began a dialogue with Mark over a year ago. We talk a lot about our common backgrounds where we’ve made money, where we’ve lost money and why we both sit on these business models. And that developed I think a tremendous respect for what’s been built. And dialog in year, almost 14 months ago we began back and forth, we had a sense of what we wanted to do around the holiday break, and we really got into it the last 75 days. This transaction, I think once Mark and I had a meeting on minds on valuation which is very important to him obviously and one importantly with respect to partnership, I didn’t spend a lot on the deferred purchase price, so since that second, I think they can now, but that’s an important component of this. We think that deferred purchase price over five years is really — it’s not really structured as a waterfall that you have to hit over the five-year period, approximately a 70% pretax ROE, nor that number gets shared 80% with us 20% with the management team. Because of the earnings coming on later, it’s back ended. That number today would look like 40 million to 50 million. The team believes, which is another reason why I love them, the number will be much higher than that. If the number is much higher than, we are very happy as shareholders.

So, to answer to your question, relationship discussion started with Mark approximately 14 months ago; it’s been ongoing in the last 75 days after reached agreement on an unbinding NOI, we began very extensive due diligence to 25 people, several thousand man hours with the due diligence covering everything from systems to vendor relationships to processing to accounting, the financing. So, it’s been a very extensive process. Sorry for the long answer.

Nick Stogdill

And then, I realized it would have been early days for the Service Finance company but could you talk a little bit how the return profile and profitability looks through the financial crisis in the U.S.?

Steven Hudson

Yes. This is the one of the better performing assets. I would reference you to someone will ask I am sure, why can’t banks do this directly? FDIC-insured institutions that are overseen by the OCC are not allowed to offer promotional loans directly. They can purchase them and diversify pools, which is what this program is. There are some smaller regional banks that can offer it and that’s what obviously we’ll speak. One of those is InterBank; I would ask you to look at that bank, very small. It does do the stuff but on a very, very small regional basis. Their portfolio performed just fine through the reactionary period. It’s because of the focus on prime and super prime credit. But you can look their credit status online, happy to follow up with you, post this.

Nick Stogdill

And then, just one last one from me. Could you guys disclose the book value of Service Finance, and then maybe just your leverage capacity post this transaction here? I am not sure if I saw those numbers?

Steven Hudson

There isn’t much book value; it’s all about earnings. This is a cash flow monster. I think it produces lots and lots of cash. It doesn’t meet leverage, right. We aren’t going change the business model. They are selling loans this morning through to FDIC insured institutions; that’s going to change. We have — our utilization in our bank — Grier?

Grier Colter

I think we have got 300 utilized, so we have got US$2.2 billion available.

Steven Hudson

So, we have lots of capacity available, it won’t be utilized for this business; I think that’s safe to say. Once we get through this harvesting and redeployment when we right size capital, we will also right size the bank facility. Right now, we are paying a lot standby fees for bank. Funds are not being utilized but I think that it’s important to point. I can’t understate — because we’re investment grade as counterparty, and Mark now has that arrow in his quiver. They can now go back to manufactures that wanted access to balance sheet. They don’t need the balance sheet, they don’t want the balance sheet, but they want the businesses around for next 20 years that has lots of stability.

Operator

Our next question comes from Vincent Caintic with Stephens. You may go ahead.

Vincent Caintic

The day to day economic breakdown of the contract and how the business works. So, when you give the EPS guidance, how much of those earnings are gain on sale revenues versus the servicing income? And when you speak about servicing, is it simply just taking the cash flows and moving it to the banks or are there other types of services that you might be providing in the business?

Steven Hudson

Good morning, Vincent, I didn’t quite hear the first part, but I think I heard the first part of your question. If you look to the economic model, we provided some data in the appendices here for you and be happy to follow up with John or Matt post the call. They get about — if you look at the 5%, 6% yield coming off the manage book, about 60% of that on average is for funding the loan and the other 40, 45% is for managing the loan, the loan get — and it really matches that; you get paid upfront for funding the loan which is sold through and you get the rest for managing loan over its term. There are activities required, Vincent, to manage the loan, not all the accounts payback, the vast majority paid back, but there are some collection activities. Lots of underwriting activities; you have to reach out and make sure every single consumer was happy with the work done by the contractors before it’s funded and sold through. We will be happy to follow-up with more details, post the call.

Vincent Caintic

Okay, got it. So, about half of that revenue on average portfolio is gain on sale and the other is kind of an ongoing servicing fee?

Steven Hudson

It differs institution by institution but that’s not a bad guide.

Vincent Caintic

Okay, great. And then, talking about the growth of this opportunity, I know when we speak other financiers like Alliance Data and Synchrony and even guys like Erin, you kind of talk about the total addressable market of the space. Given your vendor relationships currently, I think 7,000, but how big is the market available to you and when you think about the vendors with Service Finance down sort of the home improvement type focus, is there anything beyond that that this sort of platform can grow into?

Steven Hudson

So, in the U.S. today, there are 700,000 contractors, dealers. We deal with 1% 7,000. All of those dealers have come through the vendor programs. So, we want a vendor, a manufacturer first and we underwrite the dealers. So, we think there is significant growth. Service Finance is so fussy about the new business which is another risk, but I love them. Even though we have a vendor, a manufacturer like a Lennox, we underwrite each dealer coming through that program and make sure that dealers got good credit, even though it’s not recourse the dealer but want to make sure they are in business and will be in business, want to make sure that they have an excellent relationship with respect to consumer satisfaction. We’re adding 150 dealers a month, Vincent. I think you can expect that that will increase. And I think that these national exclusive programs, I think more good news to come but not today.

Vincent Caintic

Okay, got it. And then, last one for me before I re-queue, but when — so, you’ve made the strong acquisition, is this the primary platform to go further, are there other assets that you’re looking for as adjacencies?

Steven Hudson

That’s a good question, Vincent. We are — we’ve made a commitment to our shareholders to exit business that don’t provide an acceptable growth profile and ROE, we’re continuing on that path, hence my reference to we’ll probably meet again before the quarter gets reported. There are other businesses that are somewhat similar to Service Finance; I would Service Finance without an equal in the home improvement space. And I think that there are some short-term vendors that we can help Mark and his team with to bringing them to the family. But there is lot of growth here that we haven’t. But the key to this business, Vincent, is staying on focused. We don’t want to originate financings that don’t qualify for the FDIC insured institution; we won’t do it.

Operator

Our next question comes from Tom MacKinnon with BMO Capital. You may go ahead.

Tom MacKinnon

Thanks very much. Good morning. Steve, I think on slide 10, you talk about installment contracts representing about 12% to 14% market share, the home improvement market. Do you know what Service Finance market share is in this business and who would be its key competitors, and what advantage it has over them?

Steven Hudson

Tom, I can talk to the competitive landscape a bit. With respect to the share, they have 7,000 dealers of 700,000 dealers, we don’t want all $700,000 dealers but I’m sure our share is relatively small but growing significantly. In terms of competitive landscape, when you go back to that couple at Wichita; I use Wichita because I used to live there, at that kitchen table this morning or this afternoon thinking about that new air conditioning system that they are — the competitor here is cash or it’s credit card. Those are viable options, particularly for prime and super prime credits. But people — if they can get a reasonable financing relationship, I’ll come back to reasonable in a second, they will take the installment based program, particularly if the manufacturer has brought that down. So, if it’s 2.9%, 4.5% [ph] program this morning, most credits will take that.

In terms of people offering installment based credit as a direct competitor, I mentioned the small regional bank out west but it’s very small, focused just on regional manufacturers that can’t offer a national footprint; it’s restricted in size. There is a company called GreenSky that’s privately owned that does home improvement. It does it through a retail provider; ours is done through manufacturer is we think that the superior model Tom, particularly when it comes to the first look on credit which we think is so important to us and our banking partners. So, we think that model — so, we’re not — that’s the competitive landscape, cash and credit card. Mostly we won’t do the credit cards, so they don’t want to put a hoe improvement on revolving credit at 16% to 18% in seller based credits. There are some small regional players, Green Sky would be a player but their focus is more on retail contracts originated at the likes of Home Depot and others; ours are through manufacturers and through dealers. I think it’s an important distinction to the quality of this business.

Tom MacKinnon

And on slide 13, the national vendor partners you mention there, are those all exclusive relationships?

Steven Hudson

Yes, they are Tom.

Tom MacKinnon

And presumably if you wanted to expand it, would you have to actually peel away an exclusive arrangement from another from a competitor?

Steven Hudson

Yes. So, let me go back to exclusive. Lennox will offer cash this, right. Lennox is happy to take cash. Lennox will offer clients, customer the ability to put that financing on their wells on Synchrony credit card. But we are exclusive on the installment based credit offering. I just wanted to clarify that.

Tom MacKinnon

If you wanted to expand the list of vendor partners here on an installment basis, do you actually — would other potential vendor partners have exclusive relationships with other installment contract providers?

Steven Hudson

Yes. Tom, once you pick your vendor in the sector, you have to stick with that vendor. So, we’re exclusive to Lennox. So, they’re exclusive to us; we’re exclusive to them. But, if you look to this list, there is probably an opportunity in the window space on a national basis. There is probably an opportunity on the solar space, right. I don’t want to get too far down the road, but Lennox has had a very successful partnership with Service Finance. It started out as a non-exclusive program in 2015 and went exclusive across the nation, and they’ve been adding more business lines to it. So, I think the success — that speaks to the success of Service Finance. And I think that success is what other vendors look at.

Tom MacKinnon

Okay. And then, you had mentioned, Steve, I think on the previous quarter’s conference call about 3.5 to 4 billion in balance sheet capacity here which would be 700 million, in at least an equity firepower and close to 3 billion on your senior line. Where do we stand now with respect to that? I assume this 400 is just funded with the senior line and that’s it. So, they…

Steven Hudson

What we have is cash because we’ve got cash back on the C&V US sales with cash today, so utilized cash that was returned. We returned a lot of capital to the balance sheet of ECN on the sale of CMV. So, we’re utilizing that cash today. This has an impact. There aren’t any assets to put in the senior line here. It’s a pure management business, but we’re going to keep that firepower in place both on the equity and debt side until we complete this strategic transition of ECN. I don’t want to foreshadow too much but we’ll probably be back to about other asset light businesses here as we go through the year.

Operator

Our next question comes from Geoff Kwan with RBC Capital Markets. You may go ahead.

Geoff Kwan

Hi. Good morning. Maybe just to follow up on the questions on the vendor agreements. Can you talk about, I guess, the terms of those agreements? And maybe, if you have some examples, like how long have these agreements kind of been in place? I’m just trying to get a sense in terms of the opportunities as well as the potential for others to try and wrestle their way into these types of relationships you have.

Steven Hudson

Good morning, Geoff. If I can use Lennox as an example as that program started in 2011 or 2012 if I’m not mistaken, it’s started as an essence of test, they rolled it out in a series of states. In 2015, it went exclusive across the nation. That program is renewable every three years. But, you this business is very much like the business that we’ve created; it’s almost a copycat of the business we [indiscernible] financial services. I hate the term, the electronic heroin that gets ejected at the manufacturer, that technology that’s sitting in that kitchen table this afternoon in Wichita is Service Finance technology. All that customer information is resident with us; now it’s protected on behalf of Lennox, but it’s resident with us. That customer is our customer but it’s on behalf of Lennox. It very difficult for a vendor to get a divorce from its vendor finance partner as you saw in the sale of the C&V U.S. business.

Geoff Kwan

Okay.

Steven Hudson

So, we have very strict in relationships, Geoff.

Geoff Kwan

And then, on the guidance you’ve given on EBITDA, it looks like it’s forecasted to almost double in 2018. Obviously you are looking to get some growth on originations and whatnot, but is there something else; is it just the scalability of business, like what’s driving that big shift in EBITDA growth for next year?

Steven Hudson

Let me put you back to slide 14, look at the growth in originations in March, April May, and just starting in June but the June data is very impressive. Mark and his partners were able to see that data every day, Geoff, what they are growing, and why has it gone up because they have been picking up vendors and picking up dealers. It’s a very scalable system. You are not adding to OpEx to bring these people on, because it’s a technology driven interface on the front-end and on the back-end. And we have not put — almost zero, a little bit, the vendor relationships that we know are coming down the pipe. But this is all existing vendors and growth for vendor channels.

Geoff Kwan

Okay, perfect. And if I can sneak in two very, very, quick questions. So, from your conversations or your comments before, and it sounded like this might have been an exclusive process. Can you confirm that? And then also, is there any circumstance that you would hold any of these types of things on your balance sheet or is it 100% going to the FIs? I’m just not sure if there is any requirement that they would also like you to have some sort of portion that’s held on your balance sheet?

Steven Hudson

It wasn’t exclusive process, Geoff. When word leaked out, one or two — private equity investors try to jump into, but I like the reaction of Mark and his partners, which they pushed back very hard and said there was an agreement placed and they defended the agreement. So, kudos to them, so an exclusive arrangement on the process. What was the second part of your question?

Geoff Kwan

Yes. Sorry, just you talked about how you’re going to be selling these to U.S. FIs. Is there any circumstance either by choice or by necessity from these partners that have you hold anything on the balance sheet?

Steven Hudson

These loans qualify for our balance sheet; they qualify for a senior line today. But we are not going to change this business model. Mark has sold loans through 2018 and we look forward commitments to sell loans. We’re well into 2018, could be well into 2019 depending upon additional banks who sign up here. So, we are not going to disturb that relationship; we are not going to get in the middle of it. Now, our banking partner wanted us to provide a co-investment, we would look at it, but none of that’s on the table. We don’t want to change the business model, we don’t want to disturb that very powerful relationship with these FDIC institutions. That bank counterparty is part of the secret sauce here. We are not going to complete with them.

Operator

Our next question comes from Jeff Fenwick with Cormark Securities. Please go ahead.

Jeff Fenwick

I was just hoping you could run to the economic model of these contracts a little bit more with us here, just trying to understand you’re sort of guiding sort of 2% to 3% run rate off of an origination and then these are prime or super prime as you have mentioned. So, how is the contract structure that gets you that; is that a administrative fee or setup fees or the consumer pays, how does that come about.

Steven Hudson

Go back to that Wichita table example this afternoon. If it’s a 2.9 and the several promotional programs let you to 2.9 programs. The dealer manufacturer will buy down that rate by selling us the contract at a discount. So, that drives up the yield to us or to the bank pursuing the contract. So, these contracts have an effective yield of 10%, either through the face rate of the contract or buydown, from the manufacture the buydown occurs through a discount on the sale or financing.

Jeff Fenwick

And then, maybe talk a little bit about — the guys are taking the paper on the backend here. And what’s the nature of the contractual commitments to the business here, is it an annual type of relationship, they have sort of volume targets in terms of what they will take or how is that structured?

Steven Hudson

I think, Mark and Ian and Eric have been very careful in matching expectations. They have banks now that want to increase their capacity and they have not don’t it, they manage expectations so that, there is an ability to meet there expectations. I would say that loan funding is well out into 2018, verging on 2019. There are contractual arrangements in place. The challenge is managing expectations with the banks that — what they are expected to get on volume is actually produced. So, in this case, we have a lot more demand and supply.

Jeff Fenwick

Okay. And then in terms of what their revenue share with you, is it — when they are taking that paper, are they basing it off some sort of spread? Like, is there a potential for revenue variability with you?

Steven Hudson

The average yield here we think it is 10%, we get our 3%, 3.5% fund for funding it and 2.5% for managing it. So their net yield after all this is in and around the five mark. Again, no recourse, no capital, no first loss and all that stuff.

Operator

Our next question comes from Mario Mendonca with TD Securities. You may go ahead.

Mario Mendonca

Steven, can you just go through — there were few things you answered already that I was little confused on. You said that the earn-out would be best guess, and I’m not going to hold it true obviously, but $40 million to $50 million U.S. mostly at the end of the year, for the end of the five-year period?

Steven Hudson

Right. The — sorry, Mario.

Mario Mendonca

Go ahead. I just want to make sure I understood it correctly.

Steven Hudson

Yes, it’s an ROE, pre-tax ROE above which the income gets shared. So, in 2018 that pre-tax ROE is 14%; it grows to 20% at the back end. Each year that pool above — earnings above that 14% ROE is shared in a pool, which we get 80%, they get 20%; it’s on an annual basis. Obviously you have to be there participating [ph] in the pool, and because of the way that structure is, most of it gets back into 2020, 2021, 2022.

Mario Mendonca

And your best guess is U.S. 40 to 50.

Steven Hudson

Yes, it steps up, Mario, in — in 2018, it goes to 16% and then it goes to 18, and then it goes to 20. At 20, our scale comes in, we step up the ROE hurdle rate.

Mario Mendonca

All pre-tax?

Steven Hudson

Yes.

Mario Mendonca

And the base, sort of the denominator if you will for the purpose of the calculating ROE, is that the 410 million that you’re paying or whatever…

Steven Hudson

Yes and any additional capital that they may call down to run their business?

Mario Mendonca

I see, okay. That was very helpful. And somewhere in your presentation you referred to your book value declining, like you took out the 410. Are you essentially saying — you are just talking about tangible book now because the purchase doesn’t take down your book value, your GAAP book value, so it’s intangible that you are doing here?

Steven Hudson

Correct. I was trying to say that really our — the new ECN is being on earnings and I’ve given you our few of value of that business [Indiscernible] if you take tangible, I still believe our book is book, I believe this capital we’ve invested this morning is a great investment.

Mario Mendonca

Your depiction is fair, I just wanted to understand it little better. Make sure I understood an answer to another question. You talked about the split between the gain on sale and the ongoing fees; you said that was 60% gain on sale 40% of the fees? Is that the appropriate split to be looking at?

Steven Hudson

Yes. I would say it’s about 3. It varies by bank, but call it 3% to 3.5% upfront, and the rest on your 6% yield on is based upon management fees.

Mario Mendonca

And that amount again on sale is paid all at once on origination?

Steven Hudson

Correct. You get paid upfront for the origination because you are selling it without credit without first loss.

Mario Mendonca

Okay. And I’ll try to be quick…

Steven Hudson

Again, Mario, you’re underwriting that loan on their algorithms. We are not — this is not a credit package; we’re making up — we do underwrite it as if it’s ours. But we are underwriting it on their algorithms.

Mario Mendonca

Okay. And this buydown that the manufacturer does taking the yield from 10% to say 3% that’s reminiscent of the subventing process in the auto market, is that a fair characterization?

Steven Hudson

Well, it depends. For sure, but it’s not as deep as what you saw with the auto manufacturers. These are 5.9% and that lasts for a very limited period of time, Mario, hence the shorter duration of these assets.

Mario Mendonca

Okay. And then, you refer to 75% of current originations through five strategic national partners. Would the largest one be like a really big number, like 40% or 50%?

Steven Hudson

No, largest would be Lennox, which is approximately — we don’t give numbers but approximately 20% to 25%.

Mario Mendonca

Okay. And then, one final question this is for Mark, if he can answer it, is the business has been around I guess or 13 years. And in that period, has there ever been a time when you felt the risk of disintermediation or a potential for that?

Steven Hudson

In the future, Mario, the risk could be — let’s just take that one step further if I can. Maybe there is a change in regulation where the OCC says banks can go directly into promotional loan. That could change. Today, that’s not the model. But, by then, these manufacturers are under contract to us exclusively, if that ever were to happen. I’m sure this would be in a very attractive business.

Mario Mendonca

So, the promotional — it’s the promotional aspect of it like the buydown essentially that the banks aren’t allowed to participate in?

Steven Hudson

Yes. FDIC insured banks that are OCC regulated cannot participate in these promotional loans. They can buy them in diversified tools, they can’t offer them directly. And it’s a regulation change or change is — because we have the vendors locked up, it’s not so much to what’s happened in the C&V U.S. business, but I doubt that’s going to happen here in the short-term.

Mario Mendonca

Steve, to the best of your knowledge, there has never been any kind of — what you are suggesting here is this intermediation argument that’s never been a real risk over the last 13 years or so.

Steven Hudson

I haven’t seen it, Mario.

Operator

Our next question comes from Stephen Boland with GMP Securities. Please go ahead.

Stephen Boland

The credit losses, they are quite low. Can you just talk about the past due experience because

certainly there is always with contractors involved, a portion of people that are unhappy with the work and they don’t pay? And maybe you can just explain, since you’ve already sold the loan, who’s working on collecting the loan or getting it reactivated and obviously making sure that your — the guys who’ve bought the loan are happy?

Steven Hudson

First of all, one of the great results of our underwriting, that’s 75 days is 2,500 man hours. There wasn’t a single case where a consumer had a complaint. Now these loans get funded. So, you’re happy as a consumer with the quality of work and you’re signed off. So, there is no risk on that. If you have a complaint and it’s not done properly, the loan is not going to get funded. And that will be a resolved between you and the dealer. We can bring pressure through the manufacturer but you don’t want that happening, you won’t fund it. So, I’m sure people have had experience with dealers; that’s when the dealer network has to see Service Finance. You do have some late payments, we don’t — I can get to those stats posted. We manage those late payments on behalf of banks; we manage them as if there are our loans but it is relatively modest. You’re dealing with people who love their prime and super-prime credit trading, and it’s very important that they maintain that prime and super prime credit rating.

Operator

Our next question is from Victor Dri with National Bank Financial. You may go ahead.

Victor Dri

Yes. Good morning. I just wanted to ask the question here on the timing of the next transaction. Is this is kind of — does this deal take away from any of the ability to complete anything in this year? Is there any kind of push out to next year now that this is done?

Steven Hudson

Well, John and I have talked about looking at over 50 opportunities to say now. This is one we liked a lot. We are looking at other opportunities but we’re very disciplined on that focus. I would suggest you that we probably have – in the short-term want to talk to you about divestitures. But, I suspect we will be back to you later this year before the years out, talking about one or two more acquisitions.

Victor Dri

Okay, perfect. Thanks for that. And then, the last question here is in terms of the bank counterparties, are you able to give a little bit of a concentration number there, like you said a couple of — one or two of the banks have 20 to 30% of the concentration or can you talk to that a little bit?

Steven Hudson

It’s a diverse group of 13 FDIC insured banks with more banks being added. There was a new bank added this spring that’s not in the group. The challenge here is meeting expectations of banks, you won’t find a concentration issue.

Operator

[Operator Instructions] And I have a follow-up question now from Vincent Caintic with Stephens. You may go ahead.

Vincent Caintic

Hey, thanks again. Two more questions, one on your operating leverage here. So, you’ve got expenses of about 1.5 to 2%. I’m just wondering how much growth you can have while keeping that. Is it primary the platform business that you’re able to keep it that way or maybe even take down that 1.5 to 2% as you scale up?

Steven Hudson

You see that’s in data set in the appendix, we talk about OpEx going from 2 to 1.5. There is a benefit of scale here, we can follow up post the call with you, but it will scale damage we’ll add to it. You do require investment in IT; the system in Service Finance has now is great. We just want to add little more durability to it as you double, potentially triple the originations.

Vincent Caintic

And then the last one for me and just another — this might be too early to question about thinking about growth again. When I think about how some of the maybe the retailers and maybe some of the other manufacturers are doing, seems like retail sales and maybe manufacturing sales broadly are weakening, so we see some of the maybe broad retail guys. But, when business services companies, you have Alliance Data, Synchrony to offer these products, seems to drive more sales and the vendors appreciate them. I am just kind of wondering what sort of activities you could be doing to drive more sales at these vendors, are there any kind of national accounts, beyond the kind of promotional activity that you are doing now with the low interest rates?

Steven Hudson

I don’t want to get too much on this call today about additional vendor, but I did reference spaces like replacement windows and solar where we think there could be a national program, so more to come on that file. The credit card is not a great option for a consumer that if you are putting this on a Synchrony or Wells credit cards, you are using all your revolving capacity, $10,000 purchase for a new furnace is a big use of your capacity. And if you are a prime or super prime cycle and you are going to finance 16% to 18%, so that it’s higher cost credit and it’s revolving. Service Finance falls true. They follow all the federal regulations with respect to how to offer these loans, one of which is truth in lending. So, when that consumer is contacted to make sure that they had a great experience, they also get simple, true and playing disclosure on the cost of credit, which is far less than 16, 18%. So, we think that we can take share, not us, Mark and his team can take share from the credit card providers. So, we’ve see growth in additional national vendors and solar and windows, we see growth in taking share away from credit card and cash, and we also want to see the growth in the replacement cycle. I think we’re very early, notwithstanding your comments which are right on some softness. We are very early in the replacement cycle, the home improvement. People may down purchase of new homes. They’re slowing down their reinvesting in windows and rooms and upgraded HVAC. We think that cycle is early. And we think we will take share away from some other competitors. I think the near and mid-term is quite good.

Operator

This concludes the time allocated for questions and today’s conference call. You may disconnect your lines. Thank you for participating and have a great day.

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