ITEM 1. BUSINESS
General
Pioneer Financial Services, Inc. (“PFSI”), a corporation formed under the laws of Missouri in 1932, is a wholly owned subsidiary of MidCountry Financial Corp., a Georgia corporation (“MCFC”). PFSI, with its wholly owned subsidiaries (collectively “we,” “us,” “our” or the “Company”), purchases consumer loans made primarily to active-duty or career retired U.S. military personnel. We intend to hold these consumer loans and retail installment contracts until repaid.
We purchase consumer loans from the Consumer Banking Division (“CBD”) (formerly known as the Military Banking Division and Pioneer Military Lending Division) of MidCountry Bank (“MCB”), a federally chartered savings bank and wholly owned subsidiary of our parent, MCFC. CBD originates these consumer loans via the internet and through loan production offices. Military customers use loan proceeds for personal financial needs or to purchase consumer goods and services.
We are not associated with, nor are we endorsed by, the U.S. military or U.S. Department of Defense. However, we do seek to maintain a positive, supportive relationship with the military community.
As of September 30, 2015, Timothy L. Stanley, Chief Executive Officer and Laura V. Stack, Chief Operating Officer and Chief Financial Officer, were our sole executive officers and are responsible for our policy-making decisions. None of these officers are directly compensated by us. Ms. Stack was an employee of CBD. On April 1, 2015, Ms. Stack became an employee of MCFC. Mr. Stanley is also an employee of MCFC. CBD provides compensation and remuneration for services to all the employees of CBD that provide services to PFSI. We pay fees to CBD for management and record keeping services. MCFC provides compensation and remuneration for services to all the employees of MCFC that provide services to PFSI. We have an expense sharing agreement with MCFC. See "Management and Record Keeping Services" herein for further information.
Lending and Servicing Operations
Primary Supplier of Loans
We have retained CBD as our sole supplier of loans. We entered into a Loan Sale and Master Services Agreement (“LSMS Agreement”) with CBD whereby we purchase loans originated by CBD and CBD services these loans on our behalf. Under the LSMS Agreement, PFSI has the exclusive right to purchase loans originated by CBD that meet the following guidelines:
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All borrowers are primarily active-duty or career retired U.S. military personnel;
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All potential borrowers must complete standardized credit applications online via the internet or through applications facilitated in retail merchant locations; and
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All loans must meet additional purchase criteria that was developed from our past credit repayment experience and is periodically revalidated based on current portfolio performance.
To the extent CBD originates loans with these purchasing criteria; we have the exclusive right to purchase such loans. Loans purchased from CBD are referred to as “military loans.” See “Item 1A.
ITEM 1A. Risk Factors
Our operations are subject to a number of risks, including but not limited to those described below. If any of the following risks actually occur, our business, financial condition or operating results could be materially adversely affected.
We rely on debt funding to provide us with liquidity, which contains limits on the amount of available credit from our bank group facility and from our regulators. We have a maximum amount of available credit, which limits the amount of debt funding we receive from our bank group and could have a material adverse effect on our results of operations and financial condition.
We use debt financing to provide us with liquidity. To procure and maintain this financing, we are required to comply with various restrictive covenants and limits on the amount of available credit. Our bank facility is an uncommitted credit facility where our lenders have indicated a willingness to participate in fundings up to an aggregate maximum amount. As of September 30, 2015, the lenders have indicated a willingness to participate in fundings up to an aggregate of $163.5 million during the next 12 months, including $153.9 million that is currently outstanding. As of September 30, 2015, our credit facility had a 94.1% utilization, which may restrict future growth in our loan receivable portfolio. If we cannot secure new borrowings or increased funding participation from our Secured Senior Lending Agreement ("SSLA") lenders, our future growth will be limited, which could have a material adverse effect on our results of operations and financial condition. Available credit limits may inhibit the way we operate our business and thus have a material adverse effect on our results of operations and financial
condition. Any lender may elect not to participate in future fundings at any time without penalty. The banks that are party to the SSLA may choose not to make loans to us in the future, and in such case, we may need to raise capital from other sources. There is no assurance that alternative sources of liquidity will be available to us.
We, MCB, and the retail merchants are subject to extensive laws, regulations and governmental supervision by federal and state agencies in the conduct of our business operations, which such regulations are costly, time consuming and intended to protect borrowers and depositors. Failure to comply with such regulations could result in further restrictions on our business, damage our reputation, and have an adverse effect on our business, results of operations, and financial condition.
We, as a wholly owned subsidiary of a savings and loan holding company, and MCB, are currently supervised by the Federal Reserve Bank of Atlanta (the “Federal Reserve”) and the OCC, respectively. Our loan purchasing operations, MCB’s lending and servicing operations and retail merchants are also subject to regulation by federal and state finance and consumer protection authorities and various laws and judicial and administrative decisions imposing various requirements and restrictions on operations, including the requirement to obtain and maintain certain licenses and qualifications. These regulations are primarily designed to protect depositors, borrowers and the financial system as a whole. We are also regulated by state and federal securities regulators, and will continue to be as long as our investment notes are outstanding. These laws and regulations govern or affect, among other things:
•the manner in which MCB may offer and sell products and services;
•the interest rates that may be charged customers;
•terms of loans, including fees, maximum amounts, and minimum durations;
•the number of simultaneous or consecutive loans and required waiting periods between loans;
•disclosure practices;
•privacy of personal customer information;
•the types of products and services that we and MCB may offer;
•collection practices; and
•approval or granting of required licenses.
Changes to statutes, regulations or regulatory policies, including interpretation, implementation and enforcement of statutes, regulations or policies, could affect us in substantial and unpredictable ways, including limiting the types of financial services and products we and MCB may offer and increasing the ability of competitors to offer competing financial services and products. Compliance with these regulations is expensive and requires the time and attention of management, thereby diverting capital and focus away from efforts intended to grow our business. Because these laws and regulations are complex and often subject to interpretation, or because of a result of unintended errors, we and MCB may, from time to time, inadvertently violate these laws, regulations and policies, as each is interpreted by our regulators. If we and MCB do not successfully comply with laws, regulations or policies, our compliance costs could increase, our operations could be limited and we may suffer damage to our reputation. If more restrictive laws, rules and regulations are enacted or more restrictive judicial and administrative interpretations of those laws are issued, compliance with the laws could become more expensive or difficult. Furthermore, changes in these laws and regulations could require changes in the way we and MCB conduct our businesses and we cannot predict the impact such changes could have on our profitability.
In entering into retail installment contracts, retail merchants also must comply with both state and federal credit and trade practice statutes and regulations. If retail merchants fail to comply with these statutes and regulations, consumers may have rights of rescission and other remedies. In such cases, we have rights under our agreements with these merchants to require the merchant to repurchase the related retail installment contracts and to pay us for any damages we may incur or litigation costs, including attorney’s fees and costs. However, if we are unable to enforce our agreement with the merchant, resulting consumer rescission rights and remedies could have an adverse effect on our business, results of operation, financial condition and cash flow.
In June 2013, MCB received a letter from the OCC (the “OCC Letter”) regarding certain former business practices of MCB that the OCC alleged violated Section 5 of the FTC Act. In July 2013, MCB responded in writing to the OCC regarding its analysis of the former business practices and stated that it did not believe it engaged in practices that rose to the level of a violation of law. Nevertheless, on September 26, 2014, our Board adopted and approved a voluntary Remediation Action Plan (the “Plan”) developed in cooperation with MCB to address certain issues identified by the OCC with respect to certain loans and related products that were originated or sold by MCB to certain individuals (“Customers”) that were later sold to us or our subsidiaries. The OCC reviewed the Plan and MCB's management has received no supervisory objections from the OCC to the Plan as presented and management continues to implement the Plan.
We are subject to regulation and oversight by various state and federal agencies, particularly in the area of consumer protection, including regulations promulgated by the CFPB, which was established in July 2011 as part of the Dodd-Frank Act to,
among other things, establish regulations regarding consumer financial protection laws. The CFPB has investigatory and enforcement authority with respect to whether persons are engaged in unlawful acts or practices in connection with the collection of consumer debts. This and other increased regulatory authority and any resulting investigations or proceedings could result in new legal precedents and industry-wide regulations or practices, as well as proceedings or investigations against us, that could adversely affect our business, financial condition and results of operations.
MCFC is operating under a Memorandum of Understanding.
On September 2, 2015, MCFC entered into a confidential and informal Memorandum of Understanding ("MOU") with its primary federal regulator. This MOU replaced and superseded a prior MOU with the Office of Thrift Supervision (the "OTS") that was dated February 26, 2009. The MOU requires MCFC through its board of directors to comply with the requirements of the MOU. The MOU, among other things, contains certain restrictions and limitations on MCFC and certain of its direct and indirect subsidiaries, including restrictions on PFSI’s ability to incur debt or issue additional debt securities beyond certain limits without the prior approval of the Federal Reserve, however, such limits in the opinion of PFSI would allow PFSI to continue to operate its business consistent with its past practices. The MOU is an informal agreement and is not publicly available. The provisions of the MOU require MCFC and certain subsidiaries including PFSI to take certain actions to comply with the MOU. Non-compliance with the MOU could result in a formal enforcement action or may cause our regulators to seek additional restrictions on MCFC or its subsidiaries. A formal enforcement action, the imposition of additional restrictions or the failure by the Federal Reserve to provide a consent on any restricted activity could have a material adverse impact on our ability to issue additional debt securities, incur debt, fund our operations and could have a material adverse impact on our business, results of operations, financial condition and cash flow and could require us to change our business model.
As long as our investment notes are outstanding, we are subject to federal and state securities laws and regulations and failure to comply with or changes in such laws and regulations may adversely affect us.
We are regulated by state and federal securities regulators. These regulations are designed to protect investors in securities (such as the investment notes) that we sell. Congress, state legislatures and foreign, federal and state regulatory agencies continually review laws, regulations and policies for possible changes. Changes to statutes, regulations or regulatory policies, including interpretation, implementation and enforcement of statutes, regulations or policies, could affect us in substantial and unpredictable ways including limiting the types of securities we may issue or increasing substantially the disclosure required by us.
Compliance with new and existing laws and regulations may increase our costs, reduce our revenue and increase compliance challenges.
Under the current regulatory environment, bank and thrift holding companies, financial institutions and their non-banking affiliates are subject to significantly increased legislation oversight and regulation. We expect this oversight and regulation of our business and our affiliates' businesses to continue to expand in scope and complexity. Accordingly, as required under the Dodd-Frank Act, the Federal Reserve, the OCC and the CFPB have increased the scope of their examinations of banks, holding companies and their non-banking affiliates. In connection with these examinations, regulators have begun identifying areas in which lenders could improve lending practices and disclosures to borrowers in connection with charging fees, collecting accounts and offering financial products, among other practices.
We are working diligently to institute best practices and to ensure that those from whom we purchase military loans provide clarity and transparency to existing and potential customers. However, a wide and increasing array of banking and consumer lending laws apply to almost every aspect of our business. The complexity of the regulations issued in connection with the Dodd-Frank Act and the need for additional rulemaking creates ambiguity as to whether the charging of fees, offering of financial products and certain other practices were done in a sufficiently transparent manner.
Changes in laws and regulations or the interpretation and enforcement of laws and regulations could negatively affect our business, results of operations and financial condition.
The laws and regulations directly affecting our and MCB's activities are subject to change, especially as a result of current economic conditions, changes in the make-up of the current executive and legislative branches, and the political focus on issues of consumer and borrower protection. In addition, consumer advocacy groups and various other media sources continue to advocate for governmental and regulatory action to prohibit or severely restrict various financial products, including the loan products offered by MCB, and the manner in which such products are offered. Any changes in such laws and regulations could force us and MCB to modify, suspend or cease product offerings. It is also possible that the scope of federal regulations could change or expand in such a way as to alter what has traditionally been state law regulation of our business activities. The enactment of one or more of such regulatory changes, whether affecting us or MCB, may adversely affect our business, results of operations, and prospects.
States and the federal government may also seek to impose new requirements or interpret or enforce existing requirements in new ways. For example, the application of general principles of equity relating to the protection of consumers and the interpretation of whether a practice is unfair or deceptive may vary in the future. Changes in current laws or regulations or the implementation of new laws or regulations in the future may restrict our or MCB's ability to continue current methods of operation or to expand operations. Additionally, changes to these laws and regulations, or the enforcement thereof, could subject us or MCB to liability for prior operating activities or lower or eliminate the profitability of operations going forward by, among other things, reducing the amount of interest and fees that we may charge in connection with our loans.
Our regulatory authorities have extensive discretion in connection with their supervisory and enforcement activities, including the imposition of restrictions on our operations, the classification of our assets, and the adequacy of our allowance for loan losses. Any change in such regulation and oversight, whether in the form of regulatory policy, regulations, or legislation, could have a material impact on us and our operations. Because our business is highly regulated, the laws, rules and applicable regulations are subject to regular modification and change. Laws, rules and regulations may be adopted in the future that could make compliance more difficult or expensive or otherwise adversely affect our business, financial condition or prospects.
Changes in laws or regulations, and the enforcement thereof, may have an adverse effect on our overall business, results of operations, and financial condition, even in the event that any such change is directly applicable only to MCB. Changes in laws or regulations, or the enforcement thereof, which impacts the ability of MCB to offer financial products or impacts the profitability of such products will likely have a material adverse effect on our overall business, results of operations, and financial condition.
We may have to make changes to our business operations in order to comply with recently adopted changes to the Military Lending Act and a policy change to the Government Allotment System; these changes may adversely affect our financial position and results of operations.
The Department of Defense adopted certain amendments to the Military Lending Act (the “MLA”) in July 2015, which became effective on October 1, 2015, although compliance is not required until October 2016. The new rules provide additional consumer credit protection for active-duty service members. The MLA was enacted in 2006 and capped annual interest rates at 36% for certain payday, vehicle title, and refund anticipation loans. The newly adopted rules extend these MLA protections, including the 36% to a wider range of credit products to forms of credit that are subject to the Truth in Lending Act, including credit cards, vehicle title loans, deposit advance loans, installment loans, refund anticipation loans and unsecured open lines of credit. CBD voluntarily capped the interest rate at 36% on the loans it originates to active-duty service members when then MLA was enacted in 2006. The MLA amendments may decrease our interest income in the future and thus adversely affect our future results of operations and financial position.
The Government Allotment System policy change was effective on January 1, 2015 and prohibits active-duty service members from using new allotments to purchase, lease, or rent personal property. A portion of the loans we purchase are made to active-duty service members who use the loan proceeds to purchase personal property or consumer goods. MCB services loans on behalf of the Company and collects loan payments through the Government Allotment System. This may decrease MCB’s ability to collect loan payments on our behalf and could increase our credit risk and adversely affect our business, results of operations, financial condition and cash flow. Although current allotments are not affected, we are likely to see a decline in loan payments received through the Government Allotment System as a result of this policy change.
The Dodd-Frank Act resulted in many new laws and regulations that have increased our costs of operations.
The Dodd-Frank Act was signed into law on July 21, 2010. Many provisions of the Dodd-Frank Act became effective on July 21, 2011 (the "Transfer Date"). This financial reform law has materially changed the current financial services regulatory environment and has affected the lending, deposit, investment, trading and operating activities of financial and depositary institutions and their holding companies and affiliates.
Certain provisions of the Dodd-Frank Act have had an impact on us, and such impact has been, and will continue to be significant. The Dodd-Frank Act eliminated the OTS, which was the primary federal regulator for MCB and its affiliates, including MCFC, which is a savings and loan holding company. Oversight of federally chartered thrift institutions, like MCB, has been transferred to the OCC, the primary federal regulator for national banks. The Federal Reserve now has exclusive authority to regulate all bank and savings and loan holding companies and their non-bank subsidiaries. As a result, MCB and MCFC are now subject to regulation and supervision by the OCC and Federal Reserve, respectively, instead of the OTS. The application and administration of laws and regulations by the Federal Reserve and the OCC may vary, as compared to past application and administration by the OTS. It is possible that the OCC may regulate certain activities in ways that are more restrictive than the OTS has in the past. This may cause us to incur increased costs or become more restricted in certain activities than we have been in the past.
Under prior OTS regulations, MCFC was not subject to specific capital requirements; however, pursuant to the Dodd-Frank Act the Federal Reserve created new regulatory capital requirements, in July 2013, that MCFC must achieve and maintain effective January 1, 2015. MCB is also subject to increased capital requirements and new capital ratios. The new
capital requirements could cause MCB or MCFC to modify their business strategy, including reducing the origination of new loans.
The Dodd-Frank Act also mandates that the Federal Reserve conduct regular bank-type examinations of activities of non-bank affiliates. Accordingly, the Federal Reserve now examines our activities. The Dodd-Frank Act also created the CFPB and authorized it to promulgate and enforce consumer protection regulations relating to financial products, which will affect both bank and non-bank finance companies. We are now subject to the consumer regulations promulgated by the CFPB.
The Dodd-Frank Act also weakens the federal preemption of state laws and regulations previously available to national banks and federal thrifts. Most importantly to us, it has eliminated federal preemption for subsidiaries, affiliates and agents of national banks and federal thrifts. Because our existing business model relied upon such federal preemption, these changes have a significant impact upon us and have required us to change some of our current business operations. Certain state laws became applicable to us on the Transfer Date and require us to become licensed and regulated in various states as a small loan lender if we purchase certain consumer loans originated by MCB.
Many provisions of the Dodd-Frank Act remain to be implemented through the rulemaking process at various regulatory agencies. We are unable to predict what the final form of those rules will be when fully implemented by the respective regulatory agencies. Certain aspects of the legislation, including, without limitation, the costs of compliance with disclosure and reporting requirements and examinations, has had a significant impact on our business, financial condition and results of operations. Additionally, we cannot predict whether there will be additional proposed laws or reforms that would affect the U.S. financial system or financial institutions, whether or when such changes may be adopted, how such changes may be interpreted and enforced or how such changes would affect us. However, the regulatory burden and cost of compliance with the new federal regulations, and with state statutes and regulations that were previously preempted, has increased significantly.
The Dodd-Frank Act authorizes the CFPB to adopt rules and regulations that could potentially have an impact on our and MCB's ability to offer short-term consumer loans and have an adverse effect on our operations and financial performance.
Title X of the Dodd-Frank Act establishes the CFPB, which became operational on the Transfer Date. Under the Dodd-Frank Act, the CFPB has regulatory, supervisory, and enforcement powers over providers of consumer financial products, including explicit supervisory authority to examine and require registration of installment lenders. Included in the powers afforded to the CFPB is the authority to adopt rules describing specified acts and practices as being "unfair," "deceptive," or "abusive," and hence unlawful. Specifically, the CFPB has the authority to declare an act or practice abusive if it, among other things, materially interferes with the ability of a consumer to understand a term or condition of a consumer financial product or service or takes unreasonable advantage of a lack of understanding on the part of the consumer of the product or service. Although the Dodd-Frank Act expressly provides that the CFPB has no authority to establish usury limits, some consumer advocacy groups have suggested that certain forms of alternative consumer finance products, such as installment loans, should be a regulatory priority, and it is possible that at some time in the future the CFPB could propose and adopt rules making such lending or other products less profitable or impractical. The CFPB may target specific features of loans or loan practices, such as refinancing, by rulemaking that could cause us to cease offering certain products or engaging in certain practices. Any such rules may have an adverse effect on our business, results of operations, and financial condition.
In addition to the Dodd-Frank Act's grant of regulatory powers to the CFPB, the Dodd-Frank Act gives the CFPB authority to pursue administrative proceedings or litigation for violations of federal consumer financial laws. In these proceedings, the CFPB can obtain cease and desist orders (which can include orders for restitution or rescission of contracts, as well as other kinds of affirmative relief) and monetary penalties ranging from $5,000 per day for minor violations of federal consumer financial laws (including the CFPB's own rules) to $25,000 per day for reckless violations and $1 million per day for knowing violations. The CFPB has this examination and enforcement authority over all banks and savings institutions with more than $10 billion in assets. However, institutions that have assets of $10 billion or less, such as MCFC and MCB, will continue to be supervised in this area by their primary federal regulators (in the case of MCFC, the Federal Reserve, and in the case of MCB, the OCC). Also, where a company has violated Title X of the Dodd-Frank Act or CFPB regulations under Title X, the Dodd-Frank Act empowers state attorneys general and state regulators to bring civil actions for the kind of cease and desist orders available to the CFPB (but not for civil penalties). If the CFPB or one or more state or federal officials find that we or MCB have violated the foregoing or other laws, they could exercise their enforcement powers in ways that would have a material adverse effect on us. Any exercise by a state or federal regulator or other official of its enforcement powers against MCB would also have an indirect material adverse effect on us by limiting the amount of loan products which we may be able to purchase from MCB in the future.
On January 5, 2012, the CFPB launched a federal supervision program for nonbanks that offer or provide consumer financial products or services. Under the CFPB's nonbank supervision program, the CFPB will conduct individual examinations and may also require reports from businesses to determine what businesses require greater focus by the CFPB. The frequency and scope of any such examinations will depend on the CFPB's analysis of risks posed to consumers based on factors such as a particular nonbank's volume of business, types of products or services, and the extent of state oversight.
State regulators may take actions that adversely affect our business.
As a division of a federal savings bank, MCB is exempt from state licensing and most state regulatory requirements. However, as a result of regulatory changes resulting from the Dodd-Frank Act, as purchaser of certain consumer loans originated by our affiliate, MCB, we are subject to various state licensing requirements and certain state consumer protection laws. State regulators may assert that certain state statutes or regulations apply to us or to loans purchased by us from MCB. State regulators may take actions against us seeking to enforce state statutes and regulations that could adversely affect our business (including reduced loan volume and damage to our reputation), results of operations, financial condition and cash flow.
Regulators may impose restrictions on our operations or the operations of MCFC and MCB from time to time, which could adversely impact our results of operations.
The Federal Reserve and the OCC, as a result of their examinations of us, MCFC and MCB, may impose restrictions on our operations or the operations of MCFC and MCB. These restrictions could include restrictions on the origination, purchase, sale or servicing of loans, required capital levels in excess of regulatory requirements, restrictions on acquisitions and requiring regulatory approval to engage in new lines of business. Any such restrictions could cause MCB to originate fewer loans for purchase by us, or could prohibit us from purchasing loans at desired volumes, which would adversely impact our results of operations, including our ability to service our debts.
We may experience reduced availability under the SSLA due to a decreased willingness to lend by our bank group as a result of any formal action by the OCC against MCB.
We currently fund our operations in large part through bank debt. We cannot guarantee that such financing will be available in the future. Our bank debt is comprised of individual loans from lenders, which are party to our SSLA. The SSLA is an uncommitted credit facility that provides common terms and conditions pursuant to which individual banks that are a party to this agreement may choose to make loans to us in the future. No lender has an obligation to make any additional future loans to us.
As of September 30, 2015, we could request up to $9.6 million in additional funds and remain in compliance with the terms of the SSLA. If banks party to the SSLA choose not to make loans to us in the future due to any formal action by the OCC against MCB or otherwise, our liquidity may be insufficient to satisfy our capital needs. In such case, we may need to raise capital from other sources. There is no assurance that alternative sources of liquidity will be available to us, and thus we may not be able to repay our indebtedness when it becomes due or meet our other cash needs.
Defaults by MCFC or its subsidiaries, other than PFSI, in their respective credit agreements may negatively impact our liquidity and reduce our availability under the SSLA due to a decreased willingness to lend by our bank group.
In connection with the execution of the SSLA, MCFC entered into an Unlimited Continuing Guaranty. MCFC guaranteed the bank debt and accrued interest under the SSLA in accordance with the terms of the Unlimited Continuing Guaranty. MCFC also guarantees the bank debt of its other consolidated subsidiaries. The banks that are party to the SSLA may choose not to make loans to us in the future due to a default by MCFC or its other consolidated subsidiaries, where MCFC is also the guarantor of their respective bank debt. In such case, we may need to raise capital from other sources. There is no assurance that alternative sources of liquidity will be available to us.
We may experience limited availability of financing and fluctuation in our funding costs, as a result of continuing economic conditions.
Over the past eight years, events in the debt markets and the economy generally have caused significant dislocations, illiquidity and volatility in the domestic and wider global financial markets. The prolonged downturn in the general economy has affected the financial strength of many banks and retailers. Any further economic downturn may adversely affect the financial resources of such. The profitability of our business and our ability to purchase loans currently depends on our ability to access bank debt at competitive rates, and we cannot guarantee that such financing will be available in the future. With the ongoing strains in the financial markets, we see liquidity, capital and earnings challenges for some banks in our credit group that may reduce their ability to participate in the credit facility or may cause a decrease in their willingness to lend at the current levels. If our existing sources of liquidity become insufficient to satisfy our financial needs or our access to these sources become restricted, we may need to raise capital from other sources. There is no assurance that alternate sources of liquidity will be available to us.
We rely on debt funding to provide us with liquidity, which contains restrictive covenants. These restrictive covenants could have a material adverse effect on our results of operations and financial condition.
We use debt financing to provide us with liquidity. To procure and maintain this financing, we are required to comply with various restrictive covenants. Such covenants may inhibit the way we operate our business and thus have a material adverse effect on our results of operations and financial condition. We may incur additional indebtedness in the future, which may contain more restrictive covenants. The banks that are party to the SSLA may choose not to make loans to us in the future
for a default of a restrictive covenant by PFSI, regardless of whether we obtain a waiver for the default. In such case, we may need to raise capital from other sources. There is no assurance that alternative sources of liquidity will be available to us.
Worsening general business and economic conditions could have a material adverse effect on our business, financial position, results of operations, and cash flows, and may increase loan defaults and affect the value and liquidity of your investment.
Our financial performance generally, and in particular the ability of our borrowers to make payments on outstanding loans, is highly dependent upon the business and economic environments in the markets where we operate and in the United States as a whole.
During an economic downturn or recession, credit losses in the financial services industry generally increase and demand for credit products often decreases. Declining asset values, defaults on consumer loans, and the lack of market and investor confidence, as well as other factors, have all combined to decrease liquidity. As a result of these factors, some banks and other lenders have suffered significant losses, and the strength and liquidity of many financial institutions worldwide has weakened. Additionally, the costs we incur for loan servicing and collection services may increase as we may have to expend greater time and resources on these activities. Our purchase criteria, policies and procedures, and product offerings may not sufficiently protect our growth and profitability during a sustained period of economic downturn or recession. Any continued or further economic downturn will adversely affect the financial resources of our customers and may result in the inability of our customers to make principal and interest payments on, or refinance, the outstanding debt when due.
A reduction in demand for products and our failure to adapt to such reduction could adversely affect our business and results of operations.
The demand for the products MCB offers may be reduced due to a variety of factors, such as demographic patterns, changes in customer preferences or financial conditions, regulatory restrictions that decrease customer access to particular products, or the availability of competing products. Should MCB fail to adapt to significant changes in customer demand for, or access to, its products, our revenues could decrease significantly and our operations could be harmed. Even if the MCB does make changes to existing products or introduce new products to fulfill customer demand, customers may resist or may reject such products. Moreover, the effect of any product change on the results of our business may not be fully ascertainable until the change has been in effect for some time, and by that time, it may be too late to make further modifications to such products without causing further harm to our business, results of operations, and financial condition.
Controls and procedures may fail or be circumvented.
Controls and procedures are particularly important for purchasing consumer loans that we intend to hold until maturity. Any system of controls, however well designed and operated, is based in part on certain assumptions and can provide only reasonable, not absolute, assurance that the objectives of the system are met. Any failure or circumvention of our controls and procedures or failure to comply with regulations related to controls and procedures for purchasing consumer loans could have a material adverse effect on our business, results of operations and financial condition.
Changes in government priorities may affect military spending, the size of the military, and laws regulating loans to military personnel, and our financial condition and results of operations could suffer as a result.
We purchase and own loans made to active-duty United States military. Changes in priorities may affect the amount that the United States government spends on defense and could cause the size of the United States military to decrease. In such an event, our customer base may suffer a corresponding contraction and our current military customers may face increased difficulties in repaying outstanding obligations. Further, any announced military drawdown, or even the perception by military personnel that a drawdown may in the future occur, may cause an immediate decrease in demand for our and MCB's products. The occurrence of any of these events may have a material adverse impact on our business, financial condition, and results of operations.
In addition, certain federal laws and regulations impose limitations on loans made to active-duty military personnel, active-duty reservists, and members of the National Guard and their immediate families. Further regulation of lending to members of the military and their families will impact our business, results of operations, and financial condition.
The MCB faces intense competition from financial institutions, financial services companies, and other organizations offering products and services similar to those offered by MCB, which could prevent us from sustaining or growing our businesses.
The financial services industry, including consumer lending and consumer finance, is highly competitive, and we encounter strong competition for loans and other financial services in all of our market areas and distribution channels. Our principal competitors include commercial banks, savings banks, savings and loan associations, and consumer finance companies, including those that lend exclusively to military personnel, as well as a wide range of other financial institutions, such as credit card companies. Many of our competitors are larger than us and have greater access to capital and other
resources. If we and MCB are unable to compete effectively, we will lose market share and our income from loans and other products may diminish.
Our ability to compete successfully depends on a number of factors, including, among other things:
•the ability to adapt successfully to regulatory and technological changes within the financial services industry generally;
•the ability to develop, maintain, and build upon long-term customer relationships based on top quality service and high ethical standards;
•the scope, relevance, and pricing of products and services offered to meet customer needs and demands;
•the rate at which MCB introduces new products and services relative to our competitors;
•customer satisfaction with our level of service; and
•industry and general economic trends.
Failure to perform in any of these areas could significantly weaken our competitive position, which could adversely affect our growth and profitability, which, in turn, could have a material adverse effect on our financial condition and results of operations. There can be no assurance that the competitive pressures we face will not have a material adverse effect on our results of operations, financial condition and liquidity.
We may be limited in our ability to collect on our loan portfolio, all of which is unsecured.
We contract with MCB to provide collection services pursuant to the LSMS Agreement. Legal and practical limitations may limit our ability to collect on our loan portfolio, resulting in increased loan losses, decreased revenues, and decreased earnings. State and federal laws and regulations restrict our collection efforts. In addition, the consumer loans that we hold are not secured by collateral or guaranteed or insured by any third-party, making it more difficult for us to collect on our loan portfolio. Since the loans are unsecured, borrowers may choose to repay obligations under other indebtedness before repaying loans to us because our borrowers have no collateral at risk. Further, given the relatively small size of some of our loans, the costs of collecting a loan may be high relative to the amount of the loan. These factors may increase our loan losses, which would have a material adverse effect on our results of operations and financial condition.
Security breaches, cyber-attacks, interruption of our information systems or fraudulent activity could result in damage to our operations or lead to reputational damage.
Security breaches or cyber-attacks with respect to our or MCB's facilities, computer networks, and databases could cause harm to our business and reputation and result in a loss of customers. We have instituted security measures to protect our systems and to assure our customers that these systems are secure. However, we may still be vulnerable to theft and unauthorized entry to our facilities, computer viruses, attacks by hackers, or similar disruptive problems. Our third-party contractors and vendors also may experience security breaches involving the storage and transmission of proprietary and customer information. If unauthorized persons gain access to our databases, they may be able to steal, publish, delete, or modify confidential and customer information (including personal financial information) that is stored or transmitted on our networks. If a third-party were to misappropriate this information, we potentially could be subject to both private and public legal actions, as we are subject to extensive laws and regulations concerning our use and safeguarding of this information. Any security or privacy breach could adversely affect our business, financial condition, and results of operations, including in the following ways:
•deterring customers from using our products and services;
•decreasing our revenue and income as a result of system downtime caused by a breach or attack;
•deterring third-parties (such as other financial institutions) from supplying us with information or entering into relationships with us;
•harming our reputation generally and in the markets we serve;
•exposing us to financial liability, legal proceedings (such as class action lawsuits), or regulatory action; or
•increasing our operating expenses to respond to and correct problems caused by any breach of security, including in connection with potential legal proceedings or responding to regulatory action.
Any failure, interruption, or breach in security of our information systems, including any failure of our back-up systems, may also result in failures or disruptions in our customer relationship management, general ledger, loan, and other systems and could subject us to additional regulatory scrutiny, any of which could have a material adverse effect on our financial condition and results of operations. Furthermore, we may not be able to immediately detect any such failure or breach, which may increase the losses that we would suffer.
We currently lack product and business diversification; as a result, our revenues and earnings may be disproportionately negatively impacted by external factors and may be more susceptible to fluctuations than more diversified companies.
Our primary business activity is purchasing consumer loans and historically retail installment contracts, on a worldwide basis, made primarily to active-duty or career retired U.S. military personnel. We intend to hold these consumer loans and retail installment contracts until repaid. Thus, any developments, whether regulatory, economic or otherwise, that would hinder, reduce the profitability of or limit our ability to operate on the terms currently conducted would have a direct and adverse impact on our business, profitability and perhaps even our viability. Our current lack of business diversification could inhibit our opportunities for growth, reduce our revenues and profits and make us more susceptible to earnings fluctuations than many other companies whose operations are more diversified.
We are exposed to credit risk.
Our ability to collect on loans depends on the willingness and repayment ability of our borrowers. Any material adverse change in the ability or willingness of a significant portion of our borrowers to meet their obligations to us, whether due to changes in economic conditions, the cost of consumer goods, interest rates, natural disasters, acts of war or terrorism, or other causes over which we have no control, would have a material adverse impact on our earnings and financial condition. We cannot be certain that the credit administration personnel, policies, and procedures of the MCB will adequately adapt to changes in economic or any other conditions affecting customers and the quality of the loan portfolio.
Our allowance for loan losses may not be adequate to cover actual loan losses, which may require us to take additional charges to our earnings and adversely impact our financial condition and results of operations.
Management determines our provision for loan losses based upon an analysis of general market conditions, the credit quality of our loan investment portfolio, and the performance of our customers relative to their financial obligations with us. The determination of the appropriate level of the allowance for loan losses inherently involves a high degree of subjectivity and requires us to make significant estimates of current credit risks and future trends, all of which may undergo material changes. The amount of future losses is susceptible to changes in economic, operating, and other conditions, which may be beyond our control, and such losses may exceed our allowance for estimated loan losses. There can be no assurance that the allowance will prove sufficient to cover actual loan losses in the future. Significant increases to the provision for loan losses may be necessary if material adverse changes in general economic conditions occur or the performance of our loan investment portfolio further deteriorates.
There is a risk of default on the retail installment contracts that we purchased.
There is an inherent risk that a portion of the retail installment contracts that we hold will be in default or be subject to certain claims or defenses that the borrower may assert against the originator of the contract, or us as the holder of the contract. We face the risk that if high unemployment or adverse economic developments occur or continue in one or more of our markets, a large number of retail installment contracts will be in default. In addition, most of the borrowers under these contracts have some negative credit history. There can be no assurance that our allowance for credit losses will prove sufficient to cover actual losses in the future on these contracts.
We are dependent on our key officers and the loss of services of any member of our team may have an adverse effect on our operations.
Our success depends in large part on the retention of our key officers, including: Timothy L. Stanley, our Chief Executive Officer and Laura V. Stack, our Chief Operating Officer and Chief Financial Officer. The loss of one or both of our executive officers could have a material adverse impact to us. There is no assurance that we will be able to retain our current key officers or attract additional officers as needed.
Competition for employees is intense, and the process of locating key personnel with the combination of skills and attributes required to execute our business plan may be lengthy. We may not be successful in retaining our key officers and the unexpected loss of services of one or more of our key personnel could have a material adverse effect on our business because of their skills, knowledge of our market and financial products, years of industry experience, long-term customer relationships and the difficulty of promptly finding qualified replacement personnel. If the services of any of our key personnel should become unavailable for any reason, we may not be able to identify and hire qualified persons on terms acceptable to us, which could have an adverse effect on our business, financial condition and results of operations.
We face risks of interest rate fluctuations, and if we are not able to adequately protect our portfolio from changes in interest rates, our results of operations could be adversely affected and impair our ability to pay interest and principal on the investment notes.
Our earnings are significantly dependent on our net interest income, as we realize income primarily from the difference between the rate of interest we receive on the loans we own and the interest rate we must pay on our outstanding bank debt and
investment notes. We may be unable to predict future fluctuations in market interest rates, which are affected by many factors, including inflation, economic growth, employment rates, fiscal and monetary policy and disorder and instability in domestic and foreign financial markets. Sustained, significant increases in market rates could unfavorably impact our liquidity and profitability. Any significant reduction in our profitability would have a material adverse impact on our business, results of operations, financial condition and cash flow. This would also diminish our ability to pay interest and principal on our outstanding investment notes.
Fluctuations in our expenses and other costs may hurt our financial results.
Our expenses and other costs will directly affect our earnings. Many factors can influence the amount of our expenses. As our business develops and changes, additional expenses may arise from regulatory compliance, structural reorganization, and a reevaluation of business strategies. Other factors that can affect the amount of our expenses include those related to legal and administrative cases and proceedings, which can be expensive to pursue or defend. In addition, changes in accounting policies can significantly affect how we calculate expenses and earnings.
MCB and other historical vendors, from which we purchase consumer loans and retail installment contracts, have in place policies and procedures for underwriting, processing, and servicing loans and retail installment contracts that are subject to potential failure or circumvention, which may lead to greater loan delinquencies and charge-offs.
All of MCB's underwriting activities and credit extension decisions are made at its Nevada branch. MCB trains their employees to make loans that conform to their underwriting standards and our purchase criteria. Such training includes critical aspects of state and federal regulatory compliance, cash handling, account management, and customer relations. Although MCB has standardized employee manuals, MCB primarily relies on supervisors to train and supervise employees, rather than centralized or standardized training programs. Therefore, the quality of training and supervision may vary depending upon the amount of time apportioned to training and supervision and individual interpretations of operating policies and procedures. MCB cannot be certain that every loan is made in accordance with its underwriting standards and rules and our purchasing criteria. MCB has in the past experienced some instances of loans extended that varied from its underwriting standards. Variances in underwriting standards and lack of supervision could expose us to greater delinquencies and charge-offs than we have historically experienced.
In addition, MCB's underwriting decisions are based on information provided by customers and counterparties, the inaccuracy or incompleteness of which may adversely affect our results of operations. In deciding whether to extend credit or enter into other transactions with customers and counterparties, MCB and retail merchants rely on information furnished to them by or on behalf of customers and counterparties, including financial information. MCB and retail merchants also rely on representations of customers and counterparties as to the accuracy and completeness of that information. Our earnings and our financial condition could be negatively impacted to the extent the information furnished to our vendors by and on behalf of customers and counterparties is not correct or complete.
MCB may modify underwriting and servicing standards and does not have to lend to the customers who, traditionally have met our business model and lending criteria, which may have a material adverse effect on our business operations, cash flow, results of operations, financial condition and profitability.
We have the exclusive rights to purchase all the loans made to U.S. active-duty military or retired military that are originated by MCB and that meet our business model, systems and our purchasing criteria. In addition, we have retained MCB to service all loans we own. However, MCB is not obligated to continue to originate loans that meet our purchasing criteria. MCB does have the right to modify its lending criteria, systems and models. MCB may also originate for its own account loans that are not deemed to be military loans made in the ordinary course of business as previously conducted by us. If MCB does modify the models significantly, we may not be willing to purchase such loans. No assurance can be given that if MCB does modify the lending criteria and business models and systems that these modifications would be successful. Any such modifications may have a material adverse impact on our business, financial condition and results of operations. On April 22, 2015, MCB modified its lending criteria and scoring model to use credit score information provided by the FICO Score 8 model, in combination with credit overlays. The Company modified its purchasing guidelines to accept loans originated by MCB with the FICO Score 8 model and credit overlays. The change to the FICO Score 8 model could have a material adverse effect on our business operations, cash flow, results of operations, financial condition and profitability.
A significant portion of MCB's loan customers are active-duty military or federal government employees who could be instructed not to do business with MCB or us, our access to the Government Allotment System could be denied or amended, or the federal government could significantly reduce active-duty forces.
When they deem it to be in the best interest of their personnel, military commanders and supervisors of federal employees may instruct their personnel, formally or informally, not to patronize a business. If military commanders or federal employee supervisors at any given level determine that the Company's internet site to be off limits, we and MCB would be unable to do new business with the potential customers they command or supervise.
Additionally, approximately 31% of our borrowers make their monthly loan payments through the Government Allotment System. The new policy change for the Government Allotment System prevents new allotments to be made after January 1, 2015 to purchase, lease, or rent personal property. This policy change is likely to adversely affect our business. Moreover, military commanders or federal employee supervisors could deny those they command or supervise access to these programs, increasing our credit risk on the loans we own. The federal government also establishes troop levels for our active-duty military customers and we could be adversely affected if these levels were significantly reduced. Without access to sufficient new customers or to the Government Allotment System, MCB may be forced to discontinue lending to the U.S. military and we may be forced to liquidate our portfolio of military loans and retail installment contracts.
Media and public perception of consumer installment loans as being predatory or abusive could materially adversely affect our business, prospects, results of operations and financial condition.
Consumer advocacy groups and various other media sources continue to advocate for governmental and regulatory action to prohibit or severely restrict MCB’s products and services. These critics frequently characterize loan products and services as predatory or abusive toward consumers. If this negative characterization of the consumer installment loans we purchase becomes widely accepted by government policymakers or is embodied in legislative, regulatory, policy or litigation developments that adversely affect our ability to continue offering our products and services or the profitability of these products and services, our business, results of operations and financial condition would be materially and adversely affected. Negative perception of our products and services could also result in increased scrutiny from regulators and potential litigants. Such trends could materially adversely affect our business, prospects, results of operations and financial condition.
If a customer leaves the military prior to repaying the military loan, there is an increased risk that the loan will not be repaid.
The terms of repayment on the loans we purchase are generally structured so the entire loan amount is repaid prior to the customer's estimated separation from the military. If, however, a customer unexpectedly leaves the military or other events occur that result in the loan not being repaid prior to the customer's departure from the military, there is an increased chance that the loan will not be repaid. Because we do not know whether or when a customer will leave the military early, we cannot institute policies or procedures to ensure that the entire loan is repaid before the customer leaves the military. Further, as military personnel anticipate not being able to reenlist, many may become more financially conservative, potentially resulting in them stopping payment on current loans and/or resulting in a reduction of demand for future loans. As of September 30, 2015, we had approximately $10.3 million, or 3.7% of our total portfolio, from customers who advised us of their separation from the military prior to repaying their loan. If that amount increases or the number of customers who separate from the military prior to their scheduled separation date materially increases, our charge-offs may increase. This would have a material adverse effect on our business, cash flow, results of operations and financial condition.
The payments we may make to our parent, MCFC, reduces our working capital and could reduce and diminish our ability to pay interest and principal on the investment notes.
As of September 30, 2015, our sole shareholder, MCFC, owned the outstanding share of our common stock. Accordingly, MCFC is able to exercise significant control over our affairs including, but not limited to, the election of directors, operational decisions and decisions regarding the investment notes. The SSLA, among other things, limits the amounts that we can pay to MCFC each year. The SSLA prohibits us from paying MCFC more than $765,750 for strategic planning services, professional services, product identification and branding and service charges in the form of indirect cost allocations in fiscal 2015 and may be adjusted annually with changes in the Consumer Price Index. We are also prohibited from paying MCFC more than $1,877,636 in the fiscal year 2015 for the reimbursement of direct allocated amounts for shared services, plus 7% per annum thereafter. Other than the covenants contained in the SSLA, there are no significant contractual limits on the amounts we can pay to our parent or other affiliates.
We purchase loans that were made primarily to the military market, which traditionally has higher delinquencies than customers in other markets, resulting in higher charge-offs, a reduction in profitability and impairment of our ability to pay interest and principal on the investment notes.
A large portion of our loan customers are unable to obtain financing from traditional sources, due to factors such as their age, frequent relocations and lack of credit history. Historically, we have experienced higher delinquency rates than traditional financial institutions. When we purchase loans, we depend on underwriting standards and collection procedures designed to mitigate the higher credit risk associated with lending to these borrowers. However, these standards and procedures may not offer adequate protection against risks of default. Higher than anticipated delinquencies, foreclosures or losses on the loans we own could reduce our profitability and have a material adverse impact on our business, financial condition and results of operations. Such adverse effects could also restrict our ability to pay interest and principal on our outstanding investment notes.
If a large number of borrowers are wounded in combat, our profits may be adversely affected.
The debt protection feature on loans that we purchase will cancel the outstanding debt of our customer's loan in the event of accidental loss of life or disability for loans originated by MCB with this feature. The debt protection feature includes additional covered events such as unforeseen military discharge, divorce and in certain instances where our customers do not, under no fault of the customer, receive pay ("no-pay-due"). These events trigger payment of the loan as they become due during a customer's disability due to illness or injury, including war-related injuries, and pay the balance in the event of death, including war-related fatalities. Therefore, if a large number of borrowers are injured and disabled in combat, our profitability would be impaired, which could have a material adverse impact on our business, results of operations, financial condition and cash flow and may impair our ability to pay interest and principal on our outstanding investment notes.
Failure of third-party service providers upon which we rely could adversely affect our business.
We rely on certain third-party service providers, and such reliance can expose us to risks. Specifically, if any of our third-party service providers are unable to provide their services timely and effectively, or at all, it could have an adverse effect on our business, financial condition, results of operations and cash flows.
Our business is dependent on technology and our ability to invest in technological improvements, the failure of which may adversely affect our business, financial condition, and results of operations.
The financial services industry is undergoing rapid technological changes with frequent introductions of new technology-driven products and services. We depend in part upon our ability to address the needs of our customers by using technology to provide products and services that satisfy their operational needs. Many of our competitors have substantially greater resources to invest in technological improvements and third-party support. There can be no assurance that we will continue to effectively implement new technology-driven products and services or successfully market these products and services to our customers. For example, converting to a new lending platform will cause us to incur a significant expenditure, and if the conversion is unsuccessful, our business, financial condition, and results of operations may be adversely affected.
Failure of third-party systems on which we rely could adversely affect our business.
We also rely on our computer systems and the technology of online and third-party service providers. Our daily operations depend on the operational effectiveness of their technology. For example, we rely on these computer systems to accurately track and record our assets and liabilities. If our computer systems or outside technology sources become unreliable, fail, or experience a breach of security, our ability to maintain accurate financial records may be impaired, which could affect our business, financial condition, and results of operations.
If our arrangement with any third-party is terminated, we may not be able to find an alternative source of systems to support our needs on a timely basis or on commercially reasonable terms. This could have a material adverse effect on our business, financial condition and results of operations.
ITEM 1B.
ITEM 1B. UNRESOLVED STAFF COMMENTS
None.
ITEM 2.
ITEM 2. PROPERTIES
As of September 30, 2015, the Company has a sublease agreement with MCB for its office location in Kansas City, Missouri. At any time after the occurrence of a default by MCB under the lease, the Company may, at its option, elect to make all rental payments and other charges due under the lease directly to the landlord.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
We are subject to legal proceedings and claims that arise in the ordinary course of business. In the opinion of management, the amount of ultimate liability with respect to these actions will not have a material adverse effect on our financial position, results of operations or cash flows.
ITEM 4.
ITEM 4. MINE SAFETY DISCLOSURES
Not applicable.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES.
Our outstanding common stock is held by MCFC and, accordingly, there is no established public trading market for it. We have not sold or repurchased any of our common stock since our acquisition by MCFC. During fiscal 2015 and fiscal 2014, we declared and paid dividends to MCFC in the amount of $2.3 million and $3.2 million, respectively. Our ability to pay dividends is limited by the terms and conditions of the SSLA. See “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources - Senior Indebtedness - Bank Debt.”
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
The following selected consolidated financial data should be read in conjunction with our audited consolidated financial statements and the related notes, with other financial data included in this Report and with “Item 7.
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Overview
We purchase consumer loans made primarily to active-duty or career retired U.S. military personnel. Our source of military loans is CBD, an affiliate that originates direct military loans via the internet. Military personnel use these loan proceeds to purchase goods and services.
Our LSMS Agreement with CBD outlines the terms of the sale and servicing of these loans. We historically purchased retail installment contracts from retail merchants that sold consumer goods to active-duty or career retired U.S. military personnel. However, we terminated the purchasing of finance receivables from retail merchants on March 31, 2014. We plan to hold the military loans and retail installment contracts until repaid.
Our finance receivables are effectively unsecured and consist of loans originated by CBD or historically purchased from retail merchants. All finance receivables have fixed interest rates and typically have a maturity of less than 48 months. During fiscal year 2015, the average size of a loan when acquired was $4,250 and had an average term of 33 months. A large portion of the loans we purchase are made to customers who are unable to obtain financing from traditional sources due to factors such as their employment history, frequent relocations and lack of credit history. These factors may not allow them to build relationships with traditional sources of financing.
Improvement of our profitability is dependent upon the quality of finance receivables we are able to acquire from CBD and upon the business and economic environments in the markets where we operate and in the United States as a whole.
The Company entered into a Master Services Agreement (the "MSA") with Fidelity Information Services, LLC ("FIS"), effective as of June 30, 2014, to provide products and services for the development of a new consumer lending software platform (the "FIS Platform"). The implementation and launch of the FIS Platform was expected to be completed during the second quarter of fiscal year 2015. On April 24, 2015, the Company notified FIS that it was terminating its relationship with FIS under the MSA. Effective June 10, 2015, the Company and FIS entered into a written settlement agreement whereby the parties released, waived and discharged one another and their affiliates from any and all liabilities arising out of or relating to the MSA. Pursuant to the settlement agreement, the Company made a one-time payment to FIS of $3.2 million, during the fourth quarter of fiscal 2015, a portion of which constituted a license fee for FIS's Default Manager software. The settlement contains other customary settlement provisions, and no other payments are required by the parties under the settlement agreement or MSA. The Company recorded a $2.3 million expense in the third quarter of fiscal 2015, which included $1.2 million for the FIS settlement and $1.1 million for previously capitalized consumer lending software development costs. The Company capitalized $2.0 million of the FIS settlement for the FIS Default Manager software and consumer lending software development and design costs. The Company has selected a new vendor for the development of a new consumer lending system with implementation expected to be completed in fiscal year 2016.
On September 26, 2014, the Board adopted and approved a voluntary Remediation Action Plan (the “Plan”) developed in cooperation with CBD to address certain issues identified by the OCC with respect to certain loans and related products that were originated by CBD to certain customers that were later sold to the Company or its subsidiaries. The Plan provides a framework for carrying out, monitoring and assessing the provision of approximately $13.5 million in payments, credit balance, and other account adjustments to those customers whose loans are now held by the Company or its subsidiaries. An additional $1.0 million was accrued to the remediation payable for estimated administration costs. The Company began implementation of the Plan in October 2014 and deposited approximately $8.4 million, or 110% of its cash remediation obligation, into an account to be administered by an external independent consulting firm. The Company received a $9.0 million capital infusion from MCFC in October 2014 prior to funding the $8.4 million cash remediation obligation. As of September 30, 2015, the Company's remaining liability for remediation was $1.4 million. All planned customer mailings and payments, under the Plan, have been completed as of September 30, 2015. The Company expects the completion of the Plan in the first half of fiscal 2016.
Our annual goodwill impairment test as of September 30, 2014, determined that the implied fair value of goodwill was less than the carrying value, resulting in an impairment charge of $31.5 million for the year ended September 30, 2014. The impairment charge was the result of a decline in future projected earnings due to changes in CBD's underwriting criteria and other operational changes. An impairment charge of $2.6 million was also recorded for the year ended September 30, 2014 for the carrying value of amortizable intangible assets. Goodwill and amortizable intangible asset balances were zero at September 30, 2015.
Sources of Income
We generate revenues primarily from interest income earned on the military loans purchased from CBD and retail installment contracts purchased from retail merchants. We also earn revenues from debt protection fees. For purposes of the following discussion, “revenues” means the sum of our interest income and debt protection premiums and fees.
Interest income and fees. Interest income and fees consist of interest and origination revenue earned on the military loans and retail installment contracts we own (referred to throughout individually as “loan” or collectively as “loans” or “finance receivables”). Our interest revenue is based on the risk adjusted interest rates charged customers for loans that we purchase. Interest rates vary by loan and are based on many factors, including the overall degree of credit risk assumed and the interest rates allowed in the state where the loan is originated. Our interest income and fees comprised approximately 99.6% of our total revenues in fiscal 2015.
Non-interest income, net. Non-interest income, net consists of revenue from debt protection income and related expenses. Debt protection income and related expenses comprised approximately 0.4% of our total revenues in fiscal 2015.
Finance Receivables
Our finance receivables are comprised of loans purchased from CBD (collectively referred to below as “military loans”) and retail installment contracts historically purchased from a network of retail merchants. The following table sets forth certain information about the components of our finance receivables as of the end of the years presented:
Net Interest Margin
The principal component of our profitability is net interest margin, which is the difference between the interest earned on our finance receivables and the interest paid on borrowed funds. Some states and federal statutes regulate the interest rates that may be charged to our customers. In addition, competitive market conditions also impact interest rates.
Our interest expense is sensitive to general market interest rate fluctuations. These general market fluctuations directly impact our cost of funds. CBD voluntarily capped the interest rate at 36.0% on the loans it originates to active-duty service members. Our inability to increase the annual percentage rate earned on new and existing finance receivables restricts our ability to react to increases in cost of funds. Accordingly, increases in market interest rates generally will narrow interest
rate spreads and lower profitability, while decreases in market interest rates generally will widen interest rate spreads and increase profitability.
The following table presents a three-year history of data relating to our net interest margin as of and for the fiscal years presented.
(1) Averages are computed using month-end balances.
Results of Operations
Year Ended September 30, 2015 Compared to Year Ended September 30, 2014.
Total Finance Receivables. Our aggregate finance receivables increased 4.3% to $280.0 million on September 30, 2015 from $268.5 million on September 30, 2014 due to an increase in our loan purchases during fiscal 2015 compared to fiscal 2014. CBD saw a $96.3 million or 41.9% increase in military loan originations during fiscal 2015 compared to fiscal 2014. The increase in loan originations was due primarily to pricing and underwriting changes made in April 2015. In April 2015, CBD modified our proprietary lending criteria and scoring model to use credit score information provided by the FICO Score 8 model, in combination with certain credit overlays. The Company modified its purchasing guidelines to accept loans originated by CBD with the FICO Score 8 model with certain credit overlays. The four new loan production offices that opened in fiscal 2015 also contributed to the increase in loan originations. Our acquisition of retail installment contracts decreased during fiscal 2015 by $1.7 million or 100.0% compared to fiscal 2014 due to our decision to no longer purchase retail installment contracts after March 31, 2014. See further discussion in the sections titled “Loan Acquisition” and “Liquidity and Capital Resources.”
Total Interest Income and Fees. Total interest income and fees in fiscal 2015 represented 99.6% of our revenue compared to 98.6% in fiscal 2014. Interest income and fees decreased to $76.6 million in fiscal 2015 from $92.3 million in fiscal 2014, a decrease of $15.7 million or 17.0%. This decrease is primarily due to a $56.3 million or 18.1% decrease in the aggregate average finance receivables during fiscal 2015. Average finance receivables were $254.8 million for the fiscal year ended September 30, 2015 compared to $311.1 million for the fiscal year ended September 30, 2014.
Interest Expense. Interest expense in fiscal 2015, decreased to $11.4 million from $15.6 million in fiscal 2014, a decrease of $4.2 million or 26.9%. This decrease is primarily due to a decrease in average interest bearing liabilities of $52.2 million or 23.6%. Our junior subordinated investment notes decreased to $41.1 million at September 30, 2015 compared to $54.8 million at September 30, 2014. The weighted-average interest rate of our junior subordinated investment notes was 9.23% at September 30, 2015 compared to 5.68% for our amortizing term notes at September 30, 2015. The weighted-average interest rates for the junior subordinated investment notes and amortizing term notes at September 30, 2014 were 9.23% and 6.09%, respectively.
Provision for Credit Losses. The provision for credit losses decreased to $25.2 million in fiscal 2015 from $35.7 million in fiscal 2014, a decrease of $10.5 million or 29.4%. Net charge-offs decreased to $28.1 million in fiscal 2015 compared to $35.2 million in fiscal 2014, a decrease of $7.1 million or 20.2%. The net charge-off ratio decreased to 11.0% in fiscal 2015 compared to 11.3% in fiscal 2014. Our decrease in net charge-offs in fiscal 2015 compared to fiscal 2014 was due primarily to the Company's adoption of purchasing guidelines that accept loans originated under the FICO Score 8 model with certain credit overlays and a decrease in customers who separated from the military prior to repaying their loan. See further discussion in “Credit Loss Experience and Provision for Credit Losses.”
Debt Protection Income, net. Debt protection income, net consists of debt protection revenue, claims benefit expenses and third-party commissions. Debt protection revenue totaled $1.7 million in fiscal 2015 compared to $3.0 million in fiscal 2014, a decrease of $1.3 million or 43.3%. Claims benefit expenses decreased to $1.2 million in fiscal 2015 compared to $1.3 million in fiscal 2014, a decrease of $0.1 million or 7.7%. The decline in debt protection revenue and claims benefit expenses is due primarily to the lower loan purchases in fiscal 2014 compared fiscal 2015 and correspondingly reduced sales of our debt protection product in fiscal 2014, where debt protection income is recognized over the life of the loan. Average finance receivables were $254.8 million at September 30, 2015 compared to $311.1 million at September 30, 2014.
Non-Interest Expense. Non-interest expense in fiscal 2015 decreased to $31.2 million compared to $84.8 million in fiscal 2014, a decrease of $53.6 million or 63.2%. The decrease included a $34.0 million goodwill and intangibles impairment charge in fiscal 2014 due to the Company's annual fiscal year goodwill impairment test. Non-interest expense in fiscal 2014 also included $14.5 million for remediation expense. See further discussion in "Overview" herein. Non-interest expense in fiscal 2015 included a $6.2 million decrease in management and record keeping services compared to fiscal 2014, which is the result of an 18.1% decline in average finance receivables and a reduced monthly servicing fee under the amended and restated LSMS Agreement.
Provision for Income Taxes. The Company’s effective tax rate was 40.3% in fiscal 2015 compared to 9.8% in fiscal 2014. This increase is primarily due to the goodwill impairment reducing the federal and state tax benefit recorded in fiscal 2014 by approximately 29.0%. In addition, there is a net increase in fiscal year 2015 from the impact of various state audit settlements, redetermination of state apportionment factors, and repricing deferred tax assets related to these settlements and current tax return filings. See further discussion in "Consolidated Financial Statements - Note 7: Income Taxes."
Year Ended September 30, 2014 Compared to Year Ended September 30, 2013.
Total Finance Receivables. Our aggregate finance receivables decreased 26.3% to $268.5 million on September 30, 2014 from $364.2 million on September 30, 2013 due to lower demand for military loans, the closure of CBD loan production offices in October 2013, the cessation of purchasing retail installment contracts on March 31, 2014, a decline in customers purchasing the debt protection feature and underwriting changes made by CBD. Demand has been impacted by the fragile state of the United States’ economic recovery and uncertainty amongst our military customers regarding the future size of the United States military. Our primary supplier of loans, CBD, saw a $159.2 million or 40.9% decrease in military loan originations during fiscal 2014 from $389.0 million during fiscal 2013. Our acquisition of retail installment contracts decreased during fiscal 2014 by $10.9 million or 86.7% compared to fiscal 2013. Our aggregate average finance receivables decreased during this period to $311.1 million in fiscal 2014 from $374.3 million in fiscal 2013, a decrease of $63.2 million or 16.9%.
Total Interest Income and Fees. Total interest income and fees in fiscal 2014 represented 98.6% of our revenue compared to 98.3% in fiscal 2013. Interest income and fees decreased to $92.3 million from $109.8 million in fiscal 2014, a decrease of $17.5 million or 15.9%. This decrease is primarily due to the 42.3% overall decline in originations from fiscal 2013 and an overall decrease in aggregate average finance receivables of 16.9%.
Interest Expense. Interest expense in fiscal 2014, decreased to $15.6 million from $18.3 million in fiscal 2013, a decrease of $2.7 million or 14.8%. This decrease is primarily due to a decrease in average interest bearing liabilities of $40.1 million or 15.3%. Our junior subordinated investment notes decreased to $54.8 million at September 30, 2014 compared to $63.9 million at September 30, 2013. The weighted-average interest rate of our junior subordinated investment notes was 9.23% at September 30, 2014 compared to 6.09% for our amortizing term notes at September 30, 2014. The weighted-average interest rates for the junior subordinated investment notes and amortizing term notes at September 30, 2013 were 9.15% and 6.11%, respectively.
Provision for Credit Losses. The provision for credit losses decreased to $35.7 million in fiscal 2014 from $36.4 million in fiscal 2013, a decrease of $0.7 million or 1.9%. Net charge-offs increased to $35.2 million in fiscal 2014 compared to $34.0 million in fiscal 2013, an increase of $1.2 million or 3.5%. The net charge-off ratio increased to 11.3% in fiscal 2014 compared to 9.1% in fiscal 2013. Our increase in net charge-offs in fiscal 2014 compared to fiscal 2013, was due primarily to an increase in customers who separated from the military prior to repaying their loan. See further discussion in “Credit Loss Experience and Provision for Credit Losses.”
Debt Protection Income, net. Debt protection income, net consists of debt protection revenue, claims benefit expenses and third-party commissions. Debt protection revenue totaled $3.0 million in fiscal 2014 compared to $5.7 million in fiscal 2013, a decrease of $2.7 million or 47.4%. Claims benefit expenses decreased to $1.3 million in fiscal 2014 compared to $3.3 million in fiscal 2013, a decrease of $2.0 million or 60.6%. The decline in debt protection revenue and claims benefit expenses is due primarily to a 40.9% decrease in military originations and a reduction in the number of customers purchasing the feature.
Other Revenue. The $0.1 million decline in other revenue from fiscal 2013, to fiscal 2014 is due primarily to a decrease in investment income. Total investments declined $1.4 million from September 30, 2013 to September 30, 2014.
Non-Interest Expense. Non-interest expense in fiscal 2014 increased to $84.8 million compared to $43.3 million in fiscal 2013, an increase of $41.5 million or 95.8%. The increase included a $34.0 million goodwill and intangibles impairment charge in fiscal 2014 due to the Company's annual fiscal year goodwill impairment test. A decline in future projected earnings due to CBD's underwriting changes and other operational changes resulted in an implied fair value of goodwill that exceeded its carrying value. See "Consolidated Financial Statements - Note 5 Goodwill and Intangibles" for further discussion. Non-interest expense in fiscal 2014 also included $14.5 million for remediation expense. The Company adopted a voluntary remediation plan to address questions raised by the OCC with respect to certain loans and related products that were originated by CBD to certain customers that were later sold to the Company or its subsidiaries. See further discussion in "Consolidated Financial Statements - Note 9: Voluntary Remediation." Non-interest expense included an $8.8 million decrease in management and record keeping services, which is the result of a 16.9% decline in average finance receivables and a reduced monthly servicing fee under the amended and restated LSMS Agreement.
Provision for Income Taxes. The Company’s effective tax rate was 9.8% in fiscal 2014 compared to 31.4% in fiscal 2013. This decrease is primarily due to the goodwill impairment reducing the tax benefit recorded in fiscal 2014 by $11 million, or 26%. This is offset by the recording of $0.6 million in fiscal 2013 from favorable state audit settlements and the redetermination of state apportionment factors related to previously filed state tax returns. See further discussion in "Consolidated Financial Statements - Note 7: Income Taxes."
Off-Balance Sheet Arrangements
There were no off-balance sheet arrangements during fiscal 2015 or 2014 that have or are reasonably likely to have a current or future material effect on financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources.
Delinquency Experience
Our customers are required to make monthly payments of interest and principal. Our servicer, CBD, under our supervision, analyzes our delinquencies on a recency delinquency basis utilizing our guidelines. A loan is delinquent under the recency method when a full payment (95% or more of the contracted payment amount) has not been received for 30 days. The decline in recency delinquent balances, 60 days or more past due, for fiscal 2015 is due to a decline in recency delinquent loans from customers who advised us of their separation from the military and due to the modified purchasing guidelines adopted by the Company in April 2015 that contemplate accepting loans originated by CBD with the FICO Score 8 model with certain credit overlays. As of September 30, 2015 and September 30, 2014, we had approximately $4.6 million and $5.4 million in recency delinquent loans, 60 days or more past due, respectively, from customers who advised us of their separation from the military prior to repaying their loan. See “Non-performing Assets” below.
The following table sets forth the three-year history of our recency delinquency experience for accounts of which payments are 60 days or more past due.
Credit Loss Experience and Provision for Credit Losses
General. The allowance for credit losses is maintained at an amount that management considers sufficient to cover losses inherent in the outstanding finance receivable portfolio. We utilize a statistical model based on potential credit risk trends incorporating historical factors to estimate losses. These results and management’s judgment are used to estimate inherent losses and in establishing the current provision and allowance for credit losses. These estimates are influenced by factors outside our control, such as economic conditions, current or future military deployments and completion of military service prior to repayment of a loan. There is uncertainty inherent in these estimates, making it reasonably possible that they could change in the near term. See “Item 1A. Risk Factors.”
Military Loans. Our charge-off policy is to charge-off military loans that are 180 days recency past due and also greater than 30 days contractually past due. From time to time, our customers remit several loan payments in advance of the payment due date, where the loan is contractually current, but recency past due. Charge-offs can occur when a customer leaves the military prior to repaying the finance receivable or is subject to longer term and more frequent deployments. When purchasing loans we cannot predict when or whether a customer may depart from the military early. Accordingly, we cannot implement policies or procedures for CBD to follow to ensure that we will be repaid in full prior to a customer leaving the military, nor can we predict when a customer may be subject to deployment at a duration or frequency that causes a default on his or her loan.
The following table shows a three-year history of net charge-offs on military loans and net charge-offs as a percentage of military loans:
(1) Averages are computed using month-end balances.
Retail Installment Contracts. Historically, we purchased retail installment contracts from a retail merchant network. Under many of our arrangements with retail merchants, we would withhold a percentage (usually between five and ten percent) of the principal amount of the retail installment contract purchased. The amounts withheld from a particular retail merchant are recorded in a specific reserve account. Any losses incurred on the retail installment contracts purchased from that retail merchant are charged against its reserve account. Upon the retail merchant’s request, and no more often than annually, we will pay the retail merchant the amount by which its reserve account exceeds 15% of the aggregate outstanding balance on all retail installment contracts purchased from them, less losses we have sustained, or reasonably could sustain, due to debtor defaults, collection expenses, delinquencies and breaches of our agreement with the retail merchant. On March 31, 2014, we ceased purchasing retail installment contracts from the retail merchant network.
Our allowance for credit losses is utilized to the extent that the loss on any individual retail installment contract exceeds the retail merchant’s aggregate reserve account at the time of the loss.
The following table shows a three-year history of net charge-offs on retail installment contracts and net charge-offs as a percentage of retail installment contracts:
(1) Averages are computed using month-end balances.
Former Military. As of September 30, 2015 and September 30, 2014, we had approximately $10.3 million, or 3.7% of our total portfolio, and $12.5 million, or 4.6% of our total portfolio, respectively, from customers who advised us of their separation from the military prior to repaying their loan. See “Non-performing Assets” below.
Our net charge-offs as a percentage of average finance receivables has decreased due the Company's April 2015 adoption of purchasing guidelines that contemplate accepting loans originated by CBD with the FICO Score 8 model with certain credit overlays and to the $2.2 million decline in our total portfolio from customers who advised us of their separation from the military prior to repaying their loan. Military loan net charge-offs, from customers who advised us of their separation from the military, were $12.4 million and represented 44.1% of net charge-offs in fiscal 2015 compared to $19.7 million and 59.3% in fiscal 2014. Our allowance for credit losses on military loans decreased $1.8 million to $28.7 million at September 30, 2015 compared to $30.5 million at September 30, 2014 due primarily to the $5.6 million decrease in net-charge offs.
Allowance for Credit Losses. The following table sets forth the three-year history of our allowance for credit losses:
(1) Averages are computed using month-end balances.
The allowance for credit losses in fiscal 2015 decreased to $29.0 million from $31.9 million at the end of fiscal 2014 and was due primarily to the decline in net charge-offs.
The following table sets forth the three year history of the roll-forward of our allowance for credit losses:
Non-performing Assets
The accrual of interest income is suspended when three full payments (95% or more of the contracted payment amount) on either military loans or retail installment contracts have not been received and accrued interest is limited to no more than 92 days. Loans that are 92 days past their contractual due date are deemed to be non-performing. As of September 30, 2015, we had $15.2 million in military loans and $0.3 million in retail installment contracts that were non-performing loans compared to $16.2 million in military loans and $1.1 million in retail installment contracts that were non-performing loans as of September 30, 2014.
Loan Acquisition
Asset growth is an important factor in determining our future revenues. We are dependent upon CBD to increase its originations for our future growth. In connection with purchasing the loans, we pay CBD a fee in the amount of $26.00 for each military consumer loan originated by CBD and purchased by us. This fee may be adjusted annually on the basis of the annual increase or decrease in CBD’s deferred acquisition cost analysis. For fiscal 2015, loans purchased (including refinancings) from CBD increased to $326.1 million from $231.5 million in fiscal 2014, an increase of $94.6 million or 40.9%. The increase in loans purchased and average loan amounts were due primarily to pricing and underwriting changes made in April 2015. On April 22, 2015, CBD modified its lending criteria and scoring model to use credit score information provided by the FICO Score 8 model, in combination with certain credit overlays. We modified our purchasing guidelines to accept loans originated by CBD with the FICO Score 8 model with certain credit overlays. Four new loan production offices opening during fiscal 2015 also contributed to the increase in loan originations. CBD launched a new loan production office concept in the first quarter of fiscal 2015, which is focused on technology and customer service. On March 31, 2014, we ceased purchasing retail installment contracts from the retail merchant network.
The following table sets forth the three-year history of overall purchases of military loans and retail installment contracts, including those refinanced:
Liquidity and Capital Resources
A relatively high ratio of borrowings to invested capital is customary in the consumer finance industry. Our principal use of cash is to purchase military loans. We use borrowings to fund the difference, if any, between the cash used to purchase military loans and operations, and the cash generated from loan repayments and operations. Cash used in investing activities in fiscal 2015 was approximately $40.4 million and cash provided from financing activities was $16.7 million, which was funded from operating activities of $23.1 million. Cash provided from investing activities in fiscal 2014 was approximately $56.4 million and cash used in financing activities was $94.0 million, which was funded from $43.4 million of cash from operating activities.
The majority of our liquidity requirements are secured by our funding through the SSLA. Additional sources of funds may be generated through our sales of investment notes and borrowings with MCFC. Our available credit facility decreased $43.2 million in fiscal 2015 due primarily to the $94.6 million increase in loans purchased in fiscal 2015 compared to fiscal 2014. Further, we have decreased our investment notes to $41.1 million in 2015 from $54.8 million in 2014, a decrease of $13.7 million or 25.0%.
We keep our SSLA lenders informed of any material developments with the Company and MCB's regulators. Our SSLA lenders have been informed that MCB reviewed and responded to letters from the OCC regarding certain former
business practices of the CBD that the OCC believes may have violated Section 5 of the Federal Trade Commission Act. MCB responded to the OCC that it does not believe the business practices rose to the level of a violation of law. On September 26, 2014, our Board adopted and approved a voluntary Remediation Action Plan (the "Plan") developed in cooperation with MCB to address certain issues identified by the OCC with respect to certain loans and related products that were originated by MCB and later sold to us or our subsidiaries. The OCC has indicated acceptance of the Plan and management will continue to implement the Plan.
Because the SSLA is an uncommitted facility, individual banks that are party to this agreement have no obligation to make any future loans to us. If our lenders perceive that as a result of the issues raised by the OCC, the CBD’s ability to originate and service consumer loans will be adversely affected, or any financial or other remediation must be made by MCB, one or more of our lenders may choose to reduce or cease their participation in the SSLA. As a result, we may experience diminished availability under the SSLA as a result of material developments with MCB’s or our regulators that adversely affect our business and operations.
Senior Indebtedness - Bank Debt
On June 12, 2009, we entered into the SSLA with certain lenders and UMB Bank, N.A. (the “Agent”). The term of the current SSLA ends on March 31, 2016 and is automatically extended annually unless any lender gives written notice of its objection by March 1 of each calendar year. Our assets secure the loans extended under the SSLA for the benefit of the lenders and other holders of the notes issued pursuant to the SSLA (the “Senior Debt”). The facility is an uncommitted credit facility that provides common terms and conditions pursuant to which the individual lenders that are a party to the SSLA may choose to make loans to us in the future. Any lender may elect not to participate in future fundings at any time without penalty. If a lender were to choose not to participate in future fundings, the outstanding amortizing notes would be repaid based on the original terms of the note. Any existing borrowings from that lender under the revolving credit line are payable in 12 equal monthly installments. As of September 30, 2015, we could request up to $9.6 million in additional funds and remain in compliance with the terms of the SSLA. No lender, however, has any contractual obligation to lend us these additional funds. As of September 30, 2015, our credit facility had a 94.1% utilization, which may restrict future growth in our loan receivable portfolio. If we cannot secure new borrowings or increased funding participation from our SSLA lenders, our future growth will be limited, which could have a material adverse effect on our results of operations and financial condition. As of September 30, 2015, we had $153.9 million of senior debt outstanding, compared to $127.8 million at September 30, 2014, an increase of $26.1 million, or 20.4%. Overall indebtedness, including senior and subordinated indebtedness, increased $12.4 million, or 6.8%, to $195.0 million at September 30, 2015 from $182.6 million at September 30, 2014. The increase in overall indebtedness coincides with the $11.5 million increase in gross finance receivables from September 30, 2014 to September 30, 2015. As of September 30, 2015 we were in compliance with all covenants under the SSLA.
Advances outstanding under the revolving credit line were $15.4 million as of September 30, 2015, compared to zero at September 30, 2014, an increase of $15.4 million, or 100%.
As of September 30, 2015, the lenders have indicated a willingness to participate in fundings up to an aggregate of $163.5 million during the next 12 months, including $153.9 million that is currently outstanding. Included in this amount are no borrowings from withdrawing banks that previously participated in the SSLA. In the first quarter of fiscal 2016, two banks increased their total funding participation by $8.0 million.
On September 2, 2015, MCFC entered into a confidential Memorandum of Understanding (“MOU”) with its primary federal regulator. Under the MOU, the Company's senior borrowings are limited to $170.6 million, without prior approval from our primary federal regulator.
Our SSLA allows additional banks to become parties to the SSLA under a modified non-voting role. We have identified each lender that has voting rights under the SSLA as “voting bank(s)” and lenders that do not have voting rights under the SSLA, as “non-voting bank(s)”. While all voting and non-voting banks have the same rights to the collateral and are a party to the same terms and conditions of the SSLA, all of the non-voting banks acknowledge and agree that they have no right to vote on any matter nor to prohibit or limit any action by us, or the voting banks. As of September 30, 2015, we had three non-voting banks with an outstanding principal balance of $0.3 million.
The aggregate notional balance outstanding under amortizing notes was $138.4 million and $127.8 million at September 30, 2015 and 2014, respectively. Interest on the amortizing notes is fixed at 270 basis points over the 90-day moving average of like-term treasury notes when issued. All amortizing notes have terms not to exceed 48 months, payable in equal monthly principal and interest payments. There were 222 and 320 amortizing term notes outstanding at September 30, 2015 and 2014, respectively, with a weighted-average interest rate of 5.68% and 6.09%, respectively. In addition, we are
paying our lenders a quarterly uncommitted availability fee in an amount equal to ten basis points multiplied by the quarterly average aggregate outstanding principal amount of all amortizing notes held by the lenders. Uncommitted availability fees in fiscal years 2015 and 2014 were $0.4 million and $0.6 million, respectively.
Substantially all of our assets secure this debt under the SSLA. The SSLA also limits, among other things, our ability to: (1) incur additional debt from the lenders beyond that allowed by specific financial ratios and tests; (2) borrow or incur other additional debt except as permitted in the SSLA; (3) pledge assets; (4) pay dividends; (5) consummate certain asset sales and dispositions; (6) merge, consolidate or enter into a business combination with any other person; (7) pay fees to MCFC each year except as provided in the SSLA; (8) purchase, redeem, retire or otherwise acquire any of our outstanding equity interests; (9) issue additional equity interests; (10) guarantee the debt of others without reasonable compensation and only in the ordinary course of business; or (11) enter into management agreements with our affiliates.
Under the SSLA, we are subject to certain financial covenants that require that we, among other things, maintain specific financial ratios and satisfy certain financial tests. In part, these covenants require us to: (1) maintain an allowance for credit losses equal to or greater than the allowance for credit losses shown on our audited financial statements as of the end of our most recent fiscal year and at no time less than 5.25% of our consolidated net receivables, unless otherwise required by U.S. Generally Accepted Accounting Principles (“U.S. GAAP”); (2) limit our senior indebtedness as of the end of each quarter to not greater than three and one half times our tangible net worth; (3) maintain a positive net income in each fiscal year; (4) limit our senior indebtedness as of the end of each quarter to not greater than 70% of our consolidated receivables; and (5) maintain a consolidated total required capital of at least $75 million plus 50% of the cumulative positive net income earned by us during each of our fiscal years ending after September 30, 2008. Any part of the 50% of positive net income not distributed by us as a dividend for any fiscal year within 120 days after the last day of such fiscal year must be added to our consolidated total required capital and may not be distributed as a dividend or otherwise. No part of the consolidated total required may be distributed as a dividend.
We may not make any payment to MCFC in any fiscal year for services performed or reasonable expenses incurred in an aggregate amount greater than $765,750 plus reimbursable expenses. Such amount may be increased on each anniversary of the SSLA by the percentage increase in the CPI published by the United States Bureau of Labor for the calendar year then most recently ended. Payments we make to MCFC for the reimbursement of direct expense allocations are limited to an annual maximum of $1,877,636 for fiscal year 2015, plus 7% per annum thereafter. The breach of any of these covenants could result in a default under the SSLA, in which event the lenders could seek to declare all amounts outstanding to be immediately due and payable. As of September 30, 2015, we were in compliance with all loan covenants.
If an event of default has occurred, the Agent has the right, on behalf of all holders of the Senior Debt, to immediately take possession and control of the collateral. If the Agent notifies us of an event of default, the interest rate on all Senior Debt will automatically increase to a default rate equal to 2% above the interest rate otherwise payable on such Senior Debt. The default rate will remain in effect so long as any event of default has not been cured.
In connection with the execution of the SSLA, MCFC entered into an Unlimited Continuing Guaranty. MCFC guaranteed the Senior Debt in accordance with the terms of the Unlimited Continuing Guaranty. Under the Unlimited Continuing Guaranty, MCFC also agreed to indemnify the lenders and the Agent for all reasonable costs and expenses (including reasonable fees of counsel) incurred by the lenders or the Agent for payments made under the Senior Debt that are rescinded or must be repaid by lenders to us. If MCFC is required to satisfy any of borrowers’ obligations under the Senior Debt, the lenders and the Agent will assign without recourse the related Senior Debt to MCFC.
Concurrently, in connection with the execution of the SSLA, MCFC entered into a Negative Pledge Agreement in favor of the Agent. Under the Negative Pledge Agreement, MCFC represented that it will not pledge, sell, assign or transfer its ownership of all or any part of our issued and outstanding capital stock and will not otherwise or further encumber any of such capital stock beyond the currently existing negative pledge thereof in favor of Branch Banking and Trust Company (“BB&T”). On December 16, 2015, MCFC and BB&T amended their loan agreement to eliminate the negative pledge with respect to the Company's stock.
The following table sets forth a three-year history of the total borrowings and availability under the SSLA and the former SLA:
(1) Maximum available credit assumes proceeds in excess of the amounts shown below under “Credit facility available” are used to increase qualifying finance receivables and all terms of the SSLA are met, including maintaining a senior indebtedness to consolidated net receivable ratio of not more than 70.0% as of September 30, 2015 and 2014 and 80.0% as of September 30, 2013.
(2) Includes 48-month amortizing term notes.
(3) Credit facility available is based on the existing asset borrowing base and maintaining a senior indebtedness to consolidated net notes receivable ratio of 70.0% as of September 30, 2015 and 2014 and 80.0% as of September 30, 2013.
Subordinated Debt - Parent. Our SSLA allows for a line of credit with MCFC. Funding on this line of credit is provided as needed at our discretion and dependent upon the availability of MCFC and is due upon demand. The maximum principal balance of this line of credit is $25.0 million. Interest is payable monthly and is based on prime or 5.0%, whichever is greater. As of September 30, 2015, and 2014, the outstanding balance under this line of credit was zero. Under the MOU, the Company would need to obtain permission from its primary federal regulator before borrowing under the line of credit with MCFC.
Outstanding Investment Notes. We fund certain capital and financial needs through the sale of investment notes. These notes have varying fixed interest rates and are subordinate to all senior indebtedness. We can redeem these notes at any time upon 30 days' written notice. As of September 30, 2015, we had outstanding $41.1 million (with accrued interest), which includes a $0.04 million purchase adjustment. The purchase adjustment relates to a fair value adjustment recorded as part of the purchase of the Company by MCFC. These notes had a weighted-average interest rate of 9.23% as of September 30, 2015.
Under the MOU, the Company's total subordinated borrowings are limited to $44.0 million, without prior approval from our primary federal regulator.
On April 29, 2015, we filed with the Securities and Exchange Commission ("SEC") a post-effective amendment to remove from registration all securities that remain unsold under our amended registration statement originally filed with the SEC on January 28, 2011 (the "Registration Statement"). We subsequently filed a Form RW, on June 5, 2015, to withdraw Post-Effective Amendment No. 4 to the Registration Statement, pursuant to which no securities were sold and which was never declared effective by the SEC. We will no longer offer and sell investment notes pursuant to the Registration Statement.
Series A Subordinated Debentures. In December 2015, the Company offered up to $7.0 million in Series A subordinated debentures to certain investors in a private placement. The debentures have varying interest rates between 5.5% and 7.5% and varying maturities between one and three years.
Off-Balance Sheet Arrangements. As of the end of fiscal 2015 we had no significant off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that is material to our shareholder.
Impact of Inflation and General Economic Conditions
Although inflation has not had a material adverse effect on our financial condition or results of operations, increases in the inflation rate generally are associated with increased interest rates. A significant and sustained increase in interest rates could unfavorably impact our profitability by reducing the interest rate spread between the rate of interest we receive on military loans and retail installment contracts and interest rates paid under our SSLA and investment notes. Inflation also may negatively affect our operating expenses. With the ongoing strains in the financial markets, we see liquidity, capital and earnings challenges for some lenders in our credit group that may reduce their ability to participate in the credit or may cause a decrease in their willingness to lend at the current levels. See “Liquidity and Capital Resources.”
Critical Accounting Policies
General. Our accounting and reporting policies are in accordance with U.S. GAAP and conform to general practices within the finance company industry. The significant accounting policies used in the preparation of the consolidated financial statements are discussed in Note 1 to the Consolidated Financial Statements. Critical accounting policies require management to make estimates and assumptions, which affect the reported amounts of assets, liabilities, income and expenses. As a result, changes in these estimates and assumptions could significantly affect our financial position and results of operations.
Allowance for Credit Losses and Provision for Credit Losses. We consider our policy regarding the allowance and resulting provision for credit losses to be our most important accounting policy due to the significant degree of management judgment applied in establishing the allowance and the provision.
We utilize a statistical model that incorporates historical factors to forecast probable inherent losses or credit risk trends to determine the appropriate amount of allowance for credit losses.
We evaluate the finance receivable portfolio quarterly. Our portfolio consists of a large number of relatively small, homogenous accounts. No account is large enough to warrant individual evaluation for impairment. We consider numerous qualitative and quantitative factors in estimating losses in our finance receivable portfolio, including the following:
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Prior credit losses and recovery experience;
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Current economic conditions;
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Current finance receivable delinquency trends; and
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Demographics of the current finance receivable portfolio.
We also use several ratios to aid in the process of evaluating prior finance receivable loss and delinquency experience. Each ratio is useful, but each has its limitations. These ratios include:
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Delinquency ratio - finance receivables 60 days or more past due, on a recency basis, as a percentage of finance receivables;
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Allowance ratio - allowance for finance receivable losses as a percentage of finance receivables;
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Charge-off ratio - net charge-offs as a percentage of the average of finance receivables at the beginning of each month during the period; and
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Charge-off coverage - allowance for finance receivable losses to net charge-offs.
In addition to these models, we exercise our judgment, based on our experience in the consumer finance industry, when determining the amount of the allowance for credit losses. We consider this estimate to be a critical accounting estimate that affects our net income in total and the pretax operating income of our business. See “Credit Loss Experience and Provision for Credit Losses.”
Contractual Obligations
We have the following payment obligations under current financing arrangements as of September 30, 2015:
(1)
Interest on long term debt is calculated using the weighted-average interest rate of 5.68% for amortizing term notes and 9.23% for investment notes as of September 30, 2015.
Impact of New and Emerging Accounting Pronouncements Not Yet Adopted
In May 2014, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update (“ASU”) No. 2014-09, Revenue from Contracts with Customers (Topic 606). This guidance supersedes the revenue recognition requirements in Accounting Standards Codification Topic 605, Revenue Recognition, and most industry-specific guidance throughout the Codification Topic. The guidance requires an entity to recognize revenue that depicts the transfer of promised goods or services to customers in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods or services. The standard is effective for public entities for fiscal years and interim periods beginning December 15, 2016. The Company is currently assessing the impact of the adoption of this guidance on its financial position, results of operations or disclosures.
In August 2014, the FASB issued ASU No. 2014-15, Presentation of Financial Statements-Going Concern (Subtopic 205-40): Disclosure of Uncertainties about an Entities Ability to Continue as a Going Concern. The amendments in this update provide guidance in GAAP about management’s responsibility to evaluate whether there is a substantial doubt about an entity’s ability to continue as a going concern and to provide related footnote disclosures. The amendments (1) provide a definition of the term substantial doubt, (2) require an evaluation every reporting period, (3) provide principles for considering the mitigating effect of management’s plans, (4) require certain disclosures when substantial doubt is alleviated as a result of consideration of management’s plans, (5) require an express statement and other disclosures when substantial doubt is not alleviated, and (6) require an assessment for a period of one year after the date that the financial statements are issued (or available to be issued). The standard is effective for all entities for the annual period ending after December 15, 2016, and for annual periods thereafter. The Company is currently assessing the impact of the adoption of this guidance on its financial position, results of operations or disclosures.
In January 2015, the FASB issued ASU No. 2015-01, Income Statement- Extraordinary and Unusual Items (Subtopic 225-20): Simplifying Income Statement Presentation by Eliminating the Concept of Extraordinary Items. This standard eliminates from GAAP the concept of extraordinary items and was issued to reduce complexity in accounting standards. The standard is effective for all entities for fiscal years beginning after December 15, 2015. The Company is currently assessing the impact of the adoption of this guidance on its financial position, results of operations or disclosures, but does not anticipate a material impact on the company’s results.
In February 2015, the FASB issued ASU No. 2015-02, Consolidation (Topic 810): Amendments to the Consolidation Analysis. The amendments in this update will change the analysis that a reporting entity must perform to determine whether it
should consolidate certain types of legal entities. The standard is effective for public entities for fiscal years beginning after December 15, 2015. The Company is currently assessing the impact of the adoption of this guidance on its financial position, results of operations or disclosures.
In April 2015, the FASB issued ASU No. 2015-03, Interest- Imputation of Interest (Subtopic 835-30): Simplifying the Presentation of Debt Issuance Costs. This guidance simplifies the presentation of debt issuance costs and requires 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. The standard is effective for public entities for fiscal years beginning after December 15, 2015. The Company is currently assessing the impact of the adoption of this guidance on its financial position, results of operations or disclosures.
In August 2015, the FASB issued ASU No. 2015-14, Revenue from Contracts with Customers (Topic 606): Deferral of the Effective Date. The amendments in this ASU defer the effective date of ASU 2014-09 for all entities by one year. The standard is effective for public entities for fiscal years and interim periods beginning December 15, 2017. The Company is currently assessing the impact of the adoption of this guidance on its financial position, results of operations or disclosures.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
Our finance income is generally not sensitive to fluctuations in market interest rates. We currently do not experience interest rate sensitivity on our borrowings. Our revolving credit lines bear interest per annum at the prime rate of interest; however, the minimum interest rate per annum cannot be less than 4.00% in accordance with our SSLA. The prime rate as of September 30, 2015 was 3.25%. In order for any impact to occur, the prime rate will need to increase more than 75 basis points. Our amortizing notes bear interest based on the 90 day moving average rate of treasury notes plus 270 basis points; however, the minimum interest rate per annum cannot be less than 5.25% in accordance with our SSLA. The 90 day moving average rate of treasury notes as of September 30, 2015 was 1.29%. In order for any impact to occur, the 90 day moving average rate of treasury notes would need to increase by 126 basis points.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
PIONEER FINANCIAL SERVICES, INC.
CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2015, 2014 and 2013
(WITH INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM REPORT THEREON)
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Directors and Stockholder of Pioneer Financial Services, Inc.
Pioneer Financial Services, Inc.
Kansas City, Missouri
We have audited the accompanying consolidated balance sheets of Pioneer Financial Services, Inc. (the “Company”) as of September 30, 2015 and 2014, and the related consolidated statements of operations, comprehensive income, stockholder’s equity, and cash flows for the three years ended September 30, 2015. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of its internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall consolidated financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Pioneer Financial Services, Inc. as of September 30, 2015 and 2014, and the results of their operations and their cash flows for each of the three years ended September 30, 2015, in conformity with accounting principles generally accepted in the United States of America.
PIONEER FINANCIAL SERVICES, INC.
CONSOLIDATED BALANCE SHEETS
SEPTEMBER 30, 2015 AND 2014
See Notes to Consolidated Financial Statements
PIONEER FINANCIAL SERVICES, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED SEPTEMBER 30, 2015, 2014 and 2013
(1)
Number of shares outstanding is one.
See Notes to Consolidated Financial Statements
PIONEER FINANCIAL SERVICES, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
FOR THE YEARS ENDED SEPTEMBER 30, 2015, 2014 and 2013
See Notes to Consolidated Financial Statements
PIONEER FINANCIAL SERVICES, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDER'S EQUITY
FOR THE YEARS ENDED SEPTEMBER 30, 2015, 2014 and 2013
(1)
Number of shares outstanding is one.
See Notes to Consolidated Financial Statements
PIONEER FINANCIAL SERVICES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED SEPTEMBER 30, 2015, 2014 and 2013
See Notes to Consolidated Financial Statements
PIONEER FINANCIAL SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
AS OF AND FOR THE YEARS ENDED SEPTEMBER 30, 2015, 2014, AND 2013
NOTE 1: NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
The accompanying consolidated financial statements include the accounts of Pioneer Financial Services, Inc. and its wholly owned subsidiaries (collectively “we,” “us,” “our” or the “Company”). Intercompany balances and transactions have been eliminated. We were acquired on May 31, 2007 by our parent, MidCountry Financial Corp, a Georgia corporation (“MCFC”) as a wholly owned subsidiary (the “Transaction”).
Immediately subsequent to the Transaction, we declared and paid a dividend to MCFC of our business operation and certain assets and liabilities related to the origination and servicing of our finance receivables. MCFC contributed these operations to MidCountry Bank ("MCB"), a federally chartered savings bank and wholly owned subsidiary of MCFC. MCB formed the Consumer Banking Division (“CBD”), which is composed exclusively of the assets and liabilities contributed from MCFC. As part of the Transaction, we entered into a Loan Sale and Master Services Agreement (the “LSMS Agreement”) with CBD. Under the LSMS Agreement, CBD originates loans and we have the exclusive right to purchase those loans that meet our business model and lending criteria. Also under the LSMS Agreement, CBD will provide us with management and record keeping services. As part of the Transaction, all of our employees became employees of CBD. We pay fees for loans purchased and originated by CBD and management and record keeping services provided by CBD. The LSMS Agreement is further described in "Note 8: Related Party Transactions."
Nature of Operations and Concentration
We are headquartered in Kansas City, Missouri. We purchase finance receivables from CBD. These receivables represent loans primarily to active-duty or career retired U.S. military personnel. Prior to March 31, 2014, we also purchased finance receivables from retail merchants that sell consumer goods to active-duty or career retired U.S. military personnel.
Cash and cash equivalents - Non-Restricted
Our cash consisted of checking and money market accounts with an aggregate balance of approximately $7.0 million and $7.7 million as of September 30, 2015 and 2014, respectively.
Cash - Restricted
We are required to maintain restricted cash pursuant to the Nevada Department of Insurance.
Investments
Available-for-sale investments are recorded at fair value. Unrealized gains and losses on available-for-sale investments are recorded as accumulated other comprehensive income in the shareholder’s equity section of our balance sheet, net of related income tax effects. If the fair value of any investment security declines below cost and we consider the decline to be other than temporary, we reduce the investment security to its fair value, and record a loss.
Finance Receivables
Finance receivables are carried at amortized cost and are adjusted for unamortized direct origination fees and reduced for finance charges on pre-computed finance receivables, unearned merchant discounts, allowances for credit losses, debt protection reserves and unearned fees. Debt protection reserves and unearned fees applicable to credit risk on consumer receivables are treated as a reduction of finance receivables in the consolidated balance sheet since the payments on such policies generally, are used to reduce outstanding receivables.
Allowance for Credit Losses
We maintain an allowance for credit losses, which represents management’s best estimate of inherent losses in the outstanding finance receivable portfolio. The allowance for credit losses is reduced by actual credit losses and is increased by the provision for credit losses and recoveries of previous losses. The provision for finance receivable losses are charged to earnings to bring
the total allowance to a level considered necessary by management. As the portfolio of total finance receivables consists of military loans and retail installment contracts, a large number of relatively small, homogenous accounts, the finance receivables are evaluated for impairment as two separate components: military loans and retail installment contracts. Management considers numerous factors in estimating losses in our credit portfolio, including the following:
•
Prior credit losses and recovery experience;
•
Current economic conditions;
•
Current finance receivable delinquency trends; and
•
Demographics of the current finance receivable portfolio.
Deferred Policy Acquisition Costs
The costs of acquiring the debt protection fees and insurance policies are primarily related to the production of new and renewal business and have been deferred to the extent that such costs are deemed recoverable from future revenue. Such costs principally include debt protection commission and third-party servicing fees. Costs deferred on property and casualty and credit policies are amortized over the term of the related policies in relation to the premiums and fees earned. Deferred policy acquisition costs are written off to current period results of operations if such costs are deemed to be not recoverable from future investment income.
Debt Protection - Insurance Claims and Reserves
Life and health reserves for credit coverage consist principally of future policy benefit reserves and reserves for estimates of future payments on incurred claims reported and unreported but not yet paid. Such estimates are developed using actuarial principles and assumptions based on past experience adjusted for current trends. Any change in the probable ultimate liabilities is reflected in net income in the period in which the change in probable ultimate liabilities was determined.
Revenue Recognition
Interest Income on Finance Receivables
Interest income on finance receivables is recognized as revenue on an accrual basis using the effective yield method. The deferred fees, net of costs, are accreted into income using the effective yield method over the estimated life of the finance receivable. If a finance receivable, net of costs, liquidates before accretion is completed, we charge or credit any unaccreted net deferred fees or costs to income at the date of liquidation. The accrual of interest income is suspended when three full (95% of the contracted payment amount) payments on either military loans or retail installment contracts have not been received and accrued interest is limited to no more than 92 days.
Debt Protection
CBD sells life, accident and health protection along with other exclusive coverages that are unique to our customers. Under an agreement, we assume from CBD, all risks on debt protection, credit accident, health insurance and all other coverage’s written on the military loans purchased from CBD. Unearned fees and premiums are recognized as non-interest income over the period of risk in proportion to the amount of debt protection provided.
Income Taxes
We use the asset and liability method of accounting for income taxes. Under the asset and liability method, deferred tax assets and liabilities are recorded at currently enacted tax rates applicable to the period in which assets or liabilities are expected to be realized or settled. Deferred tax assets and liabilities are adjusted to reflect changes in statutory tax rates resulting in income adjustments in the period such changes are enacted.
The Company’s operations are included in the consolidated federal income tax return of its parent, and various combined state returns. Income taxes are paid to or refunded by its parent pursuant to the terms of a tax-sharing agreement, approved by the Company Board of Directors (the "Board") as well as the MCFC Board of Directors, under which taxes approximate the amount that would have been computed on a separate company basis. The Company receives a benefit at the federal and state rate in the current year for net losses incurred in that year to the extent losses can be utilized in the consolidated federal income tax return or combined state income tax return of the parent. In the event the parent incurs a consolidated net loss in the current or future years, income tax incurred in the current and prior years may be available for recoupment by the Company.
In June 2014, federal regulators released an addendum to their “Interagency Policy Statement on the Income Tax Allocation in a Holding Company Structure”, which required the consolidated group to amend their tax allocation agreement to include specific language regarding the agency relationship between the Parent and the Company, as outlined in the addendum, no later than October 31, 2014. In August 2014, the tax-sharing agreement was amended by the parent, and approved by the Board, to include the required language.
In the event the future tax consequences of differences between the financial reporting bases and the tax bases of the Company’s assets and liabilities results in deferred tax assets, an evaluation of the probability of being able to realize the future benefits indicated by such asset is required. A valuation allowance is provided for the portion of the deferred tax asset when it is more likely than not that some or all of the deferred tax asset will not be realized. In assessing the realizability of the deferred tax assets, management considers the scheduled reversals of deferred tax liabilities, projected future taxable earnings, and tax planning strategies.
The provisions of the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 740, Income Taxes, prescribes a comprehensive financial statement model of how a company should recognize, measure, present, and disclose uncertain tax positions that the company has taken or expects to take in its income tax returns. The Company recognizes tax benefits that meet the “more likely than not” recognition threshold as defined within FASB ASC 740. In the preparation of income tax returns, tax positions are taken based on interpretation of federal and state income tax laws for which the outcome is uncertain. Management periodically reviews and evaluates the status of uncertain tax positions and makes estimates of amounts ultimately due or owed. The benefits of tax positions are recorded in income tax expense in the consolidated financial statements, net of the estimates of ultimate amounts due or owed, including any applicable interest and penalties. Changes in the estimated amounts due or owed may result from closing of the statute of limitations on tax returns, new legislation, and clarification of existing legislation through government pronouncements, the courts, and through the examination process.
The parent and its subsidiaries currently file income tax returns in the United States federal jurisdiction, and most state jurisdictions. These tax returns, which often require interpretation due to their complexity, are subject to changes in income tax regulations or in how the regulations are interpreted. In the normal course of business, the parent and its subsidiaries are routinely subject to examinations and challenges from federal and state taxing authorities regarding the amount of taxes due in connection with the businesses they are engaged in. Recently, federal and state taxing authorities have become increasingly aggressive in challenging tax positions taken by financial services organizations. The challenges made by taxing authorities may result in adjustments to the timing or amount of taxable income or deductions, or the allocation of income among tax jurisdictions. The Company does not believe any adjustments that may result from these examinations will be material to the Company.
New Accounting Pronouncements Not Yet Adopted
In May 2014, the FASB issued Accounting Standards Update (“ASU”) No. 2014-09, Revenue from Contracts with Customers (Topic 606). This guidance supersedes the revenue recognition requirements in Accounting Standards Codification Topic 605, Revenue Recognition, and most industry-specific guidance throughout the Codification Topic. The guidance requires an entity to recognize revenue that depicts the transfer of promised goods or services to customers in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods or services. The standard is effective for public entities for fiscal years and interim periods beginning December 15, 2016. The Company is currently assessing the impact of the adoption of this guidance on its financial position, results of operations or disclosures.
In August 2014, the FASB issued ASU No. 2014-15, Presentation of Financial Statements-Going Concern (Subtopic 205-40): Disclosure of Uncertainties about an Entities Ability to Continue as a Going Concern. The amendments in this update provide guidance in GAAP about management’s responsibility to evaluate whether there is a substantial doubt about an entity’s ability to continue as a going concern and to provide related footnote disclosures. The amendments (1) provide a definition of the term substantial doubt, (2) require an evaluation every reporting period, (3) provide principles for considering the mitigating effect of management’s plans, (4) require certain disclosures when substantial doubt is alleviated as a result of consideration of management’s plans, (5) require an express statement and other disclosures when substantial doubt is not alleviated, and (6) require an assessment for a period of one year after the date that the financial statements are issued (or available to be issued). The standard is effective for all entities for the annual period ending after December 15, 2016, and for annual periods thereafter. The Company is currently assessing the impact of the adoption of this guidance on its financial position, results of operations or disclosures.
In January 2015, the FASB issued ASU No. 2015-01, Income Statement- Extraordinary and Unusual Items (Subtopic 225-20): Simplifying Income Statement Presentation by Eliminating the Concept of Extraordinary Items. This standard eliminates from
GAAP the concept of extraordinary items and was issued to reduce complexity in accounting standards. The standard is effective for all entities for fiscal years beginning after December 15, 2015. The Company is currently assessing the impact of the adoption of this guidance on its financial position, results of operations or disclosures, but does not anticipate a material impact on the company’s results.
In February 2015, the FASB issued ASU No. 2015-02, Consolidation (Topic 810): Amendments to the Consolidation Analysis. The amendments in this update will change the analysis that a reporting entity must perform to determine whether it should consolidate certain types of legal entities. The standard is effective for public entities for fiscal years beginning after December 15, 2015. The Company is currently assessing the impact of the adoption of this guidance on its financial position, results of operations or disclosures.
In April 2015, the FASB issued ASU No. 2015-03, Interest- Imputation of Interest (Subtopic 835-30): Simplifying the Presentation of Debt Issuance Costs. This guidance simplifies the presentation of debt issuance costs and requires 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. The standard is effective for public entities for fiscal years beginning after December 15, 2015. The Company is currently assessing the impact of the adoption of this guidance on its financial position, results of operations or disclosures.
In August 2015, the FASB issued ASU No. 2015-14, Revenue from Contracts with Customers (Topic 606): Deferral of the Effective Date. The amendments in this ASU defer the effective date of ASU 2014-09 for all entities by one year. The standard is effective for public entities for fiscal years and interim periods beginning December 15, 2017. The Company is currently assessing the impact of the adoption of this guidance on its financial position, results of operations or disclosures.
Use of Estimates
The preparation of the consolidated financial statements requires management to make estimates and assumptions that affect amounts reported in the consolidated financial statements and in disclosures of contingent assets and liabilities. We use estimates and employ the judgments in determining the amount of our allowance for credit losses, insurance claims and policy reserves, deferred tax assets and liabilities and establishing the fair value of our financial instruments. While the consolidated financial statements and footnotes reflect the best estimates and judgments at the time, actual results could differ significantly from those estimates.
NOTE 2: FINANCE RECEIVABLES
Our finance receivables are comprised of military loans and retail installment contracts. During fiscal 2015, we purchased $326.1 million of military loans from CBD compared to $229.9 million during fiscal 2014. We acquired no retail installment contracts during fiscal 2015 compared to $1.7 million during fiscal 2014. Approximately 36.1% of the amount of military loans we purchased in fiscal 2015 were refinancings of outstanding loans compared to 33.9% during fiscal 2014.
In the normal course of business, we receive some customer payments through the Federal Government Allotment System on the first day of each month. If the first day of the month falls on a weekend or holiday, our customer payments are received on the last business day of the preceding month. These payments and use of cash are reflected on the balance sheet as a reduction of net finance receivables and the corresponding accrued interest receivable. There were no Federal Government Allotment System payments received in advance of the payment due dates on September 30, 2015 or September 30, 2014.
The following table represents finance receivables for the periods presented:
Management has an established methodology to determine the adequacy of the allowance for credit losses that assesses the risks and losses inherent in the finance receivable portfolio. Our portfolio consists of a large number of relatively small, homogenous accounts. No account is large enough to warrant individual evaluation for impairment. For purposes of determining the allowance for credit losses, we have segmented the finance receivable portfolio by military loans and retail installment contracts.
The allowance for credit losses for military loans and retail installment contracts is maintained at an amount that management considers sufficient to cover estimated losses inherent in the finance receivable portfolio. Our allowance for credit losses is sensitive to historical losses, economic assumptions and delinquency trends driving statistically modeled reserves. We consider numerous qualitative and quantitative factors in estimating losses in our finance receivable portfolio, including the following:
•
Prior credit losses and recovery experience;
•
Current economic conditions;
•
Current finance receivable delinquency trends; and
•
Demographics of the current finance receivable portfolio.
We also use internally developed data in this process. We utilize a statistical model based on potential credit risk trends and charge off data, when incorporating historical factors to estimate losses. These results and management’s judgment are used to project inherent losses and to establish the allowance for credit losses for each segment of our finance receivables.
As part of the on-going monitoring of the credit quality of our entire finance receivable portfolio, management tracks certain credit quality indicators of our customers including trends related to: (1) net charge-offs, (2) non-performing loans and (3) payment history.
There is uncertainty inherent in these estimates, making it possible that they could change in the near term. We make regular enhancements to our allowance estimation methodology that have not resulted in material changes to our allowance.
The following table sets forth changes in the components of our allowance for credit losses on finance receivables as of the end of the years presented:
The accrual of interest income is suspended when three full (95% of the contracted payment amount) payments on either military loans or retail installment contracts have not been received and accrued interest is limited to no more than 92 days. Non-performing assets represent those finance receivables where the accrual of interest income has been suspended. As of September 30, 2015, we had $15.2 million in military assets and $0.3 million in retail installment contracts that were non-performing loans compared to $16.2 million in military loans and $1.1 million in retail installment contracts that were non-performing loans as of September 30, 2014. As of September 30, 2015, we had $0.9 million in accrued interest for military loans and $4,000 in accrued interest for retail installment contracts for assets that were classified as non-performing. As of September 30, 2014, we had $0.9 million in accrued interest for military loans and $0.02 million in accrued interest for retail installment contracts for assets that were classified as non-performing.
We consider a loan impaired when a full payment has not been received for 180 days and is also 30 days contractually past due. Impaired loans are removed from our finance receivable portfolio, including any accrued interest, and charged against income. We do not restructure troubled debt as a form of curing delinquencies.
A large portion of our customers are unable to obtain financing from traditional sources due to factors such as employment history, frequent relocations and lack of credit history. These factors may not allow them to build relationships with traditional sources of financing. As a result, our receivables do not have a credit risk profile that can be easily measured by the credit quality indicators normally used by the financial markets. We manage the risk by closely monitoring the performance of the portfolio and through our purchase criteria.
The following reflects the credit quality of the Company’s finance receivables:
As of September 30, 2015, and 2014 the past due finance receivables, on a recency basis, are as follows:
Additionally, we have adopted purchasing criteria, which was developed from our past customer credit repayment experience and is periodically evaluated based on current portfolio performance. These criteria require the following:
•
All borrowers are primarily active-duty, or career retired U.S. military personnel or U.S. Defense Department employees;
•
All potential borrowers must complete standardized credit applications online via the internet; and
•
All loans must meet additional purchase criteria that was developed from our past credit repayment experience and is periodically revalidated based on current portfolio performance.
These criteria are used to help minimize the risk of purchasing loans where there is unwillingness or inability to repay. The CBD limits the loan amount to an amount the customer could reasonably be expected to repay.
On April 22, 2015, CBD modified its lending criteria and scoring model to use credit score information provided by the FICO Score 8 model, in combination with certain credit overlays. The Company modified its purchasing guidelines to accept loans originated by CBD with the FICO 8 model and certain credit overlays.
The liability for unpaid debt protection claims and claim adjustment expenses is estimated using an actuarially computed amount payable on claims reported prior to the balance sheet date that have not yet been settled, claims reported subsequent to the balance sheet date that have been incurred during the period ended, and an estimate (based on prior experience) of incurred but unreported claims relating to such period.
Activity in the liability for unpaid claims and claim adjustment expenses for our debt protection and reinsurance products are summarized as follows:
NOTE 3: INVESTMENTS
There were no investments outstanding as of September 30, 2015. Book value of investments outstanding as of September 30, 2014 was $0.35 million, $0.25 million of which was U.S. government bonds and the remaining $0.1 million was certificates of deposit. There were no unrealized gains as of September 30, 2014, as carrying value approximated fair value.
During fiscal 2015 and 2014, the Company received $0.35 million and $1.4 million, respectively, in proceeds from investment maturities. The Company did not recognize any realized gains or losses or receive proceeds from sales on investments during fiscal 2015 or 2014. The Company had a realized gain of $0.04 million in 2013 from the sale of investments.
NOTE 4: FURNITURE AND EQUIPMENT
Cost and accumulated depreciation of furniture and equipment at September 30, 2015 and 2014 is as follows:
Furniture and equipment are carried at cost less accumulated depreciation and amortization. Depreciation and amortization are computed using the straight-line method. Estimated useful lives are 7 years for furniture and equipment, and 3 years for computer software. Major improvements are capitalized, while maintenance and repairs are charged to expense as incurred. Depreciation expense was $0.2 million for the years ended September 30, 2015, 2014 and 2013.
The Company entered into a Master Services Agreement (the "MSA") with Fidelity Information Services, LLC ("FIS"), effective as of June 30, 2014, to provide products and services for the development of a new consumer lending software platform (the "FIS Platform"). The implementation and launch of the FIS Platform was expected to be completed during the second quarter of fiscal year 2015. On April 24, 2015, the Company notified FIS that it was terminating its relationship with FIS under the MSA. Effective June 10, 2015, the Company and FIS entered into a written settlement agreement whereby the parties released, waived and discharged one another and their affiliates from any and all liabilities arising out of or relating to the MSA. Pursuant to the settlement agreement, the Company made a one-time payment to FIS of $3.2 million, during the fourth quarter of fiscal 2015, a portion of which constituted a license fee for FIS's Default Manager software. The settlement contains other customary settlement provisions, and no other payments are required by the parties under the settlement agreement or MSA.
The Company recorded a $2.3 million expense in the third quarter of fiscal 2015, which included $1.2 million for the FIS settlement and $1.1 million for previously capitalized consumer lending software development costs. The Company capitalized $2.0 million of the FIS settlement for the FIS Default Manager software and consumer lending software development and design costs. In November 2015, the Company entered into agreements with new vendors for the development of a consumer lending system with implementation expected to be completed in fiscal year 2016.
As of September 30, 2015, the Company had $2.8 million in work in process related to the development of a new consumer lending software platform and the FIS Default Manager software.
NOTE 5: GOODWILL AND OTHER INTANGIBLE ASSETS
Our annual goodwill impairment test as of September 30, 2014, indicated that the implied fair value of goodwill was less than the carrying value, resulting in an impairment charge of $31.5 million for the year ended September 30, 2014. Due to the nature of our amortizable intangible assets outstanding, management determined that our amortizable intangible assets were fully impaired at September 30, 2014. An impairment charge of $2.6 million was recorded for the year ended September 30, 2014 for the carrying value of amortizable intangible assets. Amortization expense was zero, $1.2 million and $1.7 million in fiscal 2015, 2014 and 2013, respectively.
NOTE 6: BORROWINGS
Secured Senior Lending Agreement
On June 12, 2009, we entered into the SSLA with the lenders listed on the SSLA (“the lenders”) and UMB Bank, N.A. (the “Agent”). The SSLA replaced and superseded the Senior Lending Agreement, dated as of June 9, 1993, as subsequently amended and restated (the “SLA”). The term of the current SSLA ends March 31, 2016 and is automatically extended annually unless any lender gives written notice of its objection by March 1 of each calendar year. Our assets secure the loans extended under the SSLA for the benefit of the lenders and other holders of the notes issued pursuant to the SSLA (the “Senior Debt”). The facility is an uncommitted credit facility that provides common terms and conditions pursuant to which the individual lenders that are a party to the SSLA may choose to make loans to us in the future. Any lender may elect not to participate in future fundings at any time without penalty. If a lender were to choose not to participate in future fundings, the outstanding amortizing notes would be repaid based on the original terms of the note. Any existing borrowings from that lender under the revolving credit line are payable in 12 equal monthly installments. As of September 30, 2015, we could request up to $9.6 million in additional funds and remain in compliance with the terms of the SSLA. No lender, however, has any contractual obligation to lend us these additional funds.
As of September 30, 2015, the lenders have indicated a willingness to participate in fundings up to an aggregate of $163.5 million during the next 12 months, including $153.9 million that is currently outstanding. Included in this amount are no borrowings from withdrawing banks that previously participated in the SSLA. In the first quarter of fiscal 2016, two banks increased their total funding participation by $8.0 million.
On September 2, 2015, MCFC entered into a confidential Memorandum of Understanding ("MOU") with its primary federal regulator. The Company's senior borrowings are limited to $170.6 million, without prior approval from our primary federal regulator.
Our SSLA allows additional banks to become parties to the SSLA under a modified non-voting role. We have identified each lender that has voting rights under the SSLA as “voting bank(s)” and lenders that do not have voting rights under the SSLA, as “non-voting bank(s)”. While all voting and non-voting banks have the same rights to the collateral and are a party to the same terms and conditions of the SSLA, all of the non-voting banks acknowledge and agree that they have no right to vote on any matter nor to prohibit or limit any action by us, or the voting banks. As of September 30, 2015, we had three non-voting banks with an outstanding principal balance of $0.3 million.
The aggregate notional balance outstanding under amortizing notes was $138.4 million and $127.8 million at September 30, 2015 and 2014, respectively. There were 222 and 320 amortizing term notes outstanding at September 30, 2015 and 2014, respectively, with a weighted-average interest rate of 5.68% and 6.09%, respectively. Interest on the amortizing notes is fixed at 270 basis points over the 90-day moving average of like-term treasury notes when issued. The interest rate may not be less than 5.25%. All amortizing notes have terms not to exceed 48 months, payable in equal monthly principal and interest payments. In addition, we are paying our lenders a quarterly uncommitted availability fee in an amount equal to ten basis points multiplied by the quarterly average aggregate outstanding principal amount of all amortizing notes held by the lenders. Uncommitted availability fees in fiscal years 2015 and 2014 were $0.4 million and $0.6 million, respectively.
Advances outstanding under the revolving credit line were $15.4 million and zero at September 30, 2015 and 2014, respectively. When a lender elects not to participate in future fundings, any existing borrowings from that lender under the revolving credit line are payable in 12 equal monthly installments. Interest on borrowings under the revolving credit line is payable monthly and is based on prime or 4.00%, whichever is greater. Interest on borrowings was 4.00% at September 30, 2015 and 2014.
Substantially all of our assets secure the debt under the SSLA. The SSLA also limits, among other things, our ability to: (1) incur additional debt from the lenders beyond that allowed by specific financial ratios and tests; (2) borrow or incur other additional debt except as permitted in the SSLA; (3) pledge assets; (4) pay dividends; (5) consummate certain asset sales and dispositions; (6) merge, consolidate or enter into a business combination with any other person; (7) pay to MCFC service charge fees each year except as provided in the SSLA; (8) purchase, redeem, retire or otherwise acquire any of our outstanding equity interests, (9) issue additional equity interests; (10) guarantee the debt of others without reasonable compensation and only in the ordinary course of business or; (11) enter into management agreements with our affiliates.
Under the SSLA, we are subject to certain financial covenants that require that we, among other things, maintain specific financial ratios and satisfy certain financial tests. In part, these covenants require us to: (1) maintain an allowance for credit losses equal to or greater than the allowance for credit losses shown on our audited financial statements as of the end of our most recent fiscal year and at no time less than 5.25% of our consolidated net finance receivables, unless otherwise required by generally accepted accounting principles (“GAAP”); (2) limit our senior indebtedness as of the end of each quarter to not greater than three and one half times our tangible net worth; (3) maintain a positive net income in each fiscal year; (4) limit our senior indebtedness as of the end of each quarter to not greater than 70% of our consolidated net finance receivables; and (5) maintain a consolidated total required capital of at least $75 million plus 50% of the cumulative positive net income earned by us during each of our fiscal years ending after September 30, 2008. Any part of the 50% of positive net income not distributed by us as a dividend for any fiscal year within 120 days after the last day of such fiscal year must be added to our consolidated total required capital and may not be distributed as a dividend or otherwise. No part of the consolidated total required capital may be distributed as a dividend.
We may not make any payment to MCFC in any fiscal year for services performed or reasonable expenses incurred in an aggregate amount greater than $765,750 plus reimbursable expenses. Such amount may be increased on each anniversary of the SSLA by the percentage increase in the CPI published by the United States Bureau of Labor for the calendar year then most recently ended. Except as required by law, we may not stop purchasing small loans to military families from CBD, unless the lenders consent to such action.
The breach of any of these covenants could result in a default under the SSLA, in which event the lenders could seek to declare all amounts outstanding to be immediately due and payable. If an event of default has occurred, the Agent has the right, on behalf of all holders of the Senior Debt, to immediately take possession and control of the collateral. If the Agent notifies us of an event of default, the interest rate on all Senior Debt will automatically increase to a default rate equal to 2% above the interest rate otherwise payable on such Senior Debt. The default rate will remain in effect so long as any event of default has not been cured.
In connection with the execution of the SSLA, MCFC entered into an Unlimited Continuing Guaranty. MCFC guaranteed the Senior Debt and accrued interest in accordance with the terms of the Unlimited Continuing Guaranty. Under the Unlimited Continuing Guarantee, MCFC also agreed to indemnify the lenders and the Agent for all reasonable costs and expenses (including reasonable fees of counsel) incurred by the lenders or the Agent for payments made under the Senior Debt that are rescinded or must be repaid by lenders to us. If MCFC is required to satisfy any of borrowers’ obligations under the Senior Debt, the lenders and the Agent will assign without recourse the related Senior Debt to MCFC.
Concurrently, in connection with the execution of the SSLA, MCFC entered into a Negative Pledge Agreement in favor of the Agent. Under the Negative Pledge Agreement, MCFC represented that it will not pledge, sell, assign or transfer its ownership of all or any part of the issued and outstanding capital stock of the Company and will not otherwise or further encumber any of such capital stock beyond the currently existing negative pledge thereof in favor of Branch Banking and Trust (“BB&T”). On December 16, 2015, MCFC and BB&T amended their loan agreement to eliminate the negative pledge with respect to the Company's stock.
Subordinated Debt - Parent
Our SSLA allows for a line of credit with MCFC. Funding on this line of credit is provided as needed at our discretion and dependent upon the availability of funds from our parent and is due upon demand. The maximum principal balance on this line of credit is $25.0 million. Interest is payable monthly and is based on prime or 5.0%, whichever is greater. As of September 30, 2015 and 2014, the outstanding balance under this line of credit was zero. Under the MOU, the Company would need to obtain permission from its primary federal regulator before borrowing under the line of credit with MCFC.
Investment Notes
We have borrowings through the issuance of investment notes (with accrued interest) with an outstanding notional balance of $41.1 million, which includes a $0.04 million purchase adjustment as of September 30, 2015 and $54.8 million, which includes a $0.1 million purchase adjustment as of September 30, 2014. The purchase adjustments relate to fair value adjustments recorded as part of the Transaction. These investment notes are nonredeemable before maturity by the holders, issued at various rates and mature 1 to 10 years from date of issue. At our option, we may redeem and retire any or all of the debt upon 30 days written notice. The average investment note payable was $52,714 and $53,062, with a weighted-average interest rate of 9.23% and 9.23% at September 30, 2015 and 2014, respectively. Interest is paid either monthly or annually at the option of the note holder.
Under the MOU, the Company's subordinated borrowings are limited to $44.0 million, without prior approval from our primary federal regulator.
On April 29, 2015, we filed with the Securities and Exchange Commission ("SEC") our post-effective amendment to remove from registration all securities that remain unsold under our amended registration statement originally filed with the SEC on January 28, 2011 (the "Registration Statement"). We subsequently filed a Form RW, on June 5, 2015, to withdraw Post-Effective Amendment No. 4 to the Registration Statement, pursuant to which no securities were sold and which was never declared effective by the SEC. We will no longer offer and sell investment notes pursuant to the Registration Statement.
Series A Subordinated Debentures
In December 2015, the Company offered up to $7.0 million in Series A subordinated debentures to certain investors in a private placement. The debentures have varying interest rates between 5.5% and 7.5% and varying maturities between one and three years.
Maturities
A summary of maturities for the amortizing notes and investment notes (net of purchase price adjustments) at September 30, 2015, follows:
NOTE 7: INCOME TAXES
The provision (benefit) for income taxes for the years ended September 30, 2015, 2014, and 2013, consisted of the following:
The actual tax expense for the fiscal years ended 2015, 2014, and 2013, differs from the computed ‘expected’ tax expense (benefit) for those years (computed by applying the currently applicable United States federal corporate tax rates of 35% to income before income taxes) as follows:
The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and liabilities as of September 30, 2015 and 2014 are presented below:
As of September 30, 2015, the Company had state net operating loss carryforwards of approximately $3.5 million, and state alternative minimum tax credit carryforwards of approximately $1,000. The net operating loss carryforwards begin expiring in 2022 through 2035.
In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of the deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary difference become deductible. Management considers the scheduled reversal of deferred tax liabilities, projected future taxable income, and tax planning strategies in making this assessment.
The Company is included in the consolidated federal income tax return and, for certain states, combined state tax returns of its parent. Under the benefits-for-loss approach, net operating losses and other tax attributes of the Company are characterized as realized when utilized by the parent. Therefore, recognition of deferred tax assets is based on all available evidence as it relates to both the parent and the Company. As the Company is party to a tax sharing agreement with its parent that will reimburse it for any losses utilized in the parent’s consolidated tax returns, management believes it is more likely than not that the Company will realize the benefits of those deductible differences based on the Parent’s historical taxable income and projections for future taxable income over the periods in which the deferred tax assets are deductible, with the exception of certain state differences. Accordingly, at September 30, 2015 and 2014, the Company recorded a valuation allowance on these deferred tax assets of $38,000 and $32,000, respectively.
As of September 30, 2015, 2014 and 2013, the reserve for uncertain tax positions was approximately $201,000, $470,000, and $500,000 respectively. The reserve for uncertain tax positions is included in accrued expenses and other liabilities in the consolidated balance sheet as of September 30, 2015, 2014, and 2013. The Company had approximately $64,000 of unrecognized tax benefit that if realized would affect the effective tax rate. Interest and penalties recognized are recorded as a component of income tax benefit in the amount of approximately $(68,000), $(13,000) and $(20,000) for the years ended September 30, 2015, 2014, and 2013 respectively.
A reconciliation of unrecognized tax benefits for fiscal year 2015, 2014 and 2013 is as follows:
In addition, the Company has accrued cumulative interest and penalties of approximately $93,000, $161,000, and $174,000 as of September 30, 2015, 2014 and 2013, respectively.
The Company does not believe a significant increase or decrease in the uncertain tax positions will occur in the next twelve months.
The parent’s federal income tax returns are open and subject to examination by the Internal Revenue Service for the tax year ended September 30, 2012 and later. MCFC and its subsidiaries state returns are generally open and subject to examinations for the tax year ended September 30, 2011 and later for major state jurisdictions. The Company does not believe any adjustments that may result from these examinations will be material to the Company.
NOTE 8: RELATED PARTY TRANSACTIONS
We entered into the fourth amended and restated Loan Sale and Master Services Agreement (“LSMS Agreement”) with MCB in November 2014. Under the LSMS Agreement, we buy certain military loans that CBD originates and receive management and record keeping services from CBD. The following table represents the related party transactions associated with this agreement and other related party transactions for the periods presented.
(1)
Effective October 1, 2014, the monthly servicing fee to CBD was 0.496% of the outstanding principal under the amended LSMS agreement. From April 1, 2014 to September 30, 2014, the monthly servicing fee to CBD was 0.43% of outstanding principal under the amended LSMS Agreement. The monthly servicing fee to CBD was 0.68% of outstanding principal for the twelve month period April 1, 2013 to March 31, 2014. Prior to April 1, 2013, the monthly servicing fee was 0.70% of outstanding principal.
(2)
Effective on April 1, 2014, monthly fees for special services that are not included in the LSMS Agreement will be at a rate of 125% of the cost of services.
(3)
Effective April 1, 2014, $500,000 annual base fee, payable monthly to CBD. Prorated for fiscal 2014.
(4)
The annual maximum for fiscal years 2015 is $765,750. The maximum may be increased annually in June with an increase in the Consumer Price Index. The maximum in fiscal years 2014 and 2013 was $750,000.
(5)
The monthly relationship fee ceased on March 31, 2014 with the amended LSMS Agreement. Monthly relationship fee to CBD was equal to $2.91 for each loan owned at the prior fiscal year end for the six months ended March 31, 2014. Monthly relationship fee to CBD was equal to $2.82 for each loan owned at June 21, 2013 for the three month period July 1, 2013 through September 30, 2013. Prior to June, 21, 2013, the monthly relationship fee was $2.82 for each loan owned at the prior fiscal year end.
(6)
Effective October 1, 2014, we pay a $26.00 fee for each military loan purchased from CBD to reimburse CBD for loan origination costs. In fiscal 2014 and 2013 the fee was $30.00 for each military loan purchased from CBD.
(7)
This allocation has a $1,877,636 annual maximum for fiscal year 2015 plus 7% per annum thereafter. $1,754,800 annual maximum for fiscal year 2014. $1,640,000 annual maximum for fiscal year 2013.
(8)
A one-time fee of $1,650,000 to implement a new consumer lending system that was paid over five monthly installments beginning on October 1, 2014.
NOTE 9: VOLUNTARY REMEDIATION
In June 2013, MCB received a letter from the Office of the Comptroller of the Currency (the "OCC") regarding certain former business practices of CBD that the OCC alleged violated Section 5 of the Federal Trade Commission Act. In July 2013, MCB responded in writing to the OCC regarding its analysis of the former business practices and stated that it did not believe it engaged in practices that rose to the level of a violation of law. On July 22, 2014, MCB's Board of Directors directed management to develop a plan of self-remediation to address the sales and marketing practices in question. While developing the self-remediation plan, it was determined on September 1, 2014 that MCB's affiliates who benefited from the practices in question should also adopt self-remediation plans and participate proportionately in the execution of the overall plan of self-remediation.
On September 26, 2014, the Boards of Directors of MCB, Heights Finance Funding Co. and the Company approved self-remediation plans (the "Plans") and entered into an Affiliate Remediation Payment Agreement ("ARP Agreement"). In accordance with the Plans, remediation payments will be made to certain customers impacted by the practices in question. The ARP Agreement requires, among other provisions, that all professional fees and other costs to be split on a proportionate basis between affiliates based on customer remediation payments under the Plans, effective September 1, 2014.
Under the terms of the Plans, an independent administrator of the Plans has been engaged. The implementation of the Plans required an initial cash contribution to be placed with the administrator approximating the cash payments to customers, plus an additional 10%. On October 10, 2014, the Company deposited its portion of the cash contribution in the amount of approximately $8.4 million. The Company received a $9.0 million capital infusion from MCFC on October 10, 2014 prior to funding the $8.4 million cash remediation obligation.
Under the Plans, the Company's proportionate liability for customer remediation is approximately $13.5 million. The Company has accrued an additional $1.0 million related to the estimated proportionate share of further legal, administrator, audit and data fees. As of September 30, 2015, the Company's remaining liability for remediation was $1.4 million. All planned customer mailings and payments, under the Plans, have been completed as of September 30, 2015. The Company expects the completion of Plans in the first half of fiscal 2016.
The OCC has indicated acceptance of the Plans and management will continue to implement the Plans as outlined above.
NOTE 10: LITIGATION
We are subject to legal proceedings and claims that arise in the ordinary course of business. In the opinion of management, the amount of ultimate liability with respect to these actions will not have a material adverse effect on the financial position, results of operations or cash flow.
NOTE 11: DISCLOSURE ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS
Fair value measurement requires that valuation techniques maximize the use of observable inputs and minimize the use of unobservable inputs and also establishes a fair value hierarchy that categorizes into three levels the inputs to valuation techniques used to measure fair value as follows:
•
Level 1 - Inputs are unadjusted quoted prices in active markets for identical assets or liabilities that the Company has the ability to access at the measurement date.
•
Level 2 - Inputs include quoted prices for similar assets and liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active, inputs other than quoted prices that are observable for the asset or liability and inputs that are derived principally from or corroborated by observable market data by correlation or other means (market corroborated inputs).
•
Level 3 - Unobservable inputs reflect the Company’s judgments about the assumptions market participants would use in pricing the asset or liability since limited market data exists. The Company develops these inputs based on the best information available, including the Company’s own data.
The Company’s policy is to recognize transfers in and transfers out as of the ending of the reporting period. During fiscal years 2015 and 2014, there were no significant transfers in or out of Levels 1, 2 or 3.
The following methods and assumptions were used to estimate the fair value of its financial instruments:
Cash and cash equivalents - Non-restricted and Restricted - The carrying value approximates fair value due to their liquid nature and classified as Level 1 in the fair value hierarchy.
Investments - Fair value for U.S. government bond investments is based on quoted prices for similar assets in active markets and classified as Level 2.
Finance Receivables - The fair value of finance receivables is estimated by discounting the receivables using current rates at which similar finance receivables would be made to borrowers with similar credit ratings and for the same remaining maturities as of fiscal year end. In addition, the best estimate of losses inherent in the portfolio is deducted when computing the estimated fair value of finance receivables. If the Company’s finance receivables were measured at fair value in the financial statements these finance receivables would be classified as Level 3 in the fair value hierarchy.
Amortizing Term Notes - The fair value of the amortizing term notes with fixed interest rates is estimated using the discounted cash flow analysis based on the Company’s current incremental borrowing rates for similar types of borrowing arrangements. If the Company’s amortizing term notes were measured at fair value in the financial statements, these amortizing term notes would be categorized as Level 2 in the fair value hierarchy.
Investment Notes - The fair value of investment notes is estimated by discounting future cash flows using current rates at which similar investment notes would be offered to lenders for the same remaining maturities. If the Company’s investment notes were measured at fair value in the financial statements, these investment notes would be categorized as Level 2 in the fair value hierarchy.
The carrying amounts and estimated fair values of our financial instruments at September 30, 2015 and 2014 are as follows:
NOTE 12: QUARTERLY FINANCIAL DATA (UNAUDITED)
The following is a summary of quarterly financial results:
(1)
Number of shares outstanding is one.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
Not applicable.
ITEM 9A.
ITEM 9A. CONTROLS AND PROCEDURES
Our management, under the supervision and with the participation of our principal executive officer and principal financial officer, evaluated the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the fiscal year, as defined under rule 13a-15(e) of the Exchange Act, which is the subject of this Annual Report on Form 10-K. Based on this evaluation, our principal executive officer and principal financial officer have concluded that the design and operation of our disclosure controls and procedures are effective.
There were no changes in our internal controls over financial reporting identified in connection with management’s evaluation that occurred during the fourth quarter of fiscal year ended September 30, 2015 that have materially affected, or are reasonably likely to materially affect our internal controls over financial reporting.
MANAGEMENT’S REPORT ON INTERNAL CONTROLS OVER FINANCIAL REPORTING
Management is responsible for establishing and maintaining an effective internal control over financial reporting as this term is defined under Rule 13a-15(f) of the Exchange Act and has made organizational arrangements providing appropriate divisions of responsibility and has established communication programs aimed at assuring that its policies, procedures and principles of business conduct are understood and practiced by the employees of CBD on behalf of the Company. All internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation.
Our management has assessed the effectiveness of our internal control over financial reporting as of September 30, 2015. In making this assessment, we used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) in establishing our control environment. Based on these criteria and our assessment, we have determined that, as of September 30, 2015, our internal control over financial reporting was effective.
This Annual Report does not include an attestation report of our registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by the Company’s registered public accounting firm pursuant to rules of the Securities and Exchange Commission that permit the Company to provide only an annual report from management with regard to the internal control over financial reporting in this Annual Report.
/s/ Timothy L. Stanley
Timothy L. Stanley
Chief Executive Officer
(Principal Executive Officer)
/s/ Laura V. Stack
Laura V. Stack
Chief Operating Officer, Chief Financial Officer,
Treasurer and Asst. Secretary
(Principal Financial Officer)
ITEM 9B.
ITEM 9B. OTHER INFORMATION
None.
PART III
ITEM 10.
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
Directors and Executive Officers
The following table sets forth information regarding our current directors and executive officers.
Name
Age
Position
Timothy L. Stanley
Chief Executive Officer and Vice Chairman
Laura V. Stack
Chief Operating Officer, Chief Financial Officer, Treasurer, Asst. Secretary and Director
Robert F. Hatcher
Chairman
For each member of our executive team and our Board, we set forth below information regarding such member’s business experience and the specific experience, qualifications, attributes and/or skills that, in the opinion of our Board, qualifies this person to serve as a director and are likely to enhance our Board’s ability to manage and direct our business and affairs. The information in this section should not be understood to mean that any of the directors is an “expert” within the meaning of the federal securities laws.
Timothy L. Stanley has served as a member of our Board since December 18, 2013. Mr. Stanley has served as our Chief Executive Officer since October 13, 2014. Mr. Stanley joined Heights Finance Corporation (“Heights”) as its President since in April 2003. He has served as Heights' Chief Executive Officer since August 2004 and as the Chief Operating Officer of MCFC since September 2010. Prior to joining Heights, Mr. Stanley spent 23 years with Wells Fargo Financial and held a variety of positions in branch operations, marketing, client services, and technology during his tenure, including Senior Vice President of the Information Services Group. Mr. Stanley has management and financial experience as a chief executive officer and a chief operating officer of a financial services company. He has oversight responsibility for the operations, legal, information technology and human resources functions of MCFC, as well as ongoing corporate-wide initiatives. He also has oversight and corporate governance experience as a current member and former chairman of the American Financial Services Association and a current and former director of various corporate and nonprofit entities.
Since June 2007, Laura V. Stack has served as our Chief Financial Officer, Treasurer and Asst. Secretary. In April 2015, she also became our Chief Operating Officer. She has been a member of the Board since January 12, 2010 and a member of our compensation and audit committees and the audit committee financial expert since December 2010. Prior to December 2007, Ms. Stack was our Director of Corporate Finance and previously held the position of Controller. Ms. Stack joined us in 1999, after serving as Vice President for a financial services firm with responsibilities for accounting, cash management, financial/regulatory reporting, consolidating-corporation budget and auditing. Ms. Stack serves on the board of directors for the charitable organizations, Friends of Alvin Ailey and the Junior Achievement. Ms. Stack has accounting experience and knowledge about public companies, the concerns and challenges faced in our industry, our regulatory environment and significant experience in financial reporting of finance companies to the SEC and our lenders.
Robert F. Hatcher has served as a member of our Board since January 2010. Mr. Hatcher has served as President and Chief Executive Officer of MCFC since its inception in 2002. Mr. Hatcher was the President of First Liberty Bank from 1988 until 1990 and President and Chief Executive Officer of that bank and its parent, First Liberty Financial Corp., from 1990 until its merger with BB&T in 1999. Prior to joining First Liberty, Mr. Hatcher served in various positions with Trust Company Bank (now SunTrust) for 27 years. He has been a director of MCFC since 2002. Mr. Hatcher has management and financial experience as a chief executive officer of a financial services company. He also has oversight and corporate governance experience as a current member and former chairman of the Board of Regents of the University System of Georgia and a current and former director of various corporate and nonprofit entities.
Director Compensation, Composition and Committees
We have no outside independent directors and do not pay separate compensation for serving as a director.
We are a wholly owned subsidiary of MCFC. In view of this, the small size of our Board and that we do not have publicly traded equity securities that are subject to exchange listing requirements, we do not have a separate standing nominating committee. The functions that are normally performed by the nominating committee are performed by our Board as a whole. Our Board has formed audit and compensation committees, each consisting of two members of our Board, Laura V. Stack and Timothy L. Stanley. In recognition of the expertise and experience of the MCFC Board Compensation Committee (the "MCFC Compensation Committee"), our compensation committee (the "Compensation Committee") relies and expects to continue to rely heavily on the MCFC Compensation Committee in fulfilling the functions of a compensation committee. Our Compensation Committee has a separate charter. Ms. Stack has been appointed the chair of the audit committee and is the audit committee financial expert. The designation of a person as an “audit committee financial expert,” within the meaning of the rules under Section 407 of the Sarbanes-Oxley Act of 2002, shall not impose any greater responsibility or liability on that person than the responsibility and liability imposed on such person as a member of the audit committee, nor shall it decrease the duties and obligations of other audit committee members or the Board. In recognition of the expertise and experience of the risk and audit committee of MCFC, (the "MCFC Risk and Audit Committee"), our audit committee (the "Audit Committee") relies and expects to continue to rely heavily on the MCFC Risk and Audit Committee in fulfilling the functions of an audit committee. The Audit Committee has a separate charter. Our executive officers and directors, including our principal executive, financial and principal accounting officers are subject to our Code of Business Conduct and Ethics, a copy of which may be obtained at no charge from us upon written request directed to us at Pioneer Financial Services Inc., 4700 Belleview Ave., Suite 300, Kansas City, Missouri 64112.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
COMPENSATION DISCUSSION AND ANALYSIS
This Compensation Discussion and Analysis (“CD&A”) describes the material elements of compensation awarded to, earned by, or paid to our Principal Executive Officer (referred to in this CD&A as our “Chief Executive Officer”), Principal Financial Officer (referred to in this CD&A as our “Chief Financial Officer”) and other executive officers for all services rendered by these officers in all capacities to us during fiscal year 2015. Timothy Stanley serves as our Chief Executive Officer and is an employee of MCFC. Mr. Stanley provided less than 50% of his services to us. Laura Stack serves as our Chief Financial Officer. Ms. Stack was employed by CBD until April 2015 when Ms. Stack became an employee of MCFC. Ms. Stack provided over 50% of her services to us during fiscal year 2015. All compensation for the named and other executive officers is paid by CBD or MCFC. As disclosed under “Item 7. Management Discussion and Analysis of Financial Condition and Results of Operations-Results of Operations,” we pay CBD and MCFC various fees for the services provided to us. The compensation for the Chief Executive Officer is reviewed by the MCFC Compensation Committee. For fiscal 2015, the compensation of the Chief Financial Officer was reviewed by the Chief Executive Officer of the Company.
The purpose of the CD&A is to summarize the philosophical principles, specific program elements and other factors considered in making decisions about executive compensation. Our CD&A primarily focuses on the compensation information for the last completed fiscal year, as contained in the tables, related footnotes and other narrative descriptions that follow this discussion, but we also describe compensation actions taken before or after the last completed fiscal year to the extent it enhances the understanding of our executive compensation disclosure.
MCFC Compensation Committee’s Responsibilities
In recognition of the expertise and experience of the MCFC Compensation Committee, our Compensation Committee relies and expects to continue to rely heavily on the MCFC Compensation Committee in fulfilling the functions of a compensation committee. The MCFC Board established the MCFC Compensation Committee that is responsible for oversight of MCFC’s executive compensation program, including stock grants, to ensure that CBD and MCFC provide the appropriate motivation to retain key executives and employees and achieve superior corporate performance and shareholder value. The MCFC Compensation Committee is responsible for all matters dealing with executive officers’ and directors' compensation including: annual incentive plans, employment contracts for executive officers and restricted stock unit awards for eligible employees.
The MCFC Compensation Committee is composed of three independent MCFC Board Directors and meets approximately four times per year. Reports of the MCFC Compensation Committee’s actions and recommendations are presented to the full MCFC Board after each meeting. In May 2014, the MCFC Compensation Committee engaged Blanchard
Consulting Group (“Blanchard”), an independent executive compensation consultant, to advise it on compensation practices for executive officers based on information provided to Blanchard by MCFC’s management and Blanchard’s independent research. Blanchard completed a formal executive compensation review (“Blanchard Report”) and presented this to the MCFC Compensation Committee in October 2014. A formal review of executive compensation is completed every two years by an independent executive compensation consultant. In May 2015 the MCFC Compensation Committee retained Lockton Company ("Lockton") to provide executive compensation consulting services to the MCFC Board. Lockton will be preparing and presenting the bi-annual compensation review to the MCFC Compensation Committee in 2016.
Compensation Philosophy
MCFC is a privately held company and its primary concerns are providing value for its shareholders and meeting our obligations to our investment note holders. Accordingly, the guiding compensation philosophy of the MCFC Compensation Committee is to establish a compensation program that will enable the attraction, development, and retention of key executives and employees who are motivated to achieve excellent corporate performance, strong results of operations and cash flows and sustained long-term shareholder value. Furthermore, the pay practices we have in place do not encourage employees to take inappropriate or excessive risks that would be potentially detrimental to our financial or operating results, our cash flow, our profits and the interests of our investment note holders.
Program Elements
Our executive compensation program is composed of base salary, annual incentive compensation and long-term incentive compensation. The following table outlines the total compensation earned by, and awarded to, our named executive officers for services provided to us in any capacity.
Total Compensation
(1) Mr. Stanley was appointed Chief Executive Officer on October 13, 2014.
(2) Annual incentives are generally paid in the subsequent fiscal year. In addition 20% of Mr. Stanley’s incentive is deferred and paid in two annual installments in December of the next two following years. The amount shown is the full amount for the fiscal year although 20% of it will have deferred payment over the next two years.
Base Salary
Base salaries are determined after considering an individual’s responsibilities, experience and overall job performance. The MCFC Compensation Committee reviewed the competitiveness of base compensation as compared to market published survey data and a third-party peer group in the Blanchard Report. Base salaries are targeted at the midpoint to seventy-fifth percentile of the market based on job experience and as compared to similar positions in markets where we compete for talent.
The third-party peer group of companies consists of:
All executive officers are eligible for an annual merit increase to base salary, effective January 1, based primarily on performance of job responsibilities and accomplishment of predetermined performance objectives. Job accomplishments are measured by a written performance appraisal that includes evaluating the key responsibilities of the position using five levels of defined performance ratings culminating in an overall job performance rating. The Chief Executive Officer of PFSI evaluates the Chief Financial Officer's performance and the Chief Executive Officer of MCFC evaluates our Chief Executive Officer’s performance.
Annual Incentive
MCFC provides our named executive officers with an annual opportunity to earn cash incentive awards through the Annual Incentive Plan (the “AIP”). Annual incentive compensation is paid in cash. Incentive opportunity levels for named executive officers are generally positioned at or above market competitive levels. Cash incentives are targeted to be between the midpoint and seventy-fifth percentile when targeted performance is met and above the seventy-fifth percentile when maximum performance is met. Additionally, the Company believes in deferring a portion of the AIP to ensure accurate performance measurement and to add a retention component to short-term awards.
Incentive and Retention Plan Awards
Generally, incentives are determined by the MCFC Compensation Committee and based upon meeting various financial and performance target metrics. For the fiscal year 2015, performance metrics were between the target level and the maximum level.
Long Term Incentive Awards
MCFC provides our executive officers with a Long Term Incentive Plan (“LTIP”) that annually grants restricted MCFC stock unit awards to officers based on the earned annual cash incentive, if one is earned. The restricted MCFC stock unit awards generally vest 40% on the third anniversary of the grant date, 30% on the fourth anniversary of the grant date and 30% on the fifth anniversary of the grant date.
The MCFC Compensation Committee reviewed the competitiveness of LTIP compensation as compared to market published survey data and a third-party peer group in the Blanchard Report. The following table provides information concerning options exercised and restricted stock awards vested during the year ended September 30, 2015, for each of our named executive officers.
Option Exercises and Restricted Stock Vested
Deductibility of Executive Compensation
Section 162(m) of the Internal Revenue Code provides guidance on the deductibility of compensation paid to our five highest paid officers. Historically, CBD has taken the necessary actions to ensure the deductibility of payments under our annual and long-term performance incentive compensation plans. MCFC also intends to take the actions necessary to maintain the future deductibility of payments and awards under these programs.
Conclusion
We are satisfied that the base salary, annual incentive plan and long-term incentive plan provided to our named executive officers by CBD and MCFC are structured to foster a performance-oriented culture. They create strong alignment with the long-term best interests of our shareholder and note holders. Compensation levels are reasonable in light of services provided, executive performance, our performance and industry practices. Furthermore, the pay practices we have in place do
not encourage employees to take inappropriate or excessive risks that would be potentially detrimental to our financial or operating results, our cash flow, our profits and the interests of our investment note holders.
Potential payments upon termination
Under the employment agreement between Timothy L. Stanley and MCFC, if Mr. Stanley were to be terminated by the Company without cause or by Mr. Stanley with good reason as of September 30, 2015, Mr. Stanley would be entitled to payments as stipulated in the terms of his signed employment agreement, as follows.
Severance Benefits
(1) Average amounts are based on the most current three years.
No payment shall be due under or made pursuant to an employment agreement without the prior approval of the appropriate federal regulators if such approval is required under the Golden Parachute Regulation; provided, however, that MCFC will exercise commercially reasonable efforts to obtain the approval of the appropriate federal regulators to make any payments provided herein (or, to the extent that the regulators will not approve payment in full, such lesser payment as will be acceptable to the regulators).
Mr. Stanley has an employment agreement that in the event of disability, as defined in that agreement, he would be eligible to receive his then current base salary for a period of up to one year. Such payments will be offset by any payments from any MCFC sponsored disability plan or insurance. No severance payment is provided for any of the executive officers in the event of death or retirement. Assuming the employment of our named executive officers were to be terminated due to death, disability or retirement after attaining age 65, restricted stock unit awards would automatically vest. If employment of the named executive officer is terminated because of death or disability, stock options may be exercised to the extent exercisable on the termination date. In the case of retirement after attaining age 65, stock options and restricted stock unit awards would become fully vested on the termination date. Upon all other terminations, the amounts in the AIP and LTIP would be forfeited.
REPORT OF THE COMPENSATION COMMITTEE
Our Compensation Committee has, with the assistance of the MCFC Compensation Committee, reviewed and discussed the CD&A presented above with management. Based on that review and discussion, our Compensation Committee has recommended that the Compensation Discussion and Analysis be included in this Annual Report on Form 10-K.
By: Laura V. Stack and Timothy L. Stanley.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
As previously stated, the members of the Board are Timothy L. Stanley, Laura V. Stack and Robert F. Hatcher. Mr. Stanley and Ms. Stack were employees of MCFC during the fiscal year. Mr. Stanley, our Chief Executive Officer, and Ms. Stack, our Chief Operating and Financial Officer were both members of the Compensation Committee during fiscal 2015. During the past three fiscal years, none of our executive officers served on the MCFC Compensation Committee or any compensation committee (or equivalent) or the board of directors of another entity whose executive officer(s) served on the MCFC Compensation Committee.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
As of September 30, 2015, MCFC, a Georgia corporation, owned one share of our common stock, which constitutes our only outstanding and issued share of common stock. We have no other class of capital stock authorized. The address of MCFC is 201 Second Street, Suite 950, Macon, Georgia 31201. MCFC has sole voting and investment power with respect to the share of our common stock set forth above. Neither our directors nor any of our executive officers own any shares of our common stock.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS AND DIRECTOR INDEPENDENCE
We entered into a LSMS Agreement with CBD in June 2013. Under the LSMS agreement, we buy certain military loans that CBD originates and receive management and record keeping services from CBD. The following table represents the related party transactions associated with this agreement and other related transactions for the periods presented.
(1)
Effective October 1, 2014, the monthly servicing fee to CBD was 0.496% of the outstanding principal under the amended LSMS agreement. From April 1, 2014 to September 30, 2014, the monthly servicing fee to CBD was 0.43% of outstanding principal under the amended LSMS Agreement. The monthly servicing fee to CBD was 0.68% of outstanding principal for the twelve month period April 1, 2013 to March 31, 2014. Prior to April 1, 2013, the monthly servicing fee was 0.70% of outstanding principal.
(2)
Effective on April 1, 2014, monthly fees for special services that are not included in the LSMS Agreement will be at a rate of 125% of the cost of services.
(3)
Effective April 1, 2014, $500,000 annual base fee, payable monthly to CBD. Prorated for fiscal 2014.
(4)
The annual maximum for fiscal years 2015 is $765,750. The maximum may be increased annually in June with an increase in the Consumer Price Index. The maximum in fiscal years 2014 and 2013 was $750,000.
(5)
The monthly relationship fee ceased on March 31, 2014 with the amended LSMS Agreement. Monthly relationship fee to CBD was equal to $2.91 for each loan owned at the prior fiscal year end for the six months ended March 31, 2014. Monthly relationship fee to CBD was equal to $2.82 for each loan owned at June 21, 2013 for the three month period July 1, 2013 through September 30, 2013. Prior to June, 21, 2013, the monthly relationship fee was $2.82 for each loan owned at the prior fiscal year end.
(6)
Effective October 1, 2014, we pay a $26.00 fee for each military loan purchased from CBD to reimburse CBD for loan origination costs. In fiscal 2014 and 2013 the fee was $30.00 for each military loan purchased from CBD.
(7)
This allocation has a $1,877,636 annual maximum for fiscal year 2015 plus 7% per annum thereafter. $1,754,800 annual maximum for fiscal year 2014. $1,640,000 annual maximum for fiscal year 2013.
(8)
A one-time fee of $1,650,000 to implement a new consumer lending system that was paid over five monthly installments beginning on October 1, 2014.
Policies and Procedures
The Audit Committee, with the assistance of the MCFC Risk and Audit Committee, reviews, approves or ratifies any related party transactions. The review includes the nature of the relationship, the materiality of the transaction, the related person’s interest in the transaction and position, the benefit to us and the related party, and the effect on the related person’s willingness or ability in making such determination to properly perform their duties here.
Director Independence
On September 30, 2015, our Board consisted of the following three persons: Timothy L. Stanley, Laura V. Stack and Robert F. Hatcher. As each of these individuals is an executive officer of PFSI or an executive officer of MCFC, our Board has determined that none of these individuals are independent, as the term is defined under the listing standards of the NASDAQ Global Select Market. Our only outstanding share of common stock is held by MCFC and neither our common stock nor investment notes are listed on any national exchange stock. Therefore, our Company is a “controlled company” and may rely on NASDAQ Rules 5605(b)(1) and 5615(c)(2) as an exemption to the requirement that a majority of the Board members be independent, pursuant to Item 407(a)(1)(ii) of Regulation S-K. None of the members of our Board sit on the board of directors of any public company.
ITEM 14.
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
AUDIT MATTERS
Report of the Audit Committee
In fulfilling its oversight responsibilities, the Audit Committee, with the assistance of the MCFC Risk and Audit Committee, reviewed and discussed the audited consolidated financial statements for fiscal year 2015 with our management and our independent registered public accounting firm and discussed the quality of the accounting principles, the reasonableness of judgments and the clarity of disclosures in the financial statements. In addition, the Audit Committee, with the assistance of the MCFC Risk and Audit Committee, discussed with our independent registered public accounting firm the matters required to be discussed by Auditing Standards No. 61, as amended, (Communication with Audit Committees), as adopted by the Public Company Accounting Oversight Board.
The Audit Committee, with the assistance of the MCFC Risk and Audit Committee, has received from our independent registered public accounting firm written disclosures and a letter concerning their independence from us, as required by Ethics and Independence Rule 3526, “Communication with Audit Committees Concerning Independence.” These disclosures have been reviewed by the Audit Committee, with the assistance of the MCFC Risk and Audit Committee, and discussed with our independent registered public accounting firm. The Audit Committee, with the assistance of the MCFC Risk and Audit Committee, has considered whether audit-related and non-audit related services provided by our independent registered public accounting firm to the Company are compatible with maintaining the auditors’ independence and has discussed with the auditors their independence.
Based on these reviews and discussions, the Audit Committee, with the assistance of the MCFC Risk and Audit Committee, has recommended that the audited consolidated financial statements be included in the Annual Report on Form 10-K for the year ended September 30, 2015 for filing with the U.S. Securities and Exchange Commission.
By the Audit Committee:
/s/ Laura V. Stack
Laura V. Stack
/s/ Timothy L. Stanley
Timothy L. Stanley
Audit Fees
Deloitte & Touche LLP, ("DT"), has been engaged to perform the audit of the financial statements for the fiscal year ended September 30, 2015 and 2014. The aggregate fees DT billed for professional services rendered in fiscal years 2015 and 2014 were approximately $374,000 and $331,000 respectively.
Audit-Related Fees
The aggregate fees billed for audit-related services rendered in fiscal years 2015 and 2014 by DT, which are not reported under “Audit Fees” above, were approximately $22,000 and $28,000 respectively. These fees were primarily for out-of-pocket expenses.
Tax Fees
The aggregate fees billed for tax services rendered in fiscal year 2015 and 2014 by DT were approximately $112,000 and $150,000, respectively. These fees were primarily for preparation of federal and state tax returns.
All Other Fees
There were no other fees paid to DT for fiscal 2015 and 2014.
PART IV
ITEM 15.
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES
Pursuant to the rules and regulations of the SEC, we have filed certain agreements as exhibits to this Annual Report on Form 10-K. These agreements may contain representations, warranties and covenants by the parties and other factual information about us, CBD or MCFC or their respective businesses or operations. These representations, warranties covenants and other factual statements (i) have been made solely for the benefit of the other party or parties to such agreements; (ii) were made only as of the date of such agreements or such other date(s) as expressly set forth in such agreements and are subject to more recent developments, which may not be fully reflected in our public disclosure; (iii) may have been subject to qualifications with respect to materiality, knowledge and other matters, which qualifications modify, qualify and create exceptions to the representations, warranties and covenants in the agreements; (iv) may be qualified by disclosures made to such other party or parties in connection with signing such agreements, which disclosures contain information that modifies, qualifies and creates exceptions to the representations, warranties and covenants in the agreements; (v) have been made to reflect the allocation of risk among the parties to such agreements rather than establishing matters as facts; and (vi) may apply materiality standards different from what may be viewed as material to investors. Accordingly, these representations, warranties, covenants and statements of act should not be relied upon by investors as they may not describe our actual state of affairs as of September 30, 2015 or as of the date of filing this Annual Report on Form 10-K.
The following documents are filed as exhibits to this Annual Report:
*Denotes an executive compensation plan or agreement.
**Confidential treatment has been granted with respect to certain portions of this Exhibit.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
PIONEER FINANCIAL SERVICES, INC.
/s/ Timothy L. Stanley
Timothy L. Stanley
Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed by the following persons on behalf of the registrant and in the capacities indicated and on the dates indicated.