Element Financial has achieved rapid growth since the last time Monitor interviewed CEO Steve Hudson and president Brad Nullmeyer in 2012. On the power of a business model and strategy that truly differentiates it from competitors, and after a string of strategic acquisitions during three short years, Element has assembled one of the largest equipment finance companies in North America. Element’s leadership is highly focused, very experienced and ready to take advantage of a post-recession M&A environment that has been conducive for growth.

A Series of Strategic Acquisitions

How did Element achieve this? It began with three key ingredients: strong funding relationships within the life insurance industry, an understanding of how equipment finance assets could satisfy the investment objectives of these funding partners, and a post-recession market for equipment financing in North America that was underserviced but positioned for growth.

“We saw that there was an opportunity for a team with access to stable sources of funding to build a company focused on serving growth segments of the market that had been left underserviced following the 2008 financial crisis,” says Hudson. “We found great management teams running well-established equipment finance businesses with excellent origination channels that were underperforming only because they had been capital constrained by their previous owners.”

In 2011, shortly after the arrival of Hudson as CEO, Element acquired Alter Moneta, which, at its peak, serviced a portfolio in excess of $2 billion. The portfolio was in run-off, but the back office systems were pristine, robust and scalable.

In May 2012, Element entered the fleet management business with its acquisition of TLS Fleet Management, Canada’s third largest fleet leasing company.

To gain scale in its Commercial & Vendor Finance vertical, Element then acquired U.S.-based CoActiv Capital Partners in December 2012, and subsequently rebranded it Element Financial (USA). Under Element’s ownership, and with renewed funding capacity, this vendor business has since grown more than five-fold to about $1.7 billion in net earning assets by the end of the first half in 2015. In Monitor’s vendor ranking this year, Element rose to the No. 5 spot on the strength of a 163% year-over-year increase in vendor finance originations.

“If that was the only story that we had today, it would be a very compelling story, a very exciting story,” Nullmeyer says, noting that the vendor business is “very strong in the transportation, construction and material handling industries. It has very high growth potential. We like the business. We like the relationships there.”
In 2013, Element acquired Nexcap Finance and GE Capital’s helicopter portfolio. Element also formed an alliance with Trinity Industries in December 2013, resulting in the addition of railcar assets which were expanded further in 2014.

Element began creating serious scale in its Fleet Management business with the acquisition of GE Capital Canadian Fleet Services in June of 2013. In 2014, when activist investors prompted PHH to accelerate the sale of its PHH Arval fleet leasing division, Element agreed to buy the business for $1.4 billion.

Last year ended with Element reporting earning assets of $7.6 billion, but the best was yet to come. In April 2015, General Electric announced it would sell off its non-strategic financial services businesses and concentrate on being an industrial company, setting the stage for act three. Element had the ear of GE’s senior management and expressed interest in acquiring GE Fleet. Element tapped the equity market for C$2.8 billion of fresh capital in May and stepped up to the table as a bona fide buyer of GE’s Fleet Leasing Business.

In June, Element agreed to an $8.6 billion all-cash purchase of GE Capital’s vehicle fleet leasing businesses in the U.S., Mexico, Australia and New Zealand. Element closed these acquisitions in August and September of this year, bringing its total assets to approximately $16.5 billion. This increase will, no doubt, vault Element into the Monitor 100’s top 10 companies in next year’s 25th anniversary issue.

Nullmeyer says the combination of PHH Arval and GE Fleet gives Element a global platform in the fleet business. “We’ve become a North American industry leader in fleet management,” he says. “More importantly, we’ve become the company with the ability to innovate in the space. We’re planning to use this [platform] as a catalyst for change — to bring new innovative cost-saving solutions to fleet customers right across all segments of the industry.”

Element also differentiates itself with an ability to serve clients globally, through a partnership with BNP Paribas known as the Element-Arval Global Alliance. This agreement seamlessly ties together the two companies’ fleet businesses and offers clients a single touchpoint for fleet management all around the world.

“Through this alliance a customer in the States who wants to operate a global vehicle fleet gains access to Element’s global buying power and global reporting,” Nullmeyer says. “By having a strategic alliance with Element-Arval, we’re able to support a multi-national customer’s fleet requirements in Europe with the same level of service that they have grown to expect from us in North America.”

More Than Money Over Money

Today, Nullmeyer says fleet management “is a data-driven service-based business.” Some customers might be able to access a cheaper cost of capital, “but they wouldn’t get all of the fleet management services, data analytics and technology solutions that Element can provide. In the fleet segment, we’re turning the standard commercial finance model, where you quote a five-year lease to a 20% balloon payment at money over money rate, into a completely different customer offering driven off the delivery of services that reduce the total cost of ownership.”

As the fleet business has become more data-driven, Nullmeyer says Element has applied fleet management technology to other parts of its business, such as transportation and construction operations. Using material handling equipment as an example, Nullmeyer says, “What we’ve been able to do is connect our system to the forklifts and scissor lifts in a customer’s warehouse so that we can report information back to the customer on the operating cost of that equipment, how much it’s being utilized and when its maintenance is due.

“We have the technology to be able to help our customers understand and manage the costs of their capital equipment, whether it’s 10,000 panel vans or 25 pieces of material handling equipment,” Nullmeyer says, noting that regardless of equipment type, clients face similar issues: warranty, maintenance, and equipment usage and location. “It’s all about cost of ownership; with the right systems and analytics, it becomes a very data driven business and it’s where we excel.”

Element uses a focus on data and technology to help customers in multiple ways. As the winner of the ELFA’s Operation and Technology Excellence Award for 2015, Element was recognized for “engineering an innovative process to dramatically improve title and registration services across 2,700 unique jurisdictions for their fleet management customers.”

The larger implication of this model is how these value-added services translate into fee income, which represented over 40% of Element’s total income in the most recent quarter. Nullmeyer expects Element’s fee momentum to continue moving up as Element further demonstrates the value the services bring, and adds even more services to its suite of offerings.

“In our fleet business, the split between fee income and spread income is about 50/50. If someone has a fleet of 10,000 panel vans, we’ll certainly finance those assets. But the fleet management services that we offer are how we are able to help the customer minimize the total cost of ownership,” says Nullmeyer.

It’s fair to say that Element has taken the notion of “value add” to a whole new level. “I don’t want to minimize the money over money business,” Nullmeyer says, “Its still core to what we do, but by adding these value-added services — which have a very high level of stickiness — we get the benefit of great returns for our shareholders and better savings for our customers.”

Funding Side

Looking at the long list of Element’s recent accomplishments leads to another question: how did the company fund this accelerated growth?
Hudson points to the strength and confidence of what Element calls its “funding partners,” large and stable banks and insurance companies that work closely with Element. These funding partners want to invest in finance assets that match their liabilities and provide diversification from assets like commercial real estate, which they can originate on their own.

“It’s a really symbiotic relationship that we have with our funding partners, and it’s a real strength of this company,” says Hudson.
Element also enjoys strong support from equity markets, where the company has typically funded acquisitions, and from debt providers.
To fund its current portfolio and organic growth, Element has been very careful to match its assets with long-term, committed bank facilities that do not rely on the short-term commercial paper market.

In August, the company ensured it had ample capacity on those lines by entering a credit agreement with a syndicate of 24 lenders that provided it with an expanded $8.5 billion senior secured three-year credit facility. DBRS provided more good news by giving Element an investment grade issuer credit rating of BBB. Concurrent with receipt of the DBRS ratings, Element would have its interest rate reduced by 35 basis points on top of the 20 basis point reduction that came into effect when Element closed the U.S. portion of the of the GE Capital fleet management business.

“As we’ve grown the business, we have diversified our sources of funding and we have strengthened our access to capital,” Hudson says. “When you look at what DBRS said when they rated us — recognizing our leading position in North America fleet management, our better-than-average credit risks profile and our strengthening earnings profile — that really to me ratifies the hard work we’ve put in to ensuring that this company is on the best possible financial footing.”

The company also enjoys access to the asset backed securities (ABS) markets, which provide longer-term funding and free up capital on the company’s own balance sheet.

“For more permanent funding, as we originate transactions specifically in the fleet business, you’ll see us roll these assets into the asset backed securities market,” Nullmeyer adds. “It’s a very efficient and very stable funding platform.”

“When Element purchased PHH, it had an ABS program called Chesapeake that had been running for many years. Element has continued to use Chesapeake, funding fleet vehicles using its bank lines until a portfolio gets to the $500 million to $750 million size range, then rolling the assets into the ABS market.”

“If the ABS marketplace moves away from us, it doesn’t matter because we have committed bank lines that exceed the term of the average life of these assets,” Nullmeyer says. “We’ll still be able to continue to fund our customers, which is the most important thing and we’ll continue to still be matched for rate, duration and currency.”

Element also uses ABS markets in other verticals.

“For our rail business, we use our committed bank lines and then tap the ABS market as these portfolios are assembled,” Nullmeyer says.
In its aviation business, Element structured a $1.21 billion debt offering earlier this year as an ABS issuer with a “precedent-setting” transaction secured by a portfolio of 49 current-generation, in-production, commercial passenger aircraft.

Element’s diverse and solid sources of funding are of huge value, Nullmeyer says. So is the growing fee business, which is not affected by any disruption in the capital markets because it requires no external funding.

“What makes me sleep at night is that I have a three-year term committed bank facility that can support our funding needs through periods of market uncertainty,” Nullmeyer says.

On the flip side, what keeps Nullmeyer up at night? The threat of complacency.

“We challenge ourselves every day, thinking there is someone trying to develop something that is bigger, faster and stronger. That’s why every day we make sure customer focus is front and center with all of our employees and make sure our customers really value the experience of dealing with Element.”

“Other than that, I sleep like a baby,” he adds.

Five-Year Outlook

Using net earning assets (NEA) as of June 30, 2015 as a basis — prior to the close of the GE Capital Fleet deal — Element’s mix of earning assets was: 49.0% Fleet Management, 21.4% Commercial/Vendor, 15.7% Rail Finance and 14.0% Aviation Services. Pro-forma, including the GE Capital Fleet acquisition, the Fleet Management business jumps to 74% of the total, with the addition of $5.3 billion in fleet assets, for a grand total of $14.0 billion.

“We like all four of our business verticals because they are proven businesses and they deliver quality asset growth,” Hudson says. “Our goal is to help North American businesses finance and manage the essential capital equipment that makes them productive, profitable and powerful. In each of these verticals, there are opportunities to innovate, to find new and better ways to enable our customers to succeed.”

As an example, Nullmeyer says Element’s aviation business is moving toward a fee-based advisory model. “This will have an impact on the allocation of capital within our business verticals and brings the focus more on growing quality annuity-like earnings versus accumulating assets” he explains.
Nullmeyer says that another probable change will be the shift into more U.S. dollar revenues, instead of Canadian dollars.

Looking further out, Hudson expects Element to keep building, innovating and growing.

“Clearly, our near-term focus is the GE Fleet integration because doing that right is just so important,” Hudson says. “Beyond that, I expect that Element will be an even larger force in the North American fleet management industry, especially as we apply our ability to innovate cost saving solutions for our customers due to the scale we’ve achieved.”

GE Capital Divestiture

On the topic of change, Nullmeyer points to GE Capital. “GE’s decision to downsize GE Capital is the most significant change in our industry in decades,” he says, noting that GE Capital has a large business in the vendor space. “There are one or two parties that, we think, will move on this business, so that will change the competition landscape a little bit. We share vendor clients with GE, so what’s occurred has allowed us to build stronger relationships with those clients on our side.”

Nullmeyer explains that many manufacturers want to form a long-term partnership with a finance company, which will enable the manufacturer to use its balance sheet to support growth, without having to worry about the capital markets.

“We give them that capital stability where the CEO of the manufacturing company doesn’t have to worry about what the capital markets may do, we do that for them.”

Nullmeyer says that GE Capital vendors should be confident as the GE divestiture plays out, and Element’s purchase of GE Fleet is a good example of why.

“If you were a fleet customer of GE four months ago, and you heard GE fleet might be for sale, you’re not going to worry because Element Fleet is taking that over,” he explains. “In our case, GE made it a priority through our acquisition that their employees and their customers were taken care of — it goes right to [the] heart of GE. When you do that, you end up with a very happy customer. When we named Kristi Webb, the former head of GE Fleet Services as the new CEO of our fleet business, it served to amplify the importance of listening to the customer.”

Customers aren’t the only Element stakeholders who are happy; shareholders have rejoiced this year as shares of Element Financial have risen 38%, making it one of Canada’s best performing financial stocks. Zachary Curry, chief operating officer and portfolio manager at Davis Rea, rates Element as a “Top Pick” for investors, noting that Element’s recent acquisition of GE’s fleet assets provides an opportunity to gain additional fee income similar to the “add-ons” they offer on their current assets. Curry says the acquisition could allow for a dividend to be initiated earlier than planned (2016) and notes, “Management has experience in the industry and is using a more conservative financing approach to growth than it has in the past.”

These comments are clearly indicative of a commercial finance business that is being driven by a unique model brought to life by a group of executives who have applied decades of experience in the industry in an environment conducive for growth.

Hudson sums it all up when he says “We’ve got a unique business model, a group of executives with decades of expertise and a strong service culture across the enterprise. We’re excited about what we can do with this company as a catalyst for innovation that creates value and opportunity for our investors, our customers and our employees.”