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Merchants Bancorp - Quarter Report: 2023 March (Form 10-Q)

Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D. C. 20549

FORM 10-Q

(Mark One)

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

For the quarterly period ended

March 31, 2023

OR

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

MBIN

NASDAQ

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

MBINP

MBINO

NASDAQ

NASDAQ

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

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

MBINN

MBINM

NASDAQ

NASDAQ

As of May 1, 2023, the latest practicable date, 43,233,618 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, 2023 and December 31, 2022

3

Condensed Consolidated Statements of Income for the Three Months Ended March 31, 2023 and 2022

4

Condensed Consolidated Statements of Comprehensive Income for the Three Months Ended March 31, 2023 and 2022

5

Condensed Consolidated Statements of Shareholders’ Equity for the Three Months Ended March 31, 2023 and 2022

6

Condensed Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2023 and 2022

7

Notes to Condensed Consolidated Financial Statements

8

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

40

Item 3 Quantitative and Qualitative Disclosures About Market Risk

57

Item 4 Controls and Procedures

57

PART II – OTHER INFORMATION

58

Item 1 Legal Proceedings

58

Item 1A Risk Factors

58

Item 2 Unregistered Sales of Equity Securities and Use of Proceeds

58

Item 3 Defaults Upon Senior Securities

58

Item 4 Mine Safety Disclosures

58

Item 5 Other Information

58

Item 6 Exhibits

59

SIGNATURES

60

2

Table of Contents

Part I – Financial Information

Item 1. Financial Statements

Merchants Bancorp

Condensed Consolidated Balance Sheets

March 31, 2023 (Unaudited) and December 31, 2022

(In thousands, except share data)

March 31, 

December 31, 

    

2023

    

2022

Assets

 

  

 

  

Cash and due from banks

$

19,002

$

22,170

Interest-earning demand accounts

 

350,584

 

203,994

Cash and cash equivalents

 

369,586

 

226,164

Securities purchased under agreements to resell

 

3,438

 

3,464

Mortgage loans in process of securitization

 

197,074

 

154,194

Securities available for sale

 

679,518

 

323,337

Securities held to maturity (includes $1,106,582 and $1,118,966 at fair value, respectively)

1,104,835

1,119,078

Federal Home Loan Bank (FHLB) stock

 

39,130

 

39,130

Loans held for sale (includes $85,516 and $82,192 at fair value, respectively)

 

2,855,250

 

2,910,576

Loans receivable, net of allowance for credit losses on loans of $51,838 and $44,014, respectively

 

8,575,210

 

7,426,858

Premises and equipment, net

 

35,793

 

35,438

Servicing rights

 

143,867

 

146,248

Interest receivable

 

64,282

 

56,262

Goodwill

 

15,845

 

15,845

Intangible assets, net

 

1,068

 

1,186

Other assets and receivables

 

156,070

 

157,447

Total assets

$

14,240,966

$

12,615,227

Liabilities and Shareholders' Equity

 

 

Liabilities

 

  

 

  

Deposits

 

  

 

  

Noninterest-bearing

$

313,733

$

326,875

Interest-bearing

 

11,031,498

 

9,744,470

Total deposits

 

11,345,231

 

10,071,345

Borrowings

 

1,233,762

 

930,392

Deferred and current tax liabilities, net

 

32,827

 

19,613

Other liabilities

 

123,462

 

134,138

Total liabilities

 

12,735,282

 

11,155,488

Commitments and Contingencies

 

  

 

  

Shareholders' Equity

 

  

 

  

Common stock, without par value

 

  

 

  

Authorized - 75,000,000 shares

 

  

 

  

Issued and outstanding - 43,233,618 shares at March 31, 2023 and 43,113,127 shares at December 31, 2022

 

138,105

 

137,781

Preferred stock, without par value - 5,000,000 total shares authorized

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

6% Series C Preferred stock - $1,000 per share liquidation preference

Authorized - 200,000 shares

Issued and outstanding - 196,181 shares (equivalent to 7,847,233 depositary shares)

191,084

191,084

8.25% Series D Preferred stock - $1,000 per share liquidation preference

Authorized - 300,000 shares

Issued and outstanding - 142,500 shares (equivalent to 5,700,000 depositary shares)

137,459

137,459

Retained earnings

 

875,700

 

832,871

Accumulated other comprehensive loss

 

(7,729)

 

(10,521)

Total shareholders' equity

 

1,505,684

 

1,459,739

Total liabilities and shareholders' equity

$

14,240,966

$

12,615,227

See notes to condensed consolidated financial statements.

3

Table of Contents

Merchants Bancorp

Condensed Consolidated Statements of Income (Unaudited)

For the Three Months Ended March 31, 2023 and 2022

(In thousands, except share data)

Three Months Ended

March 31, 

    

2023

    

2022

    

Interest Income

 

  

 

  

Loans

$

189,450

$

72,196

Mortgage loans in process of securitization

 

1,648

 

2,245

Investment securities:

 

 

Available for sale - taxable

 

2,266

 

701

Held to maturity

15,754

Federal Home Loan Bank stock

 

427

 

269

Other

 

1,749

 

601

Total interest income

 

211,294

 

76,012

Interest Expense

 

  

 

  

Deposits

 

104,442

 

8,813

Borrowed funds

 

6,159

 

1,474

Total interest expense

 

110,601

 

10,287

Net Interest Income

 

100,693

 

65,725

Provision for credit losses

 

6,867

 

2,451

Net Interest Income After Provision for Credit Losses

 

93,826

 

63,274

Noninterest Income

 

  

 

  

Gain on sale of loans

 

6,733

 

17,965

Loan servicing fees, net

 

2,360

 

9,731

Mortgage warehouse fees

 

1,028

 

1,858

Syndication and asset management fees

1,212

614

Other income

 

2,931

 

4,429

Total noninterest income

 

14,264

 

34,597

Noninterest Expense

 

  

 

  

Salaries and employee benefits

 

22,146

 

21,293

Loan expenses

 

804

 

1,211

Occupancy and equipment

 

2,232

 

1,814

Professional fees

 

2,269

 

1,303

Deposit insurance expense

 

2,178

 

759

Technology expense

 

1,577

 

1,236

Other expense

 

3,566

 

3,417

Total noninterest expense

 

34,772

 

31,033

Income Before Income Taxes

 

73,318

 

66,838

Provision for income taxes

 

18,363

 

16,696

Net Income

$

54,955

$

50,142

Dividends on preferred stock

(8,667)

(5,728)

Net Income Allocated to Common Shareholders

46,288

44,414

Basic Earnings Per Share

$

1.07

$

1.03

Diluted Earnings Per Share

$

1.07

$

1.02

Weighted-Average Shares Outstanding

 

  

 

  

Basic

 

43,179,604

 

43,190,066

Diluted

 

43,290,779

 

43,360,034

See notes to condensed consolidated financial statements.

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Table of Contents

Merchants Bancorp

Condensed Consolidated Statements of Comprehensive Income (Unaudited)

For the Three Months Ended March 31, 2023 and 2022

(In thousands)

Three Months Ended

March 31, 

    

2023

    

2022

Net Income

$

54,955

$

50,142

Other Comprehensive Income (Loss):

 

  

 

Net change in unrealized gain/(losses) on investment securities available for sale, net of tax (expense)/benefits of $(934) and $1,650, respectively

 

2,792

 

(4,850)

Other comprehensive income (loss) for the period

 

2,792

 

(4,850)

Comprehensive Income

$

57,747

$

45,292

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, 2023 and 2022

(In thousands, except share data)

Three Months Ended

March 31, 

    

2023

    

2022

Shares

Amount

Shares

Amount

Common Stock

 

  

 

  

Balance beginning of period

43,113,127

$

137,781

43,180,079

$

137,565

Cash paid in lieu of fractional shares for stock split

-

-

(29)

(1)

Distribution to employee stock ownership plan

33,293

810

20,709

653

Shares issued for stock compensation plans, net of taxes withheld to satisfy tax obligations

87,198

(486)

67,017

(335)

Balance end of period

43,233,618

138,105

43,267,776

137,882

7% Series A Preferred Stock

Balance at beginning and end of period

2,081,800

50,221

2,081,800

50,221

6% Series B Preferred Stock

Balance at beginning and end of period

125,000

120,844

125,000

120,844

6% Series C Preferred Stock

Balance at beginning and end of period

196,181

191,084

196,181

191,084

8.25% Series D Preferred Stock

Balance at beginning and end of period

142,500

137,459

-

-

Retained Earnings

Balance beginning of period

832,871

657,149

Net income

54,955

50,142

Impact from adoption of ASU 2016-13 (Credit Losses)

-

(3,648)

Impact from adoption of ASU 2016-02 (Leases)

-

(110)

Dividends on 7% Series A preferred stock, $1.75 per share, annually

(910)

(910)

Dividends on 6% Series B preferred stock, $60.00 per share, annually

(1,875)

(1,875)

Dividends on 6% Series C preferred stock, $60.00 per share, annually

(2,943)

(2,943)

Dividends on 8.25% Series D preferred stock, $82.50 per share, annually

(2,939)

-

Dividends on common stock, $0.32 per share, annually in 2023 and $0.28 per share, annually in 2022

(3,459)

(3,029)

Balance end of period

875,700

694,776

Accumulated Other Comprehensive Loss

Balance beginning of period

(10,521)

(1,454)

Other comprehensive loss

2,792

(4,850)

Balance end of period

(7,729)

(6,304)

Total shareholders' equity

$

1,505,684

$

1,188,503

See notes to condensed consolidated financial statements.

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Table of Contents

Merchants Bancorp

Condensed Consolidated Statements of Cash Flows (Unaudited)

Three Months Ended March 31, 2023 and 2022

(In thousands)

Three Months Ended

March 31, 

    

2023

    

2022

Operating activities:

 

  

 

  

Net income

$

54,955

$

50,142

Adjustments to reconcile net income to net cash provided by operating activities:

 

 

Depreciation

 

686

 

591

Provision for credit losses

 

6,867

 

2,451

Gain on sale of loans

 

(6,733)

 

(17,965)

Proceeds from sales of loans

 

3,356,860

 

8,214,273

Loans and participations originated and purchased for sale

 

(3,674,484)

 

(7,178,991)

Purchases of low-income housing tax credits for sale

(7,932)

(6,651)

Proceeds from sale of low-income housing tax credits

8,670

Change in servicing rights for paydowns and fair value adjustments

 

4,554

 

(4,896)

Net change in:

 

 

Mortgage loans in process of securitization

 

(42,880)

 

244,959

Other assets and receivables

 

(8,116)

 

(15,325)

Other liabilities

 

7,607

 

8,030

Other

 

(1,587)

 

(988)

Net cash (used in) provided by operating activities

 

(301,533)

 

1,295,630

Investing activities:

 

 

  

Net change in securities purchased under agreements to resell

 

26

 

1,090

Purchases of securities available for sale

 

(353,249)

 

(20,002)

Purchases of securities held to maturity

(1,540)

Proceeds from calls, maturities and paydowns of securities available for sale

 

832

 

9,302

Proceeds from calls, maturities and paydowns of securities held to maturity

15,783

Purchases of loans

 

(98,791)

 

(40,672)

Net change in loans receivable

 

(678,522)

 

(187,323)

Proceeds from sale of FHLB stock

 

 

784

Purchases of premises and equipment

 

(1,041)

 

(3,939)

Purchase of servicing rights

(2,057)

Purchase of limited partnership interests

(4,580)

(6,577)

Other investing activities

 

906

2,245

Net cash used in investing activities

 

(1,120,176)

 

(247,149)

Financing activities:

 

  

 

Net change in deposits

 

1,273,886

 

(1,506,792)

Proceeds from borrowings

 

22,335,000

 

626,000

Repayment of borrowings

 

(22,185,180)

 

(780,025)

Proceeds from credit linked notes

153,546

Dividends

(12,126)

(8,757)

Other financing activities

 

5

 

Net cash provided by (used in) financing activities

 

1,565,131

 

(1,669,574)

Net Change in Cash and Cash Equivalents

 

143,422

 

(621,093)

Cash and Cash Equivalents, Beginning of Period

 

226,164

 

1,032,614

Cash and Cash Equivalents, End of Period

$

369,586

$

411,521

Supplemental Cash Flows Information:

 

 

  

Interest paid

$

101,381

$

10,228

Income taxes paid, net of refunds

 

966

 

(497)

Transfer of loans from loans held for sale to loans receivable

 

377,460

 

See notes to condensed consolidated financial statements.

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Table of Contents

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”), Farmers-Merchants Bank of Illinois (“FMBI”) and Merchants Asset Management, LLC (“MAM”). Merchants Bank’s primary operating subsidiaries include Merchants Capital Corp. (“MCC”), Merchants Capital Servicing, LLC (“MCS”) and Merchants Capital Investments, LLC (“MCI”). All direct and indirectly owned subsidiaries owned by Merchants Bancorp are collectively referred to as the “Company”.

The accompanying unaudited condensed consolidated balance sheet of the Company as of December 31, 2022, which has been derived from audited financial statements, and unaudited condensed consolidated financial statements of the Company as of March 31, 2023 and for the three months ended March 31, 2023 and 2022, 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, 2022 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, 2023 and the results of operations for the three months ended March 31, 2023 and 2022, and cash flows for the three months ended March 31, 2023 and 2022. All interim amounts have not been audited and the results of operations for the three months ended March 31, 2023, 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, 2023 and 2022 include results from the Company, and its wholly owned subsidiaries, Merchants Bank, FMBI and MAM. Also included are Merchants Bank’s primary operating subsidiaries, MCC, MCS and MCI, as well as all direct and indirectly owned subsidiaries owned by Merchants Bancorp.

In addition, when the Company makes an equity investment in or has a relationship with an entity for which it holds a variable interest, it is evaluated for consolidation requirements under Accounting Standards Update of Topic 810. Accordingly, the entity is assessed for potential consolidation under the variable interest entity (“VIE”) model and would only consolidate those entities for which it is a primary beneficiary. A primary beneficiary is defined as the party that has both the power to direct the activities that most significantly impact the entity, and an interest that could be significant to the entity. To determine if an interest could be significant to the entity, both qualitative and quantitative factors regarding the nature, size and form of the Company’s involvement with the entity are evaluated. Alternatively, under the voting interest model, it would only consolidate those entities for which it has a controlling interest. Because the variable interest investments held by the Company as of March 31, 2023 are not deemed to be primary beneficiaries or controlling interests, the entities are not consolidated and the equity method or proportional method of accounting has been applied. The Company will analyze whether its entities are the primary beneficiary on an ongoing basis. Changes in facts and circumstances occurring since the previous primary beneficiary determination will be considered as part of this ongoing assessment. See Note 5: Variable Interest Entities (VIEs) for additional information about VIEs.

All significant intercompany accounts and transactions have been eliminated in consolidation.

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Merchants Bancorp

Notes to Condensed Consolidated Financial Statements

(Unaudited)

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 credit losses on loans, servicing rights and fair values of financial instruments.

Significant Accounting Policies

The significant accounting policies followed by the Company for interim financial reporting are consistent with the accounting policies followed for annual financial reporting.

On January 1, 2022, the Company adopted FASB Accounting Standards Update (ASU) No. 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments ("CECL"). The Company revised certain accounting policies and implemented certain accounting policy elections, related to the adoption of CECL, which are described below. All adjustments, which are of a normal recurring nature and are, in the opinion of management, necessary for a fair statement of the results for the periods reported, have been included in the accompanying Condensed Consolidated Financial Statements.

CECL replaces the previous "allowance for loan and lease losses" model for measuring credit losses, which encompassed allowances for current known and inherent losses within the portfolio, with an "expected loss" model for measuring credit losses, which encompasses allowances for losses expected to be incurred over the life of the included assets. The new CECL model requires the measurement of all expected credit losses for financial assets measured at amortized cost and certain off-balance sheet credit exposures (“OBCEs”) based on historical experiences, current conditions, and reasonable and supportable forecasts. CECL also requires enhanced disclosures related to the significant estimates and judgments used in estimating credit losses, as well as credit quality and underwriting standards of an organization's portfolio. In addition, CECL includes certain changes to the accounting for investment securities available for sale depending on whether management intends to sell the securities or believes that it is more likely than not they will be required to sell.

As of the adoption date on January 1, 2022, the Company recorded a $3.6 million decrease, net of taxes, to retained earnings for the cumulative effect of adopting CECL. The transition adjustment included a $0.3 million increase to retained earnings related to allowance for credit losses on loans (“ACL-Loans”) and a $5.2 million decrease to retained earnings related to allowance for OBCEs (“ACL-OBCEs”). The following table summarizes the impact of the adoption of CECL on the Company’s balance sheet as of January 1, 2022.

ACL-Loans - the ACL-Loans is a valuation account that is deducted from the loans’ amortized cost basis to present the net amount expected to be collected on loans over the contractual term. Loans are charged off against the allowance when the uncollectibility of the loan is confirmed. Expected recoveries do not exceed the aggregate of amounts previously charged off and expected to be charged off. Adjustments to the ACL-Loans are reported in the income statement as a provision for credit loss. Further information regarding the policies and methodology used to estimate the ACL-Loans is detailed in Note 4: Loans and Allowance for credit losses on loans of these Notes to Consolidated Condensed Financial Statements.

ACL-OBCEs – the ACL–OBCEs is a liability account representing expected credit losses over the contractual period for which the Company is exposed to credit risk resulting from a contractual obligation to extend credit. No allowance is recognized if the Company has the unconditional right to cancel the obligation. OBCEs primarily consist of amounts available under outstanding lines of credit. For the period of exposure, the estimate of expected credit losses considers both the likelihood that funding will occur and the amount expected to be funded over the estimated remaining

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Merchants Bancorp

Notes to Condensed Consolidated Financial Statements

(Unaudited)

life of the commitment. The likelihood and expected amount of funding are based on historical utilization rates. The amount of the allowance represents management’s best estimate of expected credit losses on commitments expected to be funded over the contractual life of the commitment. The ACL–OBCEs is adjusted through the income statement as a component of provision for credit loss.

Restricted Cash

Included in cash equivalents is an account restricted as collateral for the potential risk of loss on $158.1 million of senior credit linked notes issued by the Company in March 2023. As of March 31, 2023, there was $20.5 million in restricted cash. Also see Note 11: Borrowings.

Reclassifications

Certain reclassifications may have been made to the 2022 financial statements to conform to the financial statement presentation as of and for the three months ended March 31, 2023. These reclassifications had no effect on net income.

Note 2:   Investment Securities

The amortized cost and approximate fair values, together with gross unrealized gains and losses, of securities available for sale and held to maturity were as follows:

March 31, 2023

Gross

Gross

Amortized

Unrealized

Unrealized

Fair

    

Cost

    

Gains

    

Losses

    

Value

(In thousands)

Securities available for sale:

 

  

 

  

 

  

 

  

Treasury notes

$

175,766

$

52

$

719

$

175,099

Federal agencies

 

299,990

 

 

9,659

 

290,331

Mortgage-backed - Government-sponsored entity (GSE)

214,086

6

4

214,088

Total securities available for sale

$

689,842

$

58

$

10,382

$

679,518

Securities held to maturity:

Mortgage-backed - Non-GSE multi-family

$

867,072

$

$

285

$

866,787

Mortgage-backed - Non-GSE residential

236,225

2,088

238,313

Mortgage-backed - Government - sponsored entity (GSE)

1,538

56

1,482

Total securities held to maturity

$

1,104,835

$

2,088

$

341

$

1,106,582

December 31, 2022

Gross

Gross

Amortized

Unrealized

Unrealized

Fair

    

Cost

    

Gains

    

Losses

    

Value

(In thousands)

Securities available for sale:

 

  

 

  

 

  

 

  

Treasury notes

$

37,234

$

1

$

955

$

36,280

Federal agencies

 

284,986

 

 

13,096

 

271,890

Mortgage-backed - Government-sponsored entity (GSE)

15,167

7

7

15,167

Total securities available for sale

$

337,387

$

8

$

14,058

$

323,337

Securities held to maturity:

Mortgage-backed - Non-GSE multi-family

$

871,772

$

12

$

$

871,784

Mortgage-backed - Non-GSE residential

247,306

124

247,182

Total securities held to maturity

$

1,119,078

$

12

$

124

$

1,118,966

10

Table of Contents

Merchants Bancorp

Notes to Condensed Consolidated Financial Statements

(Unaudited)

At March 31, 2023 and December 31, 2022, GSE mortgage-backed securities included in the tables above are primarily backed by multi-family loans. The tables above for March 31, 2023 and December 31, 2022 primarily include securities held to maturity that were purchased following the September 2022 loan sale and securitization transactions.

Accrued interest on securities available for sale totaled $1.5 million at March 31, 2023 and $0.5 million at December 31, 2022, respectively, and is excluded from the estimate of credit losses.

Accrued interest on securities held to maturity totaled $4.4 million at March 31, 2023 and $4.3 million at December 31, 2022, respectively, and is excluded from the estimate of credit losses.

The amortized cost and fair value of available for sale securities at March 31, 2023 and December 31, 2022, 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, 2023

December 31, 2022

Amortized

Fair

Amortized

Fair

    

Cost

    

Value

    

Cost

    

Value

Securities available for sale:

(In thousands)

Within one year

$

341,569

$

336,159

$

118,984

$

115,386

After one through five years

 

134,187

 

129,271

 

203,236

 

192,784

 

475,756

 

465,430

 

322,220

 

308,170

Mortgage-backed - Government-sponsored entity (GSE)

214,086

214,088

15,167

15,167

$

689,842

$

679,518

$

337,387

$

323,337

Securities held to maturity:

Mortgage-backed - Non-GSE multi-family

$

867,072

$

866,787

$

871,772

$

871,784

Mortgage-backed - Non-GSE residential

236,225

238,313

Mortgage-backed - Government - sponsored entity (GSE)

1,538

 

1,482

 

247,306

 

247,182

$

1,104,835

$

1,106,582

$

1,119,078

$

1,118,966

During the three months ended March 31, 2023 and 2022, no securities available for sale were sold.

The following tables show the Company’s gross unrealized losses and fair value of the Company’s investment securities with unrealized losses for which an ACL has not been recorded, aggregated by investment class and length of

11

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Merchants Bancorp

Notes to Condensed Consolidated Financial Statements

(Unaudited)

time that individual securities have been in a continuous unrealized loss position at March 31, 2023 and December 31, 2022:

March 31, 2023

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)

Securities available for sale:

 

  

 

  

 

  

 

  

 

  

 

  

Treasury notes

$

29,757

$

588

$

5,862

$

131

$

35,619

$

719

Federal agencies

14,947

53

275,385

9,606

290,332

9,659

Mortgage-backed - Government-sponsored entity (GSE)

74

2

200

2

274

4

$

44,778

$

643

$

281,447

$

9,739

$

326,225

$

10,382

Securities held to maturity:

Mortgage-backed - Non-GSE multi-family

$

866,787

$

285

$

$

$

866,787

$

285

Mortgage-backed - Government - sponsored entity (GSE)

1,482

56

1,482

56

$

868,269

$

341

$

$

$

868,269

$

341

December 31, 2022

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)

Securities available for sale:

 

  

 

  

 

  

 

  

 

  

 

  

Treasury notes

$

29,560

$

762

$

5,798

$

193

$

35,358

$

955

Federal agencies

19,276

724

252,613

12,372

271,889

13,096

Mortgage-backed - Government-sponsored entity (GSE)

709

7

709

7

$

49,545

$

1,493

$

258,411

$

12,565

$

307,956

$

14,058

Securities held to maturity:

Mortgage-backed - Non-GSE residential

247,182

124

247,182

124

$

247,182

$

124

$

$

$

247,182

$

124

     

Allowance for Credit Losses

For securities available for sale with an unrealized loss position, the Company evaluates the securities to determine whether the decline in the fair value below the amortized cost basis (impairment) is due to credit-related factors or non-credit related factors. Any impairment that is not credit-related is recognized in AOCI, net of tax. Credit-related impairment is recognized as an ACL for securities available for sale on the balance sheet, limited to the amount by which the amortized cost basis exceeds the fair value, with a corresponding adjustment to earnings. Accrued interest receivable is excluded from the estimate of credit losses. Both the ACL and the adjustment to net income may be reversed if conditions change. However, if the Company expects, or is required, to sell an impaired available for sale security before recovering its amortized cost basis, the entire impairment amount would be recognized in earnings with a

12

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Merchants Bancorp

Notes to Condensed Consolidated Financial Statements

(Unaudited)

corresponding adjustment to the security’s amortized cost basis. Because the security’s amortized cost basis is adjusted to fair value, there is no ACL in this situation.

In evaluating securities available for sale in unrealized loss positions for impairment and the criteria regarding its intent or requirement to sell such securities, the Company considers the extent to which fair value is less than amortized cost, whether the securities are issued by the federal government or its agencies, whether downgrades by bond rating agencies have occurred, and the results of reviews of the issuers’ financial condition, among other factors. Unrealized losses on the Company’s investment securities portfolio have not been recognized as an expense because the securities are of high credit quality, and the decline in fair values is attributable to changes in the prevailing interest rate environment since the purchase date. Fair value is expected to recover as securities reach maturity and/or the interest rate environment returns to conditions similar to when these securities were purchased. There were no credit related factors underlying unrealized losses on available for sale debt securities at March 31, 2023 and December 31, 2022.

Securities held to maturity are comprised of non-GSE mortgage-backed securities secured by multi-family or single-family properties, and GSE mortgage-backed securities secured by multi-family properties. The GSE security is a Government National Mortgage Association (“Ginnie Mae”) mortgage-backed security and backed by the full faith and credit of the U.S. government. Accordingly, no allowance for credit losses has been recorded for this security. The non-GSE securities were purchased under securitization arrangements where a credit loss component was purchased by third party investors. These securities were evaluated for credit losses over and above the credit loss percentage sold under the arrangements, and the Company does not anticipate any such losses. Additional qualitative factors are evaluated, including the timeliness of principal and interest payments under the contractual terms of the securities. Accordingly, no allowance for credit losses has been recorded for the non-GSE securities

Note 3:   Mortgage Loans in Process of Securitization

Mortgage loans in process of securitization are recorded at fair value with changes in fair value recorded in earnings. These include multi-family rental real estate loan originations to be sold as Ginnie Mae mortgage-backed securities and Federal National Mortgage Association (“Fannie Mae”) and Federal Home Loan Mortgage Corporation (“Freddie Mac”) participation certificates, all of which are pending settlements with firm investor commitments to purchase the securities, typically occurring within 30 days. The fair value increases recorded in earnings for mortgage loans in process of securitization totaled $4.0 million and $2.8 million at March 31, 2023 and 2022, respectively.

Note 4:   Loans and Allowance for Credit Losses on Loans

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 ACL-Loans, 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 Company has made a policy election to exclude accrued interest from the amortized cost basis of loans and reports accrued interest separately from the related loan balance in the consolidated balance sheets. Accrued interest on loans totaled $42.6 million and $35.0 million at March 31, 2023 and December 31, 2022, respectively.

The Company also elected not to measure an allowance for credit losses for accrued interest receivables. 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 collected on these loans is applied to the principal balance until the loan can be returned to

13

Table of Contents

Merchants Bancorp

Notes to Condensed Consolidated Financial Statements

(Unaudited)

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.

When cash payments for accrued interest are received on nonaccrual loans in each loan class, the Company records a reduction in principle on the balance of the loan. For loan modifications, interest income is recognized on an accrual basis at the renegotiated rate if the loan is in compliance with the modified terms.

The Company offers warehouse loans or credit to fund mortgage loans held for sale from closing until sale to an investor. Under a warehousing arrangement the Company funds a mortgage loan as secured financing. The warehousing arrangement is secured by the underlying mortgages and a combination of deposits, personal guarantees and advance rates. The Company typically holds the collateral until it is sent under a bailee arrangement instructing the investor to send proceeds to the Company. Typical investors are large financial institutions or government agencies. Interest earned from the time of funding to the time of sale is recognized as interest income as accrued. Fees earned agreements are recognized when collected as noninterest income.

Loan Portfolio Summary

Loans receivable at March 31, 2023 and December 31, 2022 include:

March 31, 

December 31, 

    

2023

    

2022

(In thousands)

Mortgage warehouse lines of credit

$

604,445

$

464,785

Residential real estate

 

1,215,252

 

1,178,401

Multi-family financing

 

3,566,530

 

3,135,535

Healthcare financing

1,941,204

1,604,341

Commercial and commercial real estate(1)(2)

 

1,194,320

 

978,661

Agricultural production and real estate

 

89,516

 

95,651

Consumer and margin loans

 

15,781

 

13,498

 

8,627,048

 

7,470,872

Less:

 

  

 

  

ACL-Loans

 

51,838

 

44,014

Loans Receivable

$

8,575,210

$

7,426,858

(1)Includes $672.9 million and $497.0 million of revolving lines of credit collateralized primarily by single-family mortgage servicing rights as of March 31, 2023 and December 31, 2022, respectively.
(2)Includes only $9.1 million of non-owner occupied commercial real estate as of March 31, 2023 and included only $12.8 million as of December 31, 2022.

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

14

Table of Contents

Merchants Bancorp

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 repurchase agreement, 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 the Federal Reserve’s Secured Overnight Financing Rate (“SOFR”), or mortgage note rate and 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. However, the warehouse customers are required to hedge the change in value of these loans to mitigate the risk.

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. First-lien HELOC mortgages included in this segment typically carry a base rate of 30-day LIBOR or the One-Year Constant Maturity Treasury (“CMT”), plus a margin.

Multi-Family Financing (MF FIN): The Company engages in multi-family financing, including construction loans, specializing in originating and servicing loans for multi-family rental 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 are dependent on the cash flow of the property, and may include permanent loans, sales of developed property or an interim loan commitment from the Company until permanent agency-eligible financing is obtained. 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. Loans included in this segment typically carry a base rate of the Federal Reserve’s Secured Overnight Financing Rate (“SOFR”) that adjusts on a monthly basis and a margin.

Healthcare Financing (HC FIN): The healthcare financing portfolio includes customized loan products for independent living, assisted living, memory care and skilled nursing projects. A variety of loan products are available to accommodate rehabilitation, acquisition, and refinancing of healthcare properties. Credit risk in these loans are primarily driven by local demographics and the expertise of the operators of the facilities. 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, as well as successful operation of a business or property and the borrower’s cash flows. Loans included in this segment typically carry a base rate of SOFR that adjusts on a monthly basis and a margin.

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 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. Small Business Administration (“SBA”) loans are included in this category. Less than 1% of total commercial and commercial real estate loans are made up of non-owner occupied commercial real estate loans. The Company strategically focuses on loan classes that are government backed or can be sold in the secondary market.

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

15

Table of Contents

Merchants Bancorp

Notes to Condensed Consolidated Financial Statements

(Unaudited)

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. Agricultural real estate loans included in this segment are typically structured with a one-year ARM, 3-year ARM or 5-year ARM CMT and a margin. Agriculture production, livestock, and equipment loans are structured with variable rates that are indexed to prime or fixed for terms not exceeding 5 years.

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.

ACL-Loans

The Company adopted CECL on January 1, 2022. CECL replaces the previous “Allowance for Loan and Lease Losses” standard for measuring credit losses. Upon adoption of CECL, the difference in the two measurements was recorded in the ACL-Loans and retained earnings.

The ACL-Loans is the Company’s estimate of expected credit losses. Loans receivable is presented net of the allowance to reflect the principal balance expected to be collected over the contractual term of the loans. This life of loan allowance is established through a provision for credit losses charged to net interest income as loans are recorded in the financial statements. The provision for a reporting period also reflects increases or decreases in the allowance related to changes in credit loss expectations. Actual credit losses are charged against the allowance when management believes the uncollectibility of a loan balance, or a portion thereof, is confirmed. Subsequent recoveries, if any, are credited to the allowance.

The ACL-Loans is evaluated on a regular basis by management and is based upon management’s periodic review of the collectability of the loans considering relevant available information from internal and external sources, including 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. The allowance also incorporates reasonable and supportable forecasts. There have been no changes to the credit quality components used to assess risk during the year ended December 31, 2022. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available. The level of the ACL is believed to be adequate to absorb innate expected future losses in the loan portfolio as of the measurement date.

The ACL-Loans consists of individually evaluated loans and pooled loan components. The Company’s primary portfolio segmentation is by credit risk grade. Loans risk graded substandard and worse are individually evaluated for expected credit losses. For individually evaluated loans that are collateral dependent, an allowance is established when the fair value of the collateral, the loan’s obtainable market price, or the present value of expected future cash flows discounted at the loan’s effective interest rate, is lower than the carrying value of that loan. A loan is considered to be collateral dependent when repayment is expected to be provided substantially through the operation or the sale of the collateral.

16

Table of Contents

Merchants Bancorp

Notes to Condensed Consolidated Financial Statements

(Unaudited)

To calculate the allowance for expected credit losses on loans risk graded pass through special mention, the portfolio is segmented by loans with similar risk characteristics.

Loan Portfolio Segment

    

ACL-Loans Methodology

Mortgage warehouse lines of credit

Remaining Life Method

Residential real estate

Discounted Cash Flow

Multi-family financing

Discounted Cash Flow

Healthcare financing

Discounted Cash Flow

Commercial and commercial real estate

Discounted Cash Flow

Agricultural production and real estate

Remaining Life Method

Consumer and margin loans

Remaining Life Method

Loan characteristics used in determining the segmentation include the underlying collateral, type or purpose of the loan, and expected credit loss patterns. The estimation of expected credit losses for each segment is primarily based on historical credit loss experience. Given the Company’s modest historical credit loss experience, peer and industry data was incorporated into the measurement. Expected life of loan credit losses are quantified using discounted cash flows and remaining life methodologies.

Model results are supplemented by qualitative adjustments for risk factors relevant in assessing the expected credit losses within the portfolio segments. These adjustments may increase or decrease the estimate of expected credit losses based upon the assessed level of risk for each qualitative factor.

The models utilized and the applicable qualitative adjustments require assumptions and management judgment that can be subjective in nature. The above measurement approach is also used to estimate the expected credit losses associated with unfunded loan commitments, which also incorporates expected utilization rates.

The following table presents, by loan portfolio segment, the activity in the ACL-Loans for the three months ended March 31, 2023 and 2022:

For the Three Months Ended March 31, 2023

 

MTG WHLOC

 

RES RE

 

MF FIN

 

HC FIN

CML & CRE

 

AG & AGRE

 

CON & MAR

 

TOTAL

(In thousands)

ACL-Loans

Balance, beginning of period

$

1,249

$

7,029

 

$

16,781

$

9,882

$

8,326

$

565

$

182

$

44,014

Provision for credit losses

 

415

 

349

 

3,070

1,871

 

2,149

 

(22)

 

(15)

 

7,817

Loans charged to the allowance

 

 

 

 

 

 

 

Recoveries of loans previously charged off

 

 

 

 

7

 

 

 

7

Balance, end of period

$

1,664

$

7,378

$

19,851

$

11,753

$

10,482

$

543

$

167

$

51,838

For the Three Months Ended March 31, 2022

 

MTG WHLOC

 

RES RE

 

MF FIN

 

HC FIN

CML & CRE

 

AG & AGRE

 

CON & MAR

 

TOTAL

(In thousands)

ACL-Loans

Balance, beginning of period

$

1,955

$

4,170

 

$

14,084

$

4,461

$

5,879

$

657

$

138

$

31,344

Impact of adopting CECL

41

275

520

139

(1,277)

(18)

21

(299)

Provision for credit losses

 

(55)

 

102

 

527

1,018

 

431

 

(42)

 

 

1,981

Loans charged to the allowance

 

 

 

 

(931)

 

 

 

(931)

Recoveries of loans previously charged off

 

 

 

 

 

 

7

 

7

Balance, end of period

$

1,941

$

4,547

$

15,131

$

5,618

$

4,102

$

597

$

166

$

32,102

17

Table of Contents

Merchants Bancorp

Notes to Condensed Consolidated Financial Statements

(Unaudited)

The Company recorded a total provision for credit losses of $6.9 million for the three months ended March 31, 2023. The $6.9 million total provision for credit losses consisted of $7.8 million for the ACL-Loans as shown above and $(0.9) million for the ACL-OBCE’s.

The Company recorded a total provision for credit losses of $2.5 million for the three months ended March 31, 2022. The $2.5 million total provision for credit losses consisted of $2.0 million for the ACL-Loans as shown above and $0.5 million for the ACL-OBCE’s.

The following table presents the allowance for loan losses and the recorded investment in loans and impairment method as of December 31, 2022:

December 31, 2022

 

MTG WHLOC

 

RES RE

 

MF FIN

 

HC FIN

CML & CRE

 

AG & AGRE

 

CON & MAR

 

TOTAL

(In thousands)

ACL-Loans

Balance, beginning of period

$

1,955

$

4,170

 

$

14,084

$

4,461

$

5,879

$

657

$

138

$

31,344

Impact of adopting CECL

41

275

520

139

(1,277)

(18)

21

(299)

Provision for credit losses

 

(747)

 

2,588

 

2,177

5,282

 

4,216

 

(74)

 

31

 

13,473

Loans charged to the allowance

 

 

(4)

 

 

(1,238)

 

 

(15)

 

(1,257)

Recoveries of loans previously charged off

 

 

 

 

746

 

 

7

 

753

Balance, end of period

$

1,249

$

7,029

$

16,781

$

9,882

$

8,326

$

565

$

182

$

44,014

The below table presents the amortized cost basis and ACL-Loans allocated for collateral dependent loans, which are individually evaluated to determine expected credit losses:

March 31, 2023

    

Real Estate

    

Accounts Receivable / Equipment

    

Other

    

Total

    

ACL-Loans Allocation

(In thousands)

RES RE

$

231

$

$

9

$

240

$

38

MF FIN

36,760

36,760

184

HC FIN

 

21,783

 

 

 

21,783

 

132

CML & CRE

 

 

4,986

 

1,493

 

6,479

 

1,381

AG & AGRE

 

147

 

 

 

147

 

1

CON & MAR

 

 

 

5

 

5

 

Total collateral dependent loans

$

58,921

$

4,986

$

1,507

$

65,414

$

1,736

There have been no significant changes to the types of collateral securing the Company’s collateral dependent loans compared to March 31, 2022.

Internal Risk Categories

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

Pass – Loans that are considered to be of acceptable credit quality, and not classified as Special Mention, Substandard or Doubtful.

Special Mention (Watch) – This is a loan that is sound and collectable but contains potential 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.

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Merchants Bancorp

Notes to Condensed Consolidated Financial Statements

(Unaudited)

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 risk rating category as of March 31, 2023 and December 31, 2022:

As of March 31, 2023

    

2023

    

2022

    

2021

2020

    

2019

    

Prior

    

Revolving Loans

    

TOTAL

(In thousands)

MTG WHLOC

Pass

$

$

$

$

$

$

$

604,445

$

604,445

Total

$

$

$

$

$

$

$

604,445

$

604,445

RES RE

Pass

3,207

13,097

8,339

24,856

3,475

12,867

1,148,709

1,214,550

Special Mention (Watch)

60

402

462

Substandard

240

240

Total

$

3,207

$

13,097

$

8,339

$

24,856

$

3,535

$

13,509

$

1,148,709

$

1,215,252

MF FIN

Pass

382,298

1,221,448

494,235

156,813

32,201

11,347

1,159,249

3,457,591

Special Mention (Watch)

32,807

16,379

8,000

14,993

72,179

Substandard

36,760

36,760

Total

$

382,298

$

1,291,015

$

510,614

$

164,813

$

32,201

$

11,347

$

1,174,242

$

3,566,530

HC FIN

Pass

93,837

1,176,484

265,032

79,805

13,682

207,521

1,836,361

Special Mention (Watch)

22,709

22,437

29,014

8,900

83,060

Substandard

21,783

21,783

Total

$

116,546

$

1,198,921

$

315,829

$

79,805

$

13,682

$

$

216,421

$

1,941,204

CML & CRE

Pass

23,150

130,905

85,065

22,411

22,109

19,553

881,494

1,184,687

Special Mention (Watch)

17

41

473

1,103

116

323

1,081

3,154

Substandard

496

2,057

586

70

632

2,638

6,479

Total

$

23,167

$

131,442

$

87,595

$

24,100

$

22,295

$

20,508

$

885,213

$

1,194,320

AG & AGRE

Pass

4,439

11,116

7,163

15,049

5,675

20,352

24,124

87,918

Special Mention (Watch)

14

54

462

344

551

26

1,451

Substandard

147

147

Total

$

4,439

$

11,130

$

7,217

$

15,511

$

6,019

$

21,050

$

24,150

$

89,516

CON & MAR

Pass

137

4,570

403

220

62

4,502

5,861

15,755

Special Mention (Watch)

19

2

21

Substandard

5

5

Total

$

137

$

4,570

$

403

$

239

$

62

$

4,509

$

5,861

$

15,781

Total Pass

$

507,068

$

2,557,620

$

860,237

$

299,154

$

77,204

$

68,621

$

4,031,403

$

8,401,307

Total Special Mention (Watch)

$

22,726

$

55,299

$

45,920

$

9,584

$

520

$

1,278

$

25,000

$

160,327

Total Substandard

$

$

37,256

$

23,840

$

586

$

70

$

1,024

$

2,638

$

65,414

Total Loans

$

529,794

$

2,650,175

$

929,997

$

309,324

$

77,794

$

70,923

$

4,059,041

$

8,627,048

Total Charge offs

$

$

$

$

$

$

$

$

19

Table of Contents

Merchants Bancorp

Notes to Condensed Consolidated Financial Statements

(Unaudited)

December 31, 2022

    

2022

    

2021

    

2020

    

2019

    

2018

    

Prior

    

Revolving Loans

    

TOTAL

(In thousands)

MTG WHLOC

Pass

$

$

$

$

$

$

$

464,785

$

464,785

Total

$

$

$

$

$

$

$

464,785

$

464,785

RES RE

Pass

13,344

8,192

24,708

3,498

1,722

11,166

1,114,705

1,177,335

Special Mention (Watch)

61

668

91

820

Substandard

74

172

246

Total

$

13,344

$

8,192

$

24,708

$

3,559

$

1,796

$

12,006

$

1,114,796

$

1,178,401

MF FIN

Pass

1,212,008

544,823

200,829

32,349

4,416

7,229

1,042,024

3,043,678

Special Mention (Watch)

32,919

8,000

14,178

55,097

Substandard

36,760

36,760

Total

$

1,281,687

$

544,823

$

208,829

$

32,349

$

4,416

$

7,229

$

1,056,202

$

3,135,535

HC FIN

Pass

987,676

301,103

78,792

13,770

123,888

1,505,229

Special Mention (Watch)

52,022

25,307

77,329

Substandard

21,783

21,783

Total

$

1,039,698

$

348,193

$

78,792

$

13,770

$

$

$

123,888

$

1,604,341

CML & CRE

Pass

123,757

86,282

23,803

24,730

12,335

8,765

690,114

969,786

Special Mention (Watch)

43

164

963

119

99

228

1,376

2,992

Substandard

2,017

591

72

666

2,537

5,883

Total

$

123,800

$

88,463

$

25,357

$

24,921

$

12,434

$

9,659

$

694,027

$

978,661

AG & AGRE

Pass

12,112

7,485

15,660

5,808

3,137

20,176

29,566

93,944

Special Mention (Watch)

14

55

462

421

163

389

56

1,560

Substandard

147

147

Total

$

12,126

$

7,540

$

16,122

$

6,229

$

3,300

$

20,712

$

29,622

$

95,651

CON & MAR

Pass

4,673

463

307

101

4,589

9

3,328

13,470

Special Mention (Watch)

20

2

22

Substandard

6

6

Total

$

4,673

$

463

$

327

$

101

$

4,589

$

17

$

3,328

$

13,498

Total Pass

$

2,353,570

$

948,348

$

344,099

$

80,256

$

26,199

$

47,345

$

3,468,410

$

7,268,227

Total Special Mention (Watch)

$

84,998

$

25,526

$

9,445

$

601

$

262

$

1,287

$

15,701

$

137,820

Total Substandard

$

36,760

$

23,800

$

591

$

72

$

74

$

991

$

2,537

$

64,825

Total Loans

$

2,475,328

$

997,674

$

354,135

$

80,929

$

26,535

$

49,623

$

3,486,648

$

7,470,872

The Company did not have any material revolving loans converted to term loans at March 31, 2023 or December 31, 2022.

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

20

Table of Contents

Merchants Bancorp

Notes to Condensed Consolidated Financial Statements

(Unaudited)

Delinquent Loans

The following tables present the Company’s loan portfolio aging analysis of the recorded investment in loans as of March 31, 2023 and December 31, 2022.

March 31, 2023

    

30-59 Days

    

60-89 Days

    

Greater Than

    

Total

    

    

Total

Past Due

Past Due

90 Days

Past Due

Current

Loans

(In thousands)

MTG WHLOC

$

$

$

$

$

604,445

$

604,445

RES RE

 

2,573

2,409

 

918

 

5,900

 

1,209,352

 

1,215,252

MF FIN

 

12,975

 

36,760

 

49,735

 

3,516,795

 

3,566,530

HC FIN

21,783

21,783

1,919,421

1,941,204

CML & CRE

 

209

495

 

3,778

 

4,482

 

1,189,838

 

1,194,320

AG & AGRE

 

236

43

 

1,242

 

1,521

 

87,995

 

89,516

CON & MAR

 

47

1

 

22

 

70

 

15,711

 

15,781

$

3,065

$

15,923

$

64,503

$

83,491

$

8,543,557

$

8,627,048

December 31, 2022

    

30-59 Days

    

60-89 Days

    

Greater Than

    

Total

    

    

Total

Past Due

Past Due

90 Days

Past Due

Current

Loans

(In thousands)

MTG WHLOC

$

 

$

$

$

$

464,785

$

464,785

RES RE

 

4,053

 

152

 

272

 

4,477

 

1,173,924

 

1,178,401

MF FIN

 

 

 

 

 

3,135,535

 

3,135,535

HC FIN

21,783

21,783

1,582,558

1,604,341

CML & CRE

 

4,759

 

 

3,778

 

8,537

 

970,124

 

978,661

AG & AGRE

 

4,903

 

 

 

4,903

 

90,748

 

95,651

CON & MAR

 

6

 

24

 

22

 

52

 

13,446

 

13,498

$

13,721

$

176

$

25,855

$

39,752

$

7,431,120

$

7,470,872

Nonperforming Loans

Nonaccrual loans, including modified loans 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. Generally, this is at 90 or more days past due. The amount of interest income recognized on nonaccrual financial assets during the year ended March 31, 2023 was immaterial.

21

Table of Contents

Merchants Bancorp

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, 2023 and December 31, 2022.

March 31, 

December 31, 

2023

2022

Total Loans >

Total Loans >

90 Days &

90 Days &

    

Nonaccrual

    

Accruing

    

Nonaccrual

    

Accruing

(In thousands)

RES RE

$

240

$

741

$

245

$

96

MF FIN

 

36,760

 

 

 

HC FIN

21,783

21,783

CML & CRE

 

4,357

 

4,390

AG & AGRE

 

147

 

1,242

 

147

 

CON & MAR

 

5

 

17

 

6

 

16

$

63,292

$

2,000

$

26,571

$

112

The Company did not have any nonperforming loans without an estimated ACL at March 31, 2023.

On January 1, 2023, the Company adopted FASB Accounting Standards Update (ASU) No. 2022-02, Financial Instruments – Credit Losses (Topic 326) Troubled Debt Restructurings and Vintage Disclosures. The Company adopted the prospective approach for this new guidance. During the three months ended March 31, 2023, there was one customer experiencing financial difficulty that was modified from the original contractual terms to a delayed payment schedule. No modified loans defaulted or had a financial impact during the three months ended March 31, 2023.

The following table presents the Company’s modified loans during the three months ended March 31, 2023.

For the Three Months Ended March 31, 2023

  

Principal Forgiveness

  

Payment Delay

  

Term Extension

  

Interest Rate Reduction

Combination Term Extension and Principal Forgiveness

Combination Term Extension Interest Rate Reduction

Total Class of Financing Receivable

(In thousands)

Commercial and commercial real estate

$

$

4,357

$

$

$

$

%

Total

$

$

4,357

$

$

$

$

%

There were no residential loans in the process of foreclosure as of March 31, 2023 and December 31, 2022.

Loans Purchased

The Company purchased $98.8 million and $40.7 million of loans during the three months ended March 31, 2023 and 2022, respectively.

22

Table of Contents

Merchants Bancorp

Notes to Condensed Consolidated Financial Statements

(Unaudited)

Note 5: Variable Interest Entities (VIEs)

A VIE is a corporation, partnership, limited liability company, or any other legal structure used to conduct activities or hold assets generally that either:

Does not have equity investors with voting rights that can directly or indirectly make decisions about the entity’s activities through those voting rights or similar rights; or

Has equity investors that do not provide sufficient equity for the entity to finance its activities without additional subordinated financial support.

The Company has invested in single-family, multi-family, and healthcare debt financing entities, as well as low-income housing syndicated funds that are deemed to be VIEs. The Company has also deemed as a VIE, a real estate mortgage investment conduit (“REMIC”) trust that was established in conjunction with the September 2022 multi-family loan sale and securitization transaction. Accordingly, the entities were assessed for potential consolidation under the VIE model that requires primary beneficiaries to consolidate the entity’s results. A primary beneficiary is defined as the party that has both the power to direct the activities that most significantly impact the entity, and an interest that could be significant to the entity. To determine if an interest could be significant to the entity, both qualitative and quantitative factors regarding the nature, size and form of involvement with the entity are evaluated.

At March 31, 2023 the Company determined it was not the primary beneficiary of its VIEs primarily because the Company did not have the obligation to absorb losses or the rights to receive benefits from the VIE that could potentially be significant to the VIE. Evaluation and assessment of VIEs for consolidation is performed on an ongoing basis by management. Any changes in facts and circumstances occurring since the previous primary beneficiary determination will be considered as part of this ongoing assessment.

The Company’s maximum exposure to loss associated with its VIEs consists of the capital invested plus any unfunded equity commitments. These investments are recorded in other assets and other liabilities on the consolidated balance sheets. The table below reflects the size of the VIEs as well as the maximum exposure to loss in connection with these investments at March 31, 2023 and December 31, 2022.

Total

Total

Maximum

Assets ($ in thousands)

    

Assets

    

Liabilities

    

Exposure to Loss

(In thousands)

March 31, 2023

 

  

 

  

 

  

Unconsolidated VIEs

$

60,466

$

25,207

$

60,466

December 31, 2022

 

  

 

  

 

  

Unconsolidated VIEs

$

52,125

$

25,564

$

52,125

In addition to the table above, the Company also has a VIE in a REMIC trust that was established in September 2022 in conjunction with a loan sale and securitization. Although the trust is not recognized on the balance sheet, the maximum exposure to loss is the carrying value of the security acquired as part of the securitization transaction, which was $867.1 and $871.8 million at March 31, 2023 and December 31, 2022, respectively.

Note 6:   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

23

Table of Contents

Merchants Bancorp

Notes to Condensed Consolidated Financial Statements

(Unaudited)

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, 2023 and December 31, 2022, that the Company, Merchants Bank, and FMBI met all capital adequacy requirements to which they were subject.

As of March 31, 2023 and December 31, 2022, the most recent notifications from the Federal Reserve categorized the Company as well capitalized and most recent notifications from the 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.

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

Minimum

Minimum

Amount Required

Amount To Be

for Adequately

Well

Actual

Capitalized(1)

Capitalized(1)

    

Amount

    

Ratio

    

Amount

    

Ratio

Amount

    

Ratio

    

(Dollars in thousands)

March 31, 2023

Total capital(1) (to risk-weighted assets)

 

  

 

  

 

  

 

  

 

Company

$

1,558,187

 

12.4

%  

$

1,006,425

 

8.0

%  

$

 

N/A

%  

Merchants Bank

1,488,469

 

12.1

%  

 

986,980

 

8.0

%  

 

1,233,725

 

10.0

FMBI

 

36,044

 

11.4

%  

 

25,309

 

8.0

%  

 

31,636

 

10.0

%  

Tier I capital(1) (to risk-weighted assets)

 

  

 

  

 

  

 

  

 

  

 

  

Company

 

1,495,800

 

11.9

%  

 

754,818

 

6.0

%  

 

 

N/A

%  

Merchants Bank

1,426,815

 

11.6

%  

 

740,235

 

6.0

%  

 

986,980

 

8.0

FMBI

 

35,311

 

11.2

%  

 

18,981

 

6.0

%  

 

25,309

 

8.0

%  

Common Equity Tier I capital(1) (to risk-weighted assets)

Company

 

996,192

 

7.9

%  

 

566,114

 

4.5

%  

 

 

N/A

%  

Merchants Bank

1,426,815

 

11.6

%  

 

555,176

 

4.5

%  

 

801,921

 

6.5

FMBI

 

35,311

 

11.2

%  

 

14,236

 

4.5

%  

 

20,563

 

6.5

%  

Tier I capital(1) (to average assets)

 

 

  

 

  

 

 

  

 

  

Company

 

1,495,800

 

11.6

%  

 

514,725

 

4.0

%  

 

 

N/A

%  

Merchants Bank

1,426,815

 

11.3

%  

 

503,987

 

4.0

%  

 

629,983

 

5.0

FMBI

 

35,311

 

10.6

%  

 

13,347

 

4.0

%  

 

16,684

 

5.0

%  

(1)As defined by regulatory agencies.

24

Table of Contents

Merchants Bancorp

Notes to Condensed Consolidated Financial Statements

(Unaudited)

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, 2022

Total capital(1) (to risk-weighted assets)

 

  

 

  

 

  

 

  

 

Company

$

1,507,968

 

12.2

%  

$

992,883

 

8.0

%  

$

 

N/A

%  

Merchants Bank

1,427,738

 

11.7

%  

 

975,853

 

8.0

%  

 

1,219,817

 

10.0

%  

FMBI

 

34,769

 

11.3

%  

 

24,703

 

8.0

%  

 

30,878

 

10.0

%  

Tier I capital(1) (to risk-weighted assets)

 

  

 

  

 

  

 

  

 

  

 

  

Company

 

1,452,456

 

11.7

%  

 

744,662

 

6.0

%  

 

 

N/A

%  

Merchants Bank

1,372,941

 

11.3

%  

 

731,890

 

6.0

%  

 

975,853

 

8.0

%  

FMBI

 

34,054

 

11.0

%  

 

18,527

 

6.0

%  

 

24,703

 

8.0

%  

Common Equity Tier I capital(1) (to risk-weighted assets)

Company

 

952,848

 

7.7

%  

 

558,497

 

4.5

%  

 

 

N/A

%  

Merchants Bank

1,372,941

 

11.3

%  

 

548,917

 

4.5

%  

 

792,881

 

6.5

%  

FMBI

 

34,054

 

11.0

%  

 

13,895

 

4.5

%  

 

20,071

 

6.5

%  

Tier I capital(1) (to average assets)

 

 

  

 

  

 

 

  

 

  

Company

 

1,452,456

 

11.7

%  

 

497,604

 

4.0

%  

 

 

N/A

%  

Merchants Bank

1,372,941

 

11.3

%  

 

487,511

 

4.0

%  

 

609,389

 

5.0

%  

FMBI

 

34,054

 

10.7

%  

 

12,702

 

4.0

%  

 

15,878

 

5.0

%  

(1)As defined by regulatory agencies.

Note 7:    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.

Forward Sales Commitments, Interest Rate Lock Commitments, and Interest Rate Swaps

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.

Interest rate swaps are also used by the Company to reduce the risk that significant increases in interest rates may have on the value of certain fixed rate loans held for sale and the respective loan payments received from borrowers.  All changes in the fair market value of these interest rate swaps and associated loans held for sale have been included in gain on sale of loans.  Any difference between the fixed and floating interest rate components of these transactions have been included in interest income.

All 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

25

Table of Contents

Merchants Bancorp

Notes to Condensed Consolidated Financial Statements

(Unaudited)

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, forward contracts, and interest rate swaps utilized by the Company at March 31, 2023 and December 31, 2022. This table excludes the fair market value adjustment on loans associated with these derivatives.

Notional

Fair Value

Amount

 

Balance Sheet Location

 

Asset

 

Liability

March 31, 2023

(In thousands)

(In thousands)

Interest rate lock commitments

$

32,018

Other assets/liabilities

$

218

$

4

Forward contracts

$

29,317

Other assets/liabilities

2

235

Interest rate swaps

$

57,566

Other assets/liabilities

 

1,694

$

1,914

$

239

Notional

Fair Value

Amount

 

Balance Sheet Location

 

Asset

 

Liability

December 31, 2022

(In thousands)

(In thousands)

Interest rate lock commitments

$

8,759

Other assets/liabilities

$

28

$

23

Forward contracts

$

13,096

Other assets/liabilities

46

52

Interest rate swaps

$

57,574

Other assets/liabilities

3,030

$

3,104

$

75

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, 2023 and 2022.

Three Months Ended

March 31, 

    

    

2023

    

2022

(In thousands)

Derivative gain (loss) included in other income:

Interest rate lock commitments

$

209

$

(882)

Forward contracts (includes pair-off settlements)

(96)

3,150

Net derivative gains (loss)

$

113

$

2,268

Gain (loss) included in gain on sale of loans:

Interest rates swaps - change in fair value

(1,336)

Loans held for sale - change in fair value

 

1,560

Net gain (loss)

$

224

$

Derivatives on Behalf of Customers

The Company offers derivative contracts to some customers in connection with their risk management needs. These derivatives include back-to-back 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,

26

Table of Contents

Merchants Bancorp

Notes to Condensed Consolidated Financial Statements

(Unaudited)

changes in fair value of the corresponding derivative financial asset or liability were recorded as either a charge or credit to current 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 back-to-back interest rate swaps were recorded in the consolidated balance sheets as follows:

Notional

Fair Value

Amount

 

Balance Sheet Location

 

Asset

 

Liability

(In thousands)

(In thousands)

March 31, 2023

$

77,354

Other assets/liabilities

$

2,461

$

2,461

December 31, 2022

$

77,495

Other assets/liabilities

$

3,041

$

3,041

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, 

    

    

2023

    

2022

(In thousands)

Gross swap gains

$

580

$

496

Gross swap losses

 

580

496

Net swap gains (losses)

$

$

The Company pledged $0 in collateral to secure its obligations under swap contracts at both March 31, 2023 and December 31, 2022.

Note 8:    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

27

Table of Contents

Merchants Bancorp

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, 2023 and December 31, 2022:

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, 2023

Mortgage loans in process of securitization

$

197,074

$

$

197,074

$

Securities available for sale:

 

  

 

  

 

  

 

  

Treasury notes

 

175,099

 

175,099

 

 

Federal agencies

 

290,331

 

 

290,331

 

Mortgage-backed - Government-sponsored entity (GSE)

 

214,088

 

 

214,088

 

Loans held for sale

 

85,516

 

 

85,516

 

Servicing rights

 

143,867

 

 

 

143,867

Derivative assets - interest rate lock commitments

 

218

 

 

 

218

Derivative assets - forward contracts

 

2

 

 

2

 

Derivative assets - interest rate swaps

1,694

1,694

Derivative assets - interest rate swaps (back-to-back)

 

2,461

 

 

2,461

 

Derivative liabilities - interest rate lock commitments

 

4

4

Derivative liabilities - forward contracts

 

235

235

Derivative liabilities - interest rate swaps (back-to-back)

 

2,461

2,461

December 31, 2022

 

  

Mortgage loans in process of securitization

$

154,194

$

$

154,194

$

Securities available for sale:

 

  

 

  

 

  

 

  

Treasury notes

 

36,280

 

36,280

 

 

Federal agencies

 

271,890

 

 

271,890

 

Mortgage-backed - Government-sponsored entity (GSE)

 

15,167

 

 

15,167

 

Loans held for sale

 

82,192

 

 

82,192

 

Servicing rights

 

146,248

 

 

 

146,248

Derivative assets - interest rate lock commitments

 

28

 

 

 

28

Derivative assets - forward contracts

 

46

 

 

46

 

Derivative assets - interest rate swaps

3,030

 

3,030

 

Derivative assets - interest rate swaps (back-to-back)

3,041

3,041

Derivative liabilities - interest rate lock commitments

 

23

23

Derivative liabilities - forward contracts

 

52

52

Derivative liabilities - interest rate swaps (back-to-back)

 

3,041

3,041

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, 2023 and the year ended December 31, 2022. For assets classified within Level 3 of the fair value hierarchy, the process used to develop the reported fair value is described below.

28

Table of Contents

Merchants Bancorp

Notes to Condensed Consolidated Financial Statements

(Unaudited)

Mortgage Loans in Process of Securitization and Securities Available for Sale

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, municipal securities 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.

Servicing Rights

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, cost of servicing, interest rates, and default rate. Due to the nature of the valuation inputs, 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 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 expense on its condensed consolidated statement of income.

29

Table of Contents

Merchants Bancorp

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, 

    

2023

    

2022

(In thousands)

Servicing rights

Balance, beginning of period

$

146,248

$

110,348

Additions

 

 

  

Originated servicing

 

2,173

 

5,792

Subtractions

 

  

 

  

Paydowns

 

(1,698)

 

(2,749)

Sales of servicing

Changes in fair value due to changes in valuation inputs or assumptions used in the valuation model

 

(2,856)

 

7,645

Balance, end of period

$

143,867

$

121,036

Derivative Assets - interest rate lock commitments

Balance, beginning of period

$

28

$

264

Changes in fair value

 

190

 

(152)

Balance, end of period

$

218

$

112

Derivative Liabilities - interest rate lock commitments

Balance, beginning of period

$

23

$

41

Changes in fair value

 

(19)

 

730

Balance, end of period

$

4

$

771

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, 2023 and December 31, 2022.

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, 2023

 

  

 

  

 

  

 

  

Impaired loans (collateral-dependent)

$

$

$

$

December 31, 2022

 

  

 

  

 

  

 

  

Impaired loans (collateral-dependent)

$

4,465

$

$

$

4,465

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.

30

Table of Contents

Merchants Bancorp

Notes to Condensed Consolidated Financial Statements

(Unaudited)

Collateral Dependent Loans, Net of ACL-Loans

The estimated fair value of collateral dependent loans is based on the appraised fair value of the collateral, less estimated cost to sell. Collateral dependent 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 Chief Credit Officer’s (“CCO”) office. Appraisals and evaluations 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

Weighted

    

Fair Value

    

Technique

    

Unobservable Inputs

Range

    

Average

(In thousands)

At March 31, 2023:

 

  

 

  

 

Servicing rights - Multi-family

$

109,706

 

Discounted cash flow

 

Discount rate

8% - 13%

 

9%

Constant prepayment rate

0 - 39%

 

8%

Servicing rights - Single-family

$

29,078

 

Discounted cash flow

 

Discount rate

9% - 10%

9%

Constant prepayment rate

7% - 10%

7%

Servicing rights - SBA

$

5,083

 

Discounted cash flow

 

Discount rate

16%

 

16%

Constant prepayment rate

3% - 12%

8%

Derivative assets - interest rate lock commitments

$

218

 

Discounted cash flow

 

Loan closing rates

51% - 99%

 

75%

Derivative liabilities - interest rate lock commitments

$

4

 

Discounted cash flow

 

Loan closing rates

51% - 99%

 

75%

At December 31, 2022:

 

  

 

  

 

Collateral dependent loans

$

4,465

 

Market comparable properties

 

Marketability discount

4% - 54%

 

5%

Servicing rights - Multi-family

$

111,690

 

Discounted cash flow

 

Discount rate

8% - 13%

 

9%

Constant prepayment rate

0 - 39%

 

8%

Servicing rights - Single-family

$

29,926

 

Discounted cash flow

 

Discount rate

9% - 10%

9%

Constant prepayment rate

7% - 10%

7%

Servicing rights - SBA

$

4,632

 

Discounted cash flow

 

Discount rate

16%

 

16%

Constant prepayment rate

3% - 12%

8%

Derivative assets - interest rate lock commitments

$

28

 

Discounted cash flow

 

Loan closing rates

60% - 87%

 

77%

Derivative liabilities - interest rate lock commitments

$

23

 

Discounted cash flow

 

Loan closing rates

60% - 87%

 

77%

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.

Servicing Rights

The significant unobservable inputs used in the fair value measurement of the Company’s servicing rights are discount rates and constant prepayment rates. These two inputs can drive a significant amount of a market participant’s

31

Table of Contents

Merchants Bancorp

Notes to Condensed Consolidated Financial Statements

(Unaudited)

valuation of servicing rights. Significant increases (decreases) in the discount rate or assumed constant prepayment rates used to value servicing rights would decrease (increase) the value derived.

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, 2023 and December 31, 2022.

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, 2023

Financial assets:

 

  

 

  

 

  

 

  

 

  

Cash and cash equivalents

$

369,586

$

369,586

$

369,586

$

$

Securities purchased under agreements to resell

 

3,438

 

3,438

 

 

3,438

 

Securities held to maturity

 

1,104,835

 

1,106,582

 

 

239,795

 

866,787

FHLB stock

 

39,130

 

39,130

 

 

39,130

 

Loans held for sale

 

2,769,734

 

2,769,734

 

 

2,769,734

 

Loans receivable, net

 

8,575,210

 

8,553,015

 

 

 

8,553,015

Interest receivable

 

64,282

 

64,282

 

 

64,282

 

Financial liabilities:

 

  

 

 

  

 

  

 

  

Deposits

 

11,345,231

 

11,343,744

 

7,208,222

 

4,135,522

 

Short-term subordinated debt

 

21,000

 

21,000

 

 

21,000

 

FHLB advances

 

859,211

 

858,957

 

 

858,957

 

Other borrowing

200,000

200,000

200,000

Credit linked notes

153,551

154,520

154,520

Interest payable

 

32,605

 

32,605

 

 

32,605

 

December 31, 2022

 

  

 

  

 

  

 

  

 

  

Financial assets:

 

  

 

  

 

  

 

  

 

  

Cash and cash equivalents

$

226,164

$

226,164

$

226,164

$

$

Securities purchased under agreements to resell

 

3,464

 

3,464

 

 

3,464

 

Securities held to maturity

1,119,078

 

1,118,966

 

 

247,182

 

871,784

FHLB stock

 

39,130

 

39,130

 

 

39,130

 

Loans held for sale

 

2,828,384

 

2,828,384

 

 

2,828,384

 

Loans receivable, net

 

7,426,858

 

7,431,731

 

 

 

7,431,731

Interest receivable

 

56,262

 

56,262

 

 

56,262

 

Financial liabilities:

 

  

 

 

  

 

  

 

  

Deposits

 

10,071,345

 

10,064,941

 

7,082,056

 

2,982,885

 

Short-term subordinated debt

 

21,000

 

21,000

 

 

21,000

 

FHLB advances

 

859,392

 

858,984

 

 

858,984

 

Other borrowing

50,000

50,000

50,000

Interest payable

 

23,384

 

23,384

 

 

23,384

 

32

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Merchants Bancorp

Notes to Condensed Consolidated Financial Statements

(Unaudited)

Note 9: Leases

The Company has operating leases for various locations with terms ranging from one to eleven years. Some operating leases include options to extend. The extensions were included in the right-of-use asset if the likelihood of extension was fairly certain. The Company elected not to separate non-lease components from lease components for its operating leases.

The Company has operating lease right-of-use assets of $10.5 million as of March 31, 2023 and operating lease right-of-use liabilities of $11.6 million as of March 31, 2023.

Balance sheet, income statement and cash flow detail regarding operating leases follows:

March 31, 2023

December 31, 2022

Balance Sheet

(In thousands)

(In thousands)

Operating lease right-of-of use asset (in other assets)

$

10,483

$

10,969

Operating lease liability (in other liabilities)

11,644

11,992

Weighted average remaining lease term (years)

6.3

6.5

Weighted average discount rate

2.68%

2.65%

Maturities of lease liabilities:

One year or less

$

1,731

$

2,181

Year two

2,345

2,321

Year three

1,881

1,881

Year four

1,911

1,911

Year five

1,853

1,853

Thereafter

2,902

2,902

Total future minimum lease payments

12,623

13,049

Less: imputed interest

979

1,057

Total

$

11,644

$

11,992

Three Months Ended

Three Months Ended

March 31, 2023

March 31, 2022

Income Statement

(In thousands)

(In thousands)

Components of lease expense:

Operating lease cost (in occupancy and equipment expense)

$

583

$

367

Three Months Ended

Three Months Ended

March 31, 2023

March 31, 2022

Cash Flow Statement

(In thousands)

(In thousands)

Supplemental cash flow information:

Operating cash flows from operating leases

$

426

$

283

33

Table of Contents

Merchants Bancorp

Notes to Condensed Consolidated Financial Statements

(Unaudited)

Note 10: Deposits

Deposits were comprised of the following at March 31, 2023 and December 31, 2022:

March 31, 2023

December 31,

    

2023

    

2022

(In thousands)

Noninterest-bearing deposits

Demand deposits

$

313,733

$

326,875

Total noninterest-bearing deposits

313,733

326,875

Interest-bearing deposits

Demand deposits

$

3,843,282

$

3,720,363

Savings deposits

 

3,051,207

 

3,034,818

Certificates of deposit

 

4,137,009

 

2,989,289

Total interest-bearing deposits

11,031,498

9,744,470

Total deposits

$

11,345,231

$

10,071,345

Maturities for certificates of deposit are as follows:

    

March 31, 2023

(In thousands)

Due within one year

$

4,004,937

Due in one year to two years

 

90,668

Due in two years to three years

 

39,683

Due in three years to four years

 

1,114

Due in four years to five years

585

Due in five years to six years

 

22

$

4,137,009

Brokered deposit amounts at March 31, 2023 and December 31, 2022, were as follows:

March 31,

December 31, 

    

2023

    

2022

(In thousands)

Brokered certificates of deposit

$

3,679,084

$

2,681,198

Brokered savings deposits

 

51,076

 

81,532

Brokered deposit on demand accounts

 

 

13

$

3,730,160

$

2,762,743

Note 11: Borrowings

Borrowings were comprised of the following at March 31, 2023 and December 31, 2022:

March 31, 

December 31, 

    

2023

    

2022

(In thousands)

Federal Reserve discount window borrowings

$

200,000

$

20,000

Short-term subordinated debt

 

21,000

 

21,000

FHLB advances

859,211

859,392

American Financial Exchange borrowing

30,000

Credit linked notes

 

153,551

 

Total borrowings

$

1,233,762

$

930,392

34

Table of Contents

Merchants Bancorp

Notes to Condensed Consolidated Financial Statements

(Unaudited)

On March 30, 2023, Merchants Bank of Indiana issued and sold $158.1 million senior credit linked notes, due May 26, 2028. The net proceeds of the offering were approximately $153.5 million. The repayment of principal on the notes is linked to an approximately $1.1 billion reference pool of loans originated under the Bank’s healthcare commercial real estate lending program, but the notes are not secured by the loans. The notes provide periodic payments of interest in addition to payment of principal over the life of the note and these values are tied to the performance of the loans.  Therefore, the notes effectively transfer credit risk in excess of the first 1% of losses on the reference pool of loans. The reduction in risk weighted assets provides additional balance sheet capacity and benefits capital ratios for additional growth in the existing loan pipeline. The Company will maintain the ACL associated with the loans in the reference pool on the Company’s balance sheet.

The notes accrue interest at a rate equal to SOFR plus 15.50% and interest pays monthly. As of March 31, 2023, the effective interest rate was 21.5%. However, the interest earned on the collateral account maintained by the Company for the transaction had an effective rate of 4.5%, resulting in a net effective rate of 17.0% related to the notes. The principal amount of the notes will be reduced by a portion of the Bank’s loss on such loans if one of the following occurs with respect to a loan: (i) the Bank experiences a realized loss, or (ii) an expected loss is determined for any delinquent loan at the stated maturity date or upon early redemption. However, such reduction will not occur until aggregate realized or expected losses reach more than one percent of the principal balance of the loans. The Bank has the right to redeem the notes in full upon the occurrence of certain regulatory events.

The notes are secured by a restricted collateral account which the Company is required to maintain with a third-party financial institution.  The collateral account maintains an amount equal to at least the initial aggregate unpaid principal of the notes.  As of March 31, 2023, the account included $20.5 million of restricted cash and $137.6 million of short-term Treasury securities.  These are reported as cash equivalents and securities available for sale in the consolidated balance sheets.

Note 12:   Earnings Per Share

Earnings per share were computed as follows:

Three Month Periods Ended March 31, 

2023

2022

Weighted-

Per 

Weighted-

Per 

Net

Average

Share

Net

Average

Share

    

Income

    

Shares

    

Amount

    

Income

    

Shares

    

Amount

(In thousands)

(In thousands)

Net income

$

54,955

 

  

 

  

$

50,142

 

  

 

  

Dividends on preferred stock

 

(8,667)

 

  

 

  

 

(5,728)

 

  

 

  

Net income allocated to common shareholders

$

46,288

 

  

 

  

$

44,414

 

  

 

  

Basic earnings per share

 

  

 

43,179,604

$

1.07

 

  

 

43,190,066

$

1.03

Effect of dilutive securities-restricted stock awards

 

  

 

111,175

 

  

 

  

 

169,968

 

  

Diluted earnings per share

 

  

 

43,290,779

$

1.07

 

  

 

43,360,034

$

1.02

Note 13:   Share-Based Payment Plans

Equity-based incentive awards for Company officers are currently issued pursuant to the 2017 Equity Incentive Plan (the “2017 Incentive Plan”). During the three months ended March 31, 2023 and March 31, 2022, the Company issued 84,335 and 64,962 shares, respectively.

35

Table of Contents

Merchants Bancorp

Notes to Condensed Consolidated Financial Statements

(Unaudited)

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. In January 2021, the Board of Directors amended the plan for nonexecutive directors to receive a portion of their annual fees, issued quarterly, in the form of restricted common stock equal to $50,000 per member, rounded up to the nearest whole share, to be effective after the Company’s annual meeting of shareholders held in May 2021. Accordingly, there were 2,863 and 2,055 shares, issued to non-executive directors during the three months ended March 31, 2023 and March 31, 2022, respectively.

The Company established an employee stock ownership plan (“ESOP”) effective as of January 1, 2020 to provide certain benefits for all employees who meet certain requirements. Expense recognized for the contribution to the ESOP totaled $810,000 and $653,000 for the three months ended March 31, 2023 and March 31, 2022, respectively. The Company contributed 33,293 shares and 20,709 shares to the ESOP for the three months ended March 31, 2023 and March 31, 2022, respectively.

Note 14:   Segment Information

The Company’s 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. It is also a fully integrated syndicator of low-income housing tax credit and debt funds. 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.

The tables below present selected business segment financial information for the three months ended March 31, 2023 and 2022.

Multi-family

    

 

Mortgage 

Mortgage

 

    

Banking

    

Warehousing

    

Banking

    

Other

    

Total

Three Months Ended March 31, 2023

(In thousands)

Interest income

$

1,106

$

42,318

$

166,726

$

1,144

 

$

211,294

Interest expense

 

 

27,794

 

84,526

 

(1,719)

 

 

110,601

Net interest income

 

1,106

 

14,524

 

82,200

 

2,863

 

 

100,693

Provision for credit losses

 

 

1,364

 

5,503

 

 

 

6,867

Net interest income after provision for credit losses

 

1,106

 

13,160

 

76,697

 

2,863

 

 

93,826

Noninterest income

 

16,597

 

1,033

 

(1,189)

 

(2,177)

 

 

14,264

Noninterest expense

 

14,631

 

2,755

 

10,170

 

7,216

 

 

34,772

Income (loss) before income taxes

 

3,072

 

11,438

 

65,338

 

(6,530)

 

 

73,318

Income taxes

 

1,106

 

2,797

 

16,031

 

(1,571)

 

 

18,363

Net income (loss)

$

1,966

$

8,641

$

49,307

$

(4,959)

 

$

54,955

Total assets

$

341,487

$

3,318,491

$

10,430,293

$

150,695

 

$

14,240,966

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Notes to Condensed Consolidated Financial Statements

(Unaudited)

Multi-family

 

Mortgage 

Mortgage

 

    

Banking

    

Warehousing

    

Banking

    

Other

    

Total

Three Months Ended March 31, 2022

(In thousands)

Interest income

$

257

$

20,329

$

53,725

$

1,701

 

$

76,012

Interest expense

 

 

2,021

 

8,517

 

(251)

 

 

10,287

Net interest income

 

257

 

18,308

 

45,208

 

1,952

 

 

65,725

Provision for credit losses

 

 

(207)

 

2,658

 

 

 

2,451

Net interest income after provision for credit losses

 

257

 

18,515

 

42,550

 

1,952

 

 

63,274

Noninterest income

 

32,186

 

1,860

 

2,189

 

(1,638)

 

 

34,597

Noninterest expense

 

16,531

 

2,926

 

6,574

 

5,002

 

 

31,033

Income (loss) before income taxes

 

15,912

 

17,449

 

38,165

 

(4,688)

 

 

66,838

Income taxes

 

4,420

 

4,290

 

9,401

 

(1,415)

 

 

16,696

Net income (loss)

$

11,492

$

13,159

$

28,764

$

(3,273)

 

$

50,142

Total assets

$

293,286

$

2,863,907

$

6,409,943

$

83,456

 

$

9,650,592

Note 15:   Recent Accounting Pronouncements

The Company continually monitors potential accounting pronouncement and SEC release changes. The following pronouncements and releases have been deemed to have the most applicability to the Company’s financial statements:

FASB ASU 2022-02 - Financial Instruments — Credit Losses (Topic 326): Troubled Debt Restructurings and Vintage Disclosures

In February 2022, the FASB issued an ASU update to eliminate the recognition and measurement guidance on troubled debt restructurings for creditors that have adopted CECL and require enhanced disclosures about loan modifications for borrowers experiencing financial difficulty. The new guidance also requires public business entities to present current-period gross write-offs (on a current year-to-date basis for interim-period disclosures) by year of origination in their vintage disclosures. These changes would be applied on a prospective basis.  Disclosure would not be required to prior period comparative periods.

The updates in ASU 2022-02 are effective for interim and annual periods beginning after December 15, 2022.  The Company adopted this new guidance as of January 1, 2023, but does not expect it to have a material impact on the Company’s financial position or results of operations.

Note 16:   Subsequent Events

No material events were noted.

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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. 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, 2022 or “Item 2 - Management’s Discussion and Analysis of Financial Condition and Results of Operations” of this Form 10-Q or the following:

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

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Notes to Condensed Consolidated Financial Statements

(Unaudited)

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, 2023 and results of operations for the three months ended March 31, 2023 and 2022, 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, 2023

Net income of $55.0 million increased $4.8 million, or 10%, compared to the three months ended March 31, 2022. The increase was primarily driven by a $35.0 million, or 53%, increase in net interest income that was partially offset by a $11.2 million, or 63%, decrease in gain on sale of loans, a $7.4 million, or 76%, decrease in loan servicing fees, and a $4.4 million, or 180%, increase in provision for credit losses.
Diluted earnings per share of $1.07 increased 5% compared to the three months ended March 31, 2022.
Results included a $2.9 million negative fair market value adjustment to servicing rights compared to a $7.6 million positive adjustment in the three months ended March 31, 2022.
Total assets of $14.2 billion increased 48% compared to March 31, 2022, and increased 13% compared to December 31, 2022.
Loans receivable of $8.6 billion, net of allowance for credit losses on loans, increased $2.6 billion, or 43%, compared to March 31, 2022, and increased $1.1 billion, or 15%, compared to December 31, 2022.
Net interest margin was 3.27% compared to 2.62% for the three months ended March 31, 2022.
Efficiency ratio was 30.3% compared to 30.9% for the three months ended March 31, 2022.
As of March 31, 2023, the Company had $4.0 billion in unused borrowing capacity with the Federal Home Loan Bank and the Federal Reserve Discount window, based on available collateral.
The Company’s most liquid assets are in unrestricted cash, short-term investments, including interest-bearing demand deposits, mortgage loans in process of securitization, loans held for sale, and warehouse lines of credit included in loans receivable. Taken together, with unused borrowing capacity, these totaled $7.8 billion, or 55%, of the $14.2 billion in total assets as of March 31, 2023.
Uninsured deposits totaled approximately $2 billion as of March 31, 2023, representing less than 25% of total deposits. Since 2018, the Company has offered its customers an opportunity to insure balances in excess of $250,000 through our Insured Cash Sweep program that extends FDIC protection up to $100 million. The balance of deposits in this program was $1.6 billion as of March 31, 2023.
As of March 31, 2023, approximately 93% of the total net loans at Merchants Bank reprice within three months, which reduces the risk of market rate increases.
Tangible book value per common share of $22.88 increased 22% compared to $18.70 for the three months ended March 31, 2022.

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Quarterly dividends of $0.08 per common share increased 14% compared to the three months ended March 31, 2022.
On March 30, 2023, the Company issued and sold $158.1 million senior credit linked notes, due May 26, 2028. The net proceeds of the offering were approximately $153.5 million and resulted in a reduction of risk-weighted assets, which will benefit regulatory capital ratios to support loan growth.
The volume of warehouse loans funded during the three months ended March 31, 2023 amounted to $5.4 billion, a decrease of $3.9 billion, or 42%, compared to the three months ended March 31, 2022. This compared to the 52% industry decrease in single-family residential loan volumes for the three months ended March 31, 2023 to the same period in 2022, according to an estimate of industry volume by the Mortgage Bankers Association.
The volume of loans originated and acquired for sale in the secondary market through our multi-family business decreased by $427.5 million, or 79%, to $114.1 million, compared to $541.6 million for the three months ended March 31, 2022.

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 multiple business segments, including Multi-family Mortgage Banking that offers multi-family housing and healthcare facility financing and servicing, as well as syndicated low-income housing tax credit and debt funds; Mortgage Warehousing that offers mortgage warehouse financing, commercial loans, and deposit services; and Banking that offers portfolio lending for multi-family and healthcare facility loans, retail and correspondent residential mortgage banking, agricultural lending, Small Business Administration (“SBA”) lending, and traditional community banking.

Our business consists primarily of funding fixed rate, low risk, multi-family, residential and SBA loans meeting underwriting standards of government programs under an originate to sell model, and retaining adjustable rate loans as held for investment to reduce interest rate risk. The gain on sale of these loans and servicing fees contribute to noninterest income. The funding source is primarily from mortgage custodial, municipal, retail, commercial, brokered deposits, and short-term borrowing. 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, which serves to maximize net income and higher than industry 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 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, 2022. 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, 2022.

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Financial Condition

As of March 31, 2023, we had approximately $14.2 billion in total assets, $11.3 billion in deposits, and $1.5 billion in total shareholders’ equity. Total assets as of March 31, 2023 included approximately $369.6 million of cash and cash equivalents, $2.9 billion of loans held for sale and $8.6 billion of loans receivable, net of ACL-Loans. Assets also included $197.1 million of mortgage loans in the process of securitization 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 were also $1.1 billion in securities held to maturity and $679.5 million in securities available for sale that are match funded with related custodial deposits. There are restrictions on the types of securities we hold, as these are funded by certain custodial deposits where we set the cost of deposits based on the yield of the related securities. Servicing rights at March 31, 2023 were $143.9 million based on the fair value of the loan servicing, which are primarily GNMA multi-family servicing rights with 10-year call protection.

Comparison of Financial Condition at March 31, 2023 and December 31, 2022

Total Assets.   Total assets increased $1.6 billion, or 13%, to $14.2 billion at March 31, 2023 from $12.6 billion at December 31, 2022. The increase was due primarily to significant growth in the multi-family and healthcare loan portfolios.

Cash and Cash Equivalents.  Cash and cash equivalents increased $143.4 million, or 63%, to $369.6 million at March 31, 2023 from $226.2 million at December 31, 2022. The 63% increase reflected higher liquidity to fund anticipated loan growth. Included in cash equivalents was $20.5 million in restricted cash associated with the March 2023 issuance of senior credit linked notes described in Note: 10 Borrowings.

Mortgage Loans in Process of Securitization.  Mortgage loans in process of securitization increased $42.9 million, or 28%, to $197.1 million at March 31, 2023, from $154.2 million at December 31, 2022. 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 28% increase was primarily due to an increase in the volume of loans that had not yet settled with government agencies.

Securities Available for Sale.   Securities available for sale increased $356.2 million, or 110%, to $679.5 million at March 31, 2023 from $323.3 million at December 31, 2022. The increase in securities available for sale was primarily due to purchases of $353.2 million, offset by calls, maturities, sales and repayments of securities totaling $0.8 million and a decrease of unrealized loss on securities of $3.7 million during the period.

As of March 31, 2023, Accumulated Other Comprehensive Losses (“AOCI”) of $7.7 million, related to securities available for sale, decreased $2.8 million, or 27%, compared to losses of $10.5 million at December 31, 2022. The $7.7 million of AOCI losses as of March 31, 2023 represented less than 1% of total equity and 1% of total securities available for sale.

Securities Held to Maturity. Securities held to maturity decreased $14.2 million, or 1%, to $1.1 billion at March 31, 2023 from December 31, 2022. The decrease was primarily due to purchases of $1.5 million offset by repayments of securities totaling $15.8 million during the period. The majority of these securities were acquired in September 2022 as part of a private securitization of originated loans described in Note 5: Loans and Allowance for Credit Losses on Loans. The remaining securities were primarily acquired in December 2022 as part of a securitization by an external related party.

Loans Held for Sale.   Loans held for sale, comprised primarily of single-family residential real estate loan participations that meet Federal National Mortgage Association (“Fannie Mae”), Federal Home Loan Mortgage Corporation (“Freddie Mac”), or Ginnie Mae (“GNMA”) eligibility, decreased $55.3 million, or 2%, to $2.9 billion at March 31, 2023 compared to December 31, 2022. The decrease in loans held for sale was due primarily to a decrease in

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warehouse participations, as the industry experienced lower volume associated with the recent increase in market interest rates.

Loans Receivable, Net.   Loans receivable, net, which are comprised of loans held for investment, increased $1.1 billion, or 15%, to $8.6 billion at March 31, 2023 compared to December 31, 2022. The increase in net loans was comprised primarily of:

an increase of $431.0 million, or 14%, in multi-family financing loans, to $3.6 billion at March 31, 2023,
an increase of $336.9 million, or 21%, in healthcare financing loans, to $1.9 billion at March 31, 2023,
an increase of $215.7 million, or 22%, in commercial and commercial real estate, to $1.2 billion at March 31, 2023,
an increase of $139.7 million, or 30%, in mortgage warehouse lines of credit, to $604.4 million at March 31, 2023,
an increase of $36.9 million, or 3%, in residential real estate, to $1.2 billion at March 31, 2023.

The $431.0 million increase in multi-family 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 $336.9 million increase in healthcare financing was due to transfers of loans previously in loans held for sale, associated with our credit link note transaction.

The $215.7 million increase in commercial and commercial real estate was primarily due to an increase in warehouse revolving lines of credit collateralized primarily by single-family mortgage servicing rights during the period.

As of March 31, 2023, approximately 93% of the total net loans at Merchants Bank reprice within three months, which reduces the risk of market rate increases.

Allowance for Credit Losses on Loans (“ACL-Loans”). The ACL-Loans of $51.8 million at March 31, 2023 increased $7.8 million, or 18%, compared to December 31, 2022, primarily reflecting increases associated with loan growth and portfolio mix.

Also influencing the overall level of the ACL-Loans 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 under government programs.

Goodwill.   Goodwill of $15.8 million at March 31, 2023 remained unchanged compared to December 31, 2022. At this time, we do not believe there exists any impairment to goodwill or intangible assets.

Servicing Rights.   Servicing rights decreased $2.4 million, or 2%, to $143.9 million as of March 31, 2023 compared to December 31, 2022. During the three months ended March 31, 2023, a fair value decrease of $2.9 million, and paydowns of $1.7 million were partially offset by originated and purchased servicing of $2.2 million. The $2.9 million negative fair market value adjustment reflected $2.2 million for multi-family mortgages and $0.7 million for single-family and SBA mortgages and during the three months ended March 31, 2023. 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 servicing rights are recorded and carried at fair value. The fair value decrease recorded during the three months ended March 31, 2022 was driven by lower interest rates that impacted fair market value adjustments. The value

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of servicing rights generally increases in rising interest rate environments and declines in falling interest rate environments due to expected prepayments.

Deposits.   Deposits increased $1.3 billion, or 13%, to $11.3 billion at March 31, 2023 from $10.1 billion at December 31, 2022. The increase was primarily due to a $1.0 billion increase in brokered certificates of deposit. Total certificates of deposit increased $1.1 billion, demand deposits increased $109.8 million, savings deposits increased $16.4 million. As of March 31, 2023, approximately 74% of the total deposits at Merchants Bank reprice within three months.

Uninsured deposits totaled approximately $2 billion as of March 31, 2023, representing less than 25% of total deposits. Since 2018, the Company has offered its customers an opportunity to insure balances in excess of $250,000 through our Insured Cash Sweep program that extends FDIC protection up to $100 million. The balance of deposits in this program was $1.6 billion as of March 31, 2023.

We have increased our use of brokered deposits by $1.0 billion, or 35%, to $3.7 billion at March 31, 2023 compared to December 31, 2022. Brokered deposits represented 33% of total deposits at March 31, 2023, compared to 27% of total deposits at December 31, 2022. As of March 31, 2023, brokered certificates of deposit had a weighted average remaining duration of 70 days.

Brokered certificates of deposit accounts increased $1.0 billion, or 37%, to $3.7 billion at March 31, 2023 compared to December 31, 2022.
Brokered savings deposits decreased $30.5 million, or 37%, to $51.1 million at March 31, 2023 compared to December 31, 2022.

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 Federal Deposit Insurance Corporation (“FDIC”).

Compared to December 31, 2022, interest-bearing deposits increased $1.3 billion, or 13%, to $11.0 billion at March 31, 2023, and noninterest-bearing deposits decreased $13.1 million, or 4%, to $313.7 million at March 31, 2023.

Borrowings.   Borrowings totaled $1.2 billion as of March 31, 2023, an increase of $303.4 million, or 33%, from December 31, 2023. The increase was primarily due to a $180.0 million increase in the usage of the Federal Reserve’s discount window and the issuance of $158.1 million senior credit linked notes described in Note 11: Borrowings. Depending on rates and timing, borrowing can be a more effective liquidity management alternative than utilizing brokered certificates of deposits. The Company primarily utilizes borrowing facilities from the FHLB, the Federal Reserve’s discount window, and the American Financial Exchange (“AFX”).

The Company continues to have significant borrowing capacity based on available collateral. As of March 31, 2023, unused lines of credit totaled $4.0 billion, compared to $3.1 billion at December 31, 2022.

Total Shareholders’ Equity.   Total shareholders’ equity was $1.5 billion as of March 31, 2023. The $45.9 million increase compared to December 31, 2022 resulted primarily from the net income of $55.0 million, which was partially offset by dividends paid on common and preferred shares of $12.1 million during the period.

Asset Quality

Total nonperforming loans (nonaccrual and greater than 90 days late but still accruing) were $65.3 million, or 0.76%, of total loans at March 31, 2023, compared to $26.7 million, or 0.36%, of total loans at December 31, 2022 and

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$4.7 million, or 0.08%, at March 31, 2022. The increase compared to March 31, 2022 was due to the delinquency of one multi-family customer and one healthcare customer.

As a percentage of nonperforming loans, the ACL-Loans was 79% at March 31, 2023 compared to 165% at December 31, 2022 and 683% at March 31, 2022. The changes compared to both periods were primarily due to the changes in the nonperforming loans.

Total loans greater than 30 days past due were $83.5 million at March 31, 2023, $39.8 million at December 31, 2022, and $13.6 million at March 31, 2022. The increase compared to March 31, 2022 was due to the delinquency of one multi-family customer and one healthcare customer.

Special Mention (Watch) loans were $160.3 million at March 31, 2023, compared to $137.8 million at December 31, 2022 and $144.4 million at March 31, 2022.

During the three months ended March 31, 2023, there were $0 of charge-offs and $7,000 of recoveries, compared to $931,000 of charge-offs and $7,000 of recoveries for the three months ended March 31, 2022.

Comparison of Operating Results for the Three Months Ended March 31, 2023 and 2022

General.   Net income of $55.0 million for the three months ended March 31, 2023 increased by $4.8 million, or 10%, compared to the three months ended March 31, 2022, primarily driven by a $35.0 million, or 53%, increase in net interest income that was partially offset by a $11.2 million, or 63%, decrease in gain on sale of loans, a $7.4 million, or 76%, decrease in loan servicing fees, and a $4.4 million, or 180%, increase in provision for credit losses. Results for the first three months of 2023 included a $2.9 million negative fair market value adjustment to servicing rights compared to a $7.6 million positive adjustment in the first three months of 2022.

Net Interest Income.   Net interest income increased $35.0 million, or 53%, to $100.7 million for the three months ended March 31, 2023, compared with the three months ended March 31, 2022. The increase reflected higher yields and average balances on loans and loans held for sale, as well as new balances of securities held to maturity, which were partially offset by higher interest rates on deposits and borrowings. The interest rate spread of 2.76% for the three months ended March 31, 2023 increased 21 basis points compared to 2.55% for the three months ended March 31, 2022.

Our net interest margin increased 65 basis points, to 3.27%, for the three months ended March 31, 2023 from 2.62% for the three months ended March 31, 2022. The increase in net interest margin reflected higher yields and average loan balances that were partially offset by higher rates on higher average deposit balances.

Interest Income.   Interest income increased $135.3 million, or 178%, to $211.3 million for the three months ended March 31, 2023, compared with $76.0 million for the three months ended March 31, 2022. The $135.3 million increase in interest income was primarily attributable to a $117.3 million increase from loans and loans held for sale and a $15.8 million increase from securities held to maturity. This increase was primarily due to an increase in both yields and average balances of loans and loans held for sale, as well as new balances in securities held to maturity.

The average balance of loans, including loans held for sale, during the three months ended March 31, 2023 increased $2.5 billion, or 32%, to $10.6 billion compared to the three months ended March 31, 2022, while the average yield on loans increased 361 basis points, to 7.25%, for the three months ended March 31, 2023, compared to 3.64% for the three months ended March 31, 2022. The increase in average balances of loans and loans held for sale was primarily due to increases in healthcare and multi-family loans during the period.
The average balance of securities held to maturity increased $1.1 billion, at an average yield of 5.73%, as they were all acquired since March 31, 2022. The $1.1 billion increase was primarily driven by the purchase of a security backed by multi-family loans originated by Merchants.

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The average balance of securities available for sale increased $140.0 million, or 46%, to $445.6 million for the three months ended March 31, 2023 from $305.6 million for the three months ended March 31, 2022, while the average yield increased 113 basis points, to 2.06%, for the three months ended March 31, 2023.
The average balance of interest-earning deposits and other decreased $1.3 billion, or 87%, to $184.5 million for the three months ended March 31, 2023 from $1.5 billion for the three months ended March 31, 2022, while the average yield increased 454 basis points, to 4.78%, for the three months ended March 31, 2023.
The average balance of mortgage loans in process of securitization decreased $189.7 million, or 54%, to $159.3 million for the three months ended March 31, 2023, compared to $349.0 million for the three months ended March 31, 2022, while the average yield increased 158 basis points to 4.19% for the three months ended March 31, 2023.

Interest Expense.   Total interest expense increased $100.3 million, or 975%, to $110.6 million for the three months ended March 31, 2023, compared with $10.3 million for the three months ended March 31, 2022.

Interest expense on deposits increased $95.6 million, or 1,085%, to $104.4 million for the three months ended March 31, 2023, from $8.8 million for the three months ended March 31, 2022. The increase was primarily due to higher rates for interest-bearing checking, certificates of deposit, and money market accounts, as well as higher average balances of certificates of deposits.

The average balance of interest-bearing checking accounts was $4.1 billion for the three months ended March 31, 2023, which increased $36.4 million, or 1%, compared to the three months ended March 31, 2022. The average yield of interest-bearing checking was 4.07% for the three months ended March 31, 2023, which was a 385 basis point increase compared to 0.22% for the three months ended March 31, 2022.
The average balance of certificates of deposits was $3.3 billion for the three months ended March 31, 2023, which increased $2.2 million, or 208%, compared to the three months ended March 31, 2022. The average yield of certificates of deposits was 4.26% for the three months ended March 31, 2023, which was a 376 basis point increase compared to 0.50% for the three months ended March 31, 2022.
The average balance of money market accounts of $2.8 billion for the three months ended March 31, 2023 increased $137.5 million, or 5%, compared to the three months ended March 31, 2022. The average yield of money market accounts was 4.07% for the three months ended March 31, 2023, which was a 328 basis point increase compared to 0.79% for the three months ended March 31, 2022.

Interest expense on borrowings increased $4.7 million, or 318%, to $6.2 million for the three months ended March 31, 2023, compared to the three months ended March 31, 2022. The increase was due primarily to a 416 basis point increase in the average cost of borrowings to 5.17%, compared to 1.01% for the three months ended March 31, 2022. Also included in borrowings, our warehouse structured financing agreements provide for an additional interest payment for a portion of the earnings generated. As a result, the cost of borrowings increased from a base rate of 4.82% and 0.35%, to an effective rate of 5.17% and 1.01% for the three months ended March 31, 2023 and 2021, respectively.

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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, 

 

2023

2022

 

    

Interest

    

    

Interest

 

Average

Income/

Yield/

Average

Income/

Yield/

 

    

Balance

    

Expense

    

Rate 

    

Balance

    

Expense

    

Rate 

 

(Dollars in thousands)

Assets:

Interest-bearing deposits, and other

$

184,470

$

2,176

 

4.78

%  

$

1,460,486

$

870

 

0.24

%

Securities available for sale - taxable

 

445,614

 

2,266

 

2.06

%  

 

305,600

 

701

 

0.93

%

Securities held to maturity

1,115,243

15,754

5.73

%  

 

 

%  

Mortgage loans in process of securitization

 

159,333

 

1,648

 

4.19

%  

 

349,027

 

2,245

 

2.61

%

Loans and loans held for sale

 

10,595,669

 

189,450

 

7.25

%  

 

8,049,877

 

72,196

 

3.64

%

Total interest-earning assets

 

12,500,329

 

211,294

 

6.86

%  

 

10,164,990

 

76,012

 

3.03

%

Allowance for credit losses on loans

 

(45,190)

 

  

 

  

 

(31,023)

 

  

 

  

Noninterest-earning assets

 

430,596

 

  

 

  

 

302,481

 

  

 

  

Total assets

$

12,885,735

 

  

 

  

$

10,436,448

 

  

 

  

Liabilities/Equity:

 

  

 

  

 

  

 

  

 

  

 

  

Interest-bearing checking

$

4,052,081

$

40,647

 

4.07

%  

$

4,015,709

$

2,204

 

0.22

%

Savings deposits

 

237,289

 

265

 

0.45

%  

 

230,702

 

33

 

0.06

%

Money market

 

2,848,500

 

28,608

 

4.07

%  

 

2,710,961

 

5,252

 

0.79

%

Certificates of deposit

 

3,322,991

 

34,922

 

4.26

%  

 

1,080,438

 

1,324

 

0.50

%

Total interest-bearing deposits

 

10,460,861

 

104,442

 

4.05

%  

 

8,037,810

 

8,813

 

0.44

%

Borrowings

 

482,723

 

6,159

 

5.17

%  

 

589,597

 

1,474

 

1.01

%

Total interest-bearing liabilities

 

10,943,584

 

110,601

 

4.10

%  

 

8,627,407

 

10,287

 

0.48

%

Noninterest-bearing deposits

 

304,119

 

  

 

  

 

518,140

 

  

 

  

Noninterest-bearing liabilities

 

141,422

 

  

 

  

 

117,064

 

  

 

  

Total liabilities

 

11,389,125

 

  

 

  

 

9,262,611

 

  

 

  

Equity

 

1,496,610

 

  

 

  

 

1,173,837

 

  

 

  

Total liabilities and equity

$

12,885,735

 

  

 

  

$

10,436,448

 

  

 

  

Net interest income

 

  

$

100,693

 

  

 

  

$

65,725

 

  

Interest rate spread

 

  

 

  

 

2.76

%  

 

  

 

  

 

2.55

%

Net interest-earning assets

$

1,556,745

 

  

 

  

$

1,537,583

 

  

 

  

Net interest margin

 

  

 

  

 

3.27

%  

 

  

 

  

 

2.62

%

Average interest-earning assets to average interest-bearing liabilities

 

  

 

  

 

114.23

%  

 

  

 

  

 

117.82

%

Increases and decreases in interest income and interest expense result from changes in average balances (volume) of interest-earning assets and interest-bearing liabilities, as well as changes in weighted average interest rates. The following table sets forth the effects of changing rates and volumes on our net interest income during the periods shown. Information is provided with respect to (i) effects on interest income attributable to changes in volume (changes in volume multiplied by prior rate) and (ii) effects on interest income attributable to changes in rate (changes in rate multiplied by prior volume). Changes applicable to both volume and rate have been allocated to volume. Yields have been calculated on a pre-tax basis.

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The following table summarizes the increases and decreases in interest income and interest expense resulting from changes in average balances (volume) and changes in average interest rates:

Three Months Ended March 31, 2023

compared to March 31, 2022

Increase (Decrease)

Due to

(Dollars in thousands)

    

Volume

    

Rate

    

Total

Interest income

 

  

 

  

 

  

Interest-bearing deposits and other

$

(760)

$

2,066

$

1,306

Securities available for sale - taxable

 

321

 

1,244

 

1,565

Securities held to maturity

15,754

15,754

Mortgage loans in process of securitization

 

(1,220)

 

623

 

(597)

Loans and loans held for sale

 

22,832

 

94,422

 

117,254

Total interest income

 

36,927

 

98,355

 

135,282

Interest expense

 

  

 

  

 

  

Deposits

 

  

 

  

 

  

Interest-bearing checking

 

20

 

38,423

 

38,443

Savings deposits

 

1

 

231

 

232

Money market deposits

 

266

 

23,090

 

23,356

Certificates of deposit

 

2,748

 

30,850

 

33,598

Total Deposits

 

3,035

 

92,594

 

95,629

Borrowings

 

369

 

4,316

 

4,685

Total interest expense

 

3,404

 

96,910

 

100,314

Net interest income

$

33,523

$

1,445

$

34,968

Provision for Credit Losses.   We recorded a provision for credit losses of $6.9 million for the three months ended March 31, 2023, an increase of $4.4 million, or 180%, over the three months ended March 31, 2022. The $6.9 million provision for credit losses consisted of a $7.8 million increase for the ACL-Loans and a reduction of $0.9 million for the ACL-OBCE’s. The ACL-Loans was $51.8 million, or 0.60% of total loans, at March 31, 2023, compared to $44.0 million, or 0.59% of total loans, at December 31, 2022, and $32.1 million, or 0.53%, at March 31, 2022. The increases in the ACL-Loans compared to both prior periods reflected increases associated with loan growth and portfolio mix. Of the $19.7 million increase in the ACL-Loans since March 31, 2022, $15.9 million, or 81%, was attributable to loan growth during the period. Additional details are provided in the ACL-Loans portion of the Comparison of Financial Condition at March 31, 2023 and December 31, 2022 and in Note 4: Loans and Allowance for Credit Losses on Loans.

Noninterest Income.   Noninterest income decreased $20.3 million, or 59%, to $14.3 million for the three months ended March 31, 2023, compared to the three months ended March 31, 2022. The decrease was primarily due to a $11.2 million, or 63%, decrease in gain on sale of loans resulting from higher interest rates across the industry that have led lower volumes sold in the secondary market. A $7.4 million, or 76%, decrease in loan servicing fees also contributed to the lower noninterest income. Loan servicing fees included a $2.9 million negative fair market value adjustment to servicing rights for the three months ended March 31, 2023, compared to a $7.6 million positive adjustment to fair value of servicing rights for the three months ended March 31, 2022.

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A summary of the gain on sale of loans for the three months ended March 31, 2023 and 2022 is below:

Gain on Sale of Loans

Three Months Ended

March 31, 

March 31, 

2023

2022

(in thousands)

Loan Type

Multi-family

$

4,920

$

14,953

Single-family

277

457

Small Business Association (SBA)

1,536

2,555

Total

$

6,733

$

17,965

Noninterest Expense.   Noninterest expense increased $3.7 million, or 12%, to $34.8 million for the three months ended March 31, 2023, compared to the three months ended March 31, 2022. The increase was due primarily to a $1.4 million, or 187%, increase in FDIC deposit insurance expenses reflecting our growth in assets, as well as a $1.0 million, or 74%, increase in professional fees. The efficiency ratio was at 30.3% in the three months ended March 31, 2023, compared with 30.9% in the three months ended March 31, 2022.

Income Taxes.   Income tax expense increased $1.7 million, or 10%, to $18.4 million for the three months ended March 31, 2023 from the three months ended March 31, 2022. The increase was due primarily to a 10% increase in pretax income period to period. The effective tax rate was 25.0% for the three months ended March 31, 2023 and March 31, 2022.

Our Segments

We operate in three primary segments: Multi-family Mortgage Banking, Mortgage Warehousing, and Banking. The reportable 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.  It is also a fully integrated syndicator of low-income housing tax credit and debt funds.  As one of the top ranked agency lenders in the nation, our licenses with Fannie Mae, Freddie Mac, and FHA, coupled with our bank financing products, provide sponsors custom beginning-to-end financing solutions that adapt to an ever-changing market. We are also one of the largest GNMA servicers in the country based on aggregate loan principal value. As of March 31, 2023 the Company’s total servicing portfolio had an unpaid principal balance of $22.5 billion, primarily managed in the Multi-Family Mortgage Banking segment. Included in this amount was an unpaid principal balance of loans serviced for others of $13.2 billion, an unpaid principal balance of loans sub-serviced for others of $2.0 billion, and other servicing balances of $0.7 billion at March 31, 2023. These loans are not included in the accompanying balance sheets. The Company also manages $6.6 billion of loans for customers that have loans on the balance sheet at March 31, 2023. The servicing portfolio is primarily GNMA, Fannie Mae, and Freddie Mac loans 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 $111 billion in 2020, $78 billion in 2021, $33.2 billion in 2022, and $5.4 billion in the three months ended March 31, 2023. 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

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business. The Banking segment has a well-diversified customer and borrower base and has experienced significant growth over the past three years.

Our 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 Merchant 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 borrowing capacity during periods of high residential loan volume for Mortgage Warehousing. Mortgage Warehousing provides leads to correspondent residential lending in the banking segment. MCC also provides leads to Merchants Bank for core deposit opportunities. Retail and commercial customers provide cross selling opportunities within the banking segment. These and other synergies form a part of our strategic plan.

For the three months ended March 31, 2023 and 2022, we had total net income of $55.0 million and $50.1 million, respectively. Net income for our three segments for the respective periods was as follows:

For the Three Months Ended

March 31, 

    

2023

    

2022

    

(In thousands)

Multi-family Mortgage Banking

$

1,966

$

11,492

Mortgage Warehousing

 

8,641

 

13,159

Banking

 

49,307

 

28,764

Other

 

(4,959)

 

(3,273)

Total

$

54,955

$

50,142

Multi-family Mortgage Banking.   The Multi-family Mortgage Banking segment reported net income of $2.0 million for the three months ended March 31, 2023, a decrease of $9.5 million, or 83%, from net income of $11.5 million reported for the three months ended March 31, 2022. The decrease in net income was primarily due to $12.9 million lower gain on sale of loans associated with higher interest rates. The lower noninterest income was partially offset by lower noninterest expense of $1.9 million from lower salaries and employee benefits, including commissions.

The results included a $2.2 million negative fair market value adjustment to servicing rights for the three months ended March 31, 2023, compared to a $3.3 million positive adjustment to fair value of servicing rights for the three months ended March 31, 2022.

Mortgage Warehousing.   The Mortgage Warehousing segment reported net income of $8.6 million for the three months ended March 31, 2023, a decrease of $4.5 million, or 34%, over the three months ended March 31, 2022. The decrease in net income reflected lower net interest income and mortgage warehouse fees as industry volumes declined as market interest rates increased.

There was a 42% decrease in warehouse loan volume of $5.4 billion compared to $9.3 billion for the three months ended March 31, 2022, which was less than the industry volume decreases of 52%, according to the Mortgage Bankers Association.

Banking.   The Banking segment reported net income of $49.3 million for the three months ended March 31, 2023, an increase of $20.5 million, or 71%, over the three months ended March 31, 2022. The increase in net income was primarily due to $37.0 million higher net interest income from higher yields and average balances that was partially offset by higher provision for income taxes of $6.6 million on higher income.

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The results included a $0.7 million negative fair market value adjustment to servicing rights for the three months ended March 31, 2023, compared to a $4.3 million positive adjustment to fair value of servicing rights for the three months ended March 31, 2022.

Liquidity and Capital Resources

Liquidity.

Recent bank failures have had minimal impact to our deposit base or operations. Our liquidity remains strong and has continued to expand organically, without the need to utilize the Federal Reserve’s Bank Term Funding Program. Our strategy to minimize interest rate and credit risks by originating and selling adjustable-rate loans that typically reprice within 30 days, has allowed us to generate profitable growth through many economic cycles.

Our primary sources of funds are business and consumer deposits, escrow and custodial deposits, brokered deposits, borrowings, 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. The Company’s most liquid assets are in cash, short-term investments, including interest-bearing demand deposits, mortgage loans in process of securitization, loans held for sale, and warehouse lines of credit included in loans receivable. Taken together with its unused borrowing capacity of $4.0 billion described below, these totaled $7.8 billion, or 55% of its $14.2 billion total assets at March 31, 2023. The levels of these assets are dependent on our operating, financing, lending, and investing activities during any given period.

Our liquid assets and borrowing capacity significantly exceeded the $2 billion of uninsured deposits as of December 31, 2022. Uninsured deposits totaled approximately $2 billion as of March 31, 2023, representing less than 25% of total deposits. Since 2018, the Company has offered its customers an opportunity to insure balances in excess of $250,000 through our Insured Cash Sweep program that extends FDIC protection up to $100 million. The balance of deposits in this program was $1.6 billion as of March 31, 2023.

The Company’s investment portfolio has minimal levels of unrealized losses and management does not anticipate a need to sell securities for liquidity purposes at a loss. We are able to maintain minimal levels of investment securities because of our originate to sell model, which provides ongoing liquidity. As of March 31, 2023, Accumulated Other Comprehensive Losses (“AOCI”) of $7.7 million, related to securities available for sale, decreased $2.8 million, or 27%, compared to losses of $10.5 million as of December 31, 2022. The $7.7 million of AOCI as of March 31, 2023 represented less than 1% of total equity and 1% of total securities available for sale.

Our cash flows are comprised of three primary classifications: cash flows from operating activities, investing activities, and financing activities. Net cash (used in) provided by operating activities was $(301.5) million and $1.3 billion for the three months ended March 31, 2023 and 2022, respectively. Net cash (used in) investing activities, which consists primarily of net change in loans receivable and purchases, sales and maturities of investment securities and loans, was $(1.1) billion and $(247.1) million for the three months ended March 31, 2023 and 2022, respectively. Net cash provided by (used in) financing activities, which is comprised primarily of net change in borrowings and deposits was $1.6 billion and $(1.7) million for the three months ended March 31, 2023 and 2022, respectively.

At March 31, 2023, we had $3.3 billion in outstanding commitments to extend credit that are subject to credit risk and $4.4 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.

Certificates of deposit that are scheduled to mature in less than one year from March 31, 2023 totaled $4.0 billion, or 97% of total certificates of deposit. 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

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FHLB advances, the Federal Reserve discount window, brokered deposits, or raise interest rates on deposits to attract new accounts, which may result in higher levels of interest expense.

Off-Balance Sheet Arrangements.

In the normal course of operations, we engage in a variety of financial transactions that, in accordance with U.S. generally accepted accounting principles, are not recorded in our financial statements. These transactions involve, to varying degrees, elements of credit, interest rate and liquidity risk. Such transactions are used primarily to manage customers’ requests for funding and take the form of loan commitments, lines of credit and standby letters of credit.

Capital Resources.

At March 31, 2023, based on available collateral, we had $4.0 billion in available unused borrowing capacity with the FHLB and the Federal Reserve discount window. While the amounts available fluctuate daily, we also had available capacity in credit lines through our membership in the AFX. This liquidity enhances the ability to effectively manage interest expense and asset levels in the future.

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 shelf registration statement on Form S-3 with the SEC on August 8, 2022, which was declared effective on August 17, 2022, under which we can issue up to $300 million aggregate offering amount of registered securities to finance our growth objectives. As previously demonstrated, the Company also has the ability to utilize securitization transactions to free up capital as needed.

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.

Shareholders’ Equity. Shareholders’ equity was $1.5 billion as of March 31, 2023 and December 31, 2022. There was a $45.9 million increase that resulted primarily from the net income of $55.0 million, which was partially offset by dividends paid on common and preferred shares of $12.1 million during the period.

7% Series A 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. The terms of the Series A

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Preferred Stock permit us to replace LIBOR with a substitute index once LIBOR is no longer considered an acceptable market index. However, because the Series A Preferred Stock is still in its fixed rate period, we have not transitioned to a substitute index and likely will not do so until closer to the end of the fixed rate period, allowing additional time for us to determine whether the Federal Reserve’s Secured Overnight Financing Rate (“SOFR”) or another index has become an acceptable market index and is appropriate.

6% Series B 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 share (equivalent to $1.50 per depositary share) through September 30, 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. The terms of the Series B Preferred Stock permit us to replace LIBOR with a substitute index once LIBOR is no longer considered an acceptable market index. However, because the Series B Preferred Stock is still in its fixed rate period, we have not transitioned to a substitute index and likely will not do so until closer to the end of the fixed rate period, allowing additional time for us to determine whether SOFR or another index has become an acceptable market index and is appropriate.

6% Series C Preferred Stock. On March 23, 2021, the Company issued 6,000,000 depositary shares, each representing a 1/40th interest in a share of its 6.00% Fixed Rate Series C Non-Cumulative Perpetual Preferred Stock, without par value (the “Series C 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 $150.0 million, and after deducting underwriting discounts and commissions and offering expenses of approximately $5.1 million paid to third parties, the Company received total net proceeds of $144.9 million.

On May 6, 2021, our previously issued, 8% preferred shareholders participated in a private offering to replace their redeemed 8% preferred shares with the Company’s 6% Series C preferred stock. Accordingly, 46,181 shares (1,847,233 depositary shares) of the Company’s 6% Series C preferred stock were issued at a price of $25 per depositary share. The total capital raised from the private offering was $46.2 million, net of $23,000 in expenses.

Dividends on the Series C Preferred Stock, to the extent declared by the Company’s board, are payable quarterly. The Company may redeem the Series C Preferred Stock, in whole or in part, at our option, on any dividend payment date on or after April 1, 2026, 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.

8.25% Series D Preferred Stock. On September 27, 2022, the Company issued 5,200,000 depositary shares, each representing a 1/40th interest in a share of its 8.25% Fixed Rate Series D Non-Cumulative Perpetual Preferred Stock, without par value (the “Series D 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 $130.0 million, and after deducting underwriting discounts and commissions and offering expenses of approximately $4.6 million paid to third parties, the Company received total net proceeds of $125.4 million. On September 30, 2022, the Company issued an additional 500,000 shares of Series D 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 $12.1 million in net proceeds, after deducting $0.4 million in underwriting discounts.

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Dividends on the Series D Preferred Stock, to the extent declared by the Company’s board, are payable quarterly. The Company may redeem the Series D Preferred Stock, in whole or in part, at our option, on any dividend payment date on or after October 1, 2027, 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.

Common Shares/Dividends. As of March 31, 2023, the Company had 43,233,618 common shares issued and outstanding. The Board expects to declare a quarterly dividend of $0.08 per share in each quarter of 2023.

Capital Adequacy.

The following tables present the Company’s capital ratios at March 31, 2023 and December 31, 2022:

Minimum

Minimum

Amount Required

Amount To Be

for Adequately

Well

Actual

Capitalized(1)

Capitalized(1)

    

Amount

    

Ratio

    

Amount

    

Ratio

Amount

    

Ratio

    

(Dollars in thousands)

March 31, 2023

Total capital(1) (to risk-weighted assets)

 

  

 

  

 

  

 

  

 

Company

$

1,558,187

 

12.4

%  

$

1,006,425

 

8.0

%  

$

 

N/A

%  

Merchants Bank

1,488,469

 

12.1

%  

 

986,980

 

8.0

%  

 

1,233,725

 

10.0

FMBI

 

36,044

 

11.4

%  

 

25,309

 

8.0

%  

 

31,636

 

10.0

%  

Tier I capital(1) (to risk-weighted assets)

 

  

 

  

 

  

 

  

 

  

 

  

Company

 

1,495,800

 

11.9

%  

 

754,818

 

6.0

%  

 

 

N/A

%  

Merchants Bank

1,426,815

 

11.6

%  

 

740,235

 

6.0

%  

 

986,980

 

8.0

FMBI

 

35,311

 

11.2

%  

 

18,981

 

6.0

%  

 

25,309

 

8.0

%  

Common Equity Tier I capital(1) (to risk-weighted assets)

Company

 

996,192

 

7.9

%  

 

566,114

 

4.5

%  

 

 

N/A

%  

Merchants Bank

1,426,815

 

11.6

%  

 

555,176

 

4.5

%  

 

801,921

 

6.5

FMBI

 

35,311

 

11.2

%  

 

14,236

 

4.5

%  

 

20,563

 

6.5

%  

Tier I capital(1) (to average assets)

 

 

  

 

  

 

 

  

 

  

Company

 

1,495,800

 

11.6

%  

 

514,725

 

4.0

%  

 

 

N/A

%  

Merchants Bank

1,426,815

 

11.3

%  

 

503,987

 

4.0

%  

 

629,983

 

5.0

FMBI

 

35,311

 

10.6

%  

 

13,347

 

4.0

%  

 

16,684

 

5.0

%  

(1)As defined by regulatory agencies.

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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, 2022

Total capital(1) (to risk-weighted assets)

 

  

 

  

 

  

 

  

 

Company

$

1,507,968

 

12.2

%  

$

992,883

 

8.0

%  

$

 

N/A

%  

Merchants Bank

1,427,738

 

11.7

%  

 

975,853

 

8.0

%  

 

1,219,817

 

10.0

%  

FMBI

 

34,769

 

11.3

%  

 

24,703

 

8.0

%  

 

30,878

 

10.0

%  

Tier I capital(1) (to risk-weighted assets)

 

  

 

  

 

  

 

  

 

  

 

  

Company

 

1,452,456

 

11.7

%  

 

744,662

 

6.0

%  

 

 

N/A

%  

Merchants Bank

1,372,941

 

11.3

%  

 

731,890

 

6.0

%  

 

975,853

 

8.0

%  

FMBI

 

34,054

 

11.0

%  

 

18,527

 

6.0

%  

 

24,703

 

8.0

%  

Common Equity Tier I capital(1) (to risk-weighted assets)

Company

 

952,848

 

7.7

%  

 

558,497

 

4.5

%  

 

 

N/A

%  

Merchants Bank

1,372,941

 

11.3

%  

 

548,917

 

4.5

%  

 

792,881

 

6.5

%  

FMBI

 

34,054

 

11.0

%  

 

13,895

 

4.5

%  

 

20,071

 

6.5

%  

Tier I capital(1) (to average assets)

 

 

  

 

  

 

 

  

 

  

Company

 

1,452,456

 

11.7

%  

 

497,604

 

4.0

%  

 

 

N/A

%  

Merchants Bank

1,372,941

 

11.3

%  

 

487,511

 

4.0

%  

 

609,389

 

5.0

%  

FMBI

 

34,054

 

10.7

%  

 

12,702

 

4.0

%  

 

15,878

 

5.0

%  

(1)As defined by regulatory agencies.

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, 2023 and December 31, 2022, that the Company, Merchants Bank, and FMBI met all capital adequacy requirements to which they were subject.

As of March 31, 2023 and December 31, 2022, the most recent notifications from the Federal Reserve categorized the Company as well capitalized and most recent notifications from the 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.

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

Overview. Interest rate risk is the risk to earnings and value arising from changes in market interest rates. Interest rate risk arises from timing differences in the repricings and maturities of interest-earning assets and interest-bearing liabilities (reprice risk), changes in the expected maturities of assets and liabilities arising from embedded options, such as borrowers’ ability to prepay residential mortgage loans at any time and depositors’ ability to redeem certificates of deposit before maturity (option risk), changes in the shape of the yield curve where interest rates increase or decrease in

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a nonparallel fashion (yield curve risk), and changes in spread relationships between different yield curves, such as U.S. Treasuries, LIBOR or SOFR.

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.

Interest rate risk management is an active process that encompasses monitoring loan and deposit flows complemented by investment and funding activities. Effective management of interest rate risk begins with understanding the dynamic characteristics of assets and liabilities and determining the appropriate interest rate risk posture given business forecasts, management objectives, market expectations, and policy constraints.

An asset sensitive position refers to a balance sheet position in which an increase in short-term interest rates is expected to generate higher net interest income, as rates earned on our interest-earning assets would reprice upward more quickly than rates paid on our interest-bearing liabilities, thus expanding our net interest margin. Conversely, a liability sensitive position refers to a balance sheet position in which an increase in short-term interest rates is expected to generate lower net interest income, as rates paid on our interest-bearing liabilities would reprice upward more quickly than rates earned on our interest-earning assets, thus compressing our net interest margin.

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 and excludes non-interest income. 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.

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, 2023 and December 31, 2022.

Net Interest Income Sensitivity

 

Twelve Months Forward

 

- 200

    

- 100

    

+ 100

    

+ 200

 

(Dollars in thousands)

 

March 31, 2023:

  

 

  

 

  

 

  

Dollar change

$

(91,174)

$

(45,625)

$

35,788

$

69,900

Percent change

 

(22.2)

%  

 

(11.1)

%  

 

8.7

%  

 

17.0

%

December 31, 2022:

 

  

 

  

 

  

 

  

Dollar change

$

(96,861)

$

(48,581)

$

37,232

$

74,094

Percent change

 

(23.8)

%  

 

(11.9)

%  

 

9.2

%  

 

18.2

%

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, 2023 we estimated that we are within policy limits set by our board of directors for the -200, -100, +100, and +200 basis point scenarios.

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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, 2023:

  

 

  

 

  

 

  

Dollar change

$

3,829

$

1,787

$

(5,300)

$

(17,547)

Percent change

 

0.3

%  

 

0.1

%  

 

(0.4)

%  

 

(1.2)

%

December 31, 2022:

 

  

 

  

 

  

 

  

Dollar change

$

22,855

$

11,640

$

(10,925)

$

(26,385)

Percent change

 

1.6

%  

 

0.8

%  

 

(0.8)

%  

 

(1.9)

%

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, 2023 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.”

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, 2023, 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

There have been no material changes from 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, 2022.

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

Second Amended and Restated Articles of Incorporation of Merchants Bancorp (incorporated by reference to Exhibit 3.1 of Form 8-K, filed on May 24, 2022).

3.2

Articles of Amendment to the Second Amended and Restated Articles of Incorporation dated September 27, 2022 designating the 8.25% Fixed Rate Reset Series D Non-Cumulative Perpetual Preferred Stock (incorporated by reference to Exhibit 3.2 of Form 8-A filed on September 27, 2022).

3.3

Second Amended and Restated By-Laws of Merchants Bancorp (incorporated by reference to Exhibit 3.1 of Form 8-K, filed on November 20, 2017).

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 – the instance document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL 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

104

XBRL Taxonomy Extension Presentation Linkbase Document

Cover Page Interactive Data File – The cover page interactive data file does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL 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 10, 2023

By:

/s/ Michael F. Petrie

Michael F. Petrie

Chairman & Chief Executive Officer

Date:

May 10, 2023

By:

/s/ John F. Macke

John F. Macke

Chief Financial & Accounting Officer

(Principal Financial Officer)

60