Merchants Bancorp — Q3 2017 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2017. Financial statements are unaudited. Merchants Bancorp is an Indiana bank holding company focused on multifamily and healthcare mortgage banking, mortgage warehousing, and community banking.
Financial performance and condition
- Q3 earnings: Net income was $10.5 million, down 9.8% from $11.6 million in Q3 2016; diluted EPS was $0.45 versus $0.51. Pretax income was $16.9 million. Interest income was $26.0 million and noninterest income was $8.1 million.
- Nine-month earnings: Net income rose 41.0% to $34.4 million from $24.4 million; diluted EPS was $1.50 versus $1.10. Pretax income was $55.5 million. Interest income was $67.5 million and noninterest income was $32.8 million.
- Net interest performance: Q3 net interest income increased 22.8% to $18.4 million; net interest margin was 2.38%, up from 2.12%. For nine months, net interest income rose 22.8% to $47.6 million and margin was 2.28%, compared with 2.06%. Higher asset yields and growth contributed, while deposit costs also increased.
- Assets and loans: Total assets grew 19.1% from year-end 2016 to $3.24 billion. Cash and cash equivalents were $566.8 million. Loans held for sale were $798.1 million and net loans held for investment were $1.20 billion. Investment in loans held for sale and loans held for investment together was approximately $2.0 billion.
- Funding, debt and equity: Deposits increased 19.5% to $2.90 billion; noninterest-bearing deposits were $721.2 million. Borrowings were $56.6 million, including $25 million of line-of-credit debt and $30 million of subordinated debt. Shareholders’ equity was $243.3 million. Common and preferred dividends totaled $5.7 million for the nine-month period.
- Cash flow: Nine-month operating cash flow was $31.7 million, versus $(423.4) million in 2016; investing cash use was $377.3 million, and financing cash flow was $466.8 million. Cash increased $121.1 million to $566.8 million. Operating cash flow is affected by large, offsetting mortgage-loan origination and sale flows.
- Asset quality: The allowance for loan losses was $7.5 million, or 0.62% of loans, versus $6.0 million, or 0.58%, at September 2016. Nonperforming loans were $2.9 million versus $3.4 million; loans past due more than 30 days increased to $10.6 million from $5.3 million. Allowance coverage of nonperforming loans was 259.4%. The nine-month provision was $1.1 million, and net recoveries were $135,000.
- Capital and liquidity: The Bank was categorized as well capitalized, with total risk-based capital of 12.7%, CET1 of 12.4%, and Tier 1 leverage of 8.7%. The Company’s corresponding ratios were 10.2%, 8.0%, and 7.0%. The Company reported access to up to $440.6 million in additional FHLB advances, subject to available collateral and other conditions.
Material changes and developments
- Nine-month profit growth reflected higher net interest income and a $10.7 million increase in gains on loan sales. In Q3, by contrast, gains on loan sales fell $3.3 million year over year as multifamily loan sales declined, contributing to lower quarterly profit.
- Noninterest expense rose 24.7% in Q3 and 23.3% year to date, mainly due to higher salaries and benefits. Headcount increased to 181 from 139 a year earlier. Deposit interest expense also rose substantially as deposit balances and rates increased.
- Net loans held for investment grew 28.4% from year-end, led by multifamily/healthcare and commercial lending; mortgage warehouse lines declined. The filing reports $14.4 billion in loans originated or purchased for sale during the nine months, slightly below the prior-year period.
- The Bank acquired Richmac Funding LLC on August 15 for $8.1 million in Company shares. The transaction added $5.5 million of goodwill and $1.6 million of intangible assets; management said it did not materially affect the period’s financial results.
- A proposed Company purchase of Joy State Bank, for approximately $5.4 million plus specified carrying costs, remained subject to Illinois regulatory approval. Management expected closing in Q1 2018.
- After quarter-end, the Company completed an IPO of 6.25 million shares at $16 per share and issued another 937,500 shares through the underwriters’ option. Net proceeds were approximately $106.3 million after offering costs; $101.9 million had been contributed to the Bank by the filing date.
Outlook, risks and unusual items
- The filing gives no quantified earnings or revenue guidance. Management said it expected sufficient funds to meet current loan-origination commitments and expected a substantial portion of $388.1 million in certificates of deposit maturing within one year to renew. Replacing deposits with advances or higher-rate deposits could increase funding costs.
- Interest-rate modeling estimated that a 100-basis-point decline would reduce forward 12-month net interest income by 16.9%, beyond the stated 15% policy limit. Management cited potentially higher mortgage volumes as a mitigating factor. A 100-basis-point increase was estimated to raise net interest income by 12.6%. Economic value of equity was within policy limits in the disclosed rate scenarios.
- The $30 million subordinated debt carries variable-rate interest and an additional payment equal to 49% of NMF earnings; the filing reports an effective borrowing cost of 12.04% for Q3 and 12.21% for the nine months.
- Risks identified include credit quality and loan-loss estimates, real estate values and construction-project performance, deposit and liquidity conditions, changing interest rates, regulation, cybersecurity, growth execution, competition, and mortgage-servicing valuation. Management noted that the expected-credit-loss accounting standard may increase the allowance; its impact was still under evaluation.
- Mortgage servicing rights were valued using Level 3 discounted-cash-flow assumptions, including discount rates of 8%–15% and prepayment rates of 1.1%–35.8%; changes in assumptions can materially affect valuation. The filing reported no material changes to risk factors, no legal proceedings, and effective disclosure controls.
Most important facts for investors to verify
- Whether loan growth and multifamily loan-sale volumes—and the related gains and servicing income—can be sustained, given the Q3 decline in multifamily sales.
- Whether rising deposit costs, greater brokered-deposit reliance, and certificate maturities pressure net interest margin or liquidity.
- Whether the increase in loans past due over 30 days and the allowance remain consistent with underlying portfolio risk, particularly in commercial and multifamily lending.
- How interest-rate changes affect net interest income in practice, including the assumptions behind mortgage-volume mitigation of the modeled downside.
- How the IPO proceeds, Richmac integration, and any eventual Joy State Bank acquisition affect capital, earnings, and execution risk.