Document
 
 
 
 
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C.  20549
FORM 10-Q

☒  QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended December 31, 2016

☐  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from            to

Commission File Number:  0-22140

META FINANCIAL GROUP, INC.®
(Exact name of registrant as specified in its charter)

Delaware
42-1406262
(State or other jurisdiction of incorporation or organization)
(I.R.S. Employer Identification No.)

5501 South Broadband Lane, Sioux Falls, South Dakota 57108
(Address of principal executive offices and Zip Code)

(605) 782-1767
(Registrant’s telephone number, including area code)

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  YES ☒  NO☐

Indicate by check mark whether the Registrant has submitted electronically and posted on its corporate web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the Registrant was required to submit and post such files).  YES ☒  NO ☐

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company.  (Check one):

Large accelerated filer☐
Accelerated filer☒
Non-accelerated filer☐
Smaller Reporting Company☐

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).   ☐ YES  ☒ NO

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

Class:
Outstanding at February 3, 2017:
Common Stock, $.01 par value
9,345,762 shares
Nonvoting Common Stock, $.01 par value
0 Nonvoting shares
 
 
 
 
 



META FINANCIAL GROUP, INC.
FORM 10-Q

Table of Contents
 
 
 
Item 1.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Item 2.
 
 
 
Item 3.
 
 
 
Item 4.
 
 
 
 
 
Item 1.
 
 
 
Item 1A.  
 
 
 
Item 2.
 
 
 
Item 6.
 
 

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Table of Contents
PART I - FINANCIAL INFORMATION
Item 1.    Financial Statements.
META FINANCIAL GROUP, INC.
AND SUBSIDIARIES
Condensed Consolidated Statements of Financial Condition (Unaudited)
(Dollars in Thousands, Except Share and Per Share Data)
ASSETS
December 31, 2016
 
September 30, 2016
Cash and cash equivalents
$
695,731

 
$
773,830

Investment securities available for sale
936,832

 
910,309

Mortgage-backed securities available for sale
534,939

 
558,940

Investment securities held to maturity
478,611

 
486,095

Mortgage-backed securities held to maturity
126,365

 
133,758

Loans held for sale
1,223

 

Loans receivable
1,113,485

 
925,105

Allowance for loan losses
(6,415
)
 
(5,635
)
Federal Home Loan Bank Stock, at cost
3,832

 
47,512

Accrued interest receivable
21,375

 
17,199

Premises, furniture, and equipment, net
20,093

 
18,626

Bank-owned life insurance
57,934

 
57,486

Foreclosed real estate and repossessed assets
76

 
76

Goodwill
98,898

 
36,928

Intangible assets
73,472

 
28,921

Prepaid assets
35,722

 
9,443

Deferred taxes
12,420

 

Meta Payment Systems accounts receivable
6,885

 
6,334

Other assets
1,851

 
1,492

 


 
 
        Total assets
$
4,213,329

 
$
4,006,419

 
 
LIABILITIES AND STOCKHOLDERS’ EQUITY
 

 
 

 
 
 
 
LIABILITIES
 

 
 

Non-interest-bearing checking
$
2,473,275

 
$
2,167,522

Interest-bearing checking
41,119

 
38,077

Savings deposits
52,566

 
50,742

Money market deposits
46,856

 
47,749

Time certificates of deposit
122,334

 
125,992

Wholesale deposits
926,987

 

        Total deposits
3,663,137

 
2,430,082

Short-term debt
3,857

 
1,095,118

Long-term debt
92,479

 
92,460

Accrued interest payable
2,255

 
875

Deferred taxes

 
4,600

Accrued expenses and other liabilities
79,815

 
48,309

          Total liabilities
3,841,543

 
3,671,444

 
 
 
 
STOCKHOLDERS’ EQUITY
 

 
 

Preferred stock, 3,000,000 shares authorized, no shares issued or outstanding at December 31, 2016 and September 30, 2016, respectively

 

Common stock, $.01 par value; 15,000,000 shares authorized, 9,305,079 shares issued and outstanding at December 31, 2016 and 8,523,641 shares issued and outstanding at September 30, 2016
93

 
85

Common stock, Nonvoting, $.01 par value; 3,000,000 shares authorized, no shares issued or outstanding at December 31, 2016 and September 30, 2016, respectively

 

Additional paid-in capital
249,476

 
184,780

Retained earnings
127,239

 
127,190

Accumulated other comprehensive income (loss)
(5,022
)
 
22,920

         Total stockholders’ equity
371,786

 
334,975

 
 
 
 
         Total liabilities and stockholders’ equity
$
4,213,329

 
$
4,006,419

See Notes to Condensed Consolidated Financial Statements.

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Table of Contents


META FINANCIAL GROUP, INC.
AND SUBSIDIARIES
Condensed Consolidated Statements of Operations (Unaudited)
(Dollars in Thousands, Except Share and Per Share Data)
 
Three Months Ended December 31,
 
 
2016
 
2015
 
Interest and dividend income:
 
 
 
 
Loans receivable, including fees
$
10,678

 
$
8,319

 
Mortgage-backed securities
3,320

 
3,713

 
Other investments
8,577

 
6,243

 
 
22,575

 
18,275

 
Interest expense:
 

 
 

 
Deposits
938

 
163

 
FHLB advances and other borrowings
1,804

 
557

 
 
2,742

 
720

 
 
 
 
 
 
Net interest income
19,833

 
17,555

 
 
 
 
 
 
Provision (recovery) for loan losses
843

 
786

 
 
 
 
 
 
Net interest income after provision for loan losses
18,990

 
16,769

 
 
 
 
 
 
Non-interest income:
 

 
 

 
Tax product fees
625

 
135

 
Card fees
18,414

 
15,256

 
Loan fees
870

 
792

 
Bank-owned life insurance
448

 
374

 
Deposit fees
150

 
162

 
Gain (loss) on sale of securities available for sale, net (includes ($1,234) and $21 reclassified from accumulated other comprehensive income (loss) for net gains (losses) on available for sale securities for the three months ended December, 2016 and 2015, respectively)
(1,234
)
 
21

 
Other income (loss)
76

 
94

 
Total non-interest income
19,349

 
16,834

 
 
 
 
 
 
Non-interest expense:
 

 
 

 
Compensation and benefits
17,850

 
14,655

 
Tax product
78

 
18

 
Card processing
5,579

 
5,234

 
Occupancy and equipment
3,977

 
3,379

 
Legal and consulting
2,723

 
1,131

 
Marketing
470

 
502

 
Data processing
363

 
341

 
Amortization expense
1,525

 
1,213

 
Other expense
4,188

 
3,535

 
Total non-interest expense
36,753

 
30,008

 
 
 
 
 
 
 
 
 
 
 
Income before income tax expense
1,586

 
3,595

 
 
 
 
 
 
Income tax expense (includes ($463) and $8 income tax expense (benefit) reclassified from accumulated other comprehensive income (loss) for the three months ended December 31, 2016 and 2015, respectively)
342

 
(463
)
 
 
 
 
 
 
Net income
$
1,244

 
$
4,058

 
 
 
 
 
 
Earnings per common share:
 

 
 

 
Basic
$
0.14

 
$
0.49

 
Diluted
$
0.14

 
$
0.49

 
See Notes to Condensed Consolidated Financial Statements.

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Table of Contents

META FINANCIAL GROUP, INC.
AND SUBSIDIARIES
Condensed Consolidated Statements of Comprehensive Income (Loss) (Unaudited)
(Dollars in Thousands)
 
Three Months Ended
December 31,
 
 
2016
 
2015
 
Net income
$
1,244

 
$
4,058

 
 
 
 
 
 
Other comprehensive income (loss):
 

 
 

 
Change in net unrealized gain (loss) on securities
(45,268
)
 
2,621

 
Losses (gains) realized in net income
1,234

 
(21
)
 
 
(44,034
)
 
2,600

 
LESS: Deferred income tax effect
(16,092
)
 
974

 
Total other comprehensive income (loss)
(27,942
)
 
1,626

 
Total comprehensive income (loss)
$
(26,698
)
 
$
5,684

 

See Notes to Condensed Consolidated Financial Statements.


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Table of Contents

META FINANCIAL GROUP, INC.
AND SUBSIDIARIES
Condensed Consolidated Statements of Changes in Stockholders' Equity (Unaudited)
For the Three Months Ended December 31, 2016 and 2015
(Dollars in Thousands, Except Share and Per Share Data)
 
 
 
Common
Stock
 
 
Additional
Paid-in
Capital
 
 
 
Retained
Earnings
 
Accumulated
Other
Comprehensive
Income (Loss)
 
 
 
Treasury
Stock
 
 
Total
Stockholders’
Equity
Balance, September 30, 2015
$
82

 
$
170,749

 
$
98,359

 
$
2,455

 
$
(310
)
 
$
271,335

 
 
 
 
 
 
 
 
 
 
 
 
Cash dividends declared on common stock ($0.13 per share)

 

 
(1,068
)
 

 

 
(1,068
)
 
 
 
 
 
 
 
 
 
 
 
 
Issuance of common shares from the sales of equity securities
3

 
11,614

 

 

 

 
11,617

 
 
 
 
 
 
 
 
 
 
 
 
Issuance of common shares due to issuance of stock options, restricted stock and ESOP

 
1,060

 

 

 
310

 
1,370

 
 
 
 
 
 
 
 
 
 
 
 
Stock compensation

 
639

 

 

 

 
639

 
 
 
 
 
 
 
 
 
 
 
 
Net change in unrealized gains on securities, net of income taxes

 

 

 
1,626

 

 
1,626

 
 
 
 
 
 
 
 
 
 
 
 
Net income

 

 
4,058

 

 

 
4,058

 
 
 
 
 
 
 
 
 
 
 
 
Balance, December 31, 2015
$
85

 
$
184,062

 
$
101,349

 
$
4,081

 
$

 
$
289,577

 
 
 
 
 
 
 
 
 
 
 
 
Balance, September 30, 2016
$
85

 
$
184,780

 
$
127,190

 
$
22,920

 
$

 
$
334,975

 
 
 
 
 
 
 
 
 
 
 
 
Cash dividends declared on common stock ($0.13 per share)

 

 
(1,195
)
 

 

 
(1,195
)
 
 
 
 
 
 
 
 
 
 
 
 
Issuance of common shares due to issuance of stock options, restricted stock and ESOP
3

 
3,245

 

 

 

 
3,248

 
 
 
 
 
 
 
 
 
 
 
 
Issuance of common shares due to acquisitions
5

 
37,291

 

 

 

 
37,296

 
 
 
 
 
 
 
 
 
 
 
 
Contingent consideration equity earnout due to SCS acquisition

 
24,091

 

 

 

 
24,091

 
 
 
 
 
 
 
 
 
 
 
 
Stock compensation

 
69

 

 

 

 
69

 
 
 
 
 
 
 
 
 
 
 
 
Net change in unrealized gains on securities, net of income taxes

 

 

 
(27,942
)
 

 
(27,942
)
 
 
 
 
 
 
 
 
 
 
 
 
Net income

 

 
1,244

 

 

 
1,244

 
 
 
 
 
 
 
 
 
 
 
 
Balance, December 31, 2016
$
93

 
$
249,476

 
$
127,239

 
$
(5,022
)
 
$

 
$
371,786


See Notes to Condensed Consolidated Financial Statements.

5

Table of Contents


META FINANCIAL GROUP, INC.
AND SUBSIDIARIES
Condensed Consolidated Statements of Cash Flows (Unaudited)
(Dollars in Thousands)
 
Three Months Ended December 31,
 
2016
 
2015
Cash flows from operating activities:
 
 
 
Net income
$
1,244

 
$
4,058

Adjustments to reconcile net income to net cash provided by (used in) operating activities:
 

 
 

Depreciation, amortization and accretion, net
9,479

 
8,635

Provision (recovery) for loan losses
843

 
786

Provision (recovery) for deferred taxes
(927
)
 
(1,148
)
(Gain) loss on other assets
(6
)
 
(12
)
(Gain) loss on sale of securities available for sale, net
1,234

 
(21
)
Capital lease obligations interest expense
31

 
32

Net change in accrued interest receivable
(4,176
)
 
(2,954
)
Originations of loans held for sale
(27,191
)
 

Proceeds from sales of loans held for sale
25,968

 

Change in bank-owned life insurance value
(448
)
 
(374
)
Net change in other assets
(27,164
)
 
(1,857
)
Net change in accrued interest payable
1,379

 
(43
)
Net change in accrued expenses and other liabilities
14,224

 
(11,436
)
Net cash provided by (used in) operating activities
(5,510
)
 
(4,334
)
 
 
 
 
Cash flows from investing activities:
 

 
 

Purchase of securities available-for-sale
(144,024
)
 
(135,466
)
Proceeds from sales of securities available-for-sale
60,623

 
27,672

Proceeds from maturities and principal repayments of securities available-for-sale
30,849

 
25,646

Purchase of securities held to maturity

 
(69,526
)
Proceeds from maturities and principal repayments of securities held to maturity
13,301

 
3,029

Purchase of student loan portfolio
(136,172
)
 

Proceeds from loan sales
6,525

 

Net change in loans receivable
(59,008
)
 
(31,660
)
Net cash paid for acquisitions
(29,425
)
 

Federal Home Loan Bank stock purchases
(140,680
)
 
(193,640
)
Federal Home Loan Bank stock redemptions
184,360

 
213,240

Proceeds from the sale of premises and equipment
58

 
13

Purchase of premises and equipment
(2,899
)
 
(1,521
)
Net cash provided by (used in) investing activities
(216,492
)
 
(162,213
)
 
 
 
 
Cash flows from financing activities:
 

 
 

Net change in checking, savings, and money market deposits
309,726

 
928,701

Net change in time deposits
(3,658
)
 
(17,192
)
Net change in wholesale deposits
926,987

 

Net change in FHLB and other borrowings
(100,000
)
 
50,000

Net change in federal funds
(992,000
)
 
(540,000
)
Net change in securities sold under agreements to repurchase
744

 
(2,000
)
Principal payments on capital lease obligations
(18
)
 
(31
)
Cash dividends paid
(1,195
)
 
(1,068
)
Stock compensation
69

 
639

Proceeds from issuance of common stock
3,248

 
12,987

Net cash provided by (used in) financing activities
143,903

 
432,036

 
 
 
 
Net change in cash and cash equivalents
(78,099
)
 
265,489

 
 
 
 
Cash and cash equivalents at beginning of period
773,830

 
27,658

Cash and cash equivalents at end of period
$
695,731

 
$
293,147

 
 
 
 




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META FINANCIAL GROUP, INC.
AND SUBSIDIARIES
Condensed Consolidated Statements of Cash Flows (Con't.)
 
Three Months Ended December 31,
 
2016
 
2015
Supplemental disclosure of cash flow information
 

 
 

Cash paid during the period for:
 

 
 

Interest
$
1,362

 
$
763

Income taxes
2,110

 
1,579

Franchise taxes
20

 
20

Other taxes
1

 
1

 
 
 
 
Supplemental schedule of non-cash investing activities:
 

 
 

Stock issued for acquisitions
$
(37,296
)
 
$

Contingent consideration - cash
(17,259
)
 

Contingent consideration - equity
(24,091
)
 

Purchase of available-for-sale securities accrued, not paid

 
4,264

See Notes to Condensed Consolidated Financial Statements.


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NOTE 1.    BASIS OF PRESENTATION

The interim unaudited Condensed Consolidated Financial Statements contained herein should be read in conjunction with the audited consolidated financial statements and accompanying notes to the consolidated financial statements for the fiscal year ended September 30, 2016 included in Meta Financial Group, Inc.’s (“Meta Financial” or the “Company”) Annual Report on Form 10-K filed with the Securities and Exchange Commission (“SEC”) on December 14, 2016.  Accordingly, footnote disclosures which would substantially duplicate the disclosures contained in the audited consolidated financial statements have been omitted.

The financial information of the Company included herein has been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) for interim financial reporting and has been prepared pursuant to the rules and regulations for reporting on Form 10-Q and Rule 10-01 of Regulation S-X.  Such information reflects all adjustments (consisting of normal recurring adjustments), that are, in the opinion of management, necessary for a fair presentation of the financial position and results of operations for the periods presented. The results of the three month period ended December 31, 2016 are not necessarily indicative of the results expected for the fiscal year ending September 30, 2017.

The Company reclassified insignificant ERO and taxpayer advance fee income and related expenses during the first quarter of fiscal year 2017 from loan fees and other income to tax product fees and other expenses to tax product expense. Prior period amounts have also been reclassified.

NOTE 2.    ACQUISITIONS

EPS Financial
On November 1, 2016, the Company, through its wholly-owned subsidiary, MetaBank, completed the acquisition of substantially all of the assets and certain liabilities of EPS Financial, LLC ("EPS") from privately-held Drake Enterprises, Ltd. ("Drake"). The assets acquired by MetaBank in the EPS acquisition include the EPS trade name, operating platform, and other assets. EPS is a leading provider of comprehensive tax-related financial transaction solutions for over 10,000 Electronic Return Originators ("ERO's") nationwide, offering a one-stop-shop for all tax preparer financial transactions. These solutions include a full-suite of refund settlement products, prepaid payroll card solutions and merchant services.
Under the terms of the purchase agreement, the aggregate purchase price, which was based upon the November 1, 2016 tangible book value of EPS, included the payment of $21.9 million in cash, after adjustments, and 369,179 shares of Meta Financial common stock. The Company acquired assets with approximate fair values of $17.9 million of intangible assets, including customer relationships, trademark, and non-compete agreements, and $0.1 million of other assets, resulting in $30.4 million of goodwill.
The following table represents the approximate fair value of assets acquired and liabilities assumed of EPS on the consolidated statement of financial condition as of November 1, 2016.
 
As of November 1, 2016
 
(Dollars in Thousands)
Fair value of consideration paid
 
   Cash
21,877

   Stock issued
26,507

      Total consideration paid
48,384

 
 
Fair value of assets acquired
 
   Intangible assets
17,930

   Other assets
79

      Total assets
18,009

Fair value of net assets acquired
18,009

Goodwill resulting from acquisition
30,375


The Company included the financial results of EPS in its consolidated financial statements subsequent to the acquisition date. The EPS transaction has been accounted for under the acquisition method of accounting. The assets and liabilities, both tangible and intangible, were recorded at their estimated fair values as of the transaction date. The Company made significant estimates and exercised judgment in estimating fair values and accounting for such acquired assets and liabilities.

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The Company recognized goodwill of $30.4 million, which is calculated as the excess of both the consideration exchanged and the liabilities assumed, which were negligible, as compared to the fair value of identifiable assets acquired. Goodwill resulted from expected operational synergies and expanded product lines and is expected to be deductible for tax purposes. See Note 12 to the Condensed Consolidated Financial Statements for further information on goodwill.
The Company recognized $0.5 million of pre-tax transaction related expenses during the first three months of fiscal year 2017. The transaction expenses are reflected on the consolidated statement of operations primarily under legal and consulting.
SCS
On December 14, 2016, the Company, through MetaBank, completed the acquisition of substantially all of the assets and specified liabilities of Specialty Consumer Services LP ("SCS"). The assets acquired by MetaBank in the SCS acquisition include the SCS trade name, propriety underwriting model and loan management system and other assets. SCS primarily provides consumer tax advance and other consumer credit services through its loan management services and other financial products.
Under the terms of the purchase agreement, the aggregate purchase price paid at closing, which was based upon the December 14, 2016 tangible book value of SCS, was approximately $7.5 million in cash and 113,328 shares of Meta Financial common stock. In addition, cash contingent consideration of up to $17.3 million (estimated fair value), payable in cash, and equity contingent consideration of up to 264,431 shares of Meta Financial common stock, will be paid if certain performance benchmarks are achieved subsequent to closing (described more fully below). The Company acquired assets with approximate fair values of $28.1 million of intangible assets, including customer relationships, trademark, and non-compete agreements, and negligible other assets, resulting in goodwill of $31.6 million. All amounts are at estimated fair market values.
Subject to the equity earn-out terms of the purchase agreement, SCS will be eligible to receive up to an aggregate of 264,431 shares of Meta Financial common stock within 20 days after the applicable equity earn-out statement is deemed final if certain targets are achieved. The equity earn-out measurements are as follows; 1) if, as of an equity earn-out measurement date, the anticipated 2018 measured gross profit meets or exceeds the statement amount, MetaBank will deliver to SCS a stated number of shares of Meta common stock; 2) if, as of an equity earn-out measurement date, the aggregate anticipated loan volume under all 2018 eligible contracts is greater than or equal to the agreed upon volume amount, then MetaBank will deliver to SCS a stated number of shares of Meta common stock; and 3) if, as of an equity earn-out measurement date, each agreement specified in the contract is in effect and each such agreement is not amended or modified as of such time (except as approved in writing by the President of MetaBank, in his or her sole discretion), then MetaBank will deliver to SCS a stated number of shares of Meta common stock. None of the equity earn-out payments are contingent on the achievement of any of the other equity earn-out targets.
Subject to the cash earn-out terms of the purchase agreement, MetaBank agreed to pay to SCS an amount equal to 100% of the 2017 measured business gross profit up to a maximum of $17.5 million within 20 days after the date on which each determination of the cash earn-out payment is deemed final.
The Company included the financial results of SCS in its consolidated financial statements subsequent to the acquisition date. The fair value of the liability for the cash contingent consideration was approximately $17.3 million and was included in other liabilities in the Company's consolidated statement of financial condition. The fair value of the equity contingent consideration was approximately $24.1 million at closing and was included in additional paid-in capital in the Company's consolidated statement of financial condition. The respective fair values of the liability and equity were estimated using an option based income valuation method with significant inputs that are not observable in the market and thus represents a Level 3 fair value measurement as defined in the FASB's Accounting Standards Codification ("ASC") 820, Fair Value Measurements and Disclosures. The significant inputs in the Level 3 measurement not supported by market activity included our probability assessments of the expected future cash flows related to our acquisition of SCS during the earn-out period.
The following table represents the approximate fair value of assets acquired and liabilities recorded of SCS on the consolidated statement of financial condition as of December 14, 2016.


Table of Contents

 
As of December 14, 2016
 
(Dollars in Thousands)
Fair value of transaction consideration
 
   Cash
7,548

   Stock issued
10,789

      Paid consideration
18,337

   Contingent consideration - cash
17,259

   Contingent consideration - equity
24,091

      Contingent consideration payable
41,350

         Total consideration paid
59,687

 
 
Fair value of assets acquired
 
   Intangible assets
28,090

   Other assets
2

      Total assets
28,092

Fair value of net assets acquired
28,092

Goodwill resulting from acquisition
31,595


The SCS transaction has been accounted for under the acquisition method of accounting. The assets and liabilities, both tangible and intangible, were recorded at their estimated fair values as of the transaction date. The Company made significant estimates and exercised judgment in estimating fair values and accounting for such acquired assets and liabilities. The Company recorded a contingent liability in the amount of $17.3 million million upon completion of the acquisition to reflect the fair market value of the potential cash earn-out payment.
The Company recognized goodwill of $31.6 million, which is calculated as the excess of both the consideration exchanged and the liabilities recorded as compared to the fair value of identifiable assets acquired. Goodwill resulted from expected operational synergies and expanded product lines and is expected to be deductible for tax purposes. See Note 12 to the Condensed Consolidated Financial Statements for further information on goodwill.
The Company recognized $0.5 million of pre-tax transaction related expenses during the first three months of fiscal year 2017. The transaction expenses are reflected on the consolidated statement of operations primarily under legal and consulting.

NOTE 3.    CREDIT DISCLOSURES

The allowance for loan losses represents management’s estimate of probable loan losses which have been incurred as of the date of the consolidated financial statements.  The allowance for loan losses is increased by a provision for loan losses charged to expense and decreased by charge-offs (net of recoveries).  Estimating the risk of loss and the amount of loss on any loan is necessarily subjective.  Management’s periodic evaluation of the appropriateness of the allowance is based on the Company’s past loan loss experience, known and inherent risks in the portfolio, adverse situations that may affect the borrower’s ability to repay, the estimated value of any underlying collateral, and current economic conditions.  While management may periodically allocate portions of the allowance for specific problem loan situations, the entire allowance is available for any loan charge-offs that occur.

Loans are considered impaired if full principal or interest payments are not probable in accordance with the contractual loan terms.  Impaired loans are carried at the present value of expected future cash flows discounted at the loan’s effective interest rate or at the fair value of the collateral if the loan is collateral dependent.  A portion of the allowance for loan losses is allocated to impaired loans if the value of such loans is deemed to be less than the unpaid balance.

The allowance consists of specific, general and unallocated components.  The specific component relates to impaired loans.  For such loans, an allowance is established when the discounted cash flows (or collateral value or observable market price) of the impaired loan is lower than the carrying value of that loan.  The general component covers loans not considered impaired and is based on historical loss experience adjusted for qualitative factors.  An unallocated component is maintained to cover uncertainties that could affect management’s estimate of probable losses.  The unallocated component of the allowance reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating specific and general losses in the portfolio.


Table of Contents

Smaller-balance homogeneous loans are collectively evaluated for impairment.  Such loans include premium finance loans, residential first mortgage loans secured by one-to-four family residences, residential construction loans, automobile, manufactured homes, home equity and second mortgage loans, and tax product loans.  Commercial and agricultural loans and mortgage loans secured by other properties are evaluated individually for impairment.  When analysis of borrower operating results and financial condition indicates that underlying cash flows of the borrower’s business are not adequate to meet its debt service requirements, the loan is evaluated for impairment.  Often this is associated with a delay or shortfall in payments of 210 days or more for premium finance loans and 90 days or more for other loan categories.  Non-accrual loans and all troubled debt restructurings are considered impaired.  Impaired loans, or portions thereof, are charged off when deemed uncollectible.

Loans receivable at December 31, 2016 and September 30, 2016 are as follows:
 
December 31, 2016
 
September 30, 2016
 
(Dollars in Thousands)
1-4 Family Real Estate
$
172,877

 
$
162,298

Commercial and Multi-Family Real Estate
440,512

 
422,932

Agricultural Real Estate
64,014

 
63,612

Consumer
173,164

 
37,094

Commercial Operating
50,824

 
31,271

Agricultural Operating
33,617

 
37,083

Premium Finance
179,508

 
171,604

Total Loans Receivable
1,114,516

 
925,894

 
 
 
 
Allowance for Loan Losses
(6,415
)
 
(5,635
)
Net Deferred Loan Origination Fees
(1,031
)
 
(789
)
Total Loans Receivable, Net
$
1,107,070

 
$
919,470





11

Table of Contents

Activity in the allowance for loan losses and balances of loans receivable by portfolio segment for the three months ended December 31, 2016 and 2015 is as follows:

 
1-4 Family
Real Estate
 
Commercial and
Multi-Family
Real Estate
 
Agricultural
Real Estate
 
Consumer
 
Commercial
Operating
 
Agricultural
Operating
 
Premium
Finance
 
Unallocated
 
Total
 
(Dollars in Thousands)
Three Months Ended
December 31, 2016
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Allowance for loan losses:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Beginning balance
$
654

 
$
2,198

 
$
142

 
$
51

 
$
117

 
$
1,332

 
$
588

 
$
553

 
$
5,635

Provision (recovery) for loan losses

 
(286
)
 
334

 
(28
)
 
691

 
(3
)
 
110

 
25

 
843

Charge offs

 

 

 

 

 

 
(118
)
 

 
(118
)
Recoveries

 

 

 
24

 
5

 
12

 
14

 

 
55

Ending balance
$
654

 
$
1,912

 
$
476

 
$
47

 
$
813

 
$
1,341

 
$
594

 
$
578

 
$
6,415

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Ending balance: individually evaluated for impairment
11

 

 

 

 
339

 

 

 

 
350

Ending balance: collectively evaluated for impairment
643

 
1,912

 
476

 
47

 
474

 
1,341

 
594

 
578

 
6,065

Total
$
654

 
$
1,912

 
$
476

 
$
47

 
$
813

 
$
1,341

 
$
594

 
$
578

 
$
6,415

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Loans:
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Ending balance: individually
evaluated for impairment
190

 
429

 

 

 
505

 

 

 

 
1,124

Ending balance: collectively
evaluated for impairment
172,687

 
440,083

 
64,014

 
173,164

 
50,319

 
33,617

 
179,508

 

 
1,113,392

Total
$
172,877

 
$
440,512

 
$
64,014

 
$
173,164

 
$
50,824

 
$
33,617

 
$
179,508

 
$

 
$
1,114,516


12

Table of Contents

 
1-4 Family
Real Estate
 
Commercial and
Multi-Family
Real Estate
 
Agricultural
Real Estate
 
Consumer
 
Commercial
Operating
 
Agricultural
Operating
 
Premium
Finance
 
Unallocated
 
Total
 
(Dollars in Thousands)
Three Months Ended
December 31, 2015
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Allowance for loan losses:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Beginning balance
$
278

 
$
1,187

 
$
163

 
$
20

 
$
28

 
$
3,537

 
$
293

 
$
749

 
$
6,255

Provision (recovery) for loan losses
7

 
7

 
8

 

 
79

 
319

 
506

 
(140
)
 
786

Charge offs

 

 

 

 

 

 
(390
)
 

 
(390
)
Recoveries

 

 

 

 

 

 
15

 

 
15

Ending balance
$
285

 
$
1,194

 
$
171

 
$
20

 
$
107

 
$
3,856

 
$
424

 
$
609

 
$
6,666

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Ending balance: individually
evaluated for impairment

 
235

 

 

 

 
3,614

 

 

 
3,849

Ending balance: collectively
evaluated for impairment
285

 
959

 
171

 
20

 
107

 
242

 
424

 
609

 
2,817

Total
$
285

 
$
1,194

 
$
171

 
$
20

 
$
107

 
$
3,856

 
$
424

 
$
609

 
$
6,666

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Loans:
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Ending balance: individually
evaluated for impairment
117

 
1,341

 

 

 
8

 
4,832

 

 

 
6,298

Ending balance: collectively
evaluated for impairment
134,733

 
320,784

 
64,181

 
34,868

 
37,497

 
35,580

 
110,640

 

 
738,283

Total
$
134,850

 
$
322,125

 
$
64,181

 
$
34,868

 
$
37,505

 
$
40,412

 
$
110,640

 
$

 
$
744,581



13

Table of Contents

Federal regulations promulgated by the Company's primary federal regulator, the Office of the Comptroller of the Currency (the "OCC"), provide for the classification of loans and other assets such as debt and equity securities. The loan classification and risk rating definitions are generally as follows:

Pass- A pass asset is of sufficient quality in terms of repayment, collateral and management to preclude a special mention or an adverse rating.

Watch- A watch asset is generally credit performing well under current terms and conditions but with identifiable weakness meriting additional scrutiny and corrective measures.  Watch is not a regulatory classification but can be used to designate assets that are exhibiting one or more weaknesses that deserve management’s attention.  These assets are of better quality than special mention assets.

Special Mention- Special mention assets are credits with potential weaknesses deserving management’s close attention and if left uncorrected, may result in deterioration of the repayment prospects for the asset.  Special mention assets are not adversely classified and do not expose an institution to sufficient risk to warrant adverse classification.  Special mention is a temporary status with aggressive credit management required to garner adequate progress and move to watch or higher.

Substandard- A substandard asset is inadequately protected by the net worth and/or repayment ability or by a weak collateral position.  Assets so classified have well-defined weaknesses creating a distinct possibility that the Bank will sustain some loss if the weaknesses are not corrected.  Loss potential does not have to exist for an asset to be classified as substandard.

Doubtful- A doubtful asset has weaknesses similar to those classified substandard, with the degree of weakness causing the likely loss of some principal in any reasonable collection effort.  Due to pending factors the asset’s classification as loss is not yet appropriate.

Loss- A loss asset is considered uncollectible and of such little value that the asset’s continuance on the Bank’s balance sheet is no longer warranted.  This classification does not necessarily mean an asset has no recovery or salvage value leaving room for future collection efforts.

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.
 
The Company recognizes that concentrations of credit may naturally occur and may take the form of a large volume of related loans to an individual, a specific industry, a geographic location, or an occupation.  Credit concentration is a direct, indirect, or contingent obligation that has a common bond where the aggregate exposure equals or exceeds a certain percentage of the Bank’s Tier 1 Capital plus the Allowance for Loan Losses.
 
The asset classification of loans at December 31, 2016 and September 30, 2016 are as follows:

December 31, 2016
1-4 Family
Real Estate
 
Commercial and
Multi-Family
Real Estate
 
Agricultural
Real Estate
 
Consumer
 
Commercial
Operating
 
Agricultural
Operating
 
Premium
Finance
 
Total
 
(Dollars in Thousands)
Pass
$
171,840

 
$
439,186

 
$
33,272

 
$
173,164

 
$
50,139

 
$
17,815

 
$
179,508

 
$
1,064,924

Watch
197

 
73

 
1,641

 

 
180

 
1,999

 

 
4,090

Special Mention
663

 
938

 
24,645

 

 

 
3,286

 

 
29,532

Substandard
177

 
315

 
4,456

 

 
165

 
10,517

 

 
15,630

Doubtful

 

 

 

 
340

 

 

 
340

 
$
172,877

 
$
440,512

 
$
64,014

 
$
173,164

 
$
50,824

 
$
33,617

 
$
179,508

 
$
1,114,516



14

Table of Contents

September 30, 2016
1-4 Family
Real Estate
 
Commercial and
Multi-Family
Real Estate
 
Agricultural
Real Estate
 
Consumer
 
Commercial
Operating
 
Agricultural
Operating
 
Premium
Finance
 
Total
 
(Dollars in Thousands)
Pass
$
161,255

 
$
421,577

 
$
34,421

 
$
37,094

 
$
30,574

 
$
19,669

 
$
171,604

 
$
876,194

Watch
200

 
72

 
2,934

 

 
184

 
4,625

 

 
8,015

Special Mention
666

 
962

 
25,675

 

 

 
5,407

 

 
32,710

Substandard
177

 
321

 
582

 

 
513

 
7,382

 

 
8,975

Doubtful

 

 

 

 

 

 

 

 
$
162,298

 
$
422,932

 
$
63,612

 
$
37,094

 
$
31,271

 
$
37,083

 
$
171,604

 
$
925,894


One-to-Four Family Residential Mortgage Lending.  One-to-four family residential mortgage loan originations are generated by the Company’s marketing efforts, its present customers, walk-in customers and referrals. The Company offers fixed-rate and adjustable rate mortgage (“ARM”) loans for both permanent structures and those under construction.  The Company’s one-to-four family residential mortgage originations are secured primarily by properties located in its primary market area and surrounding areas.

The Company originates one-to-four family residential mortgage loans with terms up to a maximum of 30 years and with loan-to-value ratios up to 100% of the lesser of the appraised value of the security property or the contract price.  The Company generally requires that private mortgage insurance be obtained in an amount sufficient to reduce the Company’s exposure to at or below the 80% loan‑to‑value level. Residential loans generally do not include prepayment penalties.

Due to consumer demand, the Company offers fixed-rate mortgage loans with terms up to 30 years, most of which conform to secondary market, i.e., Fannie Mae, Ginnie Mae, and Freddie Mac standards.  The Company typically holds all fixed-rate mortgage loans and does not engage in secondary market sales.  Interest rates charged on these fixed-rate loans are competitively priced according to market conditions.

The Company also currently offers five- and ten-year ARM loans.  These loans have a fixed-rate for the stated period and, thereafter, adjust annually.  These loans generally provide for an annual cap of up to 200 basis points and a lifetime cap of 600 basis points over the initial rate.  As a consequence of using an initial fixed-rate and caps, the interest rates on these loans may not be as rate sensitive as the Company’s cost of funds.  The Company’s ARMs do not permit negative amortization of principal and are not convertible into fixed-rate loans.  The Company’s delinquency experience on its ARM loans has generally been similar to its experience on fixed-rate residential loans.  The current low mortgage interest rate environment makes ARM loans relatively unattractive and very few are currently being originated.

In underwriting one-to-four family residential real estate loans, the Company evaluates both the borrower’s ability to make monthly payments and the value of the property securing the loan.  Properties securing real estate loans made by the Company are appraised by independent appraisers approved by the Board of Directors.  The Company generally requires borrowers to obtain an attorney’s title opinion or title insurance, and fire and property insurance (including flood insurance, if necessary) in an amount not less than the amount of the loan.  Real estate loans originated by the Company generally contain a “due on sale” clause allowing the Company to declare the unpaid principal balance due and payable upon the sale of the security property.  The Company has not engaged in sub-prime residential mortgage originations.

Commercial and Multi-Family Real Estate Lending.  The Company engages in commercial and multi-family real estate lending in its primary market area and surrounding areas and, in order to supplement its loan portfolio, has purchased whole loan and participation interests in loans from other financial institutions.  The purchased loans and loan participation interests are generally secured by properties primarily located in the Midwest.

15

Table of Contents

The Company’s commercial and multi-family real estate loan portfolio is secured primarily by apartment buildings, office buildings and hotels.  Commercial and multi-family real estate loans generally are underwritten with terms not exceeding 20 years, have loan-to-value ratios of up to 80% of the appraised value of the security property, and are typically secured by guarantees of the borrowers.  The Company has a variety of rate adjustment features and other terms in its commercial and multi-family real estate loan portfolio.  Commercial and multi-family real estate loans provide for a margin over a number of different indices.  In underwriting these loans, the Company analyzes the financial condition of the borrower, the borrower’s credit history, and the reliability and predictability of the cash flow generated by the property securing the loan.  Appraisals on properties securing commercial real estate loans originated by the Company are performed by independent appraisers.

Commercial and multi-family real estate loans generally present a higher level of risk than loans secured by one-to-four family residences.  This greater risk is due to several factors, including the concentration of principal in a limited number of loans and borrowers, the effect of general economic conditions on income producing properties and the increased difficulty of evaluating and monitoring these types of loans.  Furthermore, the repayment of loans secured by commercial and multi-family real estate is typically dependent upon the successful operation of the related real estate project.  If the cash flow from the project is reduced (for example, if leases are not obtained or renewed, or a bankruptcy court modifies a lease term, or a major tenant is unable to fulfill its lease obligations), the borrower’s ability to repay the loan may be impaired.

Agricultural Lending.  The Company originates loans to finance the purchase of farmland, livestock, farm machinery and equipment, seed, fertilizer and other farm-related products.  Agricultural operating loans are originated at either an adjustable or fixed rate of interest for up to a one year term or, in the case of livestock, upon sale.  Such loans provide for payments of principal and interest at least annually or a lump sum payment upon maturity if the original term is less than one year.  Loans secured by agricultural machinery are generally originated as fixed-rate loans with terms of up to seven years.

Agricultural real estate loans are frequently originated with adjustable rates of interest.  Generally, such loans provide for a fixed rate of interest for the first five to ten years, which then balloon or adjust annually thereafter.  In addition, such loans generally amortize over a period of 20 to 25 years.  Fixed-rate agricultural real estate loans generally have terms up to ten years.  Agricultural real estate loans are generally limited to 75% of the value of the property securing the loan.

Agricultural lending affords the Company the opportunity to earn yields higher than those obtainable on one-to-four family residential lending, but involves a greater degree of risk than one-to-four family residential mortgage loans because of the typically larger loan amount.  In addition, payments on loans are dependent on the successful operation or management of the farm property securing the loan or for which an operating loan is utilized.  The success of the loan may also be affected by many factors outside the control of the borrower.

Weather presents one of the greatest risks as hail, drought, floods, or other conditions can severely limit crop yields and thus impair loan repayments and the value of the underlying collateral.  This risk can be reduced by the farmer with a variety of insurance coverages which can help to ensure loan repayment.  Government support programs and the Company generally require that farmers procure crop insurance coverage.  Grain and livestock prices also present a risk as prices may decline prior to sale, resulting in a failure to cover production costs.  These risks may be reduced by the farmer with the use of futures contracts or options to mitigate price risk.  The Company frequently requires borrowers to use futures contracts or options to reduce price risk and help ensure loan repayment.  Another risk is the uncertainty of government programs and other regulations.  During periods of low commodity prices, the income from government programs can be a significant source of cash for the borrower to make loan payments, and if these programs are discontinued or significantly changed, cash flow problems or defaults could result.  Finally, many farms are dependent on a limited number of key individuals whose injury or death may result in an inability to successfully operate the farm.

Consumer Lending.  The Company originates a variety of secured consumer loans, including home equity, home improvement, automobile, boat and loans secured by savings deposits.  In addition, the Company offers other secured and unsecured consumer loans and currently originates most of its consumer loans in its primary market area and surrounding areas.

The Company also purchased a seasoned, floating rate, private student loan portfolio in December 2016. The portfolio is serviced by ReliaMax Lending Services, LLC and insured by ReliaMax Surety Company. All loans are indexed to three-month LIBOR plus various margins.

The Retail Bank’s consumer loan portfolio primarily consists of home equity loans and lines of credit.  Substantially all of the Retail Bank’s home equity loans and lines of credit are secured by second mortgages on principal residences.  The Retail Bank will lend amounts which, together with all prior liens, may be up to 90% of the appraised value of the property securing the loan.  Home equity loans and lines of credit generally have maximum terms of five years.


16

Table of Contents

The Retail Bank primarily originates automobile loans on a direct basis to the borrower, as opposed to indirect loans, which are made when the Retail Bank purchases loan contracts, often at a discount, from automobile dealers which have extended credit to their customers.  The Bank’s automobile loans typically are originated at fixed interest rates with terms of up to 60 months for new and used vehicles.  Loans secured by automobiles are generally originated for up to 80% of the N.A.D.A. book value of the automobile securing the loan.

Consumer loan terms vary according to the type and value of collateral, length of contract and creditworthiness of the borrower.  The underwriting standards employed by the Bank for consumer loans include an application, a determination of the applicant’s payment history on other debts and an assessment of ability to meet existing obligations and payments on the proposed loan.  Although creditworthiness of the applicant is a primary consideration, the underwriting process also may include a comparison of the value of the security, if any, in relation to the proposed loan amount.

Consumer loans may entail greater credit risk than residential mortgage loans, particularly in the case of consumer loans which are unsecured or are secured by rapidly depreciable assets, such as automobiles or recreational equipment.  In such cases, any repossessed collateral for a defaulted consumer loan may not provide an adequate source of repayment of the outstanding loan balance as a result of the greater likelihood of damage, loss or depreciation.  In addition, consumer loan collections are dependent on the borrower’s continuing financial stability, and thus more likely to be affected by adverse personal circumstances.  Furthermore, the application of various federal and state laws, including bankruptcy and insolvency laws, may limit the amount which can be recovered on such loans.

Consumer Lending- Meta Payment Systems (“MPS”).  The Company believes that well-managed, nationwide credit programs can help meet legitimate credit needs for prime and sub-prime borrowers, and affords the Company an opportunity to diversify the loan portfolio and minimize earnings exposure due to economic downturns.  Therefore, MPS designs and administers certain credit programs that seek to accomplish these objectives.  The MPS Credit Committee, consisting of members of executive management of the Company, is charged with monitoring, evaluating and reporting portfolio performance and the overall credit risk posed by its credit products. All proposed credit programs must first be reviewed and approved by the committee before such programs are presented to the Bank’s Board of Directors for approval.  The Board of Directors of the Bank is ultimately responsible for final approval of any credit program.

MPS strives to offer consumers innovative payment products, including credit products.  Most credit products have fallen into the category of portfolio lending.  MPS continues developing new alternative portfolio lending products primarily to serve its customer base and to provide innovative lending solutions to the unbanked and under-banked segment.

A Portfolio Credit Policy, which has been approved by the Board of Directors, governs portfolio credit initiatives undertaken by MPS, whereby the Company retains some or all receivables and relies on the borrower as the underlying source of repayment.  Several portfolio lending programs also have a contractual provision that requires the Bank to be indemnified for credit losses that meet or exceed predetermined levels.  Such a program carries additional risks not commonly found in sponsorship programs, specifically funding and credit risk.  Therefore, MPS has strived to employ policies, procedures and information systems that it believes commensurate with the added risk and exposure.

The Company recognizes concentrations of credit may naturally occur and may take the form of a large volume of related loans to an individual, a specific industry, a geographic location or an occupation. Credit concentration is a direct, indirect or contingent obligation that has a common bond where the aggregate exposure equals or exceeds a certain percentage of the Bank’s Tier 1 Capital plus the Allowance for Loan Losses. The MPS Credit Committee monitors and identifies the credit concentrations in accordance with the Bank’s concentration policy and evaluates the specific nature of each concentration to determine the potential risk to the Bank. An evaluation includes the following:
A recommendation regarding additional controls needed to mitigate the concentration exposure.
A limitation or cap placed on the size of the concentration.
The potential necessity for increased capital and/or credit reserves to cover the increased risk caused by the concentration(s).
A strategy to reduce to acceptable levels those concentration(s) that are determined to create undue risk to the Bank.

17

Table of Contents

Through its tax divisions, MetaBank also provides short-term consumer refund advance loans. Taxpayers are underwritten to determine eligibility for the advances and the advances are unsecured. These consumer loans are interest and fee free to the consumer. Due to the nature of consumer advance loans, it typically takes no more than three e-file cycles, the period of time between scheduled IRS payments, from when the return is accepted to collect. In the event of default, MetaBank has no recourse with the tax consumer. Generally, when the refund advance loan becomes delinquent for 90 days or more, or when collection of principal becomes doubtful, the Company will charge off the loan balance. The Company expects this portfolio to expand significantly following its agreements with H&R Block and Jackson Hewitt to offer such loans during the 2017 tax season.
Certain tax consumer loan balances are classified as held for sale on the statement of financial condition as they will be sold to participating financial institutions.
Commercial Operating Lending.  The Company also originates commercial operating loans.  Most of the Company’s commercial operating loans have been extended to finance local and regional businesses and include short-term loans to finance machinery and equipment purchases, inventory and accounts receivable, and operating costs for the Company’s network of tax electronic return originators (“EROs”).  Commercial loans also may involve the extension of revolving credit for a combination of equipment acquisitions and working capital in expanding companies.

The maximum term for loans extended on machinery and equipment is based on the projected useful life of such machinery and equipment.  Generally, the maximum term on non-mortgage lines of credit is one year.  The loan-to-value ratio on such loans and lines of credit generally may not exceed 80% of the value of the collateral securing the loan.  ERO loans are not collateralized.  The Company’s commercial operating lending policy includes credit file documentation and analysis of the borrower’s character, capacity to repay the loan, the adequacy of the borrower’s capital and collateral as well as an evaluation of conditions affecting the borrower.  Analysis of the borrower’s past, present and future cash flows is also an important aspect of the Company’s current credit analysis.  Nonetheless, such loans are believed to carry higher credit risk than more traditional lending activities.

Unlike residential mortgage loans, which generally are made on the basis of the borrower’s ability to make repayment from his or her employment and other income and which are secured by real property whose value tends to be more easily ascertainable, commercial operating loans typically are made on the basis of the borrower’s ability to make repayment from the cash flow of the borrower’s business.  As a result, the availability of funds for the repayment of commercial operating loans may be substantially dependent on the success of the business itself (which, in turn, is likely to be dependent upon the general economic environment).  The Company’s commercial operating loans are usually, but not always, secured by business assets and personal guarantees.  However, the collateral securing the loans may depreciate over time, may be difficult to appraise and may fluctuate in value based on the success of the business.

Through its Refund Advantage and EPS divisions, MetaBank also provides short-term ERO advance loans on a nation-wide basis. These loans are typically utilized to purchase tax preparation software and to prepare tax offices for the upcoming season. EROs go through an underwriting process to determine eligibility for the advances and the advances are unsecured. Due to the nature of ERO advance loans, it typically takes no more than three e-file cycles once the return is accepted to begin collection. Generally, when the ERO advance loan becomes delinquent for 90 days or more, or when collection of principal becomes doubtful, the Company will charge off the loan balance.

Premium Finance Lending.  Through its AFS/IBEX division, MetaBank provides short-term and primarily collateralized financing to facilitate the commercial customers’ purchase of insurance for various forms of risk otherwise known as insurance premium financing.  This includes, but is not limited to, policies for commercial property, casualty and liability risk.  The AFS/IBEX division markets itself to the insurance community as a competitive option based on service, reputation, competitive terms, cost and ease of operation.

Insurance premium financing is the business of extending credit to a policyholder to pay for insurance premiums when the insurance carrier requires payment in full at inception of coverage.  Premiums are advanced either directly to the insurance carrier or through an intermediary/broker and repaid by the policyholder with interest during the policy term.  The policyholder generally makes a 20% to 25% down payment to the insurance broker and finances the remainder over nine to ten months on average.  The down payment is set such that if the policy is canceled, the unearned premium returned is typically sufficient to cover the loan balance, accrued interest and other charges due.


18

Table of Contents

Due to the nature of collateral for commercial premium finance receivables, it customarily takes 60-210 days to convert the collateral into cash.  In the event of default, AFS/IBEX, by statute and contract, has the power to cancel the insurance policy and establish a first position lien on the unearned portion of the premium from the insurance carrier. Due to notification requirements and processing time by most insurance carriers, many receivables will become delinquent beyond 90 days while the insurer is processing the return of the unearned premium.  Generally, when a premium finance loan becomes delinquent for 210 days or more, or when collection of principal or interest becomes doubtful, the Company will charge off the loan balance and any remaining interest and fees after applying any collection from the insurance company.

Past due loans at December 31, 2016 and September 30, 2016 were as follows:

December 31, 2016
30-59 Days
Past Due
 
60-89 Days
Past Due
 
Greater Than
90 Days
 
Total Past
Due
 
Current
 
Non-Accrual
Loans
 
Total Loans
Receivable
 
(Dollars in Thousands)
1-4 Family Real Estate
$
98

 
$

 
$
382

 
$
480

 
$
172,285

 
$
112

 
$
172,877

Commercial and Multi-Family Real Estate
3,040

 
155

 

 
3,195

 
437,317

 

 
440,512

Agricultural Real Estate
1,146

 
1,060

 

 
2,206

 
61,808

 

 
64,014

Consumer
309

 

 
29

 
338

 
172,826

 

 
173,164

Commercial Operating

 

 

 

 
50,319

 
505

 
50,824

Agricultural Operating

 

 

 

 
33,617

 

 
33,617

Premium Finance
1,080

 
431

 
1,207

 
2,718

 
176,790

 

 
179,508

Total
$
5,673

 
$
1,646

 
$
1,618

 
$
8,937

 
$
1,104,962

 
$
617

 
$
1,114,516



September 30, 2016
30-59 Days
Past Due
 
60-89 Days
Past Due
 
Greater Than
90 Days
 
Total Past
Due
 
Current
 
Non-Accrual
Loans
 
Total Loans
Receivable
 
(Dollars in Thousands)
1-4 Family Real Estate
$

 
$
30

 
$

 
$
30

 
$
162,185

 
$
83

 
$
162,298

Commercial and Multi-Family Real Estate

 

 

 

 
422,932

 

 
422,932

Agricultural Real Estate

 

 

 

 
63,612

 

 
63,612

Consumer

 

 
53

 
53

 
37,041

 

 
37,094

Commercial Operating
151

 
354

 

 
505

 
30,766

 

 
31,271

Agricultural Operating

 

 

 

 
37,083

 

 
37,083

Premium Finance
1,398

 
275

 
965

 
2,638

 
168,966

 

 
171,604

Total
$
1,549

 
$
659

 
$
1,018

 
$
3,226

 
$
922,585

 
$
83

 
$
925,894


When analysis of borrower operating results and financial condition indicates that underlying cash flows of the borrower’s business are not adequate to meet its debt service requirements, the loan is evaluated for impairment.  Often this is associated with a delay or shortfall in payments of 210 days or more for premium finance loans and 90 days or more for other loan categories.  As of December 31, 2016, there were no Premium Finance loans greater than 210 days past due.

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Table of Contents

Impaired loans at December 31, 2016 and September 30, 2016 were as follows:

 
Recorded
Balance
 
Unpaid Principal
Balance
 
Specific
Allowance
December 31, 2016
(Dollars in Thousands)
Loans without a specific valuation allowance
 
 
 
 
 
1-4 Family Real Estate
$
112

 
$
112

 
$

Commercial and Multi-Family Real Estate
429

 
429

 

Total
$
541

 
$
541

 
$

Loans with a specific valuation allowance
 

 
 

 
 

1-4 Family Real Estate
$
78

 
$
78

 
$
11

Commercial Operating
$
505

 
$
505

 
$
339

Total
$
583

 
$
583

 
$
350

 
Recorded
Balance
 
Unpaid Principal
Balance
 
Specific
Allowance
September 30, 2016
(Dollars in Thousands)
Loans without a specific valuation allowance
 
 
 
 
 
1-4 Family Real Estate
$
84

 
$
84

 
$

Commercial and Multi-Family Real Estate
433

 
433

 

Total
$
517

 
$
517

 
$

Loans with a specific valuation allowance
 

 
 

 
 

1-4 Family Real Estate
$
78

 
$
78

 
$
10

Total
$
78

 
$
78

 
$
10


The following table provides the average recorded investment in impaired loans for the three month periods ended December 31, 2016 and 2015.

 
Three Months Ended December 31,
 
 
2016
 
2015
 
 
Average
Recorded
Investment
 
Average
Recorded
Investment
 
 
(Dollars in Thousands)
1-4 Family Real Estate
$
172

 
$
119

 
Commercial and Multi-Family Real Estate
432

 
1,347

 
Commercial Operating
168

 
10

 
Agricultural Operating

 
5,032

 
Total
$
772

 
$
6,508

 

The Company’s troubled debt restructurings (“TDR”) typically involve forgiving a portion of interest or principal on existing loans or making loans at a rate materially less than current market rates. There were no loans modified in a TDR during the three month periods ended December 31, 2016 and 2015.  Additionally, there were no TDR loans for which there was a payment default during the three month periods ended December 31, 2016 and 2015 that had been modified during the 12-month period prior to the default.





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Table of Contents

NOTE 4.    ALLOWANCE FOR LOAN LOSSES

At December 31, 2016, the Company’s allowance for loan losses increased to $6.4 million from $5.6 million at September 30, 2016.  During the three months ended December 31, 2016, the Company recorded a provision for loan losses of $0.8 million. The Company had $0.1 million of net charge offs for the three months ended December 31, 2016, compared to $0.4 million for the three months ended December 31, 2015.

The allowance for loan losses is established through the provision for loan losses based on management’s evaluation of the risk inherent in its loan portfolio and changes in the nature and volume of its loan activity, including those loans which are being specifically monitored by management.  Such evaluation, which includes a review of loans for which full collectability may not be reasonably assured, considers, among other matters, the estimated fair value of the underlying collateral, economic conditions, historical loan loss experience and other factors that warrant recognition in providing for an appropriate loan loss allowance.

Management closely monitors economic developments both regionally and nationwide, and considers these factors when assessing the appropriateness of its allowance for loan losses.  The current economic environment continues to show signs of improvement in the Bank’s markets.  The Bank’s average loss rates over the past three years were low, offset with a higher agricultural loss rate in fiscal year 2016 driven by the charge off of one relationship.The Bank does not believe it is likely these low loss conditions will continue indefinitely.  Although the Bank’s four market areas have indirectly benefited from a stable agricultural market, the market has become slightly stressed as commodity prices have remained lower than a few years ago. Management expects that future losses in the agriculture operations and agriculture real estate loan portfolios could be higher than recent historical experience. Management believes the low commodity prices and high land rents have the potential to negatively impact the economies of our agricultural markets.

Management believes that, based on a detailed review of the loan portfolio, historic loan losses, current economic conditions, the size of the loan portfolio and other factors, the current level of the allowance for loan losses at December 31, 2016, reflects an appropriate allowance against probable losses from the loan portfolio.  Although the Company maintains its allowance for loan losses at a level it considers to be appropriate, investors and others are cautioned that there can be no assurance that future losses will not exceed estimated amounts, or that additional provisions for loan losses will not be required in future periods.  In addition, the Company’s determination of the allowance for loan losses is subject to review by the OCC, which can require the establishment of additional general or specific allowances.

Real estate properties acquired through foreclosure are recorded at fair value.  If fair value at the date of foreclosure is lower than the balance of the related loan, the difference will be charged to the allowance for loan losses at the time of transfer.  Valuations are periodically updated by management and, if the value declines, a specific provision for losses on such property is established by a charge to operations.


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NOTE 5.    EARNINGS PER COMMON SHARE (“EPS”)

Basic EPS is based on the net income divided by the weighted average number of common shares outstanding during the period.  Allocated Employee Stock Ownership Plan (“ESOP”) shares are considered outstanding for EPS calculations, as they are committed to be released; unallocated ESOP shares are not considered outstanding.  All ESOP shares were allocated as of December 31, 2016 and September 30, 2016.  Diluted EPS shows the dilutive effect of additional common shares issuable pursuant to stock option agreements.

A reconciliation of net income and common stock share amounts used in the computation of basic and diluted EPS for the three months ended December 31, 2016 and 2015 is presented below.

Three Months Ended December 31,
2016
 
2015
(Dollars in Thousands, Except Share and Per Share Data)
 
 
 
Earnings
 
 
 
Net Income
$
1,244

 
$
4,058

 
 
 
 
Basic EPS
 

 
 

Weighted average common shares outstanding
8,938,339

 
8,245,368

LESS: weighted average nonvested shares
151,312

 
27,311

Weighted average common shares outstanding
8,787,027

 
8,218,057

 
 
 
 
Earnings Per Common Share
 

 
 

Basic
$
0.14

 
$
0.49

 
 
 
 
Diluted EPS
 

 
 

Weighted average common shares outstanding for basic earnings per common share
8,787,027

 
8,218,057

Dilutive effect of assumed exercises of stock options, net of tax benefits
82,050

 
66,198

Weighted average common and dilutive potential common shares outstanding
8,869,077

 
8,284,255

 
 
 
 
Earnings Per Common Share
 

 
 

Diluted
$
0.14

 
$
0.49


All stock options and shares under the treasury stock method were considered in computing diluted EPS for the three months ended December 31, 2016 and 2015.



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Table of Contents

NOTE 6.    SECURITIES

The amortized cost, gross unrealized gains and losses and estimated fair values of available for sale and held to maturity securities at December 31, 2016 and September 30, 2016 are presented below.

Available For Sale
 
 
GROSS

 
GROSS

 
 
At December 31, 2016
AMORTIZED
COST

 
UNREALIZED
GAINS

 
UNREALIZED
(LOSSES)

 
FAIR
VALUE

 
(Dollars in Thousands)
Debt securities
 
 
 
 
 
 
 
Small business administration securities
78,396

 
1,104

 
(52
)
 
79,448

Non-bank qualified obligations of states and political subdivisions
740,723

 
3,432

 
(6,172
)
 
737,983

Asset-backed securities
118,085

 
791

 
(729
)
 
118,147

Mortgage-backed securities
543,698

 
497

 
(9,256
)
 
534,939

Total debt securities
1,480,902

 
5,824

 
(16,209
)
 
1,470,517

Common equities and mutual funds
856

 
406

 
(8
)
 
1,254

Total available for sale securities
$
1,481,758

 
$
6,230

 
$
(16,217
)
 
$
1,471,771


At September 30, 2016
AMORTIZED
COST

 
GROSS
UNREALIZED
GAINS

 
GROSS
UNREALIZED
(LOSSES)

 
FAIR
VALUE

 
(Dollars in Thousands)
Debt securities
 
 
 
 
 
 
 
Trust preferred securities
$
14,935

 
$

 
$
(1,957
)
 
$
12,978

Small business administration securities
78,431

 
2,288

 

 
80,719

Non-bank qualified obligations of states and political subdivisions
668,628

 
30,141

 
(97
)
 
698,672

 Asset-backed securities
117,487

 
73

 
(745
)
 
116,815

Mortgage-backed securities
555,036

 
4,382

 
(478
)
 
558,940

Total debt securities
1,434,517

 
36,884

 
(3,277
)
 
1,468,124

Common equities and mutual funds
755

 
373

 
(3
)
 
1,125

Total available for sale securities
$
1,435,272

 
$
37,257

 
$
(3,280
)
 
$
1,469,249

Held to Maturity
 
 
GROSS

 
GROSS

 
 
At December 31, 2016
AMORTIZED
COST

 
UNREALIZED
GAINS

 
UNREALIZED
(LOSSES)

 
FAIR
VALUE

 
(Dollars in Thousands)
Debt securities
 
 
 
 
 
 
 
Obligations of states and political subdivisions
$
20,352

 
$
45

 
$
(278
)
 
$
20,119

Non-bank qualified obligations of states and political subdivisions
458,259

 
1,326

 
(5,072
)
 
454,513

Mortgage-backed securities
126,365

 

 
(1,896
)
 
124,469

Total held to maturity securities
$
604,976

 
$
1,371

 
$
(7,246
)
 
$
599,101


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Table of Contents

At September 30, 2016
AMORTIZED
COST

 
GROSS
UNREALIZED
GAINS

 
GROSS
UNREALIZED
(LOSSES)

 
FAIR
VALUE

 
(Dollars in Thousands)
Debt securities
 
 
 
 
 
 
 
Obligations of states and political subdivisions
$
20,626

 
$
355

 
$
(44
)
 
$
20,937

Non-bank qualified obligations of states and political subdivisions
465,469

 
11,744

 
(11
)
 
477,202

Mortgage-backed securities
133,758

 
708

 
(31
)
 
134,435

Total held to maturity securities
$
619,853

 
$
12,807

 
$
(86
)
 
$
632,574


Included in securities available for sale are trust preferred securities as follows:

During the first quarter of fiscal 2017, the Company sold all trust preferred securities.

At September 30, 2016
 
 
 
 
 
 
 
 
     
Issuer
Amortized Cost
 
Fair Value
 
Unrealized
Gain (Loss)
 
S&P
Credit Rating
 
Moody's
Credit Rating
 
(Dollars in Thousands)
 
 
 
  
Key Corp. Capital I
$
4,987

 
$
4,189

 
$
(798
)
 
BB+
 
Baa2
Huntington Capital Trust II SE
4,981

 
4,077

 
(904
)
 
BB
 
Baa2
PNC Capital Trust
4,968

 
4,712

 
(256
)
 
BBB-
 
Baa1
Total
$
14,936

 
$
12,978

 
$
(1,958
)
 
 
 
  

 

Management has implemented a process to identify securities with potential credit impairment that are other-than-temporary.  This process involves evaluation of the length of time and extent to which the fair value has been less than the amortized cost basis, review of available information regarding the financial position of the issuer, monitoring the rating, watch, and outlook of the security, monitoring changes in value, cash flow projections, and the Company’s intent to sell a security or whether it is more likely than not we will be required to sell the security before the recovery of its amortized cost which, in some cases, may extend to maturity.  To the extent we determine that a security is deemed to be other-than-temporarily impaired, an impairment loss is recognized.

For all securities considered temporarily impaired, the Company does not intend to sell these securities and it is not more likely than not that the Company will be required to sell the security before recovery of its amortized cost, which may occur at maturity.  The Company believes it will collect all principal and interest due on all investments with amortized cost in excess of fair value and considered only temporarily impaired.

Generally accepted accounting principles require that, at acquisition, an enterprise classify debt securities into one of three categories: Available for sale (“AFS”), Held to Maturity (“HTM”) or trading. AFS securities are carried at fair value on the consolidated statements of financial condition, and unrealized holding gains and losses are excluded from earnings and recognized as a separate component of equity in accumulated other comprehensive income (“AOCI”). HTM debt securities are measured at amortized cost. Both AFS and HTM are subject to review for other-than-temporary impairment. The Company did not have any trading securities at December 31, 2016 or September 30, 2016.

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Table of Contents

Gross unrealized losses and fair value, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position at December 31, 2016 and September 30, 2016, were as follows:

Available For Sale
LESS THAN 12 MONTHS
 
OVER 12 MONTHS
 
TOTAL
At December 31, 2016
Fair
Value
 
Unrealized
(Losses)
 
Fair
Value
 
Unrealized
(Losses)
 
Fair
Value
 
Unrealized
(Losses)
 
(Dollars in Thousands)
Debt securities
 
 
 
 
 
 
 
 
 
 
 
   Small business administration securities
$
28,331

 
$
(52
)
 
$

 
$

 
$
28,331

 
$
(52
)
Non-bank qualified obligations of states and political subdivisions
396,493

 
(6,002
)
 
2,561

 
(170
)
 
399,054

 
(6,172
)
Asset-backed securities
50,481

 
(729
)
 

 

 
50,481

 
(729
)
Mortgage-backed securities
473,394

 
(8,333
)
 
34,794

 
(923
)
 
508,188

 
(9,256
)
Total debt securities
948,699

 
(15,116
)
 
37,355

 
(1,093
)
 
986,054

 
(16,209
)
Common equities and mutual funds

 

 
120

 
(8
)
 
120

 
(8
)
Total available for sale securities
$
948,699

 
$
(15,116
)
 
$
37,475

 
$
(1,101
)
 
$
986,174

 
$
(16,217
)

 
LESS THAN 12 MONTHS
 
OVER 12 MONTHS
 
TOTAL
At September 30, 2016
Fair
Value
 
Unrealized
(Losses)
 
Fair
Value
 
Unrealized
(Losses)
 
Fair
Value
 
Unrealized
(Losses)
 
(Dollars in Thousands)
Debt securities
 
 
 
 
 
 
 
 
 
 
 
Trust preferred securities
$

 
$

 
$
12,978

 
$
(1,957
)
 
$
12,978

 
$
(1,957
)
Non-bank qualified obligations of states and political subdivisions
8,481

 
(58
)
 
2,688

 
(39
)
 
11,169

 
(97
)
Asset-backed securities
89,403

 
(745
)
 

 

 
89,403

 
(745
)
Mortgage-backed securities
54,065

 
(230
)
 
36,979

 
(248
)
 
91,044

 
(478
)
Total debt securities
151,949

 
(1,033
)
 
52,645

 
(2,244
)
 
204,594

 
(3,277
)
Common equities and mutual funds

 

 
125

 
(3
)
 
125

 
(3
)
Total available for sale securities
$
151,949

 
$
(1,033
)
 
$
52,770

 
$
(2,247
)
 
$
204,719

 
$
(3,280
)
Held To Maturity
LESS THAN 12 MONTHS
 
OVER 12 MONTHS
 
TOTAL
At December 31, 2016
Fair
Value
 
Unrealized
(Losses)
 
Fair
Value
 
Unrealized
(Losses)
 
Fair
Value
 
Unrealized
(Losses)
 
(Dollars in Thousands)
Debt securities
 
 
 
 
 
 
 
 
 
 
 
Obligations of states and political subdivisions
$
14,552

 
$
(230
)
 
$
2,236

 
$
(48
)
 
$
16,788

 
$
(278
)
Non-bank qualified obligations of states and political subdivisions
356,031

 
(5,072
)
 

 

 
356,031

 
(5,072
)
Mortgage-backed securities
124,469

 
(1,896
)
 

 

 
124,469

 
(1,896
)
Total held to maturity securities
$
495,052

 
$
(7,198
)
 
$
2,236

 
$
(48
)
 
$
497,288

 
$
(7,246
)

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Table of Contents

 
LESS THAN 12 MONTHS
 
OVER 12 MONTHS
 
TOTAL
At September 30, 2016
Fair
Value
 
Unrealized
(Losses)
 
Fair
Value
 
Unrealized
(Losses)
 
Fair Value
 
Unrealized
(Losses)
 
(Dollars in Thousands)
Debt securities
 
 
 
 
 
 
 
 
 
 
 
Obligations of states and political subdivisions
$
2,909

 
$
(13
)
 
$
2,256

 
$
(31
)
 
$
5,165

 
$
(44
)
Non-bank qualified obligations of states and political subdivisions
1,294

 
(11
)
 

 

 
1,294

 
(11
)
Mortgage-backed securities
20,061

 
(31
)
 

 

 
20,061

 
(31
)
Total held to maturity securities
$
24,264

 
$
(55
)
 
$
2,256

 
$
(31
)
 
$
26,520

 
$
(86
)

At December 31, 2016, the investment portfolio included securities with current unrealized losses which have existed for longer than one year.  All of these securities are considered to be acceptable credit risks.  Because the declines in fair value were due to changes in market interest rates, not in estimated cash flows, and the Company does not intend to sell these securities (has not made a decision to sell) and it is not more likely than not that the Company will be required to sell the security before recovery of its amortized cost basis, which may occur at maturity, no other-than-temporary impairment was recorded at December 31, 2016.

The amortized cost and fair value of debt securities by contractual maturity are shown below.  Certain securities have call features which allow the issuer to call the security prior to maturity.  Expected maturities may differ from contractual maturities in mortgage-backed securities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.  Therefore, mortgage-backed securities are not included in the maturity categories in the following maturity summary.  The expected maturities of certain Small Business Administration and certain asset-backed securities may differ from contractual maturities because the borrowers may have the right to prepay the obligation. However, certain prepayment penalties may apply.

Available For Sale
AMORTIZED
COST

 
FAIR
VALUE

 
At December 31, 2016
(Dollars in Thousands)
 
 
 
 
Due in one year or less
$

 
$

Due after one year through five years
13,248

 
13,386

Due after five years through ten years
408,123

 
410,652

Due after ten years
515,833

 
511,540

 
937,204

 
935,578

Mortgage-backed securities
543,698

 
534,939

Common equities and mutual funds
856

 
1,254

Total available for sale securities
$
1,481,758

 
$
1,471,771

 
AMORTIZED
COST

 
FAIR
VALUE

At September 30, 2016
(Dollars in Thousands)
 
 
 
 
Due in one year or less
$

 
$

Due after one year through five years
17,370

 
17,897

Due after five years through ten years
426,034

 
446,771

Due after ten years
436,077

 
444,516

 
879,481

 
909,184

Mortgage-backed securities
555,036

 
558,940

Common equities and mutual funds
755

 
1,125

Total available for sale securities
$
1,435,272

 
$
1,469,249


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Table of Contents

Held To Maturity
AMORTIZED
COST

 
FAIR
VALUE

 
At December 31, 2016
(Dollars in Thousands)
 
 
 
 
Due in one year or less
$
341

 
$
341

Due after one year through five years
12,648

 
12,618

Due after five years through ten years
157,174

 
156,228

Due after ten years
308,448

 
305,445

 
478,611

 
474,632

Mortgage-backed securities
126,365

 
124,469

Total held to maturity securities
$
604,976

 
$
599,101


 
AMORTIZED
COST

 
FAIR
VALUE

At September 30, 2016
(Dollars in Thousands)
Due in one year or less
$
472

 
$
471

Due after one year through five years
12,502

 
12,696

Due after five years through ten years
157,944

 
163,806

Due after ten years
315,177

 
321,166

 
486,095

 
498,139

Mortgage-backed securities
133,758

 
134,435

Total held to maturity securities
$
619,853

 
$
632,574


NOTE 7.    COMMITMENTS AND CONTINGENCIES

In the normal course of business, the Bank makes various commitments to extend credit which are not reflected in the accompanying consolidated financial statements.

At December 31, 2016 and September 30, 2016, unfunded loan commitments approximated $228.9 million and $182.9 million, respectively, excluding undisbursed portions of loans in process.  These unfunded loan commitments were principally for variable rate loans.  Commitments, which are disbursed subject to certain limitations, extend over various periods of time.  Generally, unused commitments are canceled upon expiration of the commitment term as outlined in each individual contract.

The Company had no commitments to purchase securities at December 31, 2016 and September 30, 2016. During the first quarter of fiscal 2017, the Company entered into an agreement, effective January 1, 2017, with H&R Block to provide interest and fee free refund advance loans for H&R Block tax preparation customers throughout the 2017 tax season.

The exposure to credit loss in the event of nonperformance by other parties to financial instruments for commitments to extend credit is represented by the contractual amount of those instruments.  The same credit policies and collateral requirements are used in making commitments and conditional obligations as are used for on-balance-sheet instruments.

Since certain commitments to make loans and to fund lines of credit and loans in process expire without being used, the amount does not necessarily represent future cash commitments.  In addition, commitments used to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract.

27

Table of Contents

Legal Proceedings

The Bank was served on April 15, 2013, with a lawsuit captioned Inter National Bank v. NetSpend Corporation, MetaBank, BDO USA, LLP d/b/a BDO Seidman, Cause No. C-2084-12-I filed in the District Court of Hidalgo County, Texas. The Plaintiff’s Second Amended Original Petition and Application for Temporary Restraining Order and Temporary Injunction adds both MetaBank and BDO Seidman to the original causes of action against NetSpend. NetSpend acts as a prepaid card program manager and processor for both INB and MetaBank. According to the Petition, NetSpend has informed Inter National Bank (“INB”) that the depository accounts at INB for the NetSpend program supposedly contained $10.5 million less than they should. INB alleges that NetSpend has breached its fiduciary duty by making affirmative misrepresentations to INB about the safety and stability of the program, and by failing to timely disclose the nature and extent of any alleged shortfall in settlement of funds related to cardholder activity and the nature and extent of NetSpend’s systemic deficiencies in its accounting and settlement processing procedures. To the extent that an accounting reveals that there is an actual shortfall, INB alleges that MetaBank may be liable for portions or all of said sum due to the fact that funds have been transferred from INB to MetaBank, and thus MetaBank would have been unjustly enriched. The Bank is vigorously contesting this matter. In January 2014, NetSpend was granted summary judgment in this matter which is under appeal. Because the theory of liability against both NetSpend and the Bank is the same, the Bank views the NetSpend summary judgment as a positive in support of our position.  An estimate of a range of reasonably possible loss cannot be made at this stage of the litigation because discovery is still being conducted.

The Bank commenced action against C&B Farms, LLC, Dakota River Farms, LLC, Dakota Grain Farms, LLC, Heather Swenson and Tracy Clement in early July, 2015, in the Third Judicial Circuit Court of the State of South Dakota, seeking to collect upon certain delinquent loans made in connection with the 2014 farming operations of the three identified limited liability companies and the personal guaranties of Swenson and Clement. The three companies and Clement answered the Complaint and asserted a counterclaim against the Bank and a third-party claim against the Bank’s loan officer, alleging fraud and misrepresentation, as well as promissory estoppel.   On January 7, 2016, the Bank obtained a judgment for $6.1 million, the full amount due and owing on the delinquent loans, together with attorneys’ fees, costs and post-judgment interest.  On February 25, 2016, the Court entered an order and judgment in favor of the Bank granting the Bank’s renewed motion for summary judgment as to counterclaims and third party claim. Tracy Clement, the primary guarantor of the C&B Farms, Dakota Grain Farms, and Dakota River Farms indebtedness has filed a Chapter 11 bankruptcy proceeding in Minnesota. The Bank is an unsecured creditor in the bankruptcy proceeding. The Bank still has the right to collect from the three limited liability company debtors (C&B, Dakota Grain, and Dakota River). However, the Bank believes each entity is now insolvent and the collateral recovered and liquidated to the extent possible. The Bank has also settled with the other personal guarantor, Heather Swenson. The Bank commenced action against Interstate Commodities, Inc., on February 1, 2016, in the United States District Court for the District of South Dakota, Central Division. This matter arises out of the Bank’s loans to C&B Farms, which were guaranteed by Tracy Clement. The case alleges that Interstate Commodities has breached the terms of a subordination agreement entered into between Interstate Commodities and the Bank relating to the 2015 crops of C&B Farms, LLC. In March 2015, the Bank sent a letter to C&B Farms and Interstate Commodities agreeing that the Bank would subordinate its first position lien in the farm products of C&B Farms once the Bank’s 2015 input advances in an agreed upon sum had been paid in full. Interstate Commodities entered into various agreements with C&B Farms in which they agreed to purchase grain at a future date and provided purchase price advance financing to C&B Farms. Interstate Commodities also partially performed under the subordination agreement by paying or allowing certain sums to flow back to the Bank to pay on the agreed upon inputs. Interstate Commodities terminated the payments to the Bank before allowing full repayment of the 2015 inputs financed by the Bank before the subordination agreement was reached. This large, non-performing agricultural relationship was partially charged off during fiscal year 2016 and has no remaining loan balance.

The Bank was served, on October 14, 2016, with a lawsuit captioned Card Limited, LLC v. MetaBank dba Meta Payment Systems, Civil No. 2:16-cv-00980 in the United States District Court for the District of Utah. This action was initiated by a former prepaid program manager of the Bank, which was terminated by the Bank earlier this year. Card Limited alleges that after all of the programs were wound down, there were two accounts with a positive balance to which they are entitled. The Bank’s position is that Card Limited is not entitled to the funds contained in said accounts. The total amount to which Card Limited claims it is entitled is $1,579,398. The Bank intends to vigorously defend this claim. An estimate of a range of reasonably possible loss cannot be made at this stage of the litigation because discovery is still being conducted.

Other than the matters set forth above and litigation routine to the Company's or its subsidiaries' respective businesses, there are no other new material pending legal proceedings or updates to which the Company or its subsidiaries is a party.







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NOTE 8.    STOCK OPTION PLAN

The Company maintains the 2002 Omnibus Incentive Plan, as amended and restated, which, among other things, provides for the awarding of stock options and nonvested (restricted) shares to certain officers and directors of the Company.  Awards are granted by the Compensation Committee of the Board of Directors based on the performance of the award recipients or other relevant factors.

Compensation expense for share based awards is recorded over the vesting period at the fair value of the award at the time of grant.  The exercise price of options or fair value of nonvested shares granted under the Company’s incentive plans is equal to the fair market value of the underlying stock at the grant date.

The following tables show the activity of options and nonvested (restricted) shares granted, exercised, or forfeited under the Company’s option and incentive plan for the three months ended December 31, 2016:

 
Number
of
Shares

 
Weighted
Average
Exercise
Price

 
Weighted
Average
Remaining
Contractual
Term (Yrs)

 
Aggregate
 Intrinsic
Value

 
(Dollars in Thousands, Except Share and Per Share Data)
Options outstanding, September 30, 2016
125,560

 
$
25.73

 
2.68

 
$
4,379

Granted

 

 

 

Exercised
(4,023
)
 
35.69

 

 
229

Forfeited or expired
(16,252
)
 
25.00

 

 
1,272

Options outstanding, December 31, 2016
105,285

 
$
25.52

 
2.47

 
$
8,147

 
 
 
 
 
 
 
 
Options exercisable, December 31, 2016
105,285

 
$
25.79

 
2.44

 
$
8,147


 
Number
of
Shares

 
Weighted
Average
Fair Value
at Grant

(Dollars in Thousands, Except Share and Per Share Data)
Nonvested shares outstanding, September 30, 2016
20,656

 
$
41.37

Granted
279,065

 
86.47

Vested
(13,927
)
 
64.72

Forfeited or expired

 

Nonvested shares outstanding, December 31, 2016
285,794

 
$
84.27


During the first quarter of fiscal 2017, stock awards were granted to the Company's three highest paid named executive officers in connection with their signing of employment agreements with the Company. These stock awards vest over eight years.

At December 31, 2016, stock based compensation expense not yet recognized in income totaled $21.9 million, which is expected to be recognized over a weighted average remaining period of 4.14 years.

NOTE 9.    SEGMENT INFORMATION

An operating segment is generally defined as a component of a business for which discrete financial information is available and whose results are reviewed by the chief operating decision-maker. Operating segments are aggregated into reportable segments if certain criteria are met.

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The following tables present segment data for the Company for the three months ended December 31, 2016 and 2015, respectively.

 
Payments
 
Banking
 
Corporate
Services/Other
 
Total
Three Months Ended December 31, 2016
 
 
 
 
 
 
 
Interest income
$
2,912

 
$
10,754

 
$
8,909

 
$
22,575

Interest expense

 
544

 
2,198

 
2,742

Net interest income (expense)
2,912

 
10,210

 
6,711

 
19,833

Provision (recovery) for loan losses
331

 
512

 

 
843

Non-interest income
19,024

 
1,072

 
(747
)
 
19,349

Non-interest expense
20,871

 
5,555

 
10,327

 
36,753

Income (loss) before income tax expense (benefit)
734

 
5,215

 
(4,363
)
 
1,586

 
 
 
 
 
 
 
 
Total assets
87,069

 
1,101,542

 
3,024,718

 
4,213,329

Total deposits
2,435,530

 
225,182

 
1,002,425

 
3,663,137

 
Payments
 
Banking
 
Corporate
Services/Other
 
Total
Three Months Ended December 31, 2015
 
 
 
 
 
 
 
Interest income
$
1,964

 
$
8,851

 
$
7,460

 
$
18,275

Interest expense
40

 
253

 
427

 
720

Net interest income (expense)
1,924

 
8,598

 
7,033

 
17,555

Provision (recovery) for loan losses
80

 
706

 

 
786

Non-interest income
15,352

 
1,056

 
426

 
16,834

Non-interest expense
16,017

 
5,428

 
8,563

 
30,008

Income (loss) before income tax expense (benefit)
1,179

 
3,520

 
(1,104
)
 
3,595

 
 
 
 
 
 
 
 
Total assets
51,359

 
735,222

 
2,173,653

 
2,960,234

Total deposits
2,341,783

 
227,260

 

 
2,569,043


NOTE 10.    NEW ACCOUNTING PRONOUNCEMENTS

Accounting Standards Update (“ASU”) No. 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments

This ASU requires organizations to replace the incurred loss impairment methodology with a methodology reflecting expected credit losses with considerations for a broader range of reasonable and supportable information to substantiate credit loss estimates. This ASU is effective for annual reporting periods beginning after December 15, 2019, and the Company is currently undertaking a data analysis and taking measures so that its systems capture data applicable to the standard.

ASU No. 2016-04, Extinguishment of liabilities (Subtopic 405-20): Recognition of Breakage for Certain Prepaid Stored-Value Products

This ASU requires organizations to derecognize the deposit liabilities for unredeemed prepaid stored-value products (i.e. – breakage) consistent with breakage guidance in Topic 606, Revenue from Contracts with Customers. This ASU is effective for annual reporting periods beginning after December 15, 2017, and the Company is currently assessing the potential impact to the consolidated financial statements.


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ASU No. 2016-02, Leases (Topic 842): Amendments to the Leases Analysis

This ASU requires organizations to recognize lease assets and lease liabilities on the balance sheet, along with disclosing key information about leasing arrangements.  This update is effective for annual reporting periods beginning after December 15, 2018, including interim periods within that reporting period, and the Company is currently taking inventory of all leases and analyzing what their treatment will be under the new guidance.

ASU No. 2014-09, Revenue Recognition – Revenue from Contracts with Customers (Topic 606)

This ASU provides guidance on when to recognize revenue from contracts with customers.  The objective of this ASU is to eliminate diversity in practice related to this topic and to provide guidance that would streamline and enhance revenue recognition requirements.  The ASU defines five steps to recognize revenue, including identify the contract with a customer, identify the performance obligations in the contract, determine a transaction price, allocate the transaction price to the performance obligations and then recognize the revenue when or as the entity satisfies a performance obligation.  This update is effective for annual reporting periods beginning after December 15, 2017, including interim periods within that reporting period, and the Company is currently assessing our different prepaid card programs and income streams to ascertain how breakage will be recognized under the standard.

ASU No. 2015-03, Interest-Imputation of Interest (Subtopic 835-30): Simplifying the Presentation of Debt Issuance Costs

This ASU provides guidance on balance sheet presentation requirements for debt issuance costs and debt discount and premium. The objective of this ASU is to simplify presentation of debt issuance costs by requiring that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts. This update became effective for the Company beginning with its fiscal year ending September 30, 2017, and does not have an impact to the consolidated financial statements.

ASU 2015-17, Income Taxes (Topic 740): Balance Sheet Classification of Deferred Taxes

This ASU requires entities with a classified balance sheet to present all deferred tax assets and liabilities as noncurrent. This update is effective for annual and interim periods in fiscal years beginning after December 15, 2016, and the Company is currently assessing the potential impact to the consolidated financial statements.

ASU 2016-09, Compensation - Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting

This ASU provides guidance to improve the accounting for share-based payment transactions as part of the FASB’s simplification initiative. The ASU changes seven aspects of the accounting for share-based payment award transactions, including: (1) accounting for income taxes; (2) classification of excess tax benefits on the statement of cash flows; (3) forfeitures; (4) minimum statutory tax withholding requirements; (5) classification of employee taxes paid on the statement of cash flows when an employer withholds shares for tax-withholding purposes; (6) practical expedient - expected term (nonpublic companies only); and (7) intrinsic value (nonpublic companies only). This update is effective for annual and interim periods in fiscal years beginning after December 15, 2016, and the Company is currently assessing the potential impact to the consolidated financial statements.

ASU 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments

This ASU addresses eight classification issues related to the statement of cash flows including: debt prepayment or debt extinguishment costs, settlement of zero-coupon bonds, contingent consideration payments made after a business combination, proceeds from the settlement of insurance claims, proceeds from the settlement of corporate-owned life insurance policies, including bank-owned life insurance policies, distributions received from equity method investees, beneficial interests in securitization transactions, and separately identifiable cash flows and application of the predominance principle. This update is effective for annual and interim periods in fiscal years beginning after December 15, 2017, and the Company is currently assessing the potential impact to the consolidated financial statements.


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NOTE 11.          FAIR VALUE MEASUREMENTS

Accounting Standards Codification (“ASC”) 820, Fair Value Measurements defines fair value, establishes a framework for measuring the fair value of assets and liabilities using a hierarchy system and requires disclosures about fair value measurement.  It clarifies that fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants in the market in which the reporting entity transacts.

The fair value hierarchy is as follows:

Level 1 Inputs – Valuation is based upon quoted prices for identical instruments traded in active markets that the Company has the ability to access at measurement date.

Level 2 Inputs – Valuation is based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active and model-based valuation techniques for which significant assumptions are observable in the market.

Level 3 Inputs – Valuation is generated from model-based techniques that use significant assumptions not observable in the market and are used only to the extent that observable inputs are not available.  These unobservable assumptions reflect the Company’s own estimates of assumptions that market participants would use in pricing the asset or liability.  Valuation techniques include use of option pricing models, discounted cash flow models and similar techniques.



Securities Available for Sale and Held to Maturity.  Securities available for sale are recorded at fair value on a recurring basis and securities held to maturity are carried at amortized cost.  Fair value measurement is based upon quoted prices, if available.  If quoted prices are not available, fair values are measured using an independent pricing service.  For both Level 1 and Level 2 securities, management uses various methods and techniques to corroborate prices obtained from the pricing service, including but not limited to reference to dealer or other market quotes, and by reviewing valuations of comparable instruments.  The Company’s Level 1 securities include equity securities and mutual funds.  Level 2 securities include U.S. Government agency and instrumentality securities, U.S. Government agency and instrumentality mortgage-backed securities, municipal bonds, corporate debt securities and trust preferred securities.  The Company had no Level 3 securities at December 31, 2016 or September 30, 2016.

The fair values of securities are determined by obtaining quoted prices on nationally recognized securities exchanges (Level 1 inputs), or valuation based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active and model based valuation techniques for which significant assumptions are observable in the market (Level 2 inputs).  The Company considers these valuations supplied by a third party provider which utilizes several sources for valuing fixed-income securities.  These sources include Interactive Data Corporation, Reuters, Standard and Poor’s, Bloomberg Financial Markets, Street Software Technology, and the third party provider’s own matrix and desk pricing.  The Company, no less than annually, reviews the third party’s methods and source’s methodology for reasonableness and to ensure an understanding of inputs utilized in determining fair value.  Sources utilized by the third party provider include but are not limited to pricing models that vary based by asset class and include available trade, bid, and other market information.  This methodology includes but is not limited to broker quotes, proprietary models, descriptive terms and conditions databases, as well as extensive quality control programs. Monthly, the Company receives and compares prices provided by multiple securities dealers and pricing providers to validate the accuracy and reasonableness of prices received from the third party provider. On a monthly basis, the Investment Committee reviews mark-to-market changes in the securities portfolio for reasonableness.
 
The following table summarizes the fair values of securities available for sale and held to maturity at December 31, 2016 and September 30, 2016.  Securities available for sale are measured at fair value on a recurring basis, while securities held to maturity are carried at amortized cost in the consolidated statements of financial condition.

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Table of Contents

 
Fair Value At December 31, 2016
 
Available For Sale
 
Held to Maturity
(Dollars in Thousands)
Total
 
Level 1
 
Level 2
 
Level 3
 
Total
 
Level 1
 
Level 2
 
Level 3
Debt securities
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Small business administration securities
79,448

 

 
79,448

 

 

 

 

 

Obligations of states and political subdivisions

 

 

 

 
20,119

 

 
20,119

 

Non-bank qualified obligations of states and political subdivisions
737,983

 

 
737,983

 

 
454,513

 

 
454,513

 

Asset-backed securities
118,147

 

 
118,147

 

 

 

 

 

Mortgage-backed securities
534,939

 

 
534,939

 

 
124,469

 

 
124,469

 

Total debt securities
1,470,517

 

 
1,470,517

 

 
599,101

 

 
599,101

 

Common equities and mutual funds
1,254

 
1,254

 

 

 

 

 

 

Total securities
$
1,471,771

 
$
1,254

 
$
1,470,517

 
$

 
$
599,101

 
$

 
$
599,101

 
$

 
Fair Value At September 30, 2016
 
Available For Sale
 
Held to Maturity
(Dollars in Thousands)
Total
 
Level 1
 
Level 2
 
Level 3
 
Total
 
Level 1
 
Level 2
 
Level 3
Debt securities
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Trust preferred securities
$
12,978

 
$

 
$
12,978

 
$

 
$

 
$

 
$

 
$

Small business administration securities
80,719

 

 
80,719

 

 

 

 

 

Obligations of states and political subdivisions

 

 

 

 
20,937

 

 
20,937

 

Non-bank qualified obligations of states and political subdivisions
698,672

 

 
698,672

 

 
477,202

 

 
477,202

 

Asset-backed securities
116,815

 

 
116,815

 

 

 

 

 

Mortgage-backed securities
558,940

 

 
558,940

 

 
134,435

 

 
134,435

 

Total debt securities
1,468,124

 

 
1,468,124

 

 
632,574

 

 
632,574

 

Common equities and mutual funds
1,125

 
1,125

 

 

 

 

 

 

Total securities
$
1,469,249

 
$
1,125

 
$
1,468,124

 
$

 
$
632,574

 
$

 
$
632,574

 
$


Contingent Consideration. The fair value of the cash contingent consideration liability in the SCS acquisition was estimated using an option based income valuation method with significant inputs that are not observable in the market and thus represents a Level 3 fair value measurement as defined in the FASB's ASC 820, Fair Value Measurements and Disclosures. The significant inputs in the Level 3 measurement not supported by market activity included our probability assessments of expected future cash flows related to our acquisition of SCS during the earn-out period.
 
December 31, 2016
 
September 30, 2016
 
Fair Value Measurements Using Input Types
 
Fair Value Measurements Using Input Types
(Dollars in Thousands)
Level 1
Level 2
Level 3
Total
 
Level 1
Level 2
Level 3
Total
Liabilities:
 
 
 
 
 
 
 
 
 
Contingent Consideration
$

$

$
17,259

$
17,259

 
$

$

$

$

     Total liabilities
$

$

$
17,259

$
17,259

 
$

$

$

$


Loans.  The Company does not record loans at fair value on a recurring basis.  However, if a loan is considered impaired, an allowance for loan losses is established.  Once a loan is identified as individually impaired, management measures impairment in accordance with ASC 310, Receivables.

The following table summarizes the assets of the Company that were measured at fair value in the consolidated statements of financial condition on a non-recurring basis as of December 31, 2016 and September 30, 2016.
 

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Table of Contents

 
Fair Value At December 31, 2016
(Dollars in Thousands)
Total
 
Level 1
 
Level 2
 
Level 3
Impaired Loans, net
 
 
 
 
 
 
 
  1-4 family residential mortgage loans
$
67

 
$

 
$

 
$
67

   Commercial operating loans
$
165

 
$

 
$

 
$
165

     Total Impaired Loans
$
232

 
$

 
$

 
$
232

Foreclosed Assets, net
$
76

 
$

 
$

 
$
76

Total
$
308

 
$

 
$

 
$
308

 
Fair Value At September 30, 2016
(Dollars in Thousands)
Total
 
Level 1
 
Level 2
 
Level 3
Impaired Loans, net
 
 
 
 
 
 
 
  1-4 family residential mortgage loans
$
68

 
$

 
$

 
$
68

     Total Impaired Loans
68

 

 

 
68

Foreclosed Assets, net
76

 
 
 
 
 
76

Total
$
144

 
$

 
$

 
$
144

 
Quantitative Information About Level 3 Fair Value Measurements
(Dollars in Thousands)
Fair Value at
December 31, 2016
 
Fair Value at
September 30, 2016
 
Valuation
Technique
 
Unobservable Input
 
Range of Inputs
Impaired Loans, net
$
232

 
68

 
Market approach
 
Appraised values (1)
 
4.00 - 10.00%
Foreclosed Assets, net
$
76

 
76

 
Market approach
 
Appraised values (1)
 
4.00 - 10.00%
Contingent Consideration
$
17,259

 

 
Option based income
 
Discount rate
 
7.20%
 
 
 
 
 
 
 
Risk-free rate
 
1.02%
 
 
 
 
 
 
 
Company specific discount rate
 
1.76%
(1) 
The Company generally relies on external appraisers to develop this information.  Management reduced the appraised value by estimated selling costs in a range of 4% to 10%.


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Table of Contents

The following table discloses the Company’s estimated fair value amounts of its financial instruments.  It is management’s belief that the fair values presented below are reasonable based on the valuation techniques and data available to the Company as of December 31, 2016 and September 30, 2016, as more fully described below.  The operations of the Company are managed from a going concern basis and not a liquidation basis.  As a result, the ultimate value realized for the financial instruments presented could be substantially different when actually recognized over time through the normal course of operations.  Additionally, a substantial portion of the Company’s inherent value is the Bank’s capitalization and franchise value.  Neither of these components have been given consideration in the presentation of fair values below.

The following presents the carrying amount and estimated fair value of the financial instruments held by the Company at December 31, 2016 and September 30, 2016.
 
 
December 31, 2016
 
Carrying
Amount
 
Estimated
Fair Value
 
Level 1
 
Level 2
 
Level 3
 
(Dollars in Thousands)
Financial assets
 
 
 
 
 
 
 
 
 
Cash and cash equivalents
$
695,731

 
$
695,731

 
$
695,731

 
$

 
$

 
 
 
 
 
 
 
 
 
 
Securities available for sale
1,471,771

 
1,471,771

 
1,254

 
1,470,517

 

Securities held to maturity
604,976

 
599,101

 

 
599,101

 

Total securities
2,076,747

 
2,070,872

 
1,254

 
2,069,618

 

 
 
 
 
 
 
 
 
 
 
Loans held-for-sale
1,223

 
1,223

 

 
1,223

 

 
 
 
 
 
 
 
 
 
 
Loans receivable:
 

 
 

 
 

 
 

 
 

One to four family residential mortgage loans
172,877

 
170,283

 

 

 
170,283

Commercial and multi-family real estate loans
440,512

 
432,143

 

 

 
432,143

Agricultural real estate loans
64,014

 
62,973

 

 

 
62,973

Consumer loans
173,164

 
174,796

 

 

 
174,796

Commercial operating loans
50,824

 
50,149

 

 

 
50,149

Agricultural operating loans
33,617

 
33,481

 

 

 
33,481

Premium finance loans
179,508

 
179,874

 

 

 
179,874

Total loans receivable
1,114,516

 
1,103,699

 

 

 
1,103,699

 
 
 
 
 
 
 
 
 
 
Federal Home Loan Bank stock
3,832

 
3,832

 

 
3,832

 

Accrued interest receivable
21,375

 
21,375

 
21,375

 

 

 
 
 
 
 
 
 
 
 
 
Financial liabilities
 

 
 

 
 

 
 

 
 

Noninterest bearing demand deposits
2,473,275

 
2,473,275

 
2,473,275

 

 

Interest bearing demand deposits, savings, and money markets
140,541

 
140,541

 
140,541

 

 

Certificates of deposit
122,334

 
121,830

 

 
121,830

 

Wholesale non-maturing deposits
499,608

 
499,608

 
499,608

 

 

Wholesale certificates of deposit
427,379

 
426,960

 

 
426,960

 

Total deposits
3,663,137

 
3,662,214

 
3,113,424

 
548,790

 

 
 
 
 
 
 
 
 
 
 
Advances from Federal Home Loan Bank
7,000

 
7,940

 

 
7,940

 

Securities sold under agreements to repurchase
3,782

 
3,782

 

 
3,782

 

Capital lease
2,000

 
2,000

 

 
2,000

 

Trust preferred securities
10,310

 
10,436

 

 
10,436

 

Subordinated debentures
73,244

 
76,843

 

 
76,843

 

Accrued interest payable
2,255

 
2,255

 
2,255

 

 


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Table of Contents

 
September 30, 2016
 
Carrying
Amount
 
Estimated
Fair Value
 
Level 1
 
Level 2
 
Level 3
 
(Dollars in Thousands)
Financial assets
 
 
 
 
 
 
 
 
 
Cash and cash equivalents
$
773,830

 
$
773,830

 
$
773,830

 
$

 
$

 
 
 
 
 
 
 
 
 
 
Securities available for sale
1,469,249

 
1,469,249

 
1,125

 
1,468,124

 

Securities held to maturity
619,853

 
632,574

 

 
632,574

 

Total securities
2,089,102

 
2,101,823

 
1,125

 
2,100,698

 

 
 
 
 
 
 
 
 
 
 
Loans receivable:
 

 
 

 
 

 
 

 
 

One to four family residential mortgage loans
162,298

 
163,886

 

 

 
163,886

Commercial and multi-family real estate loans
422,932

 
422,307

 

 

 
422,307

Agricultural real estate loans
63,612

 
63,868

 

 

 
63,868

Consumer loans
37,094

 
36,738

 

 

 
36,738

Commercial operating loans
31,271

 
31,108

 

 

 
31,108

Agricultural operating loans
37,083

 
36,897

 

 

 
36,897

Premium finance loans
171,604

 
172,000

 

 

 
172,000

Total loans receivable
925,894

 
926,803

 

 

 
926,803

 
 
 
 
 
 
 
 
 
 
Federal Home Loan Bank stock
47,512

 
47,512

 

 
47,512

 

Accrued interest receivable
17,199

 
17,199

 
17,199

 

 

 
 
 
 
 
 
 
 
 
 
Financial liabilities
 

 
 

 
 

 
 

 
 

Noninterest bearing demand deposits
2,167,522

 
2,167,522

 
2,167,522

 

 

Interest bearing demand deposits, savings, and money markets
136,568

 
136,568

 
136,568

 

 

Certificates of deposit
125,992

 
125,772

 

 
125,772

 

Total deposits
2,430,082

 
2,429,862

 
2,304,090

 
125,772

 

 
 
 
 
 
 
 
 
 
 
Advances from Federal Home Loan Bank
107,000

 
108,168

 

 
108,168

 

Federal funds purchased
992,000

 
992,000

 
992,000

 

 

Securities sold under agreements to repurchase
3,039

 
3,039

 

 
3,039

 

Capital lease
2,018

 
2,018

 

 
2,018

 

Trust preferred securities
10,310

 
10,437

 

 
10,437

 

Subordinated debentures
73,211

 
77,250

 

 
77,250

 

Accrued interest payable
875

 
875

 
875

 

 


The following sets forth the methods and assumptions used in determining the fair value estimates for the Company’s financial instruments at December 31, 2016 and September 30, 2016.
 
CASH AND CASH EQUIVALENTS
The carrying amount of cash and short-term investments is assumed to approximate the fair value.
 
SECURITIES AVAILABLE FOR SALE AND HELD TO MATURITY
Securities available for sale are recorded at fair value on a recurring basis and securities held to maturity are carried at amortized cost.  Fair values for investment securities are based on obtaining quoted prices on nationally recognized securities exchanges, or matrix pricing, which is a mathematical technique widely used in the industry to value debt securities without relying exclusively on quoted prices for the specific securities, but rather by relying on the securities’ relationship to other benchmark quoted securities.

LOANS HELD FOR SALE
The carrying amount of loans held for sale is assumed to approximate the fair value.


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LOANS RECEIVABLE, NET
The fair value of loans is estimated using a historical or replacement cost basis concept (i.e. an entrance price concept).  The fair value of loans was estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers and for similar remaining maturities.  When using the discounting method to determine fair value, loans were grouped by homogeneous loans with similar terms and conditions and discounted at a target rate at which similar loans would be made to borrowers at December 31, 2016 or September 30, 2016.  In addition, when computing the estimated fair value for all loans, allowances for loan losses have been subtracted from the calculated fair value as a result of the discounted cash flow which approximates the fair value adjustment for the credit quality component.
 
FEDERAL HOME LOAN BANK (“FHLB”) STOCK
The fair value of such stock is assumed to approximate book value since the Company is only able to redeem this stock at par value.
 
ACCRUED INTEREST RECEIVABLE
The carrying amount of accrued interest receivable is assumed to approximate the fair value.
 
DEPOSITS
The carrying values of non-interest bearing checking deposits, interest bearing checking deposits, savings, money markets, and wholesale non-maturing deposits is assumed to approximate fair value, since such deposits are immediately withdrawable without penalty.  The fair value of time certificates of deposit and wholesale certificates of deposit were estimated by discounting expected future cash flows by the current rates offered on certificates of deposit with similar remaining maturities.
 
In accordance with ASC 825, Financial Instruments, no value has been assigned to the Company’s long-term relationships with its deposit customers (core value of deposits intangible) since such intangibles are not financial instruments as defined under ASC 825.
 
ADVANCES FROM FHLB
The fair value of such advances was estimated by discounting the expected future cash flows using current interest rates for advances with similar terms and remaining maturities.
 
FEDERAL FUNDS PURCHASED
The carrying amount of federal funds purchased is assumed to approximate the fair value.
 
SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE AND SUBORDINATED DEBENTURES
The fair value of these instruments was estimated by discounting the expected future cash flows using derived interest rates approximating market over the contractual maturity of such borrowings.
 
ACCRUED INTEREST PAYABLE
The carrying amount of accrued interest payable is assumed to approximate the fair value.
 
LIMITATIONS
Fair value estimates are made at a specific point in time and are based on relevant market information about the financial instrument.  Additionally, fair value estimates are based on existing on- and off-balance sheet financial instruments without attempting to estimate the value of anticipated future business, customer relationships and the value of assets and liabilities that are not considered financial instruments.  These estimates do not reflect any premium or discount that could result from offering the Company’s entire holdings of a particular financial instrument for sale at one time.  Furthermore, since no market exists for certain of the Company’s financial instruments, fair value estimates may be based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments and other factors.  These estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with a high level of precision.  Changes in assumptions as well as tax considerations could significantly affect the estimates.  Accordingly, based on the limitations described above, the aggregate fair value estimates are not intended to represent the underlying value of the Company, on either a going concern or a liquidation basis.


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NOTE 12.    GOODWILL AND INTANGIBLE ASSETS

The Company held a total of $98.9 million of goodwill as of December 31, 2016. The recorded goodwill was due to two separate business combinations during fiscal 2015 and two separate business combinations during the first quarter of fiscal 2017: $11.6 million of goodwill in connection with the purchase of substantially all of the commercial loan portfolio and related assets of AFS/IBEX on December 2, 2014; $25.4 million of goodwill in connection with the purchase of substantially all of the assets and liabilities of Refund Advantage on September 8, 2015; $30.4 million of goodwill in connection with the purchase of substantially all of the assets of EPS on November 1, 2016; and $31.6 million of goodwill in connection with the purchase of substantially all of the assets and specified liabilities of SCS on December 14, 2016. The goodwill associated with these transactions is deductible for tax purposes.
 
As part of each business combination, the Company also recognized the following amortizable intangible assets:
AFS/IBEX
 
 
 
 
 
 
 
 
   
Intangible
Amount Upon Acquisition
 
Accumulated Amortization
 
Balance at December 31, 2016
 
Book Amortization
Period (Years)
 
Method
Trademark
$
540

 
(75
)
 
465

 
15
 
Straight Line
Non-Compete
260

 
(181
)
 
79

 
3
 
Straight Line
Customer Relationships
7,240

 
(2,543
)
 
4,697

 
30
 
Accelerated
Technology/Other
173

 
(105
)
 
68

 
Varied
 
Straight Line
Total
$
8,213

 
(2,904
)
 
5,309

 
 
 
 

Refund Advantage
 
 
 
 
 
 
 
 
   
Intangible
Amount Upon Acquisition
 
Accumulated Amortization
 
Balance at December 31, 2016
 
Book Amortization
Period (Years)
 
Method
Trademark
$
4,950

 
(343
)
 
4,607

 
15
 
Accelerated
Non-Compete
40

 
(18
)
 
22

 
3
 
Straight Line
Customer Relationships
18,800

 
(3,789
)
 
15,011

 
12 to 20
 
Accelerated
Technology/Other
329

 
(90
)
 
239

 
Varied
 
Straight Line
Total
$
24,119

 
(4,240
)
 
19,879

 
 
 
 

EPS
 
 
 
 
 
 
 
 
   
Intangible
Amount Upon Acquisition
 
Accumulated Amortization
 
Balance at December 31, 2016
 
Book Amortization
Period (Years)
 
Method
Trademark
$
5,190

 
(39
)
 
5,151

 
15
 
Accelerated
Non-Compete
1,630

 
(55
)
 
1,575

 
Varied
 
Straight Line
Customer Relationships
10,110

 
(311
)
 
9,799

 
20
 
Accelerated
Technology/Other
1,000

 
(55
)
 
945

 
3
 
Straight Line
Total
$
17,930

 
(460
)
 
17,470

 
 
 
 

SCS
 
 
 
 
 
 
 
 
   
Intangible
Amount Upon Acquisition
 
Accumulated Amortization
 
Balance at December 31, 2016
 
Book Amortization
Period (Years)
 
Method
Trademark
$
290

 
(4
)
 
286

 
5
 
Accelerated
Non-Compete
580

 
(6
)
 
574

 
Varied
 
Straight Line
Customer Relationships
22,120

 

 
22,120

 
Varied
 
Accelerated
Technology/Other
5,100

 
(14
)
 
5,086

 
15
 
Straight Line
Total
$
28,090

 
(24
)
 
28,066

 
 
 
 

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Other
 
 
 
 
 
 
 
 
   
Intangible
Total Accumulated Costs, Net (1)
 
Accumulated Amortization
 
Balance at December 31, 2016
 
Book Amortization
Period (Years)
 
Method
Technology/Other
$
3,110

 
(362
)
 
2,748

 
Varied
 
Straight Line
Total
$
3,110

 
(362
)
 
2,748

 
 
 
 
(1) Net of Patents write-offs, to date, totaling, $378K.

The changes in the carrying amount of the Company’s goodwill and intangible assets for the three months ended December 31, 2016 and 2015 were as follows:
 
 
2016
 
2015
 
(Dollars in Thousands)
Goodwill
 
 
 
Balance as of September 30,
$
36,928

 
$
36,928

Acquisitions during the period
61,970

 

Write-offs during the period

 

Balance as of December 31,
$
98,898

 
$
36,928

 
Trademark
 
Non-Compete
 
Customer
Relationships
 
All Others
 
Total
Intangibles
 
Balance as of September 30, 2016
$
5,149

 
$
127

 
$
20,590

 
$
3,055

 
$
28,921

Acquisitions during the period
5,480

 
2,210

 
32,230

 
6,156

 
46,076

Amortization during the period
(120
)
 
(86
)
 
(1,193
)
 
(126
)
 
(1,525
)
Write-offs during the period

 

 

 

 

Balance as of December 31, 2016
$
10,509

 
$
2,251

 
$
51,627

 
$
9,085

 
$
73,472


 
Trademark
 
Non-Compete
 
Customer
Relationships
 
All Others
 
Total
Intangibles
 
Balance as of September 30, 2015
$
5,439

 
$
227

 
$
24,811

 
$
3,100

 
$
33,577

Acquisitions during the period

 

 

 
54

 
54

Amortization during the period
(72
)
 
(25
)
 
(1,064
)
 
(52
)
 
(1,213
)
Write-offs during the period

 

 

 

 

Balance as of December 31, 2015
$
5,367

 
$
202

 
$
23,747

 
$
3,102

 
$
32,418


The Company tests intangible assets for impairment at least annually or more often if conditions indicate a possible impairment.  There were no impairment to intangible assets during the three months ended December 31, 2016 and 2015.  The annual goodwill impairment test will be conducted at September 30, 2017.
 
NOTE 13.    REGULATORY MATTERS AND SETTLEMENT OF OTS ENFORCEMENT ACTIONS

On January 5, 2015, the Federal Deposit Insurance Corporation (“FDIC”) published industry guidance in the form of Frequently Asked Questions (“FAQs”) with respect to the categorization of deposit liabilities as “brokered” deposits. On November 13, 2015, the FDIC issued for comment updated and annotated FAQs, and on June 30, 2016, the FDIC finalized the FAQs. The Company believes that the final FAQs do not materially impact the processes that it uses to identify, accept and report brokered deposits. On April 26, 2016, the FDIC issued a final rule to amend how small banks (less than $10 billion in assets that have been FDIC insured for at least five years) are assessed for deposit insurance (the "Final Rule"). The Final Rule will impose higher assessments for banks that FDIC believes present higher risk profiles. The Final Rule becomes effective with the Bank's December 2016 assessment invoice, which the Company expects to receive in March 2017.


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Due to the Bank’s status as a "well-capitalized" institution under the FDIC's prompt corrective action regulations, and further with respect to the Bank’s financial condition in general, the Company does not at this time anticipate that either the FAQs or the Final Rule will have a material adverse impact on the Company’s business operations.  However, should the Bank ever fail to be well-capitalized in the future, as a result of failing to meet the well-capitalized requirements, or the imposition of an individual minimum capital requirement or similar formal requirements, then, notwithstanding that the Bank has capital in excess of the well-capitalized minimum requirements, the Bank would be prohibited, absent waiver from the FDIC, from utilizing brokered deposits (i.e., may not accept, renew or rollover brokered deposits), which could produce serious adverse effects on the Company’s liquidity, and financial condition and results of operations.  Similarly, should the Bank’s financial condition in general deteriorate, future FDIC assessments could have a material adverse effect on the Company.

NOTE 14.    SUBSEQUENT EVENTS

Management has evaluated subsequent events.  There were no material subsequent events that would require recognition or disclosure in our consolidated financial statements as of or for the quarter ended December 31, 2016.


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Item 2.    Management’s Discussion and Analysis of Financial Condition and Results of Operations.

META FINANCIAL GROUP, INC®.
AND SUBSIDIARIES
 
FORWARD LOOKING STATEMENTS
 
Meta Financial Group, Inc.®, (“Meta Financial” or “the Company” or “us”) and its wholly-owned subsidiary, MetaBank® (the “Bank” or “MetaBank”), may from time to time make written or oral “forward-looking statements,” including statements contained in this Quarterly Report on Form 10-Q, in its other filings with the Securities and Exchange Commission (“SEC”), in its reports to stockholders, and in other communications by the Company and the Bank, 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: the potential benefits of the acquisitions of assets from Specialty Consumer Services LP ("SCS") and EPS Financial, LLC ("EPS"), including but not limited to, whether such acquisitions may increase the Company's growth; future operating results; customer retention; loan and other product demand; important components of the Company's statements of financial condition and operations; growth and expansion; new products and services, such as those offered by the Bank or Meta Payment Systems® (“MPS”), a division of the Bank; credit quality and adequacy of reserves; technology; and the Company's employees. 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: the risk that the businesses of the Bank, EPS and SCS may not be combined successfully, or any such combination may take longer or be more difficult, time-consuming or costly to accomplish than expected; the risk that sales of EPS and SCS products by the Bank may not be as high as anticipated; the risk that the expected growth opportunities or cost savings from the EPS and SCS acquisitions may not be fully realized or may take longer to realize than expected, that customer losses and business disruption following the EPS and SCS acquisitions, including adverse effects on relationships with former or current employees of EPS and SCS, may be greater than expected; the risk that the Company may incur unanticipated or unknown losses or liabilities in connection with the EPS and SCS acquisitions; the risk that loan production levels and other anticipated benefits related to the recent agreements signed with H&R Block and Jackson Hewitt may not be as much as anticipated, and that the Company may incur unanticipated or unknown risks, losses or liabilities in connection with such transactions; maintaining our executive management team; the strength of the United States' economy, in general, and the strength of the local economies in which the Company conducts operations; the effects of, and changes in, trade, monetary, and fiscal policies and laws, including interest rate policies of the Board of Governors of the Federal Reserve System (the “Federal Reserve”), as well as efforts of the United States Treasury in conjunction with bank regulatory agencies to stimulate the economy and protect the financial system; inflation, interest rate, market, and monetary fluctuations; the timely development of, and acceptance of new products and services offered by the Company, as well as risks (including reputational and litigation) attendant thereto, and the perceived overall value of these products and services by users; the risks of dealing with or utilizing third parties; any actions which may be initiated by our regulators in the future; the impact of changes in financial services laws and regulations, including, but not limited to, laws and regulations relating to the tax refund industry and the insurance premium finance industry, our relationship with our primary regulators, the Office of the Comptroller of the Currency (“OCC”) and the Federal Reserve, as well as the Federal Deposit Insurance Corporation (“FDIC”), which insures the Bank’s deposit accounts up to applicable limits; technological changes, including, but not limited to, the protection of electronic files or databases; acquisitions; litigation risk, in general, including, but not limited to, those risks involving the Bank's divisions; the growth of the Company’s business, as well as expenses related thereto; continued maintenance by the Bank of its status as a well-capitalized institution, particularly in light of our growing deposit base, a substantial portion of which has been characterized as “brokered”; changes in consumer spending and saving habits; 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.





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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 speak only as of the date hereof.  All subsequent written and oral forward-looking statements attributable to us or any person acting on our behalf are expressly qualified in their entirety by the cautionary statements contained or referred to in this section.  Additional discussions of factors affecting the Company’s business and prospects are included under the caption "Risk Factors" and in other sections of the Company’s Annual Report on Form 10-K for the fiscal year ended September 30, 2016 and in 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.

GENERAL
 
The Company, a registered unitary savings and loan holding company, is a Delaware corporation, the principal assets of which are all the issued and outstanding shares of the Bank, a federal savings bank.  Unless the context otherwise requires, references herein to the Company include Meta Financial and the Bank, and all direct or indirect subsidiaries of Meta 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 December 31, 2016, compared to September 30, 2016, and the consolidated results of operations for the three months ended December 31, 2016 and 2015.  This discussion should be read in conjunction with the Company’s consolidated financial statements, and notes thereto, for the year ended September 30, 2016 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, 2016.
 
OVERVIEW OF RECENT CORPORATE DEVELOPMENTS
 
MetaBank entered into an agreement with H&R Block in the first quarter of fiscal 2017 to provide funding for interest and fee free refund advance loans for H&R Block tax preparation customers throughout the 2017 tax season. H&R Block is the world's largest tax services provider with approximately 12,000 company-owned and franchise retail locations.

On November 1, 2016, MetaBank, completed the acquisition from privately-held Drake Enterprises, Ltd. (“Drake”) of substantially all of the assets and certain liabilities of EPS, a leading provider of comprehensive tax-related financial transaction solutions for over 10,000 electronic return originators nationwide. These solutions include a full-suite of refund settlement products, prepaid payroll card solutions and merchant services, offering a one-stop shop for all tax preparer financial transactions. The purchase price for the acquisition included the payment of approximately $21.9 million in cash and the issuance of 369,179 shares of Meta Financial common stock to Drake. MetaBank acquired EPS assets with estimated fair values of $17.9 million of intangible assets, including customer relationships, trademark, and non-compete agreements, and $0.1 million of other assets, resulting in goodwill of $30.4 million. The Company also recorded a negligible amount of other liabilities.

On December 14, 2016, MetaBank completed the acquisition of substantially all of the assets and specified liabilities of SCS, a FinTech provider of consumer tax advances and other consumer credit services through its propriety underwriting model and loan management system. The assets acquired by MetaBank in the SCS acquisition include the SCS trade name, propriety underwriting model and loan management system and other assets. The purchase price for the acquisition included the payment of approximately $7.5 million in cash to SCS and the issuance of 113,328 shares of Meta Financial common stock to SCS’ stakeholders on behalf of SCS. In addition, contingent consideration of up to $41.4 million (estimated fair value), payable in cash and Meta common stock, will be paid if certain performance benchmarks are achieved subsequent to closing. MetaBank acquired SCS assets with estimated fair values of $28.1 million of intangible assets, including customer relationships, trademark, and non-compete agreements, and negligible other assets, resulting in goodwill of $31.6 million. The Company also recorded a liability of $17.3 million, which consisted of the fair value of the contingent cash earn out.

In the first quarter of fiscal 2017, MetaBank and Jackson Hewitt entered into an agreement whereby MetaBank will be originating, underwriting and servicing Express Refund Advances to Jackson Hewitt customers.

As previously announced on December 8, 2016, Rodney Muilenburg, 72, retired from Meta's Board of Directors after 27 years of service effective at the end of his term at the Company's annual meeting on January 23, 2017.



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On December 20, 2016, MetaBank purchased, net of purchase discount, a $134.0 million seasoned, floating rate, private student loan portfolio. All loans are indexed to three-month LIBOR plus various margins. The portfolio is serviced by ReliaMax Lending Services, LLC and insured by ReliaMax Surety Company. Based on the purchase discount and projected prepayment rates, the Company expects to realize current net yields of over 5%.

FINANCIAL CONDITION
 
At December 31, 2016, the Company’s assets grew by $206.9 million, or 5%, to $4.21 billion compared to $4.01 billion at September 30, 2016. The increase in assets was due primarily to increases in net loans receivable funded by significant deposit growth as the Company tested funding lines for tax-related lending as well as growth in goodwill and intangible assets due to the Company's recent acquisitions.

Total cash and cash equivalents were $695.7 million at December 31, 2016, a decrease of $78.1 million, or 10%, from $773.8 million at September 30, 2016.  The decrease was primarily the result of the Company’s decreased balances maintained in other banking institutions.  The Company held much higher than typical, historical cash balances as it prepared and tested funding lines for tax-related lending in the Company's second quarter and chose to forgo its typical dollar cost averaging investment purchases in anticipation of the tax related lending. The Company maintains its cash investments primarily in interest-bearing overnight deposits with the FHLB of Des Moines and the Federal Reserve Bank.  Consistent with December 31, 2015, the Company did not have any federal funds purchased at December 31, 2016.

The total of mortgage-backed securities (“MBS”) and investment securities decreased $12.4 million, or 0.6%, to $2.08 billion at December 31, 2016, compared to $2.09 billion at September 30, 2016, as investment purchases did not exceed maturities, sales, and principal pay downs.  The Company’s portfolio of investment securities and MBS securities consists primarily of U.S. Government agency and instrumentality MBS, which have relatively short expected lives, U.S. Government related asset backed securities, and high quality non-bank qualified obligations of states and political subdivisions (“NBQ”), which mature in approximately 15 years or less.  Of the total MBS, $534.9 million are classified as available for sale, and $126.4 million are classified as held to maturity.  Of the total investment securities, $936.8 million are classified as available for sale and $478.6 million are classified as held to maturity. During the three month period ended December 31, 2016, the Company did not purchase any MBS securities and purchased $144.0 million of investment securities available for sale, with the available for sale purchases consisting primarily of Ginnie Mae (“GNMA”) backed municipal housing securities.  These securities are NBQ, tax free municipal securities that receive principal and interest directly from the underlying GNMA pool.  These bonds are also convertible, at our request, directly into the GNMA MBS securing the bond.
 
The Company’s portfolio of net loans receivable increased $187.6 million, or 20%, to $1.11 billion at December 31, 2016, from $925.1 million at September 30, 2016. This increase is primarily attributable to a $136.1 million increase in consumer loans primarily due to the student loan portfolio purchase, a $19.6 million, or 63%, increase in commercial operating loans, an increase in electronic return originator ("ERO") advances of $13.5 million, a $17.6 million, or 4%, increase in commercial real estate loans, a $10.6 million, or 7%, increase in residential mortgage loans, and a $7.9 million, or 5%, increase in premium finance loans, offset in part by a $3.1 million, or 3%, decrease in total agricultural loans, during this period. Retail bank loans increased $31.9 million, or 4%, during this period. Excluding the student loan portfolio purchase, total loans, net of allowance for loan losses, increased $53.6 million, or 6%, from September 30, 2016 to December 31, 2016 and retail bank loans increased $31.9 million, or 4%, during this period. Total loans, net of allowance for loan losses, increased $369.9 million, or 50%, from December 31, 2015 to December 31, 2016.  This increase is due to growth in Banking segment loans of $363.8 million (including $158.4 million and $68.9 million from retail bank and premium finance loans, respectively) and Payments segment loans of $6.2 million. The Banking segment loan increase included a $138.0 million increase in consumer loans, $134.0 million of which was due to the student loan portfolio purchase, a $118.4 million increase, or 37%, in commercial real estate loans and a $68.9 million increase, or 62%, in premium finance loans. The Payments segment loan increase was comprised primarily of ERO advances of $13.5 million. Of the $440.5 million in commercial and multi-family real estate loans at December 31, 2016, $66.0 million were considered high-volatility commercial real estate (“HVCRE”).  While such HVCRE is risk-weighted at 150% rather than 100%, as is customary for non-HVCRE commercial loans, the increase to the Company’s risk-weighted assets has been inconsequential in terms of the Company’s capital ratios.

Total deposits increased $1.23 billion, or 51%, at December 31, 2016, to $3.66 billion from $2.43 billion at September 30, 2016, primarily related to the addition of wholesale deposits executed by the Company during the fiscal 2017 first quarter to prepare for the upcoming tax season, as well as an increase in non-interest bearing deposits. Total wholesale deposits at December 31, 2016 were $927.0 million. The vast majority of the wholesale deposits are temporary and will not remain on the Company's consolidated balance sheet at March 31, 2017. Deposits attributable to MPS increased by $304.5 million, or 14%, to $2.44 billion at December 31, 2016, compared to $2.13 billion at September 30, 2016.  The average balance of total deposits and interest-bearing liabilities was $3.06 billion for the three month period ended December 31, 2016, compared to $2.38 billion for the same period in the prior year. 

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The average balance of non-interest bearing deposits for the three month period ended December 31, 2016 increased by $298.2 million, or 17% to $2.06 billion at December 31, 2016, compared to $1.76 billion for the same period in the prior year.
 
Total borrowings decreased $1.09 billion, or 92%, from $1.19 billion at September 30, 2016 to $96.3 million at December 31, 2016, primarily due to the decrease of federal funds purchased and as a result of the additional, temporary wholesale deposits.  The Company’s overnight federal funds purchased fluctuates on a daily basis due to the nature of a portion of its non-interest bearing deposit base, primarily related to payroll processing timing with a higher volume of overnight federal funds purchased on Monday through Wednesday, which are typically paid down on Thursday and Friday.  Secondarily, a portion of certain programs are prefunded, typically in the final week of the month and the corresponding deposits are received typically on the 1st of the following month causing a temporary increased need for overnight borrowings. Accordingly, our level of borrowings may fluctuate significantly on any particular quarter end date. The addition of wholesale deposits executed by the Company during the fiscal 2017 first quarter to prepare for the upcoming tax season also contributed to the reduction in federal funds purchased.

At December 31, 2016, the Company’s stockholders’ equity totaled $371.8 million, an increase of $36.8 million, from $335.0 million at September 30, 2016.  The increase was attributable to net earnings and an increase in additional paid-in capital due to the Company's fiscal first quarter acquisitions, offset by dividends paid. At December 31, 2016, the Bank continued to exceed all regulatory requirements for classification as a well‑capitalized institution.  See “Liquidity and Capital Resources” for further information.
 
Non-performing Assets and Allowance for Loan Losses
 
Generally, when a loan becomes delinquent 90 days or more for the majority of loan segments, and 210 days or more for premium finance, or when the collection of principal or interest becomes doubtful, the Company will place the loan on a non-accrual status and, as a result, previously accrued interest income on the loan is reversed against current income.  The loan will remain in non-accrual status until the loan becomes current and has demonstrated a sustained period of satisfactory performance, typically after six months.
 
The Company believes that the level of allowance for loan losses at December 31, 2016 is appropriate and reflects probable losses related to these loans; however, there can be no assurance that all loans will be fully collectible or that the present level of the allowance will be adequate in the future.  See “Allowance for Loan Losses” below.
 
The table below sets forth the amounts and categories of non-performing assets in the Company’s portfolio.  Foreclosed assets include assets acquired in settlement of loans.

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Non-Performing Assets As Of
 
December 31, 2016
 
September 30, 2016
Non-Performing Loans
(Dollars in Thousands)
 
 
 
 
Non-Accruing Loans:
 
 
 
1-4 Family Real Estate
$
112

 
$
83

Commercial Operating
505

 

Total (1)
617

 
83

 
 
 
 
Accruing Loans Delinquent 90 Days or More
 

 
 

1-4 Family Real Estate
382

 

Consumer
29

 
53

Premium Finance
1,207

 
965

Total
1,618

 
1,018

 
 
 
 
Total Non-Performing Loans
2,235

 
1,101

 
 
 
 
Other Assets
 

 
 

 
 
 
 
Foreclosed Assets:
 
 
 
   1-4 Family Real Estate
76

 
76

       Total
76

 
76

 
 
 
 
Total Other Assets
$
76

 
$
76

 
 
 
 
Total Non-Performing Assets
$
2,311

 
$
1,177

Total as a Percentage of Total Assets
0.05
%
 
0.03
%
 
(1)
The Company did not have any non-performing troubled debt restructurings ("TDRs") as of December 31, 2016 or September 30, 2016. In addition, the Company had $0.5 million and $0.5 million of TDRs performing in accordance with their terms at each of December 31, 2016 and September 30, 2016.

At December 31, 2016, non-performing loans totaled $2.2 million, representing 0.20% of total loans, compared to $1.1 million, or 0.12% of total loans at September 30, 2016. This increase in non-performing loans was primarily due to the downgrade of a $0.5 million relationship and $0.6 million in increased past due loans.
 
Classified Assets.  Federal regulations provide for the classification of loans and other assets such as debt and equity securities considered by our regulator, the OCC, to be of lesser quality as “substandard,” “doubtful” or “loss.”  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.


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On the basis of management’s review of its loans and other assets, at December 31, 2016, the Company had classified $15.6 million of its assets as substandard and $0.3 million as doubtful and did not classify any assets as loss. At September 30, 2016, the Company classified $9.0 million of its assets as substandard and did not classify any assets as doubtful or loss. 
 
Allowance for Loan Losses.  The allowance for loan losses is established through a provision for loan losses based on management’s evaluation of the risk inherent in its loan portfolio and changes in the nature and volume of its loan activity, including those loans which are being specifically monitored by management.  Such evaluation, which includes a review of loans for which full collectability may not be reasonably assured, involves consideration of, among other matters, the estimated fair value of the underlying collateral, economic conditions, historical loan loss experience and other factors that warrant recognition in providing for an appropriate loan loss allowance.
 
Management closely monitors economic developments both regionally and nationwide, and considers these factors when assessing the appropriateness of its allowance for loan losses. While management believes that the current economic environment is still slightly strained, it has continued to show signs of improvement in the Bank’s markets over the last several years. The Bank’s loss rates over the past seven years have been relatively low for all loan segments, although the Company did have a significant charge off of an agriculture relationship during fiscal year 2016.  Notwithstanding these signs of improvement, the Bank does not believe it is likely these low loss conditions will continue indefinitely.  Although the Bank’s four market areas have indirectly benefited from a relatively stable agricultural market, the market has become somewhat more stressed with lower commodity prices over the last couple of years and commodity prices remain lower than a few years ago.   Management expects that future losses in this portfolio could be higher than recent historical experience.  Management believes the low commodity prices and high land rents have the potential to negatively impact the economies of our agricultural markets.
 
At December 31, 2016, the Company had established an allowance for loan losses totaling $6.4 million, compared to $5.6 million at September 30, 2016. During the three months ended December 31, 2016, the Company recorded a provision for loan losses of $0.8 million, partially offset by $0.1 million of net charge offs, compared to $0.4 million of net charge offs for the three months ended December 31, 2015.  Management believes that, based on a detailed review of the loan portfolio, historic loan losses, current economic conditions, the size of the loan portfolio, and other factors, the current level of the allowance for loan losses at December 31, 2016 reflects an appropriate allowance against probable losses from the loan portfolio.  Although the Company maintains its allowance for loan losses at a level that it considers to be adequate, investors and others are cautioned that there can be no assurance that future losses will not exceed estimated amounts, or that additional provisions for loan losses will not be required in future periods.
 
The allowance for loan losses reflects management’s best estimate of probable losses inherent in the portfolio based on currently available information.  In addition to the factors mentioned above, future additions to the allowance for loan losses may become necessary based upon changing economic conditions, increased loan balances or changes in the underlying collateral of the loan portfolio.  In addition, our regulators have the ability to order us to increase our allowance.
 
CRITICAL ACCOUNTING ESTIMATES
 
The Company’s financial statements are prepared in accordance with U.S. 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.  Based on its consideration of accounting policies that:  (i) involve the most complex and subjective decisions and assessments which may be uncertain at the time the estimate was made, and (ii) different estimates that reasonably could have been used in the current period, or changes in the accounting estimate that are reasonably likely to occur from period to period, would have a material impact on the financial statements, management has identified the policies described below as Critical Accounting Policies.  This discussion and analysis should be read in conjunction with the Company’s financial statements and the accompanying notes presented in Part II, Item 8 “Consolidated Financial Statements and Supplementary Data” of its Annual Report on Form 10-K for the year ended September 30, 2016, and information contained herein.

Allowance for Loan Losses.  The Company’s allowance for loan loss methodology incorporates a variety of risk considerations, both quantitative and qualitative, in establishing an allowance for loan loss that management believes is appropriate at each reporting date.  Quantitative factors include the Company’s historical loss experience, delinquency and charge-off trends, collateral values, changes in nonperforming loans, and other factors.  Quantitative factors also incorporate known information about individual loans, including borrowers’ sensitivity to interest rate movements.  Qualitative factors include the general economic environment in the Company’s markets, including economic conditions throughout the Midwest and, in particular, the state of certain industries.  Size and complexity of individual credits in relation to loan structure, existing loan policies, and pace of portfolio growth are other qualitative factors that are considered in the methodology.  Although management believes the levels of the allowance at both December 31, 2016 and September 30, 2016 were adequate to absorb probable losses inherent in the loan portfolio, a decline in local economic conditions or other factors could result in losses in excess of the applicable allowance.

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 Goodwill and Intangible Assets.  Each quarter, the Company evaluates the estimated useful lives of its amortizable intangible assets and whether events or changes in circumstances warrant a revision to the remaining periods of amortization.  In accordance with ASC 350, Intangibles – Goodwill and Other, recoverability of these assets is measured by comparison of the carrying amount of the asset to the future undiscounted cash flows the asset is expected to generate.  If the asset is considered to be impaired, the amount of any impairment is measured as the difference between the carrying value and the fair value of the impaired asset.
 
In addition, goodwill and intangible assets are tested annually as of our fiscal year end for impairment or more often if conditions indicate a possible impairment.  Determining the fair value of a reporting unit involves the use of significant estimates and assumptions.  These estimates and assumptions include revenue growth rates and operating margins used to calculate future cash flows, risk-adjusted discount rates, future economic and market conditions, comparison of the Company’s market value to book value and determination of appropriate market comparables.  Actual future results may differ from those estimates.

Assumptions and estimates about future values and remaining useful lives of the Company’s intangible and other long-lived assets are complex and subjective.  They can be affected by a variety of factors, including external factors such as industry and economic trends, and internal factors such as changes in the Company’s business strategy and internal forecasts.  Although the Company believes the historical assumptions and estimates used are reasonable and appropriate, different assumptions and estimates could materially impact the reported financial results.
 
Customer relationship, trademark, and non-compete intangibles are amortized over the periods in which the asset is expected to meaningfully contribute to the business as a whole, using either the present value of excess earnings or straight line amortization, depending on the nature of the intangible asset.  Patents are estimated to have a useful life of 20 years, beginning on the date the patent application is originally filed.  Thus, patents are amortized based on the remaining useful life once granted.  Periodically, the Company reviews the intangible assets for events or circumstances that may indicate a change in recoverability of the underlying basis.
 
Deferred Tax Assets.  The Company accounts for income taxes according to the asset and liability method.  Under this method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis.  Deferred tax assets and liabilities are measured using the enacted tax rates applicable to income for the years in which those temporary differences are expected to be recovered or settled.  Deferred tax assets are recognized subject to management’s judgment that realization is more-likely-than-not.  An estimate of probable income tax benefits that will not be realized in future years is required in determining the necessity for a valuation allowance.

Security Impairment.  Management monitors the investment securities portfolio for impairment on a security by security basis.  Management has a process in place to identify securities that could potentially have a credit impairment that is other-than-temporary.  This process involves the length of time and extent to which the fair value has been less than the amortized cost basis, review of available information regarding the financial position of the issuer, monitoring the rating of the security, monitoring changes in value, cash flow projections, and the Company’s intent to sell a security or whether it is more likely than not the Company will be required to sell the security before the recovery of its amortized cost which, in some cases, may extend to maturity.  To the extent we determine that a security is deemed to be other-than-temporarily impaired, an impairment loss is recognized.  If the Company intends to sell a security or it is more likely than not that the Company would be required to sell a security before the recovery of its amortized cost, the Company recognizes an other-than-temporary impairment in earnings for the difference between amortized cost and fair value.  If we do not expect to recover the amortized cost basis, we do not plan to sell the security and if it is not more likely than not that the Company would be required to sell a security before the recovery of its amortized cost, the recognition of the other-than-temporary impairment is bifurcated.  For those securities, the Company separates the total impairment into a credit loss component recognized in earnings, and the amount of the loss related to other factors is recognized in other comprehensive income net of taxes.
 
The amount of the credit loss component of a debt security impairment is estimated as the difference between amortized cost and the present value of the expected cash flows of the security.  The present value is determined using the best estimate of cash flows discounted at the effective interest rate implicit to the security at the date of purchase or the current yield to accrete an asset- backed or floating rate security.  Cash flow estimates for trust preferred securities are derived from scenario-based outcomes of forecasted default rates, loss severity, prepayment speeds and structural support.

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Table of Contents

Level 3 Fair Value Measurement. U.S. GAAP requires the Company to measure the fair value of financial instruments under a standard which describes three levels of inputs that may be used to measure fair value.  Level 3 measurement includes significant unobservable inputs that reflect the Company’s own assumptions about the assumptions that market participants would use in pricing an asset or liability.  Level 3 assets and liabilities include financial instruments whose value is determined using pricing models, discounted cash flow methodologies, or similar techniques, as well as instruments for which the determination of fair value requires significant management judgment or estimation.  Although management believes that it uses a best estimate of information available to determine fair value, due to the uncertainty of future events, the approach includes a process that may differ significantly from other methodologies and still produce an estimate that is in accordance with U.S. GAAP.
 
RESULTS OF OPERATIONS
 
General. The Company recorded net income of $1.2 million, or $0.14 per diluted share, for the three months ended December 31, 2016, compared to net income of $4.1 million, or $0.49 per diluted share, for the three months ended December 31, 2015. The 2017 fiscal first quarter pre-tax results included $1.5 million in amortization of intangibles, $1.2 million in securities losses, $1.2 million in non-cash stock-related compensation associated with employment agreements for three named executive officers, $1.0 million in direct tax season start-up expenses, and $1.0 million of acquisition-related expenses. Total revenue for the fiscal 2017 first quarter was $39.2 million, compared to $34.4 million for the same quarter in 2016, an increase of $4.8 million, or 14%, primarily due to growth in card fee income, income from tax-exempt securities (included in other investment securities), and interest from loans, which was partially offset, as expected, by delayed securities purchases and higher cash balances.

Seasonality.  In the industries for electronic payments processing and tax refund processing, companies commonly experience seasonal fluctuations in revenue.  For example, in recent years, our results of operations for the first half of each fiscal year have been favorably affected by large numbers of taxpayers electing to receive their tax refunds via direct deposit on our pre-paid cards, which caused our operating revenues to be typically higher in the first half of those years than they were in the corresponding second half of those years.  Additionally, our tax refund processing services business is highly seasonal as it generates the majority of its revenue in the second fiscal quarter. We expect our revenue to continue to be based on seasonal factors that affect the electronic payments processing and tax refund processing industries as a whole. We and our tax preparation partners rely on the Internal Revenue Services (the “IRS”), technology, and employees when processing and preparing tax refunds and tax-related products and services.

Net Interest Income.  Net interest income for the fiscal 2017 first quarter increased by $2.3 million, or 13%, to $19.8 million from $17.6 million for the same period in the prior fiscal year primarily due to increases in volume of tax exempt and asset backed investments and continued sizable loan growth funded by non-interest bearing prepaid deposit growth. Additionally, the overall increase was driven by a better mix and higher percentage of loans and higher yielding investments primarily in high credit quality tax-exempt municipal bonds. While the Company carried a higher than typical cash balance due to testing and implementation of new funding programs to support the interest and fee free refund advance loans, overall net interest income was not materially affected as the funding costs were similar to the rate earned on excess cash balances. However, due to the student loan portfolio purchase and tax-related lending, the Company deferred significant securities purchases that would have historically taken place in the August through December months. As a result of the deferral of securities purchases, net interest income was negatively affected, as compared to the comparable prior fiscal year period. Given the significant, recent increase in interest rates, we expect these deferred purchases, which the Company anticipates will take place in February and March 2017, to have significantly higher yields that will have a strong, positive effect on earnings going forward.

Net Interest Margin (“NIM”) decreased from 3.21% in the fiscal 2016 first quarter to 2.90% in the fiscal 2017 first quarter.  NIM during the 2017 first quarter was adversely impacted as the Company carried a higher than typical cash balance due to testing and implementation of new funding programs to support the interest-free tax refund advance lending program, together with a full quarter of interest expense related to our 5.75% fixed-to-floating rate subordinated notes issued in August 2016. While the subordinated debt issuance in 2016 increased the cost of funds at the Company level, MetaBank's cost of funds remained at levels much lower than the overall Company cost of funds, though somewhat higher than historical levels due to preparation for the new tax season funding programs. Overall, tax equivalent yield (“TEY”) on average earning assets decreased by nine basis points in the 2017 first quarter, compared to the 2016 first quarter, primarily driven by the aforementioned higher than typical cash balances.

The fiscal 2017 first quarter TEY on the securities portfolio increased by two basis points compared to the comparable prior year fiscal quarter primarily due to a shifting mix in the investment portfolio, with new investments in overall higher yielding investment securities rather than MBS. We expect margins to increase in fiscal 2017 with slower premium amortization on the MBS portfolio if recent higher rates continue. The 2017 first quarter yield on MBS decreased by 27 basis points compared to the same period of the prior year, while longer term interest rates experienced significant volatility and overall trended downward.  Non-MBS investment securities yield increased by five basis points, compared to the same prior year quarter. 


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Table of Contents

We believe that the purchase of the floating-rate student loan portfolio and the floating rate government related asset-backed securities, as well as the growing AFS/IBEX loan portfolio, provides a higher runway for the Company's normalized NIM should short-term interest rates continue to rise. The Company also seeks to remain diligent and disciplined when evaluating sizable loan pool deal flow to continue to optimize the deployment of our national, non-interest bearing deposit base. We anticipate that many of these loan pools could add immediate earnings accretion with acceptable risk parameters as we believe to be the case with the recent student loan portfolio purchase. In that respect, while the addition of the student loan portfolio did not materially affect NIM or the TEY on average earning assets in the current quarter as the portfolio purchase was completed near the end of the quarter, the impact should be positive going forward if interest rates continue to rise. Management believes that the increase in non-interest-bearing liabilities aids NIM improvement, and highlights the competitive advantage of the growing MPS deposit base, particularly if interest rates rise.

The Company’s average interest-earning assets for the fiscal 2017 first quarter increased by $719.8 million, or 29%, to $3.22 billion, up from $2.50 billion during the same quarter last fiscal year, primarily from growth in the securities and loan portfolios of $344.1 million and $234.9 million, respectively.
 
The Company’s average total deposits and interest-bearing liabilities for the 2017 first fiscal quarter increased $680.0 million, or 29%, to $3.06 billion from $2.38 billion for the same quarter of the prior fiscal year.  This increase was generated primarily from an increase in wholesale deposits along with increases in MPS-related non-interest bearing deposits, time deposits and savings deposits. MPS average quarterly deposits for the fiscal 2017 first quarter increased $280.2 million, or 16%, from the same period last year.  This increase resulted almost entirely from growth in core prepaid card programs and the addition of several new prepaid partners. Total wholesale deposits increased $927.0 million at December 31, 2016 compared to December 31, 2015. Overall, rates on all deposits and interest-bearing liabilities increased by twenty-four basis points from 0.12% in the fiscal 2016 first quarter to 0.36% in the comparable 2017 period. The subordinated debt issuance in 2016 impacted this increase by 14 basis points. At December 31, 2016 and 2015, low-cost checking deposits represented 70% and 95% of total deposits, respectively.
 




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Table of Contents

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.  Tax equivalent adjustments have been made in yield on interest bearing assets and net interest margin.  Non-accruing loans have been included in the table as loans carrying a zero yield.

Three Months Ended December 31,
2016
 
2015
(Dollars in Thousands)
 
Average
Outstanding
Balance
 
Interest
Earned /
Paid
 
Yield /
Rate
 
Average
Outstanding
Balance
 
Interest
Earned /
Paid
 
Yield /
Rate
Interest-earning assets:
 
 
 
 
 
 
 
 
 
 
 
  Specialty Finance Loans*
$
200,954

 
$
2,509

 
4.95
%
 
$
113,914

 
$
1,623

 
5.67
%
  Retail Bank Loans
768,730

 
8,169

 
4.22
%
 
620,870

 
6,696

 
4.29
%
  Mortgage-Backed Securities
689,617

 
3,320

 
1.91
%
 
679,094

 
3,713

 
2.18
%
  Tax Exempt Investment Securities
1,172,252

 
6,902

 
3.59
%
 
941,982

 
5,427

 
3.53
%
   Asset-Backed Securities
117,928

 
695

 
2.34
%
 

 

 
%
  Other Investment Securities
87,029

 
589

 
2.69
%
 
101,661

 
637

 
2.90
%
  Cash & Fed Funds Sold
186,565

 
391

 
0.83
%
 
45,723

 
179

 
1.56
%
Total interest-earning assets
3,223,075

 
$
22,575

 
3.24
%
 
2,503,244

 
$
18,275

 
3.33
%
Non-interest-earning assets
267,947

 
 
 
 
 
183,467

 
 
 
 
Total assets
$
3,491,022

 
 
 
 
 
$
2,686,711

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Non-interest bearing deposits
$
2,055,842

 
$

 
0.00
%
 
$
1,757,603

 
$

 
0.00
%
Interest-bearing liabilities:
 
 
 
 
 
 
 
 
 
 
 
Interest-bearing checking
38,229

 
39

 
0.40
%
 
34,537

 
21

 
0.24
%
Savings
50,528

 
7

 
0.06
%
 
45,599

 
6

 
0.05
%
Money markets
47,605

 
21

 
0.18
%
 
44,846

 
18

 
0.16
%
Time deposits
131,169

 
259

 
0.78
%
 
85,656

 
118

 
0.55
%
Wholesale funding
357,224

 
612

 
0.68
%
 

 

 
%
FHLB advances
20,043

 
141

 
2.80
%
 
117,870

 
206

 
0.69
%
Overnight fed funds purchased
271,272

 
392

 
0.57
%
 
278,924

 
238

 
0.34
%
Subordinated debentures
73,223

 
1,111

 
6.02
%
 

 

 
%
Other borrowings
15,580

 
160

 
4.06
%
 
15,678

 
113

 
2.87
%
Total interest-bearing liabilities
1,004,873

 
2,742

 
1.08
%
 
623,110

 
720

 
0.46
%
Total deposits and interest-bearing liabilities
3,060,715

 
$
2,742

 
0.36
%
 
2,380,713

 
$
720

 
0.12
%
Other non-interest bearing liabilities
78,219

 
 
 
 
 
31,210

 
 
 
 
Total liabilities
3,138,934

 
 
 
 
 
2,411,923

 
 
 
 
Shareholders' equity
352,088

 
 
 
 
 
274,788

 
 
 
 
Total liabilities and shareholders' equity
$
3,491,022

 
 
 
 
 
$
2,686,711

 
 

 
 

Net interest income and net interest rate spread including non-interest bearing deposits
 
 
$
19,833

 
2.88
%
 
 
 
$
17,555

 
3.21
%
 
 
 
 
 
 
 
 
 
 
 
 
Net interest margin
 

 
 
 
2.90
%
 
 
 
 
 
3.21
%
*Specialty Finance Loan Receivables include loan portfolios the Company deems as non-retail bank product offerings or loans not generated by the Retail Bank itself (for example, premium finance and purchased loan portfolios). The loan receivables included in this line item are included in the customary loan categories presented elsewhere in this report.


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Table of Contents

The following table presents, for the periods indicated, the Company’s total dollar amount of interest income from average securities portfolio assets and the resulting yields expressed both in dollars and rates.  Tax equivalent adjustments have been made in the yield.
Three Months Ended December 31,
2016
 
2015
(Dollars in Thousands)
 
Average
Outstanding
Balance
 
Interest
Earned /
Paid
 
Yield /
Rate
(1)
 
Average
Outstanding
Balance
 
Interest
Earned /
Paid
 
Yield /
Rate
(2)
Securities Portfolio Assets
 
 
 
 
 
 
 
 
 
 
 
Mortgage-backed securities
$
689,617

 
$
3,320

 
1.91
%
 
$
679,094

 
$
3,713

 
2.18
%
*Other investments
1,377,209

 
8,186

 
3.43
%
 
1,043,643

 
6,064

 
3.38
%
Total Securities Portfolio Assets
$
2,066,826

 
$
11,506

 
2.92
%
 
$
1,722,737

 
$
9,777

 
2.90
%
*Excludes FHLB Stock
 

 
 

 
 

 
 

 
 

 
 

(1)
Tax rate used to arrive at a TEY for three months ended December 31, 2016 is 35%
(2)
Tax rate used to arrive at a TEY for three months ended December 31, 2015 is 34%

Provision for Loan Losses.  The Company recorded a $0.8 million provision for loan losses in each of the three month periods ended December 31, 2016 and December 31, 2015.  See Note 3 to the Condensed Consolidated Financial Statements.

Non-Interest Income.  Non-interest income for the fiscal 2017 first quarter increased by $2.5 million, or 15%, to $19.3 million from $16.8 million for the same period in the prior fiscal year.  The change was primarily due to an increase in card fee income from new and existing business partners of $3.2 million and tax product fee income of $0.5 million, which was partially offset by a loss on sale from the investment portfolio of $1.3 million.

Non-Interest Expense.  Non-interest expense increased $6.7 million, or 22%, to $36.8 million, for the first quarter of fiscal year 2017, as compared to $30.0 million for the same period in fiscal year 2016. Legal expense increased $1.6 million due primarily to the aforementioned acquisitions and loan funding transactions. Tax product expense, which includes fees related to our tax processing business, increased $0.1 million for the three months ended December 31, 2016 compared to December 31, 2015.

Compensation expense increased $3.2 million, or 22%, to $17.9 million for the three months ended December 31, 2016, as compared to $14.7 million for the same period in fiscal year 2016. The increase in compensation was primarily due to the employees added in connection with the EPS and SCS acquisitions, non-cash stock related compensation awards granted in connection with three named executive officers signing employment agreements, and additional staffing to support the Company’s growth initiatives. We expect the growth rate in compensation expense to decrease during the remainder of 2017 as staffing levels grow more modestly.

Other expense increased $0.7 million, occupancy and equipment expense increased $0.6 million and amortization expense increased $0.3 million, primarily due to the recent acquisitions, in each case for the three months ended December 31, 2016, as compared to the three months ended December 31, 2015.

Income Tax.  Income tax expense for the first quarter of fiscal 2017 was $0.3 million, for an effective tax rate of 21.6%, compared to income tax benefit of $0.5 million, for an effective tax rate of (12.9)%, for the same period in the prior fiscal year.  The increase in the effective tax rate is mainly due to increased annual projected taxable earnings for fiscal 2017 and the effective tax rate is expected to stay approximately at that level for the remainder of fiscal 2017.

LIQUIDITY AND CAPITAL RESOURCES

On August 15, 2016, the Company announced that it had completed the public offering of $75 million of its 5.75% fixed-to-floating rate subordinated debentures due August 15, 2026. Use of proceeds from the offering are for general purposes, acquisitions and investments in MetaBank as Tier 1 capital to support growth.

The Company’s primary sources of funds are deposits, derived principally through its MPS division, and to a lesser extent through its Retail Bank division, borrowings, principal and interest payments on loans and mortgage-backed securities, and maturing investment securities. 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.

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The Company uses its capital resources principally to meet ongoing commitments to fund maturing certificates of deposits and loan commitments, to maintain liquidity, and to meet operating expenses.  At December 31, 2016, the Company had commitments to originate and purchase loans and unused lines of credit totaling $228.9 million.  The Company believes that loan repayments and other sources of funds will be adequate to meet its foreseeable short- and long-term liquidity needs. During the first quarter of fiscal 2017, the Company entered into an agreement, effective January 1, 2017, with H&R Block to provide interest and fee free refund advance loans for H&R Block tax preparation customers throughout the 2017 tax season.

In July 2013, the Company’s primary federal regulator, the Federal Reserve, and the Bank’s primary federal regulator, the OCC, approved final rules (the “Basel III Capital Rules”) establishing a new comprehensive capital framework for U.S. banking organizations. The Basel III Capital Rules generally implement the Basel Committee on Banking Supervision’s (the “Basel Committee”) December 2010 final capital framework referred to as “Basel III” for strengthening international capital standards.  The Basel III Capital Rules substantially revise the risk-based capital requirements applicable to financial institution holding companies and their depository institution subsidiaries, including us and the Bank, as compared to the current U.S. general risk-based capital rules. The Basel III Capital Rules revise the definitions and the components of regulatory capital, as well as address other issues affecting the numerator in banking institutions’ regulatory capital ratios.  The Basel III Capital Rules also address asset risk weights and other matters affecting the denominator in banking institutions’ regulatory capital ratios and replace the existing general risk-weighting approach, which was derived from the Basel Committee’s 1988 “Basel I” capital accords, with a more risk-sensitive approach based, in part, on the “standardized approach” in the Basel Committee’s 2004 “Basel II” capital accords. In addition, the Basel III Capital Rules implement certain provisions of the Dodd-Frank Act, including the requirements of Section 939A to remove references to credit ratings from the federal agencies’ rules. The Basel III Capital Rules became effective for us and the Bank on January 1, 2015, subject to phase-in periods for certain of their components and other provisions.

Pursuant to the Basel III Capital Rules, the Company and Bank, respectively, are subject to regulatory capital adequacy requirements promulgated by the Federal Reserve and the OCC. Failure by the Company or Bank to meet minimum capital requirements could result in certain mandatory and discretionary actions by our regulators that could have a material adverse effect on our consolidated financial statements. Prior to January 1, 2015, our Bank was subject to capital requirements under Basel I and there were no capital requirements for the Company. Under the capital requirements and the regulatory framework for prompt corrective action, the Company and Bank must meet specific capital guidelines that involve quantitative measures of the Company 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.

Quantitative measures established by regulation to ensure capital adequacy require the Company and the Bank to maintain minimum amounts and ratios (set forth in the table below) of total risk-based capital and Tier I capital (as defined in the regulations) to risk-weighted assets (as defined), and a leverage ratio consisting of Tier I capital (as defined) to average assets (as defined).  At December 31, 2016, both the Bank and the Company 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 accumulated other comprehensive income (“AOCI”) opt-out election; under the rule, non-advanced approach banking organizations were given a one-time option to exclude certain AOCI components. 

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 analysis.

 
 
 
 
 
 
 
Minimum
 
 
 
 
 
 
 
 
Requirement to Be
 
 
 
 
 
 
Minimum
 
Well Capitalized
 
 
 
 
 
 
Requirement For
 
Under Prompt
 
 
 
 
 
 
Capital Adequacy
 
Corrective Action
 
At December 31, 2016
Company
 
Bank
 
Purposes
 
Provisions
 
 
 
 
 
 
 
 
 
 
Tier 1 leverage ratio
7.12
%
 
9.61
%
 
4.00
%
 
5.00
%
 
Common equity Tier 1 capital ratio
13.36

 
18.55

 
4.50

 
6.50

 
Tier 1 capital ratio
13.78

 
18.55

 
6.00

 
8.00

 
Total qualifying capital ratio
18.40

 
18.93

 
8.00

 
10.00

 

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The following table provides certain non-GAAP financial measures used to compute certain of the ratios included in the table above, as well as a reconciliation of such non-GAAP financial measures to the most directly comparable financial measure in accordance with GAAP:
 
Standardized Approach (1)
December 31, 2016
 
(Dollars in Thousands)
 
 
Total equity
$
371,786

Adjustments:


LESS: Goodwill, net of associated deferred tax liabilities
97,288

LESS: Certain other intangible assets
44,083

LESS: Net deferred tax assets from operating loss and tax credit carry-forwards
4,574

LESS: Net unrealized gains (losses) on available-for-sale securities
(5,022
)
Common Equity Tier 1 (1)
230,863

Long-term debt and other instruments qualifying as Tier 1
10,310

LESS: Additional tier 1 capital deductions
3,049

Total Tier 1 capital
238,124

Allowance for loan losses
6,587

Subordinated debentures (net of issuance costs)
73,244

Total qualifying capital
317,955

(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 CET1 ratio; those changes are being fully phased in through the end of 2021.

The following table provides a reconciliation of tangible common equity used in calculating tangible book value data to Total Stockholders' Equity.
 
December 31, 2016
 
(Dollars in Thousands)
Total Stockholders' Equity
$
371,786

LESS: Goodwill
98,898

LESS: Intangible assets
73,472

     Tangible common equity
199,416

LESS: AOCI
(5,022
)
     Tangible common equity excluding AOCI
204,438


Due to the predictable, quarterly cyclicality of MPS deposits in conjunction with tax season business activity, management believes that a six-month capital calculation is a useful metric to monitor the Company’s overall capital management process. As such, the Bank’s six-month average Tier 1 leverage ratio, Common equity Tier 1 capital ratio, Tier 1 capital ratio, and Total qualifying capital ratio as of December 31, 2016 were 9.80%, 21.14%, 21.14%, and 21.58%, respectively.

Beginning January 1, 2016, Basel III implemented a requirement for all banking organizations 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 required to be 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. On January 1, 2016, the Company and Bank complied with the capital conservation buffer requirement, which increases the three risk-based capital ratios by 0.625% each year through 2019, equivalent to 2.5% of risk-weighted assets in addition to the minimum risk-based capital ratios, at which point, the requirement for common equity tier 1 risk-based, tier 1 risk-based and total risk-based capital ratios will be 7.0%, 8.5% and 10.5%, respectively.


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Based on current and expected continued profitability and subject to continued access to capital markets, we believe that the Company and the Bank will be able to meet targeted capital ratios required by the revised requirements, as they become effective.

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, 2016 for a summary of our contractual obligations as of September 30, 2016. There were no material changes outside the ordinary course of our business in contractual obligations from September 30, 2016 through December 31, 2016.

OFF-BALANCE SHEET FINANCING ARRANGEMENTS

For discussion of the Company’s off-balance sheet financing arrangements as of December 31, 2016, see Note 7 to our consolidated financial statements included in Part I, Item 1 “Financial Statements” of this Quarterly Report on Form 10-Q. Depending on the extent to which the commitments or contingencies described in Note 7 occur, the effect on the Company’s capital and net income could be significant.

Item 3.    Quantitative and Qualitative Disclosure About Market Risk.

MARKET RISK

The Company derives a portion of its income from the excess of interest collected over interest paid.  The rates of interest the Company earns on assets and pays on liabilities generally are established contractually for a period of time.  Market interest rates change over time.  Accordingly, the Company’s results of operations, like those of most financial institutions, are impacted by changes in interest rates and the interest rate sensitivity of its assets and liabilities.  The risk associated with changes in interest rates and the Company’s ability to adapt to these changes is known as interest rate risk and is the Company’s only significant “market” risk.

The Company monitors and measures its exposure to changes in interest rates in order to comply with applicable government regulations and risk policies established by the Board of Directors, and in order to preserve stockholder value.  In monitoring interest rate risk, the Company analyzes assets and liabilities based on characteristics including size, coupon rate, repricing frequency, maturity date, and likelihood of prepayment.

If the Company’s assets mature or reprice more rapidly or to a greater extent than its liabilities, then economic value of equity and net interest income would tend to increase during periods of rising rates and decrease during periods of falling interest rates.  Conversely, if the Company’s assets mature or reprice more slowly or to a lesser extent than its liabilities, then economic value of equity and net interest income would tend to decrease during periods of rising interest rates and increase during periods of falling interest rates.

The Company currently focuses lending efforts toward originating and purchasing competitively priced adjustable-rate and fixed-rate loan products with short to intermediate terms to maturity, generally five years or less, though the Company will consider ten year fixed-rate loans for high quality agricultural and commercial borrowers so long as the loan agreements have an appropriate structure and prepayment penalties.  This theoretically allows the Company to maintain a portfolio of loans that will have relatively little sensitivity to changes in the level of interest rates, while providing a reasonable spread to the cost of liabilities used to fund the loans.

The Company’s primary objective for its investment portfolio is to provide a source of liquidity for the Company.  In addition, the investment portfolio may be used in the management of the Company’s interest rate risk profile.  The investment policy generally calls for funds to be invested among various categories of security types and maturities based upon the Company’s need for liquidity, desire to achieve a proper balance between minimizing risk while maximizing yield, the need to provide collateral for borrowings, and to fulfill the Company’s asset/liability management goals.








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The Company’s cost of funds responds to changes in interest rates due to the relatively short-term nature of its non-MPS deposit portfolio, and due to the relatively short-term nature of its borrowed funds.  The Company believes that its growing portfolio of low-cost deposits provides a stable and profitable funding vehicle, but also subjects the Company to greater risk in a falling interest rate environment than it would otherwise have without this portfolio.  This risk is due to the fact that, while asset yields may decrease in a falling interest rate environment, the Company cannot significantly reduce interest costs associated with these deposits, which thereby compresses the Company’s net interest margin.  As a result of the Company’s interest rate risk exposure in this regard, the Company has elected not to enter in to any new longer term wholesale borrowings, and generally has not emphasized longer term time deposit products.

The Board of Directors and relevant government regulations establish limits on the level of acceptable interest rate risk at the Company, to which management adheres.  There can be no assurance, however, that, in the event of an adverse change in interest rates, the Company’s efforts to limit interest rate risk will be successful.

Interest Rate Risk (“IRR”)

Overview. The Company actively manages interest rate risk, as changes in market interest rates can have a significant impact on reported earnings. The Bank, like other financial institutions, is subject to interest rate risk to the extent that its interest-bearing liabilities mature or reprice more rapidly than its interest-earning assets. The interest rate risk process is designed to compare income simulations in market scenarios designed to alter the direction, magnitude, and speed of interest rate changes, as well as the slope of the yield curve. The Company does not currently engage in trading activities to control interest rate risk although it may do so in the future, if deemed necessary, to help manage interest rate risk.

Earnings at risk and economic value analysis. As a continuing part of its financial strategy, the Bank considers methods of managing an asset/liability mismatch consistent with maintaining acceptable levels of net interest income. In order to properly monitor interest rate risk, the Board of Directors has created an Investment Committee whose principal responsibilities are to assess the Bank’s asset/liability mix and implement strategies that will enhance income while managing the Bank’s vulnerability to changes in interest rates.

The Company uses two approaches to model interest rate risk: Earnings at Risk (“EAR analysis”) and Economic Value of Equity (“EVE analysis”). Under EAR analysis, net interest income is calculated for each interest rate scenario to the net interest income forecast in the base case. EAR analysis measures the sensitivity of interest sensitive earnings over a one year minimum time horizon. The results are affected by projected rates, prepayments, caps and floors. Market implied forward rates and various likely and extreme interest rate scenarios can be used for EAR analysis. These likely and extreme scenarios can include rapid and gradual interest rate ramps, rate shocks and yield curve twists.

The EAR analysis used in the following table reflects the required analysis used no less than quarterly by management. It models -100, +100, +200, +300, and +400 basis point parallel shifts in market interest rates over the next one-year period. Due to the current low level of interest rates, only a -100 basis point parallel shift is represented. The Company is marginally outside policy limits for the -100 scenario while within Board policy limits for all rising rate scenarios using the snapshot as of December 31, 2016 as required by regulation.  The table below shows the results of the scenarios as of December 31, 2016:

Net Sensitive Earnings at Risk

Net Sensitive Earnings at Risk
Balances as of December 31, 2016
Standard (Parallel Shift) Year 1
 
Net Interest Income at Risk%
 
-100
 
+100
 
+200
 
+300
 
+400
Basis Point Change Scenario
-6.3
 %
 
4.4
 %
 
8.4
 %
 
12.8
 %
 
18.1
 %
Board Policy Limits
-5.0
 %
 
-5.0
 %
 
-10.0
 %
 
-15.0
 %
 
-20.0
 %

The EAR analysis reported at December 31, 2016, shows that in all rising rate scenarios, more assets than liabilities will reprice over the modeled one-year period.


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IRR is a snapshot in time.  The Company’s business and deposits are very predictably cyclical on a weekly, monthly and yearly basis.  The Company’s static IRR results could vary depending on which day of the week and timing in relation to certain payrolls, as well as time of the month in regard to early funding of certain programs, when this snapshot is taken.  The fiscal first quarter of 2017 ended on a Saturday, a day after the Company received payroll related prepaid deposits, resulting in larger than average non-interest bearing deposits. Secondly, in preparation for the origination of large volumes of refund advance loans over the tax season the Company sought out wholesale deposits that would enhance the Company’s ability to make these loans without heavily relying on the line of credit at the FHLB. These term deposits were laddered in such a way that the vast majority were not added until midway through the first fiscal quarter and will reach maturity during the second fiscal quarter of 2017. The addition of wholesale deposits substantially lowered the usage on the Company’s overnight borrowings at the FHLB during the first fiscal quarter of 2017, and this is reflected in the point in time results. These wholesale deposits, in concert with the sizable payroll related deposits, also produced a larger than average cash balance as of December 31, 2016. Owing to the snapshot nature of IRR, as is required by regulators, in concert with the Company’s predictable weekly, monthly and yearly fluctuating deposit base and overnight borrowings, the results produced by static IRR analysis are not necessarily representative of what management, the Board of Directors and others would view as the Company’s true IRR positioning.  Management and the Board are aware of and understand these typical borrowing and deposit fluctuations as well as the point in time nature of IRR analysis and have anticipated an outcome where the Company may temporarily be outside of Board policy limits based on a snapshot analysis.

For management to better understand the IRR position of the Bank, an alternative IRR analysis was completed whereby all December 31, 2016 values were utilized with the exception of overnight borrowings, total deposits, cash due from banks, non-earning assets, and non-paying liabilities. To diminish potential issues documented above, quarterly average balances were utilized for overnight borrowings, total deposits, and cash due from banks. Non-earning assets and non-paying liabilities were used to balance the balance sheet. Management believes this view on IRR, while still subject to some yearly cyclicality, more accurately portrays the Bank’s IRR position.  As noted in the below chart, the alternative EAR results are more normalized and aid in diminishing the timing issues documented above.

The Company would have been within policy limits in all scenarios utilizing the alternative IRR scenario run for management purposes.  The table below highlights those results:
Alternative Net Sensitive Earnings at Risk
Net Sensitive Earnings at Risk
Alternative IRR Results
Standard (Parallel Shift) Year 1
 
Net Interest Income at Risk%
 
-100
 
+100
 
+200
 
+300
 
+400
Basis Point Change Scenario
-4.4
 %
 
1.7
 %
 
3.0
 %
 
4.7
 %
 
7.2
 %
Board Policy Limits
-5.0
 %
 
-5.0
 %
 
-10.0
 %
 
-15.0
 %
 
-20.0
 %

The alternative EAR analysis reported at December 31, 2016 shows that in an all increasing interest rate environment, more assets than liabilities would reprice over the modeled one-year period.

The Company anticipates solid EAR results in a rising rate environment due to continued premium finance loan growth, the addition of loans and securities indexed to Libor, slower premium amortization on higher coupon, fixed rate, agency MBS, continued growth of non-interest bearing MPS deposits, and the sustained execution on its strategic plan.

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Net Sensitive Earnings at Risk as of December 31, 2016

Balances as of December 31, 2016
 
 
 
 
 
 
 
 
 
 
% of
 
Change in Interest Income/Expense
for a given change in interest rates
 
 
 
Total Earning
 
Total Earning
 
Over / (Under) Base Case Parallel Ramp
 
 
Basis Point Change Scenario
Assets (in $000's)
 
Assets
 
-100
 
Base
 
+100
 
+200
 
+300
 
+400
Total Loans
1,111,029

 
30.1
%
 
55,163

 
59,344

 
63,717

 
68,098

 
72,430

 
76,856

Total Investments (non-TEY) and other Earning Assets
2,576,329

 
69.9
%
 
44,686

 
53,592

 
62,775

 
71,676

 
80,907

 
91,012

Total Interest-Sensitive Income
3,687,358

 
100.0
%
 
99,849

 
112,936

 
126,492

 
139,774

 
153,337

 
167,868

Total Interest-Bearing Deposits
1,189,862

 
99.4
%
 
1,294

 
7,740

 
16,736

 
25,733

 
34,729

 
43,726

Total Borrowings
7,000

 
0.6
%
 
489

 
489

 
489

 
489

 
489

 
489

Total Interest-Sensitive Expense
1,196,862

 
100.0
%
 
1,783

 
8,229

 
17,225

 
26,222

 
35,218

 
44,215


Alternative Net Sensitive Earnings at Risk

Alternative IRR Results
 
 
 
 
 
 
 
 
 
 
% of
 
Change in Interest Income/Expense
for a given change in interest rates
 
 
 
Total Earning
 
Total Earning
 
Over / (Under) Base Case Parallel Ramp
 
 
Basis Point Change Scenario
Assets (in $000's)
 
Assets
 
-100
 
Base
 
+100
 
+200
 
+300
 
+400
Total Loans
1,111,029

 
34.6
%
 
55,163

 
59,344

 
63,717

 
68,098

 
72,430

 
76,856

Total Investments (non-TEY) and other Earning Assets
2,102,948

 
65.4
%
 
44,686

 
50,038

 
54,461

 
58,582

 
63,008

 
68,285

Total Interest-Sensitive Income
3,213,977

 
100.0
%
 
99,849

 
109,382

 
118,178

 
126,680

 
135,438

 
145,141

Total Interest-Bearing Deposits
624,754

 
68.2
%
 
732

 
3,497

 
7,735

 
11,972

 
16,209

 
20,445

Total Borrowings
291,315

 
31.8
%
 
502

 
2,740

 
5,583

 
8,426

 
11,269

 
14,112

Total Interest-Sensitive Expense
916,069

 
100.0
%
 
1,234

 
6,237

 
13,318

 
20,398

 
27,478

 
34,557


The Company believes that its growing portfolio of non-interest bearing deposits provides a stable and profitable funding vehicle and a significant competitive advantage in a rising interest rate environment as the Company’s cost of funds will likely remain relatively low, with less increase expected relative to many other banks. When unable to match loan growth to deposit growth, the Company continues to execute its investment strategy of primarily purchasing NBQ municipal bonds and agency MBS, however, the Bank reviews opportunities to add diverse, high quality securities at attractive relative rates when opportunities present themselves. The NBQ municipal bonds are tax exempt and as such have a tax equivalent yield higher than their book yield. The tax equivalent yield calculation for NBQ municipal bonds uses the Company’s cost of funds as one of its components. With the Company’s large volume of non-interest bearing deposits, the tax equivalent yield for these NBQ municipal bonds is higher than a similar term investment in other investment categories of similar risk and higher than most other banks can realize and sustain on the same or similar instruments. The above interest income figures are quoted on a pre-tax basis which is particularly notable due to the size of the Company’s tax-exempt municipal portfolio.

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Under EVE analysis, the economic value of financial assets, liabilities and off-balance sheet instruments, is derived under each rate scenario. The economic value of equity is calculated as the difference between the estimated market value of assets and liabilities, net of the impact of off-balance sheet instruments.
The EVE analysis used in the following table reflects the required analysis used no less than quarterly by management. It models immediate -100, +100, +200, +300 and +400 basis point parallel shifts in market interest rates. Due to the current low level of interest rates, only a -100 basis point parallel shift is represented.
The Company was within Board policy limits for all scenarios. The table below shows the results of the scenarios as of December 31, 2016:

Economic Value Sensitivity as of December 31, 2016

Balances as of December 31, 2016
Standard (Parallel Shift)
 
Economic Value of Equity at Risk%
 
-100
 
+100
 
+200
 
+300
 
+400
Basis Point Change Scenario
2.0
 %
 
-3.3
 %
 
-7.2
 %
 
-11.0
 %
 
-14.2
 %
Board Policy Limits
-10.0
 %
 
-10.0
 %
 
-20.0
 %
 
-30.0
 %
 
-40.0
 %

The EVE at risk reported at December 31, 2016 shows that as interest rates increase, the economic value of equity position will decrease from the base, partially due to the degree of the economic value of its base asset size in relation to the economic value of its base liability size.

The Company would have been within policy limits in all scenarios utilizing the alternative IRR scenario run for management purposes.  The table below highlights those results:

Alternative Economic Value Sensitivity

Alternative IRR Results
Standard (Parallel Shift)
 
Economic Value of Equity at Risk%
 
-100
 
+100
 
+200
 
+300
 
+400
Basis Point Change Scenario
4.8
 %
 
-6.0
 %
 
-12.4
 %
 
-18.6
 %
 
-23.9
 %
Board Policy Limits
-10.0
 %
 
-10.0
 %
 
-20.0
 %
 
-30.0
 %
 
-40.0
 %

The EVE at risk reported using the alternative methodology used for management purposes shows that as interest rates increase immediately, the economic value of equity position will decrease from the base, partially due to the degree of the economic value of its base asset size in relation to the economic value of its base liabilities size.

Detailed Economic Value Sensitivity

The following table details the economic value sensitivity to changes in market interest rates at December 31, 2016, for loans, investments, deposits, borrowings, and other assets and liabilities (dollars in thousands). The analysis reflects that in a +100 interest rate scenario, total assets are less sensitive than total liabilities and in the +200, +300, and +400 interest rate scenarios, total assets are marginally more sensitive than total liabilities. This sensitivity is offset by the non-interest bearing deposits.

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Table of Contents


Balances as of December 31, 2016
 
 
 
 
 
 
 
 
 
 
% of
 
Change in Economic Value
for a given change in interest rates
 
 
 
Book
 
Total
 
Over / (Under) Base Case Parallel Ramp
 
 
Basis Point Change Scenario
Value (in $000's)
 
Assets
 
-100
 
+100
 
+200
 
+300
 
+400
Total Loans
1,111,029

 
26
%
 
1.6
%
 
-1.7
 %
 
-3.4
 %
 
-5.1
 %
 
-6.7
 %
Total Investment
2,576,329

 
61
%
 
4.9
%
 
-4.8
 %
 
-9.5
 %
 
-13.9
 %
 
-17.8
 %
Other Assets
514,939

 
12
%
 
0.0
%
 
0.0
 %
 
0.0
 %
 
0.0
 %
 
0.0
 %
Assets
4,202,297

 
100
%
 
3.6
%
 
-3.6
 %
 
-7.1
 %
 
-10.3
 %
 
-13.2
 %
Interest Bearing Deposits
1,189,862

 
32
%
 
0.6
%
 
-0.4
 %
 
-0.8
 %
 
-1.1
 %
 
-1.4
 %
Non-Interest Bearing Deposits
2,480,716

 
66
%
 
6.2
%
 
-5.7
 %
 
-10.9
 %
 
-15.7
 %
 
-20.1
 %
Total Borrowings & Other Liabilities
70,653

 
2
%
 
0.3
%
 
-0.3
 %
 
-0.6
 %
 
-0.8
 %
 
-1.1
 %
Liabilities
3,741,231

 
100
%
 
4.1
%
 
-3.7
 %
 
-7.0
 %
 
-10.1
 %
 
-13.0
 %

Detailed Alternative Economic Value Sensitivity

The following is EVE at risk reported using the alternative methodology used for management purposes, for loans, investments, deposits, borrowings, and other assets and liabilities (dollars in thousands). The analysis reflects that in all interest rate scenarios, total assets are meaningfully less sensitive, than total liabilities.

Alternative IRR Results
 
 
 
 
 
 
 
 
 
 
% of
 
Change in Economic Value
for a given change in interest rates
 
 
 
Book
 
Total
 
Over / (Under) Base Case Parallel Ramp
 
 
Basis Point Change Scenario
Value (in $000's)
 
Assets
 
-100
 
+100
 
+200
 
+300
 
+400
Total Loans
1,111,029

 
26
%
 
1.6
%
 
-1.7
 %
 
-3.4
 %
 
-5.1
 %
 
-6.7
 %
Total Investment
2,102,948

 
50
%
 
6.0
%
 
-5.9
 %
 
-11.6
 %
 
-16.8
 %
 
-21.5
 %
Other Assets
988,319

 
24
%
 
0.0
%
 
0.0
 %
 
0.0
 %
 
0.0
 %
 
0.0
 %
Assets
4,202,296

 
100
%
 
3.6
%
 
-3.6
 %
 
-7.1
 %
 
-10.3
 %
 
-13.2
 %
Interest Bearing Deposits
624,754

 
17
%
 
1.0
%
 
-0.6
 %
 
-1.2
 %
 
-1.7
 %
 
-2.2
 %
Non-Interest Bearing Deposits
2,075,444

 
55
%
 
6.2
%
 
-5.7
 %
 
-10.9
 %
 
-15.6
 %
 
-20.0
 %
Total Borrowings & Other Liabilities
1,041,032

 
28
%
 
0.0
%
 
0.0
 %
 
0.0
 %
 
-0.1
 %
 
-0.1
 %
Liabilities
3,741,230

 
100
%
 
3.3
%
 
-3.0
 %
 
-5.8
 %
 
-8.3
 %
 
-10.6
 %

Certain shortcomings are inherent in the method of analysis discussed above and as presented in the table. For example, although certain assets and liabilities may have similar maturities or periods to repricing, they may react in different degrees to changes in market interest rates. Also, the interest rates on certain types of assets and liabilities may fluctuate in advance of changes in market interest rates, while interest rates on other types may lag behind changes in market rates. Additionally, certain assets, such as adjustable rate mortgage loans, have features that restrict changes in interest rates on a short-term basis and over the life of the asset. Furthermore, although management has estimated changes in the levels of prepayments and early withdrawal in these rate environments, such levels would likely deviate from those assumed in calculating the table. Finally, the ability of some borrowers to service their debt may decrease in the event of an interest rate increase.

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Item 4.    Controls and Procedures.

CONTROLS AND PROCEDURES

Any control system, no matter how well designed and operated, can provide only reasonable (not absolute) assurance that its objectives will be met.  Furthermore, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, have been detected. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in a cost-effective control system, no evaluation of controls can provide absolute assurance that misstatements due to error or fraud will not occur or that all control issues and instances of fraud, if any, within our company have been detected.

DISCLOSURE CONTROLS AND PROCEDURES

The Company’s management, with the participation of the Company’s Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of the Company’s “disclosure controls and procedures”, as such term is defined in Rules 13a – 15(e) and 15d – 15(e) of the Securities Exchange Act of 1934 (“Exchange Act”) as of the end of the period covered by the report.
 
Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that, at December 31, 2016, the Company’s disclosure controls and procedures were effective to provide reasonable assurance that (i) the information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and (ii) information required to be disclosed by us in our reports that we file or submit under the Exchange Act is accumulated and communicated to our management, including our principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.

INTERNAL CONTROL OVER FINANCIAL REPORTING

With the participation of the Company’s management, including its Chief Executive Officer and Chief Financial Officer, the Company conducted an evaluation of the Company’s internal control over financial reporting to determine whether any changes occurred during the Company’s fiscal quarter ended December 31, 2016, that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.  Based on such evaluation, management concluded that, as of the end of the period covered by this report, there have not been any changes in the Company’s internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the fiscal quarter to which this report relates that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

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META FINANCIAL GROUP, INC.
PART II - OTHER INFORMATION

FORM 10-Q

Item 1. Legal Proceedings. – See “Legal Proceedings” of Note 7 to the Notes to Condensed Consolidated Financial Statements, which is incorporated herein by reference.

Item 1A. Risk Factors. - In addition to the other information set forth in this report, you should carefully consider the factors discussed in Part I, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended September 30, 2016. Additional risks and uncertainties not currently known to us or that we currently deem immaterial may also materially and adversely affect us in the future.

Item 2.    Unregistered Sales of Equity Securities and Use of Proceeds. – None. As reflected in the Company’s Current Reports on Form 8-K, filed with the SEC on October 3, 2016 and November 10, 2016, respectively, the Company issued shares of its common stock in transactions exempt from the registration requirements under the Securities Act of 1933 in connection with the acquisition of substantially all of the assets of EPS Financial, LLC and the acquisition of substantially all of the assets of Specialty Consumer Services LP. See Note 2 - Acquisitions to the Condensed Consolidated Financial Statements for further information on these transactions.

Item 6.    Exhibits.

See Index to Exhibits.

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META FINANCIAL GROUP, INC.

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 
META FINANCIAL GROUP, INC.
 
 
 
Date: February 8, 2017
By:
/s/ J. Tyler Haahr
 
 
J. Tyler Haahr, Chairman of the Board
 
 
and Chief Executive Officer
 
 
 
Date: February 8, 2017
By:
/s/ Glen W. Herrick
 
 
Glen W. Herrick, Executive Vice President
 
 
and Chief Financial Officer

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INDEX TO EXHIBITS
Exhibit
Number
Description
 
 
3.1
Registrant's Amended and Restated By-laws, as amended.
 
 
10.1
Performance-Based Restricted Stock Agreement dated as of November 16, 2016, by and between Meta Financial Group, Inc. and J. Tyler Haahr, filed on November 18, 2016 as an exhibit to the Registrant’s Current Report on Form 8-K, is incorporated herein by reference.
 
 
10.2
Performance-Based Restricted Stock Agreement dated as of November 16, 2016, by and between Meta Financial Group, Inc. and Bradley C. Hanson, filed on November 18, 2016 as an exhibit to the Registrant’s Current Report on Form 8-K, is incorporated herein by reference.
 
 
10.3
Performance-Based Restricted Stock Agreement dated as of December 2, 2016, by and between Meta Financial Group, Inc. and Glen W. Herrick, filed on December 6, 2016 as an exhibit to the Registrant’s Current Report on Form 8-K, is incorporated herein by reference.
 
 
31.1
Section 302 certification of Chief Executive Officer.
 
 
31.2
Section 302 certification of Chief Financial Officer.
 
 
32.1
Section 906 certification of Chief Executive Officer.
 
 
32.2
Section 906 certification of Chief Financial Officer.
 
 
101.INS
Instance Document
 
 
101.SCH
XBRL Taxonomy Extension Schema Document
 
 
101.CAL
XBRL Taxonomy Extension Calculation Linkbase Document
 
 
101.DEF
XBRL Taxonomy Extension Definition Linkbase Document
 
 
101.LAB
XBRL Taxonomy Extension Label Linkbase Document
 
 
101.PRE
XBRL Taxonomy Extension Presentation Linkbase Document



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