Merchants Bancorp — Q1 2023 Form 10-Q
Reporting period: Three months ended March 31, 2023; interim financial statements are unaudited. Merchants Bancorp is a bank holding company with multi-family mortgage banking, mortgage warehousing and banking businesses.
Financial performance and position
| Metric | Q1 2023 / March 31, 2023 | Comparable period / prior year-end |
|---|---|---|
| Interest income | $211.3 million | $76.0 million in Q1 2022 |
| Net interest income | $100.7 million | $65.7 million in Q1 2022 |
| Net income | $55.0 million | $50.1 million in Q1 2022 |
| Net income allocated to common shareholders | $46.3 million; diluted EPS $1.07 | $44.4 million; diluted EPS $1.02 in Q1 2022 |
| Net interest margin | 3.27% | 2.62% in Q1 2022 |
| Efficiency ratio | 30.3% | 30.9% in Q1 2022 |
| Total assets | $14.2 billion | $12.6 billion at Dec. 31, 2022 |
| Loans receivable, net | $8.6 billion | $7.4 billion at Dec. 31, 2022 |
| Deposits | $11.3 billion | $10.1 billion at Dec. 31, 2022 |
| Borrowings | $1.2 billion | $930.4 million at Dec. 31, 2022 |
| Cash and cash equivalents | $369.6 million | $226.2 million at Dec. 31, 2022 |
| Shareholders’ equity | $1.5 billion | $1.46 billion at Dec. 31, 2022 |
Net income increased 10%, as higher net interest income more than offset lower loan-sale gains, lower servicing fees and higher credit-loss provision. Total noninterest income fell 59% to $14.3 million; gain on sale of loans declined 63% to $6.7 million, and loan servicing fees declined 76% to $2.4 million. Interest expense rose sharply to $110.6 million from $10.3 million, reflecting higher deposit and borrowing costs. The effective tax rate was 25%.
Operating cash flow was negative $301.5 million, compared with positive $1.30 billion in Q1 2022; investing cash outflow was $1.12 billion, while financing cash inflow was $1.57 billion. The company attributed liquidity and balance-sheet growth to funding loan growth and investment purchases; cash flow should be considered alongside these movements.
Material changes and credit
- Assets rose 13% from year-end, mainly on multi-family and healthcare loan growth. Net loans increased 15%; multi-family loans reached $3.6 billion and healthcare loans $1.9 billion.
- Deposit growth was $1.3 billion, including roughly $1.0 billion more brokered certificates of deposit. Brokered deposits were $3.7 billion, or 33% of deposits; uninsured deposits were approximately $2.0 billion, or less than 25% of deposits. Certificates totaling $4.0 billion mature within one year.
- Nonperforming loans rose to $65.3 million, or 0.76% of loans, from $26.7 million, or 0.36%, at year-end 2022. Management cited delinquency of one multi-family customer and one healthcare customer. The allowance for loan losses was $51.8 million, or 0.60% of loans; coverage of nonperforming loans was 79%.
- Credit-loss provision was $6.9 million, versus $2.5 million in Q1 2022. No loans were charged off in Q1 2023; special-mention loans totaled $160.3 million, up from $137.8 million at year-end.
- Available-for-sale securities increased to $679.5 million from $323.3 million; unrealized losses in accumulated other comprehensive income narrowed to $7.7 million. Management said securities’ unrealized losses were interest-rate related, not credit-related, and it did not anticipate selling securities at a loss for liquidity.
Liquidity, capital, outlook and risks
- Management reported $4.0 billion of unused FHLB and Federal Reserve discount-window borrowing capacity. Liquid assets and unused capacity together were approximately $7.8 billion, or 55% of assets. Management said recent bank failures had minimal impact on deposits and operations and the company had not used the Federal Reserve Bank Term Funding Program.
- The company issued $158.1 million of senior credit-linked notes on March 30, 2023, netting about $153.5 million. The notes transfer certain credit risk on a roughly $1.1 billion healthcare loan reference pool, subject to a first-loss threshold; the company retains the loan allowance. The notes’ stated effective interest rate was 21.5%, with a 4.5% yield on collateral and a 17.0% net effective rate. Collateral included $20.5 million of restricted cash and $137.6 million of short-term Treasury securities.
- Merchants Bank and its subsidiary were reported as well capitalized. At March 31, the bank’s total capital ratio was 12.1% and common equity Tier 1 ratio 11.6%; the company’s respective ratios were 12.4% and 7.9%.
- Management provided no specific earnings or revenue guidance. It expected sufficient funding for current loan commitments and anticipated substantial renewal of maturing certificates of deposit, while noting that replacement funding or higher deposit rates could increase interest expense.
- Key risks include rate-sensitive brokered funding, deposit retention and repricing costs, credit quality and collateral values in multi-family and healthcare lending, loan growth, market interest rates, liquidity, and servicing-rights valuations. Approximately 93% of Merchants Bank’s net loans reprice within three months, but the company’s modeled one-year net interest income fell 11.1% under a 100-basis-point rate decline and rose 8.7% under a 100-basis-point increase. Management said modeled scenarios remained within policy limits.
- No material subsequent events, legal proceedings, or changes to previously disclosed risk factors were reported. Management stated disclosure controls were effective and no material change in internal control occurred during the quarter.
Important facts for investors to verify
- Whether nonperforming and past-due loans continue to rise, especially the identified multi-family and healthcare exposures, and how the allowance develops relative to those loans.
- Deposit stability, renewal rates and pricing for the $4.0 billion of certificates maturing within one year; monitor brokered deposits’ share and the cost of funding.
- The sustainability of net interest income and margin as asset yields and deposit costs reprice, including the assumptions behind the company’s interest-rate sensitivity analysis.
- The performance, collateral requirements and net funding cost of the credit-linked notes, and their effect on regulatory capital and lending capacity.
- Loan-sale volumes, servicing fees and servicing-rights fair values, which weakened materially versus Q1 2022.