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Merchants Bancorp - Quarter Report: 2023 June (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

June 30, 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

MBINP

NASDAQ

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

MBINO

NASDAQ

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

MBINN

NASDAQ

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

MBINM

NASDAQ

As of July 31, 2023, the latest practicable date, 43,237,300 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 June 30, 2023 and December 31, 2022

3

Condensed Consolidated Statements of Income for the Three and Six Months Ended June 30, 2023 and 2022

4

Condensed Consolidated Statements of Comprehensive Income for the Three and Six Months Ended June 30, 2023 and 2022

5

Condensed Consolidated Statements of Shareholders’ Equity for the Three and Six Months Ended June 30, 2023 and 2022

6

Condensed Consolidated Statements of Cash Flows for the Six Months Ended June 30, 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

43

Item 3 Quantitative and Qualitative Disclosures About Market Risk

68

Item 4 Controls and Procedures

69

PART II – OTHER INFORMATION

70

Item 1 Legal Proceedings

70

Item 1A Risk Factors

70

Item 2 Unregistered Sales of Equity Securities and Use of Proceeds

70

Item 3 Defaults Upon Senior Securities

70

Item 4 Mine Safety Disclosures

70

Item 5 Other Information

70

Item 6 Exhibits

71

SIGNATURES

72

2

Table of Contents

Part I – Financial Information

Item 1. Financial Statements

Merchants Bancorp

Condensed Consolidated Balance Sheets

June 30, 2023 (Unaudited) and December 31, 2022

(In thousands, except share data)

June 30, 

December 31, 

    

2023

    

2022

Assets

 

  

 

  

Cash and due from banks

$

15,390

$

22,170

Interest-earning demand accounts

 

361,920

 

203,994

Cash and cash equivalents

 

377,310

 

226,164

Securities purchased under agreements to resell

 

3,412

 

3,464

Mortgage loans in process of securitization

 

298,907

 

154,194

Securities available for sale

 

648,003

 

323,337

Securities held to maturity (includes $1,058,590 and $1,118,966 at fair value, respectively)

1,062,017

1,119,078

Federal Home Loan Bank (FHLB) stock

 

39,130

 

39,130

Loans held for sale (includes $82,931 and $82,192 at fair value, respectively)

 

3,058,013

 

2,910,576

Loans receivable, net of allowance for credit losses on loans of $62,986 and $44,014, respectively

 

9,854,018

 

7,426,858

Premises and equipment, net

 

36,947

 

35,438

Servicing rights

 

147,288

 

146,248

Interest receivable

 

70,509

 

56,262

Goodwill

 

15,845

 

15,845

Intangible assets, net

 

949

 

1,186

Other assets and receivables

 

262,524

 

157,447

Total assets

$

15,874,872

$

12,615,227

Liabilities and Shareholders' Equity

 

 

Liabilities

 

  

 

  

Deposits

 

  

 

  

Noninterest-bearing

$

349,387

$

326,875

Interest-bearing

 

12,710,477

 

9,744,470

Total deposits

 

13,059,864

 

10,071,345

Borrowings

 

1,016,836

 

930,392

Deferred and current tax liabilities, net

 

16,084

 

19,613

Other liabilities

 

221,788

 

134,138

Total liabilities

 

14,314,572

 

11,155,488

Commitments and Contingencies

 

  

 

  

Shareholders' Equity

 

  

 

  

Common stock, without par value

 

  

 

  

Authorized - 75,000,000 shares

 

  

 

  

Issued and outstanding - 43,237,300 shares at June 30, 2023 and 43,113,127 shares at December 31, 2022

 

138,853

 

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

 

928,875

 

832,871

Accumulated other comprehensive loss

 

(7,036)

 

(10,521)

Total shareholders' equity

 

1,560,300

 

1,459,739

Total liabilities and shareholders' equity

$

15,874,872

$

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 and Six Months Ended June 30, 2023 and 2022

(In thousands, except share data)

Three Months Ended

Six Months Ended

June 30, 

June 30, 

    

2023

    

2022

    

2023

    

2022

Interest Income

 

  

 

  

 

  

Loans

$

228,732

$

85,994

$

418,182

$

158,190

Mortgage loans in process of securitization

 

3,127

 

1,449

 

4,775

 

3,694

Investment securities:

 

 

 

  

 

Available for sale - taxable

 

5,564

 

917

 

7,830

 

1,618

Held to maturity

17,311

33,065

Federal Home Loan Bank stock

 

471

 

284

 

898

 

553

Other

 

2,864

 

626

 

4,613

 

1,227

Total interest income

 

258,069

 

89,270

 

469,363

 

165,282

Interest Expense

 

  

 

  

 

  

 

  

Deposits

 

137,801

 

14,768

 

242,243

 

23,581

Borrowed funds

 

14,651

 

2,471

 

20,810

 

3,945

Total interest expense

 

152,452

 

17,239

 

263,053

 

27,526

Net Interest Income

 

105,617

 

72,031

 

206,310

 

137,756

Provision for credit losses

 

22,603

 

6,212

 

29,470

 

8,663

Net Interest Income After Provision for Credit Losses

 

83,014

 

65,819

 

176,840

 

129,093

Noninterest Income

 

  

 

  

 

  

 

  

Gain on sale of loans

 

11,350

 

21,564

 

18,083

 

39,529

Loan servicing fees, net

 

8,616

 

9,607

 

10,976

 

19,338

Mortgage warehouse fees

 

2,865

 

1,350

 

3,893

 

3,208

Syndication and asset management fees

3,896

1,599

5,108

2,213

Other income

 

3,155

 

5,051

 

6,086

 

9,480

Total noninterest income

 

29,882

 

39,171

 

44,146

 

73,768

Noninterest Expense

 

  

 

  

 

  

 

  

Salaries and employee benefits

 

25,724

 

22,475

 

47,870

 

43,768

Loan expenses

 

907

 

1,184

 

1,711

 

2,395

Occupancy and equipment

 

2,456

 

2,011

 

4,688

 

3,825

Professional fees

 

3,723

 

1,594

 

5,992

 

2,897

Deposit insurance expense

 

3,806

 

670

 

5,984

 

1,429

Technology expense

 

1,571

 

1,304

 

3,148

 

2,540

Other expense

 

6,133

 

3,719

 

9,699

 

7,136

Total noninterest expense

 

44,320

 

32,957

 

79,092

 

63,990

Income Before Income Taxes

 

68,576

 

72,033

 

141,894

 

138,871

Provision for income taxes

 

3,274

 

18,098

 

21,637

 

34,794

Net Income

$

65,302

$

53,935

$

120,257

$

104,077

Dividends on preferred stock

(8,668)

(5,729)

(17,335)

(11,457)

Net Income Allocated to Common Shareholders

56,634

48,206

102,922

92,620

Basic Earnings Per Share

$

1.31

$

1.12

$

2.38

$

2.14

Diluted Earnings Per Share

$

1.31

$

1.11

$

2.38

$

2.14

Weighted-Average Shares Outstanding

 

  

 

  

 

  

 

  

Basic

 

43,235,398

 

43,209,824

 

43,207,655

 

43,220,198

Diluted

 

43,309,393

 

43,335,211

 

43,300,240

 

43,367,875

See notes to condensed consolidated financial statements.

4

Table of Contents

Merchants Bancorp

Condensed Consolidated Statements of Comprehensive Income (Unaudited)

For the Three and Six Months Ended June 30, 2023 and 2022

(In thousands)

Three Months Ended

Six Months Ended

June 30, 

June 30, 

    

2023

    

2022

    

2023

    

2022

Net Income

$

65,302

$

53,935

$

120,257

$

104,077

Other Comprehensive Income (Loss):

 

  

 

 

  

 

  

Net change in unrealized gain/(losses) on investment securities available for sale, net of tax (expense)/benefits of $(402), $553, $(1,336) and $2,203, respectively

 

693

 

(1,766)

 

3,485

 

(6,616)

Other comprehensive income (loss) for the period

 

693

 

(1,766)

 

3,485

 

(6,616)

Comprehensive Income

$

65,995

$

52,169

$

123,742

$

97,461

See notes to condensed consolidated financial statements.

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Table of Contents

Merchants Bancorp

Condensed Consolidated Statement of Shareholders’ Equity (Unaudited)

For the Three and Six Months Ended June 30, 2023 and 2022

(In thousands, except share data)

Three Months Ended

Six Months Ended

June 30, 

June 30, 

    

2023

    

2022

    

2023

    

2022

Shares

Amount

Shares

Amount

Shares

Amount

Shares

Amount

Common Stock

 

  

 

  

 

  

Balance beginning of period

43,233,618

$

138,105

43,267,776

$

137,882

43,113,127

$

137,781

43,180,079

$

137,565

Repurchase of common stock

-

-

(165,037)

(1,761)

-

-

(165,037)

(1,761)

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

3,682

748

3,766

550

90,880

262

70,783

215

Balance end of period

43,237,300

138,853

43,106,505

136,671

43,237,300

138,853

43,106,505

136,671

7% Series A Preferred Stock

Balance at beginning and end of period

2,081,800

50,221

2,081,800

50,221

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

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

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

-

-

142,500

137,459

-

-

Retained Earnings

Balance beginning of period

875,700

694,776

832,871

657,149

Net income

65,302

53,935

120,257

104,077

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

(911)

(911)

(1,821)

(1,821)

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

(1,875)

(1,875)

(3,750)

(3,750)

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

(2,943)

(2,943)

(5,886)

(5,886)

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

(2,939)

-

(5,878)

-

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

(3,459)

(3,019)

(6,918)

(6,048)

Repurchase of common stock

-

(2,174)

-

(2,174)

Balance end of period

928,875

737,789

928,875

737,789

Accumulated Other Comprehensive Loss

Balance beginning of period

(7,729)

(6,304)

(10,521)

(1,454)

Other comprehensive income (loss)

693

(1,766)

3,485

(6,616)

Balance end of period

(7,036)

(8,070)

(7,036)

(8,070)

Total shareholders' equity

$

1,560,300

$

1,228,539

$

1,560,300

$

1,228,539

See notes to condensed consolidated financial statements.

6

Table of Contents

Merchants Bancorp

Condensed Consolidated Statements of Cash Flows (Unaudited)

Six Months Ended June 30, 2023 and 2022

(In thousands)

Six Months Ended

June 30, 

    

2023

    

2022

Operating activities:

 

  

 

  

Net income

$

120,257

$

104,077

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

 

 

Depreciation

 

1,385

 

1,204

Provision for credit losses

 

29,470

 

8,663

Gain on sale of loans

 

(18,083)

 

(39,529)

Proceeds from sales of loans

 

8,388,537

 

14,491,319

Loans and participations originated and purchased for sale

 

(8,900,738)

 

(13,918,978)

Purchases of low-income housing tax credits for sale

(30,117)

(9,829)

Proceeds from sale of low-income housing tax credits

19,804

Change in servicing rights for paydowns and fair value adjustments

 

3,257

 

(9,367)

Net change in:

 

 

Mortgage loans in process of securitization

 

(144,713)

 

246,193

Other assets and receivables

 

(37,233)

 

(17,738)

Other liabilities

 

28,294

 

18,389

Other

 

(3,140)

 

371

Net cash (used in) provided by operating activities

 

(543,020)

 

874,775

Investing activities:

 

 

  

Net change in securities purchased under agreements to resell

 

52

 

2,368

Purchases of securities available for sale

 

(513,520)

 

(47,866)

Purchases of securities held to maturity

(4,261)

Proceeds from the sale of securities available for sale

 

132

 

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

 

195,164

 

12,206

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

61,322

Purchases of loans

 

(269,855)

 

(92,533)

Net change in loans receivable

 

(1,805,415)

 

(1,199,040)

Purchase of FHLB stock

 

 

(10,326)

Proceeds from sale of FHLB stock

 

 

784

Purchases of premises and equipment

 

(2,943)

 

(5,113)

Purchase of servicing rights

(2,057)

Purchase of limited partnership interests

(71,001)

(13,225)

Proceeds from sale of limited partnership interests

52,458

Other investing activities

 

1,322

2,924

Net cash used in investing activities

 

(2,356,545)

 

(1,351,878)

Financing activities:

 

  

 

Net change in deposits

 

2,988,519

 

(682,875)

Proceeds from borrowings

 

42,149,880

 

21,595,000

Repayment of borrowings

 

(42,240,205)

 

(21,190,050)

Proceeds from notes payable

 

26,000

 

2,000

Proceeds from credit linked notes

153,546

Payment of credit linked notes

 

(2,980)

 

Repurchase of common stock

(3,935)

Dividends

(24,253)

(17,505)

Other financing activities

 

204

 

Net cash provided by (used in) financing activities

 

3,050,711

 

(297,365)

Net Change in Cash and Cash Equivalents

 

151,146

 

(774,468)

Cash and Cash Equivalents, Beginning of Period

 

226,164

 

1,032,614

Cash and Cash Equivalents, End of Period

$

377,310

$

258,146

Supplemental Cash Flows Information:

 

 

  

Interest paid

$

238,521

$

25,191

Income taxes paid, net of refunds

 

29,813

 

28,331

Transfer of loans from loans held for sale to loans receivable

377,460

See notes to condensed consolidated financial statements.

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Merchants Bancorp

Notes to Condensed Consolidated Financial Statements

(Unaudited)

Note 1:   Basis of Presentation

The accompanying unaudited condensed consolidated financial statements include the accounts of Merchants Bancorp, a registered bank holding company (the “Company”) and its wholly owned subsidiaries, Merchants Bank of Indiana (“Merchants Bank”), 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 June 30, 2023 and for the three and six months ended June 30, 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 June 30, 2023 and the results of operations for the three and six months ended June 30, 2023 and 2022, and cash flows for the six months ended June 30, 2023 and 2022. All interim amounts have not been audited and the results of operations for the three and six months ended June 30, 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 June 30, 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.

During the three months ended June 30, 2023, the Company acquired a variable interest in an investment fund for which it is the primary beneficiary of, and its results have been consolidated since the date of acquisition. Additionally, the Company has certain variable interest investments that were not deemed to be primary beneficiaries as of June 30, 2023. These VIEs are not consolidated and the equity or cost method of accounting has been applied. The Company will analyze whether the primary beneficiary designation has changed through triggering events on a prospective 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 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 senior credit linked notes issued by the Company in March 2023. As of June 30, 2023, there was $35.3 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 and six months ended June 30, 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:

June 30, 2023

Gross

Gross

Amortized

Unrealized

Unrealized

Fair

    

Cost

    

Gains

    

Losses

    

Value

(In thousands)

Securities available for sale:

 

  

 

  

 

  

 

  

Treasury notes

$

158,741

$

43

$

849

$

157,935

Federal agencies

 

249,994

 

 

8,422

 

241,572

Mortgage-backed - Government-sponsored entity (GSE)

248,497

6

7

248,496

Total securities available for sale

$

657,232

$

49

$

9,278

$

648,003

Securities held to maturity:

Mortgage-backed - Non-GSE multi-family

$

835,649

$

$

42

$

835,607

Mortgage-backed - Non-GSE residential

222,119

3,075

219,044

Mortgage-backed - Government - sponsored entity (GSE)

4,249

310

3,939

Total securities held to maturity

$

1,062,017

$

$

3,427

$

1,058,590

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Merchants Bancorp

Notes to Condensed Consolidated Financial Statements

(Unaudited)

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

At June 30, 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 June 30, 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 $1.9 million at June 30, 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 June 30, 2023 and $4.3 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 June 30, 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.

June 30, 2023

December 31, 2022

Amortized

Fair

Amortized

Fair

    

Cost

    

Value

    

Cost

    

Value

Securities available for sale:

(In thousands)

Within one year

$

321,992

$

316,487

$

118,984

$

115,386

After one through five years

 

86,743

 

83,020

 

203,236

 

192,784

 

408,735

 

399,507

 

322,220

 

308,170

Mortgage-backed - Government-sponsored entity (GSE)

248,497

248,496

15,167

15,167

$

657,232

$

648,003

$

337,387

$

323,337

Securities held to maturity:

Mortgage-backed - Non-GSE multi-family

$

835,649

$

835,607

$

871,772

$

871,784

Mortgage-backed - Non-GSE residential

222,119

219,044

Mortgage-backed - Government - sponsored entity (GSE)

4,249

 

3,939

 

247,306

 

247,182

$

1,062,017

$

1,058,590

$

1,119,078

$

1,118,966

During the three and six months ended June 30, 2023, proceeds from sales of securities available for sale were $132,000 and the net gain was inconsequential. During the three and six months ended June 30, 2022, no securities available for sale were sold.

11

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Merchants Bancorp

Notes to Condensed Consolidated Financial Statements

(Unaudited)

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 time that individual securities have been in a continuous unrealized loss position at June 30, 2023 and December 31, 2022:

June 30, 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

$

7,645

$

101

$

30,185

$

748

$

37,830

$

849

Federal agencies

14,854

146

226,718

8,276

241,572

8,422

Mortgage-backed - Government-sponsored entity (GSE)

444

3

191

4

635

7

$

22,943

$

250

$

257,094

$

9,028

$

280,037

$

9,278

Securities held to maturity:

Mortgage-backed - Non-GSE multi-family

$

835,607

$

42

$

$

$

835,607

$

42

Mortgage-backed - Non-GSE residential

219,044

3,075

219,044

3,075

Mortgage-backed - Government - sponsored entity (GSE)

3,939

310

3,939

310

$

1,058,590

$

3,427

$

$

$

1,058,590

$

3,427

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 available for sale securities 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 accumulated other comprehensive income, net of tax. Credit-related impairment is recognized as an ACL for available for sale securities 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

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Merchants Bancorp

Notes to Condensed Consolidated Financial Statements

(Unaudited)

in earnings with a 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 available for sale securities 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 June 30, 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 settlement 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 $0.3 million and $4.9 million at June 30, 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 $47.7 million and $35.0 million at June 30, 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

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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 lines of 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 June 30, 2023 and December 31, 2022 include:

June 30, 

December 31, 

    

2023

    

2022

(In thousands)

Mortgage warehouse lines of credit

$

1,201,932

$

464,785

Residential real estate

 

1,342,586

 

1,178,401

Multi-family financing

 

3,746,333

 

3,135,535

Healthcare financing

2,128,378

1,604,341

Commercial and commercial real estate(1)(2)

 

1,394,256

 

978,661

Agricultural production and real estate

 

91,599

 

95,651

Consumer and margin loans

 

11,920

 

13,498

 

9,917,004

 

7,470,872

Less:

 

  

 

  

ACL-Loans

 

62,986

 

44,014

Loans Receivable

$

9,854,018

$

7,426,858

(1)Includes $894.7 million and $497.0 million of revolving lines of credit collateralized primarily by mortgage servicing rights as of June 30, 2023 and December 31, 2022, respectively.

(2)Includes only $8.3 million and $12.8 million of non-owner occupied commercial real estate as of June 30, 2023 and December 31, 2022, respectively.

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

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

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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 carried a base rate of 30-day LIBOR, plus a margin. With the sunset of LIBOR, loans will be transitioned to 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 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. 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

15

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Merchants Bancorp

Notes to Condensed Consolidated Financial Statements

(Unaudited)

yields and prices. Operating lines are typically written for one year and secured by the crop and other farm assets as considered necessary. The Company is approved to sell agricultural loans in the secondary market through the Federal Agricultural Mortgage Corporation and uses this relationship to manage interest rate risk within the portfolio. 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 current 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 uncollectability 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 six months ended June 30, 2023. 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 current 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, the Company may use the fair value of the collateral, less estimated costs to sell, as a practical expedient as of the reporting date to determine the carrying amount of an asset and the allowance for credit losses, as applicable. 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 when the borrower is experiencing financial difficulty as of the reporting date.

16

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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 loans

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 included 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 judgement 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 tables present, by loan portfolio segment, the activity in the ACL-Loans for the three and six months ended June 30, 2023 and 2022:

For the Three Months Ended June 30, 2023

 

MTG WHLOC

 

RES RE

 

MF FIN

 

HC FIN

CML & CRE

 

AG & AGRE

 

CON & MAR

 

TOTAL

(In thousands)

ACL-Loans

Balance, beginning of period

$

1,664

$

7,378

 

$

19,851

$

11,753

$

10,482

$

543

$

167

$

51,838

Provision for credit losses

 

1,697

 

48

 

13,250

4,370

 

1,329

 

13

 

(29)

 

20,678

Loans charged to the allowance

 

 

(13)

 

(8,400)

 

(1,118)

 

 

(1)

 

(9,532)

Recoveries of loans previously charged-off

 

 

 

 

2

 

 

 

2

Balance, end of period

$

3,361

$

7,413

$

24,701

$

16,123

$

10,695

$

556

$

137

$

62,986

For the Three Months Ended June 30, 2022

 

MTG WHLOC

 

RES RE

 

MF FIN

 

HC FIN

CML & CRE

 

AG & AGRE

 

CON & MAR

 

TOTAL

(In thousands)

ACL-Loans

Balance, beginning of period

$

1,941

$

4,547

 

$

15,131

$

5,618

$

4,102

$

597

$

166

$

32,102

Provision for credit losses

 

481

 

363

 

1,233

2,318

 

474

 

(46)

 

(55)

 

4,768

Loans charged to the allowance

 

 

 

 

(32)

 

 

(15)

 

(47)

Recoveries of loans previously charged-off

 

 

 

 

651

 

 

 

651

Balance, end of period

$

2,422

$

4,910

$

16,364

$

7,936

$

5,195

$

551

$

96

$

37,474

The Company recorded a total provision for credit losses of $22.6 million for the three months ended June 30, 2023. The $22.6 million total provision for credit losses consisted of $20.7 million for the ACL-Loans as shown above and $1.9 million for the ACL-OBCE’s.

17

Table of Contents

Merchants Bancorp

Notes to Condensed Consolidated Financial Statements

(Unaudited)

The Company recorded a total provision for credit losses of $6.2 million for the three months ended June 30, 2022. The $6.2 million total provision for credit losses consisted of $4.8 million for the ACL-Loans as shown above, $0.2 million for the ACL-OBCE’s and $1.2 million for ACL-Guarantees.

For the Six Months Ended June 30, 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

 

2,112

397

16,320

6,241

3,478

(9)

(44)

28,495

Loans charged to the allowance

 

(13)

(8,400)

(1,118)

(1)

(9,532)

Recoveries of loans previously charged-off

 

9

 

9

Balance, end of period

$

3,361

$

7,413

$

24,701

$

16,123

$

10,695

$

556

$

137

$

62,986

For the Six Months Ended June 30, 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

 

426

465

1,760

3,336

905

(88)

(55)

 

6,749

Loans charged to the allowance

 

(963)

(15)

 

(978)

Recoveries of loans previously charged-off

 

651

7

 

658

Balance, end of period

$

2,422

$

4,910

$

16,364

$

7,936

$

5,195

$

551

$

96

$

37,474

The Company recorded a total provision for credit losses of $29.5 million for the six months ended June 30, 2023. The $29.5 million total provision for credit losses consisted of $28.5 million for the ACL-Loans as shown above and $1.0 million for the ACL-OBCE’s.

The Company recorded a total provision for credit losses of $8.7 million for the six months ended June 30, 2022. The $8.7 million total provision for credit losses consisted of $6.7 million for the ACL-Loans as shown above, $0.8 million for the ACL-OBCE’s and $1.2 million for ACL-Guarantees.

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

18

Table of Contents

Merchants Bancorp

Notes to Condensed Consolidated Financial Statements

(Unaudited)

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:

June 30, 2023

    

Real Estate

    

Accounts Receivable / Equipment

    

Other

    

Total

    

ACL-Loans Allocation

(In thousands)

RES RE

$

209

$

$

3

$

212

$

36

MF FIN

41,335

41,335

234

HC FIN

 

30,683

 

 

 

30,683

 

2,348

CML & CRE

 

 

3,830

 

3,294

 

7,124

 

1,145

AG & AGRE

 

147

 

 

 

147

 

1

CON & MAR

 

 

 

5

 

5

 

Total collateral dependent loans

$

72,374

$

3,830

$

3,302

$

79,506

$

3,764

There have been no significant changes to the types of collateral securing the Company’s collateral dependent loans compared to June 30, 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.

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.

19

Table of Contents

Merchants Bancorp

Notes to Condensed Consolidated Financial Statements

(Unaudited)

The following tables present the credit risk profile of the Company’s loan portfolio based on internal risk rating category as of June 30, 2023 and December 31, 2022:

As of June 30, 2023

    

2023

    

2022

    

2021

2020

    

2019

    

Prior

    

Revolving Loans

    

TOTAL

(In thousands)

MTG WHLOC

Pass

$

$

$

$

$

$

$

1,201,932

$

1,201,932

Total

$

$

$

$

$

$

$

1,201,932

$

1,201,932

Charge-offs

$

$

$

$

$

$

$

$

RES RE

Pass

10,295

11,246

8,469

23,210

3,349

11,801

1,273,551

1,341,921

Special Mention (Watch)

60

393

453

Substandard

212

212

Total

$

10,295

$

11,246

$

8,469

$

23,210

$

3,409

$

12,406

$

1,273,551

$

1,342,586

Charge-offs

$

$

$

$

$

$

$

13

$

13

MF FIN

Pass

770,580

1,001,864

391,935

98,073

30,073

9,467

1,330,469

3,632,461

Special Mention (Watch)

13,102

21,512

3,404

8,000

1,491

25,028

72,537

Substandard

28,360

12,975

41,335

Total

$

783,682

$

1,051,736

$

408,314

$

106,073

$

30,073

$

10,958

$

1,355,497

$

3,746,333

Charge-offs

$

$

8,400

$

$

$

$

$

$

8,400

HC FIN

Pass

334,477

1,079,976

236,816

69,827

14,769

251,640

1,987,505

Special Mention (Watch)

25,600

48,694

35,896

110,190

Substandard

21,783

8,900

30,683

Total

$

360,077

$

1,128,670

$

294,495

$

69,827

$

14,769

$

$

260,540

$

2,128,378

Charge-offs

$

$

$

$

$

$

$

$

CML & CRE

Pass

22,265

121,938

75,570

22,578

21,566

18,928

1,099,039

1,381,884

Special Mention (Watch)

16

39

4,510

173

153

334

23

5,248

Substandard

2,018

933

67

52

4,054

7,124

Total

$

22,281

$

121,977

$

82,098

$

23,684

$

21,786

$

19,314

$

1,103,116

$

1,394,256

Charge-offs

$

$

496

$

36

$

586

$

$

$

$

1,118

AG & AGRE

Pass

7,377

10,845

6,664

14,699

5,468

18,769

27,570

91,392

Special Mention (Watch)

11

49

60

Substandard

147

147

Total

$

7,377

$

10,856

$

6,713

$

14,699

$

5,468

$

18,916

$

27,570

$

91,599

Charge-offs

$

$

$

$

$

$

$

$

CON & MAR

Pass

346

4,502

349

155

37

4,451

2,041

11,881

Special Mention (Watch)

18

15

1

34

Substandard

5

5

Total

$

346

$

4,502

$

349

$

173

$

52

$

4,457

$

2,041

$

11,920

Charge-offs

$

$

$

$

$

$

1

$

$

1

Total Pass

$

1,145,340

$

2,230,371

$

719,803

$

228,542

$

75,262

$

63,416

$

5,186,242

$

9,648,976

Total Special Mention (Watch)

$

38,718

$

70,256

$

43,859

$

8,191

$

228

$

2,219

$

25,051

$

188,522

Total Substandard

$

$

28,360

$

36,776

$

933

$

67

$

416

$

12,954

$

79,506

Total Loans

$

1,184,058

$

2,328,987

$

800,438

$

237,666

$

75,557

$

66,051

$

5,224,247

$

9,917,004

Total Charge-offs

$

$

8,896

$

36

$

586

$

$

1

$

13

$

9,532

20

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 June 30, 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.

21

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 June 30, 2023 and December 31, 2022.

June 30, 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

$

$

$

$

$

1,201,932

$

1,201,932

RES RE

 

40

236

 

1,364

 

1,640

 

1,340,946

 

1,342,586

MF FIN

 

9,332

 

41,335

 

50,667

 

3,695,666

 

3,746,333

HC FIN

14,500

21,783

36,283

2,092,095

2,128,378

CML & CRE

 

451

 

3,778

 

4,229

 

1,390,027

 

1,394,256

AG & AGRE

 

 

 

 

91,599

 

91,599

CON & MAR

 

11

 

38

 

49

 

11,871

 

11,920

$

24,334

$

236

$

68,298

$

92,868

$

9,824,136

$

9,917,004

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. Most generally, this is at 90 or more days past due. The amount of interest income recognized on nonaccrual financial assets during the six months ended June 30, 2023 was immaterial.

22

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 June 30, 2023 and December 31, 2022.

June 30, 

December 31, 

2023

2022

Total Loans >

Total Loans >

90 Days &

90 Days &

    

Nonaccrual

    

Accruing

    

Nonaccrual

    

Accruing

(In thousands)

RES RE

$

212

$

1,152

$

245

$

96

MF FIN

 

41,335

 

 

 

HC FIN

21,783

21,783

CML & CRE

 

3,777

 

4,390

AG & AGRE

 

147

 

 

147

 

CON & MAR

 

5

 

34

 

6

 

16

$

67,259

$

1,186

$

26,571

$

112

The Company did not have any nonperforming loans without an estimated ACL at June 30, 2023.

Modifications to Borrowers Experiencing Financial Difficulty

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, which eliminates the recognition and measurement of a troubled debt restructuring (“TDR”). The Company adopted the prospective approach for this new guidance.

Occasionally, the Company modifies loans to borrowers in financial distress by providing principal forgiveness, term extension, an other-than-insignificant payment delay or interest rate reduction. In some cases, the Company provides multiple types of concessions on one loan. Typically, one type of concession, such as a term extension, is granted initially. If the borrower continues to experience financial difficulty, another concession, such as principal forgiveness, may be granted. For the loans included in the “combination” columns below, multiple types of modifications have been made on the same loan within the current reporting period.

The following table presents the amortized cost basis of loans at June 30, 2023 that were both experiencing financial difficulty and modified during the six months ended June 30, 2023, by class and by type of modification. There were no loans modified for borrowers experiencing financial difficulty during the three months ended June 30, 2023. The percentage of the amortized cost basis of loans that were modified to borrowers in financial distress as compared to the amortized cost basis of each class of financing receivable is also presented below:

For the Six Months Ended June 30, 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

$

$

3,778

$

$

$

$

%

Total

$

$

3,778

$

$

$

$

%

23

Table of Contents

Merchants Bancorp

Notes to Condensed Consolidated Financial Statements

(Unaudited)

The financial effects of the modifications in the table above include an increase in the weighted average term for commercial and commercial real estate loans of three months. The Company has committed to lend no additional amounts to the borrowers included in the table above.

The Company closely monitors the performance of loans that are modified to borrowers experiencing financial difficulty to understand the effectiveness of its modification efforts. The following table presents the performance of such loans that have been modified in the last twelve months:

30  59 Days

60  89 Days

Greater Than

Total

Past Due

Past Due

90 Days

Past Due

(In thousands)

Commercial and commercial real estate

$

$

$

3,778

$

3,778

Total

$

$

$

3,778

$

3,778

No modified loans defaulted during the three or six months ended June 30, 2023.

Foreclosures

There were no residential loans in process of foreclosure as of June 30, 2023 and December 31, 2022.

Loans Purchased

The Company purchased $269.9 million and $92.5 million of loans during the six months ended June 30, 2023 and 2022, respectively.

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 also has 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 June 30, 2023 the Company determined it was not the primary beneficiary for most 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

24

Table of Contents

Merchants Bancorp

Notes to Condensed Consolidated Financial Statements

(Unaudited)

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 unconsolidated VIEs consists of the capital invested plus any unfunded equity commitments. These investments are recorded in other assets and other liabilities on our consolidated balance sheet. The table below reflects the size of the VIEs as well as our maximum exposure to loss in connection with VIEs at June 30, 2023 and December 31, 2022.

Total

Total

Maximum

Assets ($ in thousands)

    

Assets

    

Liabilities

    

Exposure to Loss

(In thousands)

June 30, 2023

 

  

 

  

 

  

Unconsolidated VIEs

$

124,736

$

82,262

$

124,736

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 $835.6 million and $871.8 million at June 30, 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 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 June 30, 2023 and December 31, 2022, that the Company, Merchants Bank, and FMBI met all capital adequacy requirements to which they were subject.

As of June 30, 2023 and December 31, 2022, the most recent notifications from the Board of Governors of the Federal Reserve System (“Federal Reserve”) categorized the Company as well capitalized and most recent notifications from the Federal Deposit Insurance Corporation (“FDIC”) categorized Merchants Bank and FMBI as well capitalized under the regulatory framework for prompt corrective action. There are no conditions or events since that notification that management believes have changed the Company’s, Merchants Bank’s, or FMBI’s category.

25

Table of Contents

Merchants Bancorp

Notes to Condensed Consolidated Financial Statements

(Unaudited)

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

Minimum

Minimum

Amount Required

Amount To Be

for Adequately

Well

Actual

Capitalized(1)

Capitalized(1)

    

Amount

    

Ratio

    

Amount

    

Ratio

Amount

    

Ratio

    

(Dollars in thousands)

June 30, 2023

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

 

  

 

  

 

  

 

  

 

Company

$

1,625,223

 

11.3

%  

$

1,148,948

 

8.0

%  

$

 

N/A

%  

Merchants Bank

1,563,433

 

11.1

%  

 

1,127,989

 

8.0

%  

 

1,409,986

 

10.0

FMBI

 

37,536

 

11.3

%  

 

26,636

 

8.0

%  

 

33,295

 

10.0

%  

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

 

  

 

  

 

  

 

  

 

  

 

  

Company

 

1,549,763

 

10.8

%  

 

861,711

 

6.0

%  

 

 

N/A

%  

Merchants Bank

1,488,730

 

10.6

%  

 

845,992

 

6.0

%  

 

1,127,989

 

8.0

FMBI

 

36,779

 

11.0

%  

 

19,977

 

6.0

%  

 

26,636

 

8.0

%  

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

Company

 

1,050,155

 

7.3

%  

 

646,284

 

4.5

%  

 

 

N/A

%  

Merchants Bank

1,488,730

 

10.6

%  

 

634,494

 

4.5

%  

 

916,491

 

6.5

FMBI

 

36,779

 

11.0

%  

 

14,983

 

4.5

%  

 

21,642

 

6.5

%  

Tier I capital(1) (to average assets)

 

 

  

 

  

 

 

  

 

  

Company

 

1,549,763

 

10.6

%  

 

586,227

 

4.0

%  

 

 

N/A

%  

Merchants Bank

1,488,730

 

10.4

%  

 

574,725

 

4.0

%  

 

718,406

 

5.0

FMBI

 

36,779

 

10.6

%  

 

13,823

 

4.0

%  

 

17,279

 

5.0

%  

(1)As defined by regulatory agencies.

26

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 consolidated balance sheets while derivative instruments with a negative fair value are reported in other liabilities in the condensed consolidated balance sheets.

27

Table of Contents

Merchants Bancorp

Notes to Condensed Consolidated Financial Statements

(Unaudited)

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 June 30, 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

June 30, 2023

(In thousands)

(In thousands)

Interest rate lock commitments

$

24,216

Other assets/liabilities

$

94

$

68

Forward contracts

$

27,125

Other assets/liabilities

111

7

Interest rate swaps

$

57,557

Other assets/liabilities

 

3,291

$

3,496

$

75

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 and six months ended June 30, 2023 and 2022.

Three Months Ended

Six Months Ended

June 30, 

June 30, 

    

2023

    

2022

    

2023

    

2022

(In thousands)

(In thousands)

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

Interest rate lock commitments

$

(188)

$

837

$

21

$

(45)

Forward contracts (includes pair-off settlements)

376

1,309

280

4,459

Interest rates swaps

1,597

160

261

160

Net derivative gains (loss)

$

1,785

$

2,306

$

562

$

4,574

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, 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.

28

Table of Contents

Merchants Bancorp

Notes to Condensed Consolidated Financial Statements

(Unaudited)

The fair values of derivative assets and liabilities related to derivatives for customers with back-to-back interest rate swaps were recorded in the condensed consolidated balance sheets as follows:

Notional

Fair Value

Amount

 

Balance Sheet Location

 

Asset

 

Liability

(In thousands)

(In thousands)

June 30, 2023

$

218,291

Other assets/liabilities

$

9,477

$

9,477

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

Six Months Ended

June 30, 

June 30, 

    

2023

    

2022

    

2023

    

2022

(In thousands)

(In thousands)

Gross swap gains

$

7,016

$

2,035

$

6,436

$

2,531

Gross swap losses

7,016

2,035

 

6,436

2,531

Net swap gains (losses)

$

$

$

$

The Company pledged $0 in collateral to secure its obligations under swap contracts at both June 30, 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

29

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 June 30, 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)

June 30, 2023

Mortgage loans in process of securitization

$

298,907

$

$

298,907

$

Securities available for sale:

 

  

 

  

 

  

 

  

Treasury notes

 

157,935

 

157,935

 

 

Federal agencies

 

241,572

 

 

241,572

 

Mortgage-backed - Government-sponsored entity (GSE)

 

248,496

 

 

248,496

 

Loans held for sale

 

82,931

 

 

82,931

 

Servicing rights

 

147,288

 

 

 

147,288

Derivative assets - interest rate lock commitments

 

94

 

 

 

94

Derivative assets - forward contracts

 

111

 

 

111

 

Derivative assets - interest rate swaps

3,291

3,291

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

 

9,477

 

 

9,477

 

Derivative liabilities - interest rate lock commitments

 

68

68

Derivative liabilities - forward contracts

 

7

7

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

 

9,477

9,477

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 six months ended June 30, 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.

30

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 an independent 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 expenses on its condensed consolidated statement of income.

31

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 June 30, 

Six Months Ended June 30, 

    

2023

    

2022

    

2023

    

2022

(In thousands)

(In thousands)

Servicing rights

Balance, beginning of period

$

143,867

$

121,036

$

146,248

$

110,348

Additions

 

  

 

  

 

 

  

Originated servicing

 

2,124

 

5,203

 

4,297

 

10,995

Subtractions

 

  

 

  

 

  

 

  

Paydowns

 

(2,073)

 

(3,268)

 

(3,771)

 

(6,017)

Sales of servicing

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

 

3,370

 

7,739

 

514

 

15,384

Balance, end of period

$

147,288

$

130,710

$

147,288

$

130,710

Derivative Assets - interest rate lock commitments

Balance, beginning of period

$

218

$

112

$

28

$

264

Changes in fair value

 

(124)

 

187

 

66

 

35

Balance, end of period

$

94

$

299

$

94

$

299

Derivative Liabilities - interest rate lock commitments

Balance, beginning of period

$

4

$

771

$

23

$

41

Changes in fair value

 

64

 

(650)

 

45

 

80

Balance, end of period

$

68

$

121

$

68

$

121

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 June 30, 2023 and December 31, 2022.

Fair Value Measurements Using

Quoted Prices in

Significant

Significant

Active Markets for

Other Observable

Unobservable 

Fair

Identical Assets

Inputs

Inputs

Assets

Value

(Level 1)

(Level 2)

(Level 3)

(In thousands)

June 30, 2023

 

  

 

  

 

  

 

  

Impaired loans (collateral-dependent)

$

40,839

$

$

$

40,839

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.

32

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 June 30, 2023:

 

  

 

  

 

Collateral dependent loans

$

40,839

 

Market comparable properties

 

Marketability discount

0% - 23%

 

1%

Servicing rights - Multi-family

$

111,756

 

Discounted cash flow

 

Discount rate

8% - 13%

 

9%

Constant prepayment rate

1% - 100%

 

7%

Servicing rights - Single-family

$

30,466

 

Discounted cash flow

 

Discount rate

9% - 10%

9%

Constant prepayment rate

7% - 14%

7%

Servicing rights - SBA

$

5,066

 

Discounted cash flow

 

Discount rate

16%

 

16%

Constant prepayment rate

3% - 16%

8%

Derivative assets - interest rate lock commitments

$

94

 

Discounted cash flow

 

Loan closing rates

50% - 99%

 

79%

Derivative liabilities - interest rate lock commitments

$

68

 

Discounted cash flow

 

Loan closing rates

50% - 99%

 

79%

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.

33

Table of Contents

Merchants Bancorp

Notes to Condensed Consolidated Financial Statements

(Unaudited)

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 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 June 30, 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)

June 30, 2023

Financial assets:

 

  

 

  

 

  

 

  

 

  

Cash and cash equivalents

$

377,310

$

377,310

$

377,310

$

$

Securities purchased under agreements to resell

 

3,412

 

3,412

 

 

3,412

 

Securities held to maturity

 

1,062,017

 

1,058,590

 

 

222,983

 

835,607

FHLB stock

 

39,130

 

39,130

 

 

39,130

 

Loans held for sale

 

2,975,082

 

2,975,082

 

 

2,975,082

 

Loans receivable, net

 

9,854,018

 

9,817,979

 

 

 

9,817,979

Interest receivable

 

70,509

 

70,509

 

 

70,509

 

Financial liabilities:

 

  

 

 

  

 

  

 

  

Deposits

 

13,059,864

 

13,057,747

 

7,878,580

 

5,179,167

 

Short-term subordinated debt

 

47,000

 

47,000

 

 

47,000

 

FHLB advances

 

736,132

 

735,695

 

 

735,695

 

Other borrowing

82,934

82,934

82,934

Credit linked notes

150,770

151,720

151,720

Interest payable

 

25,489

 

25,489

 

 

25,489

 

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

 

34

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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 two 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 $11.1 million and operating lease right-of-use liabilities of $12.3 million as of June 30, 2023.

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

June 30, 2023

December 31, 2022

Balance Sheet

(In thousands)

(In thousands)

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

$

11,050

$

10,969

Operating lease liability (in other liabilities)

12,326

11,992

Weighted average remaining lease term (years)

6.3

6.5

Weighted average discount rate

2.86%

2.65%

Maturities of lease liabilities:

One year or less

$

1,243

$

2,181

Year two

2,441

2,321

Year three

2,064

1,881

Year four

2,100

1,911

Year five

2,046

1,853

Thereafter

3,566

2,902

Total future minimum lease payments

13,460

13,049

Less: imputed interest

1,134

1,057

Total

$

12,326

$

11,992

Three Months Ended

Three Months Ended

June 30, 2023

June 30, 2022

Income Statement

(In thousands)

(In thousands)

Components of lease expense:

Operating lease cost (in occupancy and equipment expense)

$

666

$

425

Six Months Ended

Six Months Ended

June 30, 2023

June 30, 2022

Income Statement

(In thousands)

(In thousands)

Components of lease expense:

Operating lease cost (in occupancy and equipment expense)

$

1,249

$

792

Six Months Ended

Six Months Ended

June 30, 2023

June 30, 2022

Cash Flow Statement

(In thousands)

(In thousands)

Supplemental cash flow information:

Operating cash flows from operating leases

$

886

$

597

35

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Merchants Bancorp

Notes to Condensed Consolidated Financial Statements

(Unaudited)

Note 10: Deposits

Deposits were comprised of the following at June 30, 2023 and December 31, 2022:

June 30, 2023

December 31,

    

2023

    

2022

(In thousands)

Noninterest-bearing deposits

Demand deposits

$

349,387

$

326,875

Total noninterest-bearing deposits

349,387

326,875

Interest-bearing deposits

Demand deposits

$

4,583,080

$

3,720,363

Savings deposits

 

2,946,113

 

3,034,818

Certificates of deposit

 

5,181,284

 

2,989,289

Total interest-bearing deposits

12,710,477

9,744,470

Total deposits

$

13,059,864

$

10,071,345

Maturities for certificates of deposit are as follows:

    

June 30, 2023

(In thousands)

Due within one year

$

5,018,137

Due in one year to two years

 

117,566

Due in two years to three years

 

43,816

Due in three years to four years

 

1,016

Due in four years to five years

749

Due in five years to six years

 

$

5,181,284

Brokered deposit amounts at June 30, 2023 and December 31, 2022, were as follows:

June 30,

December 31, 

    

2023

    

2022

(In thousands)

Brokered certificates of deposit

$

4,619,798

$

2,681,198

Brokered savings deposits

 

6,243

 

81,532

Brokered deposit on demand accounts

 

125,108

 

13

$

4,751,149

$

2,762,743

Note 11: Borrowings

Borrowings were comprised of the following at June 30, 2023 and December 31, 2022:

June 30, 

December 31, 

    

2023

    

2022

(In thousands)

Federal Reserve discount window borrowings

$

75,000

$

20,000

Short-term subordinated debt

 

47,000

 

21,000

FHLB advances

736,132

859,392

American Financial Exchange borrowing

30,000

Credit linked notes

150,770

Other borrowings

 

7,934

 

Total borrowings

$

1,016,836

$

930,392

36

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Merchants Bancorp

Notes to Condensed Consolidated Financial Statements

(Unaudited)

On March 30, 2023, Merchants Bank of Indiana issued and sold credit linked notes, due May 26, 2028. 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 June 30, 2023, the account included $35.3 million of restricted cash and the acquisition of $119.9 million in short-term Treasury securities. These are reported as cash equivalents and securities available for sale in the consolidated balance sheets.

In April 2023, the Company entered into a warehouse financing arrangement, whereby a customer agreed to invest up to $45 million in the Company’s subordinated debt. The subordinated debt balance as of June 30, 2023 was $11.0 million. As of June 30, 2023, interest on the debt is paid quarterly by the Company at a rate equal to SOFR, plus 300 bps. The agreement matures on December 1, 2023, and automatically extends for one year unless 180 day notification is received from either party.

During the three months ended June 30, 2023, the Company acquired a variable interest in an investment fund for which it is the primary beneficiary of, and the results are consolidated since the date of acquisition. The fund obtained a loan from an external party, and had a balance of $7.9 million as of June 30, 2023. Interest on the debt will accrue at the rate of 1.00% per year until it matures in 2047.

Note 12:   Earnings Per Share

Earnings per share were computed as follows:

Three Month Periods Ended June 30, 

2023

2022

Weighted-

Per 

Weighted-

Per 

Net

Average

Share

Net

Average

Share

    

Income

    

Shares

    

Amount

    

Income

    

Shares

    

Amount

(In thousands)

(In thousands)

Net income

$

65,302

 

  

 

  

$

53,935

 

  

 

  

Dividends on preferred stock

 

(8,668)

 

  

 

  

 

(5,729)

 

  

 

  

Net income allocated to common shareholders

$

56,634

 

  

 

  

$

48,206

 

  

 

  

Basic earnings per share

 

  

 

43,235,398

$

1.31

 

  

 

43,209,824

$

1.12

Effect of dilutive securities-restricted stock awards

 

  

 

73,995

 

  

 

  

 

125,387

 

  

Diluted earnings per share

 

  

 

43,309,393

$

1.31

 

  

 

43,335,211

$

1.11

Six Month Periods Ended June 30, 

2023

2022

 

Weighted-

Per 

Weighted-

Per 

Net

Average

Share

Net

Average

Share

    

Income

    

Shares

    

Amount

    

Income

    

Shares

    

Amount

(In thousands)

(In thousands)

 

Net income

$

120,257

 

  

 

  

$

104,077

 

  

 

  

Dividends on preferred stock

 

(17,335)

 

  

 

  

 

(11,457)

 

  

 

  

Net income allocated to common shareholders

$

102,922

 

  

 

  

$

92,620

 

  

 

  

Basic earnings per share

 

  

 

43,207,655

$

2.38

 

  

 

43,220,198

$

2.14

Effect of dilutive securities-restricted stock awards

 

  

 

92,585

 

  

 

  

 

147,677

 

  

Diluted earnings per share

 

  

 

43,300,240

$

2.38

 

  

 

43,367,875

$

2.14

37

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Merchants Bancorp

Notes to Condensed Consolidated Financial Statements

(Unaudited)

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 June 30, 2023 and 2022, the Company did not issue any shares. During the six months ended June 30, 2023 and 2022, the Company issued 84,335 and 64,962 shares, respectively.

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 3,682 and 3,766 shares, issued to non-executive directors during the three months ended June 30, 2023 and 2022, respectively and there were 6,545 and 5,821 shares, issued to non-executive directors during the six months ended June 30, 2023 and 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. There was no expense recognized for the contribution to the ESOP during the three months ended June 30, 2023 and 2022. Expense recognized for the contribution to the ESOP totaled $810,000 and $653,000 for the six months ended June 30, 2023 and 2022, respectively. The Company contributed 33,293 shares and 20,709 shares to the ESOP for the six months ended June 30, 2023 and 2022, respectively.

Note 14:   Segment Information

Our 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, certain elimination entries and investments in qualified affordable housing limited partnerships. All operations are domestic.

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Merchants Bancorp

Notes to Condensed Consolidated Financial Statements

(Unaudited)

The tables below present selected business segment financial information for the three and six months ended June 30, 2023 and 2022.

Multi-family

    

 

Mortgage 

Mortgage

 

    

Banking

    

Warehousing

    

Banking

    

Other

    

Total

Three Months Ended June 30, 2023

(In thousands)

Interest income

$

1,248

$

64,267

$

191,406

$

1,148

 

$

258,069

Interest expense

 

13

 

42,984

 

111,311

 

(1,856)

 

 

152,452

Net interest income

 

1,235

 

21,283

 

80,095

 

3,004

 

 

105,617

Provision for credit losses

 

 

2,320

 

20,283

 

 

 

22,603

Net interest income after provision for credit losses

 

1,235

 

18,963

 

59,812

 

3,004

 

 

83,014

Noninterest income

 

30,325

 

2,872

 

(760)

 

(2,555)

 

 

29,882

Noninterest expense

 

19,962

 

3,617

 

12,118

 

8,623

 

 

44,320

Income (loss) before income taxes

 

11,598

 

18,218

 

46,934

 

(8,174)

 

 

68,576

Income taxes

 

356

 

(378)

 

4,284

 

(988)

 

 

3,274

Net income (loss)

$

11,242

$

18,596

$

42,650

$

(7,186)

 

$

65,302

Total assets

$

373,680

$

4,474,832

$

10,784,596

$

241,764

 

$

15,874,872

Multi-family

 

Mortgage 

Mortgage

 

    

Banking

    

Warehousing

    

Banking

    

Other

    

Total

Three Months Ended June 30, 2022

(In thousands)

Interest income

$

383

$

23,247

$

63,578

$

2,062

 

$

89,270

Interest expense

 

 

5,576

 

12,036

 

(373)

 

 

17,239

Net interest income

 

383

 

17,671

 

51,542

 

2,435

 

 

72,031

Provision for credit losses

 

1,153

 

834

 

4,225

 

 

 

6,212

Net interest income after provision for credit losses

 

(770)

 

16,837

 

47,317

 

2,435

 

 

65,819

Noninterest income

 

49,430

 

1,350

 

(10,252)

 

(1,357)

 

 

39,171

Noninterest expense

 

21,959

 

2,441

 

2,634

 

5,923

 

 

32,957

Income (loss) before income taxes

 

26,701

 

15,746

 

34,431

 

(4,845)

 

 

72,033

Income taxes

 

7,145

 

3,878

 

8,499

 

(1,424)

 

 

18,098

Net income (loss)

$

19,556

$

11,868

$

25,932

$

(3,421)

 

$

53,935

Total assets

$

330,676

$

2,836,998

$

7,835,152

$

83,229

 

$

11,086,055

39

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Merchants Bancorp

Notes to Condensed Consolidated Financial Statements

(Unaudited)

Multi-family

    

 

Mortgage 

Mortgage

 

    

Banking

    

Warehousing

    

Banking

    

Other

    

Total

(In thousands)

Six Months Ended June 30, 2023

Interest income

$

2,354

$

106,585

358,132

$

2,292

 

$

469,363

Interest expense

 

13

 

70,778

 

195,837

 

(3,575)

 

 

263,053

Net interest income

 

2,341

 

35,807

 

162,295

 

5,867

 

 

206,310

Provision for credit losses

 

 

3,684

 

25,786

 

 

 

29,470

Net interest income after provision for credit losses

 

2,341

 

32,123

 

136,509

 

5,867

 

 

176,840

Noninterest income

 

46,922

 

3,905

 

(1,949)

 

(4,732)

 

 

44,146

Noninterest expense

 

34,593

 

6,372

 

22,288

 

15,839

 

 

79,092

Income (loss) before income taxes

 

14,670

 

29,656

 

112,272

 

(14,704)

 

 

141,894

Income taxes

 

1,462

 

2,419

 

20,315

 

(2,559)

 

 

21,637

Net income (loss)

$

13,208

$

27,237

$

91,957

$

(12,145)

 

$

120,257

Total assets

$

373,680

$

4,474,832

$

10,784,596

$

241,764

 

$

15,874,872

Multi-family

 

Mortgage 

Mortgage

 

    

Banking

    

Warehousing

    

Banking

    

Other

    

Total

(In thousands)

Six Months Ended June 30, 2022

Interest income

$

640

$

43,576

$

117,303

$

3,763

 

$

165,282

Interest expense

 

 

7,597

 

20,553

 

(624)

 

 

27,526

Net interest income

 

640

 

35,979

 

96,750

 

4,387

 

 

137,756

Provision for credit losses

 

1,153

 

627

 

6,883

 

 

 

8,663

Net interest income after provision for credit losses

 

(513)

 

35,352

 

89,867

 

4,387

 

 

129,093

Noninterest income

 

81,616

 

3,210

 

(8,063)

 

(2,995)

 

 

73,768

Noninterest expense

 

38,490

 

5,367

 

9,208

 

10,925

 

 

63,990

Income (loss) before income taxes

 

42,613

 

33,195

 

72,596

 

(9,533)

 

 

138,871

Income taxes

 

11,565

 

8,168

 

17,900

 

(2,839)

 

 

34,794

Net income (loss)

$

31,048

$

25,027

$

54,696

$

(6,694)

 

$

104,077

Total assets

$

330,676

$

2,836,998

$

7,835,152

$

83,229

 

$

11,086,055

Note 15:   Recent Accounting Pronouncements

The Company continually monitors potential accounting pronouncement and SEC release changes. No new pronouncements or releases are expected to be applicable to the Company.

Note 16:   Subsequent Events

No material events were noted.

40

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Merchants Bancorp

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

41

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Merchants Bancorp

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.

42

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Merchants Bancorp

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

Management’s discussion and analysis of the financial condition at June 30, 2023 and results of operations for the three and six months ended June 30, 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 June 30, 2023

Net income of $65.3 million increased 21% compared to June 30, 2022 and diluted earnings per share of $1.31 increased 18% compared to June 30, 2022.
The 21% increase in net income was primarily driven by a $33.6 million, or 47%, increase in net interest income, a $14.8 million, or 82%, decrease in the provision for income tax, a $16.4 million, or 264%, increase in provision for credit losses, a $11.4 million, or 34%, increase in noninterest expense, and a $10.2 million, or 47%, decrease in gain on sale of loans.
During the three months ended June 30, 2023, the Company recorded a $13.0 million tax benefit related to tax refunds receivable and changes to its state tax apportionment calculations, which was offset by credit events that totaled approximately $14.8 million, primarily for the impact of a multi-family loan charge-off, an increase in specific reserves for a healthcare customer, and changes to qualitative factors and forecasted loss rates.
Total assets of $15.9 billion increased 11% compared to March 31, 2023, and increased 26% compared to December 31, 2022.
As of June 30, 2023, the Company had $5.3 billion, or 34%, of total assets, 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 $10.2 billion, or 64%, of the $15.9 billion in total assets as of June 30, 2023.
Uninsured deposits totaled approximately $2 billion as of June 30, 2023, representing less than 20% of total deposits.
Loans receivable of $9.9 billion, net of allowance for credit losses on loans, increased $1.3 billion, or 15%, compared to March 31, 2023, and increased $2.4 billion, or 33%, compared to December 31, 2022.
Efficiency ratio was 32.7% compared to 29.6% for the three months ended June 30, 2022.
As of June 30, 2023, approximately 94% 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 $24.14 increased 23% compared to $19.70 for the three months ended June 30, 2022.

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The volume of warehouse loans funded during the three months ended June 30, 2023 amounted to $8.4 billion, a decrease of $459.1 million, or 5%, compared to the three months ended June 30, 2022. This compared to the 32% industry decrease in single-family residential loan volumes for the three months ended June 30, 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 increased by $261.8 million, or 64%, to $668.2 million, compared to $406.4 million for the three months ended June 30, 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.

Financial Condition

As of June 30, 2023, we had approximately $15.9 billion in total assets, $13.1 billion in deposits and $1.6 billion in total shareholders’ equity. Total assets as of June 30, 2023 included approximately $377.3 million of cash and cash equivalents, $3.1 billion of loans held for sale and $9.9 billion of loans receivable, net of ACL-loans. Assets also included $298.9 million of mortgage loans in 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 was also $1.1 billion in securities held to maturity that were primarily acquired in conjunction with the securitization of loans that the Company originated. Additionally, we

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had $648.0 million in securities available for sale that are typically match funded with related custodial deposits or required to collateralize our credit-linked notes. There are some restrictions on the types of securities we hold, particularly for those that are funded by certain custodial deposits where we set the cost of deposits based on the yield of the related securities. Servicing rights at June 30, 2023 were $147.3 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 June 30, 2023 and December 31, 2022

Total Assets.   Total assets increased $3.3 billion, or 26%, to $15.9 billion at June 30, 2023 from $12.6 billion at December 31, 2022. The increase was due primarily to significant growth in the mortgage warehouse, multi-family, and healthcare loan portfolios.

Cash and Cash Equivalents.  Cash and cash equivalents increased $151.1 million, or 67%, to $377.3 million at June 30, 2023 from $226.2 million at December 31, 2022. The 67% increase reflected higher liquidity to fund anticipated loan growth. Included in cash equivalents was $35.3 million in restricted cash associated with the March 2023 issuance of senior credit linked notes described in Note 11: Borrowings.

Mortgage Loans in Process of Securitization.   Mortgage loans in process of securitization increased $144.7 million, or 94%, to $298.9 million at June 30, 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 or other agency mortgage-backed securities with a firm investor commitment to purchase the securities. The 94% 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 $324.7 million, or 100%, to $648.0 million at June 30, 2023, from $323.3 million at December 31, 2022. The increase in available for sale securities was primarily due to purchases of $513.5 million and a decrease of unrealized loss on securities of $4.8 million, partially offset by calls, maturities, repayments and sales of securities totaling $195.2 million during the period.

As of June 30, 2023, Accumulated Other Comprehensive Losses (“AOCL”) of $7.0 million losses, related to securities available for sale, decreased $3.5 million, or 33%, compared to losses of $10.5 million at December 31, 2022. The $7.0 million of AOCL losses as of June 30, 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 $57.1 million, or 5%, to $1.1 billion at June 30, 2023 from December 31, 2022. The decrease was primarily due to purchases of $4.3 million offset by calls, maturities and repayments of securities totaling $61.3 million during the period.

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, increased $147.4 million, or 5%, to $3.1 billion at June 30, 2023 from $2.9 billion at December 31, 2022. The increase in loans held for sale was due primarily to a increase in warehouse participations, as the industry experienced higher volume.

Loans Receivable.   Loans receivable, which are comprised of loans held for investment, increased $2.4 billion, or 33%, to $9.9 billion at June 30, 2023 compared to December 31, 2022. The increase was comprised primarily of:

an increase of $737.1 million, or 159%, in mortgage warehouse lines of credit, to $1.2 billion at June 30, 2023,
an increase of $610.8 million, or 19%, in multi-family financing loans, to $3.7 billion at June 30, 2023,
an increase of $524.0 million, or 33%, in healthcare financing loans, to $2.1 billion at June 30, 2023,

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an increase of $415.6 million, or 42%, in commercial and commercial real estate loans, to $1.4 billion at June 30, 2023, and
an increase of $164.2 million, or 14%, in residential real estate loans, to $1.3 billion at June 30, 2023.

The $737.1 million increase in mortgage warehouse lines of credit was due to higher loan volume.

The $610.8 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 $524.0 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 $415.6 million increase in commercial and commercial real estate was due to higher revolving lines of credit on collateralized mortgage servicing rights during the period.

The $164.2 million increase in residential real estate loans was primarily due an increase in All-in-One®, first-lien HELOCs.

As of June 30, 2023, approximately 94% 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 $63.0 million at June 30, 2023 increased $19.0 million compared to $44.0 million at December 31, 2022. The increase was primarily due to:

loan growth in the period,
replenishment of $8.2 million related to the charge-off of a loan in the multi-family portfolio,
a $4.6 million increase related to changes in qualitative factors and forecasted loss rates to reflect changes in industry conditions, such as the impact of higher rates, and
a $2.0 million increase in net specific reserves, primarily related to a loan in the healthcare portfolio.

The increases were partially offset by charge-offs of $9.5 million, primarily associated with a multi-family customer.

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 to government agencies.

Goodwill.   Goodwill of $15.8 million at June 30, 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 increased $1.0 million, or 1%, to $147.3 million at June 30, 2023 compared to $146.3 million at December 31, 2022. During the six months ended June 30, 2023, originated servicing of $4.3 million and a positive fair market value adjustment of $0.5 million were partially offset by paydowns of $3.8 million. 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 increase recorded during the six months ended June 30, 2023 was driven by higher loan balances of mortgages serviced and higher interest rates that impacted fair market value adjustments. The value of servicing rights generally increases in rising interest rate environments and declines in falling interest rate environments due to expected prepayments.

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Other Assets and Receivables. Other assets and receivables increased $105.1 million, or 67%, to $262.5 million at June 30, 2023 compared to $157.4 million at December 31, 2022. The 67% increase in other assets and receivables was primarily due to the acquisition of low-income housing tax credit investments.

Deposits.   Deposits increased $3.0 billion, or 30%, to $13.1 billion at June 30, 2023 from $10.1 billion at December 31, 2022. The 30% increase in total deposits was primarily due to a $2.2 billion increase in certificates of deposit and a $885.2 million increase in demand deposits, partially offset by a decrease of $88.7 million in savings deposits. As of June 30, 2023, approximately 83% of the total deposits at Merchants Bank reprice within three months.

Uninsured deposits totaled approximately $2 billion as of June 30, 2023, representing less than 20% 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 $1.7 billion as of June 30, 2023.

We increased our use of brokered deposits by $2.0 billion, or 72%, to $4.8 billion at June 30, 2023 compared to December 31, 2022. Brokered deposits represented 36% of total deposits at June 30, 2023, compared to 27% of total deposits at December 31, 2022.

Brokered certificates of deposit accounts increased by $1.9 billion, or 72%, to $4.6 billion at June 30, 2023 compared to December 31, 2022.
Brokered demand deposit accounts increased by $125.1 million, to $125.1 million at June 30, 2023 compared to December 31, 2022.
Brokered savings deposits accounts decreased $75.3 million, or 92%, to $6.2 million at June 30, 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 $3.0 billion, or 30%, to $12.7 billion at June 30, 2023, and noninterest-bearing deposits increased $22.5 million, or 7%, to $349.4 million at June 30, 2023.

Borrowings.   Borrowings totaled $1.0 billion at June 30, 2023, an increase of $86.4 million, or 9%, from December 31, 2022. The increase was primarily due to the issuance of 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 June 30, 2023, unused lines of credit totaled $5.3 billion, compared to $3.1 billion at December 31, 2022.

Other Liabilities. Other liabilities increased $87.7 million, or 65%, to $221.8 million at June 30, 2023 compared to $134.1 million at December 31, 2022. The 65% increase in other liabilities was primarily due to unfunded commitments for low-income housing tax credit investments.

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Total Shareholders’ Equity.   Total shareholders’ equity was $1.6 billion as of June 30, 2023, compared to $1.5 billion as of December 31, 2022. The $100.6 million increase resulted primarily from net income of $120.3 million, which was partially offset by dividends paid on common and preferred shares of $24.3 million during the period.

Asset Quality

Total nonperforming loans (nonaccrual and greater than 90 days late but still accruing) were $68.4 million, or 0.69%, of total loans at June 30, 2023, compared to $26.7 million, or 0.36%, of total loans at December 31, 2022 and $4.8 million, or 0.07%, at June 30, 2022. The increase in non-performing loans compared to both periods was primarily due to 3 customers, while the remainder of our loan portfolio continued to generally perform as expected.

As a percentage of nonperforming loans, the ACL-Loans was 92% at June 30, 2023 compared to 165% at December 31, 2022 and 778.6% at June 30, 2022. The decrease compared to both periods were primarily due to the increases in the nonperforming loans.

Total loans greater than 30 days past due were $92.9 million at June 30, 2023, $39.8 million at December 31, 2022, and $4.9 million at June 30, 2022. The increase in non-performing loans compared to both periods was primarily due to 3 customers.

Special Mention (Watch) loans were $188.5 million at June 30, 2023, compared to $137.8 million at December 31, 2022 and $131.2 million at June 30, 2022.

During the three months ended June 30, 2023 there were $9.5 million of charge-offs and $2,000 of recoveries, compared to $47,000 of charge-offs and $651,000 recoveries for the three months ended June 30, 2022.

For the six months ended June 30, 2023, there were $9.5 million of charge-offs and $16,000 of recoveries, compared to $978,000 of charge-offs and $658,000 of recoveries for the six months ended June 30, 2022.

Comparison of Operating Results for the Three Months Ended June 30, 2023 and 2022

General.   Net income of $65.3 million for the three months ended June 30, 2023 increased by $11.4 million, or 21%, compared to the three months ended June 30, 2022. The increase was primarily driven by a $33.6 million, or 47%, increase in net interest income, a $14.8 million, or 82%, decrease in the provision for income tax, a $16.4 million, or 264%, increase in provision for credit losses, a $11.4 million, or 34%, increase in noninterest expense, and a $10.2 million, or 47%, decrease in gain on sale of loans. Included in the results were the following:

a $13.0 million tax benefit related to tax refunds receivable and changes to its state tax apportionment calculations described in the Provision for Income Tax section below, and
credit events that totaled approximately $14.8 million for the impact of a multi-family loan charge-off, an increase in specific reserves for a healthcare customer, and changes to qualitative factors and forecasted loss rates, described in the Provision for Credit Losses section below.

Net Interest Income.    Net interest income increased $33.6 million, or 47%, to $105.6 million for the three months ended June 30, 2023, compared with $72.0 million for the three months ended June 30, 2022. The 47% increase reflected a $168.8 million, or 189%, increase in interest income from higher yields and average loan balances, partially offset by a $135.2 million increase in interest expense from higher interest rates on deposits and higher average rates on borrowings, primarily related to the credit linked notes issued by the Company during the three months ended March 31, 2023. The interest rate spread of 2.41% for the three months ended June 30, 2023 decreased 49 basis points compared to 2.90% in the three months ended June 30, 2022.

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Our net interest margin decreased 6 basis points, to 2.97%, for the three months ended June 30, 2023 from 3.03% for the three months ended June 30, 2022.

Interest Income.   Interest income increased $168.8 million, or 189%, to $258.1 million for the three months ended June 30, 2023, compared with $89.3 million for the three months ended June 30, 2022. This increase was primarily attributable to an increase in both higher average yields and balances of loans and loans held for sale, as well as higher balances in securities held to maturity.

The average balance of loans, including loans held for sale, during the three months ended June 30, 2023 increased $3.3 billion, or 38%, to $12.0 billion compared to the three months ended June 30, 2022. The average yield on loans increased 368 basis points, to 7.67% for the three months ended June 30, 2023, compared to 3.99% for the three months ended June 30, 2022. The increase in average balances of loans and loans held for sale was primarily due to increases in the multi-family and healthcare portfolios, but all loan portfolios contributed to the growth during the period.

The average balance of securities held to maturity, during the three months ended June 30, 2023 increased $1.1 billion, or 100%, to $1.1 billion compared to the three months ended June 30, 2022, as none were owned as of June 30, 2022. The average yield on securities held to maturity was 6.35% for the three months ended June 30, 2023.

The average balance of securities available for sale increased $342.1 million, or 103%, to $672.9 million for the three months ended June 30, 2023 from $330.8 million for the three months ended June 30, 2022, while the average yield increased 221 basis points, to 3.32% for the three months ended June 30, 2023, compared to 1.11% for the three months ended June 30, 2022.

The average balance of interest-earning deposits and other decreased $117.8 million, or 32%, to $249.7 million for the three months ended June 30, 2023 from $367.5 million for the three months ended June 30, 2022, while the average yield increased 437 basis points, to 5.36% for the three months ended June 30, 2023, compared to 0.99% for the three months ended June 30, 2022.

The average balance of mortgage loans in process of securitization increased $81.7 million, or 41%, to $280.1 million for the three months ended June 30, 2023 compared to the three months ended June 30, 2022, while the average yield increased 155 basis points, to 4.48% for the three months ended June 30, 2023, compared to 2.93% for the three months ended June 30, 2022.

Interest Expense.   Total interest expense increased $135.2 million, or 784%, to $152.5 million for the three months ended June 30, 2023, compared to the three months ended June 30, 2022.

Interest expense on deposits increased $123.0 million, or 833%, to $137.8 million for the three months ended June 30, 2023 from $14.8 million for the three months ended June 30, 2022. The increase was primarily due to higher rates on certificates of deposit, interest-bearing checking, and money market accounts.

The average balance of certificates of deposit of $4.7 billion for the three months ended June 30, 2023 increased $4.1 billion, or 639%, compared to the three months ended June 30, 2022. The average yield of certificates of deposit was 4.98% for the three months ended June 30, 2023, which was a 423 basis point increase compared to 0.75% for three months ended June 30, 2022.

The average balance of interest-bearing checking accounts of $4.3 billion for the three months ended June 30, 2023 increased $457.9 million, or 12%, compared to $3.8 billion for the three months ended June 30, 2022. The average yield of interest-bearing checking accounts was 4.50% for the three months ended June 30, 2023, which was a 378 basis point increase compared to 0.72% for three months ended June 30, 2022.

The average balance of money market accounts of $2.7 billion for the three months ended June 30, 2023 increased $122.6, or 5%, compared to $2.6 billion for the three months ended June 30, 2022. The average yield of money market

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accounts was 4.45% for the three months ended June 30, 2023, which was a 345 basis point increase compared to 1.00% for three months ended June 30, 2022.

Interest expense on borrowings increased $12.2 million, or 493%, to $14.7 million for the three months ended June 30, 2023 from $2.5 million for the three months ended June 30, 2022. The increase reflected an 862 basis points increase in the average cost of borrowings, to 9.94% compared to 1.32% for the three months ended June 30, 2022. The increase was primarily related to the credit linked notes issued by the Company during the three months ended June 30, 2023. Partially offsetting the higher rates on borrowing was a $158.3 million, or 21%, decrease in the average balance of borrowings of $591.3 million compared to $749.6 million for the three months ended June 30, 2022. Also included in borrowings, our warehouse structured financing agreements provide for additional interest payments for a portion of the earnings generated. As a result, the cost of borrowings increased from a base rate of 9.53% and 0.80%, to an effective rate of 9.94% and 1.32% for the three months ended June 30, 2023 and 2022, 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 June 30, 

 

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

$

249,722

$

3,335

 

5.36

%  

$

367,540

$

910

 

0.99

%

Securities available for sale - taxable

 

672,887

 

5,564

 

3.32

%  

 

330,759

 

917

 

1.11

%

Securities held to maturity

1,093,018

17,311

6.35

%  

 

 

%  

Mortgage loans in process of securitization

 

280,092

 

3,127

 

4.48

%  

 

198,349

 

1,449

 

2.93

%

Loans and loans held for sale

 

11,968,565

 

228,732

 

7.67

%  

 

8,643,276

 

85,994

 

3.99

%

Total interest-earning assets

 

14,264,284

 

258,069

 

7.26

%  

 

9,539,924

 

89,270

 

3.75

%

Allowance for credit losses on loans

 

(54,411)

 

  

 

  

 

(33,401)

 

  

 

  

Noninterest-earning assets

 

463,384

 

  

 

  

 

314,355

 

  

 

  

Total assets

$

14,673,257

 

  

 

  

$

9,820,878

 

  

 

  

Liabilities/Equity:

 

  

 

  

 

  

 

  

 

  

 

  

Interest-bearing checking

$

4,307,736

$

48,296

 

4.50

%  

$

3,849,876

$

6,945

 

0.72

%

Savings deposits

 

236,012

 

299

 

0.51

%  

 

238,944

 

62

 

0.10

%

Money market

 

2,749,594

 

30,521

 

4.45

%  

 

2,626,973

 

6,567

 

1.00

%

Certificates of deposit

 

4,729,242

 

58,685

 

4.98

%  

 

639,556

 

1,194

 

0.75

%

Total interest-bearing deposits

 

12,022,584

 

137,801

 

4.60

%  

 

7,355,349

 

14,768

 

0.81

%

Borrowings

 

591,333

 

14,651

 

9.94

%  

 

749,628

 

2,471

 

1.32

%

Total interest-bearing liabilities

 

12,613,917

 

152,452

 

4.85

%  

 

8,104,977

 

17,239

 

0.85

%

Noninterest-bearing deposits

 

346,837

 

  

 

  

 

402,328

 

  

 

  

Noninterest-bearing liabilities

 

167,527

 

  

 

  

 

97,682

 

  

 

  

Total liabilities

 

13,128,281

 

  

 

  

 

8,604,987

 

  

 

  

Equity

 

1,544,976

 

  

 

  

 

1,215,891

 

  

 

  

Total liabilities and equity

$

14,673,257

 

  

 

  

$

9,820,878

 

  

 

  

Net interest income

 

  

$

105,617

 

  

 

  

$

72,031

 

  

Interest rate spread

 

  

 

  

 

2.41

%  

 

  

 

  

 

2.90

%

Net interest-earning assets

$

1,650,367

 

  

 

  

$

1,434,947

 

  

 

  

Net interest margin

 

  

 

  

 

2.97

%  

 

  

 

  

 

3.03

%

Average interest-earning assets to average interest-bearing liabilities

 

  

 

  

 

113.08

%  

 

  

 

  

 

117.70

%

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 June 30, 2023

compared to June 30, 2022

Increase (Decrease)

Due to

(Dollars in thousands)

    

Volume

    

Rate

    

Total

Interest income

 

  

 

  

 

  

Interest-bearing deposits and other

$

(292)

$

2,717

$

2,425

Securities available for sale - taxable

 

949

 

3,698

 

4,647

Securities held to maturity

17,311

17,311

Mortgage loans in process of securitization

 

597

 

1,081

 

1,678

Loans and loans held for sale

 

33,084

 

109,654

 

142,738

Total interest income

 

51,649

 

117,150

 

168,799

Interest expense

 

  

 

  

 

  

Deposits

 

  

 

  

 

  

Interest-bearing checking

 

826

 

40,525

 

41,351

Savings deposits

 

(1)

 

238

 

237

Money market deposits

 

307

 

23,647

 

23,954

Certificates of deposit

 

7,635

 

49,856

 

57,491

Total Deposits

 

8,767

 

114,266

 

123,033

Borrowings

 

(522)

 

12,702

 

12,180

Total interest expense

 

8,245

 

126,968

 

135,213

Net interest income

$

43,404

$

(9,818)

$

33,586

Provision for Credit Losses.   We recorded a total provision for credit losses of $22.6 million for the three months ended June 30, 2023, an increase of $16.4 million, compared to the three months ended June 30, 2022. The increase was primarily due to:

loan growth in the period,
replenishment of $8.2 million related to the charge-off of a loan in the multi-family portfolio,
a $4.6 million increase related to changes in qualitative factors and forecasted loss rates to reflect changes in industry conditions, such as the impact of higher rates, and
a $2.0 million increase in net specific reserves, primarily related to a loan in the healthcare portfolio.

The $22.6 million total provision for credit losses consisted of $20.7 million for the ACL-Loans and $1.9 million for the ACL-OBCE’s. The ACL-Loans was $63.0 million, or 0.64%, of total loans, at June 30, 2023, compared to $44.0 million, or 0.59%, of total loans, at December 31, 2022, and $37.5 million, or 0.53%, at June 30, 2023.

Noninterest Income.   Noninterest income decreased $9.3 million, or 24%, to $29.9 million for the three months ended June 30, 2023 compared to $39.2 million for the three months ended June 30, 2022. The decrease was primarily due to a $10.2 million, or 47%, decrease in gain on sale of loans associated with a business mix shift in multi-family lending, from volumes sold in the secondary market towards those maintained on the balance sheet.

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A summary of the gain on sale of loans for the three months ended June 30, 2023 and 2022 is below:

Gain on Sale of Loans

Three Months Ended

June 30, 

June 30, 

2023

2022

(in thousands)

Loan Type

Multi-family

$

10,361

$

19,623

Single-family

202

406

Small Business Association (SBA)

787

1,535

Total

$

11,350

$

21,564

A $1.0 million, or 10%, decrease in loan servicing fees also contributed to the lower noninterest income. Loan servicing fees included a $3.4 million positive fair market value adjustment to servicing rights for the three months ended June 30, 2023, compared to a $7.7 million positive adjustment to fair value of servicing rights for the three months ended June 30, 2022.

Noninterest Expense.   Noninterest expense increased $11.4 million, or 34%, to $44.3 million for the three months ended June 30, 2023 compared to the three months ended June 30, 2022. The increase was due primarily to a $3.2 million, or 14%, increase in salaries and employee benefits to support loan growth, as well as a $3.1 million, or 468%, increase in FDIC deposit insurance expenses, reflecting our growth in assets, Higher professional fees also contributed $2.1 million to the increase. The efficiency ratio was at 32.71% for the three months ended June 30, 2023, compared with 29.64% for the three months ended June 30, 2022.

Income Taxes.   Provision for income tax decreased $14.8 million, or 82%, to $3.3 million for the three months ended June 30, 2023, compared to $18.1 million for the three months ended June 30, 2022. The decrease reflected a $13.0 million tax benefit related to tax refunds receivable and changes to state tax apportionment calculations.

During the three months ended June 30, 2023, the Company received an advisory letter it had requested from the State of Indiana related to certain state tax apportionment provisions in the Indiana Financial Institution Tax Code and Regulations. The advisory letter provided guidance related to the methodology used to determine and source the receipts in the state of Indiana for the Company’s mortgage origination and warehousing service lines. In effect, the guidance provided the Company the ability to revise its state income tax apportionment calculation to reduce its Indiana tax and related deferred tax liabilities. As such, the Company will amend several of its state returns and request the respective refunds. In anticipation of the refunds, a receivable was established as of June 30, 2023. On July 21, 2023, the company received a final revenue ruling from the Indiana Department of Revenue supporting the revised methodology. Additionally, the change in methodology is expected to result in a 1.0% to 1.5% reduction in the Company’s overall effective tax rate in the future.

The effective tax rate was 4.8% for the three months ended June 30, 2023 and 25.1% for the three months ended June 30, 2022.

Comparison of Operating Results for the Six Months Ended June 30, 2023 and 2022

General.   Net income for the six months ended June 30, 2023 was $120.3 million, an increase of $16.2 million, or 16%, from net income of $104.1 million for the six months ended June 30, 2022. The increase was primarily due to a $68.6 million increase in net interest income and a $13.2 million decrease in provision for income taxes that was

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partially offset by a $29.6 million decrease in noninterest income, a $20.8 million increase in the provision for credit losses, and an $15.1 million increase in noninterest expense. Included in the results were the following:

a $13.0 million tax benefit related to tax refunds receivable and changes to its state tax apportionment calculations described in the Provision for Income Tax section below, and
credit events that occurred during the three months ended June 30, 2023 totaling approximately $14.8 million for the impact of a multi-family loan charge-off, an increase in specific reserves for a healthcare customer, and changes to qualitative factors and forecasted loss rates, described in the Provision for Credit Losses section below.

Net Interest Income.    Net interest income increased $68.6 million, or 50%, to $206.3 million for the six months ended June 30, 2023, compared to the six months ended June 30, 2022. The 50% increase reflected a $304.1 million, or 184%, increase in interest income from higher yields and average loan balances, partially offset by a $235.5 million, or 856%, increase in interest expense from higher interest rates and average balances of deposits. The interest rate spread of 2.57% for the six months ended June 30, 2023 decreased 15 basis points compared to 2.72% in the six months ended June 30, 2022.

Our net interest margin increased 29 basis points, to 3.11%, for the six months ended June 30, 2023 from 2.82% for the six months ended June 30, 2022.

Interest Income.   Interest income increased $304.1 million, or 184%, to $469.4 million for the six months ended June 30, 2023, compared with $165.3 million for the six months ended June 30, 2022. This increase was primarily attributable to an increase in higher average yields and loan balances, as well as higher balances of held to maturity securities that were acquired after June 30, 2022.

The average balance of loans, including loans held for sale, during the six months ended June 30, 2023 increased $2.9 billion, or 35%, to $11.3 billion compared to the six months ended June 30, 2022, and the average yield on loans increased 365 basis points, to 7.47% for the six months ended June 30, 2023, compared to 3.82% for the six months ended June 30, 2022.

The average balance of securities held to maturity, during the six months ended June 30, 2023 increased $1.1 billion, or 100%, to $1.1 billion compared to the six months ended June 30, 2022, as none were owned as of June 30, 2022. The average yield on securities held to maturity was 6.04% for the three months ended June 30, 2023.

The average balance of securities available for sale increased $241.6 million, or 76%, to $559.9 million for the six months ended June 30, 2023, from the six months ended June 30, 2022, and the average yield increased 179 basis points, to 2.82% for the six months ended June 30, 2023, compared to 1.03% for the six months ended June 30, 2022.

The average balance of interest-earning deposits and other decreased $693.7 million, or 76%, to $217.3 million for the six months ended June 30, 2023, from $911.0 million for the six months ended June 30, 2022, and the average yield increased 472 basis points, to 5.11% for the six months ended June 30, 2023, compared to 0.39% for the six months ended June 30, 2022.

Interest Expense.   Total interest expense increased $235.5 million, or 856%, to $263.1 million for the six months ended June 30, 2023, compared to the six months ended June 30, 2022.

Interest expense on deposits increased $218.7 million, or 927%, to $242.2 million for the six months ended June 30, 2023, compared to the six months ended June 30, 2022. The increase was primarily due to increases in interest rates on certificates of deposit, interest-bearing checking and money market accounts.

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The average balance of certificates of deposit accounts was $4.0 billion for the six months ended June 30, 2023, an increase of $3.2 billion, or 369%, compared to the six months ended June 30, 2022. The average yield on certificates of deposit accounts was 4.68% for the six months ended June 30, 2023, which was a 409 basis point increase compared to 0.59% for six months ended June 30, 2022.

The average balance of interest-bearing checking accounts of $4.2 billion for the six months ended June 30, 2023 increased $248.3 million, or 6%, compared to $3.9 billion for the six months ended June 30, 2022. The average yield of interest-bearing checking accounts was 4.29% for the six months ended June 30, 2023, which was a 382 basis point increase compared to 0.47% for six months ended June 30, 2022.

The average balance of money market accounts of $2.8 billion for the six months ended June 30, 2023 increased $130.0 million, or 5%, compared to $2.7 million for the six months ended June 30, 2022. The average yield of money market accounts was 4.26% for the six months ended June 30, 2023, which was a 337 basis point increase compared to 0.89% for six months ended June 30, 2022.

Interest expense on borrowings increased $16.9 million, or 428%, to $20.8 million for the six months ended June 30, 2023 from the six months ended June 30, 2022. The increase was due primarily to a 662 basis points increase in the average cost of borrowings to 7.81% compared to 1.19% for the six months ended June 30, 2022. The increase was primarily related to the credit linked notes issued by the Company during the three months ended June 30, 2023. The higher average rates were partially offset by a $132.7 million decrease in average balances compared to the six months ended June 30, 2022. Additionally, borrowings include our warehouse structured financing agreements that provide for additional interest payments for a portion of the earnings generated. As a result, the cost of borrowings increased from a base rate of 7.43% and 0.61%, to an effective rate of 7.81% and 1.19% for the six months ended June 30, 2023 and 2022, 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.

Six Months Ended June 30, 

 

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

$

217,276

$

5,511

 

5.11

%  

$

910,994

$

1,780

 

0.39

%  

Securities available for sale - taxable

 

559,878

 

7,830

 

2.82

%  

 

318,249

 

1,618

 

1.03

%  

Held to maturity securities

1,104,069

33,065

6.04

%  

 

 

%  

Mortgage loans in process of securitization

 

220,046

 

4,775

 

4.38

%  

 

273,272

 

3,694

 

2.73

%  

Loans and loans held for sale

 

11,285,909

 

418,182

 

7.47

%  

 

8,348,216

 

158,190

 

3.82

%  

Total interest-earning assets

 

13,387,178

 

469,363

 

7.07

%  

 

9,850,731

 

165,282

 

3.38

%  

Allowance for credit losses on loans

 

(49,826)

 

  

 

  

 

(32,219)

 

  

 

  

Noninterest-earning assets

 

447,082

 

  

 

  

 

308,451

 

  

 

  

Total assets

$

13,784,434

 

  

 

  

$

10,126,963

 

  

 

  

Liabilities/Equity:

 

  

 

  

 

  

 

  

 

  

 

  

Interest-bearing checking

$

4,180,614

$

88,943

 

4.29

%  

$

3,932,334

$

9,149

 

0.47

%  

Savings deposits

 

236,647

 

565

 

0.48

%  

 

234,846

 

95

 

0.08

%  

Money market

 

2,798,774

 

59,129

 

4.26

%  

 

2,668,735

 

11,819

 

0.89

%  

Certificates of deposit

 

4,030,001

 

93,606

 

4.68

%  

 

858,779

 

2,518

 

0.59

%  

Total interest-bearing deposits

 

11,246,036

 

242,243

 

4.34

%  

 

7,694,694

 

23,581

 

0.62

%  

Borrowings

 

537,328

 

20,810

 

7.81

%  

 

670,055

 

3,945

 

1.19

%  

Total interest-bearing liabilities

 

11,783,364

 

263,053

 

4.50

%  

 

8,364,749

 

27,526

 

0.66

%  

Noninterest-bearing deposits

 

325,596

 

  

 

  

 

459,914

 

  

 

  

Noninterest-bearing liabilities

 

154,547

 

  

 

  

 

107,319

 

  

 

  

Total liabilities

 

12,263,507

 

  

 

  

 

8,931,982

 

  

 

  

Equity

 

1,520,927

 

  

 

  

 

1,194,981

 

  

 

  

Total liabilities and equity

$

13,784,434

 

  

 

  

$

10,126,963

 

  

 

  

Net interest income

 

  

$

206,310

 

  

 

  

$

137,756

 

  

Interest rate spread

 

  

 

  

 

2.57

%

 

  

 

  

 

2.72

%

Net interest-earning assets

$

1,603,814

 

  

 

  

$

1,485,982

 

  

 

  

Net interest margin

 

  

 

  

 

3.11

%

 

  

 

  

 

2.82

%

Average interest-earning assets to average interest-bearing liabilities

 

  

 

  

 

113.61

%

 

  

 

  

 

117.76

%

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:

Six Months Ended June 30, 2023

compared to June 30, 2022

Increase (Decrease)

Due to

(Dollars in thousands)

    

Volume

    

Rate

    

Total

Interest income

 

  

 

  

 

  

Interest-bearing deposits and other

$

(1,355)

$

5,086

$

3,731

Securities available for sale - taxable

 

1,228

 

4,984

 

6,212

Securities held to maturity

33,065

 

33,065

Mortgage loans in process of securitization

 

(719)

 

1,800

 

1,081

Loans and loans held for sale

 

55,666

 

204,326

 

259,992

Total interest income

 

87,885

 

216,196

 

304,081

Interest expense

 

  

 

  

 

  

Deposits

 

  

 

  

 

  

Interest-bearing checking

 

578

 

79,216

 

79,794

Savings deposits

 

1

 

469

 

470

Money market deposits

 

576

 

46,734

 

47,310

Certificates of deposit

 

9,298

 

81,790

 

91,088

Total Deposits

 

10,453

 

208,209

 

218,662

Borrowings

 

(781)

 

17,646

 

16,865

Total interest expense

 

9,672

 

225,855

 

235,527

Net interest income

$

78,213

$

(9,659)

$

68,554

Provision for Loan Losses.   We recorded a provision for credit losses of $29.5 million for the six months ended June 30, 2023, an increase of $20.8 million, or 240%, compared to $8.7 million for the six months ended June 30, 2022. The increase was primarily due to:

loan growth in the period,
replenishment of $8.2 million related to the charge-off of a loan in the multi-family portfolio,
a $4.6 million increase related to changes in qualitative factors and forecasted loss rates to reflect changes in industry conditions, such as the impact of higher rates, and
a $2.0 million increase in net specific reserves, primarily related to a loan in the healthcare portfolio.

The $29.5 million total provision for credit losses consisted of $28.5 million for the ACL-Loans and $1.0 million for the ACL-OBCE’s. The ACL-Loans was $63.0 million, or 0.64%, of total loans, at June 30, 2023, compared to $44.0 million, or 0.59%, of total loans, at December 31, 2022, and $37.5 million, or 0.53%, at June 30, 2022.

Noninterest Income.   Noninterest income decreased $29.6 million, or 40%, to $44.1 million for the six months ended June 30, 2023 compared to the six months ended June 30, 2022. The decrease was primarily due to a $21.4 million, or 54%, decrease in gain on sale of loans associated with a shift in business mix to programs with lower average trade pricing in the multi-family loan portfolio, as well as lower single-family and multi-family secondary market volumes.

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A summary of the gain on sale of loans for the six months ended June 30, 2023 and 2022 is below:

Gain on Sale of Loans

Six Months Ended

June 30, 

June 30, 

2023

2022

(in thousands)

Loan Type

Multi-family

$

15,281

$

34,576

Single-family

479

863

Small Business Association (SBA)

2,323

4,090

Total

$

18,083

$

39,529

Also contributing to the lower noninterest income was an $8.4 million decrease in loan servicing fees compared to the six months ended June 30, 2022. Included in loan servicing fees was a $0.5 million positive adjustment to the fair value of servicing rights for the six months ended June 30, 2023, compared to a positive adjustment of $15.4 million for the six months ended June 30, 2022.

Partially offsetting the decreases in noninterest income was a $2.9 million increase in syndication and asset management fees compared to the six months ended June 30, 2022. This line of business is becoming a meaningful source of noninterest income.

Noninterest Expense.   Noninterest expense increased $15.1 million, or 24%, to $79.1 million for the six months ended June 30, 2023 compared to the six months ended June 30, 2022. The increase was primarily due to a $4.6 million, or 319%, increase in deposit insurance expense, reflecting asset growth. Also contributing to the higher noninterest expenses was a $4.1 million increase in salaries and employee benefits to support loan growth, as well as a $3.1 million increase in professional fees. The efficiency ratio was at 31.58% in the six months ended June 30, 2023, compared with 30.25% in the six months ended June 30, 2022.

Income Taxes.   Provision for income taxes decreased $13.2 million, or 38%, to $21.6 million for the six months ended June 30, 2023 from $34.8 million for the six months ended June 30, 2022. The decrease reflected a $13.0 million tax benefit related to tax refunds receivable and changes to state tax apportionment calculations.

During the three months ended June 30, 2023, the Company received an advisory letter that it requested from the State of Indiana related to certain state tax apportionment provisions in the Indiana Financial Institution Tax Code and Regulations. The advisory letter provided guidance related to the methodology used to determine and source the receipts in the state of Indiana for the Company’s mortgage origination and warehousing service lines. In effect, the guidance provided the Company the ability to revise its state income tax apportionment calculation to reduce its Indiana tax and related deferred tax liabilities. As such, the Company will amend several of its state returns and request the respective refunds. In anticipation of the refunds, a receivable was established as of June 30, 2023. On July 21, 2023, the company received a final revenue ruling from the Indiana Department of Revenue supporting the revised methodology. Additionally, the change in methodology is expected to result in a 1.0% to 1.5% reduction in the Company’s overall effective tax rate in the future.

The effective tax rate was 15.2% for the six months ended June 30, 2023 and 25.1% for the six months ended June 30, 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

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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 June 30, 2023 the Company’s total servicing portfolio had an unpaid principal balance of $23.5 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 $13.8 billion, an unpaid principal balance of loans sub-serviced for others of $2.1 billion, and other servicing balances of $0.7 billion at June 30, 2023. These loans are not included in the accompanying balance sheets. The Company also manages $7.0 billion of loans for customers that have loans on the balance sheet at June 30, 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 $78 billion in 2021, $33.2 billion in 2022, and $13.8 billion for the six months ended June 30, 2023. Mortgage Warehousing also provides commercial loans secured by GNMA, Fannie Mae, and Freddie Mac servicing rights and collects deposits related to the mortgage escrow accounts of its customers. Merchants was recently ranked as the third largest producer of warehouse commitments by Inside Mortgage Finance.

The Banking segment includes retail banking, commercial lending, agricultural lending, retail and correspondent residential mortgage banking, and SBA lending. Banking operates primarily in Indiana and Illinois, except for correspondent mortgage banking which, like Multi-family Mortgage Banking and Mortgage Warehousing, is a national business. The Banking segment has a well-diversified customer and borrower base and has experienced significant growth over the past three years.

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 Merchants Banking segment and the Banking segment provides GNMA custodial services to MCC. The securities available for sale funded by MCC custodial deposits, as well as loans generated by Merchants Bank, are pledged to the FHLB to provide advance capacity during periods of high residential loan volume for Mortgage Warehousing. Mortgage Warehousing provides leads to correspondent residential lending in the banking segment. 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 June 30, 2023 and 2022, we had total net income of $65.3 million and $53.9 million, respectively. For the six months ended June 30, 2023 and 2022, we had total net income of $120.3 million and $104.1 million, respectively. Net income for our three segments for the respective periods was as follows:

For the Three Months Ended

For the Six Months Ended

June 30, 

June 30, 

    

2023

    

2022

    

2023

    

2022

    

(In thousands)

Multi-family Mortgage Banking

$

11,242

$

19,556

$

13,208

$

31,048

Mortgage Warehousing

 

18,596

 

11,868

 

27,237

 

25,027

Banking

 

42,650

 

25,932

 

91,957

 

54,696

Other

 

(7,186)

 

(3,421)

 

(12,145)

 

(6,694)

Total

$

65,302

$

53,935

$

120,257

$

104,077

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Multi-family Mortgage Banking.    

Comparison of results for the three months ended June 30, 2023 and 2022:

The Multi-family Mortgage Banking segment reported net income of $11.2 million for the three months ended June 30, 2023, a decrease of $8.3 million, or 43%, compared to the three months ended June 30, 2022. The decrease was primarily due to a $19.2 decrease in gain on sale of loans, partially offset by a $6.8 million decrease in the provision for income tax that reflected a tax benefit for tax refunds receivable and changes to state tax apportionment calculations.

Also included in the results was a $2.4 million increase in syndication and asset management fees that was partially offset by a $50,000 decrease in loan servicing fees that reflected higher underlying growth offset by lower positive fair market value adjustments. The decrease in loan servicing fees reflected a positive fair market value adjustment of $2.1 million on servicing rights for the three months ended June 30, 2023 compared to a positive fair market value adjustment of $6.6 million for the three months ended June 30, 2022.

The volume of loans originated and acquired for sale in the secondary market increased by $261.8 million, or 64%, to $668.2 million, for the three months ended June 30, 2023, compared to $406.4 million for the three months ended June 30, 2022.

Comparison of results for the six months ended June 30, 2023 and 2022:

The Multi-family Mortgage Banking segment reported net income of $13.2 million for the six months ended June 30, 2023, a decrease of $17.8 million, or 57%, from the $31.0 million of net income reported for the six months ended June 30, 2022. The decrease was primarily due to a $34.7 million decrease in noninterest income, including a $32.1 million decrease in gain on sale of loans and a $1.3 million decrease in loan servicing fees. The decrease in loan servicing fees reflected a negative fair market value adjustment of $0.1 million on servicing rights for the six months ended June 30, 2023 compared to a positive fair market value adjustment of $9.9 million for the six months ended June 30, 2022.

The lower noninterest income was partially offset by a $10.1 million decrease in the provision for income tax that was associated with a tax benefit for tax refunds receivable and changes to state tax apportionment calculations, as well as lower commission expenses associated with lower gain on sale for the six months ended June 30, 2023.

The volume of loans originated and acquired for sale in the secondary market decreased by $165.7 million, or 17%, to $782.3 million, for the six months ended June 30, 2023 compared to the six months ended June 30, 2022.

Mortgage Warehousing.   

Comparison of results for the three months ended June 30, 2023 and 2022:

The Mortgage Warehousing segment reported net income of $18.6 million for the three months ended June 30, 2023, an increase of $6.7 million, or 57%, compared to the three months ended June 30, 2022. The higher net income reflected a $41.0 million increase in interest income primarily from higher yields and volumes on revolving lines of credit that are collateralized by mortgage servicing rights, as well as a decrease of $4.3 million in the provision for income tax that included a tax benefit for tax refunds receivable and changes to state tax apportionment calculations. Mortgage warehouse fees also increased by $1.5 million. These increases to net income were partially offset by a $37.4 million increase in interest expenses that reflected higher costs of deposits, a $1.5 million increase in the provision for credit losses, and a $0.8 million increase in deposit insurance expenses.

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There was a 5% decrease in warehouse loan volume of $8.4 billion compared to $8.8 billion for the three months ended June 30, 2022, which compared to an industry volume decrease of 32%, according to the Mortgage Bankers Association.

Comparison of results for the six months ended June 30, 2023 and 2022:

The Mortgage Warehousing segment reported net income for the six months ended June 30, 2023 of $27.2 million, an increase of $2.2 million, or 9%, over the $25.0 million reported for the six months ended June 30, 2022. The higher net income was primarily due to a $63.0 million increase in interest income associated with higher yields and volume on revolving lines of credit that are collateralized by mortgage servicing rights, as well as a decrease of $5.7 million in the provision for income tax that reflected a tax benefit for tax refunds receivable and changes to state tax apportionment calculations. Mortgage warehouse fees also increased by $0.7 million. These increases to net income were partially offset by a $63.2 million increase in interest expenses that reflected higher costs of deposits, a $3.1 million increase in the provision for credit losses, and a $1.1 million increase in deposit insurance expenses.

There was a 24% decrease in warehouse loan volume of $13.8 billion compared to $18.2 billion for the six months ended June 30, 2022, which compared to an industry volume decrease of 42%, according to the Mortgage Bankers Association.

Banking.   

Comparison of results for the three months ended June 30, 2023 and 2022:

The Banking segment reported net income of $42.7 million for the three months ended June 30, 2023, an increase of $16.7 million, or 64%, compared to the three months ended June 30, 2022. The increase was primarily due to a $28.6 million increase in net interest income, a $9.0 million increase in gain on sale of loans, and a $4.2 million decrease in the provision for income taxes, partially offset by a $16.1 million increase in the provision for credit losses and a $5.4 million increase in salaries and employee benefits.

Noninterest income for the three months ended June 30, 2023 included a positive fair market value adjustment of $1.3 million on single-family servicing rights, compared to a positive fair market value adjustment of $1.2 million for the three months ended June 30, 2022.

Comparison of results for the six months ended June 30, 2023 and 2022:

The Banking segment reported net income of $92.0 million for the six months ended June 30, 2023, an increase of $37.3 million, or 68%, compared to $54.7 million for the six months ended June 30, 2022. The increase was primarily due to a $65.5 million increase in net interest income and a $10.7 million increase in gain on sale of loans, partially offset by an $18.9 million increase in the provision for credit losses, a $7.8 million increase in salaries and employee benefits, a $5.1 million decrease in loan servicing fees, and a $3.5 million increase in deposit insurance expense that, reflected growth in assets and deposits.

Noninterest income for the six months ended June 30, 2023 included a positive fair market value adjustment of $0.6 million on single-family servicing rights, compared to a positive fair market value adjustment of $5.5 million for the six months ended June 30, 2022.

Liquidity and Capital Resources

Liquidity.

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

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amortization of loans are predictable sources of funds, deposit flows and mortgage prepayments are greatly influenced by market interest rates, economic conditions, and competition.

At June 30, 2023, based on available collateral, we had $5.3 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 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 $5.3 billion described below, these totaled $10.2 billion, or 64%, of its $15.9 billion total assets at June 30, 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 exceed our uninsured deposits. Uninsured deposits totaled approximately $2 billion as of June 30, 2023, representing less than 20% 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 $1.7 billion as of June 30, 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 June 30, 2023, Accumulated Other Comprehensive Losses (“AOCL”) of $7.0 million losses, related to securities available for sale, decreased $3.5 million, or 33%, compared to losses of $10.5 million as of December 31, 2022. The $7.0 million loss in AOCL as of June 30, 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 $(543.0) million and $874.8 million for the six months ended June 30, 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 $(2.4) billion and $(1.4) billion for the six months ended June 30, 2023 and 2022, respectively. Net cash provided by (used in) financing activities, which is comprised primarily of net change in borrowings and deposits was $3.1 billion and $(297.4) million for the six months ended June 30, 2023 and 2022, respectively.

At June 30, 2023 we had $3.5 billion in outstanding commitments to extend credit that are subject to credit risk and $3.7 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 June 30, 2023 totaled $5.0 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 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.

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.

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Capital Resources.

The access to and cost of funding for new business initiatives, the ability to engage in expanded business activities, the ability to pay dividends, the level of deposit insurance costs and the level and nature of regulatory oversight depend, in part, on our capital position. The Company filed a 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 $500 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 $1.6 billion as of June 30, 2023, compared to $1.5 billion as of December 31, 2022. The $100.6 million increase resulted primarily from net income of $120.3 million, which was partially offset by dividends paid on common and preferred shares of $24.3 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 were to accrue and be payable at a floating rate equal to three-month LIBOR plus a spread of 460.5 basis points per year. However, the terms of the Series A Preferred Stock permit us to replace three-month LIBOR if we determine that LIBOR has been discontinued or is no longer viewed as an acceptable benchmark for similar securities. With the cessation of published three-month LIBOR rates as of June 30, 2023, the Company has determined that three-month LIBOR has been discontinued and is no longer an acceptable benchmark. The Company anticipates replacing three-month LIBOR with Federal Reserve’s three month Secured Overnight Financing Rate (“SOFR”). The Company believes that three-month SOFR represents the most comparable replacement benchmark, is an industry-accepted substitute, and is consistent with expectations of investors in securities similar to the Series A Preferred Stock. In addition to replacing three-month LIBOR with three-month SOFR, the terms of the Series A Preferred Stock permit us to adjust the spread to ensure that the payable floating rate remains comparable. Therefore, the Company anticipates increasing the spread by 26.2 basis points, which is consistent with industry practice and the recommendation of the Federal Reserve’s Alternative Reference Rates Committee, resulting in the Company paying a floating rate of three-month SOFR plus a spread of 486.7 basis points during the floating rate period. The Company may also redeem the Series A Preferred Stock at its option, subject to regulatory approval, on or after April 1, 2024.

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

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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 were to accrue and be payable at a floating rate equal to three-month LIBOR plus a spread of 456.9 basis points per year. However, the terms of the Series B Preferred Stock permit us to replace three-month LIBOR if we determine that LIBOR has been discontinued or is no longer viewed as an acceptable benchmark for similar securities. With the cessation of published three-month LIBOR rates as of June 30, 2023, the Company has determined that three-month LIBOR has been discontinued and is no longer an acceptable benchmark. The Company anticipates replacing three-month LIBOR with Federal Reserve’s three month Secured Overnight Financing Rate (“SOFR”). The Company believes that three-month SOFR represents the most comparable replacement benchmark, is an industry-accepted substitute, and is consistent with expectations of investors in securities similar to the Series B Preferred Stock. In addition to replacing three-month LIBOR with three-month SOFR, the terms of the Series B Preferred Stock permit us to adjust the spread to ensure that the payable floating rate remains comparable. Therefore, the Company anticipates increasing the spread by 26.2 basis points, which is consistent with industry practice and the recommendation of the Federal Reserve’s Alternative Reference Rates Committee, resulting in the Company paying a floating rate of three-month SOFR plus a spread of 483.1 basis points during the floating rate period. The Company may also redeem the Series B Preferred Stock at its option, subject to regulatory approval, on or after April 1, 2024.

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.

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

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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 June 30, 2023, the Company had 43,237,300 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 June 30, 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)

June 30, 2023

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

 

  

 

  

 

  

 

  

 

Company

$

1,625,223

 

11.3

%  

$

1,148,948

 

8.0

%  

$

 

N/A

%  

Merchants Bank

1,563,433

 

11.1

%  

 

1,127,989

 

8.0

%  

 

1,409,986

 

10.0

FMBI

 

37,536

 

11.3

%  

 

26,636

 

8.0

%  

 

33,295

 

10.0

%  

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

 

  

 

  

 

  

 

  

 

  

 

  

Company

 

1,549,763

 

10.8

%  

 

861,711

 

6.0

%  

 

 

N/A

%  

Merchants Bank

1,488,730

 

10.6

%  

 

845,992

 

6.0

%  

 

1,127,989

 

8.0

FMBI

 

36,779

 

11.0

%  

 

19,977

 

6.0

%  

 

26,636

 

8.0

%  

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

Company

 

1,050,155

 

7.3

%  

 

646,284

 

4.5

%  

 

 

N/A

%  

Merchants Bank

1,488,730

 

10.6

%  

 

634,494

 

4.5

%  

 

916,491

 

6.5

FMBI

 

36,779

 

11.0

%  

 

14,983

 

4.5

%  

 

21,642

 

6.5

%  

Tier I capital(1) (to average assets)

 

 

  

 

  

 

 

  

 

  

Company

 

1,549,763

 

10.6

%  

 

586,227

 

4.0

%  

 

 

N/A

%  

Merchants Bank

1,488,730

 

10.4

%  

 

574,725

 

4.0

%  

 

718,406

 

5.0

FMBI

 

36,779

 

10.6

%  

 

13,823

 

4.0

%  

 

17,279

 

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. Management believes, as of June 30, 2023 and December 31, 2022, that the Company, Merchants Bank, and FMBI met all capital adequacy requirements to which they were subject.

As of June 30, 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.

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

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.

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

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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 June 30, 2023 and December 31, 2022.

Net Interest Income Sensitivity

 

Twelve Months Forward

 

- 200

    

- 100

    

+ 100

    

+ 200

 

(Dollars in thousands)

 

June 30, 2023:

  

 

  

 

  

 

  

Dollar change

$

(93,023)

$

(46,622)

$

32,156

$

60,629

Percent change

 

(21.0)

%  

 

(10.5)

%  

 

7.3

%  

 

13.7

%

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 June 30, 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.

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)

 

June 30, 2023:

  

 

  

 

  

 

  

Dollar change

$

1,101

$

1,024

$

(3,703)

$

(23,514)

Percent change

 

0.1

%  

 

0.1

%  

 

(0.3)

%  

 

(1.6)

%

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 June 30, 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.”

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ITEM 4        Controls and Procedures

(a)        Evaluation of disclosure controls and procedures.

Our management, under the supervision and with the participation of our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15(e) and 15d-15(e) under the Exchange Act) as of the end of the period covered by this Form 10-Q. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that, as of June 30, 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

XBRL Taxonomy Extension Presentation Linkbase Document

104

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:

August 9, 2023

By:

/s/ Michael F. Petrie

Michael F. Petrie

Chairman & Chief Executive Officer

Date:

August 9, 2023

By:

/s/ John F. Macke

John F. Macke

Chief Financial Officer

(Principal Financial & Accounting Officer)

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