Merchants Bancorp — FY 2019 Form 10-K
Reporting period: Fiscal year ended December 31, 2019. This is an annual filing, not a standalone fourth-quarter report. Merchants Bancorp is a diversified Indiana bank holding company focused on multifamily mortgage banking and servicing, mortgage warehouse lending, and community banking.
Financial performance and condition
- Scale: Assets were $6.37 billion, deposits $5.48 billion, and shareholders’ equity $653.7 million at year-end. Assets grew 64% and deposits 70% from 2018.
- Earnings: Net income was $77.3 million, up 23%; diluted EPS was $2.37. Net income available to common shareholders was $68.1 million after $9.2 million in preferred dividends.
- Revenue and margins: Net interest income rose 36% to $122.3 million; noninterest income fell 5% to $47.1 million. Net interest margin declined 14 basis points to 2.40%. Net interest spread increased 9 basis points to 2.16%.
- Expenses and profit measures: Noninterest expense increased 24% to $63.3 million, largely reflecting staffing and growth costs. The efficiency ratio worsened to 37.4% from 36.5%; return on average assets was 1.47%, down from 1.71%.
- Cash flow: Operating activities used $1.26 billion, compared with $204.3 million provided in 2018; investing activities used $957.7 million, while financing activities provided $2.38 billion. The large operating cash outflow reflects the scale and timing of mortgage loan originations and sales. Cash and cash equivalents ended at $506.7 million.
- Funding and liquidity: Year-end borrowings were $181.4 million, down from $195.5 million. Brokered deposits were $2.16 billion, about 39% of total deposits. The company reported up to $1.5 billion of additional FHLB borrowing capacity based on collateral.
- Credit quality: Nonperforming loans were $4.7 million, or 0.15% of loans, versus $2.4 million, or 0.12%, in 2018. Past-due loans over 30 days rose to $12.6 million from $3.2 million. The allowance was $15.8 million, or 0.52% of loans; net charge-offs were $802,000.
- Capital: Total shareholders’ equity increased 55%, principally after $171.1 million of net preferred-stock proceeds and annual net income. The company, Merchants Bank, and FMBI were reported as well capitalized. The company’s Tier 1 leverage ratio was 9.4% and total risk-based capital ratio was 11.6%.
Changes versus 2018
- Growth was led by mortgage warehousing: loans funded reached $46.2 billion, up 98%; the segment’s net income rose 66% to $34.8 million. Its assets more than doubled to $3.12 billion.
- Loans held for sale increased 152% to $2.09 billion, while loans held for investment, net, grew 47% to $3.01 billion. Lower interest rates supported mortgage refinancing and lending activity.
- Banking segment net income increased 21% to $31.9 million. Multifamily mortgage banking net income fell 25% to $14.8 million, reflecting lower servicing income, a negative mortgage-servicing-rights valuation adjustment, and higher expenses.
- Deposit costs increased: average cost of interest-bearing deposits rose to 1.93% from 1.62%. Higher funding costs and a shift toward short-duration warehouse lending contributed to the lower net interest margin.
- Mortgage servicing rights fell to $74.4 million from $77.8 million, including a $4.8 million fair-value decrease, primarily associated with lower rates and higher prepayment assumptions.
Outlook, risks, and notable items
- Management said 2019 volume growth may not continue. It cited Mortgage Bankers Association forecasts of higher single-family mortgage volume in 2020 followed by a decrease in 2021; these are industry forecasts, not company earnings guidance.
- Management said the loan portfolio could decrease in 2020 and the provision for loan losses could correspondingly decline, subject to problem loans and portfolio mix. It also expected continued spending on personnel, infrastructure, marketing, and public-company costs.
- The company expected to elect the Community Bank Leverage Ratio framework in Q1 2020. It expected the framework and revised mortgage-servicing-rights capital treatment to ease certain capital constraints.
- Key exposures include mortgage-volume and interest-rate changes, MSR valuation and prepayments, reliance on brokered and mortgage-related deposits, deposit concentration among mortgage businesses, credit and real-estate risk, regulatory requirements, and cybersecurity and operational risks. LIBOR transition could affect loans, instruments, and preferred stock.
- At year-end, commitments subject to credit risk totaled $788.0 million; commitments subject to performance criteria and cancellation totaled $1.95 billion. A Fannie Mae multifamily loss-sharing reserve was $277,000. Management reported no material pending litigation and no material subsequent events.
- Unaudited Q4 net income was $30.1 million and diluted EPS was $0.92, compared with Q3 net income of $20.3 million and EPS of $0.60. Q4 noninterest income rose to $22.7 million from $10.9 million in Q3; the filing text does not provide a clear quarter-specific explanation for that increase.
- The independent auditor issued an unmodified opinion on the financial statements. Management concluded disclosure controls and internal control over financial reporting were effective; the auditor did not provide an internal-control opinion.
Important facts for investors to verify
- Whether warehouse lending volumes, spreads, and profitability remain resilient if mortgage refinancing activity slows.
- The composition, concentration, maturity profile, and renewal cost of brokered and other mortgage-related deposits, including the $2.1 billion of time deposits due within one year.
- The status and resolution of rising delinquencies, including the large loans over 90 days past due, and whether allowance coverage remains adequate.
- The assumptions underlying the $74.4 million MSR valuation and the sensitivity of earnings and capital to rates and prepayments.
- The drivers of Q4’s unusually high noninterest income and net income, and whether those results are recurring.
- The effects of preferred dividends, future capital needs, the planned CBLR election, and the LIBOR-to-alternative-rate transition.