PATHWARD FINANCIAL, INC. This section should be read in conjunction with the following parts of this Form 10-K: Part II, Item 8 "Financial Statements and Supplementary Data," Part II, Item 7A, "Quantitative and Qualitative Disclosures About Market Risk," and Part I, Item 1 "Business."
General
The Company, a registered unitary savings and loan holding company, is a
Executive Summary InJanuary 2019 , the Company announced three key elements to its near-term plan that management expects will enhance long-term value for shareholders. The three key initiatives within the plan are as follows: 1) Increase the percentage of balance sheet funding from core deposits; 2) Optimize the interest-earning asset mix of the balance sheet; and 3) Improve operating efficiencies.
The Company entered into two new warehouse finance lines of credit during the
first quarter of fiscal 2019. With the addition of these two new lines of
credit, warehouse finance loans grew to
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During the second quarter of fiscal 2019, the Company became aware thatDC Solar Solutions, Inc. ,DC Solar Distribution, Inc. and their affiliates filed for bankruptcy and the entities, including their principals, are subjects of ongoing federal investigations involving allegations of fraudulent misconduct. Due to the facts and circumstances surrounding these DC Solar matters, the Company recognized a$6.6 million after-tax net non-cash charge to earnings and recorded a$2.0 million increase to goodwill. See Note 2 to the Condensed Consolidated Financial Statements included in this annual report for further discussion. The Company announced during the second quarter of fiscal 2019 that its Board of Directors authorized a share repurchase program to repurchase up to 2,000,000 shares of the Company's outstanding common stock. The program became effectiveMay 1, 2019 and was scheduled to expire onSeptember 30, 2021 . During fiscal year 2019, the Company repurchased$46.5 million , or 1,680,772 shares of its common stock, at an average price of$27.67 per share under the share repurchase program. As ofSeptember 30, 2019 , the remaining number of shares available for repurchase under this program was 319,228 shares of common stock, all of which remaining shares were repurchased inOctober 2019 . OnNovember 20, 2019 , the Company also announced the authorization by its Board of Directors of a new share repurchase program to repurchase up to an additional 7,500,000 shares of the Company's outstanding common stock. The new authorization will be effectiveNovember 21, 2019 throughDecember 31, 2022 . The Company recorded net income of$97.0 million , or$2.49 per diluted share, in fiscal year 2019, compared to$51.6 million , or$1.67 per diluted share, in fiscal year 2018. This increase was primarily driven by the Company's net interest income growing to$264.2 million in fiscal year 2019, compared to$130.5 million in the prior fiscal year. The increase was primarily attributable to improvement in the overall interest-earning asset mix due to loan and lease growth, particularly in the commercial finance portfolio. In fiscal year 2019, noninterest income increased to$222.5 million from$184.5 million in fiscal 2018. Income tax expense (benefit) decreased from$5.1 million to$(3.4) million year over year. Fiscal year 2018 included a$4.6 million income tax benefit recognized by the Company as a result of amending a historical tax return ofCrestmark Bancorp, Inc. Also contributing to the change was an increase in net income before tax during the fourth quarter of fiscal 2019 compared to the same period of the prior year. Partially offsetting the higher net interest income and noninterest income was noninterest expense, which increased from$228.2 million in fiscal year 2018 to$333.2 million in fiscal year 2019. The continued growth in loans and leases during fiscal year 2019, along with the continued optimization of the earning asset mix of the balance sheet, led to net interest income of$264.2 million and net interest margin ("NIM") of 4.91% and net interest margin, tax-equivalent ("NIM, TE") of 5.02%. The Company's average gross loans and leases increased by$1.71 billion , or 94%, while average noninterest-bearing deposits increased by$230.1 million , or 9%, when compared to the prior fiscal year. Management anticipates that NIM will continue to expand over time as the Company continues to grow and optimize the loan and lease portfolio, along with leveraging growth from its Payments division's low-cost deposits. Overall, the cost of funds at MetaBank averaged 1.16% during fiscal 2019, compared to 0.70% during 2018. The Company's non-performing assets ("NPAs") atSeptember 30, 2019 were$56.5 million , representing 0.91% of total assets, compared to$41.8 million , or 0.72% of total assets, atSeptember 30, 2018 . The increase in NPAs was primarily attributable to nonperforming loans and leases within the commercial finance portfolio. AtSeptember 30, 2019 , foreclosed and repossessed assets were$29.5 million , representing 0.48% of total assets, compared to$31.6 million or 0.54% of total assets atSeptember 30, 2018 . At each of these dates, the outstanding foreclosed and repossessed asset balance was primarily related to a previously disclosed agricultural relationship. Tangible book value per common share outstanding increased by$3.20 , or 34%, to$12.74 per share atSeptember 30, 2019 , from$9.54 per share atSeptember 30, 2018 . This increase was primarily driven by a decrease in common shares outstanding along with an increase in total stockholders' equity which was mainly attributable to increases in accumulated other comprehensive income and retained earnings. Book value per common share outstanding increased by$3.23 , or 17%, to$22.32 per share atSeptember 30, 2019 , from$19.09 per share atSeptember 30, 2018 . Subsequent Events Management has evaluated and identified subsequent events that occurred afterSeptember 30, 2019 . See Note. 23 Subsequent Events for details on these events. 60
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Financial Condition AtSeptember 30, 2019 , the Company's total assets increased by$347.8 million , or 6%, to$6.18 billion , compared to$5.84 billion atSeptember 30, 2018 . The growth in assets was primarily due to increases in loans and leases and rental equipment, partially offset by a decrease in the investment portfolio. Total cash and cash equivalents were$126.5 million atSeptember 30, 2019 , an increase of$26.6 million from$100.0 million atSeptember 30, 2018 . The Company maintains its cash investments primarily in interest-bearing overnight deposits with the FHLB ofDes Moines and the FRB. AtSeptember 30, 2019 , the Company did not have any federal funds sold. The total investment portfolio decreased by$612.7 million , or 30%, to$1.41 billion atSeptember 30, 2019 , compared toSeptember 30, 2018 , as maturities, sales and principal pay downs exceeded purchases. The Company's portfolio of securities customarily consists primarily of MBS, which have expected lives much shorter than the stated final maturity, non-bank qualified obligations of states and political subdivisions ("NBQ") that mature in approximately 15 years or less, and other tax exempt municipal mortgage related pass through securities which have average lives much shorter than their stated final maturities. All MBS held by the Company atSeptember 30, 2019 were issued by aU.S. Government agency or instrumentality. Of the total MBS, which had a fair value of$389.7 million atSeptember 30, 2019 ,$382.5 million were classified as AFS, and$7.2 million were classified as HTM. Of the total investment securities, which had a fair value of$1.02 billion atSeptember 30, 2019 ,$889.9 million were classified as AFS and$127.6 million were classified as HTM. During fiscal 2019, the Company purchased$299.3 million of investment securities available for sale and did not purchase any investment securities held to maturity or MBS securities. Loans held for sale atSeptember 30, 2019 totaled$148.8 million , increasing from$15.6 million atSeptember 30, 2018 . This increase was primarily driven by the transfer of$100.0 million of consumer credit product loans to held for sale and$171.3 million of SBA/USDA and consumer credit product loans originated into held for sale. The Company sold held for sale loans resulting in proceeds of$125.4 million during the fiscal year endedSeptember 30, 2019 . During the fiscal year endedSeptember 30, 2018 , the Company transferred, as part of the Crestmark Acquisition,$12.8 million of SBA/USDA loans to held for sale and originated$1.7 million of SBA/USDA loans as held for sale. The Company sold held for sale loans resulting in proceeds of$17.6 million during the fiscal year endedSeptember 30, 2018 . OnOctober 1, 2019 , the Company sold$111.7 million in held for sale consumer credit product loan balances and will be recording a gain on sale of$0.2 million to noninterest income in the first fiscal quarter of 2020. The Company's portfolio of gross loans and leases receivable increased by$714.1 million , or 24%, to$3.66 billion atSeptember 30, 2019 , from$2.94 billion atSeptember 30, 2018 . National lending loans and leases increased$603.3 million , or 33%, to$2.45 billion atSeptember 30, 2019 compared toSeptember 30, 2018 . Within the national lending portfolio, commercial finance loans and leases increased$406.4 million and warehouse finance loans increased$197.9 million , while the consumer finance portfolio decreased by$2.2 million atSeptember 30, 2019 compared toSeptember 30, 2018 . Community banking loans grew$103.1 million , or 9%, atSeptember 30, 2019 compared toSeptember 30, 2018 , due to growth in commercial real estate and operating loans of$93.0 million and consumer one-to-four family real estate and other loans of$12.1 million . See Note 4 to the "Notes to Consolidated Financial Statements," which is included in Part II, Item 8 "Financial Statements and Supplementary Data" of this Annual Report on Form 10-K. Through the Bank, the Company owns stock in the FHLB due to the Bank's membership and participation in the FHLB's banking system. The FHLB requires a level of stock investment based on a pre-determined formula. The Company's investment in such stock increased by$7.5 million , or 32%, to$30.9 million atSeptember 30, 2019 , from$23.4 million atSeptember 30, 2018 . The increase in FHLB stock directly correlates with the higher FHLB borrowings balances atSeptember 30, 2019 compared to the prior year. Total end-of-period deposits decreased by$94.0 million , or 2%, to$4.34 billion atSeptember 30, 2019 , as compared toSeptember 30, 2018 . The decrease in end-of-period deposits was primarily the result of a decrease in certificate of deposits of$166.9 million and a decrease in noninterest bearing checking deposits of$47.3 million , partially offset by an increase in wholesale deposits of$26.1 million and increases within money market and interest-bearing checking deposits. End of period deposits attributable to the Payments division increased$21.3 million , or 1%, atSeptember 30, 2019 , as compared toSeptember 30, 2018 . 61
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The Company's total borrowings increased$347.1 million , or 67%, from$514.7 million atSeptember 30, 2018 , to$861.9 million atSeptember 30, 2019 , primarily due to an increase in overnight federal funds purchased and long-term advances from the FHLB. During the third quarter of fiscal 2019, the Company replaced a portion of its short-term borrowings with new long-term borrowings from the FHLB of$110.0 million . The Company's short-term borrowings fluctuate on a daily basis due to the nature of a portion of its noninterest-bearing deposit base, primarily related to payroll processing timing with a higher volume of short-term borrowings on Monday and Tuesday, which are typically paid down throughout the week. This predictable fluctuation may be augmented near a month-end by a prefunding of certain programs. The Company also has an available no fee line of credit with JP Morgan of$25.0 million with no funds advanced atSeptember 30, 2019 . See Note 10 to the "Notes to Consolidated Financial Statements," which are included in Part II, Item 8 "Financial Statements and Supplementary Data" of this Annual Report on Form 10-K. AtSeptember 30, 2019 , the Company's stockholders' equity totaled$844.0 million , an increase of$96.2 million from$747.7 million atSeptember 30, 2018 . Stockholders' equity increased primarily as a result of an increase in accumulated other comprehensive income, an increase in retained earnings, and additional paid in capital. AtSeptember 30, 2019 , the Bank continued to meet regulatory requirements for classification as a well-capitalized institution. See Note 15 to the "Notes to Consolidated Financial Statements," which is included in Part II, Item 8 "Financial Statements and Supplementary Data" of this Annual Report on Form 10-K. Results of Operations The Company's results of operations are dependent on net interest income, provision for loan and lease losses, non-interest income, non-interest expense and income tax expense. Net interest income is the difference, or spread, between the average yield on interest-earning assets and the average rate paid on interest-bearing liabilities. The interest rate spread is affected by regulatory, economic and competitive factors that influence interest rates, loan and lease demand and deposit flows. Notwithstanding that a significant amount of the Company's deposits, primarily those attributable to the Payments division, pay relatively low rates of interest or none at all, the Company, like other financial institutions, is subject to interest rate risk to the extent that its interest-earning assets mature or reprice at different times, or on a different basis, than its interest-bearing liabilities. The provision for loan and lease losses is the adjustment to the allowance for loan and lease losses balance for the applicable period. The allowance for loan and lease losses is management's estimate of probable loan and lease losses in the lending portfolio based upon loan and lease losses that have been incurred as of the balance sheet date. The Company's noninterest income is derived primarily from tax product fees, prepaid cards, credit products, deposit and ATM fees attributable to the MPS division and fees charged on bank loans, leases and transaction accounts. Noninterest income is also derived from rental income, net gains on the sale of securities, net gains on the sale of loans and leases, as well as the Company's holdings of bank-owned life insurance. This income is offset by noninterest expenses, such as compensation and occupancy expenses associated with additional personnel and office locations, as well as card processing expenses and tax product expenses attributable to Payments. Noninterest expense is also impacted by acquisition-related expenses, operating lease equipment depreciation expense, occupancy and equipment expenses, regulatory expenses, and legal and consulting expenses. 62
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Average Balances, Interest Rates and Yields
The following table presents, for the periods indicated, the total dollar amount
of interest income from average interest-earning assets and the resulting
yields, as well as the interest expense on average interest-bearing liabilities,
expressed both in dollars and rates. Tax-equivalent adjustments have been made
in yields on interest-bearing assets and NIM. Non-accruing loans and leases have
been included in the table as loans or leases carrying a zero yield.
Fiscal Year Ended
September 30, 2019 2018 2017
Average Interest Average Interest Average Interest
Outstanding Earned / Yield / Outstanding Earned / Yield / Outstanding Earned / Yield /
(Dollars in Thousands) Balance Paid Rate (1) Balance Paid Rate (1) Balance Paid Rate (1)
Interest-earning
assets:
Cash & fed funds sold $ 128,507 $ 3,494 2.72 % $ 87,536 $ 2,249 2.57 % $ 150,338 $ 1,382 0.92 %
Mortgage-backed
securities 393,322 11,390 2.90 % 618,985 15,479 2.50 % 747,027 16,571 2.22 %
Tax exempt investment
securities 852,381 20,742 3.08 % 1,381,838 34,402 3.30 % 1,303,830 31,930 3.77 %
Asset-backed securities 299,777 10,705 3.57 % 167,477 5,773 3.45 % 115,716 2,999 2.59 %
Other investment
securities 164,451 4,870 2.96 % 74,491 2,156 2.89 % 114,698 3,104 2.71 %
Total investments 1,709,931 47,707 3.11 % 2,242,791 57,810 3.08 % 2,281,271 54,604 3.15 %
Total commercial
finance 1,717,869 169,941 9.89 % 474,766 36,726 7.74 % 216,478 10,199 4.71 %
Total consumer finance 341,176 29,965 8.78 % 216,128 15,086 6.98 % 100,815 6,704 6.65 %
Total tax services 110,503 8,193 7.41 % 112,583 819 0.73 % 49,026 11 0.02 %
Total warehouse finance 188,483 11,826 6.27 % 14,425 879 6.09 % - - - %
National Lending loans
and leases 2,358,031 219,925 9.33 % 817,902 53,510 6.54 % 366,319 16,914 4.62 %
Community Banking loans 1,180,594 54,603 4.63 % 1,009,255 44,965 4.46 % 820,980 35,203 4.29 %
Total loans and leases 3,538,625 274,528 7.76 % 1,827,157 98,475 5.39 % 1,187,299 52,117 4.39 %
Total interest-earning
assets 5,377,063 $ 325,729 6.16 % 4,157,484 $ 158,534 4.08 % 3,618,909 $ 108,103 3.46 %
Non-interest-earning
assets 875,124 454,688 363,392
Total assets $ 6,252,187 $ 4,612,172 $ 3,982,301
Interest-bearing
liabilities:
Interest-bearing
checking $ 136,069 $ 356 0.26 % $ 90,199 $ 211 0.23 % $ 42,231 $ 172 0.41 %
Savings 53,434 38 0.07 % 56,834 37 0.07 % 55,484 31 0.06 %
Money markets 60,719 419 0.69 % 48,320 123 0.25 % 46,466 87 0.19 %
Time deposits 149,220 2,830 1.90 % 130,944 1,803 1.38 % 103,115 830 0.80 %
Wholesale deposits 1,772,092 43,005 2.43 % 738,796 12,989 1.76 % 558,855 4,931 0.88 %
Total interest-bearing
deposits 2,171,534 46,648 2.15 % 1,065,093 15,163 1.42 % 806,151 6,051 0.75 %
Overnight fed funds
purchased 300,203 7,484 2.49 % 326,786 6,294 1.93 % 259,378 2,649 1.02 %
FHLB advances 42,712 1,037 2.43 % 68,356 947 1.39 % 52,956 1,045 1.97 %
Subordinated debentures 73,561 4,647 6.32 % 73,413 4,488 6.11 % 73,273 4,448 6.07 %
Other borrowings 44,097 1,706 3.87 % 28,014 1,093 3.90 % 15,939 680 4.27 %
Total borrowings 460,573 14,874 3.23 % 496,569 12,822 2.58 % 401,546 8,822 2.20 %
Total interest-bearing
liabilities 2,632,107 61,522 2.34 % 1,561,662 27,985 1.79 % 1,207,697 14,873 1.23 %
Non-interest bearing
deposits 2,685,502 - - % 2,455,360 - 0.00 % 2,286,358 - - %
Total deposits and
interest-bearing
liabilities 5,317,609 $ 61,522 1.16 % 4,017,022 $ 27,985 0.70 % 3,494,055 $ 14,873 0.43 %
Other non-interest
bearing liabilities 132,901 100,880 87,084
Total liabilities 5,450,510 4,117,902 3,581,139
Shareholders' equity 801,677 494,270 401,162
Total liabilities and
stockholders' equity $ 6,252,187 $ 4,612,172 $ 3,982,301
Net interest income and
net interest rate
spread including
non-interest bearing
deposits $ 264,207 5.00 % $ 130,549 3.38 % $ 93,230 3.04 %
Net interest margin 4.91 % 3.14 % 2.58 %
Tax equivalent effect 0.11 % 0.27 % 0.47 %
Net interest margin,
tax equivalent (2) 5.02 % 3.41 % 3.05 %
(1) The tax rates used to arrive at the TEY for the fiscal years ended September
30, 2019 , 2018, and 2017 were 21%, 24.53%, and 35%, respectively.
(2) Net interest margin expressed on a fully taxable equivalent basis ("net
interest margin, tax equivalent") is a non-GAAP financial measure. The
tax-equivalent adjustment to net interest income recognizes the estimated income
tax savings when comparing taxable and tax-exempt assets and adjusting for
federal and state exemption of interest income. Management of the Company
believes that it is a standard practice in the banking industry to present net
interest margin expressed on a fully taxable equivalent basis, and accordingly
believe the presentation of this non-GAAP financial measure may be useful for
peer comparison purposes.
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Rate / Volume Analysis
The following table presents, for the periods presented, the dollar amount of
changes in interest income and interest expense for major components of
interest-earning assets and interest-bearing liabilities. The table
distinguishes between the change related to higher outstanding balances and the
change due to the levels and volatility of interest rates. For each category of
interest-earning assets and interest-bearing liabilities, information is
provided on changes attributable to (i) changes in volume (i.e., changes in
volume multiplied by old rate) and (ii) changes in rate (i.e., changes in rate
multiplied by old volume). For purposes of this table, changes attributable to
both rate and volume that cannot be segregated have been allocated
proportionately to the change due to volume and the change due to rate.
Fiscal Year Ended
September 30, 2019 vs. 2018 2018 vs. 2017 (1)
Increase / Increase / Total Increase / Increase / Total
(Decrease) (Decrease) Increase / (Decrease) (Decrease) Increase /
(Dollars in Thousands) Due to Volume Due to Rate (Decrease) Due to Volume Due to Rate (Decrease)
Interest-earning assets
Cash & fed funds sold $ 1,107 $ 138 $ 1,245 $ (773 ) $ 1,640 $ 867
Mortgage-backed
securities (6,265 ) 2,176 (4,089 ) (3,042 ) 1,950 (1,092 )
Tax exempt investment
securities (11,647 ) (2,014 ) (13,661 ) 4,778 (2,306 ) 2,472
Asset-backed securities 4,717 215 4,932 1,594 1,179 2,773
Other investment
securities 2,663 51 2,714 (1,148 ) 200 (948 )
Total investments (11,176 ) 1,073 (10,103 ) 1,341 1,864 3,205
Total commercial finance 120,394 12,822 133,216 17,243 9,283 26,526
Total consumer finance 10,287 4,591 14,878 8,034 349 8,383
Total tax services (15 ) 7,389 7,374 29 779 808
Total warehouse finance 10,923 24 10,947 879 - 879
National Lending loans
and leases 135,737 30,678 166,415 27,361 9,235 36,596
Community Banking Loans 7,871 1,767 9,638 8,358 1,404 9,762
Total loans and leases 119,831 56,222 176,053 32,590 13,768 46,358
Total interest-earning
assets $ 109,762 $ 57,433 $ 167,195 $ 33,158 $ 17,272 $ 50,430
Interest-bearing
liabilities
Interest-bearing
checking $ 118 $ 28 $ 146 $ 136 $ (97 ) $ 39
Savings (2 ) 3 1 1 5 6
Money markets 39 258 297 4 32 36
Time deposits 277 749 1,026 265 708 973
Wholesale deposits 23,599 6,417 30,016 1,966 6,092 8,058
Total Interest-bearing
deposits 21,132 10,352 31,484 2,400 6,712 9,112
Overnight fed funds
purchased (545 ) 1,735 1,190 825 2,820 3,645
FHLB advances (444 ) 534 90 258 (356 ) (98 )
Subordinated debentures 9 151 160 8 31 39
Other borrowings 622 (9 ) 613 476 (63 ) 413
Total borrowings (982 ) 3,034 2,052 2,307 1,693 4,000
Total interest-bearing
liabilities $ 20,150 $ 13,386 $ 33,536 $ 4,707 $ 8,405 $ 13,112
Net effect on net
interest income $ 89,612 $ 44,047 $ 133,659 $ 28,451 $ 8,867 $ 37,318
(1)Due to the change in categorization of the Average Balances, Interest Rates
and Yields table, the rate/volume calculation results have been conformed to be
consistent with the updated categorization for all periods presented.
Comparison of Operating Results for the Fiscal Years Ended
General
The Company recorded net income of$97.0 million , or$2.49 per diluted share, for the fiscal year endedSeptember 30, 2019 , compared to$51.6 million , or$1.67 per diluted share, for the fiscal year endedSeptember 30, 2018 , an increase of$45.4 million . Total revenue for fiscal 2019 was$486.8 million , compared to$315.1 million for fiscal 2018, an increase of 54%. The increase in net income and revenue was primarily due to the improvement in net interest income, attributable to the loans and leases acquired through the Crestmark Acquisition in the fourth quarter of fiscal 2018, along with an enhanced interest-earning asset mix. 64
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Net Interest Income Net interest income for fiscal 2019 increased by$133.7 million , or 102%, to$264.2 million from$130.5 million for the same period of the prior year. The increase in net interest income was primarily due to an increase in interest income of 105% to$325.7 million for fiscal 2019, from$158.5 million for the same period of the prior year. The increase in interest income was primarily due to growth in loan and lease balances, particularly in the commercial, consumer and warehouse finance portfolios. The average balance of loans and leases as a percentage of interest-earning assets for the fiscal year endedSeptember 30, 2019 increased to 66%, from 44% for the fiscal year endedSeptember 30, 2018 , while the average balance of total investments as a percentage of interest-earnings assets decreased to 32%, from 54% over that same period. NIM was 4.91% for fiscal 2019, an increase of 177 basis points from 3.14% in fiscal 2018. NIM,TE was 5.02% in fiscal 2019, an increase of 161 basis points from 3.41% in fiscal 2018. The increases in NIM and NIM, TE in fiscal 2019, compared to the same period of the prior year, were primarily attributable to higher net loan and lease yields attained through the Crestmark division. The overall reported tax equivalent yield ("TEY") on average interest-earning assets increased by 208 basis points to 6.16% when comparing fiscal 2019 to fiscal 2018. The improvement was driven primarily by the Company's improved earning asset mix, which reflects increased balances in the National Lending portfolio. The yield on the national lending portfolio increased by 279 basis points while the yield on the community banking loan portfolio increased by 17 basis points. The fiscal 2019 TEY on the securities portfolio increased by three basis points to 3.11% as compared to the same period of the prior year. The Company's average interest earning assets for fiscal 2019 increased$1.22 billion , or 29%, to$5.38 billion , from$4.16 billion during 2018. The increase was primarily attributable to growth in the Company's average loan and lease portfolio of$1.71 billion , of which$1.54 billion was related to an increase in National Lending loans and leases and$171.3 million was related to Community Banking loans. This increase was partially offset by a decrease in total investment securities of$532.9 million , which decreased as the Company continued to utilize sales of securities and cash flow from its amortizing securities portfolio to fund loan growth. The Company's average balance of total deposits and interest-bearing liabilities increased$1.30 billion , or 32%, to$5.32 billion during fiscal 2019, from$4.02 billion during 2018. This increase was primarily due to increases in average wholesale deposits of$1.03 billion and average noninterest-bearing deposits of$230.1 million , partially offset by a decrease in the average balance of total borrowings of$36.0 million . Overall, the Company's cost of funds for all deposits and borrowings averaged 1.16% during fiscal 2019, compared to 0.70% during fiscal 2018. This increase was primarily due to the interest-bearing time deposits acquired by the Company in connection with the Crestmark Acquisition in the fourth quarter of fiscal 2018. The Company's overall cost of deposits was 0.96% during fiscal 2019, compared to 0.43% during fiscal 2018. Notwithstanding this increase, the Company believes that its growing, lower-cost deposit base gives it a distinct and significant competitive advantage, and even more so if interest rates rise, because the Company anticipates that its cost of funds will likely remain relatively low, increasing less than at many other banks. Provision for Loan and Lease Losses In fiscal 2019, the Company recorded$55.7 million in provision for loan and lease losses, compared to$29.4 million in fiscal 2018. The increase in provision expense was primarily driven by loan and lease growth and increased net charge-offs within the commercial finance portfolio. During fiscal year 2019, the Company had net charge-offs of$24.9 million within its tax services portfolio, all of which were fully reserved for. Also see Note 4 to the Condensed Consolidated Financial Statements included in this Annual Report on Form 10-K. Noninterest Income Noninterest income increased by$38.0 million , or 21%, to$222.5 million for fiscal 2019 from$184.5 million for fiscal 2018, primarily attributable to a full year of business conducted by the Crestmark division following the Crestmark Acquisition inAugust 2018 . This increase was largely due to increases in rental income of$33.7 million , gain on sale of investments of$8.9 million , gain on sale of loans and leases of$4.9 million , deposits fees of$4.6 million , and other income of$4.5 million . The increase in noninterest income was partially offset by decreases in card fee income of$14.5 million and total tax product fee income of$3.7 million . The increase in rental income, gain on sale of loans, and other income was largely attributable to the Crestmark Acquisition. The increase in deposit fee income was primarily related to the growth and transition of certain product fee income from card fees to deposit fees, attributable to the Company's Payments division. 65
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Noninterest Expense. Noninterest expense increased by$104.9 million , or 46%, to$333.2 million for fiscal 2019 from$228.2 million for fiscal 2018, primarily due to a full year of expenses attributable to the Crestmark division. This increase in noninterest expense was largely driven by an increase in compensation expense of$46.8 million and operating depreciation expense of$20.8 million when compared to the prior year. Also contributing to the increase when comparing fiscal 2019 to 2018, were increases in other expense of$14.4 million , impairment expense of$9.6 million , occupancy and equipment expense of$8.3 million and intangible amortization expense of$8.1 million . The increase in compensation and benefits was primarily due to the addition of Crestmark division employees and new hires in the second half of fiscal 2018 in support of Meta's National Lending and other business initiatives. The increase in operating depreciation expense was attributable to the Crestmark division. The impairment expense included$9.5 million related to the DC Solar relationship. Income Tax Expense The Company recorded an income tax benefit of$3.4 million for fiscal 2019, resulting in an effective tax rate of (3.4)%, compared to an income tax expense of$5.1 million and an effective tax rate of 9.0%, in fiscal 2018. Despite the increase in earnings, the Company recorded less income tax expense than the prior year due to multiple factors. Fiscal year 2018 included a$4.6 million income tax benefit recognized by the Company as a result of amending a historical tax return ofCrestmark Bancorp, Inc. The Company also recognized an investment tax credit in fiscal 2019, which reduced the Company's income tax expense by$27.1 million compared to$4.0 million in fiscal 2018, reflecting the generation of investment tax credits under the Company's initiatives in the renewable energy sector. Another factor that contributed to the reduction in both the income tax expense and effective tax rate were the provisions of the Tax Cuts and Jobs Act (the "Tax Act"), which lowered Meta's statutory rate from 24.53% in fiscal 2018 to 21% in fiscal 2019.
Comparison of Operating Results for the Fiscal Years Ended
General
The Company recorded net income of$51.6 million , or$1.67 per diluted share, for the fiscal year endedSeptember 30, 2018 , compared to$44.9 million , or$1.61 per diluted share, for the fiscal year endedSeptember 30, 2017 , an increase of$6.7 million . The increase in net income was primarily caused by an increase in net interest income of$37.3 million , a reduction of$10.2 million in intangible impairment expense, and increases in rental income of$7.3 million , tax advance fee income of$3.8 million , deposit fees of$3.7 million , and refund advance fee income of$2.9 million . The net income increase was offset in part by an increase in compensation and benefits expense of$20.3 million , loss on sale of securities of$7.7 million , legal and consulting expense of$6.7 million , other expense of$4.9 million , and occupancy and equipment expense of$3.3 million . Net Interest Income Net interest income for fiscal 2018 increased by$37.3 million , or 40%, to$130.5 million from$93.2 million for the prior year. NIM increased to 3.41% in fiscal 2018 as compared to 3.05% in fiscal 2017. The increase in net interest income was primarily due to an increase in interest income of$50.4 million to$158.5 million from$108.1 million for the prior year. The increase in interest income was primarily due to an increase in the Company's average earning assets of 15% to$4.16 billion during fiscal 2018 from$3.62 billion during 2017. This increase in average earning assets was primarily driven by a combination of strong loan growth in the Company's existing portfolios and the acquired loans and leases from the Crestmark Acquisition. Interest income on investment securities was also a contributing factor. The increase in interest income was partially offset by an increase in interest expense of$13.1 million , to$28.0 million for fiscal 2018 from$14.9 million for the prior year. The Company's average balance of total deposits and interest-bearing liabilities increased$523.0 million , or 15%, to$4.02 billion during fiscal 2018 from$3.49 billion during 2017.The increase was driven by a combination of both wholesale deposits and short-term borrowings in order to fund the Company's loan growth and acquired loan and lease portfolios. The average outstanding balance of non-interest-bearing deposits increased from$2.29 billion in fiscal 2017 to$2.46 billion in fiscal 2018. The Company's cost of total deposits and interest-bearing liabilities increased 27 basis points to 0.70% during fiscal 2018 from 0.43% during 2017. This increase was primarily due to a rise in short-term interest rates as well as higher average overall funding balances when compared to the prior year. Provision for Loan Losses In fiscal 2018, the Company recorded$29.4 million in provision for loan losses, compared to$10.6 million in fiscal 2017. The increase in provision expense was driven by a combination of higher seasonal tax services loans held on the balance sheet, growth in the existing community bank and insurance premium finance loan portfolios, provision related to the Company's student loan portfolio and provision related to the acquired Crestmark loans and leases. 66
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Non-Interest Income Non-interest income increased by$12.4 million , or 7%, to$184.5 million for fiscal 2018 from$172.2 million for fiscal 2017. This increase was primarily due to rental income, tax advance fee income, deposit fee income and refund transfer fee income, which increased$7.3 million ,$3.8 million ,$3.7 million and$2.9 million , respectively. Partially offsetting the above mentioned increases was a loss on sale of securities of$7.7 million due in large part to the Company's balance sheet restructuring related to the Crestmark Acquisition. Non-Interest Expense Non-interest expense increased by$28.6 million , or 14%, to$228.2 million for fiscal 2018 from$199.7 million for fiscal 2017. This increase in non-interest expense was largely driven by an increase in compensation expense of$20.3 million when compared to the prior year. Also contributing to the increase were legal and consulting, other expense, occupancy and equipment expense and card processing expense, which increased$6.7 million ,$4.9 million ,$3.3 million and$2.2 million , respectively, from fiscal 2017 to fiscal 2018. The increase in compensation and benefits was due in part to employees joining the Company as part of the Crestmark Acquisition along with increased staffing to support the Company's other growing business line initiatives. The Company also incurred certain costs associated with the Crestmark Acquisition throughout the fiscal year that drove the increases in legal and consulting and other expense. The increase in occupancy and equipment expense was also largely attributable to the Crestmark Acquisition. Income Tax Expense Income tax expense for fiscal 2018 was$5.1 million , resulting in an effective tax rate of 9.0%, compared to a tax expense of$10.2 million and an effective tax rate of 18.6%, in fiscal 2017. Despite the increase in earnings, the Company recorded less income tax expense than the prior year due to multiple factors. One factor that contributed to the reduction in both the income tax expense and effective tax rate were the provisions of the Tax Act, which lowered Meta's statutory rate from 35% in fiscal 2017 to 24.53% in fiscal 2018. The Company also recognized an investment tax credit in fiscal 2018, which reduced the Company's income tax expense by$4.0 million from fiscal 2017, reflecting the generation of investment tax credits under the Company's initiatives in the renewable energy sector. In addition, fiscal 2018 included a$4.6 million benefit recognized by the Company as a result of amending a historical tax return of Crestmark.
Asset Quality
AtSeptember 30, 2019 , non-performing assets, consisting of impaired/non-accruing loans and leases, accruing loans and leases delinquent 90 days or more, foreclosed real estate, repossessed property, and non-performing operating leases, totaled$56.5 million , or 0.91% of total assets, compared to$41.8 million , or 0.72% of total assets, atSeptember 30, 2018 . The increase in NPAs was primarily attributable to the growth of the commercial finance portfolio. The Company does not anticipate these nonperforming loans and leases to materialize into a significant increase in losses, as many are well-collateralized. As ofSeptember 30, 2019 , the Company had non-accruing loans and leases totaling$14.4 million and foreclosed and repossessed assets of approximately$29.5 million , or 0.48% of total assets. The outstanding foreclosed and repossessed asset balance was primarily related to a previously disclosed agricultural relationship. The Company maintains an allowance for loan and lease losses because it is probable that some loans and leases may not be repaid in full. AtSeptember 30, 2019 , the Company had an allowance for loan and lease losses of$29.1 million as compared to$13.0 million atSeptember 30, 2018 . The increase was driven by a$13.3 million increase in the commercial finance portfolio and a$2.6 million increase in the consumer finance portfolio. During fiscal year 2019, the Company had net charge-offs of$39.5 million , of which$24.9 million were related to the tax services portfolio. The charge-offs within the tax services portfolio were fully reserved for. Allowance for loan and lease losses as a percentage of the total loan and lease portfolio was 0.80% atSeptember 30, 2019 , compared to 0.44% atSeptember 30, 2018 . A primary driver of this change was the run-off and amortization of the acquired loans and leases from the Crestmark Acquisition, and the corresponding credit mark, and their replacement with newly-originated loans. Management's periodic review of the allowance for loan and lease losses is based on various subjective and objective factors, including the Company's past loss experience, known and inherent risks in the portfolio, adverse situations that may affect the borrower's ability to repay, the estimated value of any underlying collateral and current economic conditions. While management may allocate portions of the allowance for specifically identified problem loan and lease situations, the majority of the allowance is based on both subjective and objective factors related to the overall loan and lease portfolio and is available for any loan and lease charge-offs that may occur. As stated previously, there can be no assurance future losses will not exceed estimated amounts, or that additional provisions for loan and lease losses will not be required in future periods. In addition, the Bank is subject to review by the OCC, which has the authority to require management to make changes to the allowance for loan and lease losses, and the Company is subject to similar review by theFederal Reserve . 67
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In determining the allowance for loan and lease losses, the Company specifically identifies loans and leases it considers as having potential collectability problems. Based on criteria established by ASC 310, Receivables, some of these loans and leases are considered to be "impaired" while others are not considered to be impaired, but possess weaknesses that the Company believes merit additional analysis in establishing the allowance for loan and lease losses. All other loans and leases are evaluated by applying estimated loss ratios to various pools of loans and leases. The Company then analyzes other applicable qualitative factors (such as economic conditions) in determining the aggregate amount of the allowance needed. AtSeptember 30, 2019 ,$1.9 million of the allowance for loan and lease losses was allocated to impaired loans and leases. See Note 4 of the "Notes to Consolidated Financial Statements," which is included in Part II, Item 8 "Financial Statements and Supplementary Data" of this Annual Report on Form 10-K.$2.6 million of the total allowance was allocated to other identified problem loans and loan relationships, representing 1.8% of the related loan and lease balances, and$24.6 million of the total allowance, representing 0.7% of the related loan and lease balances, was allocated to the remaining overall loan and lease portfolio based on historical loss experience and qualitative factors. AtSeptember 30, 2018 , none of the allowance for loan and lease losses was allocated to impaired loans and leases.$0.8 million of the total allowance was allocated to other identified problem loan and lease situations or 0.7% of related loan and lease balances, and$12.2 million of the total allowance, representing 0.4%, was allocated against losses from the overall loan and leases portfolio based on historical loss experience and qualitative factors. The Company maintains an internal loan and lease review and classification process which involves multiple officers of the Company and is designed to assess the general quality of credit underwriting and to promote early identification of potential problem loans and leases. All loan officers are charged with the responsibility of risk rating all loans and leases in their portfolios and updating the ratings, positively or negatively, on an ongoing basis as conditions warrant. The level of potential problem loans and leases is another predominant factor in determining the relative level of risk in the loan and lease portfolio and in determining the appropriate level of the allowance for loan and lease losses. Potential problem loans and leases are generally defined by management to include loans and leases rated as substandard by management that are not considered impaired (i.e., non-accrual loans and leases and accruing troubled debt restructurings), but there are circumstances that create doubt as to the ability of the borrower to comply with repayment terms. The decision of management to include performing loans and leases in potential problem loans and leases does not necessarily mean that the Company expects losses to occur, but that management recognizes a higher degree of risk associated with these loans and leases. The loans and leases that have been reported as potential problem loans and leases are predominantly commercial loans and leases covering a diverse range of businesses and real estate property types. AtSeptember 30, 2019 , potential problem loans and leases totaled$41.2 million compared to$24.6 million atSeptember 30, 2018 .
Liquidity and Capital Resources
The Company's primary sources of funds are deposits, derived principally through its Payments division, and to a lesser extent through itsCommunity Bank division, borrowings, principal and interest payments on loans and leases and MBS, and maturing investment securities. In addition, the Company utilizes wholesale deposit sources to provide temporary funding when necessary or when favorable terms are available. While scheduled loan repayments and maturing investments are relatively predictable, deposit flows and early loan repayments are influenced by the level of interest rates, general economic conditions and competition. The Company uses its capital resources principally to meet ongoing commitments to fund maturing certificates of deposits and loan commitments, to maintain liquidity, and to meet operating expenses. The Company relies on advertising, quality customer service, convenient locations and competitive pricing to attract and retain its community bank deposits and primarily solicits these deposits from its core market areas. Based on its experience, the Company believes that its consumer checking, savings and money market accounts are relatively stable sources of deposits. The Company's ability to attract and retain time deposits has been, and will continue to be, affected by market conditions. However, the Company does not foresee any significant community bank funding issues resulting from the sensitivity of time deposits to such market factors. The low-cost checking deposits generated through the Company's Payments division may carry a greater degree of concentration risk than traditional consumer checking deposits but, based on experience, the Company believes that Paymentsgenerated deposits are a stable source of funding. To date, the Company has not experienced any material net outflows related to Payments-generated deposits, though no assurance can be given that this will continue to be the case. 68
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The Bank is required by regulation to maintain sufficient liquidity to assure its safe and sound operation. In the opinion of management, the Bank is in compliance with this requirement.
Liquidity management is both a daily and long-term function of the Company's management strategy. The Company adjusts its investments in liquid assets based upon management's assessment of (i) expected loan demand, (ii) the projected availability of purchased loan products, (iii) expected deposit flows, (iv) yields available on interest-bearing deposits and (v) the objectives of its asset/liability management program. Excess liquidity is generally invested in interest-earning overnight deposits and other short-term government agency or instrumentality obligations. If the Company requires funds beyond its ability to generate them internally, it has additional borrowing capacity with the FHLB and other wholesale funding sources. The Company is not aware of any facts that would be reasonably likely to have a material adverse impact on the Company's liquidity or its ability to borrow additional funds. The primary investing activities of the Company are the origination of loans and leases, the acquisitions of companies and the purchase of securities. During the fiscal years endedSeptember 30, 2019 , 2018 and 2017, the Company originated loans and leases totaling$10.97 billion ,$4.39 billion and$2.60 billion , respectively. Purchases of loans and leases totaled$278.1 million ,$165.7 million , and$141.4 million during the fiscal years endedSeptember 30, 2019 , 2018 and 2017. During the fiscal years endedSeptember 30, 2019 , 2018 and 2017, the Company purchased MBS and other securities in the amount of$297.8 million ,$653.2 million and$849.5 million , respectively. Of these purchases, there were no securities designated as held to maturity in fiscal 2019 and fiscal 2018 and$0.9 million designated as held to maturity in fiscal 2017. AtSeptember 30, 2019 , the Company had unfunded loan and lease commitments of$978.1 million . See Note 16 to the "Notes to Consolidated Financial Statements," which is included in Part II, Item 8 "Financial Statements and Supplementary Data" of this Annual Report on Form 10-K. Certificates of deposit scheduled to mature in one year or less atSeptember 30, 2019 totaled$1.29 billion , of which$1.21 billion were wholesale time deposits and$80.9 million were non-wholesale time deposits. Management believes that loan repayment and other sources of funds will be adequate to meet the Company's foreseeable short- and long-term liquidity needs.
The following table summarizes the Company's significant contractual obligations
at
Less than 1 More than 5
Contractual Obligations Total year 1 to 3 years 3 to 5 years years
(Dollars in thousands)
Time deposits $ 109,275 $ 80,915 $ 26,807 $ 1,553 $ -
Wholesale time deposits 1,307,215 1,208,153 98,963 99 -
Long-term borrowings 215,838 7,301 117,429 2,408 88,700
Short-term borrowings 646,019 646,019 - - -
Operating leases 34,082 3,709 6,384 5,018 18,971
Total $ 2,312,429 $ 1,946,097 $ 249,583 $ 9,078 $ 107,671
During July 2001 , the Company's unconsolidated trust subsidiary, First Midwest
Financial Capital Trust I, sold $10.3 million in floating-rate cumulative
preferred securities. Proceeds from the sale were used to purchase trust
preferred securities of the Company, which mature in 2031, and are redeemable at
any time after five years. The capital securities are required to be redeemed on
July 25, 2031 ; however, the Company has the option to redeem them earlier. The
Company used the proceeds for general corporate purposes.
In 2016, the Company completed a public offering of
Through the Crestmark Acquisition, consummated in the fourth quarter of fiscal 2018, the Company acquired$3.4 million in floating rate capital securities due to Crestmark Capital Trust I, a 100%-owned nonconsolidated subsidiary of the company. The subordinated debentures bear interest at LIBOR plus 3.00%, have a stated maturity of 30 years and are redeemable by the Company at par, with regulatory approval. See Note 8 to the "Notes to Consolidated Financial Statements," which is included in Part II, Item 8 "Financial Statements and Supplementary Data" of this Annual Report on Form 10-K. 69
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The Company and the Bank met regulatory requirements for classification as well-capitalized institutions atSeptember 30, 2019 . Based on current and expected continued profitability and subject to continued access to capital markets, management believes that the Company and the Bank will continue to meet the capital conservation buffer of 2.5% in addition to required minimum capital ratios. See Note 15 to the "Notes to Consolidated Financial Statements," which is included in Part II, Item 8 "Financial Statements and Supplementary Data" of this Annual Report on Form 10-K. The payment of dividends and repurchase of shares have the effect of reducing stockholders' equity. Prior to authorizing such transactions, the Board of Directors considers the effect the dividend or repurchase of shares would have on liquidity and regulatory capital ratios. The Board of Directors approved a minimum management target, reflected in its capital plan, for the Bank to stay at or above an 8% Tier 1 capital to adjusted total assets ratio during fiscal 2018. Management and the Board of Directors are also mindful of new capital rules that will increase bank and holding company capital requirements and liquidity requirements. No assurance can be given that our regulators will consider our liquidity level, or our capital level, though substantially in excess of current rules pursuant to which the Company and the Bank are considered "well-capitalized," to be sufficiently high in the future.
Off-Balance Sheet Financing Arrangements
For discussion of the Company's off-balance sheet financing arrangements, see Note 16 of "Notes to Consolidated Financial Statements," which is included in Part II, Item 8 "Financial Statements and Supplementary Data" of this Annual Report on Form 10-K. Depending on the extent to which the commitments or contingencies described in Note 16 occur, the effect on the Company's capital and net income could be significant.
Impact of Inflation and Changing Prices
The Consolidated Financial Statements and Notes thereto presented in this Annual Report have been prepared in accordance with GAAP, which require the measurement of financial position and operating results in terms of historical dollars without considering the change in the relative purchasing power of money over time due to inflation. The primary impact of inflation is reflected in the increased cost of the Company's operations. Unlike most industrial companies, virtually all the assets and liabilities of the Company are monetary in nature. As a result, interest rates generally have a more significant impact on a financial institution's performance than do the effects of general levels of inflation. Interest rates do not necessarily move in the same direction, or to the same extent, as the prices of goods and services. There have not been any material effects on Meta's business due to inflation during any of the last three fiscal years.
Impact of New Accounting Standards
See Note 1 to the Consolidated Financial Statements for information regarding recently issued accounting pronouncements.
Critical Accounting Policies
The Company's financial statements are prepared in accordance with GAAP. The
financial information contained within these financial statements is, to a
significant extent, based on approximate measures of the financial effects of
transactions and events that have already occurred. Management has identified
the policies described below as Critical Accounting Policies. These policies
involve complex and subjective decisions and assessments. Some of these
estimates may be uncertain at the time they are made, could change from period
to period, and could have a material impact on the financial statements.
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Allowance for Loan and Lease LossesThe Company's allowance for loan and lease losses methodology incorporates a variety of risk considerations, both quantitative and qualitative, in establishing an allowance for loan and lease losses that management believes is appropriate at each reporting date. Quantitative factors include the Company's historical loss experience, delinquency and charge-off trends, collateral values, changes in non-performing loans and leases and other factors. Quantitative factors also incorporate known information about individual loans and leases, including borrowers' sensitivity to interest rate movements. Qualitative factors include the general economic environment in the Company's markets, including economic conditions throughout the Midwest and, in particular, the state of certain industries. Size and complexity of individual credits in relation to loan and lease structure, existing loan and lease policies and pace of portfolio growth are other qualitative factors that are considered in the methodology. Although management believes the levels of the allowance as of bothSeptember 30, 2019 andSeptember 30, 2018 were adequate to absorb probable incurred losses inherent in the loan and lease portfolio, a decline in local economic conditions or other factors could result in increasing losses.Goodwill and Identifiable Intangible Assets The Company accounts for business combinations under the acquisition method of accounting in accordance with ASC 805, Business Combinations. Under the acquisition method, the Company records assets acquired, including identifiable intangible assets, liabilities assumed, and any non-controlling interest in the acquired business at their fair values as of the acquisition date. Any acquisition-related transaction costs are expensed in the period incurred. Results of operations of the acquired entity are included in the Consolidated Statements of Operations from the date of acquisition. Any measurement-period adjustments are recorded in the period the adjustment is identified. The excess of consideration paid over the fair value of the net assets acquired is recorded as goodwill. Determining the fair value of assets acquired, including identifiable intangible assets, liabilities assumed, and any non-controlling interest often requires the use of significant estimates and assumptions. This may involve estimates based on third-party valuations, such as appraisals, or internal valuations based on discounted cash flow analyses or other valuation techniques such as estimates of attrition, inflation, asset growth rates, discount rates, multiples of earnings or other relevant factors. In addition, the determination of the useful lives over which an intangible asset will be amortized is subjective. See Note 8Goodwill and Intangibles to the Consolidated Financial Statements for further information.
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