Merchants Bancorp — Q3 2021 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2021; comparisons are with the corresponding 2020 periods unless stated otherwise. Amounts are in U.S. dollars; financial amounts are generally shown in millions. The interim financial statements are unaudited.
Business context and financial performance
Merchants Bancorp is a bank holding company with multi-family mortgage banking, mortgage warehousing and banking businesses. Its model combines loan funding and sales with loan servicing, supported principally by deposits and borrowings.
- Q3: Net income was $58.5 million, up 6%; diluted EPS was $1.83, up 2%. Net income allocated to common shareholders was $52.8 million.
- Nine months: Net income was $171.9 million, up 42%; diluted EPS was $5.43 versus $3.82. Net income allocated to common shareholders was $156.8 million.
- Interest earnings: Q3 net interest income rose 5% to $68.9 million, while net interest margin fell to 2.73% from 2.81%. For nine months, net interest income rose 32% to $205.3 million and net interest margin increased to 2.82% from 2.56%. Lower funding costs and higher average loan balances drove the nine-month improvement; lower loan yields constrained Q3 margin.
- Other income and costs: Q3 noninterest income was $40.3 million (+4%) and noninterest expense $29.5 million (+12%); the efficiency ratio was 27.0% versus 25.4%. Nine-month noninterest income was $117.1 million (+38%) and expense $87.7 million (+27%); the efficiency ratio improved to 27.2% from 28.8%. Higher loan-sale gains and servicing income were important income contributors; higher compensation supported production.
- Assets and loans: Total assets were $10.95 billion at quarter-end, up 14% from December 31, 2020. The balance sheet included $802.6 million cash, $3.45 billion loans held for sale, $634.0 million mortgage loans awaiting securitization, and $5.43 billion net loans receivable. Net loans receivable decreased 1% from year-end, with multi-family and healthcare loans up 18% to $3.24 billion and mortgage warehouse lines down 44% to $891.6 million.
- Credit: The allowance for loan losses was $29.1 million, or 0.53% of loans receivable, versus $27.5 million, or 0.50%, at year-end. Q3 provision was $1.1 million versus $3.0 million a year earlier. Nonperforming loans were $2.9 million, or 0.05% of loans receivable, compared with 0.11% at year-end. Classified loans increased to $44.1 million from $14.5 million; management attributed much of the increase to a multi-family loan moved from watch status and said full repayment was expected.
Liquidity, funding and capital
- Deposits rose 21% from year-end to $8.95 billion. Brokered deposits were $1.7 billion, or 19% of deposits, versus 16% at year-end. Management cautioned they may be more rate-sensitive and harder or more costly to renew.
- Borrowings declined 40% to $809.1 million. Unused credit lines were $2.1 billion at September 30, down from $2.6 billion at year-end; availability depends on collateral and fluctuates. The company cited a change in FHLB collateral policy as a factor in shifting funding toward brokered deposits.
- For the first nine months, operating cash flow was negative $387.8 million and investing cash flow negative $113.9 million; financing cash flow was positive $1.12 billion. Cash and cash equivalents increased $622.8 million to $802.6 million, principally reflecting financing inflows and business activity.
- Shareholders’ equity increased 37% to $1.11 billion, primarily following $191.1 million of net Series C preferred stock proceeds. The 8% preferred stock was redeemed in April 2021. Common dividends were $0.09 per share each quarter in 2021.
- The company reported a 10.7% community bank leverage ratio (CBLR), above the then-applicable 8.5% threshold; Merchants Bank and FMBI reported 10.6% and 9.6%. The filing says the company remained well-capitalized. Although assets exceeded $10 billion, temporary regulatory relief allowed use of December 2019 assets for threshold eligibility during 2021; management said risk-based capital rules could apply as early as September 30, 2022 if assets remain above the threshold.
Material changes and management outlook
- Q3 growth was uneven across segments: multi-family mortgage banking net income rose to $14.4 million from $5.9 million, and Banking rose to $23.5 million from $17.5 million. Mortgage Warehousing fell to $23.2 million from $33.8 million as funded volume declined 44% year over year to $19.7 billion. Nine-month warehouse income was nearly flat at $73.8 million, despite a 28% decline in funded volume.
- Servicing rights increased 28% from year-end to $105.5 million, including a $10.5 million positive fair-value adjustment over nine months. Fair value depends on assumptions including discount and prepayment rates.
- In May, the company sold and securitized $262.0 million of multi-family loans through a Freddie Mac arrangement, purchased $28.7 million of securities and retained a first-loss obligation capped at approximately $26.2 million. It recorded a $1.4 million reserve for estimated losses; the filing reports no material gain or loss on the separate February deconsolidation of debt-fund entities.
- Management expected asset growth to be slower than in 2020 but said it may pursue market opportunities. It anticipated sufficient liquidity for current loan commitments and expected a substantial portion of $1.1 billion of certificates of deposit maturing within a year to renew. No specific earnings or revenue guidance was provided.
- Risks highlighted include COVID-19 and economic conditions, borrower and real-estate credit performance, interest-rate changes, deposit retention and liquidity, regulatory requirements, competition, cybersecurity, and the ability to manage growth. Management noted that CECL adoption may increase the allowance; the amount of the impact was still being evaluated. It was also transitioning contracts affected by LIBOR reform.
Important facts for investors to verify
- Whether brokered deposits and maturing certificates renew on acceptable terms, and how funding costs and available borrowing capacity develop.
- Credit performance behind the rise in classified loans, including the multi-family exposure management expects to repay, and the adequacy of the allowance and securitization first-loss reserve.
- Whether warehouse volumes, loan-sale gains and servicing-fee fair-value adjustments remain sustainable as rates and mortgage demand change.
- Regulatory capital treatment and requirements if assets remain above $10 billion, including the expected transition from CBLR relief.
- The eventual CECL allowance adjustment and the sensitivity of servicing-rights valuations to discount rates and prepayments.