Merchants Bancorp — Q3 2020 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2020. Unaudited consolidated results. Merchants Bancorp is a bank holding company with multi-family mortgage banking, mortgage warehousing, and banking businesses. Dollar amounts below are in millions unless stated otherwise.
Financial performance
| Metric | Q3 2020 | Q3 2019 | Nine months 2020 | Nine months 2019 |
|---|---|---|---|---|
| Net interest income | $65.3 | $32.6 | $154.9 | $84.7 |
| Provision for loan losses | $3.0 | $1.2 | $7.7 | $1.9 |
| Noninterest income | $38.7 | $10.9 | $84.7 | $24.4 |
| Noninterest expense | $26.4 | $15.5 | $69.0 | $44.5 |
| Net income | $55.0 | $20.3 | $120.7 | $47.3 |
| EPS, diluted | $1.79 | $0.60 | $3.82 | $1.45 |
- Q3 net income rose 171%; nine-month net income rose 155%. Gains were driven chiefly by higher loan volumes, net interest income and loan-sale gains.
- Q3 net interest margin was 2.81%, up 59 basis points year over year; net interest spread was 2.74%, up 76 basis points. Nine-month net interest margin was 2.56%, versus 2.45%.
- Q3 efficiency ratio was 25.4%, versus 35.7%; nine-month ratio was 28.8%, versus 40.8%.
- Loan-sale gains were $29.5 million in Q3 and $67.7 million for nine months. Mortgage warehouse fees were $6.8 million and $15.1 million, respectively.
Financial position, liquidity and cash flow
- Total assets were $9.53 billion at September 30, up 50% from December 31, 2019. Loans held for sale were $3.32 billion; net loans receivable were $4.86 billion; mortgage loans awaiting securitization were $374.7 million.
- Deposits were $7.08 billion, up 29% since year-end. Borrowings were $1.62 billion, versus $181.4 million at year-end. Cash and cash equivalents were $429.2 million, down from $506.7 million. The company reported $2.5 billion of unused credit lines.
- Borrowings included $295.0 million from the Federal Reserve discount window and $87.1 million through the Paycheck Protection Program Liquidity Facility (PPPLF). Management said these facilities supported funding and liquidity management at lower rates.
- Shareholders’ equity was $757.1 million, up 16% from year-end. The allowance for loan losses was $23.4 million, or 0.48% of loans, versus $15.8 million, or 0.52%, at year-end.
- Nine-month cash flows: operating activities used $1.21 billion; investing activities used $1.89 billion; financing activities provided $3.03 billion. Cash declined $77.5 million during the period. Operating cash use reflects the large volume of loan originations and sales.
- The parent company’s Tier 1 leverage ratio was 7.9% against the temporary 8.0% CBLR threshold and was subject to a two-quarter grace period; management expected compliance by December 31, 2020. Merchants Bank reported 8.0% and FMBI 9.5%. Management said all entities met applicable requirements under the grace-period provisions and remained categorized as well capitalized.
Changes versus comparable periods
- Growth was exceptional: total assets increased $3.2 billion from year-end, and net loans receivable rose 61%. Mortgage warehouse loans increased 115% and multi-family and healthcare loans increased 58%.
- Q3 net interest income doubled year over year, reflecting substantially larger average earning assets and lower funding costs. Deposit interest expense fell 65% in Q3, while loan interest income rose 36%.
- Mortgage warehouse loan volume funded in Q3 increased 134% year over year to $35.2 billion; nine-month volume rose 169% to $80.5 billion. The filing cites industry volume growth of 32% and 59%, respectively.
- Higher activity also increased costs: Q3 noninterest expense rose 70%, principally salaries, benefits and loan expenses; nine-month expense rose 55%. Nine-month provision for loan losses increased $5.8 million.
Outlook, risks and unusual items
- The filing provides no formal earnings or revenue guidance. Management said it could not yet determine the full effect of COVID-19 and might increase future loan-loss provisions as conditions evolve.
- Management reported 11 loans with $1.6 million of balances still in payment deferral arrangements at September 30, down from $80.6 million at June 30. COVID-related deferrals were less than 0.02% of loans and loans held for sale. The allowance included $628,000 attributed to COVID-related uncertainty.
- Credit indicators were mixed: nonperforming loans were $7.9 million, or 0.16% of loans, versus $4.7 million, or 0.15%, at year-end. Traditional Special Mention loans increased to $107.4 million from $60.3 million, with management citing certain multi-family projects’ cost overruns and lower-than-projected rent collections and occupancy.
- Interest-rate and valuation risks include mortgage servicing rights, whose fair value fell $8.0 million during the first nine months, primarily due to lower rates and higher prepayment assumptions. Further rate declines could reduce servicing-rights value further.
- Brokered deposits may be rate-sensitive and may not renew at maturity. Certificates of deposit totaling $1.1 billion were due within one year; management expected substantial renewal but noted replacement funding could cost more.
- Other stated risks include economic and real-estate conditions, borrower and construction-project performance, funding access, regulatory capital, cyber and operational risks, and changes in interest rates or government policy. No legal proceedings were reported.
- For a parallel 100-basis-point rate change, the company’s net interest income sensitivity was down 7.7% for a 100-basis-point decline and up 8.7% for an increase; management said modeled scenarios remained within board limits.
Important facts for investors to verify
- Whether the parent company achieved the 8.0% CBLR threshold by the end of the grace period and how subsequent thresholds affect capital flexibility.
- Whether extraordinary mortgage warehouse and loan-sale volumes and associated margins are sustainable as refinancing activity and interest rates change.
- Trends in multi-family watch-list loans, project cash flows, COVID-related credit quality, deferrals and the adequacy of the allowance.
- Renewal of maturing deposits, use and cost of brokered funding and borrowings, and availability of collateral-backed liquidity.
- Changes in mortgage servicing-rights valuation, prepayment assumptions, and the sensitivity of earnings and capital to interest-rate movements.