Merchants Bancorp — Q3 2022 Form 10-Q
Reporting period: Quarter ended September 30, 2022; interim financial statements are unaudited. Merchants Bancorp is a diversified bank holding company with multi-family mortgage banking, mortgage warehousing and banking operations.
Key financial results
| Metric | Q3 2022 | Q3 2021 | Change |
|---|---|---|---|
| Interest income | $134.1 million | $77.3 million | +73% |
| Net interest income | $85.4 million | $68.9 million | +24% |
| Net interest margin | 3.05% | 2.73% | +32 bps |
| Noninterest income | $29.2 million | $40.3 million | -28% |
| Noninterest expense | $35.0 million | $29.5 million | +19% |
| Net income | $58.5 million | $58.5 million | Essentially unchanged |
| Diluted EPS | $1.22 | $1.22 | Unchanged |
For the nine months ended September 30, 2022, net interest income was $223.1 million (+9% year over year), noninterest income was $103.0 million (-12%), and net income was $162.6 million (-5%). Diluted EPS was $3.36 versus $3.62. The nine-month net interest margin rose to 2.90% from 2.82%; the efficiency ratio increased to 30.34% from 27.22%.
Financial position, liquidity and capital
- Total assets were $12.0 billion at September 30, up 6% from year-end 2021. Loans receivable, net, were $6.9 billion, up 20%; loans held for sale were $2.8 billion.
- Deposits were $10.3 billion, up 15% from year-end; borrowings fell to $97.3 million from $1.03 billion. Cash and equivalents were $324.0 million, down 69%, which management attributed to intentional liquidity management.
- Brokered deposits were $2.2 billion, or 22% of deposits. Management noted they may be more rate-sensitive and could cost more to retain or replace. Unused borrowing capacity was $2.8 billion, with an additional $500 million of AFX credit lines.
- For the first nine months, operating cash flow was $1.83 billion, investing cash flow was negative $3.05 billion, and financing cash flow was positive $507.4 million. Cash declined $708.7 million over the period.
- Shareholders’ equity was $1.41 billion, up 22% from year-end, including $137.4 million net proceeds from Series D preferred stock and $162.6 million net income, partly offset by dividends and other items. The company’s September 30 regulatory ratios included 12.5% total capital, 7.8% common equity Tier 1 and 12.3% Tier 1 leverage. The company and its bank subsidiaries were reported as well capitalized.
Material changes and unusual items
- Higher loan yields and balances lifted quarterly net interest income, but higher deposit and borrowing costs sharply increased interest expense. Deposit interest expense rose to $45.0 million from $7.0 million in Q3 2021.
- Lower loan-sale gains drove the decline in noninterest income: quarterly gains were $13.4 million versus $29.0 million. Servicing fees and syndication and asset-management fees partly offset the drop. Servicing rights were $145.0 million, up 31% from year-end, including positive fair-value adjustments.
- Warehouse loan funding fell 55% year over year in Q3 to $8.8 billion, broadly matching the industry decline. Mortgage Warehousing segment net income fell 49% to $11.8 million. Banking segment net income rose 68% to $39.3 million.
- In September, the company sold a $1.2 billion portfolio of multi-family bridge loans through a private securitization and retained a $1.0 billion senior security classified as held to maturity. The transaction generated $150.6 million in proceeds net of the security acquired and a $525,000 net loss on sale. An unaffiliated investor held the first-loss position on 13.4% of portfolio losses; Merchants continues to service the loans.
- Merchants issued 8.25% Series D preferred stock, raising approximately $137.4 million net. It also adopted CECL on January 1, recording a $3.6 million after-tax reduction to retained earnings.
- With assets above $10 billion and other eligibility thresholds exceeded, the company moved from the community bank leverage ratio framework to fully phased-in Basel III risk-based capital reporting for Q3.
Outlook, risks and contingencies
- The filing provides no specific earnings or revenue guidance. Management expected a substantial portion of $2.4 billion in certificates of deposit maturing within one year to renew; replacement funding or higher deposit rates could raise funding costs.
- Management said it expects sufficient funds for current loan-origination commitments and cited the loan-sale model and borrowing capacity as liquidity resources. At quarter-end, commitments to extend credit were $3.2 billion, with another $4.0 billion in commitments subject to performance criteria and/or cancellation.
- Credit indicators weakened: nonperforming loans were $26.6 million, or 0.38% of loans, versus $0.8 million at year-end. The increase was primarily one delinquent healthcare loan, which management said was fully collateralized and expected to be repaid. Special Mention loans rose to $142.8 million from $100.8 million at year-end. The allowance for credit losses was $39.0 million, or 0.56% of loans.
- Interest-rate simulations showed projected one-year net interest income falling 15.6% under a 100-basis-point rate decline and rising 7.4% under a 100-basis-point increase; management said results were within board policy limits. Rate, credit, real-estate values, deposit retention, liquidity, regulatory compliance and cybersecurity are among the disclosed risks.
- The filing reports no material legal proceedings, no material changes to previously disclosed risk factors, and no material subsequent events. The board expected to declare quarterly common dividends of $0.07 per share during 2022.
Important facts for investors to verify
- Whether deposit pricing and retention, particularly brokered and maturing CDs, sustain funding costs and net interest margin.
- Performance and collectability of the delinquent $21.8 million healthcare loan and trends in watch-list loans and credit-loss provisions.
- Economics, valuation and risk concentration of the $1.0 billion retained securitization security, including servicing obligations and the structure of loss protection.
- Whether lower mortgage and warehouse volumes and loan-sale gains persist, and how much earnings rely on servicing-right fair-value gains.
- Liquidity and capital measures under Basel III, including how commitments, deposit flows and rate shocks affect available funding and regulatory ratios.