CASH - Pathward Financial: A Different Kind Of Bank That Definitely Warrants Consideration

2023-11-13 09:00:00 ET

Summary

• Pathward Financial is a banking firm with a differentiated business model that makes it an appealing opportunity for investors.
• The company engages in a wide variety of commercial banking activities, including commercial finance loans, consumer finance loans, and tax services loans.
• Pathward Financial has achieved attractive financial results, with growing net interest income and non-interest income, and a higher return on assets compared to similar banks.

Not every company can be analyzed in the same way. Even companies that operate in the same space might not always be approachable from the same angle. A good example of this can be seen by looking at banking firm Pathward Financial ( CASH ). Relative to book value compared to similar firms, shares of the company are very expensive. But on a price to earnings basis, the stock is attractively priced. This disparity seems to be driven by a differentiated business model that makes the firm an appealing opportunity for those who understand it.

An intriguing opportunity

The management team at Pathward Financial describes the company as a bank holding firm. This is how pretty much every bank that is publicly traded describes itself. But when you dig deeper, there is more to the story that is worth mentioning. Just like every bank that's out there, Pathward Financial engages in a wide variety of commercial banking activities. Through its wholly owned banking subsidiary, the institution accepts deposits. It also doles this money out for the purpose of granting borrowers capital. Examples of the types of loans that it gives out would include commercial finance loans, consumer finance loans, and tax services loans.

Management describes commercial loans as those centered around providing working capital, equipment financing, insurance premium financing, and more. This even includes factoring and lease financing. Under the consumer finance category, the institution offers up closed end installment loans that typically last between 12 and 84 months. It even has a program called Emerald Advance that it serves as an originator of for lines of credit. These funds are put onto a prepaid card for the consumer to use as they see fit. The firm used to engage in student lending. But it ultimately sold those operations off in the final quarter of last year. And finally, its tax services operations include refund advance loans and ERO advance loans that are unsecured advances that are used by tax preparers to purchase tax preparation software and cover other expenses necessary to their operations. This part of the company also participates in collateral based warehouse lines of credit where the bank has a senior position that sees the lines of credit collateralized by consumer receivables.

Many other banks engage in other activities as well. Examples would involve the origination of mortgages and similar loans. But Pathward Financial does not seem to operate in that way. It does, however, invest in different types of loans such as mortgage-backed securities, government securities, and more. If you think that the types of activities that the company engages in is peculiar, you would be right. But this is by design. This is because this is not your traditional bank even though it is structured in many respects like one. Management even stated in the firms 2022 annual report that its products and services are offered in order to facilitate the processing and settlement of authorized electronic transactions that involve the movement of funds. This is because the company considers its core capabilities to involve payment processing, payment issuing, and tax solutions dedicated to the financial services and financial technology industries. In fact, it even calls this line of business its BaaS (banking-as-a-service) operations.

The company engages, for instance, in the handling of various payment activities such as the acceptance, processing, and settlement of credit card and debit card payments. It basically sponsors acquiring activity for its merchant clients when it comes to these activities. It offers various money movement solutions such as providing the financing operations for ACH and wire transactions. ATM sponsorship is another activity that the company engages in, whereby its sponsors ATM independent sales organizations that involve it reviewing and providing oversight of entities that participate in debit and credit networks. In some cases, it might even hold leasehold interests in ATMs that require bank ownership. And through its issuing solutions operations, it offers up prepaid cards for customers to use.

Over the years, the company has grown into a rather sizable player in some respects. For instance, since the start of the MasterCard Send and Visa Direct programs in 2020, the company has moved over $10 billion of capital. It now helps facilitate over $11 billion in tax refunds each year and it has sponsored over 260,000 ATMs. Over 11,000 bank branches utilize some of its services and the company helps to move around $2.5 billion each day through its ACH and wire services.

By diving into these types of operations, the company has achieved attractive growth . Net interest income, for instance, grew from $229.2 million in 2021 to $330.5 million during its 2023 fiscal year that just got reported. Non-interest income is a significant part of the company's operations and has grown from $270.9 million to $316.6 million over the same window of time. Unfortunately, we have seen some weakness. The firm's net profits have risen from $343.7 million in 2021 to $161.2 million in 2023. But it's important to keep in mind that there are some adjustments that are probably warranted. For instance, in 2022, the company saw a $50 million gain on the sale of certain trademarks. So the increase from the $153.8 million in 2022 to what was reported for 2023 appears modest when, in fact, it was quite large.

Just like any bank, the growth of Pathward Financial has been made possible in large part because of a growth in assets. The value of loans on the company's books, for instance, has increased from $3.61 billion in 2021 to $4.37 billion in 2023. The value of securities has actually dropped somewhat from $1.92 billion to $1.84 billion. On the other hand, cash and cash equivalents increased from $314 million to $375.6 million. And all of this has only been made possible by a growth in overall deposits. These increased from $5.52 billion in 2021 to $6.88 billion in 2023. All the while, management has succeeded in keeping debt low. In fact, debt has fallen by nearly half from 2021 through 2023, declining from $92.8 million to $46.9 million. This is great to see and it's also great that debt as a whole remains in check.

In terms of valuing the company, the picture is a bit tricky. On a price to earnings basis, shares look very attractive at a multiple of 7.8. This is actually lower than the 10.4 industry average for the banking sector. And it's also comfortably in the range of what I have seen in many instances so far this year, with some companies trading at multiples of 5 or lower and others trading at 12 or higher. But this is not to say that valuing the company is so clear cut. Many banks, for instance, are currently trading at discounts to their book value per share and are trading somewhere around tangible book value per share or slightly above it. But if you were to look at the business through this lens, it would look quite expensive.

On a price to book basis, the company is trading at a premium of 89.8%. It's also trading at a 285.3% premium to its tangible book value. Somebody looking at only this metric and without understanding the company more intimately would likely conclude that the stock is significantly overvalued. I don't believe that's necessarily the case. As I mentioned already, the business generates a lot of its revenue from non-interest income. With many banks, this is generated from non-core operations that can be done as a secondary focus of the institution. But many of the activities that the company engages in here are actually core to its nature. In 2023, for instance, the company generated $150.7 million from payments card and deposit fees.

These types of activities necessitate other assets on the company's books. And at the end of the day, these assets make the institution more profitable. For instance, in 2023, it generated a return on assets totaling 2.33%. That's comfortably higher than the 1.17% seen by similar commercial banks. And while return on assets have been on the decline for the past three years in the banking sector, Pathward Financial has succeeded in growing this number for at least the past four years in a row. At the same time, the net interest margin that the company generates is also comfortably higher than other similar firms. So paying a premium on assets that are this profitable should not be considered outrageous.

Takeaway

Based on the data provided, Pathward Financial strikes me as an interesting institution that investors should definitely be aware of. Although I don't plan to buy shares of the business, or at least not yet, I do think that it is a quality institution that should continue to expand in the long run. Relative to earnings, shares are cheap. And so long as nothing big comes out of the woodwork, I expect the overall growth of the company to continue unabated. Because of this, I have decided to rate it a ‘buy’ for now.

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