Welcome to the Element Fleet Management first quarter 2019 financial results conference call. As a reminder, all participants are in listen-only mode, and the conference is being recorded. After the presentation, there will be an opportunity for analysts to ask questions. To join the question queue, you may press star, then one on your telephone keypad. Should you need assistance during the conference call, you may signal an operator by pressing star and zero. 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 you to the cautionary statement and risk factors of its most recent MD&A and AIF for 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 of any forward-looking statements will prove to be correct. Element's earnings release, financial statements, MD&A, supplementary information document, 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 would now like to turn the call over to Jay Forbes, Chief Executive Officer. Please go ahead.
Thank you, operator. Good morning, and thanks to all of you for joining us this morning to discuss our first quarter results, the progress that we're making on our transformation, and our latest initiatives to strengthen the business as we evolve our capital structure. Let me kick things off with a discussion of the core fleet management business, which continues to stabilize and strengthen from the multifaceted transformation program we launched last October. Building on the success of the quick wins in Q4, we've used the last three months to advance improvements to the client experience and to identify and action an additional CAD 12 million of annual run rate profitability improvements as we shift to the back-to-basics phase of this transformation program.
This brings the cumulative pretax run rate profitability improvements action to date to CAD 70 million, CAD 10 million ahead of plan, positioning us nicely to hit our CAD 100 million of action target on exit from 2019. To give a sense of what type of back-to-basics initiatives are now underway, they include enhancing our ordering platform to provide a simpler, better, and more consistent experience to our clients. Upgrading our data and analytics capabilities to improve the quality and processing speed of our systems and generate additional insight for us and for our clients. For highly repetitive and manual tasks that can only be partially automated, evaluating right shoring options to optimize the cost of execution. As importantly, we're seeing the profitability improvements we've actioned flow through to deliver on the bottom line.
Initiatives action to date will improve Element's adjusted operating income by CAD 52 million in 2019. Approximately CAD 11 million of such improvement was delivered in Q1, slightly better than planned. As you can also see in our supplementary, we have invested a total of CAD 45 million through quarter end to deliver these benefits. This, too, is slightly better than planned. As discussed from the outset, our transformation strategy is designed to consistently deliver a superior client experience that will in turn generate CAD 150 million in pre-tax run rate profitability improvement. While we're only now wrapping up month 7 of a 27-month journey, the multitude of changes we have made to date are starting to have a very positive impact on the client experience. For instance, we stated last quarter that the worst was over in terms of client attrition.
As further evidence of this fact, we didn't lose a single enterprise or mid-market client in March. This was the first month since April 2015 that this has happened. As for new business, we secure client wins in every geography, which again speaks to the compelling nature of the platform and our ability to help our clients better manage their fleets. Fleet assets under management as at the end of the quarter, showed increases in the U.S. and Canada on a constant currency basis, as well as Mexico. In the U.S. and Canada, we see growth from a core group of larger clients. More broadly across this geographic market, we're holding our own, having arrested the revenue decline. We still see more work to do as we anticipate growth.
To that end, we will begin building a go-to-market strategy to generate that broad-based growth. We'll share our progress on same in the coming quarters. In Australia and New Zealand, we're pleased with the performance of the business in the softening environment. While our competitors have otherwise been occupied, we've been focused on client acquisition and strengthening our service offering. Finally, we continue to see very strong growth in Mexico as our market-leading client experience has allowed us to capture a disproportionate share of that fast-growing market of both large local and large multinational clients. While it's too early to declare victory, we have lots of things we want to do to create that consistent, ideal experience for our clients. I nonetheless see these data points as clear indications that current and prospective clients are seeing the obvious value of entrusting Element with their fleets and their drivers.
Another important milestone in the quarter was the implementation of our balanced scorecard. As I've said previously, the balanced scorecard is really the embodiment of our strategy. Having our people able to see it and see how we're doing is going to be a very powerful tool in terms of enabling us to course-correct, allocate resources, and make decisions to achieve our strategic goals. We have shared our global balanced scorecard with you this quarter in our MD&A. We look forward to sharing with you how we are scoring on our objectives and metrics on a quarterly basis, beginning in another quarter or two. Regarding our non-core assets, having positioned 19th Capital for a runoff and/or a potential sale, it is performing in line with expectations. We received CAD 26 million of cash in the first quarter.
The only other significant non-core asset, our interest in ECAF, was successfully sold for proceeds equal to its carrying value of approximately CAD 97 million, in line with the plan we laid out in October. The combined proceeds from 19th Capital and the sale of ECAF will be used to reduce the refinancing requirement regarding the 2020 convertible debentures. As we look at what is next, at what is the best capital structure for the company over the longer term, our view is that we would like to reduce the cost of our funding, while of course, maintaining our ready access to financial markets. Convertible debentures are expensive. We would like to minimize and ideally eliminate them from our capital structure. We'd also like to access unsecured bond markets, including the U.S. unsecured bond market.
The latter would entail us securing another investment-grade rating from a U.S. agency. That is predicated on us being able to deleverage our balance sheet. While we know given sufficient time, we can work through the investment in our transformation and harvest the gains to achieve a lower leverage ratio, next year's convertible debenture maturity challenged management to surface alternative options to deleverage more quickly in order to create alternative refinancing options. After extensive analysis of these options, we concluded that if we broadened our use of syndication as a funding tool, we could accelerate the deleveraging process, positioning Element for another investment-grade rating, and thus access to a broader set of financial instruments. What's more, syndication has two additional and significant benefits. It creates a means of managing client concentration limits while funding the asset growth of one large, rapidly growing client.
It generates a whole new and material source of recurring revenue. Let me step you through the first quarter syndication activities as a means of providing some additional color. During the first quarter, we syndicated CAD 488 million of assets. In doing so, we decreased tangible leverage by 5% and generated CAD 17 million in new revenues, all of which fall to the Adjusted Operating Income line. Over coming quarters, we anticipate syndicating approximately CAD 600 million of assets per quarter. These assets will predominantly be new originations, but also some existing assets from our balance sheet. In evaluating syndication as a tool to further strengthen the balance sheet and to lower our cost of capital, we needed to be confident that there would be a strong demand for fleet assets over time and through cycles. That we can originate sufficient assets to maintain our leverage targets.
We can earn consistent and predictable transaction fees from syndication. Lastly, that we have the people, the processes, and the systems to support the intended volumes of transactions. Regarding demand, our investor presentation this quarter sets forth data that speaks to both the sizable and sustained appetite for this type of paper in the equipment syndication market. Further, we believe the attributes of our offerings could grow this market further. Moreover, we have a demonstrated track record in being able to further develop markets for our paper. For instance, consider what Element Treasury did to establish a deep and robust market for fleet ABS. Regarding supply, we originate more than CAD 6 billion of assets annually, much of this in the U.S. and much of that eligible for syndication.
We don't see constraints in our ability to sustain quarterly syndication activity in the CAD 600 million range for the foreseeable future. This is the right volume for us to be able to continue to support the one large, rapidly growing client I mentioned earlier, while managing client concentration limits on our balance sheet and accelerate our deleveraging efforts towards evolving our capital structure in the medium term. Our ability to contribute supply to meet the equipment syndication market's healthy demand for quality assets makes syndication a predictable and sustainable source of transaction fees for Element. This recurring revenue stream increases the company's earning power. You may be asking yourself how we can sell an asset without diminishing future income. The answer is that we are selling something, the tax treatment of fleet assets, that has no value to us at this time.
We can't use it because we have a surplus. We are selling this tax treatment to buyers who can use the asset immediately, they place a value on that asset. We have established the infrastructure, the people, the processes, and the systems to consistently deliver these earnings quarter after quarter. Our confidence in being able to do so is reflected in our addition of syndication revenue as a standalone item on our income statement, Vito will speak further to that in a moment. Having said all of this, I also want to stress here that we're not moving away from being an on-balance-sheet lender. We will continue to fund on our balance sheet and use our asset-backed facilities in the U.S., Canada, and Australia to securitize.
You may wonder how we will choose which assets go into our ABS facility, and which we will syndicate to ensure that we retain the high quality of asset-backed securities in that facility. The answer is that the ABS offering remains key to our funding strategy, we're very focused on ensuring that ABS offering is of the very highest quality. I would tell you that we will have more than enough top-flight assets to go around, given the high quality of our customer base and the magnitude of originations. Moreover, the facility is rated so that the rating agents are key to ensure that the assets remain top-notch. Finally, ABS investors have a great deal of transparency as to what's in that facility. In syndication, we're adding another programmatic means of funding to our toolkit while simultaneously de-leveraging and enhancing our return on equity.
Economically, again, syndication creates for Element another source of quality, recurring, predictable revenue. You can see that impact in our increased 2020 guidance. Given a stabilized and growing fleet management business, confidence in realizing the full CAD 150 million of profitability improvements to be actioned by the end of 2020, and the positive and sustainable income statement impact we will enjoy from syndication as we accelerate de-leveraging, Element is increasing its 2020 guidance on after-tax adjusted operating income per share from CAD 0.90 to CAD 0.95 to a range of CAD 1.00 to CAD 1.05. Furthermore, we're targeting a return on equity in the range of 13%-13.5% and a tangible leverage ratio below six times exiting 2020.
I'd like to circle back to the topic of capital structure because broadening our use of syndication should enable us to be in a position sooner, all else being equal, to seek an additional investment-grade rating from a U.S. agency. That additional investment-grade rating should enable us to access new markets for lower cost capital, including potentially the U.S. unsecured debt market, and that ought to improve our funding costs. Syndication gives us a more flexible balance sheet, lower leverage sooner, and a source of recurring sustainable revenue right away. In the medium term, we'll have paved the way to more economical funding structure for our on-balance-sheet business. All this, as you might appreciate, is a powerful recipe for success for Element.
Now, no doubt you'll ask me what the optimal end state is, what is the right balance between syndication and our other sources of funding, and how that might change. How does it change with the lower cost of capital added to the mix in due course when we ultimately get there? My answer today is that we have laid out a strategy and a pace that we believe is right for the company at this time, knowing what we know about client concentration limits, our growth pipeline, and our resources. If we need or want to flex that up or down, we're confident in our capabilities and the market capacity will be such that we'll be able to do so. As we grow, it is incredibly valuable to have the ability and the optionality to access multiple funding sources. Today, we like having syndication on our menu.
With that, I'll turn it over to Vito to talk through our results in more detail for the quarter, as well as discuss the new way in which we're presenting our results to reflect how we think about the business and syndication. Vito?
Thank you, Jay, and good morning, everyone. It's great to be with you this morning and share our Q1 results and further update you on our transformation journey. It's a very exciting and busy time for us, and as Jay's indicated, while much work remains ahead, we're pleased with our progress to date. Before jumping into my commentary of the Q1 results, let me take this opportunity to highlight the changes we have made to the presentation and classification of the net revenue section of our P&L. At the highest level, we believe our business disaggregates to three distinct revenue streams. They are financing revenue, servicing revenue, and now the emergent syndication revenue. As a result, we made several reclassifications, including reclassification of syndication revenue from service revenue and other to its own line item.
Reclassification of gain on sale of disposition of equipment under operating leases from service revenue and other to rental revenue and other. Reclassification of certain contract costs from interest income to servicing income, and reclassification of certain U.S. financing leases to equipment under operating leases. Additionally, we've modified our geographic locations from the U.S., Canada, and other to the U.S. and Canada, Australia and New Zealand, and thirdly, Mexico, to distinguish between the company's primary locations. The changes in presentation have been applied retrospectively to the 2018 comparative amounts in the balance sheet, income statement of cash flows, and the geographic locations disclosed in the following notes to the interim condensed consolidated financial statements. I refer you to the financial statements, MD&A, and supplementary information for additional information.
Additionally, effective January first, 2019, we adopted IFRS 16 leases, which increased our assets and liabilities by CAD 80 million for the right of use assets and lease liabilities associated primarily with our real estate leases. The income statement impact is primarily the classification of rent expense moving to depreciation and interest expense. This change in accounting did not require a restatement of prior year balance sheet or income statement. Therefore, we had an increase of CAD 3.3 million and CAD 600,000 to depreciation expense and interest expense, respectively, with an approximate offset in general and admin expense. Now on to the Q1 results for our core fleet management business. Q1 adjusted operating income from core fleet management business increased 38% from Q1 2018 and 23% from Q4 2018 to CAD 122 million, or CAD 0.21 per share after tax.
The strong performance in Q1 was driven by both growth in revenue and reductions in our operating expenses. Net revenue in Q1 was CAD 237.7 million, an increase of CAD 29.3 million or 14% versus prior year. Those increases were driven primarily by a CAD 13 million increase in finance and service revenue attributable to growth in NEA and positive foreign exchange impact, and a CAD 16 million increase in syndication revenue. As Jay indicated, during Q1, we expanded the syndication program to reduce our overall leverage and manage customer concentration risk. This resulted in syndicating CAD 488 million in net book value of finance receivables compared to approximately CAD 48 million in Q1 2018. At the time the finance receivables are syndicated, the net book value of the asset is removed from the statement of financial position, and the associated revenue and expenses are recognized immediately in the P&L.
While we expect syndication revenue to remain fairly steady over the first three quarters and then grow in the fourth quarter of 2019, it's important to note that the yield on these syndicated assets will vary from quarter to quarter based on a number of factors, including client mix, asset mix, lease term, et cetera. We have received positive feedback on our supplementary information material, and we'll continue to look for ways to provide you more insightful information about the characteristic of Element's business and the progress we are making. In regards to the drivers of the CAD 22.8 million improvement in quarter-over-quarter core AOI, I refer you to the walk we outlined in section two of this quarter's supplementary.
Turning to our core fleet expenses, adjusted operating expenses of CAD 115.7 million in Q1 decreased CAD 5.9 million from CAD 121.6 million in Q4 2018 and decreased CAD 4.5 million from CAD 120.2 million in Q1 of 2018. We're pleased with the progress. These reductions primarily reflect the savings from our transformation initiative flowing through to the reporting lines as we expected. Let's turn briefly now to earning assets. Our total core earning assets at period end were CAD 12.7 billion, a CAD 500 million reduction from the end of calendar year 2018 levels. This, of course, includes the CAD 488 million reduction related to the syndicated assets, along with a CAD 200 million reduction for changes in foreign exchange levels, offset by net growth representing originations less amortization in all geographies amounting to CAD 200 million.
Given the expanded use of syndication as a financing tool, it's important that we pivot to the measurement of assets under management as a key indicator for our business. Accordingly, in sections three four and three five of our supplementary material, you'll find our view of core fleet assets under management for the last nine quarters. Our aggregate assets under management at the end of Q1 2019 was CAD 15.5 billion, a CAD 100 million increase over the Q4 levels on a constant currency basis. Let me also touch on a couple of other key financial indicators for us moving forward. Our consolidated tangible leverage ratio at the end of Q1 calculated to 7.4, a reduction from 7.8 at the end of calendar year 2018. The reduction reflects the impact of syndication, coupled with all the other measures we've taken to de-risk our balance sheet thus far.
We're targeting a ratio below 6.x exiting 2020. Our consolidated return on equity at the end of Q1 calculated to 10.9%, and our target range is 13%-13.5%, as Jay indicated, exiting 2020. Finally, of course, our confidence in a stronger growth profile for the business and the sustainability of our syndication strategy results in an increase to our 2020 after-tax adjusted EPS guidance from CAD 0.90-CAD 0.95 to CAD 1.00-CAD 1.05. Before I hand the call back to Jay, let me take the opportunity on behalf of the entire executive team to thank all the employees at Element across all of our geographies for their incredible commitment, diligence and hard work. Our collective efforts are truly making a difference. Thanks, Jay, and back to you.
Perfect. Thanks, Vito. I will conclude by saying that we're very pleased with our progress on all fronts. We're transforming the core, we're strengthening the balance sheets, we're improving profitability, all in keeping with the commitments that we made to you last October. Let's now open the line to take any questions that you might have. Operator?
We will now begin the analyst question and answer session. To join the question queue, you may press star then one on your telephone keypad. You will hear a tone acknowledging your request. If you are using a speakerphone, please pick up your handset before pressing any keys. To withdraw your question, please press star then two. We will pause for a moment as callers join the queue. The first question comes from Paul Holden with CIBC. Please go ahead.
Thank you. Good morning. Jay, I know you made a number of comments regarding the persistency of syndication. I just want to drill down a little bit more so people can get comfort around the quality of that earnings stream. How do we think about, or how do you view the perspective on quarter-to-quarter volumes? What gives you the confidence that you have the insight to know kind of what's coming over the next three to seven quarters?
Morning, Paul. In terms of the profile, firstly, we have good visibility by virtue of having a keen line of sight to that CAD 6 billion of annual originations that the company does. Understanding that which is eligible for syndication has allowed us to profile that over the 12-month periods and understand in great level of detail where we can expect that volume to originate and ultimately activate and be eligible for syndication. Both the sustainability, if you will, of that CAD 6 billion and the consistent nature of that CAD 6 billion of origination, coupled with our ability to qualify that and profile it on a monthly basis, allows us to understand the supply aspect of this very well.
Having been in the market for more than the last 10 years, and having a well-established and a growing network of syndication investors, we know there's ample market demand for this type of asset. Marrying those two together gives us very good line of sight in terms of syndication revenue profile over any given four quarters. In terms of managing expectations, I'd also say that we would expect that the first three quarters of the year would be relatively similar in terms of the revenue that would be booked, with the fourth quarter being larger due to a number of market factors.
Got it. Then the second question, similar vein, is kind of, I guess, the persistency of syndication earnings beyond, let's say, your 2020 guidance. Maybe the skeptics will say this is really just a way of pulling forward earnings and maybe having to give up something in the future. Maybe you can address those potential questions as well.
Yeah. Really, this is all about an economic trade-off of receiving recurring revenue over time versus recurring revenue at a point in time. Whether you're talking about securitization or syndication on or off book, there really are essentially two primary factors that you need to consider as you assess the viability of either funding strategy: supply and demand. When we think about supply, it's actually a factor that is common to both. We need a recurring source of originations to replace the amortizing lease book that drives NIM over time under a securitization program or at a point in time with syndication. Again, we come back to, for securitization, we have a CAD 6 billion annual book of originations, much of which would qualify for the various securitization programs that we have in effect.
For syndications, we would have approximately half of that CAD 6 billion of global originations available for syndication in the U.S. market. To that, we'd also add the originations generated by this new, large, fast-growing client whose size requires us to syndicate significant amounts of credit exposure. Clearly we have ample supply to feed either of those funding vehicles, and that remains consistent across an on-balance sheet or an off-balance sheet funding strategy.
Got it. Then final question from me is related to the tax angle you mentioned. Element can't currently benefit from additional tax shield, but purchasers of the syndication or participants in the syndication can. Can you share a perspective on when that balance might change, i.e., will there be a point in time when Element could benefit from additional tax shield?
We have a large and growing tax shield as a consequence of the underlying business dynamics coupled with our tax planning strategies. For the foreseeable future, we would anticipate that that shield would hold and continue to grow.
Okay, that's it for me. Thank you.
The next question comes from Mario Mendonca with TD Securities.
Can you talk about any risks related to recourse either that exist contractually or more along the lines of, is there a situation where you're not legally required to take back the asset, but it's simply the right thing to do, as we saw in the ABCP market? Do you see any risks like that playing out?
No material risks of that nature.
To your knowledge, has there ever been a case, either while you've been there or over time, where assets have had to be taken back?
I'm staring across the table from Karen Martin, our treasurer, and she has given me no. I have not encountered any of those instances in my brief tenure with the organization. In Karen's long-standing nature with the organization, she's not encountered anything of that nature either, Mario.
Okay. That's helpful. This one might be appropriate for Vito as well. Vito, you referred to the assets under management as an appropriate way to look at the company now, I think I get that because the stuff subject to NII, the assets that you'd earn NII are obviously going to go down as you syndicate. Maybe you could help me understand then, what sort of management fees do you earn on those syndicated assets?
Well, we obviously maintain the relationship with the client, which is the most important component, the service income stream continues with respect to that, in addition to any management fees that would be embedded in our original contractual relationship. What we are syndicating is the interest income component of the contractual relationship with the existing client.
I'm just sorry, I understand. Are there actually management fees you earn on the amount you call syndicated assets? Like specifically related to those syndicated assets because.
There would be. Each client arrangement has its own peculiarities, if you will, from how the contract is composed. There would be management fees in many cases, yes.
Mario, maybe for greater certainty and clarity around that. Perhaps by way of example, if we had a client that we ultimately syndicated leases on 1,000 units, we would still service that client in terms of the provision of maintenance, fuel, tolls and licensing, remarketing, et cetera. We, as Vito has indicated, we are effectively selling off the lease obligation, but maintaining the service contract and the obligations and benefits that accrue with that.
That makes perfect sense. Those are fees that always exist that I thought. What I'm asking is if there's a new type of management fee that's created from the syndication activity itself. I get it. I understand you continue to service the asset.
Yeah. No additional management fee, no.
Okay. No additional management fee besides what you already have.
That's correct.
Okay. When I think about how to model this going forward, my inclination is just to take the NII down a little bit. Not down, because presumably the assets may still grow, but the growth won't be there because you're syndicating it. The syndication obviously goes up a fair bit. What would you say leads to the increase in your estimate? Is it simply that the syndication activity is just a higher yielding or a higher margin business than the NII?
That is correct. Again, as you might appreciate, there's a variety of factors that come into play in terms of that pricing. As you look at client profile, asset profile, duration of the lease, and the tax benefits and the ability of the purchaser to utilize those tax benefits, those are all key contributors in terms of the yield. To your point, and importantly, we should just kind of step back and frame this. Syndication is an enabler of two important strategies, an opportunity to reduce concentration risk in terms of a single name, coupled with an opportunity to rapidly delever the balance sheet, allowing us access to alternative financing instruments.
The wondrous thing that, as we spent the last five months thinking through and preparing for this, it became readily apparent not only would both of those important initiatives be advanced, but this was actually economically attractive given the pricing dynamics of the marketplace. Again, as indicated, that's a combination of a multitude of factors that include that client mix, asset mix, tax shields, lease term, et cetera.
Okay. You kind of hit on the last thing I wanted to talk about. You referred to the benefits from a leverage perspective, and I think I follow that. It lowers the leverage ratio, reduces your cost of funds. That makes a lot of sense to me. Where I struggled a little bit was with the ROE number you come up with for Q4 2020. I can see there's certainly the benefit from an earnings perspective, but getting to 13.5 or 13%, it strikes me that you'd have to do something with the capital structure as well. There has to be something you would do to the equity to get to that 13.5. That's just because I'm playing with numbers here in my office, and it doesn't seem like you can get there just by growing the earnings number.
Does that 13-13.5 contemplate something like reducing the equity in some way? The shareholders' equity?
No, it does not.
No?
Maybe what we'll do is we'll take that under consideration. Maybe there's a waterfall that we could build for the Q2 disclosure-
Sure
that will give you better visibility on that.
That'd be great because it's challenging to get to that number. I can get close, but not quite there. Thank you.
Okay.
Thank you.
Not at all.
Next question comes from Geoffrey Kwan with RBC Capital Markets. Please go ahead.
Hi, good morning. Just Vito, I know you mentioned with the syndication fee that it can vary quarter-to-quarter because of all these different factors there. Just call it 3.5% that was in the first quarter. If you think about it maybe on a normalized basis for the full year, is that where you would think is a reasonable number, or is it something that might be a little bit higher or lower?
I think the Q1 number is probably at the high end of the range for where we would expect it to be. We would expect on an average basis to be lower than the three and a half.
Because I think in the other quarters that you gave the information, it was kind of in the 285 range, and year-over-year, it was closer to two. I'm guessing the two is probably a little bit too low?
I think we're going to have to wait and see. As I said, we gave a fair bit of indication about where we expect the aggregate syndicated revenue to be on a quarter-to-quarter basis, expect to be in that CAD 17 million range in the next few quarters. Your rate is dependent on all the factors that we've outlined. Lower than three and a half, perhaps, is a safe bet, and we'll just leave it at that, Geoff.
Okay. Then just on the syndication partner demand, I know that you have some slides talking about size of market, you've talked about it a little bit already. Just wanting to understand, with these syndication partners you have, are there kind of agreements you have in place in terms of contracted volume expectations over, let's call it an annual basis? Then also conversely, since you're going to be not tapping the ABS market as much, is that a potential source where you would have had some buyers in that market that might now be syndication partners?
Jeff, we've had well-established relationships in this equipment syndication market by virtue of the 10+ years that we've been active in that market. In anticipation of enlarging the size of this program and developing this as a fully functioning funding ability for the organization, we've been out introducing ourselves and our paper to a larger group of participants in that market. It's a market of call it 70-80 participants, well established, and we believe capable of further expansion given just how good the quality of asset we have on offer. In terms of demand, again, for those that we've had the relationships with, they are eager to take on additional paper given, again, the longstanding relationships and the quality and performance of the underlying asset.
While this isn't a market in which they're able to give long-dated forward commitments, the indications are strong in terms of their appetite and interest in participating.
Okay, perfect. One last question I had was, I know you have intentions of getting rid of the converts out of the capital structure, and you've got a maturity coming up next year. How are the converts right now being allocated between the core and the non-core? Does that change at all as you whittle down the non-core part of the business?
Yeah. The methodology hasn't changed, Jeff, there on how we're allocating effectively. The non-core gets the proportionate share of the converts as we have in the previous quarters. Clearly as our non-core winds down, as we reported, ECAF is coming out, all that interest expense will obviously move into the core as we move forward, which is obviously embedded in our 2020 guidance as well.
Sorry, Vito, you said it's getting allocated on a proportionate basis, I'm assuming based on assets.
Yeah. It's actually 75% of the converts effectively are allocated to non-core. That's the rough range, consistent with previous quarters.
Okay, great. Thank you.
You're welcome.
The next question comes from Jaeme Gloyn with National Bank Financial.
Good morning.
Good morning.
My first question, again, still down the line of syndication income. In that 3.5% this quarter, is that only reflecting the gain on sale income? In this quarter, in Q1, were the syndicated assets sold primarily existing assets or originations?
In terms of the CAD 17 million of revenue recognized in quarter, it was indeed the revenue generated on the syndication of CAD 488 million worth of assets. In terms of the composition of that, we would have drawn from existing book as well as new originations as we ramp up the program. As I commented in reply to Paul's question earlier, we would expect, given the CAD 6 billion of annual originations and half of those being eligible for syndication, as we wrap this program up, it will be largely just drawing from new originations.
Okay. I would interpret that to mean that in this quarter it was more 50/50 between existing and originations or even tilted more heavily toward existing assets.
I'll leave the assumptions to you.
Okay, fair enough. In terms of the target or the goal to acquire a second U.S. credit rating, can you talk about what are the major criteria in achieving that outcome? Is it simply just the tangible leverage ratio, or are there other factors that we should think about as you go down that path?
Oh, we wish it was just one factor. There is a multitude of factors, and problematically, they vary greatly, whether you're talking about a Fitch, a Moody's, or an S&P. We have a good understanding of the expectations and requirements. While a lot will bear heavily on the decision process of each one of those rating agencies, certainly tangible leverage is, or a derivative thereof, is a very important area of focus. As Vito has communicated, we have targeted that to be sub six times tangible leverage on exit of 2020. Obviously we would believe that is a basis of any calculation that a Moody's or an S&P would make would be satisfactory in terms of meeting that particular hurdle. I would caution you that there are a multitude of factors to be considered.
I guess, would you be able to share what are the kind of number two and number three factors that you would be focused on in terms of achieving?
I'd be willing to share that we have a good understanding of those and are comfortable that we're on the right track to address those to the satisfaction of the rating agencies in line with the timelines that we have communicated regarding achievement of another investment grade rating.
Okay. Then on the same topic, as we look out further beyond 2020, where do you expect to see tangible leverage, let's say, on a run rate basis? Is it right at that six times level, or do you see that trending lower?
Yeah. We believe we want to be at sub six, that gives us seven quarters to achieve that. Again, given the progression that we're seeing in the core business, given the success that we're enjoying in the transformation of the business, coupled with the plan of action that we have for syndication, we think that's well enhanced.
Okay, great. Thank you very much.
Thank you.
Next question comes from Tom MacKinnon with BMO Capital.
Yeah. Thanks very much. Good morning. Just a couple questions again with respect to the syndication. Just from your customer's perspective, what's their view? Does it really matter to them? They just pay a lease payment, and you just pass it through and pay it to these people that you syndicate everything else to. Is that the way it would work? Does it matter to them?
Good morning, Tom. Ultimately, when we work with our clients, one of the overriding considerations and areas of focus for them is total cost of ownership and driving down that total cost of ownership. With the amortization cost being one of the most significant costs are constantly looking for ways to drive that down, and whether that's lower acquisition costs, higher remarketing costs, or lower interest rates on the financing. Those are primarily the three levers that you have available to you to affect economies around that aspect of the total cost of ownership. Us being able to offer them a better cost of capital by virtue of enlarging the funding sources that are available to the business would be seen as a positive in enabling them to reduce that total cost of ownership.
Okay, thanks. You talked about pricing dynamics with respect to syndicating these assets. Can you elaborate on how this market has trended? What are the key risks, what drives it, and why you think it's favorable now?
Yeah. I would say to you, demand has been very stable and very strong in this particular market. Even when we saw demand apparently dwindle, contract during the economic crisis, that was more, as we understand it, an issue of supply versus demand. There was a healthy interest, active market, but there weren't as many originations to be syndicated. We think that there is a strong, stable, and we believe an opportunity to grow demand in this market. In terms of pricing, I'm not wishing to be the least bit evasive here, it is entirely dependent and varies meaningfully based on client mix and the name and creditworthiness of those clients, as well as even client concentration.
It varies in terms of asset mix and the nature of that asset and how much upfitting and uniqueness thus that asset has, the term of the lease, how many payments are left. Again, the ability for the buyer to make use of tax benefits that accrue with buying that asset. It is actually quite amazing to see how that can vary depending on those factors. Again, gives us great peace of mind that we have been doing this as long as we have developed that knowledge, and are thus able to quite accurately determine which assets will yield the best margins for this business as we think about syndication versus securitization.
Tom, maybe I'll just add, the very characteristics that make it attractive for securitization, which are the quality of the underlying assets and obviously the quality of our client base, make it equally attractive from a syndication perspective.
Yeah, it sounds that way. As you step up your efforts in this, is there any impact on OpEx?
No. It'll be marginal compared to the revenue lift that we're seeing, an incremental person or two. Again, the processes and systems are in place to manage this and are readily scalable.
Thanks. Finally, you go look through your last couple MD&As, and you could hardly even find the three letters ROE, and now you've put it into a slideshow with a guidance on it. You are becoming, I guess, more of a fee type company as you move to syndication. You do have a lot of other service type fees. Is this a metric that matters to you, ROE? Do the rating agencies care about it, or should we just focus more on why put it out there, or should we just focus more on the EPS?
Yeah, Tom, I think it is a metric that does indeed matter to us as we think about capital allocation on behalf of our shareholders. Yes, it is absolutely a measure that matters. To that end, it is a measure, one of four financial measures that comprises our balanced scorecard for this organization. It gives you an idea as to the criticality of it from management's point of view. Again, ROE, like other metrics and other information that we're putting in the supplemental, is quite honestly designed to give you, our investment community, full view as to the business, how we're thinking about the business, and the dynamics of the business. We are providing more of a spotlight on that. We're introducing assets under management.
Again, just to try and give you greater transparency as to how we're thinking about the business and how the business model is evolving. You might remember in a previous call I had mentioned to you, one of the fascinating things about transforming an organization is you have your game plan, you're executing that game plan, and you're building momentum, you're achieving success, and lo and behold, you start to see other opportunities to view the business differently by virtue of the new perspectives and the new successes that you're enjoying. In syndication, a tool that we've used and deployed for many years, was sitting there effectively idle relative to the utility that we could derive from it as we start to think about the long-term evolution of the capital structure, reducing our cost of capital, addressing single credit risk.
It's things like that again, are a delightful byproduct of the current thrust of this plan. As we discover these different opportunities to add value, and as those means of adding value start to morph our view of the business, we want to try and share that with you in real time through the provision of supplementary information in that companion document.
Okay. This will be my last one. You mentioned four financial measures, of which ROE is one. What are the others? I assume maybe EPS, AUM. Lightness on those three others.
Yeah. EPS is one. Leverage is one. ROE is one. The fourth is actually a metric under construction. It's our enterprise risk indices. One of the references that we made in the MD&A to the balanced scorecard is we want to earn an appropriate risk-adjusted return. We think it important, given the nature of our business, that the organization in its totality has an appreciation for risk, what is inherent in the business model, and is making a conscious decision as to how we mitigate and manage that risk exposure of the organization. Vito and his team are working on that as the fourth metric as we think about our investors and how to best serve our investors in terms of long-term shareholder value creation.
Okay, that's great. Thanks.
Thank you.
Next question is from Britta.
Hi, good morning.
Hey, Britta. Good morning.
I wanted to start with the impact of syndication on the net interest margin for the remaining on-balance sheet finance receivables. A bunch of moving parts, but do we think of this as a lower proportion is funded via the Chesapeake facility such that we'd expect margin compression? Are there other things to think about there?
Yeah. We're not giving specific guidance in terms of NIM as we go forward. As I say, it's been our tradition established last October. We'll put that stake out in terms of 2020 and adjusted EPS, then try and provide you as much visibility on the components in our full compendium of disclosures.
Okay. As Mexico becomes a larger part of the business, can you then maybe tell us where this region NIM ranks relative to the U.S. business?
We don't disclose that level of detail. I will say that just really impressed with the job that David and his team are doing there. They've invested heavily over the years in terms of the relationships with existing clients as well as prospective clients, that's just paying off for them brilliantly as they capture a disproportionate share of a very fast-growing market.
Okay. As we think about the components of syndication revenue, you mentioned you're selling the net interest margin, you're selling the credit exposure, you're selling the tax shield. How do we think about those proportionate amounts as they translate into the yields that your purchasing partner is earning? I think in the past, you've mentioned amortization of a purchase discount in there. Is there room for that to expand as your overall volumes increase?
Yeah. You are correct in terms of what would comprise that syndication revenue stream. That said, again, I'll come back to it will be totally dependent on the client, the asset mix, the lease term, the lease interest rate, the tax benefits, and their ability to be utilized by the acquirer. There's just so many factors that come into play. Again, I was quite surprised by how inconsistent the pricing was given just how variable each one of those different attributes would be, and how they would be considered by the purchaser. That's a level of detail that at this point in time that we've chosen not to disclose. Instead, have provided you the more high-level guidance in terms of our progression over the first three quarters and what we would generally expect to happen in the fourth quarter.
Okay. The large customer that you've made reference to, is this customer strictly utilizing finance service, or are they using service revenues from you guys as well?
Yeah. Many of our clients request anonymity in terms of our dealings, and this happens to be one of them. I'll refrain from offering any commentary.
Okay. Switching gears to the profitability improvements. You referenced building internal capabilities. Could you just flesh out the details on what you see as the opportunity there, how you expect to be more efficient doing it in-house? Do you think that this serves to get you deeper penetration with some of your big clients?
Yeah. In terms of a productivity strategy for us, we're looking at all levers available to us as exemplified by some of the actions that have been taken in quick wins, as well as early actions under our back-to-basics program for 2019. For us, there was, for instance, a fair amount of IP that ended up getting outsourced to IT service providers as they worked on coding for us on different applications. We're looking at opportunities to bring aspects of that coding back in-house and aspects of certainly the management of that function back in-house to take full ownership of the IP surrounding our applications, and where possible, to reduce the total cost. Again, looking at this from a number of perspectives with productivity being an overarching ambition for us.
We should think of that as sort of complementary functionality versus potentially in-housing some components of your service revenue offerings?
That is correct, yes. This would've been support costs that would've been provided through third parties being repatriated in some way, shape, or fashion to lower costs and to have tighter alignment in terms of the execution of responsibilities in particular areas. This would not be about reaching down the value chain and starting to take on some functionality that third-party strategic suppliers are providing as part of our client value proposition.
Okay. Very helpful. Last one from me. When you're thinking about your capital structure, now you've referenced converts a few times as really not featuring in a long-term structure, how are you thinking about preferred shares?
Yeah. Preferred shares at this particular juncture are a key component of our capital structure. The favorable treatment by the rating agencies is helpful, we don't see any material change in terms of our [OPII preferred shares] as a component of our capital structure for the foreseeable future.
Great. Thank you very much.
Thank you.
Next question comes from John Aiken with Barclays.
Good morning. I appreciate you taking my question since we're over the hour. Hopefully, we'll be reasonably brief. In terms of the originations in the quarter, you talked about the better client retention, but can you give us a little bit of color around the quarter? Jay, in reference to the syndications, you talked about CAD 6 billion in terms of originations. I'm assuming that's backward-looking as opposed to what you're looking for prospectively given the originations that you got this quarter annualized is well above the CAD 6 billion.
Good morning, John. You're right. In terms of the CAD 6 billion, that is typically what we have been doing in any given year. Of course, this year, with the addition of this new fast-growing client, we would expect our originations to grow accordingly. In terms of client attrition, again, as we shared with you last quarter, the worst of client attrition is well behind us, and Q1 provided us with even more confidence in terms of that realization. The fact that there wasn't a loss of a single enterprise or mid-market client in March was really quite extraordinary. The processes that we have put in place to identify at-risk clients and to address those underlying issues that have put them at risk has seen us continue to make month-over-month material reductions in that number.
Delighted with the view that we've been able to build in terms of which clients are at risk. Couldn't be more pleased with the insights that that is providing us in terms of how we can create a better, more consistent experience, then the remediation efforts that the organization has put in place to address those, solve those, and to maintain those clients has really been quite extraordinary. Very, very pleased and again, as I will always caution, this is a two-year journey, and we're merely at the first few innings of it. Again, delighted with the progress that I'm seeing.
Thanks, Jay. I appreciate the commentary.
This concludes the question and answer session. We apologize for the lack of time to take additional questions. I would now like to turn the call back over to Mr. Forbes for any closing remarks.
Again, sorry that we have to wrap up. We're running over to our annual general meeting, but indeed, Mike and Scott will be available for any follow-up questions that you might have. Otherwise, again, thanks ever so much for making the time to join us here this morning.
This concludes today's conference call. You may disconnect your lines. Thank you for participating and have a pleasant day.