Pathward Financial, Inc. (CASH) Earnings

Management highlights

- **Credit Performance Update** * The quarter saw an elevated credit provision driven by two one-off loans and an adjustment to CECL reserves, which caused an increase in the non-performing loan ratio. These are idiosyncratic events not indicative of broader systemic issues across the loan portfolio. * One previously disclosed non-performing loan from the June 2025 quarter was moved to liquidation after efforts to find new project participants to complete the development failed, resulting in a specific reserve. A second new working capital loan was found to involve sophisticated fraud, requiring an additional specific reserve. * The majority of the non-performing loan increase came from multiple renewable energy construction projects tied to a single common developer; these loans have been moved to non-accrual status while management works with other parties to complete the projects. * Roughly $100 million in past due loans have returned to current status since quarter end. - **Strategic Progress** * Management's five core strategic priorities are: maintaining an optimized balance sheet, leveraging technology for scalability, investing in people and culture, building consultative risk and compliance infrastructure, and improving client experience. Progress was delivered across all priorities in the quarter. * Pathward received external recognition for its culture, being named one of U.S. News & World Report's best companies to work for 2026-2027, and earning a spot on Time's inaugural 2026 list of America's Best Companies. * Post-quarter end, the firm signed a contract extension with long-time partner Claire (an early wage access provider). The partner solutions pipeline remains full of both new partner opportunities and expansion with existing partners, with management being selective in partner selection, as the bank is positioned as a leading provider for fintech and brand partners looking to navigate evolving regulatory requirements. - **Operational Discipline** * The firm maintained disciplined expense management: non-interest expense declined, driven by lower card processing and lower legal/consulting costs, partially offset by planned strategic investments in people, processes, and technology. * The company's liquidity position remains strong at $2.7 billion as of quarter end. During the quarter, the firm repurchased 304,000 shares at an average price of $92.18, leaving 3.1 million shares remaining under the current repurchase authorization.

Guidance

- Fiscal 2026 guidance has been revised downward to an EPS range of $7.80 to $8.20, from the prior range. The downward revision entirely reflects the $28-30 million in one-off credit provision recorded this quarter (approximately $1 per share offset by underlying upside from stronger than expected business performance across other segments). Guidance assumes no additional interest rate changes, an effective tax rate of 16% to 18%, and continues to include expected share repurchases. - Initial fiscal 2027 guidance is introduced at an EPS range of $9.50 to $10.00. Guidance assumes no interest rate changes, an effective tax rate of 18% to 22%, quarterly secondary market revenues of $5 to $7 million, and share repurchases equal to 70% to 80% of net income. Management expects the 70-80% repurchase range is flexible, with opportunistic repurchases above this level possible if conditions allow. - Key factors that could push fiscal 2027 results to the top of the guidance range: faster than expected ramping of new partner programs and continued stronger growth in credit solutions origination volumes. The primary downside risk to results is unforeseen additional credit issues. - Adjusted net interest margin is expected to remain broadly stable going forward, with mild upward tailwind from higher-yielding new originations and the planned reallocation of $150 million in lower-yielding securities maturing over the next 12 months into higher-yielding loans. Short-term interest rate changes are expected to have a negligible impact on EPS, as the firm is currently nearly neutral to changes in the short end of the yield curve. Non-interest expense for fiscal 2027 is expected to grow mid-to-high single digits year-over-year, driven by planned strategic investments in people and technology, with continued discipline on other overhead costs.

Segment performance

The firm operates two main business segments: Commercial Finance and Partner Solutions (including Banking as a Service and payment solutions). For the third quarter of fiscal 2026: - **Commercial Finance**: Reported solid growth in interest income, with total loans and leases growing 8% year-over-year to end the quarter. Originations grew $760 million, driven by expansion with current partners and new contracts from the credit solutions business. New commercial loan production carried a yield of 8.99%, compared to an existing portfolio book yield of 7.42%. The segment recorded a $34 million credit provision in the quarter, $28-30 million of which was driven by one-off specific reserves for two troubled loans and CECL reserve adjustments. - **Partner Solutions (including tax services, card and deposit services)**: Non-interest income overall rose 4% year-over-year, driven by a $2 million year-over-year increase in tax product revenue from a successful tax season, after a multiqueater delay in secondary market sales volumes rebounded in the quarter. Card and deposit fee income saw a small sequential step-down due to lumpy contractual incentive revenues in the prior year quarter, but remains on track for mid-to-high single-digit core growth. Deposits were relatively flat year-over-year, with average custodial deposits $100 million higher than the prior year quarter, offset by declines in lower-yielding securities assets. Reported net interest margin was 6.59%, while adjusted non-GAAP net interest margin held stable at 5.27% year-over-year. Net income for the quarter was $29 million, with diluted EPS of $1.37. Year-to-date return on average assets was 2.37%, and return on average tangible equity was 34.29%.

Risks & headwinds

- Credit risk: The firm recorded large one-off specific reserves for two troubled commercial loans, one involving project development failure and one involving sophisticated borrower fraud, which reduced quarterly net income. Additionally, multiple renewable energy construction projects tied to a single developer were moved to non-accrual non-performing status, increasing the firm's non-performing loan ratio. - While management states these are idiosyncratic events with no other similar risks currently identified in the portfolio, unforeseen additional credit issues are the primary downside risk to future earnings guidance. - Regulatory and industry risk: Evolving regulation of partner banking and fintech lending requires ongoing investment in risk and compliance infrastructure to support partner growth. Sophisticated fraud risk continues to increase, requiring ongoing evolution of underwriting and monitoring processes to manage emerging fraud tactics. - Interest rate risk: While the firm is currently nearly neutral to changes in short-term interest rates, unexpected shifts in the yield curve could impact net interest margin. - M&A and technology development execution risk: Attractive accretive M&A opportunities have not been available at acceptable valuations, and building proprietary technology (accelerated by AI development) carries execution and cost uncertainty, particularly related to AI token and development costs.

Analyst Q&A

• Q: What changed for the previously disclosed non-performing commercial loan that led to the reserve this quarter, is the fraud-related loan new, and is the renewable energy non-performing exposure tied to recent policy changes? /

  A: The previously disclosed loan was an under-construction project where management originally expected to find new participants to complete development. This effort failed during the quarter, requiring a move to liquidation and a corresponding specific reserve. The fraud-related working capital loan is a new issue identified this quarter, not the previously disclosed credit; the firm has applied an appropriate reserve after a full collateral assessment. The renewable energy non-performing loans are idiosyncratic to a single developer, not driven by broader policy changes, and the firm remains committed to growing its alternative energy lending portfolio while adjusting exposure across sub-sectors as needed.

• Q: What factors will drive fiscal 2027 results to the top or bottom of guidance, and why was the share repurchase target set to 70-80% of net income? Is it due to higher capital needs for credit? /

  A: Faster than expected ramping of new partner programs and stronger credit solutions origination volumes would push results to the top of the range; unforeseen new credit issues are the main factor that would push results to the bottom. The 70-80% range is not driven by a need to hold extra capital for credit; management already holds a strong Tier 1 leverage ratio above 10% from prior capital build, and there is no limitation on opportunistic repurchases above this range if conditions allow.

• Q: Do the current credit events impact partner growth, and have any partners expressed concern about the credit issues? /

  A: There is no connection between the firm's commercial credit book and its partner solutions business, so the credit events have had no impact on partner relationships or growth. Partners continue to engage with Pathward to expand product offerings, as the firm remains a leading sponsor banking partner for fintechs, and the credit issues only reduced, did not eliminate, quarterly net income, leaving the balance sheet strong.

• Q: What is the outlook for adjusted net interest margin, and how will operating expenses trend going forward? /

  A: Adjusted net interest margin was only slightly down sequentially due entirely to the new non-accrual loans, so it is effectively stable. Going forward, there is mild upward tailwind from higher-yielding new originations and the reallocation of $150 million in low-yielding maturing securities to higher-yielding loans, and rate changes will have negligible impact. Operating expenses are expected to grow mid-to-high single digits next year, with discipline on overhead offsetting planned strategic investments in people and technology for long-term scalability.

• Q: How has AI changed the firm's approach to building versus buying technology? /

  A: Pathward already preferred building proprietary technology internally to meet its unique business needs, and AI development has accelerated this preference. Management evaluates the economics of building versus buying, but rising AI token costs and unique business requirements make internal development more attractive for most core capabilities going forward.