Merchants Bancorp — Form 10-Q Summary
Period: Quarter and nine months ended September 30, 2018. Financial statements are unaudited; dollar amounts below are in millions except per-share data. Merchants Bancorp operates multi-family mortgage banking, mortgage warehousing, and community banking businesses.
Key financial results
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Net interest income | $23.5 | $18.4 | $65.8 | $47.6 |
| Noninterest income | $11.9 | $8.1 | $34.9 | $32.8 |
| Net income | $16.7 | $10.5 | $47.5 | $34.4 |
| Net income allocated to common shareholders | $15.9 | $9.6 | $45.0 | $31.9 |
| Diluted EPS | $0.55 | $0.45 | $1.57 | $1.50 |
| Net interest margin | 2.53% | 2.38% | 2.52% | 2.28% |
| Interest rate spread | 1.94% | 1.98% | 2.01% | 1.92% |
Q3 net income increased 60%; nine-month net income increased 38%. Growth reflected higher net interest income as loan balances and yields rose. Q3 noninterest income benefited from servicing fees and loan-sale gains. Nine-month noninterest income rose modestly, while the provision for loan losses and operating expenses increased.
Financial position, liquidity, and capital
- At September 30, total assets were $3.81 billion, up 12% from year-end 2017. Net loans held for investment were $1.91 billion, up 39%; loans held for sale were $1.00 billion.
- Total deposits were $3.30 billion, up 12%. Interest-bearing deposits increased while noninterest-bearing deposits declined. Brokered deposits were $843.7 million, or 26% of deposits, down from 32% at year-end.
- Cash and cash equivalents were $410.8 million, compared with $359.5 million at year-end. Nine-month cash flow was $104.8 million from operations, $(377.3) million from investing, and $323.8 million from financing; cash increased $51.2 million.
- Total borrowings were $67.3 million, including a $25.0 million line of credit, $39.5 million of short-term subordinated debt, and $2.7 million of FHLB advances. The filing reports access to up to $685.6 million of additional FHLB advances based on available collateral and FHLB stock.
- Shareholders’ equity was $407.3 million. The Company reported a 10.1% Tier 1 leverage ratio and 10.9% common equity Tier 1 ratio; the Company and its banking subsidiaries were reported as well capitalized.
- Nine-month efficiency ratio was 34.5%, versus 29.7% in 2017. Dividends were $0.06 per common share in Q3 and $0.18 per share for the first nine months.
Material changes and unusual items
- Asset growth was driven primarily by a $539.5 million increase in net loans, including growth in multi-family and healthcare lending and mortgage warehouse lines. Available-for-sale securities declined $138.7 million, partly reflecting a strategy to replace some securities with reciprocal deposits and use funds more effectively for lending.
- Deposit costs increased with higher market rates and a changing funding mix. Q3 interest expense on deposits rose 106% year over year; the average cost of interest-bearing deposits increased to 1.80% from 1.05%. Q3 net interest spread narrowed slightly, although net interest margin improved.
- Noninterest expense increased 46% for the first nine months, mainly due to staffing, compensation and commissions associated with business growth and public-company operations.
- The effective tax rate fell to 25.0% in Q3 and 24.6% for nine months, from 38.1% in both comparable 2017 periods, primarily due to federal tax reform.
- The allowance for loan losses was $11.2 million, or 0.59% of loans. Nonperforming loans were $1.9 million, down from $3.1 million at year-end, but Special Mention loans increased to $66.4 million from $16.3 million. Management attributed the increase mainly to monitored construction projects with cost overruns funded by borrowers; payments remained current. Classified loans rose to $9.3 million from $7.3 million.
- In Q3, two commercial credits totaling about $4.0 million were restructured. The filing reports no residential loans in foreclosure and no loans restructured in the prior twelve months defaulting during the quarter.
- On October 1, 2018, after quarter-end, the Company acquired FM Bancorp for approximately $21.9 million. The acquired entities had approximately $109.6 million of assets, $95.7 million of deposits, and $35.0 million of net loans at September 30; purchase accounting was not complete. Joy State Bank, acquired January 2, 2018, was renamed Farmers-Merchants Bank of Illinois in October.
Outlook, risks, and contingencies
- The filing provides no quantified earnings or revenue guidance. Management expected sufficient funds to meet current loan-origination commitments and anticipated that a substantial portion of $572.5 million of certificates of deposit maturing within one year would renew.
- Outstanding commitments included $430.5 million to originate loans, $138.3 million of unused credit lines, and $25.7 million of letters of credit. Lower deposit retention could require higher deposit rates or additional FHLB funding, increasing interest expense.
- Interest-rate modeling showed estimated one-year net interest income falling 20.8% under a 200-basis-point rate decline, beyond the stated policy limit. Management cited potential higher mortgage volumes in falling-rate scenarios as a mitigating factor. Economic value of equity remained within policy limits; the modeled position was asset-sensitive.
- Management identified credit quality and allowance adequacy, real estate values and construction-project performance, deposit funding and liquidity, interest rates, regulatory compliance, cybersecurity, fraud, and execution of growth plans among key risks. Management said there were no material changes to previously disclosed risk factors. No legal proceedings were reported.
- The Company said adoption of the expected-credit-loss standard may increase the loan-loss allowance, but its impact could not yet be determined. Management reported disclosure controls were effective and no material change in internal control over financial reporting during the quarter.
Investor verification priorities
- Track the $66.4 million Special Mention portfolio and $9.3 million of classified loans, particularly construction-related credits, and monitor provision and allowance coverage as loans grow.
- Assess deposit pricing, brokered-deposit levels, certificate renewals, and reliance on contingent FHLB capacity as funding costs rise.
- Evaluate whether loan growth and asset yields continue to offset higher deposit and borrowing costs and support net interest margin.
- Review mortgage servicing rights valuations and sensitivity to prepayment and discount-rate assumptions, as well as mortgage banking volumes and gain-on-sale trends.
- Confirm the completed accounting and integration effects of the October 2018 FM Bancorp acquisition, including purchase price allocation and any subsequent reported performance.