Merchants Bancorp — Q1 2018 Form 10-Q
Period: Three months ended March 31, 2018; balance-sheet comparisons are with December 31, 2017. The interim financial statements are unaudited. Merchants is an Indiana-based bank holding company focused on multifamily and healthcare mortgage banking, mortgage warehousing, and community banking.
Financial performance and position
- Profitability: Net income rose 65% to $15.1 million from $9.1 million. Net income allocated to common shareholders was $14.2 million; basic and diluted EPS were $0.50, versus $0.39. Pretax income was $19.7 million, up from $14.7 million.
- Interest income and margins: Net interest income increased 49% to $20.1 million. Net interest margin improved to 2.52% from 2.17%, and interest-rate spread rose to 2.06% from 1.83%. Average interest-earning assets grew 28% to $3.24 billion.
- Noninterest income and costs: Noninterest income rose 40% to $11.3 million, mainly on loan-sale gains of $10.9 million versus $5.4 million. Net servicing fees shifted to a $0.3 million cost from $2.0 million of fees. Noninterest expense increased 55% to $10.3 million, including higher compensation associated with growth, commissions, and public-company staffing.
- Taxes: Income-tax expense declined to $4.7 million from $5.6 million; the effective tax rate fell to 23.7% from 38.1%, primarily reflecting federal tax reform, partly offset by higher pretax income.
- Assets and lending: Total assets increased 8% to $3.68 billion. Loans held for sale were $1.08 billion and net loans held for investment were $1.56 billion. Net loans grew 14% from year-end, including growth in multifamily and healthcare financing to $645.4 million.
- Credit quality: The allowance for loan losses was $9.7 million, or 0.62% of loans, versus $8.3 million, or 0.60%, at year-end. The quarterly provision was $1.4 million versus $0.2 million. Nonperforming loans rose to $4.9 million from $3.1 million at year-end; loans over 30 days past due rose to $5.9 million from $4.3 million. The filing reports $17,000 of net charge-offs and $5,000 of recoveries.
- Funding, debt, and liquidity: Deposits increased 4% to $3.06 billion. Brokered deposits were $897.4 million, 29% of total deposits, down from $941.5 million and 32% at year-end. Borrowings increased to $199.4 million from $56.6 million, primarily to support quarter-end warehouse funding. Cash and cash equivalents fell 20% to $287.7 million. The company reported $283.1 million of additional FHLB advance capacity and expected sufficient funds for current loan-origination commitments. Certificates of deposit totaling $593.8 million mature within a year; management expects substantial renewal but notes replacement funding could raise interest expense.
- Cash flow: Operating cash flow was negative $123.8 million, investing cash flow negative $169.2 million, and financing cash flow positive $221.2 million. Cash declined $71.8 million to $287.7 million. The filing attributes funding needs in part to loan growth and mortgage warehouse activity.
- Capital: The company, Merchants Bank, and Joy State Bank were reported as well capitalized. At March 31, company total risk-based capital was 12.7%, Tier 1 leverage 10.8%, and common equity Tier 1 11.0%.
Changes, unusual items, and outlook
- Compared with Q1 2017, earnings benefited from higher net interest income, loan-sale gains, and lower taxes; higher provision and operating expenses partly offset the gains. Banking-segment net income increased 148% to $6.0 million; multifamily mortgage banking rose 56% to $5.5 million; mortgage warehousing rose 22% to $4.6 million.
- Joy State Bank was acquired on January 2, 2018, for approximately $5.5 million. Its results did not materially contribute to the year-over-year earnings increase. Purchase accounting measurements remained subject to evaluation.
- Management provided no specific earnings or revenue guidance. It described expected deposit renewals and sufficient funding for current loan commitments. Its outlook remains subject to credit, interest-rate, liquidity, market, regulatory, growth, and operational risks.
- The company reported an asset-sensitive interest-rate position. Its modeled 12-month net interest income changes were -12.6% for a 100-basis-point decline, +11.3% for a 100-basis-point increase, and +22.5% for a 200-basis-point increase. Economic value of equity sensitivity was within the stated policy limits.
- The filing says disclosure controls were effective and reports no material change in internal control, no legal proceedings, and no material changes to previously disclosed risk factors. It warns that the expected-credit-loss accounting standard may increase the allowance, but the impact was not yet quantifiable.
Important facts for investors to verify
- Assess the rise in nonperforming, past-due, and classified loans against loan growth, especially multifamily, commercial, and warehouse exposures, and whether the allowance remains adequate.
- Review deposit pricing, brokered-deposit reliance, the $593.8 million of near-term certificate maturities, and the increased use of borrowings and available FHLB capacity.
- Understand the sustainability of loan-sale gains and the fair-value sensitivity of mortgage servicing rights, including the $0.9 million quarterly valuation decline.
- Reconcile the +22.5% modeled net interest income change under a +200-basis-point shock with the filing’s stated 20% policy limit; the filing does not explain this apparent discrepancy in the supplied text.
- Check the reported efficiency-ratio comparison: the filing states 32.7% for Q1 2017 and 30.7% for “the first quarter of 2017” again, so the intended comparison period is unclear.