Merchants Bancorp — Q2 2019 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2019. Financial statements are unaudited. Merchants Bancorp is an Indiana bank holding company with multi-family mortgage banking, mortgage warehousing and banking operations.
Key financial results
| Metric | Q2 2019 | Q2 2018 | Six months 2019 | Six months 2018 |
|---|---|---|---|---|
| Net interest income | $27.9 million | $22.2 million | $52.1 million | $42.3 million |
| Provision for loan losses | $0.1 million | $1.0 million | $0.8 million | $2.4 million |
| Noninterest income | $9.9 million | $11.6 million | $13.5 million | $22.9 million |
| Noninterest expense | $15.9 million | $12.0 million | $29.0 million | $22.3 million |
| Net income | $16.4 million | $15.7 million | $27.0 million | $30.7 million |
| Net income allocated to common shareholders | $14.7 million | $14.8 million | $24.4 million | $29.0 million |
| Basic and diluted EPS | $0.51 | $0.52 | $0.85 | $1.01 |
Q2 net income rose 5%, but six-month net income fell 12%. Q2 net interest margin was 2.49% versus 2.51% a year earlier; the six-month margin improved to 2.62% from 2.51%. The efficiency ratio increased to 42.1% for Q2 and 44.1% for the first half, versus 35.5% and 34.1%, respectively.
Financial position, funding and cash flow
- At June 30, 2019, total assets were $5.29 billion, up 36% from year-end 2018; total deposits were $4.66 billion, up 44%; and shareholders’ equity was $515.0 million, up 22%.
- Loans held for sale were $1.92 billion, compared with $832.5 million at year-end; net loans held for investment were $2.35 billion, up 15%. Cash and cash equivalents totaled $460.9 million.
- Deposits funded much of the expansion. Brokered deposits rose to $2.0 billion, or 43% of deposits, from $988.2 million, or 31%, at year-end. Interest-bearing deposit cost rose to 2.00% for the first half from 1.41% a year earlier.
- Borrowings declined to $62.2 million from $195.5 million at year-end. Available additional FHLB advances were reported at up to $648.5 million. Certificates of deposit due within one year totaled $1.7 billion.
- For the first half, operating cash flow was negative $983.4 million, compared with positive $77.6 million in 2018, reflecting the scale and timing of loan originations and sales. Investing cash flow was negative $253.3 million; financing cash flow was positive $1.36 billion, mainly from deposit growth.
- Company capital ratios at June 30 included total risk-based capital of 10.7%, Tier 1 risk-based capital of 10.4%, and common equity Tier 1 of 7.9%. The company and its banking subsidiaries were reported as well capitalized.
Changes, drivers and segment performance
- Higher loan balances lifted net interest income, while higher deposit costs and balances drove interest expense up 75% in both Q2 and the first half. Q2 interest spread improved to 2.22% from 2.03%.
- Noninterest income declined 15% in Q2 and 41% in the first half. First-half loan-sale gains fell to $11.7 million from $18.7 million, reflecting lower multi-family loan-sale volume and January federal-government-shutdown processing delays. Servicing fees were also reduced by negative mortgage-servicing-rights fair-value adjustments.
- Noninterest expenses increased 33% in Q2 and 30% in the first half, principally from salaries and benefits associated with growth and 2018 acquisitions.
- Mortgage warehousing funded $14.9 billion of loans in the first half, up 36% year over year; management cited lower mortgage rates and volume growth above the industry’s reported 4% increase. Banking segment first-half net income rose to $17.2 million from $12.5 million. Multi-family mortgage banking first-half net income fell to $1.8 million from $10.2 million, amid lower sale volume and servicing-rights valuation losses.
Credit, risks and outlook
- The allowance for loan losses was $12.6 million, or 0.53% of loans, versus $12.7 million, or 0.62%, at year-end. Nonperforming loans were $3.8 million, up from $2.4 million at year-end but below $4.3 million a year earlier. Management attributed much of the year-end increase in delinquencies to a deceased borrower’s estate probate and anticipated full repayment.
- First-half charge-offs were $857,000, versus $163,000 in the prior-year period; management said the 2019 charge-offs related to two borrowers losing primary revenue sources, not broad credit deterioration. Classified loans increased to $13.8 million from $11.2 million at year-end.
- Management said it expected sufficient funds to meet current loan-origination commitments and expected substantial renewal of maturing CDs. If deposit retention is weaker, it may use FHLB advances or offer higher deposit rates, increasing funding costs. No specific earnings or revenue guidance was provided.
- Mortgage servicing rights fell $3.3 million from year-end to $74.6 million. Management linked the first-half fair-value reduction to lower multi-family mortgage rates and higher assumed prepayments, noting that further rate declines could reduce MSR values further.
- Interest-rate simulations showed estimated net interest income sensitivity of -12.4% for a 100-basis-point rate decline and +11.8% for a 100-basis-point increase over the next year. Management reported these scenarios were within board limits. Key stated risks include credit quality, real-estate and construction performance, interest rates, deposit liquidity and costs, cybersecurity, regulatory compliance, and growth execution.
- The company issued $72.1 million of Series A preferred stock during the first half. A June private placement included 874,000 shares for $21.85 million, primarily purchased by related parties, including senior executives and a director’s family members. The Huntington Bank line of credit, with a $25 million balance at quarter-end, was paid off in July 2019.
Important facts for investors to verify
- Whether rapid mortgage-warehouse growth and the higher brokered-deposit share remain sustainable, and how funding costs affect margins.
- Renewal and pricing outcomes for the $1.7 billion of CDs due within one year, alongside available FHLB borrowing capacity and loan commitments.
- Credit trends, particularly classified and past-due loans, charge-offs, and the expected repayment associated with the borrower-estate probate.
- Mortgage-servicing-rights valuation assumptions and sensitivity to prepayments and interest rates, plus multi-family loan-sale volumes and related earnings.
- Effects of the preferred issuance—including dividends and related-party participation—on common-shareholder earnings and capital.