Merchants Bancorp — 2017 Form 10-K
Reporting period: Fiscal year ended December 31, 2017. The filing also reports unaudited fourth-quarter results. Merchants Bancorp is an Indiana bank holding company with businesses in multifamily and healthcare mortgage banking, mortgage warehousing, and community banking. It completed its IPO in October 2017.
Key financial metrics
| Metric | 2017 | 2016 |
|---|---|---|
| Total assets, year-end | $3.393 billion | $2.719 billion |
| Loans held for investment, year-end | $1.375 billion | $942 million |
| Loans held for sale, year-end | $995 million | $765 million |
| Deposits, year-end | $2.944 billion | $2.429 billion |
| Shareholders’ equity, year-end | $367.5 million | $206.3 million |
| Net interest income | $66.6 million | $54.0 million |
| Noninterest income | $47.7 million | $28.5 million |
| Net income | $54.7 million | $33.1 million |
| Net income available to common shareholders / diluted EPS | $51.4 million / $2.28 | $31.1 million / $1.47 |
| Net interest margin | 2.32% | 2.07% |
| Efficiency ratio | 30.32% | 32.40% |
Cash and cash equivalents were $359.5 million at year-end, down from $445.7 million. Cash flow was negative from operations ($175.9 million) and investing activities ($523.1 million), offset by $612.8 million provided by financing activities, primarily deposit growth. Year-end borrowings were $56.6 million: $25 million line of credit, $30 million subordinated debt, and $1.6 million of FHLB advances. The Bank had access to up to $419.7 million of additional FHLB advances, subject to available collateral.
The Bank was well capitalized: total risk-based capital was 15.7%, Tier 1 leverage was 12.5%, and common equity Tier 1 was 15.4%. The company’s corresponding ratios were 13.7%, 10.9%, and 11.8%.
Fourth-quarter results
For Q4 2017, net interest income was $19.0 million, provision for loan losses was $1.4 million, noninterest income was $14.9 million, noninterest expense was $10.8 million, and net income was $20.3 million. Q4 2016 net income was $8.8 million. The Q4 2017 tax provision was $1.3 million, reflecting the tax-law-related benefit described below.
Material changes versus 2016
- Net income rose 65%, driven by higher net interest income and noninterest income, partly offset by higher expenses and loan-loss provision.
- Net interest income increased 23%; net interest margin rose 25 basis points to 2.32%. Average loan yields increased, while average interest-bearing deposit costs rose 32 basis points to 1.01%.
- Noninterest income grew 67%, primarily from loan-sale gains, which increased to $37.8 million, and loan servicing fees, which rose to $6.3 million.
- Noninterest expense increased 30% to $34.6 million, chiefly reflecting higher salaries and benefits, growth, the RICHMAC acquisition, and public-company costs. The efficiency ratio nevertheless improved.
- Loans held for investment increased 46%; multifamily and healthcare financing loans approximately doubled to $529.3 million. Warehouse funding volume declined 7% to $23.0 billion.
- Deposits increased 21%. Brokered deposits rose 48% to $941.5 million, making up a material part of funding. The IPO raised $106.2 million net; equity also reflected $54.7 million of net income and shares issued for the RICHMAC acquisition.
Outlook, risks, contingencies, and unusual items
- The Tax Cuts and Jobs Act produced a one-time $6.9 million income-tax benefit in Q4 2017, mainly from remeasuring deferred tax balances. Reported effective tax rate fell to 29.1% from 39.5% in 2016.
- Management cited an industry forecast for U.S. residential mortgage volume to decline 6% in 2018 from 2017; this is an industry forecast, not company earnings guidance. Management expects continued spending on infrastructure, personnel, marketing, and growth.
- Management expects loan-loss provision to rise as the portfolio grows, even without a deterioration in problem loans. The allowance was $8.3 million, or 0.60% of loans, versus $6.3 million, or 0.66%, in 2016. Nonperforming loans increased to $3.1 million from $1.9 million; one $2.0 million commercial line was restructured and extended through June 2018, with refinancing considered likely.
- Liquidity and funding risks include dependence on custodial and brokered deposits, concentration in three large mortgage-related depositors, and the possibility of higher funding costs or deposit outflows. About $407 million of time deposits were due within one year.
- Interest-rate, mortgage-volume, real-estate credit, FHA/Ginnie Mae program eligibility, regulatory, cybersecurity, and third-party service-provider risks could affect earnings and growth. Mortgage servicing rights were $66.1 million and rely on Level 3 valuation assumptions, including prepayment speeds and discount rates.
- Joy State Bank was acquired on January 2, 2018 for approximately $5.5 million; it had $43.0 million of assets and $36.8 million of deposits at December 31, 2017. The acquisition was a subsequent event, not included in year-end balances.
- The company disclosed pending Indiana state-court litigation over a warehouse credit facility and believes any liability will not be material. The auditors issued an unqualified opinion on the financial statements; they did not audit internal control effectiveness. Management said disclosure controls were effective.
Important facts for investors to verify
- How much 2017 earnings growth is repeatable after excluding the one-time $6.9 million tax benefit and considering loan-sale and mortgage-servicing fair-value variability.
- Whether brokered and concentrated custodial deposits remain stable, and the cost and availability of replacement funding as deposits mature.
- Credit trends behind rising nonperforming and classified loans, the $2.0 million restructured commercial exposure, and the adequacy of the allowance as loan balances expand.
- Whether mortgage originations, servicing revenue, and warehouse volumes meet management’s growth and cost expectations amid higher rates and the forecast decline in residential mortgage volume.
- Post-acquisition performance and integration of RICHMAC and Joy State Bank; also review the subordinated debt’s variable rate and provision for payments equal to 49% of NMF earnings.