Merchants Bancorp — Q2 2018 Form 10-Q
Business context and reporting period
Unaudited results for the quarter and six months ended June 30, 2018, compared with the same 2017 periods; balance-sheet comparisons are against December 31, 2017. Merchants Bancorp is an Indiana bank holding company focused on multifamily and healthcare mortgage banking, mortgage warehousing, and community banking. The company acquired Joy State Bank on January 2, 2018.
Key financial metrics
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Total interest income | $34.1 million | $22.5 million | $63.2 million | $41.5 million |
| Net interest income | $22.2 million | $15.7 million | $42.3 million | $29.3 million |
| Net income | $15.7 million | $14.8 million | $30.7 million | $23.9 million |
| Net income to common shareholders | $14.8 million | $13.9 million | $29.0 million | $22.2 million |
| Basic and diluted EPS | $0.52 | $0.66 | $1.01 | $1.05 |
| Net interest margin | 2.51% | 2.28% | 2.51% | 2.23% |
At June 30, total assets were $3.79 billion, up 12% from year-end; loans held for investment, net, were $1.82 billion, up 33%; and loans held for sale were $953.2 million. Deposits totaled $3.18 billion, up 8%, while borrowings rose to $189.5 million from $56.6 million. Shareholders’ equity was $392.9 million. Cash and cash equivalents were $352.4 million, versus $359.5 million at year-end.
For the six months, operating cash flow was $77.6 million, investing cash flow was negative $407.2 million, and financing cash flow was positive $322.5 million; cash declined $7.1 million. The allowance for loan losses was $10.6 million, or 0.58% of loans. The Bank and the company reported regulatory capital ratios above required minimums and were categorized as well capitalized.
Material changes versus comparable periods
- Q2 net income rose 6%; first-half net income rose 29%. Net interest income grew 41% in Q2 and 45% for the first half, reflecting asset growth and higher yields. First-half average loan yield increased to 4.58% from 4.08%.
- Growth in earnings did not translate into higher EPS: Q2 basic and diluted EPS declined to $0.52 from $0.66, and first-half EPS to $1.01 from $1.05. Weighted-average common shares increased to about 28.7 million from 21.1 million, following the 2017 public offering/share issuance period.
- Q2 noninterest income fell 30% to $11.6 million, chiefly as loan-sale gains declined to $7.8 million from $15.2 million. First-half noninterest income fell 7% to $22.9 million. Management attributed weaker gains relative to sales volume partly to a higher acquired-loan mix; higher servicing income provided some offset.
- Noninterest expense increased 45% in Q2 and 49% for the first half, with hiring, business growth, commissions, and costs associated with being publicly traded contributing. The Q2 efficiency ratio was 35.5%, versus 25.5%; the first-half ratio was 34.1%, versus 27.6% in the prior-year period.
- Interest expense rose as deposit costs increased amid higher market rates and deposit growth. The average cost of interest-bearing deposits was 1.53% in Q2, versus 1.06% a year earlier. The effective tax rate declined to 24.9% in Q2 and 24.3% for the first half, primarily reflecting federal tax reform.
Outlook, risks, contingencies, and unusual items
- No earnings or financial guidance is provided. Management expects sufficient funds to meet current loan-origination commitments and expects a substantial portion of $681.2 million in certificates of deposit maturing within one year to renew. If not retained, replacement funding or higher deposit rates could increase interest expense. The company reported access to up to $565 million of additional FHLB advances.
- Credit indicators warrant attention: special-mention loans increased to $52.4 million from $16.3 million at year-end; classified loans rose to $9.4 million from $7.3 million; nonperforming loans were $4.3 million versus $3.1 million. Loans more than 30 days past due totaled $8.2 million. The allowance covered 245% of nonperforming loans, down from 264.7% at year-end.
- Interest-rate modeling showed estimated 12-month net interest income down 24.5% under a 200-basis-point decline and up 23.3% under a 200-basis-point increase. Management noted the down-rate estimate assumes a constant-sized balance sheet and believes potential mortgage-volume increases could mitigate the impact. Economic value of equity was estimated to decline 3.5% under an immediate 200-basis-point increase; modeled EVE scenarios remained within policy limits.
- A merger agreement announced June 13, 2018 would combine FM Bancorp and Farmers-Merchants National Bank of Paxton with Merchants Bancorp and Joy State Bank, respectively. Closing was expected in Q4 2018, subject to regulatory and shareholder approvals; FM Bancorp reported $114.6 million of assets as of March 31, 2018.
- Management identified credit and loan-loss allowance adequacy, real-estate values and construction performance, interest rates, deposit retention and liquidity, regulatory compliance, cybersecurity, execution of growth plans, and competition among key risks. Management said no material risk-factor changes from the 2017 Form 10-K; no legal proceedings were reported. The expected-credit-loss accounting standard may increase the allowance, but the impact was not yet measurable.
Important facts for investors to verify
- Whether the sharp increase in special-mention loans and past-due balances leads to further credit deterioration, higher provisions, or charge-offs.
- How deposit pricing, brokered-deposit concentration (33% of deposits), and certificate renewals affect funding costs and liquidity.
- Whether loan growth, loan-sale volumes and gains, and servicing-right valuations remain sustainable; servicing rights are Level 3 fair-value estimates sensitive to discount rates and prepayment assumptions.
- The source and sustainability of EPS trends given share-count dilution, higher operating costs, and lower loan-sale gains.
- Completion terms and approvals for the proposed FM Bancorp merger, and the eventual quantified effect of expected-credit-loss accounting.
Amounts are rounded; financial statements are unaudited. Interim results are not necessarily indicative of full-year results.