Merchants Bancorp — Q2 2020 Form 10-Q
Business context and reporting period. The unaudited filing covers the quarter and six months ended June 30, 2020, with comparisons to 2019. Merchants Bancorp is a bank holding company whose main businesses are multi-family mortgage banking, mortgage warehousing, and community banking. Amounts below are in U.S. dollars; financial statement amounts are converted from thousands to millions where appropriate.
Financial performance and condition
| Metric | Q2 2020 | Q2 2019 | Six months 2020 | Six months 2019 |
|---|---|---|---|---|
| Net interest income | $51.2 million | $27.9 million | $89.6 million | $52.1 million |
| Provision for loan losses | $1.7 million | $0.1 million | $4.7 million | $0.8 million |
| Noninterest income | $26.2 million | $9.9 million | $46.1 million | $13.5 million |
| Noninterest expense | $20.3 million | $15.9 million | $42.6 million | $29.0 million |
| Net income | $41.2 million | $16.4 million | $65.7 million | $27.0 million |
| Diluted earnings per common share | $1.31 | $0.51 | $2.03 | $0.85 |
| Net interest margin | 2.42% | 2.49% | 2.41% | 2.62% |
| Efficiency ratio | 26.2% | 42.1% | 31.4% | 44.2% |
- Q2 net income increased 150%; six-month net income increased 143%. Management attributed the improvement principally to higher net interest income and loan-sale gains, alongside strong mortgage warehouse growth.
- Q2 return on average assets was 1.89%, versus 1.41% a year earlier. Q2 net interest spread rose to 2.31% from 2.22%, while net interest margin fell 7 basis points, reflecting lower market rates. Six-month margin declined 21 basis points.
- At June 30, total assets were $9.44 billion, up 48% from year-end 2019. Loans held for sale were $3.88 billion; net loans receivable were $4.13 billion; and mortgage loans awaiting securitization were $518.8 million.
- Deposits were $6.91 billion, up 26% from December 31, 2019. Borrowings rose to $1.76 billion from $181.4 million, including $575 million outstanding at the Federal Reserve discount window. Shareholders’ equity was $708.2 million.
- Cash and cash equivalents were $403.2 million, down from $506.7 million at year-end. Six-month operating cash flow was negative $1.97 billion and investing cash flow negative $1.13 billion; financing cash flow was positive $3.00 billion, reflecting deposit and borrowing inflows. Management reported $1.9 billion of unused lines of credit.
- The allowance for loan losses was $20.5 million, or 0.49% of loans receivable, versus $15.8 million, or 0.52%, at year-end. Nonperforming loans were $6.7 million, 0.16% of total loans; allowance coverage of nonperforming loans was 307.2%.
Material changes and drivers
- Mortgage warehouse loans increased 68% from year-end to $1.29 billion; multi-family and healthcare loans increased 37% to $1.85 billion. Loans held for sale grew 85%, primarily from higher warehouse activity.
- Q2 mortgage warehouse funding volume reached $28.6 billion, up 201% year over year; management cited an 85% industry increase. Six-month funding volume was $45.4 billion, up 204%, versus an 81% industry increase cited in the filing.
- Loan-sale gains increased to $17.1 million in Q2 from $9.1 million and to $38.3 million for the six months from $11.7 million. Mortgage warehouse fees also rose substantially with volume.
- Lower deposit rates helped reduce Q2 deposit interest expense despite higher average balances. The company also shifted funding mix, reducing brokered certificates of deposit while increasing demand and savings deposits and using Federal Reserve borrowing.
- Mortgage servicing rights fell to $72.9 million from $74.4 million at year-end, including a $7.0 million fair-value decline for the first six months, driven mainly by interest-rate and prepayment assumption changes.
Outlook, commentary, and risks
- The filing provides no formal earnings or financial guidance. Management said the ultimate effect of COVID-19 was uncertain and that credit-loss estimates could require further adjustment during 2020.
- At June 30, 52 loans with $80.6 million in unpaid balances had payment deferrals, about 1% of loans receivable and loans held for sale. The filing separately reports $63.9 million in COVID-19 deferrals classified as Special Mention (Watch); the categories and denominators differ and should be reconciled when reviewing credit exposure. Management reported no significant disruption among existing customers at that date.
- The allowance increase since year-end was attributed mainly to loan growth, with approximately $595,000 of additional provision associated with COVID-19 uncertainty. The company had funded approximately $88 million of Paycheck Protection Program loans through June 30.
- Brokered deposits can be rate-sensitive and may not renew at maturity. Certificates of deposit totaling $1.6 billion were due within one year. Management expected substantial renewal and cited borrowing capacity and unused lines as liquidity resources.
- Under the temporary 8% Community Bank Leverage Ratio requirement, Merchants Bancorp’s consolidated Tier 1 leverage ratio was 7.9% at June 30, below the stated threshold; management expected compliance within the permitted two-quarter grace period. Merchants Bank was at 8.1% and FMBI at 9.5%. The filing said the entities were categorized as well capitalized under the regulatory framework.
- Interest-rate risk models estimated that a 100-basis-point increase would raise forward 12-month net interest income by 10.7%, while a 100-basis-point decrease would reduce it by 1.5%. The filing cautions that COVID-19, economic conditions, borrower performance, funding and deposit retention, interest rates, and market liquidity may affect results and capital.
Important facts for investors to verify
- Whether the consolidated leverage ratio reached the 8% requirement within the grace period, and how capital ratios developed afterward.
- Subsequent performance of COVID-19-deferral loans, including the relationship between the $80.6 million deferral balance and the $63.9 million COVID-19 Special Mention balance.
- Credit quality, allowance adequacy, and concentrations in mortgage warehouse and multi-family/healthcare lending as the unusually rapid loan growth continues.
- Deposit retention and funding costs, including maturities of brokered deposits and the $1.6 billion of certificates of deposit due within a year; also verify ongoing access to borrowing facilities.
- Whether mortgage warehouse and loan-sale activity, which materially supported earnings growth, remained elevated, and whether margin pressure or further mortgage servicing-rights valuation declines offset that contribution.