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Table of Contents

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

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

For the quarterly period ended: December 31, 2017
 
OR
o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 

For the transition period from        to        
 
Commission file number:  333-103293
 
Pioneer Financial Services, Inc.
(Exact name of registrant as specified in its charter) 
Missouri
 
44-0607504
(State or other jurisdiction of
 
(I.R.S. Employer
incorporation or organization)
 
Identification No.)
 
 
 
4700 Belleview Avenue, Suite 300, Kansas City, Missouri
 
64112
(Address of principal executive office)
 
(Zip Code)

Registrant’s telephone number, including area code: (816) 756-2020
 
(Former name, former address and former fiscal year, if
changed since last report)
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes x  No o
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulations S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes x  No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.  (Check one)
Large accelerated filer o
 
Accelerated filer o
 
 
 
Non-accelerated filer x
 
Smaller reporting company o
 
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of Exchange Act. o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o No x
 
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
Class
 
Outstanding as of February 12, 2018
Common Stock, no par value
 
One Share
As of February 12, 2018, one share of the registrant’s common stock is outstanding. The registrant is a wholly owned subsidiary of MidCountry Financial Corp.
 


Table of Contents

PIONEER FINANCIAL SERVICES, INC.
 
FORM 10-Q
December 31, 2017
 
TABLE OF CONTENTS
 
Item No.
 
Page
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 



Table of Contents

PART I - FINANCIAL INFORMATION
 
ITEM 1.  Consolidated Financial Statements
 
PIONEER FINANCIAL SERVICES, INC.
Consolidated Balance Sheets
As of December 31, 2017 and September 30, 2017
(unaudited)
 
 
December 31,
2017
 
September 30,
2017
 
(dollars in thousands)
 
 
 
 
ASSETS
 
 
 
 
Cash and cash equivalents
$
5,377

 
$
7,235

Gross finance receivables
243,179

 
242,684

Less:
 

 
 

Advanced finance receivable payments
(2,073
)
 
(2,068
)
Unearned fees, debt protection claims and policy reserves
(7,536
)
 
(7,450
)
Allowance for credit losses
(32,325
)
 
(33,725
)
Finance receivables, net
201,245

 
199,441

 
 
 
 
Furniture and equipment, net
4,117

 
4,114

Deferred tax asset, net
8,825

 
12,982

Prepaid and other assets
2,887

 
3,069

 
 
 
 
Total assets
$
222,451

 
$
226,841

 
 
 
 
LIABILITIES AND STOCKHOLDER’S EQUITY
 
 
 
 
Liabilities:
 

 
 

Revolving credit line - banks, net
$
111,058

 
$
114,447

Subordinated debt, net
29,136

 
29,518

Accounts payable and other liabilities
6,292

 
5,639

Total liabilities
146,486

 
149,604

 
 
 
 
Stockholder’s equity:
 

 
 

Common stock, no par value; 1 share authorized, issued and outstanding
95,416

 
95,416

Retained deficit
(19,451
)
 
(18,179
)
 
 
 
 
Total stockholder’s equity
75,965

 
77,237

 
 
 
 
Total liabilities and stockholder’s equity
$
222,451

 
$
226,841

 
See Notes to Consolidated Financial Statements

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Table of Contents

PIONEER FINANCIAL SERVICES, INC.
Consolidated Statements of Operations and Other Comprehensive Income
For the three months ended December 31, 2017 and 2016
(unaudited)
 
 
 
Three Months Ended 
 December 31,
 
 
2017
 
2016
 
(dollars in thousands)
 
 
 
 
 
Interest income and fees
 
$
18,579

 
$
20,022

 
 
 
 
 
Interest expense
 
2,482

 
2,745

 
 
 
 
 
Net interest income before provision for credit losses
 
16,097

 
17,277

Provision for credit losses
 
5,349

 
9,789

Net interest income
 
10,748

 
7,488

 
 
 
 
 
Total non-interest income, net
 
55

 
68

 
 
 
 
 
Non-interest expense
 
 

 
 

Management and record keeping services
 
6,121

 
6,503

Other operating expenses
 
1,100

 
1,011

Total non-interest expense
 
7,221

 
7,514

 
 
 
 
 
Income before income taxes
 
3,582

 
42

Provision for income taxes
 
4,649

 
19

Net (loss)/income and other comprehensive (loss)/income
 
$
(1,067
)
 
$
23

 
 
 
 
 
Net (loss)/income per share, basic and diluted (1)
 
$
(1,067
)
 
$
23

 
(1) 
Number of shares outstanding is one.
 
See Notes to Consolidated Financial Statements


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Table of Contents

PIONEER FINANCIAL SERVICES, INC.
Consolidated Statements of Stockholder’s Equity
For the three months ended December 31, 2017 and 2016
(unaudited)
 
 
Total
 
Common Stock
 
Retained Deficit
 
 
(dollars in thousands)
 
 
 
 
 
 
 
Balance, September 30, 2016
$
78,735

 
$
95,416

 
$
(16,681
)
 
 
 
 
 
 
 
 
Net income and other comprehensive income
23

 

 
23

 
Dividends declared and paid to parent (1)
(1,909
)
 

 
(1,909
)
 
 
 
 
 
 
 
 
Balance, December 31, 2016
$
76,849

 
$
95,416

 
$
(18,567
)
 
 
 
 
 
 
 
 
Balance, September 30, 2017
$
77,237

 
$
95,416

 
$
(18,179
)
 
 
 
 
 
 
 
 
Net loss and other comprehensive loss
(1,067
)
 

 
(1,067
)
 
Dividends declared and paid to parent (1)
(205
)
 

 
(205
)
 
 
 
 
 
 
 
 
Balance, December 31, 2017
$
75,965

 
$
95,416

 
$
(19,451
)
 
 
 
(1) 
Number of shares outstanding is one.

See Notes to Consolidated Financial Statements


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Table of Contents

PIONEER FINANCIAL SERVICES, INC.
Consolidated Statements of Cash Flows
For the three months ended December 31, 2017 and 2016
(unaudited)

 
Three Months Ended 
 December 31,
 
2017
 
2016
 
(dollars in thousands)
 
 
 
 
Cash flows from operating activities:
 

 
 

Net (loss)/income
$
(1,067
)
 
$
23

Adjustments to reconcile net (loss)/income to net cash provided by operating activities:
 

 
 

Provision for credit losses
5,349

 
9,789

Depreciation and amortization
197

 
87

Deferred income taxes
4,157

 
1,650

Interest accrued on investment notes
244

 
351

Changes in:
 

 
 

Accounts payable and other liabilities
653

 
688

Unearned debt protection fees
(272
)
 
(834
)
Prepaid and other assets
182

 
268

 
 
 
 
Net cash provided by operating activities
9,443

 
12,022

 
 
 
 
Cash flows from investing activities:
 

 
 

Finance receivables purchased from affiliate, net of customer repayments
(6,881
)
 
(1,536
)
Capital expenditures
(89
)
 
(559
)
 
 
 
 
Net cash used in investing activities
(6,970
)
 
(2,095
)
 
 
 
 
Cash flows from financing activities:
 

 
 

Borrowings under lines of credit
18,000

 
5,111

Repayments under lines of credit
(21,500
)
 
(16,300
)
Proceeds from other borrowings

 
3,010

Repayment of other borrowings
(626
)
 
(3,279
)
Dividends paid to parent
(205
)
 
(1,909
)
 
 
 
 
Net cash used in financing activities
(4,331
)
 
(13,367
)
 
 
 
 
Net decrease in cash
(1,858
)
 
(3,440
)
 
 
 
 
Cash and cash equivalents, Beginning of period
7,235

 
11,318

 
 
 
 
Cash and cash equivalents, End of period
$
5,377

 
$
7,878

 
 
 
 
Additional cash flow information:
 

 
 

Interest paid
$
2,703

 
$
2,385

Income taxes refunded

 
(428
)
 See Notes to Consolidated Financial Statements

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Table of Contents

PIONEER FINANCIAL SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
As of December 31, 2017 and September 30, 2017 and for the three months ended December 31, 2017 and December 31, 2016
(unaudited)
 
NOTE 1:  NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
 
Basis of Presentation
 
The accompanying unaudited consolidated financial statements include the accounts of Pioneer Financial Services, Inc. and its wholly owned subsidiaries (collectively “we,” “us,” “our” or the “Company”).  We are a wholly owned subsidiary of MidCountry Financial Corp., a Georgia corporation (“MCFC”).  The Company’s consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) for interim financial information, the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements and should be read in conjunction with the Company’s audited consolidated financial statements and the notes thereto included in our Annual Report on Form 10-K for the year ended September 30, 2017 filed with the Securities and Exchange Commission (“SEC”) on December 18, 2017. The accompanying consolidated financial statements are unaudited; however, in the opinion of the Company's management they include all normal and recurring adjustments necessary for a fair presentation of the Company’s financial position, results of operations and cash flows for the periods presented. Results of operations reported for interim periods are not necessarily indicative of results for the entire year. All intercompany balances and transactions have been eliminated.
  
Nature of Operations and Concentration
 
We are headquartered in Kansas City, Missouri.  We purchase finance receivables from, and have finance receivables serviced by, MidCountry Bank (“MCB”), a federally chartered savings bank and wholly owned subsidiary of MCFC. These receivables represent loans primarily to active-duty or career retired U.S. military personnel. 

Use of Estimates
 
The preparation of the unaudited consolidated financial statements requires management to make estimates and assumptions that affect amounts reported in the unaudited consolidated financial statements and in disclosures of contingent assets and liabilities.  We use estimates and employ judgments in determining the amount of our allowance for credit losses, deferred tax assets and liabilities and establishing the fair value of our financial instruments.  While the unaudited consolidated financial statements and footnotes reflect the best estimates and judgments at the time they are made, actual results could differ from those estimates. 



5

Table of Contents

NOTE 2:  FINANCE RECEIVABLES
 
Our finance receivables are primarily loans to active-duty or career retired U.S. military personnel.  During the first quarter of fiscal 2018, we purchased $64.7 million of loans from MCB compared to $64.6 million during the first quarter of fiscal 2017. Approximately 46.2% of the amount of loans we purchased in the first quarter of fiscal 2018 were refinancings of outstanding loans compared to 44.6% during the first quarter of fiscal 2017.
 
In the normal course of business, we receive a portion of customer loan payments through the Federal Government Allotment System ("Allotment") on the first day of each month.  If the first day of the month falls on a weekend or holiday, Allotment payments are received on the last business day of the preceding month.  On December 31, 2017 we collected $3.6 million in customer loan payments in advance of the payment due date of January 1, 2018. These Allotment payments are reflected on the balance sheet as advanced finance receivable payments and as a reduction of net finance receivables of $2.1 million and the corresponding accrued interest receivable of $1.5 million.  On September 30, 2017, we collected $3.5 million in customer loan Allotment payments in advance of the payment due date of October 1, 2017. These Allotment payments are reflected on the balance sheet as advanced finance receivable payments and as a reduction of net finance receivables of $2.1 million and the corresponding accrued interest receivable of $1.4 million

The following table presents finance receivables as of the dates presented:
 
 
December 31,
2017
 
September 30,
2017
 
(dollars in thousands)
 
 
 
 
Finance Receivables:
 

 
 

Gross finance receivables
$
243,179

 
$
242,684

 
 
 
 
Less:
 

 
 

Advanced finance receivable payments
(2,073
)
 
(2,068
)
Gross finance receivables less advanced finance receivable payments
241,106

 
240,616

 
 
 
 
Less:
 

 
 

Net deferred loan fees
(6,490
)
 
(5,949
)
Unearned debt protection fees
(587
)
 
(859
)
Debt protection claims and policy reserves
(459
)
 
(642
)
Total unearned fees, debt protection claims and policy reserves
(7,536
)
 
(7,450
)
 
 
 
 
Finance receivables - net of unearned fees, debt protection claims and policy reserves
233,570

 
233,166

 
 
 
 
Allowance for credit losses
(32,325
)
 
(33,725
)
 
 
 
 
Net finance receivables
$
201,245

 
$
199,441

 
Management has an established methodology to determine the adequacy of the allowance for credit losses that assesses the risks and estimated losses inherent in the finance receivables portfolio. There is uncertainty inherent in these estimates, making it possible that they could change in the near term. Our portfolio consists of a large number of relatively small-balance, homogenous accounts.  No account is large enough to warrant individual evaluation for impairment.

As part of the on-going monitoring of the credit quality of our finance receivables 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.
 


6

Table of Contents


The following table sets forth changes in the components of our allowance for credit losses on finance receivables for the periods presented:
 
Three Months Ended 
 December 31,
 
2017
 
2016
 
(dollars in thousands)
 
 
 
 
Allowance for credit losses:
 

 
 

Balance, beginning of period
$
33,725

 
$
30,374

Finance receivables charged-off
(7,833
)
 
(9,449
)
Recoveries
1,084

 
861

Provision for credit losses
5,349

 
9,789

Balance, end of period
$
32,325

 
$
31,575

 
 
 
 
Finance receivables:
$
243,179

 
$
273,251

Allowance for credit losses
(32,325
)
 
(31,575
)
Net finance receivables
$
210,854

 
$
241,676


The accrual of interest income is suspended when three full payments (95% or more of the contracted payment amount) have not been received. Accrued and uncollected interest is limited to no more than 92 days. The Company has experience with borrowers periodically missing payments during times of financial hardship; however, these missed payments do not necessarily render loans uncollectible. Non-accrual status, therefore, does not mean that a loan is uncollectible. Accordingly, payments received from a borrower on a non-accrual loan may be recognized as interest income. Non-performing loans represent those finance receivables where the accrual of interest income has been suspended. As of December 31, 2017, we had $15.0 million in non-performing loans, compared to $15.5 million as of September 30, 2017. As of December 31, 2017 and September 30, 2017, we had $0.9 million in accrued interest for non-performing loans.
 
We consider a loan impaired when a full payment has not been received for the preceding six calendar months and is 30 days contractually past due. Impaired loans are removed from our finance receivable portfolio and charged against the allowance for credit losses. Accrued interest on impaired loans is reversed and charged against interest income. We do not restructure troubled debt as a form of curing delinquencies.

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Table of Contents

 
A large number of our customers generally present elevated levels of credit risk and 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.  We manage credit risk by closely monitoring the performance of the portfolio and through our finance receivable purchasing criteria. The following reflects the credit quality of our finance receivables portfolio:
 
 
December 31,
2017
 
September 30,
2017
 
(dollars in thousands)
 
 

 
 

Performing
228,173

 
227,167

Non-performing
15,006

 
15,517

Gross finance receivables
$
243,179

 
$
242,684

Non-performing finance receivables as a percent of gross finance receivables
6.17
%
 
6.39
%
 

As of December 31, 2017 and September 30, 2017, past due finance receivables, on a recency basis, are as follows:
 
 
Age Analysis of Past Due Finance Receivables
 
As of December 31, 2017
 
60-89 Days
 
90-180 Days
 
Total 60-180 Days
 
0-59 Days
 
Total
 
Past Due
 
Past Due
 
Past Due
 
Past Due
 
Finance Receivables
 
(dollars in thousands)
Finance receivables
$
2,568

 
$
7,989

 
$
10,557

 
$
232,622

 
$
243,179

 
 
Age Analysis of Past Due Finance Receivables
 
As of September 30, 2017
 
60-89 Days
 
90-180 Days
 
Total 60-180 Days
 
0-59 Days
 
Total
 
Past Due
 
Past Due
 
Past Due
 
Past Due
 
Finance Receivables
 
(dollars in thousands)
Finance receivables
$
2,485

 
$
8,327

 
$
10,812

 
$
231,872

 
$
242,684

 
Additionally, we employ purchasing criteria, developed from our past customer repayment experience. The purchasing criteria are periodically evaluated based on current portfolio performance.  These criteria require the following:
 
At the time of loan origination, customers are primarily active-duty, career retired U.S. military personnel or veterans with prior loan history with us;
All potential customers must complete standardized online credit applications; and
All loans must meet additional purchase criteria developed from our past loan repayment experience, which is periodically revalidated based on current portfolio performance.

These criteria are used to help reduce the risk of purchasing finance receivables where the customer is unwilling or unable to repay.


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Table of Contents

NOTE 3: RELATED PARTY TRANSACTIONS
 
On December 23, 2015, we entered into the Fifth Amended and Restated Loan Sale and Master Services Agreement, as amended ("LSMS Agreement") with MCB. Under the LSMS Agreement, we buy certain loans that MCB originates and receive ongoing record keeping services from MCB. We also receive certain management and other administrative services from MCFC. The following table represents the related party transactions associated with the LSMS Agreement and other related party transactions for the periods presented.
 
 
Three Months Ended 
 December 31,
 
2017
 
2016
 
(dollars in thousands)
 
 
 
 
Loan purchasing:
 

 
 

Loans purchased from MCB, net
$
31,838

 
$
33,665

 
 
 
 
Management and record keeping services:
 

 
 

Servicing fee paid to MCB (1)
$
5,075

 
$
5,447

Special services fee paid to MCB (2)
865

 
899

Base fee paid to MCB (3)
125

 
125

Indirect cost allocation fees paid to MCFC 
56

 
32

Total management and record keeping services
$
6,121

 
$
6,503

 
 
 
 
Other transactions:
 

 
 

Fees paid to MCB in connection with loans purchased (4)
$
384

 
$
349

Tax refunds from MCFC

 
(428
)
Dividends paid to MCFC
205

 
1,909

Direct cost allocations paid to MCFC
292

 
301

 
(1) 
For the three months ended December 31, 2017, the servicing fee paid to MCB was 0.604% per month of the outstanding loan principal under the LSMS agreement and the monthly collections fee was 46% of amounts collected on charged-off accounts. For the three months ended December 31, 2016, the servicing fee paid to MCB was 0.617% per month of the outstanding loan principal and the monthly collections fee was 34% of amounts collected on charged-off accounts.
(2) 
The fees for special services under the LSMS Agreement are at a rate of 125% of the cost of such services incurred by MCB.
(3) 
The annual base fee is $500,000 and payable monthly to MCB.
(4) 
Effective April 1, 2017, we pay a $27.00 fee for each loan purchased from MCB to reimburse MCB for loan origination costs.  For the three months ended December 31, 2016, we paid a $25.00 fee for each loan purchased from MCB to reimburse MCB for loan origination costs. 







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NOTE 4:  BORROWINGS

Revolving Credit Line - Banks
 
The Company entered into a Credit Agreement on December 23, 2015, as subsequently amended, (the "Credit Agreement") with various financial institutions (the "Lenders"). Subject to the terms of the Credit Agreement, the Lenders have agreed to make available to the Company a revolving credit facility up to a maximum of $170.0 million whereby the Company may periodically borrow and repay funds as needed.

Borrowing availability under the revolving credit facility is limited to eligible receivables (the "Borrowing Base") as defined in the Credit Agreement. Each revolving borrowing can be divided into tranches, including (1) a borrowing that bears interest at prime plus 3.25% ("Base Rate") or (2) a borrowing that bears an interest rate offered in the London Interbank Eurodollar market for the relevant interest period plus 4.25% ("LIBOR"). As of December 31, 2017 and September 30, 2017, the Company's Borrowing Base and available revolving credit line was $136.9 million and $136.4 million, respectively. Outstanding borrowings under the Credit Agreement at December 31, 2017 were $111.5 million bearing a weighted average interest rate of 5.86%. Of the outstanding borrowings at December 31, 2017, $105.0 million were LIBOR borrowings with a 5.74% interest rate while the remaining $6.5 million comprised of Base Rate borrowings with a 7.75% interest rate. Outstanding LIBOR borrowings under the Credit Agreement at September 30, 2017 were $115.0 million bearing an interest rate of 5.48%. There were no Base Rate borrowings at September 30, 2017. In addition, we pay the Lenders a 50 basis point quarterly non-use fee for the unused portion of the $170.0 million credit facility. In the first quarter of fiscal year 2018 and 2017 non-use fees were $68 thousand and $21 thousand, respectively.

As a means of managing its exposure to rising interest rates, the Company has a $50 million notional interest rate cap agreement at December 31, 2017 that expires on December 21, 2018. The interest rate cap is indexed to 1-month LIBOR and has a strike rate of 2.5%. The interest rate cap is reflected on the consolidated balance sheet at its estimated fair value of $77 thousand at December 31, 2017 and $97 thousand at September 30, 2017.

The Credit Agreement is collateralized by all finance receivables and property and equipment of the Company, and will terminate on December 21, 2018 or earlier, if certain events occur, as noted below.

Under the Credit Agreement, we are subject to certain covenants that require, among other things, we maintain specific financial ratios, satisfy certain financial tests and maintain a minimum allowance for credit losses in relation to net charge-offs. There are also certain restrictions on the amount and timing of dividends we may pay. These covenants and other terms, which if not complied with could result in a default under the Credit Agreement. If a default under the Credit Agreement is not waived by the Lenders, it could result in the acceleration of the indebtedness evidenced by the Credit Agreement.

On September 2, 2015, MCFC entered into a confidential Memorandum of Understanding ("MOU") with its primary federal regulator. Pursuant to the MOU, the Company's senior borrowings are limited to $170.6 million, without prior approval from MCFC's primary federal regulator. 

Subordinated Debt

Investment Notes
 
We have subordinated borrowings through the issuance of investment notes with an outstanding balance, including accrued interest, of $19.6 million at December 31, 2017, and $19.7 million at September 30, 2017.  These investment notes are nonredeemable by the holders before maturity, issued at various interest rates and mature one to ten years from date of issue. At our option, we may redeem and retire any or all of the investment notes upon 30 days written notice to the note holders. The average investment note payable was $51,453 and $51,097, with a weighted average interest rate of 9.26% and 9.20% at December 31, 2017 and September 30, 2017, respectively.
 


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Subordinated Debentures

At December 31, 2017 and September 30, 2017, the Company had subordinated debentures outstanding of $9.5 million and $9.8 million, respectively. The debentures have maturities at issuance ranging from one to four years and bear interest rates between 5.50% and 8.00%. The average subordinated debenture payable was $80,462 and $78,360, with a weighted average interest rate of 7.63% and 7.60% at December 31, 2017 and September 30, 2017, respectively.

Subordinated Debt - Parent
 
We have a $25.0 million line of credit with MCFC.  Funding on this line of credit is provided as needed at our discretion, dependent upon the availability of funds from MCFC and is due upon demand.  Interest on borrowings is payable monthly and is based on prime or 5.0%, whichever is greater.  As of December 31, 2017 and September 30, 2017 the outstanding balance under this line of credit was zero.

Under MCFC's MOU, the Company's subordinated borrowings may not exceed $44.0 million, without prior approval from MCFC's primary regulator.

Contractual Maturities
 
A summary of contractual maturities for the revolving credit line and subordinated debt as of December 31, 2017 is as follows. The revolving credit line maturities exclude unamortized debt issuance costs of $0.4 million.
 
 
Revolving Credit Line - Banks
 
 
Subordinated Debt
 
Total
Year Ending September 30,
(dollars in thousands)
 
 
 
 
 
 
 
2018
$

 
 
$
375

 
$
375

2019
111,500

 
 
5,486

 
116,986

2020

 
 
5,495

 
5,495

2021

 
 
10,476

 
10,476

2022

 
 
5,077

 
5,077

2023 and beyond

 
 
2,227

 
2,227

Total
$
111,500

 
 
$
29,136

 
$
140,636


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NOTE 5: INCOME TAXES
 
On December 22, 2017, the President of the United States signed into law the Tax Cuts and Jobs Act (the "Act"). The Act amends the Internal Revenue Code to reduce tax rates and modify policies, credits, and deductions for individuals and businesses. The Act reduces the corporate income tax rate from a maximum of 35% to a flat 21% rate. The income tax rate reduction became effective on January 1, 2018. As a result of the reduction in the corporate income tax rate, the Company revalued its deferred tax assets and liabilities at December 31, 2017 to reflect the reduction in the expected tax effects resulting from the lower corporate income tax rate. The revaluation resulted in a $3.7 million reduction in the value of its net deferred tax asset, which was primarily due to a reduction in tax benefits associated with the allowance for credit losses. The reduction was recorded as additional deferred income tax expense in the Company’s consolidated statement of operations and other comprehensive income for the three months ended December 31, 2017.

The provision for income taxes for the three months ended December 31, 2017 and 2016 consisted of the following:

 
Three Months Ended December 31, 2017
 
Federal
 
State
 
Change in Valuation
Allowance
 
Total
 
(dollars in thousands)
Current
$
489

 
$
3

 
$

 
$
492

Deferred
4,207

 
(58
)
 
8

 
4,157

Total
$
4,696

 
$
(55
)
 
$
8

 
$
4,649


 
Three Months Ended December 31, 2016
 
Federal
 
State
 
Change in Valuation
Allowance
 
Total
 
(dollars in thousands)
Current
$
(1,567
)
 
$
(64
)
 
$

 
$
(1,631
)
Deferred
1,604

 
45

 
1

 
1,650

Total
$
37

 
$
(19
)
 
$
1

 
$
19



The actual income tax expense for the three months ended December 31, 2017 and 2016 differs from the computed ‘expected’ income tax expense (benefit) for those periods (computed by applying the currently applicable consolidated United States federal corporate tax rates to income before income taxes) in the following table.

 
Three Months Ended December 31,
 
2017
 
2016
 
(dollars in thousands)
Computed ‘expected’ income tax expense
$
879

 
$
15

State tax (net of federal tax benefit)
19

 
3

Deferred tax asset revaluation
3,743

 

Other
8

 
1

Total
$
4,649

 
$
19


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The income tax effects of temporary differences that give rise to significant portions of the deferred tax assets and liabilities at December 31, 2017 and September 30, 2017, are presented below:

 
December 31, 2017
 
September 30, 2017
 
(dollars in thousands)
Deferred tax assets:
 

 
 

Allowance for credit losses
$
8,343

 
$
12,220

Unearned insurance reserves
261

 
424

Accrued expenses
61

 
126

State net operating losses and credits
52

 
43

Other
273

 
418

Total deferred tax assets
8,990

 
13,231

Valuation allowance
(47
)
 
(39
)
Deferred tax assets, net of valuation allowance
8,943

 
13,192

 
 
 
 
Deferred tax liabilities:
 

 
 

Depreciation
75

 
120

Other
43

 
90

Total deferred tax liabilities
118

 
210

 
 
 
 
Net deferred tax assets
$
8,825

 
$
12,982





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NOTE 6:  DISCLOSURE ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS
 
US GAAP requires that techniques to estimate fair value maximize the use of observable inputs and minimize the use of unobservable inputs and also establishes a fair value hierarchy that categorizes the inputs to valuation techniques used to measure fair value into three levels 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.
 
For the first three months of fiscal 2018 and the fiscal year ended September 30, 2017 there were no significant transfers into or out of Levels 1, 2 or 3.

The following methods and assumptions were used to estimate the fair value of financial instruments:
 
Cash and cash equivalents — The carrying value approximates fair value due to the short-term, liquid nature of these instruments.
  
Finance Receivables — The fair value of finance receivables is estimated by discounting the receivables using current interest rates at which similar finance receivables would be made to borrowers with similar credit ratings and for the same remaining maturities as of the balance sheet date.  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.
 
Revolving Credit Line - Banks — The fair value of revolving credit line borrowings is estimated to approximate carrying value. Management believes the variable nature of the interest rate under the credit agreement approximates market terms. If the Company’s revolving credit line borrowings were measured at fair value in the financial statements, these revolving credit line borrowings would be categorized as Level 2 in the fair value hierarchy.

Subordinated Debt — The fair value of subordinated debt is estimated by discounting future cash flows using current interest rates at which similar subordinated debt would be offered for the same remaining maturities. If the Company’s subordinated debt were measured at fair value in the financial statements, the subordinated debt would be categorized as Level 2 in the fair value hierarchy.


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The carrying amounts and estimated fair values of our financial instruments at December 31, 2017 and September 30, 2017 are as follows:
 
 
December 31, 2017
 
September 30, 2017
 
Carrying
 
 
 
Carrying
 
 
 
Amount
 
Fair Value
 
Amount
 
Fair Value
 
(dollars in thousands)
 
 
 
 
 
 
 
 
Financial assets:
 

 
 

 
 

 
 

Cash and cash equivalents
$
5,377

 
$
5,377

 
$
7,235

 
$
7,235

Finance receivables, net
201,245

 
199,397

 
199,441

 
196,456

 
 
 
 
 
 
 
 
Financial liabilities:
 

 
 

 
 

 
 

Revolving credit line - banks, net
111,058

 
111,058

 
114,447

 
114,447

Subordinated debt, net
29,136

 
30,948

 
29,518

 
31,527

 
ITEM 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
Forward-Looking Statements
 
The discussion set forth below, in this quarterly report of Pioneer Financial Services, Inc. (“PFSI”), with its wholly owned subsidiaries (collectively “we,” “us,” “our” or the “Company”), contains forward-looking statements within the meaning of federal securities law.  Words such as “may,” “will,” “expect,” “anticipate,” “believe,” “estimate,” “continue,” “predict,” or other similar words, identify forward-looking statements. Forward-looking statements appear in a number of places in this Quarterly Report and include statements regarding our intent, belief or current expectation about, among other things, trends affecting the markets in which we operate our business, financial condition and growth strategies.  We may not actually achieve the plans, intentions, or expectations disclosed in our forward-looking statements, and you should not place undue reliance on our forward-looking statements. The forward-looking statements included herein reflect and contain management’s current judgment, and involve risks and uncertainties that could cause actual results, events, and performance to differ materially from the plans, intentions, and expectations disclosed in the forward-looking statements. Actual results may differ materially from those indicated in the forward-looking statements as a result of various factors, including, but not limited to, those risk factors set forth in Item 1A of Part I in our Annual Report on Form 10-K for the period ended September 30, 2017 (the "Annual Report"). If any of these risk factors occur, they could have an adverse effect on our business, financial condition and results of operations.  When considering forward-looking statements you should keep these risk factors in mind, as well as the other cautionary statements set forth in this report.  These forward-looking statements are made as of the date of this filing.  You should not place undue reliance on any forward-looking statement.  We do not intend to update any of these forward-looking statements or publicly announce the results of or any revisions to these forward-looking statements, other than as is required under the federal securities laws.
 
Overview
 
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, purchases finance receivables from MidCountry Bank (“MCB”), a federally chartered savings bank and wholly owned subsidiary of MCFC. MCB provides management and record keeping services for the PFSI finance receivables portfolio as discussed in “Management and Record Keeping Services.”

MCB originates consumer loans via the internet to primarily active-duty, career retired U.S. military personnel or veterans with prior loan history with us.  Military customers use loan proceeds for personal financial needs or to purchase consumer goods and services. We intend to hold these finance receivables until repaid.
 
Our finance receivables are unsecured, have fixed interest rates and typically have a maturity of less than 48 months. During the first quarter of fiscal 2018, the average size of a loan when acquired was $4,556 with an average term of 34 months.  A large portion of the loans we purchase are made to borrowers 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.
 

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The level of our profitability is dependent upon the quality of finance receivables we are able to acquire from MCB, including repayment performance, and upon the business and economic environments in the markets where we operate and in the United States as a whole.

On December 22, 2017, the President of the United States signed into law the Tax Cuts and Jobs Act (the "Act"). The Act amends the Internal Revenue Code to reduce tax rates and modify policies, credits, and deductions for individuals and businesses. The Act reduces the corporate income tax rate from a maximum of 35% to a flat 21% rate. The income tax rate reduction became effective on January 1, 2018. As a result of the reduction in the corporate income tax rate, the Company revalued its deferred tax assets and liabilities at December 31, 2017 to reflect the reduction in the expected tax effects resulting from the lower corporate income tax rate. The revaluation resulted in a $3.7 million reduction in the value of its net deferred tax asset, which was primarily due to a reduction in tax benefits associated with the allowance for credit losses. The reduction was recorded as additional deferred income tax expense in the Company’s consolidated statement of operations and other comprehensive income for the three months ended December 31, 2017.
   
We are not associated with, nor are we endorsed by, the U.S. military or U.S. Department of Defense.  However, we seek to maintain a positive, supportive relationship with the military community.

Critical Accounting Policies
 
In our Annual Report on Form 10-K for the fiscal year ended September 30, 2017 (“Annual Report”), we identified the critical accounting policies which affect our significant estimates and assumptions used in preparing our unaudited consolidated financial statements. We have not changed these policies from those previously disclosed in our Annual Report.
 
Lending and Servicing Operations
 
Supplier of Loans

MCB is our sole supplier of loans.  We entered into the Fifth Amended and Restated Loan Sale and Master Services Agreement ("LSMS Agreement") with MCB whereby we purchase loans originated by MCB and MCB services these loans on our behalf.  Under the LSMS Agreement, we have the exclusive right, but not the obligation, to purchase loans originated by MCB that meet the following guidelines:
 
At the time of loan origination, customers are primarily active-duty, career retired U.S. military personnel or veterans with prior loan history with us;
All potential customers must complete standardized online credit applications; and
All loans must meet additional purchase criteria developed from our past loan repayment experience, which is revalidated based on current portfolio performance.

For a description of the risks associated with these loans, see "Risk Factors" set forth in Part I, Item 1A. "Risk Factors" of our Annual Report.

Loan Purchasing
 
GeneralThe Company and MCB have more than 30 years of experience in underwriting, originating, monitoring and servicing consumer loans to the military market and have developed a deep understanding of the military and the military lifestyle. Through this extensive knowledge of our customer base, we developed a scoring model that focuses on the unique characteristics of the military market, as well as traditional credit scoring variables that are utilized by MCB when originating loans in this market.
  
We may purchase loans from MCB if they meet our purchasing criteria, which were developed with our extensive experience with lending to the military market.  Pursuant to the LSMS Agreement, we granted MCB rights to use our lending system; however, we retained ownership of the lending system.  Using our lending criteria, scoring model and system, MCB originates loans directly over the internet.  Loans typically have maximum terms of 48 months and had an average origination amount of $4,556 in the first quarter of fiscal 2018.  Effective April 1, 2017, we pay a $27.00 fee for each loan purchased from MCB to reimburse MCB for loan origination costs.  Prior to April 1, 2017, we paid a $25.00 fee for each loan purchased from MCB to reimburse MCB for loan origination costs.  In the first quarter of fiscal 2018, we paid MCB $0.4 million in fees connected with the origination of loans compared to $0.3 million in the first quarter of fiscal 2017. See further discussion in "Loan Acquisition."


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MCB uses our lending criteria and scoring model to originate loans that we subsequently purchase. Under this criteria and scoring model, in evaluating the creditworthiness of applicants, MCB primarily examines the individual’s debt-to-income ratio, prior payment experience with us (if applicable), credit bureau attributes and employment stability. MCB uses credit score information provided by the FICO Score 8 model, in combination with certain credit overlays. Our purchasing guidelines provide that we may purchase loans originated by MCB with the FICO Score 8 model and certain credit overlays. Loans are limited to amounts that the customer could reasonably be expected to repay from discretionary income.  However, when we purchase loans from MCB, we cannot predict when or whether a customer may unexpectedly leave the military or other events may occur that could result in a loan not being repaid. The average customer loan balance was $3,698 at December 31, 2017, repayable in equal monthly installments and with an average remaining term of 21 months.

A risk in all consumer lending is the customer’s unwillingness or inability to repay obligations. Unwillingness to repay is usually evidenced by a consumer’s historical credit repayment record.  An inability to repay occurs after initial credit evaluation and funding and usually results from lower income due to early separation from the military or reduction in rank, major medical expenses, or divorce.  Occasionally, these types of events are so economically severe that the customer files for protection under the bankruptcy laws.  Underwriting guidelines are used at the time the customer applies for a loan to reduce the risk of originating loans where the customer is unwilling or unable to repay.  These guidelines are developed from past customer credit repayment experience and are periodically revalidated based on current portfolio performance.  We purchase loans made to consumers that meet our purchase criteria.  The amount and interest rate of the loans purchased are set by MCB based upon these underwriting guidelines considering the estimated credit risk assumed.
 
As a customer service, we will purchase a new loan from MCB for an existing borrower who has demonstrated a positive payment history with us and where the transaction creates an economic benefit to the customer after fully underwriting the new loan request to ensure proper debt-to-income ratio, credit history and payment performance. We will not purchase refinanced loans made to cure delinquency or for the sole purpose of creating fee income.  Generally, we purchase refinanced loans when a portion of the new loan proceeds is used to repay the balance of the existing loan and the remaining portion is advanced to the customer.  Approximately 46.2% of the amount of loans we purchased in the first quarter of fiscal 2018 were refinancings of outstanding loans compared to 44.6% during the first quarter of fiscal 2017.
 
Management and Record Keeping Services
 
MCB provides management and record keeping services for us pursuant to the LSMS Agreement.  MCB services our finance receivables and we pay fees to MCB for these management and record keeping services.  Also, as part of its compensation for performing these management and record keeping services, MCB retains a portion of ancillary revenue, including late charges and insufficient funds fees, associated with these finance receivables. 

For the three months ended December 31, 2017 and 2016, the Company paid fees for services under the LSMS Agreement that include: (1) a loan origination fee of $27.00 for each loan originated by MCB and sold to the Company (prior to April 1, 2017 a $25.00 loan origination fee was paid to MCB); (2) an annual base fee of $500,000 paid in equal monthly installments; (3) a monthly servicing fee of 0.604% (7.25% annually) of the outstanding principal balance of finance receivables serviced as of the last day of the month (for the three months ended December 31, 2016, the monthly service fee was 0.617% (7.40% annually) of finance receivables serviced as of the last day of the month); (4) a monthly collections fee equal to 46% of amounts collected on charged-off accounts (prior to October 1, 2017 the monthly collections fee was 34% of amounts collected on charged-off accounts); and (5) a monthly fee equal to 125% of the actual cost for marketing and business development services.
 
To facilitate MCB’s servicing of the finance receivables, we have granted MCB: (1) the non-exclusive rights to use certain intellectual property, including our trade names and service marks; and (2) the right to use our loan processing system and related hardware and software. We have also granted MCB non-exclusive rights to market additional products and services to our customers. We retain all other borrower relationships.

In January 2018, the Company implemented a new loan servicing software system pursuant to an agreement entered into in 2015. The implementation also included modifications to our existing loan origination system. If the new service providers and software platforms do not function as anticipated, we may experience interruptions in our business processes and incur unexpected costs that could impair our ability to effectively manage and run our business. As we are dependent on our ability to accurately manage information and MCB's ability to originate and service finance receivables, the failure to timely address any deficiencies in our systems could adversely affect our results of operations and financial condition.

A formal agreement (the “Expense Sharing Agreement”) between MCFC and its consolidated subsidiaries, including the Company, is in place to govern the expenses to be shared among the parties, reimbursements to be paid by the parties to MCFC for services provided, as well as the services to be provided by the parties to MCFC and other parties. Under the

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Expense Sharing Agreement, there are three types of expenses: (1) direct expenses (those that can be specifically identified to a party, yet are paid centrally, usually by MCFC and subsequently reimbursed by the party to which the direct expense applies); (2) direct cost allocations (costs incurred for the benefit of MCFC and/or its subsidiaries that are not direct expenses); and (3) indirect cost allocations (those expenses incurred for the benefit of all parties and not specifically identifiable with an allocation methodology). The direct cost allocations are allocated based upon estimated usage of services using reliable cost indicators. The costs for MCFC services are periodically evaluated to ensure the costs are at a reasonable market rate and consistent with what an external third party may charge. Under the Expense Sharing Agreement, MCFC may provide services such as, but not limited to, executive compensation and remuneration, strategic planning, loan review, risk management, regulatory compliance support, tax, legal and information technology services. The other parties to the Expense Sharing Agreement may provide office space and servicing of finance receivables and leases.

Sources of Income
 
We generate revenues primarily from interest income and fees earned on the finance receivables purchased from MCB, which include refinanced finance receivables. We also earn revenues from debt protection fees; however, effective September 15, 2016 MCB discontinued offering the debt protection product. Therefore, our debt protection revenues will be lower relative to historical levels in future periods as existing policies continue to run-off. For purposes of the following discussion, “revenues” means the sum of our finance income and debt protection fees.

Finance Receivables
 
Our finance receivables are comprised of loans purchased from MCB.  The following table details the average loan balance and the number of loans that comprise our finance receivables as of the date presented:
 
 
December 31,
2017
 
September 30,
2017
 
 
 
 
Finance receivables:
 

 
 

Gross finance receivables balance
$
243,178,602

 
$
242,683,918

Average finance receivable balance
$
3,698

 
$
3,703

Number of finance receivables
65,754

 
65,541

 

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Net Interest Margin

The principal component of our profitability is net interest margin, which is a function of the interest and fees 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 we are able to charge.
 
 Our interest expense is sensitive to changes in general market interest rates, which directly impacts our cost of funds.  Due to certain state and federal regulations, we are unable to significantly increase the annual percentage rate earned on new and existing finance receivables, which restricts our ability to react to increases in our 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 data relating to our net interest margin as of and for the periods presented:
 
 
Three Months Ended 
 December 31,
 
2017
 
2016
 
(dollars in thousands)
 
 
 
 
Total finance receivables balance
$
243,179

 
$
273,251

Average gross finance receivables (1)
245,862

 
274,050

Average interest bearing liabilities (1)
146,249

 
181,265

Total interest income and fees
18,579

 
20,022

Total interest expense
2,482

 
2,745

 
 
 
 
Percentage of interest income and fees to average gross finance receivables (annualized)
30.2
%
 
29.2
%
Percentage of interest expense to average interest bearing liabilities (annualized)
6.8
%
 
6.1
%
Percentage of net interest margin (annualized)
26.2
%
 
25.2
%
 
(1) 
Averages are computed using month-end balances and exclude any early Allotment payments.


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Three Months Ended December 31, 2017 Compared to Three Months Ended December 31, 2016
 
Gross Finance ReceivablesOur gross finance receivables decreased 11.0% or $30.1 million, to $243.2 million as of December 31, 2017 from $273.3 million as of December 31, 2016. The decrease in finance receivables was due largely to reduced customer demand and borrowing base limitations under our Credit Agreement limiting our ability to purchase loans from MCB during fiscal 2017, as well as underwriting and purchasing criteria changes made during the second and third quarters of fiscal 2017 intended to improve credit quality.
 
Interest Income and Fees.  Interest income and fees decreased to $18.6 million in the first quarter of fiscal 2018 from $20.0 million in the first quarter of fiscal 2017, a decrease of $1.4 million or 7.0%.  The decrease in interest income and fees was due primarily to a 10.3% decrease in average gross finance receivables to $245.9 million at December 31, 2017 from $274.1 million at December 31, 2016.
 
Interest Expense.  Interest expense in the first quarter of fiscal 2018 decreased 7.4% to $2.5 million compared to $2.7 million for the first quarter of fiscal 2017.  The decrease was due to a decline in average interest bearing liabilities to $146.2 million, or 19.4%, in the first quarter of fiscal 2018 compared to $181.3 million in the first quarter of fiscal 2017. The decline in average interest bearing liabilities was due to a reduction in average gross finance receivables outstanding. The decrease in interest expense was partially offset by an increase in the weighted average interest rate of our interest bearing liabilities to 6.8% during the first quarter of fiscal 2018 compared to 6.1% during the first quarter of fiscal 2017. Due to the predominantly variable rate nature of our borrowings, our cost of funds percentage will increase as the level of market interest rates increase.
 
Provision for Credit Losses The provision for credit losses in the first quarter of fiscal 2018 decreased to $5.3 million from $9.8 million in the first quarter of fiscal 2017, a decrease of $4.5 million or 45.9%.  The decrease in the provision for credit losses was due to lower net charge-offs as compared to the prior year and a reduction in the level of allowance for credit losses necessary to cover estimated inherent credit losses in our finance receivables portfolio. The lower level of estimated credit losses reflects improved credit quality measures during the quarter from enhanced collection efforts by MCB, a stabilization of borrower repayment patterns and a lower overall finance receivables portfolio. These factors have contributed to a decline in recency basis delinquent finance receivables.

Net charge-offs were $6.7 million in the first quarter of fiscal 2018 compared to $8.6 million in the first quarter of fiscal 2017, a decrease of $1.9 million or 22.1%.  The net charge-off ratio decreased to 11.0% for the first quarter of fiscal 2018 compared to 12.5% for the first quarter of fiscal 2017. The decrease in net charge-offs and net charge-off ratio for the first quarter of fiscal 2018 resulted from a decrease in net charge-offs from customers who separated from the military and a decline in recency basis delinquent finance receivables during the fourth quarter of fiscal 2017 and the first quarter of fiscal 2018. Gross finance receivables balances 60 days or more past due as a percent of gross finance receivables were 4.3% at December 31, 2017 compared to 7.2% at December 31, 2016 and 4.5% at September 30, 2017. See further discussion in “Credit Loss Experience and Provision for Credit Losses.”
 
Non-Interest Expense.  Non-interest expense in the first quarter of fiscal 2018 was $7.2 million compared to $7.5 million for the first quarter of fiscal 2017, a decrease of $0.3 million or 4.0%.  Non-interest expense during the first quarter of fiscal 2018 decreased due to a $0.4 million, or 6.8%, decrease in the monthly servicing fee paid to MCB compared to the first quarter of fiscal 2017. The decrease in the servicing fee is due to a 10.3% decline in average gross receivables and a decrease in the monthly servicing fee rate paid to MCB. The monthly servicing fee rate was 7.25% (annually) in the first quarter of fiscal 2018 compared to 7.40% (annually) in the first quarter of fiscal 2017.

Provision for Income Taxes.  The Company’s effective tax rate was 129.8% in the first quarter of fiscal 2018 compared to 45.2% in the first quarter of fiscal 2017. The increase is primarily driven by the Tax Cuts and Jobs Act signed into law on December 22, 2017. As a result of the reduction in the corporate income tax rate, the Company revalued its deferred tax assets and liabilities at December 31, 2017 to reflect the reduction in the expected tax effects resulting from the lower corporate income tax rate. The revaluation resulted in a $3.7 million reduction in the value of its net deferred tax asset. The reduction was recorded as additional deferred income tax expense in the Company’s consolidated statement of operations and other comprehensive income for the three months ended December 31, 2017. For additional information related to our provision for income taxes, please see Note 5: Income Taxes in Notes to the Consolidated Financial Statements in Item 1 of this Report on Form 10-Q.

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Delinquency Experience
 
Our customers are required to make monthly payments of interest and principal.  Our servicer, MCB, under our supervision, analyzes customer 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. Recency delinquent finance receivables decreased to 4.3% at December 31, 2017 from 4.5% at September 30, 2017 and 7.2% at December 31, 2016. The decrease in recency delinquent finance receivables from September 30, 2017 and December 31, 2016 is attributed to enhanced collection efforts by MCB in fiscal 2017, a stabilization of borrowing repayment patterns and elevated charge-offs of delinquent accounts during fiscal 2017. Finance receivables charged-off were $7.8 million for the first three months of fiscal 2018 compared to $9.4 million for the first three months of fiscal 2017. Recency delinquent balances, 60 days or more past due, from customers separated from the military, decreased to $3.0 million at December 31, 2017 compared to $3.3 million at September 30, 2017. Changes in recency delinquency balances are generally a leading indicator of the level and direction of future charge-offs.
 
The following table sets forth our delinquency experience as of the end of the dates presented for loans for which payments are 60 days or more past due, on a recency basis.
 
 
December 31,
2017
 
September 30,
2017
 
December 31,
2016
 
(dollars in thousands)
 
 
 
 
 
 
Gross finance receivables
$
243,179

 
$
242,684

 
$
273,251

Gross finance receivables balances 60 days or more past due
10,557

 
10,812

 
19,660

Gross finance receivables balances 60 days or more past due as a percent of gross finance receivables
4.3
%
 
4.5
%
 
7.2
%
 
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 receivables portfolio. To estimate the allowance for credit losses, we utilize a statistical model based on potential credit risk trends incorporating historical factors.  The model results and management’s judgment are used to estimate inherent losses in the finance receivables portfolio and in establishing the current provision and allowance for credit losses. These estimates are influenced by factors outside our control, such as economic conditions, customers’ loan repayment behavior, 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 and that actual credit losses could be materially different from our estimates. For a description of the risks associated with these finance receivables, see Part I, Item 1A. "Risk Factors" of our Annual Report for additional discussion of risks associated with our finance receivables and business.
.
Charge-Off. Our charge-off policy is to charge-off loans when a full payment has not been received for the preceding six calendar months and is 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 due to deterioration in a customer's willingness or ability to repay 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 if a customer may depart from the military early.  Accordingly, we cannot implement policies or procedures for MCB to follow to ensure that we will be repaid in full prior to a customer leaving the military, nor can we predict if a customer will be subject to deployment at a duration or frequency that leads to a default on his or her loan.

Former Military.  As of December 31, 2017 and December 31, 2016, we had approximately $15.9 million or 6.5% of our total portfolio, and $19.8 million or 7.3% of our total portfolio, respectively, from customers who separated from the military prior to repaying their loan. Finance receivable net charge-offs from customers who separated from the military, were $2.1 million and represented 31.3% of net charge-offs in the first quarter of fiscal 2018 compared to $3.5 million and 40.8% in the first quarter of fiscal 2017.


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Allowance for Credit Losses.  The following table presents our allowance for credit losses on finance receivables and net charge-offs as of and for the periods presented. For additional information related to our allowance for credit losses, please see Note 2: Finance Receivables in Notes to the Consolidated Financial Statements in Item 1 of this Report on Form 10-Q.
 
As of and for the Three Months Ended December 31,
 
2017
 
2016
 
(dollars in thousands)
 
 
 
 
Allowance as a percentage of total finance receivables
13.3
%
 
11.6
%
Average gross finance receivables (1)
$
245,862

 
$
274,050

Percentage of net charge-offs to average gross finance receivables (annualized)
11.0
%
 
12.5
%

 
(1) 
Averages are computed using month-end balances and exclude any early Allotment payments. 

The allowance for credit losses at December 31, 2017 increased to $32.3 million from $31.6 million at December 31, 2016. The increase in the allowance for credit losses is due to an increase in reserves necessary to cover estimated inherent credit losses in our finance receivables portfolio. In the first half of fiscal 2017 we experienced increased levels of past due loans as a percentage of the finance receivables portfolio and elevated net charge-offs relative to fiscal 2016. MCB, as the servicer of our finance receivables portfolio, took steps during fiscal 2017 to mitigate this increase through enhancements to collection efforts, along with changes in underwriting, and we made changes to our purchasing criteria. During the second half of fiscal 2017 and the first three months of fiscal 2018 we experienced declining levels of past due loans as a percentage of the finance receivables portfolio as compared to the first half of fiscal 2017. Although such levels of past due loans declined during the first three months of fiscal 2018, our finance receivables portfolio remains sensitive to changes in customers’ loan repayment patterns that could lead to increased credit losses. Until such improvements in past due loan levels are sustained, we believe it is appropriate to maintain the allowance for credit losses as a percentage of finance receivables at an elevated level relative to historical periods.

Loan Acquisition
 
Finance receivable growth is an important factor in determining our future revenues.  We are dependent upon MCB to increase its originations and on having sufficient funding for our future growth.  Finance receivables purchased (including refinancings) during the first three months of fiscal 2018 were $64.7 million compared to $64.6 million during the first three months of fiscal 2017.

The following table sets forth our overall finance receivable purchases, including those refinanced, as of and for the periods presented:
 
 
As of and for the Three Months Ended December 31,
 
2017
 
2016
 
 
 
 
Finance receivables purchased:
 
 
 
Gross finance receivables balance
$
64,747,662

 
$
64,581,618

Number of finance receivable loans
14,211

 
13,956

Average finance receivable amount at time of purchase
$
4,556

 
$
4,628

 
 
 
 
 
 
 
 


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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 consumer finance receivables from MCB and pay MCB for services performed under the LSMS Agreement.  We use borrowings to fund the difference, if any, between the cash used to purchase finance receivables and pay operating expenses and the cash generated from loan repayments, interest income and fees. Cash used in investing activities in the first three months of fiscal 2018 was approximately $7.0 million and cash used in financing activities was $4.3 million, which was funded from $9.4 million in operating activities.  Cash used in investing activities in the first three months of fiscal 2017 was approximately $2.1 million and cash used in financing activities was $13.4 million, which was funded by operating activities of $12.0 million. Financing activities primarily consist of borrowing and repayments of debt incurred under our senior revolving credit facility.
 
The majority of our liquidity requirements are obtained through our senior revolving credit facility. Additional sources of funds may be generated through repayments of finance receivables, sales of subordinated debt and borrowings from MCFC. For additional information related to our borrowings, please see Note 4: Borrowings in Notes to the Consolidated Financial Statements in Item 1 of this Report on Form 10-Q. 

As of December 31, 2017, our credit facility had an 81.5% utilization, which may restrict our ability to purchase finance receivables in the future. As of December 31, 2017, we could request up to $25.4 million in additional funds and remain in compliance with the terms of the Credit Agreement.  If we cannot secure new borrowings to the extent the Company believes additional borrowings would be advisable, or increase borrowing availability under our Credit Agreement, our future growth will be limited, which could have a material adverse effect on our results of operations and financial condition.

Total borrowings and availability under the Credit Agreement as of December 31, 2017 and September 30, 2017, consisted of the following amounts as of the dates presented:
 
 
 
 
 
December 31,
2017
 
September 30,
2017
 
(dollars in thousands)
 
 
 
 
Revolving credit line:
 

 
 

Total facility
$
170,000

 
$
170,000

Gross balance, end of period
111,500

 
115,000

Maximum available credit
58,500

 
55,000

Credit facility available (1)
25,372

 
21,424

Percent utilization of the total facility
81.5
%
 
84.3
%
 

(1) 
Under the Credit Agreement, credit facility available is limited by the borrowing base.

Off-Balance Sheet Arrangements. At December 31, 2017 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 we believe is material to our shareholder, lenders and subordinated debt holders.


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ITEM 3.  Quantitative and Qualitative Disclosures About Market Risk
 
Information about market risks for the three months ended December 31, 2017, does not differ materially from that discussed under Item 7A of the Annual Report. As of December 31, 2017, we have no material market risk sensitive instruments entered into for trading or other purposes, as defined by U.S. generally accepted accounting principles.
 
Our finance income is generally not sensitive to fluctuations in market interest rates. Our revolving credit line borrowings under our Credit Agreement are divided into tranches, including (1) a borrowing that bears interest at prime plus 3.25% ("Base Rate") or (2) a borrowing that bears an interest rate offered in the London Interbank Eurodollar market for the relevant interest period plus 4.25% ("LIBOR"). We are subject to interest rate sensitivity on our LIBOR and Base Rate borrowings. As of December 31, 2017, $105.0 million of LIBOR borrowings were outstanding with an interest rate of 5.74%. As of December 31, 2017, $6.5 million of Base Rate borrowings were outstanding with an interest rate of 7.75%. As a means of managing its exposure to rising interest rates, the Company has a $50 million notional interest rate cap agreement at December 31, 2017 that expires on December 21, 2018. The interest rate cap is indexed to 1-month LIBOR and has a strike rate of 2.5%. The interest rate cap is reflected on the consolidated balance sheet at its estimated fair value of $77 thousand at December 31, 2017 and $97 thousand at September 30, 2017. Assuming $105.0 million in LIBOR annual average borrowings, a 50 basis point increase in the 30 day LIBOR index rate would increase annual interest expense approximately $525 thousand. Assuming $6.5 million in Base Rate annual average borrowings, a 50 basis point increase in the prime rate would increase annual interest expense approximately $33 thousand.

ITEM 4.  Controls and Procedures
 
We maintain disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e)) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), that are designed to ensure that information required to be disclosed in our reports under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.  Any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives.  Our management, under the supervision and with the participation of our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures as of December 31, 2017.  Based on this evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that 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 quarter ended December 31, 2017 that have materially affected, or are reasonably likely to materially affect our internal controls over financial reporting.

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Table of Contents

PART II - OTHER INFORMATION
 
ITEM 1.  Legal Proceedings
 
The Company is subject to legal proceedings and claims that arise in the ordinary course of business. During the period covered by this quarterly report, there were no legal proceedings brought against the Company nor were there material changes in current legal proceedings that management believes would have a material adverse effect on the financial position or results of operations of the Company.
 
ITEM 1A.  Risk Factors
 
In our Annual Report on Form 10-K for the fiscal year ended September 30, 2017, we identified important risks and uncertainties that could affect our results of operations, financial position, cash flow or business.  There have been no material changes from the risk factors disclosed in our Annual Report on Form 10-K.


 



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Table of Contents

ITEM 6.  Exhibits
 
Exhibit No.
 
Description
 
 
 
31.1
 
31.2
 
32.1
 
32.2
 
101
 
The following financial information from Pioneer Financial Services, Inc.’s Quarterly Report on Form 10-Q for the quarter ended December 31, 2017, filed with the SEC on February 12, 2018, formatted in Extensible Business Reporting Language (XBRL): (i) the Consolidated Statements of Operations and Other Comprehensive Income for the three months ended December 31, 2017 and December 31, 2016 (ii) the Consolidated Balance Sheets as of December 31, 2017 and September 30, 2017, (iii) the Consolidated Statements of Cash Flows for the three months ended December 31, 2017 and December 31, 2016 and (iv) Notes to Consolidated Financial Statements.


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SIGNATURES
 
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
 
Name
 
Title
 
Date
 
 
 
 
 
/s/ Timothy L. Stanley
 
Chief Executive Officer and Vice
 
February 12, 2018
Timothy L. Stanley
 
Chairman (Principal Executive Officer)
 
 
 
 
 
 
 
/s/ Pamela D. Johnson
 
Chief Financial Officer
 
February 12, 2018
Pamela D. Johnson
 
(Principal Financial Officer and Principal Accounting Officer)
 
 

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Table of Contents

EXHIBIT INDEX
 
Exhibit No.
 
Description
 
 
 
31.1
 
31.2
 
32.1
 
32.2
 
101
 
The following financial information from Pioneer Financial Services, Inc.’s Quarterly Report on Form 10-Q for the quarter ended December 31, 2017, filed with the SEC on February 12, 2018, formatted in Extensible Business Reporting Language (XBRL): (i) the Consolidated Statements of Operations and Other Comprehensive Income for the three months ended December 31, 2017 and December 31, 2016 (ii) the Consolidated Balance Sheets as of December 31, 2017 and September 30, 2017, (iii) the Consolidated Statements of Cash Flows for the three months ended December 31, 2017 and December 31, 2016 and (iv) Notes to Consolidated Financial Statements.



28