Merchants Bancorp - Quarter Report: 2020 March (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D. C. 20549

FORM 10-Q

☒	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934


For the quarterly period ended	March 31, 2020

☐	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from ____________ to _______________

Commission File No. 001-38258


	MERCHANTS BANCORP
	(Exact name of registrant as specified in its charter)

Indiana		20‑5747400
(State or other jurisdiction of		(I.R.S. Employer
incorporation or organization)		Identification Number)

410 Monon Blvd. Carmel, Indiana		46032
(Address of principal		(Zip Code)
executive office)

(317) 569‑7420

(Registrant’s telephone number, including area code)

N/A

(Former name or former address, if changed since last report)

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days.

Yes ☒ No ☐

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). ☒ Yes ☐ No

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b‑2 of the Exchange Act.

Large accelerated filer ☐	Accelerated filer ☒	Non-accelerated filer ☐	Smaller reporting company ☐
			Emerging growth company ☒

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b‑2 of the Exchange Act.).
Yes ☐ No ☒

Securities registered pursuant to Section 12(b) of the Act:

Title of each class

Trading Symbol(s)

Name of each exchange on which registered

Common Stock, without par value

Series A Preferred Stock, without par value

Depositary Shares, each representing a 1/40th interest in a share of Series B Preferred Stock, without par value

MBIN

MBINP

MBINO

NASDAQ

As of May 1, 2020, the latest practicable date, 28,742,484 shares of the registrant’s common stock, without par value, were issued and outstanding.

Table of Contents

Merchants Bancorp

Index to Quarterly Report on Form 10‑Q

PART I – FINANCIAL INFORMATION

Item 1 Interim Financial Statements (Unaudited)

Condensed Consolidated Balance Sheets as of March 31, 2020 and December 31, 2019	3

Condensed Consolidated Statements of Income for the Three Months Ended March 31, 2020 and 2019	4

Condensed Consolidated Statements of Comprehensive Income for the Three Months Ended March 31, 2020 and 2019	5

Condensed Consolidated Statements of Shareholders’ Equity for the Three Months Ended March 31, 2020 and 2019	6

Condensed Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2020 and 2019	7

Notes to Condensed Consolidated Financial Statements	8

Item 2 Management’s Discussion and Analysis of Financial Condition and Results of Operations	35

Item 3 Quantitative and Qualitative Disclosures About Market Risk	48

Item 4 Controls and Procedures	49

PART II – OTHER INFORMATION	50

Item 1 Legal Proceedings	50

Item 1A Risk Factors	50

Item 2 Unregistered Sales of Equity Securities and Use of Proceeds	50

Item 3 Defaults Upon Senior Securities	50

Item 4 Mine Safety Disclosures	50

Item 5 Other Information	50

Item 6 Exhibits	51

SIGNATURES	52

Table of Contents

Part I – Financial Information

Item 1. Financial Statements

Merchants Bancorp

Condensed Consolidated Balance Sheets

March 31, 2020 (Unaudited) and December 31, 2019

(In thousands, except share data)


	March 31,		December 31,
	2020		2019
Assets
Cash and due from banks	$	8,168	$	13,909
Interest-earning demand accounts		559,914		492,800
Cash and cash equivalents		568,082		506,709
Securities purchased under agreements to resell		6,685		6,723
Trading securities		465,157		269,891
Available for sale securities		339,053		290,243
Federal Home Loan Bank (FHLB) stock		46,156		20,369
Loans held for sale (includes $18,938 and $19,592, respectively at fair value)		2,796,008		2,093,789
Loans receivable, net of allowance for loan losses of $18,883 and $15,842, respectively		3,501,770		3,012,468
Premises and equipment, net		29,415		29,274
Mortgage servicing rights		69,978		74,387
Interest receivable		18,139		18,359
Goodwill		15,845		15,845
Intangible assets, net		3,419		3,799
Other assets and receivables		48,691		30,072
Total assets	$	7,908,398	$	6,371,928
Liabilities and Shareholders' Equity
Liabilities
Deposits
Noninterest-bearing	$	327,805	$	272,037
Interest-bearing		6,394,900		5,206,038
Total deposits		6,722,705		5,478,075
Borrowings		444,567		181,439
Other liabilities		68,157		58,686
Total liabilities		7,235,429		5,718,200
Commitments and Contingencies
Shareholders' Equity
Common stock, without par value
Authorized - 50,000,000 shares
Issued and outstanding - 28,742,484 shares at March 31, 2020 and 28,706,438 shares at December 31, 2019		135,746		135,640
Preferred stock, without par value - 5,000,000 total shares authorized
8% Preferred stock - $1,000 per share liquidation preference
Authorized - 50,000 shares
Issued and outstanding - 41,625 shares		41,581		41,581
7% Series A Preferred stock - $25 per share liquidation preference
Authorized - 3,500,000 shares
Issued and outstanding - 2,081,800 shares		50,221		50,221
6% Series B Preferred stock - $1,000 per share liquidation preference
Authorized - 125,000 shares
Issued and outstanding - 125,000 shares (equivalent to 5,000,000 depositary shares)		120,844		120,844
Retained earnings		323,651		304,984
Accumulated other comprehensive income		926		458
Total shareholders' equity		672,969		653,728
Total liabilities and shareholders' equity	$	7,908,398	$	6,371,928

See notes to condensed consolidated financial statements.

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Merchants Bancorp

Condensed Consolidated Statements of Income (Unaudited)

For the Three Months Ended March 31, 2020 and 2019

(In thousands, except share data)


	Three Months Ended
	March 31,
	2020		2019
Interest Income
Loans	$	53,564	$	34,455
Investment securities:
Trading securities		2,796		1,045
Available for sale - taxable		1,322		1,551
Available for sale - tax exempt		37		96
Federal Home Loan Bank stock		239		223
Other		2,459		2,304
Total interest income		60,417		39,674
Interest Expense
Deposits		20,630		14,227
Borrowed funds		1,434		1,316
Total interest expense		22,064		15,543
Net Interest Income		38,353		24,131
Provision for loan losses		2,998		649
Net Interest Income After Provision for Loan Losses		35,355		23,482
Noninterest Income
Gain on sale of loans		21,166		2,643
Loan servicing fees, net		(5,824)		(347)
Mortgage warehouse fees		2,746		753
Gains on sale of investments available for sale (includes $0 and $127, respectively, related to accumulated other comprehensive earnings reclassifications)		—		127
Other income		1,814		488
Total noninterest income		19,902		3,664
Noninterest Expense
Salaries and employee benefits		14,240		8,567
Loan expenses		1,164		934
Occupancy and equipment		1,492		876
Professional fees		569		539
Deposit insurance expense		1,786		277
Technology expense		610		472
Other expense		2,432		1,370
Total noninterest expense		22,293		13,035
Income Before Income Taxes		32,964		14,111
Provision for income taxes (includes $0 and $32, respectively, related to income tax expense for reclassification items)		8,381		3,541
Net Income	$	24,583	$	10,570
Dividends on preferred stock		(3,618)		(833)
Net Income Allocated to Common Shareholders		20,965		9,737
Basic Earnings Per Share	$	0.73	$	0.34
Diluted Earnings Per Share	$	0.73	$	0.34
Weighted-Average Shares Outstanding
Basic		28,734,632		28,702,250
Diluted		28,759,412		28,737,439

See notes to condensed consolidated financial statements.

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Merchants Bancorp

Condensed Consolidated Statements of Comprehensive Income (Unaudited)

For the Three Months Ended March 31, 2020 and 2019

(In thousands)


	Three Months Ended
	March 31,
	2020		2019
Net Income	$	24,583	$	10,570
Other Comprehensive Income:
Net change in unrealized gains on investment securities available for sale, net of tax expense of $152 and $192, respectively		468		559
Less: Reclassification adjustment for gains included in net income, net of tax expense of $0 and $32, respectively		—		95
Other comprehensive income for the period		468		464
Comprehensive Income	$	25,051	$	11,034

See notes to condensed consolidated financial statements.

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Merchants Bancorp

Condensed Consolidated Statement of Shareholders’ Equity (Unaudited)

For the Three Months Ended March 31, 2020

(In thousands, except share data)


															Accumulated
															Other
	Common Stock			8% Preferred Stock			7% Preferred Stock			6% Preferred Stock			Retained		Comprehensive
	Shares	Amount		Shares	Amount		Shares	Amount		Shares	Amount		Earnings		Income		Total
Balance, January 1, 2020	28,706,438	$	135,640	41,625	$	41,581	2,081,800	$	50,221	125,000	$	120,844	$	304,984	$	458	$	653,728
Net income	—		—	—		—	—		—	—		—		24,583		—		24,583
Shares issued for stock compensation plans, net of taxes withheld to satisfy employee tax obligations	36,046		106	—		—	—		—	—		—		—		—		106
Dividends on 8% preferred stock, $80.00 per share, annually	—		—	—		—	—		—	—		—		(833)		—		(833)
Dividends on 7% preferred stock, $1.75 per share, annually	—		—	—		—	—		—	—		—		(910)		—		(910)
Dividends on 6% preferred stock, $60.00 per share, annually	—		—	—		—	—		—	—		—		(1,875)		—		(1,875)
Dividends on common stock, $0.32 per share, annually	—		—	—		—	—		—	—		—		(2,298)		—		(2,298)
Other comprehensive income	—		—	—		—	—		—	—		—		—		468		468
Balance, March 31, 2020	28,742,484	$	135,746	41,625	$	41,581	2,081,800	$	50,221	125,000	$	120,844	$	323,651	$	926	$	672,969

For the Three Months Ended March 31, 2019

(In thousands, except share data)


															Accumulated
															Other
	Common Stock			8% Preferred Stock			7% Preferred Stock			6% Preferred Stock			Retained		Comprehensive
	Shares	Amount		Shares	Amount		Shares	Amount		Shares	Amount		Earnings		Income (Loss)		Total
Balance, January 1, 2019	28,694,036	$	135,057	41,625	$	41,581	—	$	—	—	$	—	$	244,909	$	(310)	$	421,237
Net income	—		—	—		—	—		—	—		—		10,570		—		10,570
Shares issued for stock compensation plans	10,127		133	—		—	—		—	—		—		—		—		133
Issuance of 7% preferred stock, net of offering expenses of $1,731	—		—	—		—	2,000,000		48,269	—		—		—		—		48,269
Dividends on 8% preferred stock, $80.00 per share, annually	—		—	—		—	—		—	—		—		(833)		—		(833)
Dividends on common stock, $0.28 per share, annually	—		—	—		—	—		—	—		—		(2,009)		—		(2,009)
Other comprehensive income	—		—	—		—	—		—	—		—		—		464		464
Balance, March 31, 2019	28,704,163	$	135,190	41,625	$	41,581	2,000,000	$	48,269	—	$	—	$	252,637	$	154	$	477,831

See notes to condensed consolidated financial statements.

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Merchants Bancorp

Condensed Consolidated Statements of Cash Flows (Unaudited)

Three Months Ended March 31, 2020 and 2019

(In thousands)


	Three Months Ended
	March 31,
	2020		2019
Operating activities:
Net income	$	24,583	$	10,570
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation		453		137
Provision for loan losses		2,998		649
Gain on sale of securities		—		(127)
Gain on sale of loans		(21,166)		(2,643)
Proceeds from sales of loans		10,866,020		3,729,430
Loans and participations originated and purchased for sale		(11,551,090)		(3,776,827)
Change in mortgage servicing rights for paydowns and fair value adjustments		8,338		2,615
Net change in:
Trading securities		(195,266)		33,505
Other assets and receivables		(17,686)		2,699
Other liabilities		9,822		1,933
Other		1,379		798
Net cash provided by (used in) operating activities		(871,615)		2,739
Investing activities:
Net change in securities purchased under agreements to resell		38		37
Purchases of available-for-sale securities		(156,666)		(45,000)
Proceeds from the sale of available-for-sale securities		—		31,086
Proceeds from calls, maturities and paydowns of available-for-sale securities		107,995		49,055
Purchases of loans		(32,631)		(14,233)
Net change in loans receivable		(459,617)		(109,620)
Purchase of Federal Home Loan Bank stock		(25,787)		(11,860)
Proceeds from sale of Federal Home Loan Bank stock		—		1,190
Purchases of premises and equipment		(594)		(4,206)
Purchase of limited partnership interests		(1,090)		—
Net cash used in investing activities		(568,352)		(103,551)
Financing activities:
Net change in deposits		1,244,630		(110,031)
Proceeds from Federal Home Loan Bank borrowings		5,597,675		2,348,720
Repayment of Federal Home Loan Bank borrowings		(5,334,998)		(2,209,281)
Proceeds from notes payable		450		4,404
Payments on notes payable		—		(1,500)
Payments of contingent consideration		(501)		—
Proceeds from issuance of preferred stock		—		48,269
Redemption of preferred stock		—		—
Dividends		(5,916)		(2,842)
Net cash provided by financing activities		1,501,340		77,739
Net Change in Cash and Cash Equivalents		61,373		(23,073)
Cash and Cash Equivalents, Beginning of Period		506,709		336,524
Cash and Cash Equivalents, End of Period	$	568,082	$	313,451
Additional Cash Flows Information:
Interest paid	$	23,782	$	14,745
Income taxes paid		46		64

See notes to condensed consolidated financial statements.

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Merchants Bancorp

Notes to Condensed Consolidated Financial Statements

(Unaudited)

Note 1: Basis of Presentation

The accompanying unaudited condensed consolidated financial statements include the accounts of Merchants Bancorp, a registered bank holding company (the “Company”) and its wholly owned subsidiaries, Merchants Bank of Indiana (“Merchants Bank”) and Farmers-Merchants Bank of Illinois (“FMBI”). Merchants Bank’s direct and indirect subsidiaries include Merchants Capital Corp. (“MCC”), Merchants Capital Servicing, LLC (“MCS”), Ash Realty Holdings, LLC (“Ash Realty”), MBI Midtown West, LLC (“MMW”), Natty Mac Funding, Inc. (“NMF”), which became dormant in the first quarter of 2019 after the Company’s acquisition of the assets of NattyMac, LLC (“NattyMac”), and OneTrust Funding, Inc. In August 2019 the company also formed PR Mortgage Investment, LP (“PRMI”), PRMIGP, LLC (“PRMIGP”), and PR Mortgage Investment Management, LLC (“PRMIM”). All these entities are collectively referred to as the “Company”.

The accompanying unaudited condensed consolidated balance sheet of the Company as of December 31, 2019, which has been derived from audited financial statements, and unaudited condensed consolidated financial statements of the Company as of March 31, 2020 and for the three months ended March 31, 2020 and 2019, were prepared in accordance with the instructions for Form 10‑Q and Article 10 of Regulation S-X and, therefore, do not include information or footnotes necessary for a complete presentation of financial position, results of operations and cash flows in conformity with accounting principles generally accepted in the United States of America. Accordingly, these condensed financial statements should be read in conjunction with the audited financial statements and notes thereto of the Company as of and for the year ended December 31, 2019 in its Annual Report on Form 10-K. Reference is made to the accounting policies of the Company described in the Notes to the Financial Statements contained in the Annual Report on Form 10-K.

In the opinion of management, all adjustments (consisting only of normal recurring adjustments) which are necessary for a fair presentation of the unaudited financial statements have been included to present fairly the financial position as of March 31, 2020 and the results of operations for the three months ended March 31, 2020 and 2019, and cash flows for the three months ended March 31, 2020 and 2019. All interim amounts have not been audited and the results of operations for the three months ended March 31, 2020, herein are not necessarily indicative of the results of operations to be expected for the entire year.

Principles of Consolidation

The unaudited condensed consolidated financial statements as of and for the period ended March 31, 2020 and 2019 include results from the Company, and its wholly owned subsidiaries, Merchants Bank, and FMBI. Also included are Merchants Bank’s wholly owned subsidiaries, MCC, MCC’s wholly owned subsidiary, MCS, Ash Realty, NMF, MMW, and OneTrust Funding, Inc. The unaudited condensed consolidated financial statements as of and for the period ended March 31, 2020 also include PRMI, PRMIGP, and PRMIM, all of which are 99% owned by Merchants Bank. All significant intercompany accounts and transactions have been eliminated in consolidation.

Use of Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

Material estimates that are particularly susceptible to significant change relate to the determination of the allowance for loan losses, loan servicing rights and fair values of financial instruments. The uncertainties related to the COVID-19 pandemic could cause significant changes to these estimates compared to what was known at the time these financial statements were prepared.

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Merchants Bancorp

Notes to Condensed Consolidated Financial Statements

(Unaudited)

Reclassifications

Certain reclassifications have been made to the 2019 financial statements to conform to the financial statement presentation as of and for the three months ended March 31, 2020. These reclassifications had no effect on net income.

Note 2: Securities Available For Sale

The amortized cost and approximate fair values, together with gross unrealized gains and losses, of securities were as follows:


	March 31, 2020
			Gross		Gross
	Amortized		Unrealized		Unrealized		Fair
	Cost		Gains		Losses		Value
	(In thousands)
Available-for-sale securities:
Treasury notes	$	1,994	$	49	$	—	$	2,043
Federal agencies		306,152		423		—		306,575
Municipals		5,566		385		—		5,951
Mortgage-backed - Government-sponsored entity (GSE) - residential		24,142		343		1		24,484
Total available-for-sale securities	$	337,854	$	1,200	$	1	$	339,053


	December 31, 2019
			Gross		Gross
	Amortized		Unrealized		Unrealized		Fair
	Cost		Gains		Losses		Value
	(In thousands)
Available-for-sale securities:
Treasury notes	$	4,744	$	21	$	—	$	4,765
Federal agencies		244,986		24		37		244,973
Municipals		5,577		360		—		5,937
Mortgage-backed - Government-sponsored entity (GSE) - residential		34,357		213		2		34,568
Total available-for-sale securities	$	289,664	$	618	$	39	$	290,243

The amortized cost and fair value of available-for-sale securities at March 31, 2020 and December 31, 2019, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties. Securities not due at a single maturity date are shown separately.


	March 31, 2020				December 31, 2019
	Amortized		Fair		Amortized		Fair
	Cost		Value		Cost		Value
Contractual Maturity	(In thousands)
Within one year	$	20,500	$	20,563	$	23,250	$	23,233
After one through five years		287,914		288,337		226,748		226,783
After five through ten years		—		—		—		—
After ten years		5,298		5,669		5,309		5,659
		313,712		314,569		255,307		255,675
Mortgage-backed - Government-sponsored entity (GSE) - residential		24,142		24,484		34,357		34,568
	$	337,854	$	339,053	$	289,664	$	290,243

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Merchants Bancorp

Notes to Condensed Consolidated Financial Statements

(Unaudited)

During the three months ended March 31, 2020, no securities available-for-sale were sold. During the three months ended March 31, 2019, $31.1 million of securities available-for-sale were sold, and a net gain of $127,000 was recognized, consisting of $361,000 in gains and $234,000 of losses.

The following tables show the Company’s investments’ gross unrealized losses and fair value of the Company’s investments with unrealized losses that are not deemed to be other-than-temporarily impaired, aggregated by investment class and length of time that individual securities have been in a continuous unrealized loss position at March 31, 2020 and December 31, 2019:


	March 31, 2020
					12 Months or
	Less than 12 Months				Longer				Total
			Gross				Gross				Gross
	Fair		Unrealized		Fair		Unrealized		Fair		Unrealized
	Value		Losses		Value		Losses		Value		Losses
	(In thousands)
Available-for-sale securities:
Treasury notes	$	—	$	—	$	—	$	—	$	—	$	—
Federal agencies		—		—		—		—		—		—
Mortgage-backed - Government-sponsored entity (GSE) - residential		1,113		1		—		—		1,113		1
	$	1,113	$	1	$	—	$	—	$	1,113	$	1


	December 31, 2019
					12 Months or
	Less than 12 Months				Longer				Total
			Gross				Gross				Gross
	Fair		Unrealized		Fair		Unrealized		Fair		Unrealized
	Value		Losses		Value		Losses		Value		Losses
	(In thousands)
Available-for-sale securities:
Treasury notes	$	—	$	—	$	—	$	—	$	—	$	—
Federal agencies		94,963		37		—		—		94,963	$	37
Municipals		—		—		—		—		—	$	—
Mortgage-backed - Government-sponsored entity (GSE) - residential		809		2		—		—		809		2
	$	95,772	$	39	$	—	$	—	$	95,772	$	39

Other-than-temporary Impairment

Unrealized losses on securities have not been recognized to income because the Company has the intent and ability to hold the securities for the foreseeable future, and the decline in fair value is primarily due to increased market interest rates. The fair value is expected to recover as the securities approach the maturity date.

Note 3: Trading Securities

Trading securities are recorded at fair value with changes in fair value recorded in earnings. These include multi-family rental real estate loan originations, primarily in Government National Mortgage Association (“GNMA”) mortgage backed securities, as well as FHA and conventional Fannie Mae and Freddie Mac participation certificates pending settlements that typically occur within 30 days. The unrealized gains included in trading securities totaled $2.2 million and $545,000 at March 31, 2020 and 2019, respectively.

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Merchants Bancorp

Notes to Condensed Consolidated Financial Statements

(Unaudited)

Note 4: Loans and Allowance for Loan Losses

Loans that management has the intent and ability to hold for the foreseeable future or until maturity or payoff are reported at their outstanding principal balances adjusted for unearned income, charge-offs, the allowance for loan losses, any unamortized deferred fees or costs on originated loans and unamortized premiums or discounts on purchased loans.

For loans at amortized cost, interest income is accrued based on the unpaid principal balance.

The accrual of interest on loans is discontinued at the time the loan is 90 days past due unless the credit is well-secured and in process of collection. Past-due status is based on contractual terms of the loan. In all cases, loans are placed on nonaccrual or charged off at an earlier date if collection of principal or interest is considered doubtful.

All interest accrued but not collected for loans that are placed on nonaccrual or charged off is reversed against interest income. The interest on these loans is applied to the principal balance until the loan can be returned to an accrual status. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.

For all loan portfolio segments, the Company promptly charges off loans, or portions thereof, when available information confirms that specific loans are uncollectable based on information that includes, but is not limited to, (1) the deteriorating financial condition of the borrower, (2) declining collateral values, and/or (3) legal action, including bankruptcy, that impairs the borrower’s ability to adequately meet its obligations. For impaired loans that are considered to be solely collateral dependent, a partial charge-off is recorded when a loss has been confirmed by an updated appraisal or other appropriate valuation of the collateral.

When cash payments are received on impaired loans in each loan class, the Company records the payment as interest income unless collection of the remaining recorded principal amount is doubtful, at which time payments are used to reduce the principal balance of the loan. Troubled debt restructured loans recognize interest income on an accrual basis at the renegotiated rate if the loan is in compliance with the modified terms.

Loans receivable at March 31, 2020 and December 31, 2019 include:


	March 31,		December 31,
	2020		2019
	(In thousands)

Mortgage warehouse lines of credit	$	1,083,776	$	765,151
Residential real estate		421,978		413,835
Multi-family and healthcare financing		1,435,206		1,347,125
Commercial and commercial real estate		468,668		398,601
Agricultural production and real estate		92,498		85,210
Consumer and margin loans		18,527		18,388
		3,520,653		3,028,310
Less
Allowance for loan losses		18,883		15,842

Loans Receivable	$	3,501,770	$	3,012,468

Risk characteristics applicable to each segment of the loan portfolio are described as follows.

Mortgage Warehouse Lines of Credit (MTG WHLOC): Under its warehouse program, the Company provides warehouse financing arrangements to approved mortgage companies for the origination and sale of residential mortgage loans and to a lesser extent multi-family loans. Agency eligible, governmental and jumbo residential mortgage loans that

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Notes to Condensed Consolidated Financial Statements

(Unaudited)

are secured by mortgages placed on existing one-to-four family dwellings may be originated or purchased and placed on each mortgage warehouse line.

As a secured line of credit, collateral pledged to the Company secures each individual mortgage until the lender sells the loan in the secondary market. A traditional secured warehouse line of credit typically carries a base interest rate of 30-day LIBOR, plus a margin, or mortgage note rate, less a margin.

Risk is evident if there is a change in the fair value of mortgage loans originated by mortgage bankers in warehouse, the sale of which is the expected source of repayment of the borrowings under a warehouse line of credit.

Residential Real Estate Loans (RES RE): Real estate loans are secured by owner-occupied 1‑4 family residences. Repayment of residential real estate loans is primarily dependent on the personal income and credit rating of the borrowers. All-in-One mortgages included in this segment typically carry a base rate of 30-day LIBOR, plus a margin.

Multi-Family and Healthcare Financing (MF RE): The Company engages in multi-family and healthcare financing, including construction loans, specializing in originating and servicing loans for multi-family rental and senior living properties. In addition, the Company originates loans secured by an assignment of federal income tax credits by partnerships invested in multi-family real estate projects. Construction and land loans are generally based upon estimates of costs and estimated value of the completed project and include independent appraisal reviews and a financial analysis of the developers and property owners. Sources of repayment of these loans may include permanent loans, sales of developed property or an interim loan commitment from the Company until permanent agency-eligible financing is obtained. These loans are considered to be higher risk than other real estate loans due to their ultimate repayment being sensitive to interest rate changes, general economic conditions and the availability of long-term financing. Credit risk in these loans may be impacted by the creditworthiness of a borrower, property values and the local economy in the Company’s market area. Repayment of these loans depends on the successful operation of a business or property and the borrower’s cash flows.

Commercial Lending and Commercial Real Estate Loans (CML & CRE): The commercial lending and commercial real estate portfolio includes loans to commercial customers for use in financing working capital needs, equipment purchases and expansions, as well as loans to commercial customers to finance land and improvements. It also includes loans collateralized by mortgage servicing rights and loan sale proceeds of mortgage warehouse customers. The loans in this category are repaid primarily from the cash flow of a borrower’s principal business operation. Credit risk in these loans is driven by creditworthiness of a borrower and the economic conditions that impact the cash flow stability from business operations.

Agricultural Production and Real Estate Loans (AG & AGRE): Agricultural production loans are generally comprised of seasonal operating lines of credit to grain farmers to plant and harvest corn and soybeans and term loans to fund the purchase of equipment. The Company also offers long term financing to purchase agricultural real estate. Specific underwriting standards have been established for agricultural-related loans including the establishment of projections for each operating year based on industry-developed estimates of farm input costs and expected commodity yields and prices. Operating lines are typically written for one year and secured by the crop and other farm assets as considered necessary. The Company is approved to sell agricultural loans in the secondary market through the Federal Agricultural Mortgage Corporation and uses this relationship to manage interest rate risk within the portfolio.

Consumer and Margin Loans (CON & MAR): Consumer loans are those loans secured by household assets. Margin loans are those loans secured by marketable securities. The term and maximum amount for these loans are determined by considering the purpose of the loan, the margin (advance percentage against value) in all collateral, the primary source of repayment, and the borrower’s other related cash flow.

Allowance for Loan Losses: The allowance for loan losses is established as losses are estimated to have occurred through a provision for loan losses charged to net interest income. Loan losses are charged against the allowance when

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Notes to Condensed Consolidated Financial Statements

(Unaudited)

management believes the uncollectability of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance.

The allowance for loan losses is evaluated on a regular basis by management and is based upon management’s periodic review of the collectability of the loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral and prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available.

The allowance consists of allocated and general components. The allocated component relates to loans that are classified as impaired. For those loans that are classified as impaired, an allowance is established when the discounted cash flows (collateral value or observable market price) of the impaired loan is lower than the carrying value of that loan. The general component covers non-impaired loans and is based on historical charge-off experience and expected loss given default derived from the Company’s internal risk rating process. Other adjustments may be made to the allowance for pools of loans after an assessment of internal or external influences on credit quality that are not fully reflected in the historical loss or risk rating data.

A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record and the amount of the shortfall in relation to the principal and interest owed. Impairment is measured on a loan-by-loan basis for commercial and construction loans by the fair value of the collateral if the loan is collateral dependent, the loan’s obtainable market price, or either the present value of expected future cash flows discounted at the loan’s effective interest rate. For impaired loans where the Company utilizes discounted cash flows to determine the level of impairment, the Company includes the entire change in the present value of cash flows as bad debt expense.

Groups of loans with similar risk characteristics are collectively evaluated for impairment based on the group’s historical loss experience adjusted for changes in trends, conditions and other relevant factors that affect repayment of the loans. Accordingly, the Company does not separately identify individual consumer and residential loans for impairment measurements, unless such loans are the subject of a restructuring agreement due to financial difficulties of the borrower.

In the course of working with borrowers, the Company may choose to restructure the contractual terms of certain loans. In restructuring the loan, the Company attempts to work out an alternative payment schedule with the borrower in order to optimize collectability of the loan. A troubled debt restructuring (“TDR)” occurs when, for economic or legal reasons related to a borrower’s financial difficulties, the Company grants a concession to the borrower that it would not otherwise consider. Terms may be modified to fit the ability of the borrower to repay in line with its current financial status, and the restructuring of the loan may include the transfer of assets from the borrower to satisfy the debt, a modification of loan terms, or a combination of the two.

Nonaccrual loans, including TDRs that have not met the six-month minimum performance criterion, are reported as nonperforming loans. For all loan classes, it is the Company’s policy to have any restructured loans which are on nonaccrual status prior to being restructured remain on nonaccrual status until three months of satisfactory borrower performance, at which time management would consider its return to accrual status. A loan is generally classified as nonaccrual when the Company believes that receipt of principal and interest is doubtful under the terms of the loan agreement. Most generally, this is at 90 or more days past due.

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Notes to Condensed Consolidated Financial Statements

(Unaudited)

With regard to determination of the amount of the allowance for credit losses, restructured loans are considered to be impaired. As a result, the determination of the amount of impaired loans for each loan portfolio segment within troubled debt restructurings is the same as detailed previously above.

The following tables present, by loan portfolio segment, the activity in the allowance for loan losses for the three months ended March 31, 2020 and 2019 and the recorded investment in loans and impairment method as of March 31, 2020:


	At or For the Three Months Ended March 31, 2020
	MTG WHLOC		RES RE		MF RE		CML & CRE		AG & AGRE		CON & MAR		TOTAL
	(In thousands)
Allowance for loan losses
Balance, beginning of period	$	1,913	$	2,042	$	7,018	$	4,173	$	523	$	173	$	15,842
Provision (credit) for loan losses		796		20		676		1,445		38		23		2,998
Loans charged to the allowance		—		—		—		—		—		(1)		(1)
Recoveries of loans previously charged off		—		—		—		44		—		—		44
Balance, end of period	$	2,709	$	2,062	$	7,694	$	5,662	$	561	$	195	$	18,883
Ending balance: individually evaluated for impairment	$	—		29		—		1,167		—		6	$	1,202
Ending balance: collectively evaluated for impairment	$	2,709	$	2,033	$	7,694	$	4,495	$	561	$	189	$	17,681
Loans
Ending balance	$	1,083,776	$	421,978	$	1,435,206	$	468,668	$	92,498	$	18,527	$	3,520,653
Ending balance individually evaluated for impairment	$	230	$	2,410	$	—	$	9,425	$	2,043	$	16	$	14,124
Ending balance collectively evaluated for impairment	$	1,083,546	$	419,568	$	1,435,206	$	459,243	$	90,455	$	18,511	$	3,506,529


	For the Three Months Ended March 31, 2019
	MTG WHLOC		RES RE		MF RE		CML & CRE		AG & AGRE		CON & MAR		TOTAL
	(In thousands)
Allowance for loan losses
Balance, beginning of period	$	1,068	$	1,986	$	6,030	$	3,051	$	429	$	140	$	12,704
Provision (credit) for loan losses		186		4		347		71		34		7		649
Loans charged to the allowance		—		—		—		—		—		—		—
Recoveries of loans previously charged off		—		—		—		—		3		—		3
Balance, end of period	$	1,254	$	1,990	$	6,377	$	3,122	$	466	$	147	$	13,356

The following table presents the allowance for loan losses and the recorded investment in loans and impairment method as of December 31, 2019:


	December 31, 2019
	MTG WHLOC		RES RE		MF RE		CML & CRE		AG & AGRE		CON & MAR		TOTAL
	(In thousands)
Allowance for loan losses
Balance, December 31, 2019	$	1,913	$	2,042	$	7,018	$	4,173	$	523	$	173	$	15,842
Ending balance: individually evaluated for impairment	$	—	$	23	$	—	$	650	$	—	$	8	$	681
Ending balance: collectively evaluated for impairment	$	1,913	$	2,019	$	7,018	$	3,523	$	523	$	165	$	15,161
Loans
Balance, December 31, 2019	$	765,151	$	413,835	$	1,347,125	$	398,601	$	85,210	$	18,388	$	3,028,310
Ending balance individually evaluated for impairment	$	233	$	3,109	$	—	$	9,152	$	—	$	23	$	12,517
Ending balance collectively evaluated for impairment	$	764,918	$	410,726	$	1,347,125	$	389,449	$	85,210	$	18,365	$	3,015,793

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Notes to Condensed Consolidated Financial Statements

(Unaudited)

Internal Risk Categories

In adherence with policy, the Company uses the following internal risk grading categories and definitions for loans:

Average or above – Loans to borrowers of satisfactory financial strength or better. Earnings performance is consistent with primary and secondary sources of repayment that are well defined and adequate to retire the debt in a timely and orderly fashion. These businesses would generally exhibit satisfactory asset quality and liquidity with moderate leverage, average performance to their peer group and experienced management in key positions. These loans are disclosed as “Acceptable and Above” in the following table.

Acceptable – Loans to borrowers involving more than average risk and which contain certain characteristics that require some supervision and attention by the lender. Asset quality is acceptable, but debt capacity is modest and little excess liquidity is available. The borrower may be fully leveraged and unable to sustain major setbacks. Covenants are structured to ensure adequate protection. Borrower’s management may have limited experience and depth. This category includes loans which are highly leveraged due to regulatory constraints, as well as loans involving reasonable exceptions to policy. These loans are disclosed as “Acceptable and Above” in the following table.

Special Mention (Watch) – This is a loan that is sound and collectable but contains considerable risk. Loans classified as special mention have a potential weakness that deserves management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or of the institution’s credit position at some future date.

Substandard - Loans classified as substandard are inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. Loans so classified have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the institution will sustain some loss if the deficiencies are not corrected.

Doubtful - Loans classified as doubtful have all the weaknesses inherent in those classified as substandard, with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable.

The following tables present the credit risk profile of the Company’s loan portfolio based on internal rating category and payment activity as of March 31, 2020 and December 31, 2019:


	March 31, 2020
	MTG WHLOC		RES RE		MF RE		CML & CRE		AG & AGRE		CON & MAR		TOTAL
	(In thousands)

Special Mention (Watch)	$	—	$	2,413	$	30,930	$	12,961	$	2,006	$	30	$	48,340
Substandard		230		2,410		—		9,425		2,043		16		14,124
Doubtful		—		—		—		—		—		—		—
Acceptable and Above		1,083,546		417,155		1,404,276		446,282		88,449		18,481		3,458,189
Total	$	1,083,776	$	421,978	$	1,435,206	$	468,668	$	92,498	$	18,527	$	3,520,653

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Notes to Condensed Consolidated Financial Statements

(Unaudited)


	December 31, 2019
	MTG WHLOC		RES RE		MF RE		CML & CRE		AG & AGRE		CON & MAR		TOTAL
	(In thousands)

Special Mention (Watch)	$	—	$	2,472	$	41,882	$	13,806	$	2,114	$	31	$	60,305
Substandard		233		3,109		—		9,152		—		23		12,517
Doubtful		—		—		—		—		—		—		—
Acceptable and Above		764,918		408,254		1,305,243		375,643		83,096		18,334		2,955,488
Total	$	765,151	$	413,835	$	1,347,125	$	398,601	$	85,210	$	18,388	$	3,028,310

The Company evaluates the loan risk grading system definitions and allowance for loan loss methodology on an ongoing basis. No significant changes were made to either during the past year.

The following tables present the Company’s loan portfolio aging analysis of the recorded investment in loans as of March 31, 2020 and December 31, 2019:


	March 31, 2020
	30-59 Days		60-89 Days		Greater Than		Total				Total
	Past Due		Past Due		90 Days		Past Due		Current		Loans
	(In thousands)
MTG WHLOC	$	—	$	—	$	—	$	—	$	1,083,776	$	1,083,776
RES RE		1,002		289		1,972		3,263		418,715		421,978
MF RE		—		—		—		—		1,435,206		1,435,206
CML & CRE		274		622		2,180		3,076		465,592		468,668
AG & AGRE		429		152		1,908		2,489		90,009		92,498
CON & MAR		610		36		42		688		17,839		18,527
	$	2,315	$	1,099	$	6,102	$	9,516	$	3,511,137	$	3,520,653


	December 31, 2019
	30-59 Days		60-89 Days		Greater Than		Total				Total
	Past Due		Past Due		90 Days		Past Due		Current		Loans
	(In thousands)
MTG WHLOC	$	—	$	—	$	—	$	—	$	765,151	$	765,151
RES RE		3,089		562		2,324		5,975		407,860		413,835
MF RE		—		—		—		—		1,347,125		1,347,125
CML & CRE		2,293		335		1,663		4,291		394,310		398,601
AG & AGRE		2,047		—		195		2,242		82,968		85,210
CON & MAR		50		31		19		100		18,288		18,388
	$	7,479	$	928	$	4,201	$	12,608	$	3,015,702	$	3,028,310

A loan is considered impaired, in accordance with the impairment accounting guidance (ASC 310-10-35-16), when based on current information and events, it is probable the Company will be unable to collect all amounts due from the borrower in accordance with the contractual terms of the loan. Impaired loans include nonperforming commercial loans but also include loans modified in TDRs.

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Notes to Condensed Consolidated Financial Statements

(Unaudited)

The following tables present impaired loans and specific valuation allowance information based on class level as of March 31, 2020 and December 31, 2019:


	March 31, 2020
	MTG WHLOC		RES RE		MF RE		CML & CRE		AG & AGRE		CON & MAR		TOTAL
	(In thousands)
Impaired loans without a specific allowance:
Recorded investment	$	230	$	2,179	$	—	$	7,028	$	2,043	$	7	$	11,487
Unpaid principal balance		230		2,179		—		7,028		2,043		7		11,487
Impaired loans with a specific allowance:
Recorded investment		—		231		—		2,397		—		9		2,637
Unpaid principal balance		—		231		—		2,397		—		9		2,637
Specific allowance		—		29		—		1,167		—		6		1,202
Total impaired loans:
Recorded investment		230		2,410		—		9,425		2,043		16		14,124
Unpaid principal balance		230		2,410		—		9,425		2,043		16		14,124
Specific allowance		—		29		—		1,167		—		6		1,202


	December 31, 2019
	MTG WHLOC		RES RE		MF RE		CML & CRE		AG & AGRE		CON & MAR		TOTAL
	(In thousands)
Impaired loans without a specific allowance:
Recorded investment	$	233	$	2,899	$	—	$	6,662	$	—	$	12	$	9,806
Unpaid principal balance		233		2,899		—		6,662		—		12		9,806
Impaired loans with a specific allowance:
Recorded investment		—		210		—		2,490		—		11		2,711
Unpaid principal balance		—		210		—		2,490		—		11		2,711
Specific allowance		—		23		—		650		—		8		681
Total impaired loans:
Recorded investment		233		3,109		—		9,152		—		23		12,517
Unpaid principal balance		233		3,109		—		9,152		—		23		12,517
Specific allowance		—		23		—		650		—		8		681

The following tables present by portfolio class, information related to the average recorded investment and interest income recognized on impaired loans for the three months ended March 31, 2020 and 2019:


	MTG WHLOC		RES RE		MF RE		CML & CRE		AG & AGRE		CON & MAR		TOTAL
	(In thousands)
Three Months Ended March 31, 2020
Average recorded investment in impaired loans	$	231	$	3,088	$	—	$	9,502	$	2,043	$	20	$	14,884
Interest income recognized		—		16		—		131		—		—		147

Three Months Ended March 31, 2019
Average recorded investment in impaired loans	$	574	$	2,806	$	—	$	8,468	$	364	$	48	$	12,260
Interest income recognized		—		15		—		140		—		—		155

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Notes to Condensed Consolidated Financial Statements

(Unaudited)

The following table presents the Company’s nonaccrual loans and loans past due 90 days or more and still accruing at March 31, 2020 and December 31, 2019.


	March 31,				December 31,
	2020				2019
			Total Loans >				Total Loans >
			90 Days &				90 Days &
	Nonaccrual		Accruing		Nonaccrual		Accruing
	(In thousands)
MTG WHLOC	$	230	$	—	$	233	$	—
RES RE		664		1,551		740		1,851
MF RE		—		—		—		—
CML & CRE		1,766		396		1,118		486
AG & AGRE		—		1,908		—		231
CON & MAR		16		26		18		1

	$	2,676	$	3,881	$	2,109	$	2,569

No troubled loans were restructured during the three months ended March 31, 2020 or 2019. No restructured loans defaulted during the three months ended March 31, 2020 or 2019. Loan modifications or forbearances related to the COVID-19 pandemic will generally not be considered TDRs.

There was one customer with a residential loan balance of $725,000 in the process of foreclosure at December 31, 2019 that was paid in full at March 31, 2020 and there were no residential loans in process of foreclosure as of March 31, 2020.

Note 5: Regulatory Matters

The Company, Merchants Bank, and FMBI are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory, and possibly additional discretionary, actions by federal and state banking regulators that, if undertaken, could have a direct material effect on the Company’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company, Merchants Bank, and FMBI must meet specific capital guidelines that involve quantitative measures of the Company’s, Merchants Bank’s, and FMBI’s assets, liabilities and certain off-balance-sheet items as calculated under regulatory accounting practices. The Company’s, Merchants Bank’s, and FMBI’s capital amounts and classification are also subject to qualitative judgments by the regulators about components, and other factors. Furthermore, the Company’s, Merchants Bank’s, and FMBI’s regulators could require adjustments to regulatory capital not reflected in these financial statements.

Quantitative measures established by regulation to ensure capital adequacy require the Company, Merchants Bank, and FMBI to maintain minimum amounts and ratios (set forth in the table below). Management believes, as of March 31, 2020 and December 31, 2019, that the Company, Merchants Bank, and FMBI met all capital adequacy requirements to which they were subject.

As of March 31, 2020 and December 31, 2019, the most recent notifications from the Board of Governors of the Federal Reserve System (“Federal Reserve”) categorized the Company as well capitalized and most recent notifications from the Federal Deposit Insurance Corporation (“FDIC”) categorized Merchants Bank and FMBI as well capitalized under the regulatory framework for prompt corrective action. There are no conditions or events since that notification that management believes have changed the Company’s, Merchants Bank’s, or FMBI’s category.

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Notes to Condensed Consolidated Financial Statements

(Unaudited)

holding companies, as directed under the Economic Growth, Regulatory Relief, and Consumer Protection Act. Under CBLR, if a qualifying depository institution or depository institution holding company elects to use such measure, such institution or holding company will be considered well capitalized if its ratio of Tier 1 capital to average total consolidated assets (i.e., leverage ratio) exceeds 9%, subject to a limited two quarter grace period, during which the leverage ratio cannot go 100 basis points below the then applicable threshold, and will not be required to calculate and report risk-based capital ratios. In April 2020, under the Coronavirus Aid, Relief, and Economic Security Act (CARES Act”), the 9% leverage ratio threshold was temporarily reduced to 8% in response to the COVID-19 pandemic. The threshold will increase to 8.5% in 2021 and return to 9% in 2022. The Company, Merchants Bank, and FMBI elected to begin using CBLR for the first quarter of 2020.

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Notes to Condensed Consolidated Financial Statements

(Unaudited)

The Company’s, Merchants Bank’s, and FMBI’s actual capital amounts and ratios are presented in the following tables.



					Minimum Amount
					To Be Well
	Actual				Capitalized(1)
	Amount		Ratio		Amount		Ratio
	(Dollars in thousands)
March 31, 2020
Tier 1 capital(1) (to average assets)
(i.e., leverage ratio)
Company	$	652,781	9.9	%	$	592,662	> 9	%
Merchants Bank		642,891	10.1	%		574,263	> 9	%
FMBI		21,969	10.7	%		18,397	> 9	%


					Minimum				Minimum
					Amount Required				Amount To Be
					for Adequately				Well
	Actual				Capitalized(1)				Capitalized(1)
	Amount		Ratio		Amount		Ratio		Amount		Ratio
	(Dollars in thousands)
December 31, 2019
Total capital(1) (to risk-weighted assets)
Company	$	637,472	11.6	%	$	440,063	8.0	%	$	—	N/A
Merchants Bank		639,104	12.0	%		426,748	8.0	%		533,435	10.0	%
FMBI		21,726	13.1	%		13,306	8.0	%		16,632	10.0	%
Tier 1 capital(1) (to risk-weighted assets)
Company		621,630	11.3	%		330,047	6.0	%		—	N/A
Merchants Bank		623,716	11.7	%		320,061	6.0	%		426,748	8.0	%
FMBI		21,272	12.8	%		9,979	6.0	%		13,306	8.0	%
Common Equity Tier 1 capital(1) (to risk-weighted assets)
Company		408,984	7.4	%		247,536	4.5	%		—	N/A
Merchants Bank		623,716	11.7	%		240,046	4.5	%		346,733	6.5	%
FMBI		21,272	12.8	%		7,484	4.5	%		10,811	6.5	%
Tier 1 capital(1) (to average assets)
Company		621,630	9.4	%		264,324	4.0	%		—	N/A
Merchants Bank		623,716	9.7	%		257,487	4.0	%		321,859	5.0	%
FMBI		21,272	11.7	%		7,302	4.0	%		9,128	5.0	%

As defined by regulatory agencies.

Failure to exceed the leverage ratio thresholds required under CBLR in the future, subject to any applicable grace period, would require the Company, Merchants Bank, and/or FMBI to return to the risk-based capital ratio thresholds previously utilized under the fully phased-in Basel III Capital Rules to determine capital adequacy.

Note 6: Derivative Financial Instruments

The Company uses derivative financial instruments to help manage exposure to interest rate risk and the effects that changes in interest rates may have on net income and the fair value of assets and liabilities.

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Merchants Bancorp

Notes to Condensed Consolidated Financial Statements

(Unaudited)

Forward Sales Commitments and Interest Rate Lock Commitments

The Company enters into forward contracts for the future delivery of mortgage loans to third party investors and enters into interest rate lock commitments with potential borrowers to fund specific mortgage loans that will be sold into the secondary market. The forward contracts are entered into in order to economically hedge the effect of changes in interest rates resulting from the Company’s commitment to fund the loans.

Each of these items are considered derivatives, but are not designated as accounting hedges, and are recorded at fair value with changes in fair value reflected in noninterest income on the condensed consolidated statements of income. The fair value of derivative instruments with a positive fair value are reported in other assets in the condensed consolidated balance sheets while derivative instruments with a negative fair value are reported in other liabilities in the condensed consolidated balance sheets.

The following table presents the notional amount and fair value of interest rate locks and forward contracts utilized by the Company at March 31, 2020 and December 31, 2019.


		Notional			Fair Value
		Amount	Balance Sheet Location		Asset		Liability
March 31, 2020		(In thousands)			(In thousands)
Interest rate lock commitments	$	162,228	Other assets/liabilities	$	2,079	$	80
Forward contracts		122,706	Other assets/liabilities		96		1,273
				$	2,175	$	1,353


		Notional			Fair Value
		Amount	Balance Sheet Location		Asset		Liability
December 31, 2019		(In thousands)			(In thousands)
Interest rate lock commitments	$	17,826	Other assets/liabilities	$	186	$	—
Forward contracts		34,268	Other assets/liabilities		—		27
				$	186	$	27

Fair values of these derivative financial instruments were estimated using changes in mortgage interest rates from the date the Company entered into the interest rate lock commitment and the balance sheet date. The following table summarizes the periodic changes in the fair value of the derivative financial instruments on the condensed consolidated statements of income for the three months ended March 31, 2020 and 2019.


	Three Months Ended
	March 31,
	2020		2019
	(In thousands)
Interest rate lock commitments	$	1,813	$	—
Forward contracts (includes pair-off settlements)		(1,844)		(5)
Net derivative gains (losses)	$	(31)	$	(5)

Derivatives on Behalf of Customers

The Company offers derivative contracts to some customers in connection with their risk management needs. These derivatives include interest rate swaps. The Company manages the risk associated with these contracts by entering into an equal and offsetting derivative with a third-party dealer. These derivatives generally work together as an economic interest rate hedge, but the Company does not designate them for hedge accounting treatment. Consequently, changes in fair value of the corresponding derivative financial asset or liability were recorded as either a charge or credit to current

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Notes to Condensed Consolidated Financial Statements

(Unaudited)

earnings during the period in which the changes occurred, typically resulting in no net earnings impact. The fair values of derivative assets and liabilities related to derivatives for customers with interest rate swaps were recorded in the condensed consolidated balance sheets as follows:


		Notional			Fair Value
		Amount	Balance Sheet Location		Asset		Liability
		(In thousands)			(In thousands)
March 31, 2020	$	62,470	Other assets/liabilities	$	3,214	$	3,214
December 31, 2019		58,067	Other assets/liabilities	$	511	$	511

The gross gains and losses on these derivative assets and liabilities were recorded in Other Noninterest income and Other Noninterest expense in the condensed consolidated statements of income as follows:


	Three Months Ended
	March 31,
	2020		2019
		(In thousands)
Gross swap gains	$	2,703	$	—
Gross swap losses		(2,703)		—
Net swap gains (losses)		—	$	—

The Company pledged $3.1 million and $590,000 in collateral to secure its obligations under swap contracts at March 31, 2020 and December 31, 2019, respectively.

Note 7: Disclosures about Fair Value of Assets and Liabilities

Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Fair value measurements must maximize the use of observable inputs and minimize the use of unobservable inputs. There is a hierarchy of three levels of inputs that may be used to measure fair value:

Level 1 Quoted prices in active markets for identical assets or liabilities

Level 2 Observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities

Level 3 Unobservable inputs supported by little or no market activity and are significant to the fair value of the assets or liabilities

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Notes to Condensed Consolidated Financial Statements

(Unaudited)

Recurring Measurements

The following tables present the fair value measurements of assets and liabilities recognized in the accompanying balance sheets measured at fair value on a recurring basis and the level within the fair value hierarchy in which the fair value measurements fall at March 31, 2020 and December 31, 2019:


	Fair Value Measurements Using
			Quoted Prices in		Significant
			Active Markets		Other		Significant
			for Identical		Observable		Unobservable
	Fair		Assets		Inputs		Inputs
Assets	Value		(Level 1)		(Level 2)		(Level 3)
	(In thousands)
March 31, 2020
Trading securities	$	465,157	$	—	$	465,157	$	—
Available-for-sale securities:
Treasury notes		2,043		2,043		—		—
Federal agencies		306,575		—		306,575		—
Municipals		5,951		—		5,951		—
Mortgage-backed - Government-sponsored entity (GSE) - residential		24,484		—		24,484		—
Loans held for sale		18,938		—		18,938		—
Mortgage servicing rights		69,978		—		—		69,978
Derivative assets - interest rate lock commitments		2,079		—		—		2,079
Derivative assets - forward contracts		96		—		96		—
Derivative assets - interest rate swaps		3,214		—		3,214		—
Derivative liabilities - interest rate lock commitments		80		—		—		80
Derivative liabilities - forward contracts		1,273		—		1,273		—
Derivative liabilities - interest rate swaps		3,214		—		3,214		—


December 31, 2019
Trading securities	$	269,891	$	—	$	269,891	$	—
Available-for-sale securities:
Treasury notes		4,765		4,765		—		—
Federal agencies		244,973		—		244,973		—
Municipals		5,937		—		5,937		—
Mortgage-backed - Government-sponsored entity (GSE) - residential		34,568		—		34,568		—
Loans held for sale		19,592		—		19,592		—
Mortgage servicing rights		74,387		—		—		74,387
Derivative assets - interest rate lock commitments		186		—		—		186
Derivative asset - interest rate swap		511		—		511		—
Derivative liabilities - forward contracts		27		—		27		—
Derivative liabilities - interest rate swap		511		—		511		—

Following is a description of the valuation methodologies and inputs used for assets measured at fair value on a recurring basis and recognized in the accompanying balance sheets, as well as the general classification of such assets pursuant to the valuation hierarchy. There have been no significant changes in the valuation techniques during the three months ended March 31, 2020 and the year ended December 31, 2019. For assets classified within Level 3 of the fair value hierarchy, the process used to develop the reported fair value is described below.

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Notes to Condensed Consolidated Financial Statements

(Unaudited)

Trading and Available-for-Sale Securities

Where quoted market prices are available in an active market, securities such as U.S. Treasuries are classified within Level 1 of the valuation hierarchy. If quoted market prices are not available, then fair values are estimated by using quoted prices of securities with similar characteristics or independent asset pricing services and pricing models, the inputs of which are market-based or independently sourced market parameters, including, but not limited to, yield curves, interest rates, volatilities, prepayments, defaults, cumulative loss projections and cash flows. Such securities are classified in Level 2 of the valuation hierarchy including federal agencies, mortgage-backed securities, U.S. Treasuries, and Federal Housing Administration participation certificates. In certain cases where Level 1 or Level 2 inputs are not available, securities are classified within Level 3 of the hierarchy.

Loans Held for Sale

Certain loans held for sale at fair value are saleable into the secondary mortgage markets and their fair values are estimated using observable quoted market or contracted prices, or market price equivalents, which would be used by other market participants. These saleable loans are considered Level 2.

Mortgage Servicing Rights

Mortgage servicing rights do not trade in an active, open market with readily observable prices. Accordingly, fair value is estimated using discounted cash flow models having significant inputs of discount rate, prepayment speed, and default rate. Due to the nature of the valuation inputs, mortgage servicing rights are classified within Level 3 of the hierarchy.

The Chief Financial Officer’s (CFO) office contracts with a pricing specialist to generate fair value estimates on a quarterly basis. The CFO’s office challenges the reasonableness of the assumptions used and reviews the methodology to ensure the estimated fair value complies with accounting standards generally accepted in the United States.

Derivative Financial Instruments

The Company estimates the fair value of interest rate lock commitments based on the value of the underlying mortgage loan, quoted mortgage backed security prices, estimates of the fair value of the mortgage servicing rights, and an estimate of the probability that the mortgage loan will fund within the terms of the interest rate lock commitment, net of expenses. With respect to its interest rate lock commitments, management determined that a Level 3 classification was most appropriate based on the various significant unobservable inputs utilized in estimating the fair value of its interest rate lock commitments. The Company estimates the fair value of forward sales commitments based on market quotes of mortgage backed security prices for securities similar to the ones used, which are considered Level 2. The fair value of interest rate swaps is based on prices that are obtained from a third party that uses observable market inputs, thereby supporting a Level 2 classification. Changes in fair value of the Company’s derivative financial instruments are recognized through noninterest income and/or noninterest expenses on its condensed consolidated statement of income.

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Notes to Condensed Consolidated Financial Statements

(Unaudited)

Level 3 Reconciliation

The following is a reconciliation of the beginning and ending balances of recurring fair value measurements recognized in the accompanying balance sheets using significant unobservable (Level 3) inputs:


	Three Months Ended March 31,
	2020		2019
	(In thousands)
Mortgage servicing rights
Balance, beginning of period	$	74,387	$	77,844
Additions
Originated and purchased servicing		3,929		1,020
Subtractions
Paydowns		(1,858)		(1,110)
Changes in fair value due to changes in valuation inputs or assumptions used in the valuation model		(6,480)		(1,505)
Balance, end of period	$	69,978	$	76,249

Derivative Assets - interest rate lock commitments
Balance, beginning of period	$	186	$	70
Changes in fair value		1,893		1
Balance, end of period	$	2,079	$	71

Derivative Liabilities - interest rate lock commitments
Balance, beginning of period	$	—	$	—
Changes in fair value		80		1
Balance, end of period	$	80	$	1

Nonrecurring Measurements

The following table presents the fair value measurement of assets measured at fair value on a nonrecurring basis and the level within the fair value hierarchy in which the fair value measurements fall at March 31, 2020 and December 31, 2019.


	Fair Value Measurements Using
			Quoted Prices in		Significant
			Active Markets		Other		Significant
			for Identical		Observable		Unobservable
	Fair		Assets		Inputs		Inputs
Assets	Value		(Level 1)		(Level 2)		(Level 3)
	(In thousands)
March 31, 2020
Impaired loans (collateral-dependent)	$	1,306	$	—	$	—	$	1,306
December 31, 2019
Impaired loans (collateral-dependent)	$	1,570	$	—	$	—	$	1,570

Following is a description of the valuation methodologies and inputs used for assets measured at fair value on a nonrecurring basis and recognized in the accompanying balance sheet, as well as the general classification of such assets pursuant to the valuation hierarchy. For assets classified within Level 3 of the fair value hierarchy, the process used to develop the reported fair value is described below.

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Notes to Condensed Consolidated Financial Statements

(Unaudited)

Collateral-Dependent Impaired Loans, Net of Allowance for Loan Losses

The estimated fair value of collateral-dependent impaired loans is based on the appraised fair value of the collateral, less estimated cost to sell. Collateral-dependent impaired loans are classified within Level 3 of the fair value hierarchy.

The Company considers the appraisal or evaluation as the starting point for determining fair value and then considers other factors and events in the environment that may affect the fair value. Appraisals of the collateral underlying collateral-dependent loans are obtained when the loan is determined to be collateral-dependent and subsequently as deemed necessary by the Company’s Chief Credit Officer’s (CCO) office. Appraisals are reviewed for accuracy and consistency by the CCO’s office. Appraisers are selected from the list of approved appraisers maintained by management. The appraised values are reduced by discounts to consider lack of marketability and estimated cost to sell if repayment or satisfaction of the loan is dependent on the sale of the collateral. These discounts and estimates are developed by the CCO’s office by comparison to historical results.

Unobservable (Level 3) Inputs:

The following table presents quantitative information about unobservable inputs used in recurring and nonrecurring Level 3 fair value measurements other than goodwill.


			Valuation
	Fair Value		Technique	Unobservable Inputs	Range
	(In thousands)
At March 31, 2020:
Collateral-dependent impaired loans	$	1,306	Market comparable properties	Marketability discount	44% - 75%
Mortgage servicing rights	$	69,978	Discounted cash flow	Discount rate	8% - 13%
				Constant prepayment rate	2% - 43%
Derivative assets - interest rate lock commitments	$	2,079	Discounted cash flow	loan closing rates	56-99%
Derivative liabilities - interest rate lock commitments	$	80	Discounted cash flow	loan closing rates	56-99%

At December 31, 2019:
Collateral-dependent impaired loans	$	1,570	Market comparable properties	Marketability discount	37%-55%
Mortgage servicing rights	$	74,387	Discounted cash flow	Discount rate	8% - 13%
				Constant prepayment rate	1% - 39%
Derivative assets - interest rate lock commitments	$	186	Discounted cash flow	loan closing rates	73-99%

Sensitivity of Significant Unobservable Inputs

The following is a discussion of the sensitivity of significant unobservable inputs, the interrelationships between those inputs and other unobservable inputs used in recurring fair value measurement, and of how those inputs might magnify or mitigate the effect of changes in the unobservable inputs on the fair value measurement.

Mortgage Servicing Rights

The significant unobservable inputs used in the fair value measurement of the Company’s mortgage servicing rights are discount rates and constant prepayment rates. Significant increases or decreases in any of those inputs in isolation would result in a significantly different fair value measurement.

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Notes to Condensed Consolidated Financial Statements

(Unaudited)

Fair Value of Financial Instruments

The following table presents the carrying amount and estimated fair values of the Company’s financial instruments not carried at fair value and the level within the fair value hierarchy in which the fair value measurements fall at March 31, 2020 and December 31, 2019.


			Fair Value Measurements Using
					Quoted Prices in		Significant
					Active Markets		Other		Significant
					for Identical		Observable		Unobservable
	Carrying		Fair		Assets		Inputs		Inputs
Assets	Value		Value		(Level 1)		(Level 2)		(Level 3)
	(In thousands)
March 31, 2020
Financial assets:
Cash and cash equivalents	$	568,082	$	568,082	$	568,082	$	—	$	—
Securities purchased under agreements to resell		6,685		6,685		—		6,685		—
FHLB stock		46,156		46,156		—		46,156		—
Loans held for sale		2,777,070		2,777,070		—		2,777,070		—
Loans, net		3,501,770		3,475,393		—		—		3,475,393
Interest receivable		18,139		18,139		—		18,139		—
Financial liabilities:
Deposits		6,722,705		6,730,101		3,967,232		2,762,869		—
Lines of credit		—		—		—		—		—
Short-term subordinated debt		12,650		12,650		—		12,650		—
FHLB advances		431,917		431,283		—		431,283		—
Interest payable		10,219		10,219		—		10,219		—


December 31, 2019
Financial assets:
Cash and cash equivalents	$	506,709	$	506,709	$	506,709	$	—	$	—
Securities purchased under agreements to resell		6,723		6,723		—		6,723		—
FHLB stock		20,369		20,369		—		20,369		—
Loans held for sale		2,074,197		2,074,197		—		2,074,197		—
Loans, net		3,012,468		2,999,580		—		—		2,999,580
Interest receivable		18,359		18,359		—		18,359		—
Financial liabilities:
Deposits		5,478,075		5,478,682		3,303,736		2,174,946		—
Lines of credit		6,540		6,540		—		6,540		—
Short-term subordinated debt		12,200		12,200		—		12,200		—
FHLB advances		162,699		162,803		—		162,803		—
Interest payable		11,938		11,938		—		11,938		—

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Notes to Condensed Consolidated Financial Statements

(Unaudited)

Note 8: Earnings Per Share

Earnings per share were computed as follows:


	Three Month Periods Ended March 31,
	2020					2019
			Weighted-	Per				Weighted-	Per
	Net		Average	Share		Net		Average	Share
	Income		Shares	Amount		Income		Shares	Amount
	(In thousands)					(In thousands)
Net income	$	24,583				$	10,570
Dividends on preferred stock		(3,618)					(833)
Net income allocated to common shareholders	$	20,965				$	9,737
Basic earnings per share			28,734,632	$	0.73			28,702,250	$	0.34
Effect of dilutive securities-restricted stock awards			24,780					35,189
Diluted earnings per share			28,759,412	$	0.73			28,737,439	$	0.34

Note 9: Share-Based Payment Plans

Equity-based incentive awards are currently issued pursuant to the 2017 Equity Incentive Plan (the “2017 Incentive Plan”). Prior to the adoption of the 2017 Incentive Plan, the equity awards issued historically consisted of restricted stock awards issued pursuant to the Incentive Plan for Merchants Bank Executive Officers (the “Prior Incentive Plan”). As of the effective date of the 2017 Equity Incentive Plan, no further awards will be granted under the Prior Incentive Plan. However, any previously outstanding incentive award granted under the Prior Incentive Plan remains subject to the terms of such plan until the time it is no longer outstanding. During the three months ended March 31, 2020 and March 31, 2019, the Company issued 36,046 and 10,127 shares, respectively, pursuant to these plans.

During 2018, the Compensation Committee of the Board of Directors approved a plan for non-executive directors to receive a portion of their annual retainer fees in the form of shares of common stock equal to $10,000, rounded up to the nearest whole share. There were no shares issued to non-executive directors during the three months ended March 31, 2020 or March 31, 2019.

Note 10: Segment Information

Our business segments are defined as Multi-family Mortgage Banking, Mortgage Warehousing, and Banking. The reportable business segments are consistent with the internal reporting and evaluation of the principal lines of business of the Company. The Multi-family Mortgage Banking segment originates and services government sponsored mortgages for multi-family and healthcare facilities. The Mortgage Warehousing segment funds agency eligible residential loans from the date of origination or purchase, until the date of sale in the secondary market, as well as commercial loans to non-depository financial institutions. The Banking segment provides a wide range of financial products and services to consumers and businesses, including retail banking, commercial lending, agricultural lending, retail and correspondent residential mortgage banking, and Small Business Administration (“SBA”) lending. Other includes general and administrative expenses that provide services to all segments, internal funds transfer pricing offsets resulting from allocations to/from the other segments, and certain elimination entries and investments in qualified affordable housing limited partnerships. All operations are domestic.

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Notes to Condensed Consolidated Financial Statements

(Unaudited)

The tables below present selected business segment financial information for the three months ended March 31, 2020 and 2019.


	Multi-family
	Mortgage		Mortgage
	Banking		Warehousing		Banking		Other		Total
	(In thousands)
Three Months Ended March 31, 2020
Interest income	$	420	$	30,099	$	29,230	$	668	$	60,417
Interest expense		—		12,085		11,807		(1,828)		22,064
Net interest income		420		18,014		17,423		2,496		38,353
Provision for loan losses		—		1,180		1,818		—		2,998
Net interest income after provision for loan losses		420		16,834		15,605		2,496		35,355
Noninterest income		17,364		2,776		683		(921)		19,902
Noninterest expense		10,348		3,019		5,688		3,238		22,293
Income before income taxes		7,436		16,591		10,600		(1,663)		32,964
Income taxes		2,037		4,154		2,650		(460)		8,381
Net income (loss)	$	5,399	$	12,437	$	7,950	$	(1,203)	$	24,583
Total assets	$	180,772	$	4,362,423	$	3,323,750	$	41,453	$	7,908,398


	Multi-family
	Mortgage		Mortgage
	Banking		Warehousing		Banking		Other		Total
	(In thousands)
Three Months Ended March 31, 2019
Interest income	$	331	$	14,380	$	24,492	$	471	$	39,674
Interest expense		—		7,529		8,982		(968)		15,543
Net interest income		331		6,851		15,510		1,439		24,131
Provision for loan losses		—		133		516		—		649
Net interest income after provision for loan losses		331		6,718		14,994		1,439		23,482
Noninterest income		2,691		753		883		(663)		3,664
Noninterest expense		3,977		2,336		4,120		2,602		13,035
Income before income taxes		(955)		5,135		11,757		(1,826)		14,111
Income taxes		(243)		1,303		2,988		(507)		3,541
Net income (loss)	$	(712)	$	3,832	$	8,769	$	(1,319)	$	10,570
Total assets	$	160,609	$	1,554,233	$	2,223,890		37,993	$	3,976,725

Note 11: Preferred Stock Offerings

Public Offerings of Preferred Stock:

On March 28, 2019, the Company issued 2,000,000 shares of 7.00% Fixed-to-Floating Rate Series A Non-Cumulative Perpetual Preferred Stock, without par value, and with a liquidation preference of $25.00 per share (the “Series A Preferred Stock”). The aggregate gross offering proceeds for the shares issued by the Company was $50.0 million, and after deducting underwriting discounts and commissions and offering expenses of approximately $1.7 million paid to third parties, the Company received total net proceeds of $48.3 million. On April 12, 2019, the Company issued an additional 81,800 shares of Series A Preferred Stock to the underwriters related to their exercise of an option to purchase additional shares under the associated underwriting agreement, resulting in an additional $2.0 million in net proceeds, after deducting $41,000 in underwriting discounts. The Series A Preferred Stock have no voting rights with respect to matters that generally require the approval of our common shareholders. Dividends on the Series A Preferred

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Notes to Condensed Consolidated Financial Statements

(Unaudited)

Stock, to the extent declared by the Company’s board, are payable quarterly. The Company may redeem the Series A Preferred Stock, in whole or in part, at our option, on any dividend payment date on or after April 1, 2024, subject to the approval of the appropriate federal banking agency, at the liquidation preference, plus any declared and unpaid dividends (without regard to any undeclared dividends) to, but excluding, the date of redemption.

On August 19, 2019, the Company issued 5,000,000 depositary shares, each representing a 1/40th interest in a share of its 6.00% Fixed-to-Floating Rate Series B Non-Cumulative Perpetual Preferred Stock, without par value (the “Series B Preferred Stock”), and with a liquidation preference of $1,000.00 per share (equivalent to $25.00 per depositary share). The aggregate gross offering proceeds for the shares issued by the Company was $125.0 million, and after deducting underwriting discounts and commissions and offering expenses of approximately $4.2 million paid to third parties, the Company received total net proceeds of $120.8 million. The Series B Preferred Stock have no voting rights with respect to matters that generally require the approval of our common shareholders. Dividends on the Series B Preferred Stock, to the extent declared by the Company’s board, are payable quarterly. The Company may redeem the Series A Preferred Stock, in whole or in part, at our option, on any dividend payment date on or after October 1, 2024, subject to the approval of the appropriate federal banking agency, at the liquidation preference, plus any declared and unpaid dividends (without regard to any undeclared dividends) to, but excluding, the date of redemption.

Private Placement Offerings of Preferred Stock

The Company previously issued a total of 41,625 shares of 8% Non-Cumulative, Perpetual Preferred Stock, without par value, with a liquidation preference of $1,000.00 per share (8% Preferred Stock”) in private placement offerings. The Company may redeem this Preferred Stock, in whole or in part, at our option, on any dividend payment date on or after December 31, 2020, subject to the approval of the appropriate federal banking agency, at the liquidation preference, plus any declared and unpaid dividends (without regard to any undeclared dividends) to, but excluding, the date of redemption.

On June 27, 2019 the Company issued an additional 874,000 shares of its 7.00% Series A Preferred Stock, without par value and with a liquidation preference of $25.00 per share, for aggregate proceeds of $21.85 million. No underwriter or placement agent was involved in this private placement and the Company did not pay any brokerage or underwriting fees or discounts in connection with the issuance of such shares. The shares were purchased primarily by related parties, including Michael Petrie, Chairman and Chief Executive Officer; Randall Rogers, Vice Chairman and a director and members of his family; Michael Dury, President of Merchants Capital; and other accredited investors.

Repurchase of Preferred Stock:

On September 23, 2019 the Company repurchased and subsequently retired 874,000 shares of its 7.00% Series A Preferred Stock, for its liquidation preference of $25 per share, at an aggregate cost of $21.85 million. There were no brokerage fees in connection with the transaction.

Note 12: Recent Accounting Pronouncements

The Company is an emerging growth company and as such will be subject to the effective dates noted for private companies if they differ from the effective dates noted for public companies.

FASB ASU 2016‑02, Leases

In February 2016, the Financial Accounting Standards Board (the “FASB”) issued ASU 2016‑02, “Leases.” Under the new guidance, lessees will be required to recognize the following for all leases (with the exception of short‑term leases) at the commencement date:

A lease liability, which is a lessee’s obligation to make lease payments arising from a lease, measured on a discounted basis; and

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Notes to Condensed Consolidated Financial Statements

(Unaudited)

A right‑of‑use asset, which is an asset that represents the lessee’s right to use, or control the use of, a specified asset for the lease term.

Under the new guidance, lessor accounting is largely unchanged. Certain targeted improvements were made to align, where necessary, lessor accounting with the lessee accounting model and Topic 606, “Revenue from Contracts with Customers.” The new lease guidance simplified the accounting for sale and leaseback transactions primarily because lessees must recognize lease assets and lease liabilities. Lessees will no longer be provided with a source of off‑balance sheet financing. Lessees (for capital and operating leases) and lessors (for sales‑type, direct financing, and operating leases) must apply a modified retrospective transition approach for leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements. The modified retrospective approach would not require any transition accounting for leases that expired before the earliest comparative period presented. Lessees and lessors may not apply a full retrospective transition approach.

As an emerging growth company, the amendments in ASU 2016-02 are effective for fiscal years beginning after December 15, 2020, and for interim periods for years beginning after January 1, 2021. The Company is continuing to evaluate the impact of adopting this new guidance, but it does not expect the adoption to have a material impact on the Company’s financial position or results of operations.

FASB ASU 2016‑13, Financial Instruments—Credit Losses

In June 2016, the FASB issued ASU 2016‑13, “Financial Instruments—Credit Losses”, commonly referred to as “CECL”. The amendments in this ASU replace the incurred loss model with a methodology that reflects the “current expected credit losses” over the life of the loan and requires consideration of a broader range of reasonable and supportable information to calculate credit loss estimates. ASU 2016‑13 replaces the incurred loss impairment methodology with a new methodology that reflects expected credit losses over the lives of the loans and requires consideration of a broader range of information to form credit loss estimates. The ASU requires an organization to estimate all expected credit losses for financial assets measured at amortized cost, including loans and held‑to‑maturity debt securities, based on historical experience, current conditions, and reasonable and supportable forecasts. Additional disclosures are required.

As an emerging growth company, the amendments in ASU 2016‑13 are effective for fiscal years beginning after December 15, 2022, including interim periods within those fiscal years. Because the Company’s status as an emerging growth company is expected to expire on December 31, 2022, this standard will likely be implemented by December 31, 2022. The Company has established a cross-functional committee that has developed a project plan to review modeling data currently available and technology needed to ensure compliance with this standard. The committee has contracted with a vendor to assist in generating specific loan level details within our core systems, as well as compiling peer and industry data that would be useful in our modeling forecasts. While the Company generally expects to recognize a one-time cumulative effect adjustment to the allowance for loan losses as of the beginning of the first reporting period in which the new standard is effective, the Company cannot yet determine the magnitude of any such one-time adjustment or the overall impact of the new guidance on the Company’s consolidated financial statements. Management continues to recognize that the implementation of this ASU may increase the balance of the allowance for loan losses and is continuing to evaluate the potential impact on the Company’s financial position and results of operations.

FASB ASU No. 2017‑04, Intangibles—Goodwill and Other (Topic 350)

In January 2017, the FASB issued ASU 2017‑04, “Intangibles—Goodwill and Other (Topic 350).” This ASU simplifies the test for goodwill impairment. Specifically, these amendments eliminate Step 2 from the goodwill impairment test and also eliminate the requirements for any reporting unit with a zero or negative carrying amount to perform a qualitative assessment and, if it fails that qualitative test, to perform Step 2 of the goodwill impairment test.

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Notes to Condensed Consolidated Financial Statements

(Unaudited)

As an emerging growth company, the amendments in this ASU are effective for annual goodwill impairment tests in fiscal years beginning after December 15, 2021. Management continues to believe that the changes will not have a material effect on the Company’s financial position and results of operations.

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Notes to Condensed Consolidated Financial Statements

(Unaudited)

Forward-Looking Statements

Certain statements in this Form 10-Q, including, but not limited to, statements within Management’s Discussion and Analysis of Financial Condition and Results of Operations, are “forward-looking statements” within the meaning of the rules and regulations of the Securities and Exchange Commission (“SEC”). These forward-looking statements reflect our current views with respect to, among other things, future events and our financial performance. These statements are often, but not always, made through the use of words or phrases such as “may,” “might,” “should,” “could,” “predict,” “potential,” “believe,” “expect,” “continue,” “will,” “anticipate,” “seek,” “estimate,” “intend,” “plan,” “projection,” “goal,” “target,” “outlook,” “aim,” “would,” “annualized,” and “outlook,” or the negative version of those words or other comparable words or phrases of a future or forward‑looking nature. These forward‑looking statements are not historical facts, and are based on current expectations, estimates and projections about our industry, management’s beliefs and certain assumptions made by management, many of which, by their nature, are inherently uncertain and beyond our control, such as the potential impacts of the COVID-19 pandemic. Accordingly, we caution that any such forward‑looking statements are not guarantees of future performance and are subject to risks, assumptions, estimates and uncertainties that are difficult to predict. Although we believe that the expectations reflected in these forward‑looking statements are reasonable as of the date made, actual results may prove to be materially different from the results expressed or implied by the forward‑looking statements.

A number of important factors could cause our actual results to differ materially from those indicated in these forward‑looking statements, including those factors identified in the “Risk Factors” section of our Annual Report on Form 10-K for the year ended December 31, 2019 or “Item 2 - Management’s Discussion and Analysis of Financial Condition and Results of Operations” of this Form 10-Q or the following:

impacts of the COVID-19 pandemic, such as the severity, magnitude, duration, and businesses’ and governments’ responses thereto, on the Company’s operations and personnel, and on activity and demand across its businesses;

business and economic conditions, particularly those affecting the financial services industry and our primary market areas;

our ability to successfully manage our credit risk and the sufficiency of our allowance for loan loss;

factors that can impact the performance of our loan portfolio, including real estate values and liquidity in our primary market areas, the financial health of our commercial borrowers and the success of construction projects that we finance, including any loans acquired in acquisition transactions;

compliance with governmental and regulatory requirements, including the Dodd‑Frank Act and others relating to banking, consumer protection, securities, and tax matters;

our ability to maintain licenses required in connection with multi‑family mortgage origination, sale, and servicing operations;

our ability to identify and address cyber‑security risks, fraud, and systems errors;

our ability to effectively execute our strategic plan and manage our growth;

changes in our senior management team and our ability to attract, motivate, and retain qualified personnel;

governmental monetary and fiscal policies, and changes in market interest rates;

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Notes to Condensed Consolidated Financial Statements

(Unaudited)

liquidity issues, including fluctuations in the fair value and liquidity of the securities we hold for sale and our ability to raise additional capital, if necessary;

incremental costs and obligations associated with operating as a public company;

effects of competition from a wide variety of local, regional, national, and other providers of financial, investment and insurance services;

the impact of any claims or legal actions to which we may be subject, including any effect on our reputation; and

changes in federal tax law or policy.

The foregoing factors should not be construed as exhaustive and should be read together with the other cautionary statements included in this Form 10-Q. Any forward‑looking statement speaks only as of the date on which it is made, and we do not undertake any obligation to update or review any forward‑looking statement, whether as a result of new information, future developments, or otherwise.

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Management’s discussion and analysis of the financial condition at March 31, 2020, and results of operations for the three months ended March 31, 2020 and 2019, is intended to assist in understanding the financial condition and results of operations of the Company. The information contained in this section should be read in conjunction with the unaudited condensed consolidated financial statements and the notes thereto, appearing in Part I, Item 1 of this Form 10-Q.

The words “the Company,” “we,” “our,” and “us” refer to Merchants Bancorp and its consolidated subsidiaries, unless we indicate otherwise.

Financial Highlights for the Three Months Ended March 31, 2020

Total assets of $7.9 billion increased $1.5 billion, or 24%, compared to December 31, 2019, driven by record-setting loan growth. Return on average assets was 1.49% compared to 1.14% for the three months ended March 31, 2019.

Net income per common share of $0.73 increased 115% compared to the three months ended March 31, 2019.

The $14.0 million, or 133%, increase in net income compared to the three months ended March 31, 2019 was primarily driven by a 701% increase in gain on sale of loans from significantly higher growth in multi-family loans, and a 59% increase in net interest income that reflected significant growth in mortgage warehouse loans.

Results reflected a $6.5 million negative fair market value adjustment to mortgage servicing rights compared to a $1.5 million negative adjustment in the three months ended March 31, 2019.

Partially offsetting the increases in net income was a $9.3 million, or 71%, increase in noninterest expenses, primarily due to an increase in salaries and employee benefits associated with higher commissions from higher volume and to support the strong growth in our businesses. The efficiency ratio was 38.3% compared to 46.9% for the three months ended March 31, 2019.

The net interest margin of 2.40% declined 37 basis points compared to 2.77% for the three months ended March 31, 2019. The decline reflected the flattening of the yield curve, and reflects the shift in business mix to a higher concentration of warehouse loans that typically are funded for a shorter duration and earn interest based on underlying mortgage rates or LIBOR. Furthermore, interest rate floors are used in the Mortgage Warehousing segment to support net interest margin. Profitability in this business, which also includes fees classified as noninterest income, made the most significant contribution to net income for the first quarter of 2020. Our diverse business model is designed to maximize overall profitability in both rising and falling interest rate environments, and unlike many other banks and holding companies, our future profitability relies less upon changes in net interest margin.

A 210% increase in warehouse loan volume compared to the three months ended March 31, 2019 was well ahead of industry volume increases of 73%, according to the Mortgage Bankers Association. We have benefited from the increased loan origination and refinancing activity due to lower market interest rates.

The volume of loans originated and acquired for sale in the secondary market through our multi-family business increased by $786.1 million, to $810.6 million, compared to $24.4 million for the three months ended March 31, 2019.

Our asset quality remained strong, with nonperforming loans representing only 0.19% of total loans, and the allowance for loan losses as a percentage nonperforming loans was 288.0%. The number of delinquencies improved, with the total balance of loans over 30 days past due declining from $12.6 million at December 31,

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2019, to $9.5 million at March 31, 2020. Loans classified as special mention (watch) also declined from $60.3 million at December 31, 2019, to $48.3 million at March 31, 2020.

Business Overview

We are a diversified bank holding company headquartered in Carmel, Indiana and registered under the Bank Holding Company Act of 1956, as amended. We currently operate in and service multiple lines of business, including multi-family housing, mortgage warehouse financing, retail and correspondent residential mortgage banking, agricultural lending, and traditional community banking.

Our business consists primarily of funding low risk loans that sell within 90 days of origination. The sale of loans and servicing fees generated primarily from the multi-family rental real estate loans servicing portfolio contribute to noninterest income. The funding source is primarily from mortgage custodial, municipal, retail, commercial, and brokered deposits. We believe that the combination of net interest income and noninterest income from the sale of low risk profile assets results in lower than industry charge offs and a lower expense base serving to maximize net income and shareholder return.

Critical Accounting Policies and Estimates

The preparation of our consolidated financial statements requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues, and expenses. These estimates are based upon historical experience and on various other assumptions that management believes are reasonable under the current circumstances. These estimates form the basis for making judgments about the carrying value of certain assets and liabilities that are not readily available from other sources. Actual results may differ from these estimates under different assumptions or conditions.

The Jumpstart Our Business Startups Act of 2012 (“JOBS Act”) contains provisions that, among other things, reduce certain reporting requirements for qualifying public companies. As an “emerging growth company” we may delay adoption of new or revised accounting pronouncements applicable to public companies until such pronouncements are made applicable to private companies. We are taking advantage of the benefits of this extended transition period. Accordingly, our financial statements may not be comparable to companies that comply with such new or revised accounting standards.

The estimates and judgments that management believes have the most effect on its reported financial position and results of operations are set forth within “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our Annual Report on Form 10-K for the fiscal year ended December 31, 2019. There have been no significant changes in critical accounting policies or the assumptions and judgments utilized in applying these policies since those reported for the year ended December 31, 2019.

Financial Condition

As of March 31, 2020, we had approximately $7.9 billion in total assets, $6.7 billion in deposits, and $673.0 million in total shareholders’ equity. Total assets as of March 31, 2020 included approximately $568.1 million of cash and cash equivalents, $2.8 billion of loans held for sale and $3.5 billion of loans held for investment. It also includes $465.2 million of trading securities that represent pre-sold multi-family rental real estate loan originations in primarily Government National Mortgage Association (“GNMA”) mortgage backed securities pending settlements that typically occur within 30 days. There are $339.1 million of available for sale securities that are match funded with related custodial deposits. There are restrictions on the types of securities, as these are funded by certain custodial deposits where we set the cost of deposits based on the yield of the related securities. Mortgage servicing rights were $70.0 million at March 31, 2020 based on the fair value of the loan servicing, which are primarily GNMA servicing rights with 10-year call protection.

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Comparison of Financial Condition at March 31, 2020 and December 31, 2019

Total Assets. Total assets increased $1.5 billion, or 24%, to $7.9 billion at March 31, 2020 from $6.4 billion at December 31, 2019. The increase was due primarily to increases in loans held for sale of $702.2 million, net loans receivable of $489.3 million, trading securities of $195.3, and cash and cash equivalents of $61.4 million.

Cash and Cash Equivalents. Cash and cash equivalents increased $61.4 million, or 12%, to $568.1 million at March 31, 2020 from $506.7 million at December 31, 2019. The 12% increase reflected cash levels consistent with balance sheet growth and increased funding activities.

Trading Securities. Trading securities increased $195.3 million, or 72%, to $465.2 million at March 31, 2020, from $269.9 million at December 31, 2019. These represent loans that our banking subsidiary, Merchants Bank, has funded and are held pending settlement, primarily as GNMA mortgage-backed securities with a firm investor commitment to purchase the securities. The 72% increase was primarily due to a significant increase in the volume of loans that had not yet settled with government agencies.

Securities Available-for-Sale. Investment securities available-for-sale increased $48.8 million, or 17%, to $339.1 million at March 31, 2020 from $290.2 million at December 31, 2019. The increase in securities available-for-sale was primarily due to purchases of $156.7 million, partially offset by calls, maturities, sales, and repayments of securities totaling $108.0 million during the period. We invest in available for sale securities primarily using funds from escrow deposits held at Merchants Bank, received in connection with our multi-family mortgage servicing activities. The available for sale securities are funded by, and paired with as to interest rates, escrow custodial deposits held at the Company on loans serviced by us. This portfolio of securities is structured to achieve a favorable interest rate spread.

Federal Home Loan Bank (“FHLB”) stock. FHLB stock increased $25.8 million, or 127%, to $46.2 million at March 31, 2020 from $20.4 million at December 31, 2019. The increase in FHLB stock was due primarily to additional borrowing from the FHLB that allows us to manage our liquidity and funding costs more effectively. Additional stock purchases are required by the FHLB in order to facilitate increased borrowing capacity.

Loans Held for Sale. Loans held for sale, comprised primarily of government agency eligible, single-family residential real estate loan participations, increased $702.2 million, or 34%, to $2.8 billion at March 31, 2020 from $2.1 billion at December 31, 2019. The increase in loans held for sale was due primarily to higher warehouse volumes at the end of the quarter ended March 31, 2020.

Loans Receivable, Net. Loans receivable, net, which are comprised of loans held for investment, increased $489.3 million, or 16%, to $3.5 billion at March 31, 2020 compared to December 31, 2019. The increase in net loans was comprised primarily of:

an increase of $318.6 million, or 42%, in mortgage warehouse lines of credit, to $1.1 billion at March 31, 2020,

an increase of $88.1 million, or 7%, in multi-family and healthcare financing loans, to $1.4 billion at March 31, 2020, and

an increase of $70.1 million, or 18%, in commercial and commercial real estate, to $468.7 million at March 31, 2020.

The increase in mortgage warehouse lines of credit was primarily due to an increase in single-family refinancing activity associated with lower market interest rates. Our growth in this business was higher than the industry overall. We reported a 3% increase in mortgage warehouse volumes for the three months ended March 31, 2020 compared to the three months ended December 31, 2019, while the forecast is for a 19% industry decline in single-family residential loan volumes for the same period, according to the Mortgage Bankers Association.

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The increase in multi-family and healthcare financing was due to higher origination volume for construction, bridge and other loans generated through our Multi-family segment that will remain on our balance sheet until they convert to permanent financing or are otherwise paid off over an average of one to three years.

The increase in commercial loans was primarily due to higher origination volume for low income housing construction projects and SBA loan growth since December 31, 2019.

As of March 31, 2020, approximately 94% of the total net loans at Merchants Bank reprice within three months.

Allowance for Loan Losses. The allowance for loan losses of $18.9 million at March 31, 2020 increased $3.0 million compared to December 31, 2019, primarily reflecting increases associated with loan growth and uncertainties surrounding the COVID-19 pandemic. Loan growth drove approximately $2.5 million, or 82%, of the $3.0 million increase, while additional provision associated with the COVID-19 pandemic represented approximately $547,000, or 18% of the increase.

The $2.5 million increase in the allowance for loan losses associated with loan growth was largely driven by the 42% growth in mortgage warehouse loans, 18% growth in commercial and commercial real estate loans, and the 9% growth in agricultural loans. Loss factors applied to mortgage warehouse loans have traditionally represented the lowest loss factors of all loan categories utilized to compute allowances for loan losses. At March 31, 2020, the higher concentration of warehouse loans with lower loss factors in the allowance, has contributed to the overall percentage of the allowance for loan losses to total loans to increase by only 2 basis points, from .52% at December 31, 2019, to .54% at March 31, 2020.

The Company has minimal direct exposure to consumer, commercial, and other small businesses that may be negatively impacted by COVID-19, but management has analyzed and increased the qualitative factors in these and other loan categories for potential future loan losses attributable to COVID-19. Accordingly, the Company has increased the allowance by approximately $547,000. As of March 31, 2020, management did not see significant disruption with existing customers related to COVID-19. However, Merchants did grant customer requests to defer payments on 24 loans with unpaid balances of $23.6 million. While it is too early to know the full extent of potential future losses associated with the impact of COVID-19, the Company continues to monitor the situation and may need to adjust future expectations with additional increases to its provision for loan losses as developments occur throughout the remainder of 2020.

Also influencing the overall level of the allowance for loan losses is our differentiated strategy to typically hold loans with shorter durations and to maintain strict underwriting standards that enable us to sell the majority of our loans to government agencies.

Goodwill. Goodwill of $15.8 million at March 31, 2020 remained unchanged compared to December 31, 2019. As of March 31, 2020, the Company’s market capitalization declined in response to news related to the COVID-19 pandemic, to a level that was below its book value, prompting an assessment of potential impairment to goodwill. At this time, we do not believe there exists any impairment to goodwill or intangible assets.

Mortgage Servicing Rights. Mortgage servicing rights decreased $4.4 million, or 6%, to $70.0 million at March 31, 2020 compared to December 31, 2019. During the three months ended March 31, 2020, originated and purchased servicing of $3.9 million was offset by paydowns of $1.9 million and a fair value decrease of $6.5 million. Mortgage servicing rights are recognized in connection with sales of loans when we retain servicing of the sold loans, as well as upon purchases of loan servicing portfolios. The mortgage servicing rights are recorded and carried at fair value. The fair value decrease recorded during the three months ended March 31, 2020 was driven primarily by the decline in short term interest rates that drive the valuation of escrow deposits held in conjunction with the servicing, and the decline in multi-family mortgage rates that increased borrower prepayment assumptions. Further decreases in interest rates could result in additional reductions to fair market values. The opposite could occur if interest rates increase.

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Deposits. Deposits increased 23%, to $6.7 billion at March 31, 2020 from $5.5 billion at December 31, 2019. The increase was primarily due to our higher use of brokered certificates of deposits to support the significant growth in warehouse loans and to match the expected duration.

Certificates of deposit accounts increased $581.1 million, or 27%, to $2.8 billion at March 31, 2020, primarily driven by the increase in brokered deposits outstanding period to period. Demand deposits increased $466.4 million, or 22%, to $2.6 billion at March 31, 2020, while savings deposits increased $197.1 million, or 16%, to $1.4 billion at March 31, 2020.

To fund the significant growth in loans that have relatively short durations, we have increased our use of brokered deposits by $671.2 million, or 31%, to $2.8 billion at March 31, 2020 from $2.2 billion at December 31, 2019.

Brokered certificates of deposit accounts increased $503.4 million, or 26%, to $2.5 billion at March 31, 2020 from $2.0 billion at December 31, 2019.

Brokered savings deposits increased $158.8 million, or 86%, to $343.4 million at March 31, 2020 from $184.6 million at December 31, 2019.

Brokered demand deposit accounts increased by $9.0 million, or 90%, to $19.0 million at March 31, 2020 from $10.0 million at December 31, 2019.

Although our brokered deposits are short-term in nature, they may be more rate sensitive compared to other sources of funding. In the future, those depositors may not replace their brokered deposits with us as they mature, or we may have to pay a higher rate of interest to keep those deposits or to replace them with other deposits or other sources of funds. Not being able to maintain or replace those deposits as they mature would adversely affect our liquidity. Additionally, if Merchants Bank does not maintain its well‑capitalized position, it may not accept or renew any brokered deposits without a waiver granted by the FDIC.

Interest-bearing deposits increased $1.2 billion, or 23%, to $6.4 billion at March 31, 2020, and noninterest-bearing deposits increased $55.8 million, to $327.8 million at March 31, 2020.

Borrowings. Borrowings totaled $444.6 million at March 31, 2020, an increase of $263.1 million, or 145%, from December 31, 2019, in order to maintain an appropriate level of cash to fund our businesses. Depending on rates and timing, borrowing can be a more effective liquidity management alternative than utilizing brokered deposits. The Company has also applied to utilize the Federal Reserve’s discount window, should the need arise.

Total Shareholders’ Equity. Total shareholders’ equity increased $19.2 million, or 3%, to $673.0 million at March 31, 2020 compared to December 31, 2019. The increase resulted primarily from an increase in net income of $24.6 million, which was partially offset by dividends paid on common and preferred shares of $2.3 million and $3.6 million, respectively, during the period.

Comparison of Operating Results for the Three Months Ended March 31, 2020 and 2019

General. Net income for the three months ended March 31, 2020 was $24.6 million, an increase of $14.0 million, or 133%, from net income of $10.6 million for the three months ended March 31, 2019. The increase was due to an $18.5 million increase in gain on sale of loans and a $14.2 million increase in net interest income. Partially offsetting the increases was a $9.3 million increase in noninterest expenses, a $5.5 million decrease in loan servicing fees related primarily to negative fair market value adjustments to mortgage servicing rights, a $4.8 million increase in the provision for income taxes, and a $2.3 million increase in the provision for loan losses.

Net Interest Income. Net interest income increased $14.2 million, or 59%, to $38.4 million for the three months ended March 31, 2020, compared with the three months ended March 31, 2019. The increase was due to a $2.9

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billion increase in our average interest earning assets that offset a 31 basis point decrease in our interest rate spread, to 2.19%, for the three months ended March 31, 2020 from 2.50% for the three months ended March 31, 2019.

Our net interest margin decreased 37 basis points, to 2.40%, for the three months ended March 31, 2020 from 2.77% for the three months ended March 31, 2019. The decline in net interest margin reflected the flattening of the yield curve compared to the prior year, and reflects the shift in business mix to a higher concentration of warehouse loans that typically are funded for a shorter duration and earn interest based on longer term rates. Profitability in this business, which also includes fees classified as noninterest income, had the most significant growth in net income of all our businesses during the three months ended March 31, 2020 compared to the three months ended March 31, 2019.

Interest Income. Interest income increased $20.7 million, or 52%, to $60.4 million for the three months ended March 31, 2020, compared with the three months ended March 31, 2019. This increase was primarily attributable to a $19.1 million increase in interest on loans and loans held for sale and a $1.8 million increase in interest on trading securities.

The average balance of loans, including loans held for sale, during the three months ended March 31, 2020 increased $2.3 billion, or 82%, to $5.0 billion from $2.7 billion for the three months ended March 31, 2019, while the average yield on loans decreased 79 basis points, to 4.3%, for the three months ended March 31, 2020, compared to 5.09% for the three months ended March 31, 2019. The increase in average balances of loans and loans held for sale was primarily due to significant increases in warehouse funding and multi-family volume. The decrease in the average yield on loans was due to the overall decrease in interest rates in the economy period to period.

The average balance of trading securities increased $240.3 million, or 220%, to $349.7 million for the three months ended March 31, 2020, compared to $109.4 million for the three months ended March 31, 2019, while the average yield decreased 65 basis points to 3.22% for the three months ended March 31, 2020.

The average balance of interest-earning deposits and other increased $408.1 million, or 110%, to $777.8 million for the three months ended March 31, 2020 from $369.7 million for the three months ended March 31, 2019, while the average yield decreased 137 basis points, to 1.40%, for the three months ended March 31, 2020.

Interest Expense. Total interest expense increased $6.5 million, or 42%, to $22.1 million for the three months ended March 31, 2020, compared with the three months ended March 31, 2019.

Interest expense on deposits increased $6.4 million, or 45%, to $20.6 million for the three months ended March 31, 2020 from the three months ended March 31, 2019. The increase was attributable to an increase in the average balance of interest-bearing deposits of $2.4 billion, or 79%, to $5.3 billion for the three months ended March 31, 2020. The higher average balances were offset by a 39 basis point decrease in the average cost of interest-bearing deposits, to 1.55% for the three months ended March 31, 2020 from 1.94% for the same period in 2019. The increase in the average balance of interest-bearing deposits was primarily due to growth in certificates of deposit and interest-bearing checking accounts, while the decrease in the cost of deposits was primarily due to the overall decrease in interest rates in the economy period to period.

Interest expense on borrowings increased $118,000, or 9%, to $1.4 million for the three months ended March 31, 2020 from $1.3 million for the three months ended March 31, 2019. The increase was due primarily to a $200.9 million, or 227%, increase in the average balance of borrowings outstanding for the three months ended March 31, 2019 that was partially offset by a 405 basis point decrease in the average cost of borrowings of 1.99%, compared to 6.04% for the three months ended March 31, 2019. The higher average balances for the three months ended March 31, 2020 reflected an increase in borrowing from the FHLB at much lower rates. Partially offsetting the lower FHLB borrowing rates, were short-term subordinated debt instruments that have carried a higher cost than our other categories of borrowing, as they include a variable interest rate equal to the one-month LIBOR rate plus an applicable margin. Additionally, our warehouse structured financing agreements provide for an additional interest payment for a portion of the earnings

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generated. As a result, the cost of borrowings increased from a base rate of 0.96% and 3.68%, to an effective rate of 1.99% and 6.04% for the three months ended March 31, 2020 and 2019, respectively.

The following table presents, for the periods indicated, information about (i) average balances, the total dollar amount of interest income from interest-earning assets and the resultant average yields; (ii) average balances, the total dollar amount of interest expense on interest-bearing liabilities and the resultant average rates; (iii) net interest income; (iv) the interest rate spread; and (v) the net interest margin. Yields have been calculated on a pre-tax basis. Nonaccrual loans are included in loans and loans held for sale.


	Three Months Ended March 31,
	2020						2019
			Interest						Interest
	Average		Income/		Yield/		Average		Income/		Yield/
	Balance		Expense		Rate		Balance		Expense		Rate
	(Dollars in thousands)
Assets:
Interest-bearing deposits, and other	$	777,820	$	2,698	1.40	%	$	369,736	$	2,527	2.77	%
Securities available for sale - taxable		293,964		1,322	1.81	%		292,500		1,551	2.15	%
Securities available for sale - tax exempt		5,305		37	2.81	%		12,460		96	3.12	%
Trading securities		349,746		2,796	3.22	%		109,423		1,045	3.87	%
Loans and loans held for sale		5,012,324		53,564	4.30	%		2,746,562		34,455	5.09	%
Total interest-earning assets		6,439,159		60,417	3.77	%		3,530,681		39,674	4.56	%
Allowance for loan losses		(15,841)						(12,704)
Noninterest-earning assets		181,076						179,968
Total assets	$	6,604,394					$	3,697,945

Liabilities/Equity:
Interest-bearing checking	$	2,064,967		6,891	1.34	%	$	1,314,733		6,434	1.98	%
Savings deposits		163,154		58	0.14	%		147,534		80	0.22	%
Money market		1,143,249		4,575	1.61	%		892,806		4,208	1.91	%
Certificates of deposit		1,964,622		9,106	1.86	%		618,646		3,505	2.30	%
Total deposits		5,335,992		20,630	1.55	%		2,973,719		14,227	1.94	%
Borrowings		289,263		1,434	1.99	%		88,353		1,316	6.04	%
Total interest-bearing liabilities		5,625,255		22,064	1.58	%		3,062,072		15,543	2.06	%
Noninterest-bearing deposits		235,020						155,218
Noninterest-bearing liabilities		74,950						51,425
Total liabilities		5,935,225						3,268,715
Equity		669,169						429,230
Total liabilities and equity	$	6,604,394					$	3,697,945
Net interest income			$	38,353					$	24,131
Interest rate spread					2.19	%					2.50	%
Net interest-earning assets	$	813,904					$	468,609
Net interest margin					2.40	%					2.77	%
Average interest-earning assets to average interest-bearing liabilities					114.47	%					115.30	%

Provision for Loan Losses. We recorded a provision for loan losses of $3.0 million for the three months ended March 31, 2020, an increase of $2.3 million, over the three months ended March 31, 2019. The allowance for loan losses was $18.9 million, or 0.54% of total loans, at March 31, 2020, compared to $15.8 million, or 0.52% of total loans, at December 31, 2019, and $13.4 million, or 0.61%, at March 31, 2019. The increases in the allowance for loan losses compared to both prior periods reflected increases associated with loan growth and uncertainties surrounding COVID-19. Additional details are provided in the Allowance for Loan Losses portion of the Comparison of Financial Condition

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at March 31, 2020 and December 31, 2019. While it is too early to know the full extent of potential future losses associated with the impact of COVID-19, the Company continues to monitor the situation and may need to adjust future expectations as developments occur throughout the remainder of 2020.

Noninterest Income. Noninterest income increased $16.2 million, or 443%, to $19.9 million for the three months ended March 31, 2020 compared to the three months ended March 31, 2019. The increase was primarily due to an $18.5 million, or 701%, increase in gain on sale of loans, to $21.2 million, for the three months ended March 31, 2020 compared to $2.6 million in the year earlier period, primarily from an increase in the volume of multi-family rental real estate loan sales.

Also contributing to the increase in noninterest income was a $2.0 million increase in mortgage warehouse fees that reached $2.7 million for the three months ended March 31, 2020, related to the significant increase in volume compared to the year earlier period.

These increases were partially offset by a $5.5 million decrease in loan servicing fees that included a $6.5 million negative adjustment to the fair value of mortgage servicing rights for the three months ended March 31, 2020, compared to a negative adjustment of $1.5 million for the three months ended March 31, 2019.

Noninterest Expense. Noninterest expense increased $9.3 million, or 71%, to $22.3 million for the three months ended March 31, 2020 compared to the three months ended March 31, 2019. The increase was due primarily to a $5.7 million, or 66% increase in salaries and employee benefits. The increase in salaries and employee benefits was due primarily to an increase in commission expense associated with higher volume and additional employees to support business growth. Also contributing to the increase was a $1.5 million increase in deposit insurance expense related to the growth in deposits and assets. The efficiency ratio was at 38.3% in the three months ended March 31, 2020, compared with 46.9% in the three months ended March 31, 2019.

Income Taxes. Income tax expense increased $4.8 million, or 137%, to $8.4 million for the three months ended March 31, 2020 from the three months ended March 31, 2019. The increase was due primarily to a 134% increase in pretax income period to period. The effective tax rate was 25.4% for the three months ended March 31, 2020 and 25.1% for the three months ended March 31, 2019.

Asset Quality

In response to the COVID-19 pandemic, we migrated employees to work-from-home arrangements in mid-March 2020 and expect to continue operating without disruption to our customers. We have also assessed our internal control environment and believe we have the necessary precautions in place to ensure business continuity.

The Company believes it has minimal direct exposure to consumer, commercial and other small businesses that may be negatively impacted by COVID-19. As of March 31, 2020, Merchants granted customer requests to defer payments on 24 loans with unpaid balances of $23.6 million, representing less than 1% of total loans receivable. Management has also assisted small businesses that could benefit from the Coronavirus Aid, Relief and Economic Security (“CARES”) Act, particularly in the SBA’s Paycheck Protection Program (“PPP”). As of March 31, 2020, the Company was taking applications, but had not funded any loans to small businesses under this program until it launched on April 3, 2020.

Total nonperforming loans (nonaccrual and greater than 90 days late but still accruing) were $6.6 million, or 0.19%, of total loans at March 31, 2020, compared to $4.7 million, or 0.15%, of total loans at December 31, 2019 and $2.6 million, or 0.12%, at March 31, 2019. The increase compared to December 31, 2019 was primarily related to one collateralized agricultural loan that was delinquent greater than 90 days, with repayment still anticipated. Also contributing to the increase compared to March 31, 2019 were higher delinquencies greater than 90 days late for residential real estate and commercial loans, for which repayment is still anticipated.

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As a percentage of nonperforming loans, the allowance for loan losses was 288.0% at March 31, 2020 compared to 338.6% at December 31, 2019 and 523.1% at March 31, 2019. The decreases compared to both periods were primarily due to the increase in the nonperforming loans.

Total loans greater than 30 days past due were $9.5 million at March 31, 2020, $12.6 million at December 31, 2019, and $6.3 million at March 31, 2019.

Special Mention (Watch) loans were $48.3 million at March 31, 2020, compared to $60.3 million at December 31, 2019 and $73.2 million at March 31, 2019. The decreases primarily reflected the completion of certain construction projects with cost over-runs that had been funded by the borrowers. Classified (substandard, doubtful and loss) loans were $14.1 million at March 31, 2020, $12.5 million at December 31, 2019 and $13.4 million at March 31, 2019. Although we currently do not anticipate COVID-19 to have a material increase to Special Mention or Classified loans, given the industries in which we provide funding, we continue to monitor the situation.

We had $1,000 of charge-offs and $44,000 in recoveries during the three months ended March 31, 2020. For the three months ended March 31, 2019, there were no charge-offs and $3,000 in recoveries.

Our Segments

We operate in three primary segments: Multi-family Mortgage Banking, Mortgage Warehousing, and Banking. We believe that Merchants Bank’s subsidiary, Merchants Capital Corp. (“MCC”), which operates in our Multi-Family Mortgage Banking segment, is one of the largest FHA lenders and GNMA servicers in the country based on aggregate loan principal value. MCC originated and acquired $1.2 billion in loans during the three months ended March 31, 2020. As of March 31, 2020, MCC also had a $13.3 billion servicing portfolio for banks and investors, including $1.9 billion serviced for Merchants Bank. The servicing portfolio is primarily GNMA and is a significant source of our noninterest income and deposits.

Our Mortgage Warehousing segment funds agency eligible loans for non-depository financial institutions from the date of origination or purchase until the date of sale to an investor, which typically takes less than 30 days and is a significant source of our net interest income, loans, and deposits. Mortgage Warehousing has grown to fund over $20 billion of loan principal annually since 2015 and exceeded $46 billion in 2019. Mortgage Warehousing also provides commercial loans and collects deposits related to the mortgage escrow accounts of its customers.

The Banking segment includes retail banking, commercial lending, agricultural lending, retail and correspondent residential mortgage banking, and SBA lending. Banking operates primarily in Indiana and Illinois, except for correspondent mortgage banking which, like Multi-family Mortgage Banking and Mortgage Warehousing, is a national business. The Banking segment has a well-diversified customer and borrower base and has experienced significant growth over the past three years. These segments diversify the net income of Merchants Bank and provide synergies across the segments. The strategic opportunities include that MCC loans are funded by the Banking segment and the Banking segment provides GNMA custodial services to MCC. The securities available for sale funded by MCC custodial deposits, as well as loans generated by Merchants Bank, are pledged to the FHLB to provide advance capacity during periods of high residential loan volume for mortgage warehousing. Mortgage Warehousing provides leads to correspondent residential lending in the banking segment. Retail, SBA and commercial customers provide cross selling opportunities within the banking segment. These and other synergies form a part of our strategic plan.

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For the three months ended March 31, 2020 and 2019, we had total net income of $24.6 million and $10.6 million, respectively. Net income for our three segments for the respective periods was as follows:


	For the Three Months Ended
	March 31,
	2020		2019
	(In thousands)
Multi-family Mortgage Banking	$	5,399	$	(712)
Mortgage Warehousing		12,437		3,832
Banking		7,950		8,769
Other		(1,203)		(1,319)

Total	$	24,583	$	10,570

Multi-family Mortgage Banking. The Multi-family Mortgage Banking segment reported net income of $5.4 million for the three months ended March 31, 2020, an increase of $6.1 million, or 858%, from the $712,000 net loss reported for the three months ended March 31, 2019. The growth was due to a $14.7 million increase in noninterest income, primarily associated with a $19.0 million increase in gain on sale of loans. The volume of loans originated and acquired for sale in the secondary market increased by $786.1 million, to $810.6 million, for the three months ended March 31, 2020 compared to $24.4 million for the three months ended March 31, 2019.

Partially offsetting the increase in gain on sale of loans compared to the prior year period were negative fair market value adjustments to mortgage servicing rights. The three months ended March 31, 2020 included a $6.5 million negative fair value adjustment to mortgage servicing rights, compared with a $1.5 million negative adjustment for the three months ended March 31, 2019.

Also partially offsetting the increase in noninterest income was a $6.4 million increase in noninterest expenses, primarily due to an increase in salaries and employee benefits associated with higher commissions and additional employees to support future growth in volume, in addition to a $2.3 million increase in the provision for income taxes associated with significantly higher pre-tax income compared to the three months ended March 31, 2019.

Mortgage Warehousing. The Mortgage Warehousing segment reported net income for the three months ended March 31, 2020 of $12.4 million, an increase of $8.6 million, or 225%, over the $3.8 million reported for the three months ended March 31, 2019. The higher net income was primarily due to a $10.1 million, or 151%, increase in net interest income after provision for loan losses, associated with significantly higher volume. The volume of loans funded during the three months ended March 31, 2020 amounted to $16.8 billion, an increase of $11.4 billion, or 210%, compared to the same period in 2019. This compared favorably to the 73% industry increase in single-family residential loan volumes from the three months ended March 31, 2019 to the three months ended March 31, 2020, according to the Mortgage Bankers Association. Also contributing to the increase in net income for the three months ended March 2020 compared to the prior year period was a $2.0 million, or 269%, increase in noninterest income that was offset by a $2.9 million increase in the provision for income taxes associated with a 223% higher pre-tax income.

Banking. The Banking segment reported net income of $8.0 million for the three months ended March 31, 2020, a decrease of $819,000 million, or 9%, over the three months ended March 31, 2019. The decrease in net income was primarily due to a $1.6 million increase in noninterest expenses that reflected higher deposit insurance related to the growth in deposits and assets compared to the prior year period. Also impacting the lower net income compared to March 31, 2019 was a $1.3 million increase in the provision for loan losses reflecting loan growth and uncertainties associated with COVID-19 that was offset by a $1.9 million increase in net interest income.

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Merchants Bancorp

Liquidity and Capital Resources

Liquidity.

Our primary sources of funds are business and consumer deposits, escrow and custodial deposits, principal and interest payments on loans, and proceeds from sale of loans. While maturities and scheduled amortization of loans are predictable sources of funds, deposit flows and mortgage prepayments are greatly influenced by market interest rates, economic conditions, and competition. Our most liquid assets are cash, short-term investments, including interest-bearing demand deposits, trading securities, and loans held for sale. The levels of these assets are dependent on our operating, financing, lending, and investing activities during any given period.

Our cash flows are comprised of three primary classifications: cash flows from operating activities, investing activities, and financing activities. Net cash provided by (used in) operating activities was $(871.6) million and $2.7 million for the three months ended March 31, 2020 and 2019, respectively. Net cash provided by (used in) investing activities, which consists primarily of net change in loans receivable and purchases, sales and maturities of investment securities, was $(568.4) million and $(103.6) million for the three months ended March 31, 2020 and 2019, respectively. Net cash provided by financing activities, which is comprised primarily of net change in deposits and borrowings, was $1.5 billion and $77.7 million for the three months ended March 31, 2020 and 2019, respectively.

At March 31, 2020, we had $786.0 million in outstanding commitments to extend credit that are subject to credit risk and $1.9 billion outstanding commitments subject to certain performance criteria and cancellation by the Company, including loans pending closing, unfunded construction draws, and unfunded lines of warehouse credit. We anticipate that we will have sufficient funds available to meet our current loan origination commitments.

Within our role as a multi-family mortgage servicer for other banks and investors, we may be obligated to remit principal and interest payments to investors on certain loans regardless of the borrower’s ability to make payments, which could become more likely as a result of the COVID-19 pandemic. If there are situations where a borrower is granted a forbearance, the Company believes it has sufficient liquidity to cover these required advances. We have not approved any requests for forbearance in our multi-family servicing portfolio as of March 31, 2020 but remain confident in our ability to fund potential advances we may be required to make as a result of the COVID-19 pandemic.

Certificates of deposit that are scheduled to mature in less than one year from March 31, 2019 totaled $2.6 billion. Management expects that a substantial portion of the maturing certificates of deposit will be renewed. However, if a substantial portion of these deposits is not retained, we may decide to utilize FHLB advances, the Federal Reserve’s discount window, or raise interest rates on deposits to attract new accounts, which may result in higher levels of interest expense.

At March 31, 2020, based on available collateral, we had access to additional FHLB advances of up to $1.2 billion.

Capital Resources.

The access to and cost of funding for new business initiatives, the ability to engage in expanded business activities, the ability to pay dividends, the level of deposit insurance costs and the level and nature of regulatory oversight depend, in part, on our capital position. The Company filed a registration statement on Form S-3 with the SEC on December 30, 2019, which was declared effective on January 9, 2020, and which provides a means to allow us to issue registered securities to finance our growth objectives.

The assessment of capital adequacy depends on a number of factors, including asset quality, liquidity, earnings performance, changing competitive conditions and economic forces. We seek to maintain a strong capital base to support our growth and expansion activities, to provide stability to our current operations and to promote public confidence in our Company.

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Shareholders’ Equity. Shareholders’ equity was $673.0 million as of March 31, 2020, compared to $653.7 million as of December 31, 2019. The $19.2 million increase resulted primarily from the net income of $24.6 million, which was partially offset by dividends paid on common and preferred shares of $2.3 million and $3.6 million, respectively, during the period.

7% Preferred Stock. In March 2019 the Company issued 2,000,000 shares of 7.00% Fixed-to-Floating Rate Series A Non-Cumulative Perpetual Preferred Stock, without par value, and with a liquidation preference of $25.00 per share (“Series A Preferred Stock”). The Company received net proceeds of $48.3 million after underwriting discounts, commissions and direct offering expenses. In April 2019, the Company issued an additional 81,800 shares of Series A Preferred Stock to the underwriters related to their exercise of an option to purchase additional shares under the associated underwriting agreement, resulting in an addition $2.0 million in net proceeds, after underwriting discounts.

In June 2019 the Company issued an additional 874,000 shares of Series A Preferred Stock for net proceeds of $21.85 million.

In September 2019 the Company repurchased and subsequently retired 874,000 shares of Series A Preferred Stock at an aggregate cost of $21.85 million. There were no brokerage fees in connection with the transaction.

Dividends on the Series A Preferred Stock, to the extent declared by the Company’s board, are payable quarterly at an annual rate of $1.75 per share through March 31, 2024. After such date, quarterly dividends will accrue and be payable at a floating rate equal to three-month LIBOR plus a spread of 460.5 basis points per year. In the event that three-month LIBOR is less than zero, three-month LIBOR shall be deemed to be zero. The Company may redeem the Series A Preferred Stock at its option, subject to regulatory approval, on or after April 1, 2024, as described in the prospectus supplement relating to the offering filed with the SEC on March 22, 2019.

6% Preferred Stock. In August 2019 the Company issued 5,000,000 depositary shares, each representing a 1/40th interest in a share of its 6.00% Fixed-to-Floating Rate Series B Non-Cumulative Perpetual Preferred Stock, without par value, and with a liquidation preference of $1,000.00 per share (equivalent to $25.00 per depositary share)(“Series B Preferred Stock”). After deducting underwriting discounts, commissions, and direct offering expenses, the Company received total net proceeds of $120.8 million.

Dividends on the Series B Preferred Stock, to the extent declared by the Company’s board, are payable quarterly at an annual rate of $60.00 per depositary share (equivalent to $1.50 per depositary share) through December 31, 2024. After such date, quarterly dividends will accrue and be payable at a floating rate equal to three-month LIBOR plus a spread of 456.9 basis points per year. In the event that three-month LIBOR is less than zero, three-month LIBOR shall be deemed to be zero. The Company may redeem the Series B Preferred Stock at its option, subject to regulatory approval, on or after October 1, 2024, as described in the prospectus supplement relating to the offering filed with the SEC on August 13, 2019.

8% Preferred Stock. The Company previously issued a total of 41,625 shares of 8% Non-Cumulative, Perpetual Preferred Stock, without par value, with a liquidation preference of $1,000.00 per share (“8% Preferred Stock”) in private placement offerings.

Dividends on the 8% Preferred Stock, to the extent declared by the Company’s board, are payable quarterly at an annual rate of $80.00 per share. The Company may redeem the 8% Preferred Stock at its option, subject to regulatory approval, on or after December 31, 2020.

Common Shares/Dividends. As of March 31, 2020, the Company had 28,742,484 common shares issued and outstanding. In February 2020, the board of directors declared quarterly dividends at an annual rate of $0.32 per share.

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Capital Adequacy.

On November 13, 2019, the federal regulators finalized and adopted a regulatory capital rule establishing a new community bank leverage ratio (“CBLR”), which became effective on January 1, 2020. The intent of CBLR is to provide a simple alternative measure of capital adequacy for electing qualifying depository institutions and depository institution holding companies, as directed under the Economic Growth, Regulatory Relief, and Consumer Protection Act. Under CBLR, if a qualifying depository institution or depository institution holding company elects to use such measure, such institution or holding company will be considered well capitalized if its ratio of Tier 1 capital to average total consolidated assets (i.e., leverage ratio) exceeds 9%, subject to a limited two quarter grace period, during which the leverage ratio cannot go 100 basis points below the then applicable threshold, and will not be required to calculate and report risk-based capital ratios. In April 2020, under the CARES Act, the 9% leverage ratio threshold was temporarily reduced to 8% in response to the COVID-19 pandemic. The threshold will increase to 8.5% in 2021 and return to 9% in 2022. The Company, Merchants Bank, and FMBI elected to begin using CBLR in the first quarter of 2020.

At March 31, 2020, the Company, Merchants Bank, and FMBI exceeded all of its regulatory capital requirements with Tier 1 leverage capital levels exceeding 9% and management is not aware of any conditions or events since the most recent regulatory notification that would change the Company’s, Merchants Bank’s, or FMBI’s category.

At March 31, 2020, the Company reported a Tier 1 leverage capital level of $652.8 million, or 9.9% of adjusted total assets, which is above the required level of $592.7 million, or 9.0%; Merchants Bank reported a Tier 1 leverage capital level of $642.9 million, or 10.1% of adjusted total assets, which is above the required level of $574.3 million, or 9.0%; FMBI reported a Tier 1 leverage capital level of $22.0 million, or 10.7% of adjusted total assets, which is above the required level of $18.4 million, or 9.0%.

Failure to exceed the leverage ratio threshold required under CBLR in the future, subject to any applicable grace period, would require the Company, Merchants Bank, and/or FMBI to return to the risk-based capital ratio thresholds previously utilized under the fully phased-in Basel III Capital Rules to determine capital adequacy.

Quantitative and Qualitative Disclosures About Market Risk

Market Risk. Market risk represents the risk of loss due to changes in market values of assets and liabilities. We incur market risk in the normal course of business through exposures to market interest rates, equity prices, and credit spreads. We have identified two primary sources of market risk: interest rate risk and price risk related to market demand.

Interest Rate Risk

Our Asset-Liability Committee, or ALCO, is a management committee that manages our interest rate risk within broad policy limits established by our board of directors. In general, we seek to minimize the impact of changing interest rates on net interest income and the economic values of assets and liabilities. Our ALCO meets quarterly to monitor the level of interest rate risk sensitivity to ensure compliance with the board of directors’ approved risk limits.

Income Simulation and Economic Value Analysis. Interest rate risk measurement is calculated and reported to the ALCO at least quarterly. The information reported includes period-end results and identifies any policy limits exceeded, along with an assessment of the policy limit breach and the action plan and timeline for resolution, mitigation, or assumption of the risk.

We use two approaches to model interest rate risk: Net Interest Income at Risk (NII at Risk) and Economic Value of Equity (“EVE”). Under NII at Risk, net interest income is modeled utilizing various assumptions for assets, liabilities, and derivatives. EVE measures the period end market value of assets minus the market value of liabilities and the change in this value as rates change. EVE is a period end measurement.

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We report NII at Risk to isolate the change in income related solely to interest-earning assets and interest-bearing liabilities. The NII at Risk results reflect the analysis used quarterly by management. It models gradual -200, -100, +100 and +200 basis point parallel shifts in market interest rates, implied by the forward yield curve over the next one-year period. The following table presents NII at Risk for Merchants Bank as of March 31, 2020 and December 31, 2019.


	Net Interest Income Sensitivity
	Twelve Months Forward
	- 200			- 100			+ 100			+ 200
	(Dollars in thousands)
March 31, 2020:
Dollar change	$	(1,512)		$	(138)		$	27,522		$	53,517
Percent change		(0.8)	%		(0.1)	%		13.7	%		26.7	%

December 31, 2019:
Dollar change	$	(10,311)		$	(16,293)		$	17,501		$	34,703
Percent change		(7.8)	%		(12.3)	%		13.2	%		26.2	%

Our interest rate risk management policy limits the change in our net interest income to 20% for a +/-100 basis point move in interest rates, and 30% for a +/-200 basis point move in rates. At March 31, 2020 we estimated that we are within policy limits set by our board of directors for the -200, -100, +100, and +200 basis point scenarios.

The EVE results for Merchants Bank included in the following table reflect the analysis used quarterly by management. It models immediate -200, -100, +100 and +200 basis point parallel shifts in market interest rates.


	Economic Value of Equity
	Sensitivity (Shock)
	Immediate Change in Rates
	- 200			- 100			+ 100			+ 200
	(Dollars in thousands)
March 31, 2020:
Dollar change	$	(7,945)		$	25,180		$	7,952		$	11,518
Percent change		(1.3)	%		4.0	%		1.3	%		1.8	%

December 31, 2019:
Dollar change	$	(3)		$	(1,154)		$	(3,130)		$	(7,615)
Percent change		—	%		(0.2)	%		(0.5)	%		(1.2)	%

Our interest rate risk management policy limits the change in our EVE to 15% for a +/-100 basis point move in interest rates, and 20% for a +/-200 basis point move in rates. We are within policy limits set by our board of directors for the -200, -100, +100 and +200 basis point scenarios. The EVE reported at March 31, 2020 projects that as interest rates increase (decrease) immediately, the economic value of equity position will be expected to decrease (increase). When interest rates rise, fixed rate assets generally lose economic value; the longer the duration, the greater the value lost. The opposite is true when interest rates fall.

ITEM 3 Quantitative and Qualitative Disclosures About Market Risk

The information required under this item is included as part of “Management’s Discussion and Analysis of Financial Condition and Results of Operations” of this Form 10-Q under the headings “Liquidity and Capital Resources” and “Interest Rate Risk.”

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ITEM 4 Controls and Procedures

(a) Evaluation of disclosure controls and procedures.

Our management, under the supervision and with the participation of our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a‑15(e) and 15d‑15(e) under the Exchange Act) as of the end of the period covered by this Form 10-Q. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that, as of March 31, 2019, the Company’s disclosure controls and procedures were effective.

(b) Changes in internal control.

There have been no changes in the Company's internal control over financial reporting during the period covered by this report that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

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Part II

Other Information

ITEM 1. Legal Proceedings

None.

ITEM 1A. Risk Factors

In addition to the risk factors previously disclosed in the “Risk Factors” section included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2019, the Company has made the following updates:

The current COVID-19 pandemic could adversely affect our business operations, asset valuations, financial condition, and results of operations.

We are unable to estimate the near-term and ultimate impacts of the COVID-19 pandemic on our business and operations at this time. It is unknown how long the COVID-19 pandemic will last, or when restrictions on individuals and businesses will be lifted and businesses and their employees will be able to resume normal activities. Additional information may emerge regarding the severity of COVID-19 and additional actions may be taken by federal, state, and local governments to contain COVID-19 or treat its impact.

While the COVID-19 pandemic has minimally impacted our business and as of March 31, 2020 we had deferred payments on only 24 loans with unpaid balances of $23.6 million and we believe deferrals may better position customers to resume their regular payments to us in the future, these deferrals, and any additional deferrals may negatively impact our revenue and other results of operations at least in the near term, may produce additional requests for deferrals and/or for extensions and modifications beyond what we anticipate, and we may not be as successful as we expect in managing our credit risk, resulting in higher credit losses in our lending portfolio.

Additionally, the COVID-19 pandemic could cause further increases to our allowance for credit losses, impairment of our goodwill and other financial assets, diminished access to capital markets and other funding sources, and reduced demand for our products and services. Further, although the Federal Reserve’s monetary policies to date have been accommodative and may benefit us to some degree by supporting economic activity of our customers, sudden shifts in the Federal Reserve’s policies may impact our ability to grow and/or effectively manage interest-rate risk. While we continue to anticipate that our capital and liquidity positions will be sufficient, sustained adverse effects may impair these positions or prevent us from satisfying our minimum regulatory capital ratios and other supervisory requirements.

ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds

None.

ITEM 3. Defaults Upon Senior Securities

None.

ITEM 4. Mine Safety Disclosures

Not applicable.

ITEM 5. Other Information

None.

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ITEM 6. Exhibits


Exhibit
Number		Description

3.1		First Amended and Restated Articles of Incorporation of Merchants Bancorp (incorporated herein by reference to Exhibit 3.1 to the Company’s Registration Statement on Form S-1, as amended (File No. 333- 220623) filed on September 25, 2018)

3.2		Articles of Amendment to the First Amended and Restated Articles of Incorporation dated March 27, 2019 designating the 7.00% Fixed-to-Floating Rate Series A Non-Cumulative Perpetual Preferred Stock (incorporated by reference to Exhibit 3.2 of the registration statement on Form 8-A filed on March 28, 2019)

3.3		Articles of Amendment to the First Amended and Restated Articles of Incorporation dated August 19, 2019 designating the 6.00% Fixed-to-Floating Rate Series B Non-Cumulative Perpetual Preferred Stock (incorporated by reference to Exhibit 3.3 of the registration statement on Form 8-A filed on August 19, 2019).

3.4		Second Amended and Restated By-Laws of Merchants Bancorp (incorporated by reference to Exhibit 3.1 of the Company’s Current Report on Form 8-K filed on November 20, 2018)

31.1		Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

31.2		Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

32		Written Statement of Chief Executive Officer and Chief Financial Officer furnished pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

101.INS		XBRL Instance Document

101.SCH		XBRL Taxonomy Extension Schema Document

101.CAL		XBRL Taxonomy Extension Calculation Linkbase Document

101.DEF		XBRL Taxonomy Extension Definition Linkbase Document

101.LAB		XBRL Taxonomy Extension Label Linkbase Document

101.PRE		XBRL Taxonomy Extension Presentation Linkbase Document

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.


			Merchants Bancorp

Date:	May 4, 2020	By:	/s/ Michael F. Petrie
			Michael F. Petrie
			Chairman & Chief Executive Officer



Date:	May 4, 2020	By:	/s/ John F. Macke
			John F. Macke Chief Financial & Accounting Officer
			(Principal Financial Officer)