PATHWARD FINANCIAL, INC. 10-K

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations. This section should be read in conjunction with the following parts of this Form 10-K: Part I, Item 1 “Business,” Part II, Item 7A, “Quantitative and Qualitative Disclosures About Market Risk,” and Part II, Item 8 “Financial Statements and Supplementary Data.” GENERAL The Company, a registered bank holding company, is a Delaware corporation, the principal assets of which are all the issued and outstanding shares of the Bank, a national bank. Unless the context otherwise requires, references herein to the Company include Pathward Financial and the Bank, and all direct or indirect subsidiaries of Pathward Financial on a consolidated basis. EXECUTIVE SUMMARY Business Highlights • On October 27, 2022, the Company announced that Sonja Theisen, currently Executive Vice President of Governance, Risk and Compliance, has been appointed to succeed Glen Herrick as the Chief Financial Officer effective April 30, 2023. Ms.Theisen, who joined Pathward in 2013, has held leaderships roles across the organization including Chief Accounting Officer, Chief of Staff, and EVP of Governance, Risk and Compliance. Additional details can be found in the related press release available at www.pathwardfinancial.com. • On October 4, 2022, the Company announced the unveiling of its new corporate brand, marked by the transition to its new name, Pathward™, N.A. ("Pathward" or the "Bank"), and the launch of the Company's new website, Pathward.com. As part of the corporate rebrand, the Company recognized $6.9 million of pre-tax expenses related to rebranding efforts during the fourth quarter of fiscal 2022. The Company continues to estimate total rebranding expenses will range between $15 million to $20 million. • As part of its strategy to continue to optimize interest-earning assets, the Company sold the entirety of its student loan portfolio during the fourth quarter of fiscal 2022. The sale generated an unfavorable pre-tax impact of approximately $0.5 million after netting the $4.3 million reversal of provision from the portfolio's allowance and the loss on sale of $4.8 million. The balance of the portfolio at time of sale was $81.5 million. • On September 26, 2022, the Company announced the completion of a private placement of $20 million of its 6.625% Fixed-to-Floating Rate Subordinated Notes due 2032 to certain qualified institutional buyers and accredited investors. The Notes are intended to qualify as Tier 2 capital for regulatory capital purposes. • The Company announced on October 10, 2022 that the American Bankers Association ("ABA") Foundation awarded it the 2022 Community Commitment Award during the ABA's Annual Convention on October 4. Pathward's Community Impact Program partners with organizations that provide resources for the unbanked and underbanked and aid to historically marginalized populations. The Community Impact Program delivers on Pathward's purpose of powering financial inclusion for all™ by lifting up the communities it serves. Financial Highlights for the 2022 Fiscal Fourth Quarter • Total revenue for the fourth quarter was $123.2 million, an increase of $3.0 million, or 3%, compared to the same quarter in fiscal 2021, primarily driven by an increase in interest income, partially offset by a decrease in noninterest income. • Net interest margin ("NIM") increased to 5.21% for the fourth quarter from 4.35% during the same period of last year. The prior year period was impacted by excess cash associated with the Company's participation in the U.S. Treasury Department's Economic Impact Program. • Total gross loans and leases at September 30, 2022 decreased $78.5 million, to $3.53 billion, or 2%, compared to September 30, 2021 and decreased $154.2 million, or 4%, when compared to June 30, 2022. The decrease compared to the prior year quarter was primarily due to the sale of all remaining community banking loans during the fiscal 2022 first quarter, the sale of the student loan portfolio during the fiscal 2022 fourth quarter, and a reduction in warehouse finance loans, partially offset by growth in the commercial finance portfolio. The primary driver for the decrease on a linked quarter basis was the sale of the student loan portfolio, a reduction in warehouse finance loans, and the seasonal decline in tax services loans. 57 Table of Contents • The Company resumed share repurchases on July 1, 2022, and during the fiscal 2022 fourth quarter repurchased 573,200 shares of common stock at an average share price of $37.05. Subsequent Events Management has evaluated and identified subsequent events that occurred after September 30, 2022. See Note 21. Subsequent Events for details on these events. FINANCIAL CONDITION At September 30, 2022, the Company’s total assets increased by $56.8 million to $6.75 billion compared to September 30, 2021. Total cash and cash equivalents was $388.0 million at September 30, 2022, increasing from $314.0 million at September 30, 2021. The Company maintains its cash investments primarily in interest-bearing overnight deposits with the FHLB of Des Moines and the FRB. At September 30, 2022, the Company did not have any federal funds sold. The total investment portfolio increased $3.0 million to $1.92 billion at September 30, 2022, compared to $1.92 billion at September 30, 2021, as purchases exceeded maturities and principal pay downs. 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, which 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. Of the total $1.35 billion MBS held by the Company at September 30, 2022, $1.10 billion were issued by a U.S. Government agency or instrumentality. During the fiscal year ended September 30, 2022, the Company purchased $907.4 million of investment securities. Loans held for sale at September 30, 2022 totaled $21.1 million, decreasing from $56.2 million at September 30, 2021. This decrease was primarily driven by a reduction in SBA/USDA loans held for sale at September 30, 2022 compared to September 30, 2021. The Company’s total loans and leases decreased $78.5 million, or 2%, to $3.53 billion at September 30, 2022, from $3.61 billion at September 30, 2021. The decrease was primarily driven due the sale of all remaining community banking loans during the fiscal 2022 first quarter, the sale of the student loan portfolio during the fiscal 2022 fourth quarter, and a reduction in warehouse finance loans, partially offset by growth in our commercial finance portfolio. 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. Commercial finance loans, which comprised 86% of the Company's gross loan and lease portfolio, totaled $3.02 billion at September 30, 2022 , reflecting growth of $298.2 million , or 11% , from September 30, 2021 . When excluding PPP loans, the community bank portfolio and the student loan portfolio, total loans and leases grew 9 % a t September 30, 2022 when compared to the same period of the prior year. Through the Bank, the Company owns stock in the FHLB due to the Bank’s membership and participation in this banking system as well as stock in the Federal Reserve Bank. The FHLB requires a level of stock investment based on a pre-determined formula. The Company’s investment in these stocks increased $0.4 million, or 1%, to $28.8 million at September 30, 2022 from $28.4 million at September 30, 2021, resulting from the purchase of FHLB membership stock. Total end-of-period deposits increased 6% to $5.87 billion at September 30, 2022, compared to $5.51 billion at September 30, 2021. The increase in end-of-period deposits was primarily driven by an increase in noninterest-bearing deposits of $628.9 million, partially offset by decreases in interest-bearing checking of $254.3 million and in wholesale deposits of $73.6 million. The Company's total borrowings decreased $56.8 million, or 61%, from $92.8 million at September 30, 2021 to $36.0 million at September 30, 2022. See Note 11 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. 58 Table of Contents At September 30, 2022, the Company’s stockholders’ equity totaled $645.1 million, a decrease of $226.7 million, from $871.9 million at September 30, 2021. The decrease was primarily attributable to a reduction in accumulated other comprehensive income and a reduction in retained earnings related to activity from the Company's share repurchase programs. The Company and Bank remained above the federal regulatory minimum capital requirements at September 30, 2022, and continued to be classified as well-capitalized, and in good standing with the regulatory agencies. 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. Noninterest-bearing Checking Deposits. The Company may hold negative balances associated with cardholder programs in the BaaS business line that are included within noninterest-bearing deposits on the Company's Consolidated Statements of Financial Condition. Negative balances can relate to any of the following payments functions: – Prefundings: The Company deploys funds to cards prior to receiving cash (typically 2-3 days) where the prefunding balance is netted at a pooled partner level utilizing ASC 210-20. – Discount fundings: The Company funds cards in alignment to expected breakage values on the card. Consumers may spend more than is estimated. These discounts are netted at a pooled partner level using ASC 210-20. The majority of these discount fundings relate to a small number of partners, and analyzed on an ongoing basis. – Demand Deposit Account ("DDA") overdrafts: Certain programs offered allow cardholders traditional DDA overdraft protection services whereby cardholders can spend a limited amount in excess of their available card balance. When overdrawn, these accounts are re-classed as loans on the balance sheet within the Consumer Finance category. The Company meets the Right of Set off criteria in ASC 210-20, Balance Sheet - Offsetting, for all payments negative deposit balances with the exception of DDA overdrafts. The following table summarizes the Company's negative deposit balances within the BaaS business line: (Dollars in thousands) September 30, 2022 September 30, 2021 Noninterest-bearing deposits $ 5,916,142 $ 5,492,646 Prefunding (244,462) (436,111) Discount funding (15,991) (26,440) DDA overdrafts (8,587) (11,862) Noninterest-bearing checking, net $ 5,647,102 $ 5,018,233 Custodial Off-Balance Sheet Deposits. The Bank utilizes a custodial deposit transference structure for certain prepaid and deposit programs whereby the Bank, acting as custodian of cardholder funds, places a portion of such cardholder funds that are not needed to support near term settlement at one or more third-party banks insured by the FDIC (each, a “Program Bank”). Accounts opened at Program Banks are established in the Bank’s name as custodian, for the benefit of the Bank’s cardholders. The Bank remains the issuer of all cards and holder of all accounts under the applicable cardholder agreements and has sole custodial control and transaction authority over the accounts opened at Program Banks. The Bank maintains the records of each cardholder’s deposits maintained at Program Banks. Program Banks undergo robust due diligence prior to becoming a Program Bank and are also subject to continuous monitoring. In return for record keeping services at Program Banks, the Bank receives a servicing fee (“Servicing Fee”). For the fiscal year ended September 30, 2022, the Company recognized $6.4 million in servicing fee income. In prior periods, the Servicing Fee was not significant. The Servicing Fee has been typically reflective of the EFFR upon a renegotiation of the contracts with Program Banks. As of September 30, 2022, the Company managed $1.31 billion of customer deposits at other banks in its capacity as custodian. These deposits provide the Company with excess deposits that can earn record keeping service fee income, typically reflective of the EFFR. Approximately 37% of the deposit balances at September 30, 2022 are subject to variable card processing expenses that are derived from the terms of contractual agreements with certain BaaS partners. These agreements are tied to a portion of a rate index, typically the EFFR. 59 Table of Contents RESULTS OF OPERATIONS The Company’s results of operations are dependent on net interest income, provision for credit losses, noninterest income, noninterest 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 BaaS business line, 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 credit losses is the adjustment to the allowance for credit losses balance for the applicable period. The allowance for credit losses represents management’s current estimate of credit losses expected to be incurred by the loan and lease portfolio over the life of each financial asset 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 BaaS business line 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 the Baas business line. 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. 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. The balances presented in the table below are calculated on a daily average basis. Tax-equivalent adjustments have been made in yields on interest-bearing assets and NIM. Nonaccruing loans and leases have been included in the table as loans or leases carrying a zero yield. 60 Table of Contents Fiscal Year Ended September 30, 2022 2021 2020 (Dollars in thousands) Average Outstanding Balance Interest Earned / Paid Yield / Rate (1) Average Outstanding Balance Interest Earned / Paid Yield / Rate (1) Average Outstanding Balance Interest Earned / Paid Yield / Rate (1) Interest-earning assets: Cash and fed funds sold $ 496,334 $ 3,535 0.71 % $ 1,919,760 $ 3,709 0.19 % $ 1,236,027 $ 2,824 0.23 % Mortgage-backed securities 1,292,804 26,846 2.08 % 728,884 12,155 1.67 % 367,869 9,028 2.45 % Tax exempt investment securities 183,936 3,565 2.45 % 281,573 4,004 1.80 % 434,262 7,477 2.18 % Asset-backed securities 283,752 3,898 1.37 % 388,458 5,340 1.37 % 319,258 7,636 2.39 % Other investment securities 268,062 6,274 2.34 % 239,283 4,566 1.91 % 198,924 4,748 2.39 % Total investments 2,028,554 40,583 2.05 % 1,638,198 26,065 1.66 % 1,320,313 28,889 2.34 % Commercial finance 2,884,585 203,004 7.04 % 2,549,335 188,855 7.41 % 2,100,464 169,189 8.05 % Consumer finance 295,356 23,097 7.82 % 248,757 19,940 8.02 % 254,293 19,808 7.79 % Tax services 179,611 12,978 7.23 % 214,835 7,321 3.41 % 148,650 6,390 4.30 % Warehouse finance 433,121 27,474 6.34 % 330,224 21,262 6.44 % 292,952 17,919 6.12 % Community banking 34,758 1,525 4.39 % 375,258 18,702 4.98 % 975,618 47,822 4.90 % Total loans and leases (3) 3,827,431 268,078 7.00 % 3,718,409 256,080 6.89 % 3,771,977 261,128 6.92 % Total interest-earning assets 6,352,319 $ 312,196 4.93 % 7,276,367 $ 285,854 3.94 % 6,328,317 $ 292,841 4.66 % Noninterest-earning assets 751,555 849,141 881,314 Total assets $ 7,103,874 $ 8,125,508 $ 7,209,631 Interest-bearing liabilities: Interest-bearing checking $ 338 $ 1 0.32 % $ 254,236 $ — — % $ 189,704 $ 259 0.14 % Savings 78,613 24 0.03 % 81,619 16 0.02 % 50,888 18 0.03 % Money markets 96,112 214 0.22 % 58,656 204 0.35 % 57,573 422 0.73 % Time deposits 8,493 38 0.45 % 13,081 139 1.06 % 61,837 1,226 1.98 % Wholesale deposits 63,529 223 0.35 % 150,213 1,234 0.82 % 1,081,935 20,691 1.91 % Total interest-bearing deposits 247,085 500 0.20 % 557,805 1,593 0.29 % 1,441,937 22,616 1.57 % Overnight fed funds purchased 32,414 235 0.73 % 6 — 0.25 % 183,438 2,804 1.53 % FHLB Advances — — — % — — — % 106,093 2,638 2.49 % Subordinated debentures 46,441 3,375 7.27 % 73,886 4,507 6.10 % 73,718 4,618 6.26 % Other borrowings 17,490 762 4.36 % 21,549 763 3.54 % 28,696 1,127 3.93 % Total borrowings 96,345 4,372 4.54 % 95,441 5,270 5.52 % 391,945 11,187 2.85 % Total interest-bearing liabilities 343,430 4,872 1.42 % 653,246 6,863 1.05 % 1,833,882 33,803 1.84 % Noninterest-bearing deposits 5,776,852 — — % 6,440,830 — — % 4,396,132 — — % Total deposits and interest-bearing liabilities 6,120,282 $ 4,872 0.08 % 7,094,115 $ 6,863 0.10 % 6,230,014 $ 33,803 0.54 % Other noninterest-bearing liabilities 202,887 189,841 143,772 Total liabilities 6,323,169 7,283,956 6,373,786 Shareholders' equity 780,705 841,552 835,845 Total liabilities and shareholders' equity $ 7,103,874 $ 8,125,508 $ 7,209,631 Net interest income and net interest rate spread including noninterest-bearing deposits $ 307,324 4.85 % $ 278,992 3.84 % $ 259,038 4.12 % Net interest margin 4.84 % 3.83 % 4.09 % Tax-equivalent effect 0.01 % 0.01 % 0.03 % Net interest margin, tax equivalent (2) 4.85 % 3.84 % 4.12 % (1) Tax rate used to arrive at the TEY for the fiscal years ended September 30, 2022, 2021, and 2020 was 21%. (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. (3) Included in the yield computation are net loan fees of $33.7 million, $35.7 million, and $24.0 million for the fiscal years ended September 30, 2022, 2021 and 2020, respectively. 61 Table of Contents 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). Due to the numerous simultaneous volume and rate changes during any period, it is not possible to precisely allocate such changes between volume and rate. For 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, 2022 vs. 2021 2021 vs. 2020 (Dollars in thousands) Increase / (Decrease) Due to Volume Increase / (Decrease) Due to Rate Total Increase / (Decrease) Increase / (Decrease) Due to Volume Increase / (Decrease) Due to Rate Total Increase / (Decrease) Interest-earning assets: Cash and fed funds sold $ (4,293) $ 4,119 $ (174) $ 1,408 $ (523) $ 885 Mortgage-backed securities 11,152 3,539 14,691 6,711 (3,584) 3,127 Tax-exempt investment securities (2,008) 1,569 (439) (2,323) (1,150) (3,473) Asset-backed securities (1,442) — (1,442) 1,423 (3,720) (2,297) Other investment securities 594 1,113 1,707 865 (1,045) (180) Total investments 7,310 7,208 14,518 6,845 (9,668) (2,823) Commercial finance 23,929 (9,779) 14,150 34,013 (14,347) 19,666 Consumer finance 3,664 (507) 3,157 (441) 573 132 Tax services (1,373) 7,030 5,657 2,440 (1,509) 931 Warehouse finance 6,546 (334) 6,212 2,362 981 3,343 Community banking (15,193) (1,984) (17,177) (29,872) 752 (29,120) Total loans and leases 7,768 4,230 11,998 (3,784) (1,264) (5,048) Total interest-earning assets $ 10,785 $ 15,557 $ 26,342 $ 4,469 $ (11,455) $ (6,986) Interest-bearing liabilities: Interest-bearing checking $ — $ — $ — $ 66 $ (324) $ (258) Savings (1) 9 8 8 (9) (1) Money markets 103 (93) 10 8 (226) (218) Time deposits (38) (63) (101) (684) (404) (1,088) Wholesale deposits (507) (504) (1,011) (11,698) (7,759) (19,457) Total interest-bearing deposits (703) (391) (1,094) (9,025) (11,997) (21,022) Overnight fed funds purchased 235 — 235 (1,527) (1,278) (2,805) FHLB Advances — — — (1,319) (1,319) (2,638) Subordinated debentures (1,887) 755 (1,132) 10 (122) (112) Other borrowings (159) 158 (1) (261) (103) (364) Total borrowings 49 (947) (898) (12,000) 6,082 (5,918) Total interest-bearing liabilities $ (654) $ (1,338) $ (1,992) $ (21,025) $ (5,915) $ (26,940) Net effect on net interest income $ 11,439 $ 16,895 $ 28,334 $ 25,494 $ (5,540) $ 19,954 Comparison of Operating Results for the Fiscal Years Ended September 30, 2022 and September 30, 2021 General The Company recorded net income of $156.4 million, or $5.26 per diluted share, for the fiscal year ended September 30, 2022, compared to $141.7 million, or $4.38 per diluted share, for the fiscal year ended September 30, 2021, an increase of $14.7 million. Total revenue for fiscal 2022 was $601.1 million, compared to $549.9 million for fiscal 2021, an increase of 9%. The increases in net income was primarily due to an increase in noninterest income and a decrease in provision for credit losses, partially offset by an increase in non-interest expense. 62 Table of Contents Net Interest Income Net interest income for fiscal 2022 increased by $28.3 million, or 10%, to $307.3 million from $279.0 million for the same period of the prior year. The increase in net interest income was mainly attributable to increased yields and an improved earning asset mix. NIM was 4.84% for fiscal 2022, an increase of 101 basis points from 3.83% in fiscal 2021. The increase in NIM in fiscal 2022, compared to the same period of the prior year was primarily attributable to the decrease in noninterest-bearing deposit balances related to government stimulus-related dollars. The overall reported tax equivalent yield ("TEY") on average interest-earning assets increased by 99 basis points to 4.93% when comparing fiscal 2022 to fiscal 2021. The growth was driven primarily by an increase in loan and lease and investment securities yields, along with a decrease in lower-yielding cash balances. The overall yield on the loan and lease portfolio increased primarily related to increased yields in the tax services portfolio. The increase in tax services yields for fiscal 2022 compared to fiscal 2021 was due to a change in mix between interest and fee income. The fiscal 2022 TEY on the securities portfolio increased by 39 basis points to 2.05% as compared to the same period of the prior year. The Company's average interest-earning assets for fiscal 2022 decreased $924.0 million, or 13%, to $6.35 billion, from $7.28 billion during fiscal 2021. The decrease was primarily attributable to a decrease in average cash balances of $1.42 billion, partially offset by increases in total average investment securities of $390.4 million, and in average loan and lease balances of $109.0 million. The increase in the Company's average loan and lease balances was driven by growth of $335.3 million and $102.9 million in commercial finance and warehouse finance loans, respectively, partially offset by the sale of the remaining community bank portfolio of $340.5 million. The Company’s average balance of total deposits and interest-bearing liabilities decreased $973.8 million, or 14%, to $6.12 billion during fiscal 2022, from $7.09 billion during fiscal 2021. This decrease was primarily due to decreases in average interest-bearing deposits of $310.7 million and noninterest-bearing deposits of $664.0 million, partially offset by an increase in the average balance of total borrowings of $0.9 million. Overall, the Company’s cost of funds for all deposits and borrowings averaged 0.08% during fiscal 2022, compared to 0.10% during fiscal 2021. The cost of deposits was 0.01% during fiscal 2022, the same as during fiscal 2021. 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 Credit Losses During fiscal 2022, the Company recorded $28.5 million in provision for credit losses, compared to $49.8 million in fiscal 2021. The decrease in provision was primarily driven by a reversal of provision for credit losses related to the community bank and student loan portfolio sales, along with a decrease in commercial finance provision expense. Also see Note 4 to the Consolidated Financial Statements included in this Annual Report on Form 10-K. Noninterest Income Noninterest income increased by $22.9 million, or 8%, to $293.8 million for fiscal 2022 from $270.9 million for fiscal 2021. The increase in noninterest income was primarily driven by gain on sale of trademarks, partially offset by loss on sale of other and a reduction in other income. Within payment card and deposit fee income, the Company recognized $6.4 million from servicing fee income on off-balance sheet deposits during the fiscal year ended September 30, 2022. The amount of servicing fee income recognized during the prior period was not significant. Noninterest Expense Noninterest expense increased by $41.6 million, or 12%, to $385.3 million for fiscal 2022 from $343.7 million for fiscal 2021. This increase in noninterest expense was primarily driven by an increase in compensation expense of $20.0 million, in card processing expense of $11.6 million, and in legal and consulting expense of $9.3 million. 63 Table of Contents The card processing expense increase was due to structured agreements with banking as a service ("BaaS") partners. The amount of expense paid under those agreements is based on an agreed upon rate index that varies depending on the deposit levels, floor rates, market conditions, and other performance conditions. Generally this rate index averages between 50% to 85% of the EFFR and reprices immediately upon a change in the EFFR. Approximately 37% of the deposit portfolio was subject to these higher card processing expenses. For the fiscal year ended September 30, 2022, card processing expenses related to these structured agreements were $9.9 million, as compared to $0.4 million for the fiscal year ended September 30, 2021. Income Tax Expense The Company recorded an income tax expense of $28.0 million for fiscal 2022, resulting in an effective tax rate of 15.2%, compared to an income tax expense of $10.7 million and an effective tax rate of 7.0%, in fiscal 2021. The increase in recorded income tax expense during the period was primarily due to a decrease in the investment tax credit. For the fiscal year ended September 30, 2022, the Company originated $62.8 million in solar leases, compared to $101.1 million for the comparable prior year period. The timing and impact of future solar tax credits are expected to vary from period to period, and the Company intends to undertake only those tax credit opportunities that meet the Company's underwriting and return criteria. Comparison of Operating Results for the Fiscal Years Ended September 30, 2021, and September 30, 2020 A comparison of the 2021 results to the 2020 results and other 2020 information not included herein can be found in the Company's Annual Report on Form 10-K: Part II, Item 7, “Management's Discussion and Analysis of Financial Condition and Results of Operations” filed November 23, 2021 and is incorporated by reference herein. Asset Quality Generally, when a loan or lease becomes delinquent 90 days or more or when the collection of principal or interest becomes doubtful, the Company will place the loan or lease on a nonaccrual status and, as a result, previously accrued interest income on the loan or lease is reversed against current income. The loan or lease will generally remain on a non-accrual status until six months of good payment history has been established or management believes the financial status of the borrower has been significantly restored. Certain relationships in the table below are over 90 days past due and still accruing. The Company considers these relationships as being in the process of collection. Insurance premium finance loans, consumer finance and tax services loans are generally not placed on nonaccrual status, but are instead written off when the collection of principal and interest become doubtful. Loans and leases, or portions thereof, are charged-off when collection of principal becomes doubtful. Generally, this is associated with a delay or shortfall in payments of greater than 210 days for insurance premium finance, 180 days for tax and other specialty lending loans, 120 days for consumer credit products and 90 days for other loans. Action is taken to charge off ERO loans if such loans have not been collected by the end of June and refund advance loans if such loans have not been collected by the end of the calendar year. Nonaccrual loans and troubled debt restructurings are generally considered impaired. The Company believes that the level of allowance for credit losses at September 30, 2022 was appropriate and reflected probable losses related to these loans and leases; however, there can be no assurance that all loans and leases will be fully collectible or that the present level of the allowance will be adequate in the future. See the section below titled “Allowance for Credit Losses” for further information. 64 Table of Contents The table below sets forth the amounts and categories of the Company's nonperforming assets. (Dollars in thousands) September 30, 2022 September 30, 2021 Nonperforming Loans and Leases Nonaccruing loans and leases: Commercial finance $ 13,375 $ 19,330 Community banking — 14,915 Total nonaccruing loans and leases 13,375 34,245 Accruing loans and leases delinquent 90 days or more: Commercial finance 4,142 12,489 Consumer finance 2,793 1,236 Tax services (1) 8,873 7,962 Total accruing loans and leases delinquent 90 days or more 15,808 21,687 Total nonperforming loans and leases 29,183 55,932 Other Assets Nonperforming operating leases 1,736 3,824 Foreclosed and repossessed assets: Commercial finance 1 2,077 Total foreclosed and repossessed assets 1 2,077 Total other assets 1,737 5,901 Total nonperforming assets $ 30,920 $ 61,833 Total as a percentage of total assets 0.46 % 0.92 % (1) Certain tax services loans do not bear interest. At September 30, 2022, nonperforming loans and leases totaled $29.2 million, representing 0.82% of total loans and leases, compared to $55.9 million, or 1.52% of total loans and leases at September 30, 2021. Classified Assets . Federal regulations provide for the classification of certain loans, leases, and other assets such as debt and equity securities considered by the Bank's primary regulator, the OCC, to be of lesser quality as “substandard,” “doubtful” or “loss,” with each such classification dependent on the facts and circumstances surrounding the assets in question. An asset is considered “substandard” if it is inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. “Substandard” assets include those characterized by the “distinct possibility” that the Bank will sustain “some loss” if the deficiencies are not corrected. Assets classified as “doubtful” have all of the weaknesses inherent in those classified “substandard,” with the added characteristic that the weaknesses present make “collection or liquidation in full,” on the basis of currently existing facts, conditions and values, “highly questionable and improbable.” Assets classified as “loss” are those considered “uncollectible” and of such minimal value that their continuance as assets without the establishment of a specific loss reserve is not warranted. General allowances represent loss allowances which have been established to recognize the inherent risk associated with lending activities, but which, unlike specific allowances, have not been allocated to particular problem assets. When assets are classified as “loss,” the Bank is required either to establish a specific allowance for losses equal to 100% of that portion of the asset so classified or to charge off such amount. The Bank’s determinations as to the classification of its assets and the amount of its valuation allowances are subject to review by its regulatory authorities, which may order the establishment of additional general or specific loss allowances. On the basis of management’s review of its loans, leases, and other assets, at September 30, 2022, the Company had classified loans and leases of $203.7 million as substandard, $4.0 million as doubtful and none as loss. At September 30, 2021, the Company classified loans and leases of $264.2 million as substandard, $12.1 million as doubtful and none as loss. 65 Table of Contents Allowance for Credit Losses . The ACL represents management’s estimate of current credit losses expected to be incurred by the loan and lease portfolio over the life of each financial asset as of the balance sheet date. The Company individually evaluates loans and leases that do not share similar risk characteristics with other financial assets, which generally means loans and leases identified as troubled debt restructurings or loans and leases on nonaccrual status. All other loans and leases are evaluated collectively for credit loss. A reserve for unfunded credit commitments such as letters of credit and binding unfunded loan commitments is recorded in other liabilities on the Consolidated Statements of Financial Condition. Individually evaluated loans and leases are a key component of the ACL. Generally, the Company measures credit loss on individually evaluated loans based on the fair value of the collateral less estimated selling costs, as the Company considers these financial assets to be collateral dependent. If an individually evaluated loan or lease is not collateral dependent, credit loss is measured at the present value of expected future cash flows discounted at the loan or lease initial effective interest rate. The Company's ACL totaled $45.9 million at September 30, 2022, a decrease compared to $68.3 million at September 30, 2021. Th e $22.3 million year-o ver-year decrease in the ACL was primarily driven by a $12.3 million decrease attributable to the disposition of the community banking portfolio, along with a $5.9 million decrease in the consumer finance portfolio and a $4.1 million decrease in the commercial finance portfolio. The following table presents the Company's ACL as a percentage of its total loans and leases. As of the Period Ended September 30, 2022 June 30, 2022 March 31, 2022 December 31, 2021 September 30, 2021 Commercial finance 1.46 % 1.56 % 1.66 % 2.04 % 1.77 % Consumer finance 0.86 % 2.44 % 3.18 % 2.70 % 2.91 % Tax services 0.05 % 54.29 % 35.76 % 1.60 % 0.02 % Warehouse finance 0.10 % 0.10 % 0.10 % 0.10 % 0.10 % Community banking — % — % — % — % 6.16 % Total loans and leases 1.30 % 2.04 % 2.38 % 1.84 % 1.89 % Total loans and leases excluding tax services 1.30 % 1.44 % 1.59 % 1.84 % 1.89 % The Company's ACL as a percentage of total loans and leases decreased to 1.30% at September 30, 2022 from 2.04% at June 30, 2022. The decrease in the total loans and leases coverage ratio was primarily driven by the seasonal tax services loan portfolio, along with a decrease in the coverage ratio for both the commercial and consumer finance portfolios. The decrease in the consumer finance portfolio coverage ratio was attributable to the sale of the student loan portfolio. The Company expects to continue to diligently monitor the ACL and adjust as necessary in future periods to maintain an appropriate and supportable level. CRITICAL ACCOUNTING POLICIES AND ESTIMATES 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 its critical accounting policies, which are those policies described below as Critical Accounting Estimates that, in management's view are most important in the portrayal of our financial condition and results of operations. 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. 66 Table of Contents Allowance for Credit Losses The Company’s allowance for credit losses methodology estimates expected credit losses over the life of each financial asset as of the balance sheet date. For the loan and lease portfolio, the Company measures credit loss on individually evaluated loans based on the fair value of the collateral less estimated selling costs if collateral dependent or based on the present value of expected future cash flows discounted at the loan or lease initial effective interest rate if not collateral dependent. The majority of the Company's loans and leases subject to individual evaluation are considered collateral dependent. Only loans and leases that are on nonaccrual status or are designated as a TDR are subject to individual evaluation. Management has also identified certain structured finance credits for alternative energy projects in which a substantial cash collateral account has been established to mitigate credit risk. Due to the nature of the transactions and significant cash collateral positions, these credits are evaluated individually. All other loans and leases are evaluated collectively for credit loss by pooling loans and leases based on similar risk characteristics. The collective evaluation of expected losses in all commercial finance portfolios is based on a cohort loss rate and adjustments for forward-looking information, including industry and macroeconomic forecasts. The cohort loss rate is a life of loan loss rate that immediately reverts to historical loss information for the remaining maturity of the financial asset. Management has elected to use a twelve-month reasonable and supportable forecast for forward-looking information. Factors utilized in the determination of the allowance include historical loss experience, current and forecasted economic conditions, and measurement date credit characteristics such as product type, delinquency, and industry. The unfunded credit commitments depend on these same factors, as well as estimates of lines of credit usage. The collective evaluation of expected credit losses for certain consumer lending portfolios utilize different methodologies when estimating expected credit losses. The Company’s student loan portfolio utilizes a roll-rate historical loss rate and adjustments for forward-looking information, including macroeconomic conditions. Management has elected to use a twelve-month reasonable and supportable forecast with an immediate reversion to historical loss rates. Factors utilized in the determination of the allowance include historical loss experience, current and forecasted economic conditions, and measurement date credit characteristics including delinquency. Investment debt securities held to maturity include implicit and explicit guarantees by government agencies and have an expected zero risk of loss, therefore no provision for credit loss for debt securities held to maturity has been included in the Company’s Consolidated Statement of Operations. Investment debt securities available for sale are recorded at fair value and are assessed quarterly for credit loss. Any such credit loss is recorded in the Company’s Provision for Credit Loss on the Company’s Consolidated Statement of Operations. Non-credit related losses are recorded in Other Comprehensive Income in the Company’s Consolidated Statement of Condition. Although management believes the levels of the allowance for credit losses at September 30, 2022 and September 30, 2021 are adequate to absorb expected credit losses in the financial assets evaluated, a decline in local economic conditions or other factors could result in increasing losses. Goodwill and 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 noncontrolling 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 8. Goodwill and Intangibles to the Consolidated Financial Statements for further information. 67 Table of Contents LIQUIDITY AND CAPITAL RESOURCES The Company’s primary sources of funds are deposits, derived principally through its BaaS business line, borrowings, principal and interest payments on loans and leases and mortgage-backed securities, 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 deposit and loan commitments, to maintain liquidity, and to meet operating expenses. 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 and the purchase of securities. During the fiscal years ended September 30, 2022, 2021 and 2020, the Company originated loans and leases totaling $14.98 billion, $12.62 billion and $9.79 billion, respectively. Purchases of loans and leases totaled $115.4 million, $311.3 million, and $151.4 million during the fiscal years ended September 30, 2022, 2021 and 2020. During the fiscal years ended September 30, 2022, 2021 and 2020, the Company purchased MBS and other securities in the amount of $907.4 million, $1.04 billion and $229.3 million, respectively. Of these purchases, there were no securities designated as held to maturity in fiscal 2022, 2021 and 2020. At September 30, 2022, the Company had unfunded loan and lease commitments of $1.27 billion. Certificates of deposit scheduled to mature in one year or less at September 30, 2022 totaled $5.9 million, of which $0.1 million were wholesale time deposits and $5.8 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 September 30, 2022. (Dollars in thousands) Total Less Than 1 Year 1 to 3 Years 3 to 5 Years More Than 5 Years Time deposits $ 7,655 $ 5,848 $ 1,807 $ — $ — Wholesale time deposits 99 99 — — — Long-term debt 36,028 603 1,764 — 33,661 Operating leases 36,503 3,946 7,631 6,287 18,639 Total $ 80,285 $ 10,496 $ 11,202 $ 6,287 $ 52,300 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. 68 Table of Contents On May 15, 2022, the Company retired the outstanding $75.0 million of its 5.75% fixed-to-floating rate subordinated debentures due August 15, 2026. On September 23, 2022, the Company completed a private placement of $20.0 million of its 6.625% fixed-to-floating rate subordinated debentures due 2032 to certain qualified institutional buyers and accredited investors. These notes will mature on September 30, 2032, unless earlier redeemed. Beginning on September 30, 2027, the notes may be redeemed, in whole or in part, at the Company's option subject to regulatory approval, on any scheduled interest payment date. Prior to September 30, 2027, the notes may be redeemed, in whole but not in part, at any time upon certain other specified events. The Company has used and intends to continue to use the net proceeds of the offering for general corporate purposes and repurchases of the Company's common stock. 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. The Company and the Bank met regulatory requirements for classification as well-capitalized institutions at September 30, 2022. 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. On August 16, 2022, the Inflation Reduction Act of 2022 ("IRA") was signed into law. The IRA imposes a 1% excise tax on net repurchases of stock by certain publicly traded corporations, including the Company. The excise tax is imposed on the value of net stock repurchased or treated as repurchased and will apply to stock repurchases occurring after December 31, 2022. 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. Impact of New Accounting Standards See Note 1 to the "Notes of Consolidated Financial Statements,” which is included in Part II, Item 8 “Financial Statements and Supplementary Data” of this Annual Report on Form 10-K, for information regarding recently issued accounting pronouncements. 69 Table of Contents