Merchants Bancorp — Q1 2020 Form 10-Q
Reporting period: Three months ended March 31, 2020; financial statements are unaudited. Merchants Bancorp is a diversified bank holding company with multi-family mortgage banking, mortgage warehousing and banking businesses.
Financial results and position
- Profitability: Net income was $24.6 million, up 133% from $10.6 million a year earlier. Net income allocated to common shareholders was $21.0 million; diluted EPS was $0.73 versus $0.34. Return on average assets was 1.49%, compared with 1.14%.
- Income and margins: Interest income was $60.4 million and interest expense $22.1 million, producing net interest income of $38.4 million, up 59%. Noninterest income was $19.9 million. Net interest margin declined 37 basis points to 2.40%; interest-rate spread fell to 2.19% from 2.50%. Efficiency ratio improved to 38.3% from 46.9%.
- Key income drivers: Gain on sale of loans rose to $21.2 million from $2.6 million, mainly reflecting higher multi-family loan sales. Mortgage warehouse fees increased to $2.7 million from $0.8 million. These gains were partly offset by a $5.8 million net loan-servicing fee loss, including a $6.5 million negative fair-value adjustment to mortgage servicing rights.
- Costs and credit provision: Noninterest expense increased 71% to $22.3 million, including higher salaries, commissions and deposit insurance expense. Provision for loan losses was $3.0 million versus $0.6 million. The effective tax rate was 25.4%, versus 25.1%.
- Balance sheet: Total assets increased 24% from year-end to $7.9 billion. Loans held for sale were $2.8 billion; net loans receivable were $3.5 billion. Cash and cash equivalents were $568.1 million, deposits $6.7 billion, borrowings $444.6 million, and shareholders’ equity $673.0 million.
- Asset quality: Allowance for loan losses was $18.9 million, or 0.54% of loans, versus $15.8 million and 0.52% at year-end. Nonperforming loans were $6.6 million, or 0.19% of loans. Loans more than 30 days past due totaled $9.5 million; special-mention loans were $48.3 million.
- Cash flow: Operating activities used $871.6 million; investing activities used $568.4 million; financing activities provided $1.5 billion. Cash increased $61.4 million to $568.1 million. The large operating outflow reflects the scale and timing of loan originations and sales.
- Capital: Under the elected Community Bank Leverage Ratio framework, the company reported a 9.9% Tier 1 leverage ratio; Merchants Bank was at 10.1% and FMBI at 10.7%. Management reported all were well capitalized.
Changes versus comparable periods
- Net income rose $14.0 million year over year, principally from higher loan-sale gains and net interest income. Growth was partially offset by higher expenses, loan-loss provision and the adverse mortgage-servicing-rights valuation adjustment.
- Net interest income benefited from rapid growth in average earning assets, while the margin narrowed due to the flatter yield curve, lower rates and a greater mix of shorter-duration warehouse lending.
- Mortgage warehouse volume funded reached $16.8 billion, up 210% year over year; the filing cites a 73% industry increase. Multi-family loans originated or acquired for sale were $810.6 million, versus $24.4 million.
- Compared with December 31, 2019, assets grew $1.5 billion, deposits increased 23%, borrowings rose 145%, and net loans receivable grew 16%. Special-mention loans and delinquencies over 30 days declined from year-end.
Outlook, risks and unusual items
- The filing gives no specific earnings or revenue guidance. Management said it expected sufficient liquidity for current commitments and anticipated that a substantial portion of certificates of deposit maturing within one year would renew; it also noted alternative funding options, including FHLB advances and the Federal Reserve discount window.
- COVID-19 created significant uncertainty. Management added approximately $547,000 to the loan-loss allowance for pandemic-related qualitative factors and said additional provision increases could be needed as conditions develop. Twenty-four loans totaling $23.6 million had payment deferrals at quarter-end. The company had received no multi-family servicing forbearance requests requiring advances as of March 31.
- Management reported no significant customer disruption at quarter-end and said employees moved to work-from-home arrangements in mid-March. The company was accepting applications for the SBA Paycheck Protection Program but had not funded PPP loans by March 31.
- Brokered deposits increased to $2.8 billion. The filing warns that these funds may be more rate-sensitive and may not renew at maturity, which could pressure liquidity or funding costs. Certificates of deposit maturing within one year totaled $2.6 billion.
- Mortgage servicing rights fell to $70.0 million after a $6.5 million fair-value decline, attributed primarily to lower short-term and multi-family mortgage rates and higher assumed prepayments. Further rate declines could cause additional reductions.
- Other stated risks include credit deterioration, real estate and construction exposure, interest-rate and liquidity risks, reduced demand, and possible impairment of goodwill or other financial assets. Although market capitalization fell below book value, management said it did not then believe goodwill or intangible assets were impaired.
- There were no legal proceedings reported. Management stated disclosure controls were effective; the controls section contains an apparent date reference to March 31, 2019 despite this being the Q1 2020 filing.
Important facts for investors to verify
- Whether record loan-sale and warehouse activity is sustainable, and how much earnings depend on gains rather than recurring net interest income.
- How COVID-19 affects borrower performance, deferred loans, allowance adequacy, nonperforming loans and future credit costs.
- Whether brokered deposits and other funding sources remain available on acceptable terms as balances mature and loan volumes change.
- How further interest-rate movements affect net interest margin, mortgage servicing rights valuations and loan prepayments.
- The timing and size of any required additional liquidity, capital or credit-loss provisions; quarter-end CBLR ratios and management’s outlook are based on conditions then known.