PATHWARD FINANCIAL, INC. 10-Q

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations. PATHWARD FINANCIAL, INC.® AND SUBSIDIARIES FORWARD-LOOKING STATEMENTS PATHWARD FINANCIAL, INC. ("Pathward Financial" or the "Company" or "us") and its wholly-owned subsidiary, Pathward ® , National Association ("Pathward ® , N.A" or "Pathward" or "the Bank") may from time to time make written or oral “forward-looking statements,” including statements contained in this Quarterly Report on Form 10-Q, the Company’s other filings with the Securities and Exchange Commission (the "SEC"), the Company’s reports to stockholders, and other communications by the Company and Pathward, N.A, which are made in good faith by the Company pursuant to the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995. You can identify forward-looking statements by words such as “may,” “hope,” “will,” “should,” “expect,” “plan,” “anticipate,” “intend,” “believe,” “estimate,” “predict,” “potential,” “continue,” “could,” “future,” or the negative of those terms, or other words of similar meaning or similar expressions. You should carefully read statements that contain these words because they discuss our future expectations or state other “forward-looking” information. These forward-looking statements are based on information currently available to us and assumptions about future events, and include statements with respect to the Company’s beliefs, expectations, estimates, and intentions, which are subject to significant risks and uncertainties, and are subject to change based on various factors, some of which are beyond the Company’s control. Such risks, uncertainties and other factors may cause our actual growth, results of operations, financial condition, cash flows, performance and business prospects and opportunities to differ materially from those expressed in, or implied by, these forward-looking statements. Such statements address, among others, the following subjects: future operating results including our performance expectations; the performance of our securities portfolio; the impact of card balances related to government stimulus programs; customer retention; loan and other product demand; new products and services; credit quality; the level of net charge-offs and the adequacy of the allowance for credit losses; and technology. The following factors, among others, could cause the Company's financial performance and results of operations to differ materially from the expectations, estimates, and intentions expressed in such forward-looking statements: maintaining our executive management team; expected growth opportunities may not be realized or may take longer to realize than expected; the potential adverse effects of unusual and infrequently occurring events, including the impact on financial markets from geopolitical conflicts such as the military conflict between Russia and Ukraine, weather-related disasters, or public health events, such as the COVID-19 pandemic, and any governmental or societal responses thereto; our ability to achieve brand recognition for Pathward equal to or greater than we enjoyed for MetaBank; our ability to successfully implement measures designed to reduce expenses and increase efficiencies; changes in trade, monetary, and fiscal policies and laws, including actual changes in interest rates and the Fed Funds rate, and their related impacts on macroeconomic conditions, customer behavior, funding costs and loan and securities portfolios; changes in tax laws; the strength of the United States' economy, and the local economies in which the Company operates; adverse developments in the financial services industry generally such as bank failures, responsive measures to mitigate and manage such developments, related supervisory and regulatory actions and costs, and related impacts on customer behavior; inflation, market, and monetary fluctuations; the timely and efficient development of new products and services offered by the Company or its strategic partners, as well as risks (including reputational and litigation) attendant thereto, and the perceived overall value of these products and services by users; Pathward's ability to maintain its Durbin Amendment exemption; the risks of dealing with or utilizing third parties, including, in connection with the Company’s prepaid card and tax refund advance businesses, the risk of reduced volume of refund advance loans as a result of reduced customer demand for or usage of Pathward’s strategic partners’ refund advance products; our relationship with, and any actions which may be initiated by, our regulators; changes in financial services laws and regulations, including laws and regulations relating to the tax refund industry and the insurance premium finance industry; technological changes, including, but not limited to, the protection of our electronic systems and information; the impact of acquisitions and divestitures; litigation risk; the growth of the Company’s business, as well as expenses related thereto; continued maintenance by Pathward of its status as a well-capitalized institution; changes in consumer borrowing, spending, and saving habits; losses from fraudulent or illegal activity; technological risks and developments and cyber threats, attacks, or events; and the success of the Company at maintaining its high quality asset level and managing and collecting assets of borrowers in default should problem assets increase. The foregoing list of factors is not exclusive. We caution you not to place undue reliance on these forward-looking statements. The forward-looking statements included in this Quarterly Report on Form 10-Q speak only as of the date hereof, and the Company does not undertake any obligation to update, revise, or clarify these forward-looking statements whether as a result of new information, future events or otherwise. All subsequent written and oral forward-looking statements attributable to us or any person acting on our behalf are expressly qualified in its entirety by the cautionary statements contained or referred to in this section. Additional discussions of factors affecting the Company’s business and prospects are reflected under the caption “Risk Factors” and in other sections of the Company’s Annual Report on Form 10-K for the Company’s fiscal year ended September 30, 2022, and in the Company's other filings made with the SEC. The Company expressly disclaims any intent or obligation to update any forward-looking statements, whether written or oral, that may be made from time to time by or on behalf of the Company or its subsidiaries, whether as a result of new information, changed circumstances, or future events or for any other reason. 37 Table of Contents 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. The Company’s common stock trades on the NASDAQ Global Select Market under the symbol “CASH.” The following discussion focuses on the consolidated financial condition of the Company at June 30, 2023, compared to September 30, 2022, and the consolidated results of operations for the three and nine months ended June 30, 2023 and 2022. This discussion should be read in conjunction with the Company’s consolidated financial statements, and notes thereto, for the fiscal year ended September 30, 2022 and the related management's discussion and analysis of financial condition and results of operations contained in the Company's Annual Report on Form 10-K for the fiscal year ended September 30, 2022. EXECUTIVE SUMMARY Company Highlights • The Company launched a new line of credit for consumers with Propel Holdings Inc. and paired with Clair to offer spending and savings accounts as well as earned wage advances. Additionally, the Company announced a new partnership where it has become the banking partner to Finix to support their launch as a payments processor. • On July 24, 2023, the Company published its third annual ESG report, which can be found on its website. The report documents the Company's progress over fiscal year 2022 showing the implementation of plans, programs and policies that built on its culture as well as the Company's purpose to power Financial Inclusion for All. Financial Highlights for the 2023 Fiscal Third Quarter • Total revenue for the third quarter was $165.2 million, an increase of $39.1 million, or 31%, compared to the same quarter in fiscal 2022, d riven by an increase in both net interest income and noninterest income. • Net interest margin ("NIM") increase d 142 basis points to 6.18% for the third quarter from 4.76% during the same period of last year p rimarily driven by increased yields and an improved earnings asset mix from the continued optimization of the portfolio. • Total gross loans and leases at June 30, 2023 increased $384.3 million to $4.07 billion compared to June 30, 2022 and increased $347.3 million , or 9%, when compared to March 31, 2 023. The increase compared to the prior year quarter was primarily due to growth in the commercial finance portfolio, partially offset by a reduction in consumer finance loans driven by the sale of the $81.5 million student loan portfolio during the fiscal 2022 fourth quarter and a reduction in warehouse finance loans. The primary drivers for the increase on a linked quarter basis was growth in both commercial finance and consumer finance loans. • During the 2023 fiscal third quarter, the Company repurchased 490,120 shares of common stock at an average share price of $43.83. Tax Season Recap For the nine months ended June 30, 2023, total tax services product revenue was $79.7 million, a decrease of 3% compared to the same period of the prior year. This was driven by a decrease in refund advance fee income partially offset by an increase in refund transfer fee income. Provision expense for refund advances increased 17% compared to the prior year. This increase was due to a mix shift from partnerships channels to independent tax providers, which was expected. Total tax services product income, net of losses and direct product expenses, decreased 19% to $35.3 million from $43.5 million, when comparing the first nine months of fiscal 2023 to the same period of the prior fiscal year. The overall decrease in tax services product income was primarily due to higher provision expense and the two tax partners that the Company did not renew heading into the 2023 tax season, as previously disclosed. 38 Table of Contents FINANCIAL CONDITION At June 30, 2023, the Company’s total assets increased by $711.2 million to $7.46 billion compared to September 30, 2022, primarily due to growth of $536.6 million in total loans and leases, $127.2 million in cash and cash equivalents, and $66.3 million in loans held for sale, partially offset by a reduction of $22.8 million in other assets. Total cash and cash equivalents was $515.3 million at June 30, 2023, increasing from $388.0 million at September 30, 2022. The Company maintains its cash investments primarily in interest-bearing overnight deposits with the FHLB of Des Moines and the FRB. At June 30, 2023, the Company did not have any federal funds sold. The Company's investment security balances increased $27.4 million, or 1%, to $1.95 billion at June 30, 2023, compared to $1.92 billion at September 30, 2022, 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. During the nine months ended June 30, 2023, the Company made $150.8 million purchases of investment securities. Loans held for sale at June 30, 2023 totaled $87.4 million, increasing from $21.1 million at September 30, 2022. This increase was primarily driven by growth in consumer credit products held for sale at June 30, 2023 compared to September 30, 2022. Total gross loans and leases totaled $4.07 billion at June 30, 2023, as compared to $3.54 billion at September 30, 2022 . The primary driver for the increase was due to increases in commercial finance, consumer finance, warehouse finance, and seasonal tax services loans. See Note 5 to the “Notes to Condensed Consolidated Financial Statements” of this Quarterly Report on Form 10-Q. Commercial finance loans, which comprised 85% of the Company's gross loan and lease portfolio, totaled $3.44 billion at June 30, 2023 , reflecting an increase of $417.1 million, or 14%, from September 30, 2022. 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 was $30.9 million at June 30, 2023 and $28.8 million at September 30, 2022, as purchases were partially offset by redemptions of FHLB membership stock during the nine months ended June 30, 2023. Total end-of-period deposits increased 8% to $6.31 billion at June 30, 2023, compared to $5.87 billion at September 30, 2022, primarily driven by an increase in noninterest-bearing deposits of $435.5 million. As of June 30, 2023 , the Company had $966.6 million in deposits related to government stimulus programs. Of the total amount of government stimulus program deposits, $349.4 million are on activated cards while $617.2 million are on inactivated cards. Between July 2023 and the end of fiscal year 2024, the inactive card balances are expected to decrease by approximately $450 million as the Company actively returns unclaimed balances to the U.S. Treasury. The Company's total borrowings increased $228.2 million from $36.0 million at September 30, 2022 to $264.2 million at June 30, 2023, primarily driven by an increase in short-term borrowings of $230.0 million partially offset by payments on long-term borrowings. At June 30, 2023, the Company’s stockholders’ equity totaled $677.7 million, an increase of $32.6 million, from $645.1 million at September 30, 2022. The increase was primarily attributable to a change in additional paid-in capital and retained earnings. The Company and Bank remained above the federal regulatory minimum capital requirements at June 30, 2023, and continued to be classified as well-capitalized, and in good standing with the regulatory agencies. See “Liquidity and Capital Resources” for further information. 39 Table of Contents 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 Condensed 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 are 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) June 30, 2023 September 30, 2022 Noninterest-bearing deposits $ 6,428,523 $ 5,916,142 Prefunding (331,834) (244,462) Discount funding (5,915) (15,991) DDA overdrafts (8,137) (8,587) Noninterest-bearing checking, net $ 6,082,637 $ 5,647,102 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 three and nine months ended June 30, 2023, the Company recognized $14.6 million and $45.7 million, respectively, in servicing fee income as compared to an insignificant amount for the three and nine months ended June 30, 2022. The Servicing Fee has been typically reflective of the EFFR upon a renegotiation of the contracts with Program Banks. As of June 30, 2023, the Company managed $781.0 million 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 48% of the deposit portfolio was subject to these higher card processing expenses during the 2023 fiscal third quarter that are derived from the terms of contractual agreements with certain BaaS partners. These agreements are tied to a rate index, typically the EFFR. 40 Table of Contents RESULTS OF OPERATIONS General The Company recorded net income of $45.1 million, or $1.68 per diluted share, for the three months ended June 30, 2023, compared to net income of $22.4 million, or $0.76 per diluted share, for the three months ended June 30, 2022. Total revenue for the fiscal 2023 third quarter was $165.2 million, an increase of $39.1 million, or 31%, compared to the same quarter in fiscal 2022, primarily driven by an increase in both noninterest income and net interest income. The Company recorded net income of $127.7 million, or $4.62 per diluted share, for the nine months ended June 30, 2023, compared to net income of $133.0 million, or $4.44 per diluted share, for the nine months ended June 30, 2022. Total revenue for the nine months ended June 30, 2023 was $543.5 million , an increase of $65.6 million , or 31%, compared to the same period of the prior fiscal year. The increase is primarily driven by increases in interest income and card and deposit fees along with the $10.0 million gain on sale of trademarks recognized during the nine months ended June 30, 2023, partially offset by the $50.0 million gain on sale of trademarks recognized during the prior fiscal year period. Net Interest Income Net interest income for the third quarter of fiscal 2023 was $97.5 million, an increase of 35% from the same quarter in fiscal 2022. The increase was mainly attributable to increased yields, higher interest-earning asset balances and an improved earning asset mix. For the nine months ended June 30, 2023, the net interest income was $282.9 million, an increase of 24%, from $227.6 million compared to the same period in the prior fiscal year. The Company’s average interest-earning assets for the third fiscal quarter increased by $244.4 million to $6.33 billion compared with the same quarter in fiscal 2022, primarily due to growth in loans and leases and an increase in total investment balances, partially offset by a decrease in cash balances. The third quarter average outstanding balance of loans and leases increased $171.6 million compared to the same quarter of the prior fiscal year, primarily due to an increase in commercial finance loans, partially offset by decreases in consumer finance loans, warehouse finance loans, and tax services loans. Fiscal 2023 third quarter NIM increased to 6.18% from 4.76% in the third fiscal quarter of last year. When including contractual card processing expense, adjusted NIM would have been 4.88% in the fiscal 2023 third quarter compared to 4.62% during the fiscal 2022 third quarter. The overall reported tax equivalent yield (“TEY”) on average earning assets increased 142 basis points to 6.31% compared to the prior fiscal year quarter, primarily driven by an increase in loan and lease, investment securities, and cash yields. The yield on the loan and lease portfolio was 8.31% compared to 6.69% for the comparable period last year and the TEY on the securities portfolio was 2.96% compared to 2.14% over that same period. For the nine months ended June 30, 2023, NIM was 5.98%, an increase of 126 basis points from 4.72% compared to the same period in the prior fiscal year. NIM, tax-equivalent for the nine months ended June 30, 2023 increased to 6.00% from 4.73% in the same period of the prior fiscal year. The Company's cost of funds for all deposits and borrowings averaged 0.13% during the fiscal 2023 third quarter, as compared to 0.12% during the prior fiscal year quarter. The Company's overall cost of deposits was 0.01% in the fiscal third quarter of 2023, as compared to 0.01% during the prior year quarter. When including contractual card processing expense, the Company's overall cost of deposits was 1.41% in the fiscal 2023 third quarter, as compared to 0.16% during the prior year quarter. The following tables present, for the periods indicated, the Company’s 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 balance. Tax-equivalent adjustments have been made in yield on interest-bearing assets and net interest margin. Nonaccruing loans and leases have been included in the table as loans carrying a zero yield. 41 Table of Contents Three Months Ended June 30, 2023 2022 (Dollars in thousands) 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 $ 248,865 $ 2,441 3.93 % $ 309,324 $ 787 1.02 % Mortgage-backed securities 1,533,122 10,234 2.68 % 1,395,149 7,381 2.12 % Tax exempt investment securities 145,474 989 3.45 % 173,192 851 2.50 % Asset-backed securities 188,039 2,120 4.52 % 210,815 750 1.43 % Other investment securities 292,025 2,320 3.19 % 246,218 1,596 2.60 % Total investments 2,158,660 15,663 2.96 % 2,025,374 10,578 2.14 % Commercial finance 3,268,780 68,174 8.37 % 2,949,813 50,785 6.91 % Consumer finance 225,470 4,665 8.30 % 300,352 4,964 6.63 % Tax services 52,477 25 0.19 % 62,934 53 0.34 % Warehouse finance 372,498 8,378 9.02 % 434,532 6,739 6.22 % Total loans and leases 3,919,225 81,242 8.31 % 3,747,631 62,541 6.69 % Total interest-earning assets 6,326,750 $ 99,346 6.31 % 6,082,329 $ 73,906 4.89 % Noninterest-earning assets 574,840 695,468 Total assets $ 6,901,590 $ 6,777,797 Interest-bearing liabilities: Interest-bearing checking $ 339 $ — 0.22 % $ 292 $ — 0.33 % Savings 69,310 7 0.04 % 82,989 7 0.03 % Money markets 126,994 76 0.24 % 101,943 53 0.21 % Time deposits 6,224 3 0.19 % 8,709 9 0.40 % Wholesale deposits 5,794 78 5.38 % 8,554 25 1.19 % Total interest-bearing deposits 208,661 164 0.32 % 202,487 94 0.19 % Overnight fed funds purchased 78,320 1,057 5.42 % 19,353 72 1.50 % Subordinated debentures 19,549 355 7.28 % 36,480 1,444 15.87 % Other borrowings 14,850 305 8.24 % 17,056 145 3.40 % Total borrowings 112,719 1,717 6.11 % 72,889 1,661 9.14 % Total interest-bearing liabilities 321,380 1,881 2.35 % 275,376 1,755 2.56 % Noninterest-bearing deposits 5,686,581 — — % 5,538,585 — — % Total deposits and interest-bearing liabilities 6,007,961 $ 1,881 0.13 % 5,813,961 $ 1,755 0.12 % Other noninterest-bearing liabilities 206,708 213,293 Total liabilities 6,214,669 6,027,254 Shareholders' equity 686,921 750,543 Total liabilities and shareholders' equity $ 6,901,590 $ 6,777,797 Net interest income and net interest rate spread including noninterest-bearing deposits $ 97,465 6.19 % $ 72,151 4.77 % Net interest margin 6.18 % 4.76 % Tax-equivalent effect 0.02 % 0.01 % Net interest margin, tax-equivalent (2) 6.20 % 4.77 % (1) Tax rate used to arrive at the TEY for the three months ended June 30, 2023 and 2022 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. 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, believes the presentation of this non-GAAP financial measure may be useful for peer comparison purposes. 42 Table of Contents Nine Months Ended June 30, 2023 2022 (Dollars in thousands) 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 $ 345,268 $ 10,000 3.87 % $ 570,806 $ 2,067 0.48 % Mortgage-backed securities 1,551,208 30,972 2.67 % 1,194,869 16,690 1.87 % Tax exempt investment securities 150,065 2,959 3.34 % 190,076 2,575 2.29 % Asset-backed securities 162,049 4,541 3.75 % 323,080 3,045 1.26 % Other investment securities 297,278 7,104 3.19 % 269,561 4,482 2.22 % Total investments 2,160,600 45,576 2.87 % 1,977,586 26,792 1.86 % Commercial finance 3,111,814 187,038 8.04 % 2,858,837 148,678 6.95 % Consumer finance 203,928 15,279 10.02 % 315,933 18,970 8.03 % Tax services 173,905 10,637 8.18 % 228,181 13,126 7.69 % Warehouse finance 327,982 20,563 8.38 % 448,358 20,816 6.21 % Community banking — — — % 46,471 1,525 4.39 % Total loans and leases 3,817,629 233,517 8.18 % 3,897,780 203,115 6.97 % Total interest-earning assets 6,323,497 $ 289,093 6.13 % 6,446,172 $ 231,974 4.83 % Noninterest-earning assets 592,064 783,251 Total assets $ 6,915,561 $ 7,229,423 Interest-bearing liabilities: Interest-bearing checking $ 352 $ 1 0.29 % $ 324 $ 1 0.32 % Savings 67,287 19 0.04 % 82,211 18 0.03 % Money markets 130,403 225 0.23 % 93,262 157 0.23 % Time deposits 6,791 7 0.14 % 8,670 34 0.52 % Wholesale deposits 65,314 2,150 0.41 % 82,754 190 0.23 % Total interest-bearing deposits 270,147 2,402 1.19 % 267,221 400 0.20 % Overnight fed funds purchased 49,865 1,845 4.95 % 38,111 135 0.47 % Subordinated debentures 19,555 1,065 7.28 % 61,505 3,432 7.46 % Other borrowings 15,319 854 7.46 % 17,857 443 3.32 % Total borrowings 84,739 3,764 5.94 % 117,473 4,010 4.56 % Total interest-bearing liabilities 354,886 6,166 2.32 % 384,694 4,410 1.53 % Noninterest-bearing deposits 5,699,937 — — % 5,843,962 — — % Total deposits and interest-bearing liabilities 6,054,823 $ 6,166 0.14 % 6,228,656 $ 4,410 0.10 % Other noninterest-bearing liabilities 192,240 203,283 Total liabilities 6,247,063 6,431,939 Shareholders' equity 668,498 797,484 Total liabilities and shareholders' equity $ 6,915,561 $ 7,229,423 Net interest income and net interest rate spread including noninterest-bearing deposits $ 282,927 5.99 % $ 227,564 4.73 % Net interest margin 5.98 % 4.72 % Tax-equivalent effect 0.02 % 0.01 % Net interest margin, tax-equivalent (2) 6.00 % 4.73 % (1) Tax rate used to arrive at the TEY for the nine months ended June 30, 2023 and 2022 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. 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, believes the presentation of this non-GAAP financial measure may be useful for peer comparison purposes. 43 Table of Contents Provision for Credit Losses The Company recognized a provision for credit losses of $1.8 million and $48.3 million for the three and nine months ended June 30, 2023, compared to a reversal of provision for credit losses expense of $1.3 million and a provision of $31.2 million for the comparable periods in the prior fiscal year. T he increase in provision for credit losses during the current quarter compared to the prior fiscal year period was primarily driven by increases in the commercial finance portfolio. Net charge-offs were $4.2 million for the quarter ended June 30, 2023, compared to $12.2 million for the quarter ended June 30, 2022. Net charge-offs attributable to the commercial finance and consumer finance portfolios for the current quarter were $2.6 million and $1.9 million, respectively, while a recovery of $0.3 million was recognized in the tax services portfolio. Noninterest Income Fiscal 2023 third quarter noninterest income increased to $67.7 million, compared to $54.0 million for the same period of the prior fiscal year. The increase was primarily attributable to increases in card and deposit fees, rental income, and other income. The period-over-period increase was partially offset by a reduction in tax services fee income. The increase in card and deposit fee income was primarily from servicing fee income on off-balance sheet deposits, which totaled $14.6 million during the 2023 fiscal third quarter, as compared to $18.2 million for the fiscal quarter ended March 31, 2023 and $0.5 million for the fiscal quarter ended June 30, 2022. Noninterest income for the nine months ended June 30, 2023 increased to $260.5 million from $250.4 million for the same period of the prior fiscal year. Noninterest Expense Noninterest expense increased 19% to $114.6 million for the fiscal 2023 third quarter, from $96.7 million for the same quarter last year. The increase was primarily attributable to increases in compensation expense, card processing expense, operating lease equipment depreciation, impairment expense, and other expense. The period-over-period increase was partially offset by a decrease in legal and consulting expense and tax services expense. During the third quarter of fiscal year 2023 , the Company recognized $2.7 million of impairment expense related to its Pathward Venture Capital business. The card processing expense increase was due to structured agreements with 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 48% of the deposit portfolio was subject to these higher card processing expenses during the 2023 fiscal third quarter. For the fiscal quarter ended June 30, 2023, card processing expenses related to these structured agreements were $20.5 million, as compared to $20.4 million for the fiscal quarter ended March 31, 2023 and $2.2 million for the fiscal quarter ended June 30, 2022. Noninterest expense for the nine months ended June 30, 2023 increased to $346.8 million from $282.2 million for the same period of the prior fiscal year. Income Tax Expense The Company recorded an income tax expense of $3.2 million, representing an effective tax rate of 6.6%, for the fiscal 2023 third quarter, compared to income tax expense of $7.0 million, representing an effective tax rate of 22.6%, for the third quarter last fiscal year. The current quarter decrease in income tax expense was primarily due to an increase in investment tax credits recognized ratably when compared to the prior year quarter. The Company originated $21.4 million in renewable energy leases during the fiscal 2023 third quarter, resulting in $5.8 million in total net investment tax credits. During the third quarter of fiscal 2022, the Company originated $4.4 million in renewable energy leases resulting in $1.0 million in total net investment tax credits. Investment tax credits related to renewable energy leases are recognized ratably based on income throughout each fiscal year. For the nine months ended June 30, 2023, the Company originated $50.9 million in renewable energy leases, compared to $26.9 million for the comparable prior year period. The timing and impact of future renewable energy 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. 44 Table of Contents 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 June 30, 2023 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. The table below sets forth the amounts and categories of the Company's nonperforming assets. (Dollars in thousands) June 30, 2023 September 30, 2022 Nonperforming Loans and Leases Nonaccruing loans and leases: Commercial finance $ 30,170 $ 13,375 Total nonaccruing loans and leases 30,170 13,375 Accruing loans and leases delinquent 90 days or more: Commercial finance 6,542 4,142 Consumer finance 2,087 2,793 Tax services (1) — 8,873 Total accruing loans and leases delinquent 90 days or more 8,629 15,808 Total nonperforming loans and leases 38,799 29,183 Other Assets Nonperforming operating leases 1,981 1,736 Foreclosed and repossessed assets: Commercial finance — 1 Total foreclosed and repossessed assets — 1 Total other assets 1,981 1,737 Total nonperforming assets $ 40,780 $ 30,920 Total as a percentage of total assets 0.55 % 0.46 % (1) Certain tax services loans do not bear interest. The Company's nonperforming loans and leases at June 30, 2023 were $38.8 million, representing 0.93% of total gross loans and leases, compared to $29.2 million, or 0.82% of total gross loans and leases at September 30, 2022. The increase in the nonperforming assets as a percentage of total assets at June 30, 2023 compared to September 30, 2022, was primarily driven by an increase nonperforming loans in the commercial finance portfolio. 45 Table of Contents 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 June 30, 2023, the Company had classified loans and leases of $189.7 million as substandard, $13.8 million as doubtful and none as loss. At September 30, 2022, the Company classified loans and leases of $203.7 million as substandard, $4.0 million as doubtful and none as loss. 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 Condensed 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 $81.9 million at June 30, 2023, an increase compared to $45.9 million at September 30, 2022. The increase in the ACL at June 30, 2023, when compared to September 30, 2022, was primarily due to a $33.1 million increase in the seasonal tax services loan portfolio and a $2.4 million increase 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 June 30, 2023 March 31, 2023 December 31, 2022 September 30, 2022 June 30, 2022 Commercial finance 1.35 % 1.53 % 1.62 % 1.46 % 1.56 % Consumer finance 0.92 % 1.99 % 1.54 % 0.86 % 2.44 % Tax services 70.20 % 53.77 % 2.01 % 0.05 % 54.29 % Warehouse finance 0.10 % 0.10 % 0.10 % 0.10 % 0.10 % Total loans and leases 2.01 % 2.27 % 1.50 % 1.30 % 2.04 % Total loans and leases excluding tax services 1.21 % 1.40 % 1.50 % 1.30 % 1.44 % 46 Table of Contents The Company's ACL as a percentage of total loans and leases decreased to 2.01% at June 30, 2023 from 2.27% at March 31, 2023 and increased from 1.30% at September 30, 2022. The decrease in the total loans and leases coverage ratio at June 30, 2023 compared to March 31, 2023 was primarily driven by the commercial finance and consumer finance portfolios, partially offset by an increase in the seasonal tax services portfolio. The decrease in the consumer finance was related to seasonal activity. The increase in the total loans and leases coverage ratio at June 30, 2023 when compared to September 30, 2022 was primarily driven by the seasonal tax services portfolio. The year-over-year increase in the allowance related to the seasonal tax services portfolio was primarily attributable to prior year charge-off activity related to a partner the Company did not renew after the 2022 tax season. 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 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. A discussion of the Company’s critical accounting policies and estimates can be found in the Company's Annual Report on Form 10-K for the year ended September 30, 2022. There were no significant changes to these critical accounting policies and estimates during the first nine months of fiscal 2023. 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. At June 30, 2023, the Company had unfunded loan and lease commitments of $1.71 billion. Management believes that loan repayment and other sources of funds will be adequate to meet its foreseeable short- and long-term liquidity needs. The liquidity sources as of June 30, 2023 include $781 million in off-balance sheet deposits and $515 million in cash and cash equivalents. When factoring in additional resources, such as the Federal Home Loan Bank, the Fed Discount Window and other unsecured funding and wholesale options, the Company has over $3 billion in total available liquidity options as of June 30, 2023. As U.S. banking organizations, the Company and the Bank are required to comply with the regulatory capital rules adopted by the Federal Reserve and the OCC (the "Capital Rules") that became effective on January 1, 2015, subject to phase-in periods for certain requirements and other provisions of the Capital Rules. Under the Capital Rules and the regulatory framework for prompt corrective action, the Company and Bank must meet specific capital guidelines that involve quantitative measures of the Company’s and Bank’s assets, liabilities and certain off-balance-sheet items as calculated under regulatory accounting practices. The Company’s and Bank’s capital amounts and classifications are also subject to qualitative judgments by regulators about components, risk weightings and other factors. The Capital Rules require the Company and the Bank to maintain minimum ratios (set forth in the table below) of total risk-based capital and Tier 1 capital (as defined in the regulations) to risk-weighted assets (as defined), and a leverage ratio consisting of Tier 1 capital (as defined) to average assets (as defined). At June 30, 2023, both the Company and the Bank exceeded federal regulatory minimum capital requirements to be classified as well-capitalized under the prompt corrective action requirements. The Company and the Bank took the AOCI opt-out election; under the rule, non-advanced approach banking organizations were given a one-time option to exclude certain AOCI components. 47 Table of Contents The tables below include certain non-GAAP financial measures that are used by investors, analysts and bank regulatory agencies to assess the capital position of financial services companies. Management reviews these measures along with other measures of capital as part of its financial analyses and has included this non-GAAP financial information, and corresponding reconciliation to total equity. Regulatory Capital is not affected by the unrealized loss on AOCI. The securities portfolio is primarily comprised of amortizing securities that should provide consistent cash flow. The Company does not intend to sell these securities, or recognize the unrealized losses on its income statement, to fund future loan growth. At June 30, 2023 Company Bank Minimum to be Adequately Capitalized Under Prompt Corrective Action Provisions Minimum to be Well Capitalized Under Prompt Corrective Action Provisions Tier 1 leverage capital ratio 8.40 % 8.67 % 4.00 % 5.00 % Common equity Tier 1 capital ratio 11.52 12.17 4.50 6.50 Tier 1 capital ratio 11.79 12.17 6.00 8.00 Total capital ratio 13.45 13.42 8.00 10.00 The following table provides a reconciliation of the amounts included in the table above for the Company. (Dollars in thousands) Standardized Approach (1) June 30, 2023 Total stockholders' equity $ 677,721 Adjustments: LESS: Goodwill, net of associated deferred tax liabilities 298,092 LESS: Certain other intangible assets 22,372 LESS: Net deferred tax assets from operating loss and tax credit carry-forwards 12,157 LESS: Net unrealized gains (losses) on available for sale securities (207,358) LESS: Noncontrolling interest (631) ADD: Adoption of Accounting Standards Update 2016-13 2,017 Common Equity Tier 1 (1) 555,106 Long-term borrowings and other instruments qualifying as Tier 1 13,661 Tier 1 minority interest not included in common equity Tier 1 capital (454) Total Tier 1 capital 568,313 Allowance for credit losses 60,489 Subordinated debentures, net of issuance costs 19,566 Total capital $ 648,368 (1) Capital ratios were determined using the Basel III capital rules that became effective on January 1, 2015. Basel III revised the definition of capital, increased minimum capital ratios, and introduced a minimum common equity tier 1 capital ratio; those changes were fully phased in through the end of 2021. The following table provides a reconciliation of tangible common equity and tangible common equity excluding AOCI, each of which is used in calculating tangible book value data, to total stockholders' equity. Each of tangible common equity and tangible common equity excluding AOCI is a non-GAAP financial measure that is commonly used within the banking industry. (Dollars in thousands) At June 30, 2023 Total stockholders' equity $ 677,721 LESS: Goodwill 309,505 LESS: Intangible assets 21,830 Tangible common equity 346,386 LESS: AOCI (207,896) Tangible common equity excluding AOCI $ 554,282 48 Table of Contents Since January 1, 2016, the Company and the Bank have been required to maintain a capital conservation buffer above the minimum risk-based capital requirements in order to avoid certain limitations on capital distributions, stock repurchases and discretionary bonus payments to executive officers. The capital conservation buffer is exclusively composed of Common Equity Tier 1 capital, and it applies to each of the three risk-based capital ratios but not the leverage ratio. The required Common Equity Tier 1 risk-based, Tier 1 risk-based and total risk-based capital ratios with the buffer are currently 7.0%, 8.5% and 10.5%, respectively. Based on current and expected continued profitability and subject to continued access to capital markets, we believe that the Company and the Bank will continue to meet the capital conservation buffer of 2.5% in addition to required minimum capital ratios. CONTRACTUAL OBLIGATIONS See "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations-Contractual Obligations " in the Company’s Annual Report on Form 10-K for its fiscal year ended September 30, 2022 for a summary of our contractual obligations as of September 30, 2022. There were no material changes outside the ordinary course of our business in contractual obligations from September 30, 2022 through June 30, 2023.