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 June 30, 2017

☐  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

metalogoa02.jpg
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) 361-4347
(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, smaller reporting company or an emerging growth company See the definitions of "large accelerated filer." "accelerated filer," "smaller reporting company," and "emerging growth company" in Rule 12b-2 of the Exchange Act (Check one):

Large accelerated filer☒
Accelerated filer☐
Non-accelerated filer☐
Smaller Reporting Company☐
Emerging growth company☐
 
 
 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
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 August 3, 2017:
Common Stock, $.01 par value
9,349,989 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 6.
 
 

i

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
June 30, 2017
 
September 30, 2016
Cash and cash equivalents
$
65,630

 
$
773,830

Investment securities available for sale
1,141,684

 
910,309

Mortgage-backed securities available for sale
666,424

 
558,940

Investment securities held to maturity
464,729

 
486,095

Mortgage-backed securities held to maturity
117,399

 
133,758

Loans receivable
1,224,359

 
925,105

Allowance for loan losses
(14,968
)
 
(5,635
)
Federal Home Loan Bank Stock, at cost
16,323

 
47,512

Accrued interest receivable
21,831

 
17,199

Premises, furniture, and equipment, net
20,107

 
18,626

Bank-owned life insurance
84,035

 
57,486

Foreclosed real estate and repossessed assets
364

 
76

Goodwill
98,723

 
36,928

Intangible assets
64,798

 
28,921

Prepaid assets
31,265

 
9,443

Deferred taxes
6,858

 
—

Payments division accounts receivable
5,858

 
6,334

Other assets
4,274

 
1,492

 


 
 
        Total assets
$
4,019,693

 
$
4,006,419

 
 
LIABILITIES AND STOCKHOLDERS’ EQUITY
 

 
 

 
 
 
 
LIABILITIES
 

 
 

Non-interest-bearing checking
$
2,481,673

 
$
2,167,522

Interest-bearing checking
40,928

 
38,077

Savings deposits
55,292

 
50,742

Money market deposits
46,709

 
47,749

Time certificates of deposit
83,760

 
125,992

Wholesale deposits
444,857

 
—

        Total deposits
3,153,219

 
2,430,082

Short-term debt
277,166

 
1,095,118

Long-term debt
92,514

 
92,460

Accrued interest payable
2,463

 
875

Deferred taxes
—

 
4,600

Accrued expenses and other liabilities
64,118

 
48,309

          Total liabilities
3,589,480

 
3,671,444

 
 
 
 
STOCKHOLDERS’ EQUITY
 

 
 

Preferred stock, 3,000,000 shares authorized, no shares issued or outstanding at June 30, 2017 and September 30, 2016, respectively
—

 
—

Common stock, $.01 par value; 15,000,000 shares authorized, 9,349,989 shares issued and outstanding at June 30, 2017 and 8,523,641 shares issued and outstanding at September 30, 2016
94

 
85

Common stock, Nonvoting, $.01 par value; 3,000,000 shares authorized, no shares issued or outstanding at June 30, 2017 and September 30, 2016, respectively
—

 
—

Additional paid-in capital
256,088

 
184,780

Retained earnings
166,634

 
127,190

Accumulated other comprehensive income
7,397

 
22,920

         Total stockholders’ equity
430,213

 
334,975

 
 
 
 
         Total liabilities and stockholders’ equity
$
4,019,693

 
$
4,006,419

See Notes to Condensed Consolidated Financial Statements.

2
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 June 30,
 
Nine Months Ended June 30,
 
2017
 
2016
 
2017
 
2016
Interest and dividend income:
 
 
 
 
 
 
 
Loans receivable, including fees
$
14,089

 
$
9,280

 
$
37,540

 
$
26,147

Mortgage-backed securities
4,544

 
3,777

 
12,345

 
12,258

Other investments
10,228

 
7,706

 
29,269

 
21,262

 
28,861

 
20,763

 
79,154

 
59,667

Interest expense:
 

 
 

 
 

 
 

Deposits
1,039

 
136

 
4,161

 
434

FHLB advances and other borrowings
2,879

 
708

 
6,251

 
1,821

 
3,918

 
844

 
10,412

 
2,255

 
 
 
 
 
 
 
 
Net interest income
24,943

 
19,919

 
68,742

 
57,412

 
 
 
 
 
 
 
 
Provision for loan losses
1,240

 
2,098

 
10,732

 
4,057

 
 
 
 
 
 
 
 
Net interest income after provision for loan losses
23,703

 
17,821

 
58,010

 
53,355

 
 
 
 
 
 
 
 
Non-interest income:
 

 
 

 
 

 
 

Refund transfer product fees
5,785

 
3,424

 
38,448

 
23,062

Tax advance product fees
(108
)
 
7

 
31,460

 
1,575

Card fees
23,052

 
18,779

 
68,013

 
52,614

Loan fees
982

 
1,084

 
3,034

 
2,551

Bank-owned life insurance
656

 
454

 
1,548

 
1,208

Deposit fees
190

 
144

 
508

 
457

Gain (loss) on sale of securities available for sale, net (includes $47 and ($102) reclassified from accumulated other comprehensive income (loss) for net gains (losses) on available for sale securities for the three months ended June 30, 2017 and 2016, respectively and ($1,331) and ($52) for the nine months ended June 30, 2017 and 2016, respectively)
47

 
(102
)
 
(1,331
)
 
(52
)
Gain on foreclosed real estate
—

 
—

 
7

 
—

Other income
216

 
17

 
652

 
127

Total non-interest income
30,820

 
23,807

 
142,339

 
81,542

 
 
 
 
 
 
 
 
Non-interest expense:
 

 
 

 
 

 
 

Compensation and benefits
22,193

 
15,375

 
66,809

 
47,140

Refund transfer product expense
1,623

 
359

 
11,852

 
8,615

Tax advance product expense
72

 
—

 
3,239

 
—

Card processing
5,755

 
5,607

 
18,377

 
16,858

Occupancy and equipment
4,034

 
3,413

 
12,202

 
10,451

Legal and consulting
1,375

 
1,221

 
5,603

 
3,211

Marketing
381

 
490

 
1,461

 
1,531

Data processing
344

 
324

 
1,099

 
1,022

Amortization expense
1,887

 
1,216

 
10,494

 
3,644

Other expense
4,555

 
3,622

 
14,782

 
10,953

Total non-interest expense
42,219

 
31,627

 
145,918

 
103,425

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Income before income tax expense
12,304

 
10,001

 
54,431

 
31,472

 
 
 
 
 
 
 
 
Income tax expense (includes $18 and ($37) income tax expense (benefit) reclassified from accumulated other comprehensive income (loss) for the three months ended June 30, 2017 and 2016, respectively and ($499) and ($19) for the nine months ended June 30, 2017 and 2016, respectively)
2,517

 
1,128

 
11,258

 
4,258

 
 
 
 
 
 
 
 
Net income
$
9,787

 
$
8,873

 
$
43,173

 
$
27,214

 
 
 
 
 
 
 
 
Earnings per common share
 

 
 

 
 

 
 

Basic
$
1.05

 
$
1.04

 
$
4.69

 
$
3.23

Diluted
$
1.04

 
$
1.04

 
$
4.66

 
$
3.21

See Notes to Condensed Consolidated Financial Statements.


3
Table of Contents

META FINANCIAL GROUP, INC.
AND SUBSIDIARIES
Condensed Consolidated Statements of Comprehensive Income (Unaudited)
(Dollars in Thousands)
 
Three Months Ended
June 30,
 
Nine Months Ended
June 30,
 
2017
 
2016
 
2017

 
2016

Net income
$
9,787

 
$
8,873

 
$
43,173

 
$
27,214

 
 
 
 
 
 
 
 
Other comprehensive income (loss):
 

 
 

 
 

 
 

Change in net unrealized gain (loss) on securities
11,902

 
17,561

 
(25,398
)
 
36,397

Losses (gains) realized in net income
(47
)
 
102

 
1,331

 
52

 
11,855

 
17,663

 
(24,067
)
 
36,449

LESS: Deferred income tax effect
4,472

 
6,399

 
(8,544
)
 
13,312

Total other comprehensive income (loss)
7,383

 
11,264

 
(15,523
)
 
23,137

Total comprehensive income
$
17,170

 
$
20,137

 
$
27,650

 
$
50,351

See Notes to Condensed Consolidated Financial Statements.


4
Table of Contents

META FINANCIAL GROUP, INC.
AND SUBSIDIARIES
Condensed Consolidated Statements of Changes in Stockholders' Equity (Unaudited)
For the Nine Months Ended June 30, 2017 and 2016
(Dollars in Thousands, Except Share and Per Share Data)
 
 
 
Common
Stock
 
 
Additional
Paid-in
Capital
 
 
 
Retained
Earnings
 
Accumulated
Other
Comprehensive
Income
 
 
 
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 ($0.39 per share)
—

 
—

 
(3,281
)
 
—

 
—

 
(3,281
)
 
 
 
 
 
 
 
 
 
 
 
 
Issuance of common shares from the sales of equity securities
2

 
11,499

 
—

 
—

 
—

 
11,501

 
 
 
 
 
 
 
 
 
 
 
 
Issuance of common shares due to issuance of stock options, restricted stock and ESOP
1

 
1,774

 
—

 
—

 
310

 
2,085

 
 
 
 
 
 
 
 
 
 
 
 
Stock compensation
—

 
678

 
—

 
—

 
—

 
678

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

 
—

 
—

 
23,137

 
—

 
23,137

 
 
 
 
 
 
 
 
 
 
 
 
Net income
—

 
—

 
27,214

 
—

 
—

 
27,214

 
 
 
 
 
 
 
 
 
 
 
 
Balance, June 30, 2016
$
85

 
$
184,700

 
$
122,292

 
$
25,592

 
$
—

 
$
332,669

 
 
 
 
 
 
 
 
 
 
 
 
Balance, September 30, 2016
$
85

 
$
184,780

 
$
127,190

 
$
22,920

 
$
—

 
$
334,975

 
 
 
 
 
 
 
 
 
 
 
 
Adoption of Accounting Standards Update 2016-09 (1)
—

 
104

 
(104
)
 
—

 
—

 
—

 
 
 
 
 
 
 
 
 
 
 
 
Cash dividends declared on common stock ($0.39 per share)
—

 
—

 
(3,625
)
 
—

 
—

 
(3,625
)
 
 
 
 
 
 
 
 
 
 
 
 
Issuance of common shares due to exercise of stock options
—

 
529

 
—

 
—

 
—

 
529

 
 
 
 
 
 
 
 
 
 
 
 
Issuance of common shares due to restricted stock
4

 
—

 
—

 
—

 
—

 
4

 
 
 
 
 
 
 
 
 
 
 
 
Issuance of common shares due to ESOP
—

 
1,174

 
—

 
—

 
—

 
1,174

 
 
 
 
 
 
 
 
 
 
 
 
Issuance of common shares due to acquisition
5

 
37,291

 
—

 
—

 
—

 
37,296

 
 
 
 
 
 
 
 
 
 
 
 
Contingent consideration equity earnout due to acquisition
—

 
24,142

 
—

 
—

 
—

 
24,142

 
 
 
 
 
 
 
 
 
 
 
 
Shares repurchased for tax withholdings on stock compensation
—

 
(337
)
 
—

 
—

 
—

 
(337
)
 
 
 
 
 
 
 
 
 
 
 
 
Stock compensation
—

 
8,405

 
—

 
—

 
—

 
8,405

 
 
 
 
 
 
 
 
 
 
 
 
Net change in unrealized losses on securities, net of income taxes
—

 
—

 
—

 
(15,523
)
 
—

 
(15,523
)
 
 
 
 
 
 
 
 
 
 
 
 
Net income
—

 
—

 
43,173

 
—

 
—

 
43,173

 
 
 
 
 
 
 
 
 
 
 
 
Balance, June 30, 2017
$
94

 
$
256,088

 
$
166,634

 
$
7,397

 
$
—

 
$
430,213

See Notes to Condensed Consolidated Financial Statements.
(1) The Company adopted Accounting Standards Update ("ASU") 2016-09 Compensation - Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting. Application of this change is on a modified retrospective basis with a cumulative adjustment to fiscal year 2016 Retained Earnings and Additional Paid-in-Capital ("APIC").


5
Table of Contents


META FINANCIAL GROUP, INC.
AND SUBSIDIARIES
Condensed Consolidated Statements of Cash Flows (Unaudited)
 
Nine Months Ended June 30,
(Dollars in Thousands)
2017
 
2016 (1)
Cash flows from operating activities:
 
 
 
Net income
$
43,173

 
$
27,214

Adjustments to reconcile net income to net cash provided by operating activities:
 

 
 

Depreciation, amortization and accretion, net
35,002

 
26,646

Stock-based compensation expense
8,405

 
678

Provision for loan losses
10,732

 
4,057

(Recovery) provision for deferred taxes
(2,914
)
 
348

(Gain) loss on other assets
(21
)
 
23

Gain on foreclosed real estate
(7
)
 
—

Loss on sale of securities available for sale, net
1,331

 
52

Capital lease obligations interest expense
(92
)
 
(95
)
Net change in accrued interest receivable
(4,632
)
 
(4,559
)
Originations of loans held for sale
(685,934
)
 
—

Proceeds from sales of loans held for sale
685,934

 
—

Change in bank-owned life insurance value
(1,549
)
 
(1,208
)
Net change in other assets
(24,179
)
 
(3,745
)
Net change in accrued interest payable
1,588

 
65

Excess contingent consideration paid
(248
)
 
—

Net change in accrued expenses and other liabilities
16,172

 
627

Net cash provided by operating activities
82,761

 
50,103

 
 
 
 
Cash flows from investing activities:
 

 
 

Purchase of securities available-for-sale
(782,169
)
 
(474,281
)
Proceeds from sales of securities available-for-sale
317,099

 
224,564

Proceeds from maturities and principal repayments of securities available-for-sale
86,516

 
83,487

Purchase of securities held to maturity
(932
)
 
(252,108
)
Proceeds from maturities and principal repayments of securities held to maturity
34,242

 
11,242

Purchase of bank owned life insurance
(25,000
)
 
(10,000
)
Purchase of student loan portfolio
(136,172
)
 
—

Proceeds from loan sales
2,141

 
88

Net change in loans receivable
(168,537
)
 
(152,396
)
Proceeds from sales of foreclosed real estate or other assets
97

 
—

Net cash paid for acquisitions
(29,425
)
 
—

Federal Home Loan Bank stock purchases
(468,291
)
 
(615,701
)
Federal Home Loan Bank stock redemptions
499,480

 
614,800

Proceeds from the sale of premises and equipment
57

 
51

Purchase of premises and equipment
(5,699
)
 
(5,536
)
Net cash used in investing activities
(676,593
)
 
(575,790
)
 
 
 
 
Cash flows from financing activities:
 

 
 

Net change in checking, savings, and money market deposits
320,512

 
520,257

Net change in time deposits
(42,232
)
 
9,165

Net change in wholesale deposits
444,857

 
—

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

Net change in federal funds
(717,000
)
 
(103,000
)
Net change in securities sold under agreements to repurchase
(938
)
 
(1,773
)
Principal payments on capital lease obligations
(59
)
 
(95
)
Cash dividends paid
(3,625
)
 
(3,281
)
Purchase of shares by ESOP
1,174

 
—

Issuance of restricted stock
4

 
—

Proceeds from exercise of stock options
529

 
13,586

Shares repurchased for tax withholdings on stock compensation
(337
)
 
—

Contingent consideration - cash paid
(17,253
)
 
—

Net cash (used in) provided by financing activities
(114,368
)
 
534,859

 
 
 
 
Net change in cash and cash equivalents
(708,200
)
 
9,172

 
 
 
 
Cash and cash equivalents at beginning of period
773,830

 
27,658

Cash and cash equivalents at end of period
$
65,630

 
$
36,830

 
 
 
 


6
Table of Contents

Supplemental disclosure of cash flow information
 

 
 

Cash paid during the period for:
 

 
 

Interest
$
8,824

 
$
2,190

Income taxes
19,947

 
5,204

Franchise taxes
156

 
74

Other taxes
289

 
78

 
 
 
 
Supplemental schedule of non-cash investing activities:
 

 
 

Loans transferred to foreclosed real estate and repossessed assets
$
(378
)
 
$
—

Stock issued for acquisitions
$
(37,296
)
 
$
—

Contingent consideration - equity
(24,142
)
 
—

Purchase of held-to-maturity securities accrued, not paid
—

 
20,884

See Notes to Condensed Consolidated Financial Statements.
(1) See Note 1. Basis of Presentation for further discussion on the current presentation.

7
Table of Contents


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 and nine month periods ended June 30, 2017 are not necessarily indicative of the results expected for the fiscal year ending September 30, 2017.

The Company reclassified insignificant electronic return originator ("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.

As of March 31, 2017, certain insignificant adjustments to previously reported Earnings Per Share ("EPS") were made to correctly reflect the effect of participating securities on basic and diluted EPS calculations in accordance with ASC 260. These changes were immaterial to the overall EPS calculation.

The Company has early adopted Accounting Standards Update ("ASU") 2016-09, "Compensation - Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting." The requirement to report the excess tax benefit related to settlements of share-based payment awards in earnings as an increase or (decrease) to income tax expense has been applied utilizing the prospective method and resulted in a tax benefit of $0.5 million for the quarter ended June 30, 2017. In addition, the Company recognized $0.3 million in compensation expense for the quarter ended June 30, 2017 related to the reversal of forfeitures in accordance with the adoption. While the adoption of ASU 2016-09 requires retrospective application to all fiscal year periods presented, the Company elected to not recast previously reported financial statements as the impact was considered insignificant. However, the Company reclassified stock compensation from financing to operating activities on the Consolidated Statement of Cash Flows as of June 30, 2017 and June 30, 2016.


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 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 the issuance of 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.

8
Table of Contents

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 has 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.
The Company recognized goodwill of $30.4 million as of November 1, 2016, which was 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 nine 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 the issuance of 113,328 shares of Meta Financial common stock. In addition, contingent cash 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 $28.3 million of intangible assets, including customer relationships, trademark, and non-compete agreements, and negligible other assets, resulting in goodwill of $31.4 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. During the third quarter of fiscal 2017, MetaBank paid out the $17.5 million of contingent cash consideration to SCS based upon the measured business gross profit.

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The Company has 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 were not observable in the market and thus represent 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 from and liabilities recorded of SCS on the consolidated statement of financial condition as of December 14, 2016.
 
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
17,252

   Contingent consideration - equity
24,142

      Contingent consideration payable
41,394

         Total consideration paid
59,731

 
 
Fair value of assets acquired
 
   Intangible assets
28,310

   Other assets
2

      Total assets
28,312

Fair value of net assets acquired
28,312

Goodwill resulting from acquisition
31,419

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. Upon receipt of final fair value estimates on certain assets, liabilities, and contingent considerations, which must be within one year of the acquisition date, the Company made final adjustments to the purchase price allocation and retrospectively adjusted the recorded goodwill. The Company recorded a contingent liability in the amount of $17.3 million to reflect the fair market value of the potential cash earn-out payment.
The Company recognized goodwill of $31.4 million as of December 14, 2016, which was calculated as the excess of both the adjusted 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 $0.8 million of pre-tax transaction related expenses during the first nine months of fiscal year 2017. The transaction expenses are reflected on the consolidated statement of operations primarily under legal and consulting.


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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.

Homogeneous loan populations are collectively evaluated for impairment.  These loan populations may include premium finance loans, residential first mortgage loans secured by one-to-four family residences, residential construction loans, home equity and second mortgage loans, and tax product loans.  Commercial and agricultural loans as well as mortgage loans secured by other properties are monitored regularly by the Bank given the larger balances. When analysis of the borrower operating results and financial condition indicates that underlying cash flows of the borrower’s business is not adequate to meet its debt service requirements, the individual loan or loan relationship is evaluated for impairment. Often this is associated with a delay or shortfall in payments of 210 days or more for premium finance, 180 days or more for refund advance loans, 120 days or more for ERO advance loans 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 June 30, 2017 and September 30, 2016 were as follows:
 
June 30, 2017
 
September 30, 2016
 
(Dollars in Thousands)
1-4 Family Real Estate
$
190,731

 
$
162,298

Commercial and Multi-Family Real Estate
493,859

 
422,932

Agricultural Real Estate
62,521

 
63,612

Consumer
172,151

 
37,094

Commercial Operating
39,076

 
31,271

Agricultural Operating
35,471

 
37,083

Premium Finance
231,587

 
171,604

Total Loans Receivable
1,225,396

 
925,894

 
 
 
 
Allowance for Loan Losses
(14,968
)
 
(5,635
)
Net Deferred Loan Origination Fees
(1,037
)
 
(789
)
Total Loans Receivable, Net
$
1,209,391

 
$
919,470





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Activity in the allowance for loan losses and balances of loans receivable by portfolio segment for the three and nine months ended June 30, 2017 and 2016 was 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 June 30, 2017
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Allowance for loan losses:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Beginning balance
$
296

 
$
1,742

 
$
1,524

 
$
7,706

 
$
767

 
$
1,349

 
$
597

 
$
621

 
$
14,602

Provision (recovery) for loan losses
510

 
386

 
(80
)
 
142

 
249

 
(44
)
 
187

 
(110
)
 
1,240

Charge offs
—

 
—

 
—

 
(1
)
 
(799
)
 
—

 
(94
)
 
—

 
(894
)
Recoveries
—

 
—

 
—

 
—

 
5

 
—

 
15

 
—

 
20

Ending balance
$
806

 
$
2,128

 
$
1,444

 
$
7,847

 
$
222

 
$
1,305

 
$
705

 
$
511

 
$
14,968

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Nine Months Ended June 30, 2017
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Allowance for loan losses:
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Beginning balance
$
654

 
$
2,198

 
$
142

 
$
51

 
$
117

 
$
1,332

 
$
588

 
$
553

 
$
5,635

Provision (recovery) for loan
losses
152

 
(70
)
 
1,302

 
7,773

 
1,244

 
(39
)
 
412

 
(42
)
 
10,732

Charge offs
—

 
—

 
—

 
(1
)
 
(1,149
)
 
—

 
(352
)
 
—

 
(1,502
)
Recoveries
—

 
—

 
—

 
24

 
10

 
12

 
57

 
—

 
103

Ending balance
$
806

 
$
2,128

 
$
1,444

 
$
7,847

 
$
222

 
$
1,305

 
$
705

 
$
511

 
$
14,968

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Ending balance: individually evaluated for impairment
—

 
—

 
—

 
—

 
—

 
—

 
—

 
—

 
—

Ending balance: collectively evaluated for impairment
806

 
2,128

 
1,444

 
7,847

 
222

 
1,305

 
705

 
511

 
14,968

Total
$
806

 
$
2,128

 
$
1,444

 
$
7,847

 
$
222

 
$
1,305

 
$
705

 
$
511

 
$
14,968

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Loans:
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Ending balance: individually
evaluated for impairment
133

 
1,301

 
—

 
—

 
—

 
—

 
—

 
—

 
1,434

Ending balance: collectively
evaluated for impairment
190,598

 
492,558

 
62,521

 
172,151

 
39,076

 
35,471

 
231,587

 
—

 
1,223,962

Total
$
190,731

 
$
493,859

 
$
62,521

 
$
172,151

 
$
39,076

 
$
35,471

 
$
231,587

 
$
—

 
$
1,225,396


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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 June 30, 2016
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Allowance for loan losses:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Beginning balance
$
327

 
$
1,694

 
$
154

 
$
1,059

 
$
45

 
$
3,327

 
$
477

 
$
348

 
$
7,431

Provision (recovery) for loan losses
66

 
428

 
49

 
(243
)
 
281

 
1,436

 
95

 
(14
)
 
2,098

Charge offs
—

 
(95
)
 
—

 
(1
)
 
—

 
(3,253
)
 
(104
)
 
—

 
(3,453
)
Recoveries
—

 
—

 
—

 
1

 
—

 
—

 
43

 
—

 
44

Ending balance
$
393

 
$
2,027

 
$
203

 
$
816

 
$
326

 
$
1,510

 
$
511

 
$
334

 
$
6,120

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Nine Months Ended June 30, 2016
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Allowance for loan losses:
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Beginning balance
$
278

 
$
1,187

 
$
163

 
$
20

 
$
28

 
$
3,537

 
$
293

 
$
749

 
$
6,255

Provision (recovery) for loan
losses
115

 
1,225

 
40

 
796

 
298

 
1,226

 
772

 
(415
)
 
4,057

Charge offs
—

 
(385
)
 
—

 
(1
)
 
—

 
(3,253
)
 
(631
)
 
—

 
(4,270
)
Recoveries
—

 
—

 
—

 
1

 
—

 
—

 
77

 
—

 
78

Ending balance
$
393

 
$
2,027

 
$
203

 
$
816

 
$
326

 
$
1,510

 
$
511

 
$
334

 
$
6,120

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Ending balance: individually
evaluated for impairment
31

 
—

 
—

 
—

 
—

 
—

 
—

 
—

 
31

Ending balance: collectively
evaluated for impairment
362

 
2,027

 
203

 
816

 
326

 
1,510

 
511

 
334

 
6,089

Total
$
393

 
$
2,027

 
$
203

 
$
816

 
$
326

 
$
1,510

 
$
511

 
$
334

 
$
6,120

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Loans:
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Ending balance: individually
evaluated for impairment
210

 
994

 
—

 
—

 
3

 
—

 
—

 
—

 
1,207

Ending balance: collectively
evaluated for impairment
150,251

 
385,804

 
64,130

 
36,986

 
40,968

 
40,435

 
141,342

 
—

 
859,916

Total
$
150,461

 
$
386,798

 
$
64,130

 
$
36,986

 
$
40,971

 
$
40,435

 
$
141,342

 
$
—

 
$
861,123



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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 for the Company and its wholly-owned subsidiary, MetaBank (the "Bank"), 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 Company'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 Company 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 Company'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, or a geographic location.  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 Company’s Tier 1 Capital plus the Allowance for Loan Losses.
 
The asset classification of loans at June 30, 2017 and September 30, 2016 were as follows:

June 30, 2017
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
$
189,645

 
$
488,279

 
$
27,580

 
$
172,151

 
$
39,076

 
$
20,018

 
$
231,587

 
$
1,168,336

Watch
532

 
3,871

 
—

 
—

 
—

 
41

 
—

 
4,444

Special Mention
398

 
203

 
2,939

 
—

 
—

 
—

 
—

 
3,540

Substandard
156

 
1,506

 
32,002

 
—

 
—

 
15,412

 
—

 
49,076

Doubtful
—

 
—

 
—

 
—

 
—

 
—

 
—

 
—

 
$
190,731

 
$
493,859

 
$
62,521

 
$
172,151

 
$
39,076

 
$
35,471

 
$
231,587

 
$
1,225,396



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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 standards, such as 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.


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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 Bank originates a variety of secured consumer loans, including home equity, home improvement, automobile and boat loans and loans secured by savings deposits.  The Bank also offers other secured and unsecured consumer loans and currently originates most of its consumer loans in its primary market area and surrounding areas. In addition, the Bank’s consumer lending portfolio includes a purchased student loan portfolio, along with consumer lending products offered through its payments segment.

The Bank's consumer loan portfolio includes home equity loans and lines of credit.  Substantially all of the Bank's home equity loans and lines of credit are secured by second mortgages on principal residences.  The 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.



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The Bank primarily originates automobile loans on a direct basis to the borrower, as opposed to indirect loans, which are made when the 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.

The Bank’s purchased private student loan portfolio is a seasoned portfolio that is serviced by ReliaMax Lending Services, LLC and insured by ReliaMax Surety Company. All loans in this portfolio are floating rate and indexed to the three-month LIBOR plus various margins.
Through its Payments segment, the Bank strives to offer consumers innovative payment products, including credit products. Most credit products have fallen into the category of portfolio lending. The Payments segment, including SCS, continues its development of new alternative portfolio lending products primarily to serve its customer base and to provide innovative lending solutions to the unbanked and under-banked segment.
The Payments segment also provides short-term consumer refund advance loans. Taxpayers are underwritten to determine eligibility for the unsecured advances. 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 by the IRS to collect from the borrower. In the event of default, the Bank has no recourse against the tax consumer. Generally, when the refund advance loan becomes delinquent for 180 days or more, or when collection of principal becomes doubtful, the Company will charge off the loan balance.

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 ope