Merchants Bancorp — FY 2018 Form 10-K
Reporting period: Fiscal year ended December 31, 2018; the filing was signed March 15, 2019. The company is a diversified Indiana bank holding company operating multi-family and healthcare mortgage banking, mortgage warehousing, and community banking businesses. It completed acquisitions of Farmers-Merchants Bank of Illinois (FMBI), Farmers-Merchants National Bank of Paxton (FMNBP), and NattyMac assets during 2018.
Financial results and condition
| Metric | FY 2018 / Dec. 31, 2018 | Prior comparable period |
|---|---|---|
| Net income | $62.9 million; diluted EPS $2.07 | FY 2017: $54.7 million; diluted EPS $2.28 |
| Net interest income | $90.0 million | FY 2017: $66.6 million |
| Noninterest income | $49.6 million | FY 2017: $47.7 million |
| Noninterest expense | $50.9 million | FY 2017: $34.6 million |
| Provision for loan losses | $4.6 million | FY 2017: $2.5 million |
| Net interest margin | 2.54% | FY 2017: 2.32% |
| Efficiency ratio | 36.47% | FY 2017: 30.32% |
| Total assets | $3.88 billion | Dec. 31, 2017: $3.39 billion |
| Deposits | $3.23 billion | Dec. 31, 2017: $2.94 billion |
| Loans held for investment, net | $2.05 billion | Dec. 31, 2017: $1.37 billion |
| Shareholders’ equity | $421.2 million | Dec. 31, 2017: $367.5 million |
| Cash and cash equivalents | $336.5 million | Dec. 31, 2017: $359.5 million |
| Borrowings | $195.5 million | Dec. 31, 2017: $56.6 million |
Net cash provided by operating activities was $203.6 million, compared with $175.9 million used in 2017. Investing activities used $509.1 million and financing activities provided $282.5 million. The company’s regulatory capital ratios remained above minimum requirements; at year-end, the consolidated Tier 1 leverage ratio was 10.0% and total risk-based capital ratio was 12.3%. Merchants Bank and FMBI were reported as well capitalized.
Fourth-quarter 2018 net income was $15.4 million, or $0.51 per common share diluted, versus $20.3 million, or $0.73 diluted, in fourth-quarter 2017. Fourth-quarter 2018 net interest income was $24.2 million, provision for loan losses $1.6 million, and noninterest expense $16.2 million.
Material changes and management commentary
- FY 2018 net income rose 15%, driven primarily by a $23.4 million increase in net interest income and lower income tax expense, partly offset by higher operating costs and loan-loss provision.
- Average loans and loans held for sale increased 32.3% to $2.53 billion; average loan yield rose 55 basis points to 4.72%. Deposit expense increased as average interest-bearing deposit cost rose from 1.01% to 1.62%; total interest expense increased 82% to $50.6 million.
- Noninterest expense rose 47%, with salaries and benefits up $10.8 million. Management attributed growth to staffing and commissions, acquisitions, and public-company and infrastructure costs; the efficiency ratio accordingly deteriorated.
- Loan growth was broad, led by multi-family and healthcare financing, up 73% to $914.4 million. Multi-family segment net income declined 31% to $19.8 million, while banking segment net income rose to $26.3 million and warehouse segment net income to $21.0 million.
- The allowance rose to $12.7 million, or 0.62% of loans. Nonperforming loans declined to $2.4 million, or 0.12% of loans, but special-mention loans increased to $90.6 million from $16.3 million. Management linked much of the increase to monitored multi-family construction projects with borrower-funded cost overruns; payments remained current.
- Deposits increased 10%, while the mix shifted materially: interest-bearing deposits rose and noninterest-bearing deposits fell. Brokered deposits totaled $988.2 million, including $578.5 million in brokered certificates of deposit. Borrowings increased mainly through short-term FHLB advances.
Outlook, risks, contingencies, and unusual items
- The filing provides no company-specific quantitative earnings or revenue guidance. Management expects continued higher administrative and growth-related expenses and anticipates that loan growth will increase the provision for loan losses. It expects sufficient funds for current loan-origination commitments and expects a substantial portion of maturing certificates of deposit to renew.
- The company cited rising rates, mortgage-volume changes, deposit pricing, and possible margin pressure as important factors. Its bank-level model estimated a 11.2% reduction in forward 12-month net interest income under a 100-basis-point rate decrease and a 10.7% increase under a 100-basis-point increase, as of year-end.
- Key risks include dependence on mortgage and secondary-market activity; rate and prepayment sensitivity of mortgage servicing rights; credit and real-estate collateral exposure; reliance on custodial, brokered, and large mortgage-customer deposits; and the ability to integrate acquisitions and manage rapid growth. The filing notes $648.2 million of certificates of deposit due within one year and $624.2 million of additional FHLB borrowing capacity.
- Off-balance-sheet exposures include $507.2 million of commitments to fund loans pending closing, $457.8 million of undisbursed multi-family construction commitments, $782.4 million available on warehouse lines, and $676.9 million of commitments to extend credit. These commitments are subject to conditions and are not necessarily expected to be fully drawn.
- NattyMac was acquired on December 31, 2018; the company repaid the associated $30 million Home Point subordinated debt and recorded $5.0 million of goodwill. Purchase accounting remained subject to further evaluation. The filing also identifies pending Indiana litigation concerning a warehouse credit facility; management, after consulting counsel, expected any liability to be immaterial.
- FY 2017 included a one-time $6.9 million tax benefit from federal tax reform. The 2018 effective tax rate was 25.2%, compared with 29.1% in 2017. The company also reported that 2018 mortgage servicing rights fair-value changes added $1.8 million, versus $3.0 million in 2017.
Most important facts for investors to verify
- Whether the sharp increase in special-mention loans, particularly multi-family construction exposures, develops into classified or nonperforming credit.
- The sustainability and funding cost of deposits, especially brokered deposits, custodial balances, and large mortgage-customer relationships, alongside near-term certificate maturities.
- Whether loan growth and higher net interest margin can offset rising deposit costs, operating expenses, and credit provisions.
- The assumptions and sensitivity behind the $77.8 million mortgage servicing rights valuation and related servicing-portfolio growth.
- Final purchase accounting, integration results, and expected returns from the 2018 acquisitions, including NattyMac.
- Capital and liquidity headroom after growth, commitments, dividends, and borrowings; confirm the holding company’s and each bank subsidiary’s regulatory measures separately.