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Merchants Bancorp - Quarter Report: 2023 September (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

September 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 November 1, 2023, the latest practicable date, 43,240,212 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 September 30, 2023 and December 31, 2022

3

Condensed Consolidated Statements of Income for the Three and Nine Months Ended September 30, 2023 and 2022

4

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

5

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

6

Condensed Consolidated Statements of Cash Flows for the Nine Months Ended September 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

44

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

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

(In thousands, except share data)

September 30, 

December 31, 

    

2023

    

2022

Assets

 

  

 

  

Cash and due from banks

$

10,633

$

22,170

Interest-earning demand accounts

 

396,605

 

203,994

Cash and cash equivalents

 

407,238

 

226,164

Securities purchased under agreements to resell

 

3,385

 

3,464

Mortgage loans in process of securitization

 

476,047

 

154,194

Securities available for sale

 

624,586

 

323,337

Securities held to maturity ($1,010,745 and $1,118,966 at fair value, respectively)

1,012,801

1,119,078

Federal Home Loan Bank (FHLB) stock

 

48,219

 

39,130

Loans held for sale (includes $90,875 and $82,192 at fair value, respectively)

 

3,477,036

 

2,910,576

Loans receivable, net of allowance for credit losses on loans of $66,864 and $44,014, respectively

 

9,910,681

 

7,426,858

Premises and equipment, net

 

36,730

 

35,438

Servicing rights

 

162,141

 

146,248

Interest receivable

 

78,401

 

56,262

Goodwill

 

15,845

 

15,845

Intangible assets, net

 

831

 

1,186

Other assets and receivables

 

241,295

 

157,447

Total assets

$

16,495,236

$

12,615,227

Liabilities and Shareholders' Equity

 

 

Liabilities

 

  

 

  

Deposits

 

  

 

  

Noninterest-bearing

$

287,846

$

326,875

Interest-bearing

 

12,719,492

 

9,744,470

Total deposits

 

13,007,338

 

10,071,345

Borrowings

 

1,654,075

 

930,392

Deferred and current tax liabilities, net

 

18,006

 

19,613

Other liabilities

 

183,102

 

134,138

Total liabilities

 

14,862,521

 

11,155,488

Commitments and Contingencies

 

  

 

  

Shareholders' Equity

 

  

 

  

Common stock, without par value

 

  

 

  

Authorized - 75,000,000 shares

 

  

 

  

Issued and outstanding - 43,240,212 shares at September 30, 2023 and 43,113,127 shares at December 31, 2022

 

139,609

 

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

 

998,252

 

832,871

Accumulated other comprehensive loss

 

(4,754)

 

(10,521)

Total shareholders' equity

 

1,632,715

 

1,459,739

Total liabilities and shareholders' equity

$

16,495,236

$

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 Nine Months Ended September 30, 2023 and 2022

(In thousands, except share data)

Three Months Ended

Nine Months Ended

September 30, 

September 30, 

    

2023

    

2022

    

2023

    

2022

Interest Income

 

  

 

  

 

  

Loans

$

266,561

$

129,101

$

684,743

$

287,291

Mortgage loans in process of securitization

 

2,583

 

2,162

 

7,358

 

5,856

Investment securities:

 

 

 

  

 

Available for sale - taxable

 

6,182

 

485

 

14,012

 

2,103

Held to maturity

17,427

970

50,492

970

Federal Home Loan Bank stock

 

572

 

379

 

1,470

 

932

Other

 

3,351

 

1,015

 

7,964

 

2,242

Total interest income

 

296,676

 

134,112

 

766,039

 

299,394

Interest Expense

 

  

 

  

 

  

 

  

Deposits

 

162,906

 

45,002

 

405,149

 

68,583

Borrowed funds

 

16,334

 

3,725

 

37,144

 

7,670

Total interest expense

 

179,240

 

48,727

 

442,293

 

76,253

Net Interest Income

 

117,436

 

85,385

 

323,746

 

223,141

Provision for credit losses

 

4,014

 

2,225

 

33,484

 

10,888

Net Interest Income After Provision for Credit Losses

 

113,422

 

83,160

 

290,262

 

212,253

Noninterest Income

 

  

 

  

 

  

 

  

Gain on sale of loans

 

10,758

 

13,354

 

28,841

 

52,883

Loan servicing fees, net

 

17,384

 

8,169

 

28,360

 

27,507

Mortgage warehouse fees

 

1,858

 

1,105

 

5,751

 

4,313

Syndication and asset management fees

2,368

3,073

7,476

5,286

Other income

 

3,700

 

3,485

 

9,786

 

12,965

Total noninterest income

 

36,068

 

29,186

 

80,214

 

102,954

Noninterest Expense

 

  

 

  

 

  

 

  

Salaries and employee benefits

 

27,052

 

23,027

 

74,922

 

66,795

Loan expenses

 

1,038

 

1,226

 

2,749

 

3,621

Occupancy and equipment

 

2,196

 

1,967

 

6,884

 

5,792

Professional fees

 

2,555

 

2,429

 

8,547

 

5,326

Deposit insurance expense

 

3,568

 

755

 

9,552

 

2,184

Technology expense

 

1,609

 

1,325

 

4,757

 

3,865

Other expense

 

4,912

 

4,222

 

14,611

 

11,358

Total noninterest expense

 

42,930

 

34,951

 

122,022

 

98,941

Income Before Income Taxes

 

106,560

 

77,395

 

248,454

 

216,266

Provision for income taxes

 

25,056

 

18,907

 

46,693

 

53,701

Net Income

$

81,504

$

58,488

$

201,761

$

162,565

Dividends on preferred stock

(8,668)

(5,729)

(26,003)

(17,186)

Net Income Allocated to Common Shareholders

72,836

52,759

175,758

145,379

Basic Earnings Per Share

$

1.68

$

1.22

$

4.07

$

3.37

Diluted Earnings Per Share

$

1.68

$

1.22

$

4.06

$

3.36

Weighted-Average Shares Outstanding

 

  

 

  

 

  

 

  

Basic

 

43,238,724

 

43,107,975

 

43,218,125

 

43,182,380

Diluted

 

43,351,208

 

43,258,925

 

43,317,343

 

43,331,148

See notes to condensed consolidated financial statements.

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Merchants Bancorp

Condensed Consolidated Statements of Comprehensive Income (Unaudited)

For the Three and Nine Months Ended September 30, 2023 and 2022

(In thousands)

Three Months Ended

Nine Months Ended

September 30, 

September 30, 

    

2023

    

2022

    

2023

    

2022

Net Income

$

81,504

$

58,488

$

201,761

$

162,565

Other Comprehensive Income (Loss):

 

  

 

 

  

 

  

Net change in unrealized gain/(losses) on investment securities available for sale, net of tax (expense)/benefits of $(714), $1,210, $(2,050) and $3,413, respectively

 

2,282

 

(3,616)

 

5,767

 

(10,232)

Other comprehensive income (loss) for the period

 

2,282

 

(3,616)

 

5,767

 

(10,232)

Comprehensive Income

$

83,786

$

54,872

$

207,528

$

152,333

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 Nine Months Ended September 30, 2023 and 2022

(In thousands, except share data)

Three Months Ended

Nine Months Ended

September 30, 

September 30, 

    

2023

    

2022

    

2023

    

2022

Shares

Amount

Shares

Amount

Shares

Amount

Shares

Amount

Common Stock

 

  

 

  

 

  

Balance beginning of period

43,237,300

$

138,853

43,106,505

$

136,671

43,113,127

$

137,781

43,180,079

$

137,565

Repurchase of common stock

-

-

-

-

-

-

(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

2,912

756

3,073

555

93,792

1,018

73,856

770

Balance end of period

43,240,212

139,609

43,109,578

137,226

43,240,212

139,609

43,109,578

137,226

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 beginning of period

142,500

137,459

-

-

142,500

137,459

-

-

Issuance of 8.25% Series D preferred stock, net of $5.1 million in offering expenses

-

-

142,500

137,371

-

-

142,500

137,371

Balance at beginning and end of period

142,500

137,459

142,500

137,371

142,500

137,459

142,500

137,371

Retained Earnings

Balance beginning of period

928,875

737,789

832,871

657,149

Net income

81,504

58,488

201,761

162,565

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)

(2,732)

(2,732)

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

(1,875)

(1,875)

(5,625)

(5,625)

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

(2,943)

(2,943)

(8,829)

(8,829)

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

(2,939)

-

(8,817)

-

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

(3,459)

(3,018)

(10,377)

(9,066)

Repurchase of common stock

-

-

-

(2,174)

Balance end of period

998,252

787,530

998,252

787,530

Accumulated Other Comprehensive Loss

Balance beginning of period

(7,036)

(8,070)

(10,521)

(1,454)

Other comprehensive income (loss)

2,282

(3,616)

5,767

(10,232)

Balance end of period

(4,754)

(11,686)

(4,754)

(11,686)

Total shareholders' equity

$

1,632,715

$

1,412,590

$

1,632,715

$

1,412,590

See notes to condensed consolidated financial statements.

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Table of Contents

Merchants Bancorp

Condensed Consolidated Statements of Cash Flows (Unaudited)

Nine Months Ended September 30, 2023 and 2022

(In thousands)

Nine Months Ended

September 30, 

    

2023

    

2022

Operating activities:

 

  

 

  

Net income

$

201,761

$

162,565

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

 

 

Depreciation

 

2,119

 

1,832

Provision for credit losses

 

33,484

 

10,888

Gain on sale of loans

 

(28,841)

 

(52,883)

Proceeds from sales of loans

 

15,552,382

 

21,488,416

Loans and participations originated and purchased for sale

 

(16,455,580)

 

(20,209,971)

Purchases of low-income housing tax credits for sale

(44,106)

(22,122)

Proceeds from sale of low-income housing tax credits

23,081

8,556

Change in servicing rights for paydowns and fair value adjustments

 

(6,729)

 

(11,974)

Net change in:

 

 

Mortgage loans in process of securitization

 

(321,853)

 

431,791

Other assets and receivables

 

(13,383)

 

(20,958)

Other liabilities

 

(9,986)

 

50,630

Other

 

(3,123)

 

(2,854)

Net cash (used in) provided by operating activities

 

(1,070,774)

 

1,833,916

Investing activities:

 

 

  

Net change in securities purchased under agreements to resell

 

79

 

2,391

Purchases of securities available for sale

 

(631,676)

 

(50,274)

Purchases of securities held to maturity

(9,786)

(1,005,487)

Proceeds from the sale of securities available for sale

 

1,516

 

11,379

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

 

339,995

 

12,755

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

116,062

Purchases of loans

 

(329,014)

 

(289,030)

Net change in loans receivable

 

(1,829,247)

 

(1,675,505)

Purchase of FHLB stock

 

(9,089)

 

(10,326)

Proceeds from sale of FHLB stock

 

 

784

Purchases of premises and equipment

 

(3,459)

 

(6,178)

Purchase of servicing rights

(2,057)

Purchase of limited partnership interests

(71,001)

(42,710)

Proceeds from sale of limited partnership interests

52,984

Other investing activities

 

1,591

4,314

Net cash used in investing activities

 

(2,371,045)

 

(3,049,944)

Financing activities:

 

  

 

Net change in deposits

 

2,935,993

 

1,336,866

Proceeds from borrowings

 

69,132,347

 

44,950,000

Repayment of borrowings

 

(68,615,360)

 

(45,890,075)

Proceeds from notes payable

 

60,000

 

3,400

Proceeds from issuance of preferred stock

 

 

137,371

Proceeds from credit linked notes

153,546

Payment of credit linked notes

 

(7,253)

 

Repurchase of common stock

(3,935)

Dividends

(36,380)

(26,252)

Net cash provided by financing activities

 

3,622,893

 

507,375

Net Change in Cash and Cash Equivalents

 

181,074

 

(708,653)

Cash and Cash Equivalents, Beginning of Period

 

226,164

 

1,032,614

Cash and Cash Equivalents, End of Period

$

407,238

$

323,961

Supplemental Cash Flows Information:

 

 

  

Interest paid

$

415,920

$

63,917

Income taxes paid, net of refunds

 

50,076

 

47,174

Transfer of loans from loans held for sale to loans receivable

377,460

Transfer of loans from loans receivable to loans held for sale

21,960

788,849

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 September 30, 2023 and for the three and nine months ended September 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 September 30, 2023 and the results of operations for the three and nine months ended September 30, 2023 and 2022, and cash flows for the nine months ended September 30, 2023 and 2022. All interim amounts have not been audited and the results of operations for the three and nine months ended September 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 September 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.

In May 2023, the Company acquired a variable interest in an investment 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 it was deemed not to be a primary beneficiary of as of September 30, 2023. These VIEs are not consolidated and the equity or proportional 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)

Sale of Farmers-Merchants Bank of Illinois branches

On September 7, 2023, the Company entered into an agreement with Bank of Pontiac to sell its Farmers-Merchants Bank of Illinois branch locations in Paxton, Melvin, and Piper City, Illinois, and into an agreement with CBI Bank & Trust, to sell its Farmers-Merchants Bank of Illinois branch located in Joy, Illinois.

In addition to the branches, Bank of Pontiac will acquire approximately $157 million in deposits and $22 million in loans, and CBI Bank & Trust will acquire approximately $62 million in deposits and $27 million in loans.

This transaction enhances the Company’s ability to focus on its core business of single and multi-family mortgage lending and strategically aligns the branches with institutions that share a similar business model and allows them to provide additional products to their customers.

The acquisitions are subject to customary closing conditions, including regulatory approvals.

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 and fair values of servicing rights and 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”).

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Merchants Bancorp

Notes to Condensed Consolidated Financial Statements

(Unaudited)

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 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 September 30, 2023, there was $52.2 million in restricted cash. Also see Note 11: Borrowings.

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Merchants Bancorp

Notes to Condensed Consolidated Financial Statements

(Unaudited)

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:

September 30, 2023

Gross

Gross

Amortized

Unrealized

Unrealized

Fair

    

Cost

    

Gains

    

Losses

    

Value

(In thousands)

Securities available for sale:

 

  

 

  

 

  

 

  

Treasury notes

$

138,520

$

33

$

667

$

137,886

Federal agencies

 

229,997

 

 

5,599

 

224,398

Mortgage-backed - Government-sponsored entity (GSE)

262,302

6

6

262,302

Total securities available for sale

$

630,819

$

39

$

6,272

$

624,586

Securities held to maturity:

Mortgage-backed - Non-GSE multi-family

$

794,575

$

$

111

$

794,464

Mortgage-backed - Non-GSE residential

208,475

1,059

207,416

Mortgage-backed - Government - sponsored entity (GSE)

9,751

886

8,865

Total securities held to maturity

$

1,012,801

$

$

2,056

$

1,010,745

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 September 30, 2023 and December 31, 2022, GSE mortgage-backed securities included in the tables above are primarily backed by multi-family and single-family loans.

Accrued interest on securities available for sale totaled $2.0 million at September 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 September 30, 2023 and $4.3 million at December 31, 2022, respectively, and is excluded from the estimate of credit losses.

The amortized cost and fair value of available for sale securities at September 30, 2023 and December 31, 2022, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because issuers may

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Merchants Bancorp

Notes to Condensed Consolidated Financial Statements

(Unaudited)

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.

September 30, 2023

December 31, 2022

Amortized

Fair

Amortized

Fair

    

Cost

    

Value

    

Cost

    

Value

Securities available for sale:

(In thousands)

Within one year

$

346,753

$

340,839

$

118,984

$

115,386

After one through five years

 

21,764

 

21,445

 

203,236

 

192,784

 

368,517

 

362,284

 

322,220

 

308,170

Mortgage-backed - Government-sponsored entity (GSE)

262,302

262,302

15,167

15,167

$

630,819

$

624,586

$

337,387

$

323,337

Securities held to maturity:

Mortgage-backed - Non-GSE multi-family

$

794,575

$

794,464

$

871,772

$

871,784

Mortgage-backed - Non-GSE residential

208,475

207,416

247,306

247,182

Mortgage-backed - Government - sponsored entity (GSE)

9,751

 

8,865

 

 

$

1,012,801

$

1,010,745

$

1,119,078

$

1,118,966

During the three and nine months ended September 30, 2023, proceeds from sales of securities available for sale were $1.4 million and $1.5 million, respectively, and the net gain was inconsequential. During the three and nine months ended September 30, 2022 one of the mortgage-backed non-GSE multi-family securities available for sale was sold for $11.4 million, resulting in no gain or loss.

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 September 30, 2023 and December 31, 2022:

September 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

$

5,312

$

52

$

32,773

$

615

$

38,085

$

667

Federal agencies

14,878

122

209,520

5,477

224,398

5,599

Mortgage-backed - Government-sponsored entity (GSE)

384

1

211

5

595

6

$

20,574

$

175

$

242,504

$

6,097

$

263,078

$

6,272

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Merchants Bancorp

Notes to Condensed Consolidated Financial Statements

(Unaudited)

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

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 (loss), 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 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 September 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 securities and backed by the full faith and credit of the U.S. government. Accordingly, no allowance for credit losses has been recorded for these securities. 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.

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Merchants Bancorp

Notes to Condensed Consolidated Financial Statements

(Unaudited)

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. A positive fair market value adjustment of $1.9 million and a negative fair market value adjustment of $3.7 million was recorded in earnings for the three months ended September 30, 2023 and 2022, respectively. A positive fair market value adjustment of $2.2 million and $1.1 million was recorded in earnings for the nine months ended September 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 $53.8 million and $35.0 million at September 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 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. Warehouse fees are accrued as noninterest income.

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Merchants Bancorp

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 Loan Portfolio Summary 

Loans receivable at September 30, 2023 and December 31, 2022 include:

September 30, 

December 31, 

    

2023

    

2022

(In thousands)

Mortgage warehouse lines of credit

$

1,022,692

$

464,785

Residential real estate(1)

 

1,358,908

 

1,178,401

Multi-family financing

 

3,709,320

 

3,135,535

Healthcare financing

2,218,559

1,604,341

Commercial and commercial real estate(2)(3)

 

1,560,031

 

978,661

Agricultural production and real estate

 

96,490

 

95,651

Consumer and margin loans

 

11,545

 

13,498

 

9,977,545

 

7,470,872

Less:

 

  

 

  

ACL-Loans

 

66,864

 

44,014

Loans Receivable

$

9,910,681

$

7,426,858

(1)Includes $1.2 billion and $1.1 billion of All-in-One© first-lien home equity lines of credit at September 30, 2023 and December 31, 2022, respectively.

(2)Includes $1.0 billion and $497.0 million of revolving lines of credit collateralized primarily by mortgage servicing rights as of September 30, 2023 and December 31, 2022, respectively.

(3)Includes only $8.1 million and $12.8 million of non-owner occupied commercial real estate as of September 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 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, typically through forward sales contracts.

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

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Merchants Bancorp

Notes to Condensed Consolidated Financial Statements

(Unaudited)

margin. With the sunset of LIBOR, loans have been 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 lines of credit 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 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.

16

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Merchants Bancorp

Notes to Condensed Consolidated Financial Statements

(Unaudited)

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 nine months ended September 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 segmenting loans with similar risk characteristics. 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.

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 initial estimation of expected credit losses for each segment is based on historical credit loss experience and management’s judgement. Given the Company’s modest historical credit loss

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Merchants Bancorp

Notes to Condensed Consolidated Financial Statements

(Unaudited)

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. At September 30, 2023, the qualitative factors increased the estimate of expected losses.

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 nine months ended September 30, 2023 and 2022:

For the Three Months Ended September 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

$

3,361

$

7,413

 

$

24,701

$

16,123

$

10,695

$

556

$

137

$

62,986

Provision for credit losses

 

(495)

 

207

 

1,121

1,876

 

1,123

 

34

 

2

 

3,868

Loans charged to the allowance

 

 

(21)

 

 

 

 

 

(21)

Recoveries of loans previously charged-off

 

 

 

 

31

 

 

 

31

Balance, end of period

$

2,866

$

7,599

$

25,822

$

17,999

$

11,849

$

590

$

139

$

66,864

For the Three Months Ended September 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

$

2,422

$

4,910

 

$

16,364

$

7,936

$

5,195

$

551

$

96

$

37,474

Provision for credit losses

 

(230)

 

1,370

 

(2,365)

1,061

 

1,821

 

1

 

51

 

1,709

Loans charged to the allowance

 

 

(4)

 

 

(275)

 

 

 

(279)

Recoveries of loans previously charged-off

 

 

 

 

92

 

 

 

92

Balance, end of period

$

2,192

$

6,276

$

13,999

$

8,997

$

6,833

$

552

$

147

$

38,996

The Company recorded a total provision for credit losses of $4.0 million for the three months ended September 30, 2023. The $4.0 million total provision for credit losses consisted of $3.9 million for the ACL-Loans as shown above and $0.1 million for the ACL-OBCE’s.

The Company recorded a total provision for credit losses of $2.2 million for the three months ended September 30, 2022. The $2.2 million total provision for credit losses consisted of $1.7 million for the ACL-Loans as shown above and $0.5 million for the ACL-OBCE’s.

For the Nine Months Ended September 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

 

1,617

604

17,441

8,117

4,601

25

(42)

32,363

Loans charged to the allowance

 

(34)

(8,400)

(1,118)

(1)

(9,553)

Recoveries of loans previously charged-off

 

40

 

40

Balance, end of period

$

2,866

$

7,599

$

25,822

$

17,999

$

11,849

$

590

$

139

$

66,864

18

Table of Contents

Merchants Bancorp

Notes to Condensed Consolidated Financial Statements

(Unaudited)

For the Nine Months Ended September 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

 

196

1,835

(605)

4,397

2,726

(87)

(4)

 

8,458

Loans charged to the allowance

 

(4)

(1,238)

(15)

 

(1,257)

Recoveries of loans previously charged-off

 

743

7

 

750

Balance, end of period

$

2,192

$

6,276

$

13,999

$

8,997

$

6,833

$

552

$

147

$

38,996

The Company recorded a total provision for credit losses of $33.5 million for the nine months ended September 30, 2023. The $33.5 million total provision for credit losses consisted of $32.4 million for the ACL-Loans as shown above and $1.1 million for the ACL-OBCE’s.

The Company recorded a total provision for credit losses of $10.9 million for the nine months ended September 30, 2022. The $10.9 million total provision for credit losses consisted of $8.5 million for the ACL-Loans as shown above, $1.2 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

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:

September 30, 2023

    

Real Estate

    

Accounts Receivable / Equipment

    

Other

    

Total

    

ACL-Loans Allocation

(In thousands)

RES RE

$

801

$

$

3

$

804

$

19

MF FIN

32,334

32,334

188

HC FIN

 

30,683

 

 

 

30,683

 

2,358

CML & CRE

 

 

3,829

 

3,333

 

7,162

 

1,124

AG & AGRE

 

147

 

 

 

147

 

1

CON & MAR

 

 

 

3

 

3

 

Total collateral dependent loans

$

63,965

$

3,829

$

3,339

$

71,133

$

3,690

19

Table of Contents

Merchants Bancorp

Notes to Condensed Consolidated Financial Statements

(Unaudited)

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

20

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 September 30, 2023 and December 31, 2022:

As of September 30, 2023

    

2023

    

2022

    

2021

2020

    

2019

    

Prior

    

Revolving Loans

    

TOTAL

(In thousands)

MTG WHLOC

Pass

$

$

$

$

$

$

$

1,022,692

$

1,022,692

Total

$

$

$

$

$

$

$

1,022,692

$

1,022,692

Charge-offs

$

$

$

$

$

$

$

$

RES RE

Pass

26,185

9,563

7,014

23,009

3,325

9,621

1,278,828

1,357,545

Special Mention (Watch)

60

499

559

Substandard

292

512

804

Total

$

26,185

$

9,563

$

7,014

$

23,009

$

3,385

$

10,412

$

1,279,340

$

1,358,908

Charge-offs

$

$

$

$

$

$

21

$

13

$

34

MF FIN

Pass

840,146

827,151

307,639

87,313

29,926

8,866

1,448,317

3,549,358

Special Mention (Watch)

70,681

3,189

3,404

9,926

1,484

38,944

127,628

Substandard

28,360

3,974

32,334

Total

$

910,827

$

858,700

$

315,017

$

97,239

$

29,926

$

10,350

$

1,487,261

$

3,709,320

Charge-offs

$

$

8,400

$

$

$

$

$

$

8,400

HC FIN

Pass

364,365

1,068,033

214,938

67,266

14,668

274,666

2,003,936

Special Mention (Watch)

93,291

46,464

31,527

12,658

183,940

Substandard

21,783

8,900

30,683

Total

$

457,656

$

1,114,497

$

268,248

$

67,266

$

14,668

$

$

296,224

$

2,218,559

Charge-offs

$

$

$

$

$

$

$

$

CML & CRE

Pass

44,605

119,145

70,194

21,533

21,188

18,714

1,247,686

1,543,065

Special Mention (Watch)

112

36

8,671

173

145

233

434

9,804

Substandard

80

2,017

904

65

51

4,045

7,162

Total

$

44,717

$

119,261

$

80,882

$

22,610

$

21,398

$

18,998

$

1,252,165

$

1,560,031

Charge-offs

$

$

496

$

36

$

586

$

$

$

$

1,118

AG & AGRE

Pass

11,805

10,023

6,660

14,537

5,077

18,745

29,496

96,343

Special Mention (Watch)

Substandard

147

147

Total

$

11,805

$

10,023

$

6,660

$

14,537

$

5,077

$

18,892

$

29,496

$

96,490

Charge-offs

$

$

$

$

$

$

$

$

CON & MAR

Pass

515

4,432

293

137

31

4,387

1,715

11,510

Special Mention (Watch)

16

15

1

32

Substandard

3

3

Total

$

515

$

4,432

$

293

$

153

$

46

$

4,391

$

1,715

$

11,545

Charge-offs

$

$

$

$

$

$

1

$

$

1

Total Pass

$

1,287,621

$

2,038,347

$

606,738

$

213,795

$

74,215

$

60,333

$

5,303,400

$

9,584,449

Total Special Mention (Watch)

$

164,084

$

49,689

$

43,602

$

10,115

$

220

$

2,217

$

52,036

$

321,963

Total Substandard

$

$

28,440

$

27,774

$

904

$

65

$

493

$

13,457

$

71,133

Total Loans

$

1,451,705

$

2,116,476

$

678,114

$

224,814

$

74,500

$

63,043

$

5,368,893

$

9,977,545

Total Charge-offs

$

$

8,896

$

36

$

586

$

$

22

$

13

$

9,553

21

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 September 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.

22

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 September 30, 2023 and December 31, 2022.

September 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

$

$

$

$

$

1,022,692

$

1,022,692

RES RE

 

749

137

 

1,787

 

2,673

 

1,356,235

 

1,358,908

MF FIN

 

6,600

 

32,334

 

38,934

 

3,670,386

 

3,709,320

HC FIN

32,000

25,600

21,783

79,383

2,139,176

2,218,559

CML & CRE

 

44

 

4,095

 

4,139

 

1,555,892

 

1,560,031

AG & AGRE

 

58

 

147

 

205

 

96,285

 

96,490

CON & MAR

 

19

 

19

 

38

 

11,507

 

11,545

$

39,368

$

25,839

$

60,165

$

125,372

$

9,852,173

$

9,977,545

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 six 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 nine months ended September 30, 2023 was inconsequential.

23

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 September 30, 2023 and December 31, 2022.

September 30, 

December 31, 

2023

2022

Total Loans >

Total Loans >

90 Days &

90 Days &

    

Nonaccrual

    

Accruing

    

Nonaccrual

    

Accruing

(In thousands)

RES RE

$

729

$

1,058

$

245

$

96

MF FIN

 

32,334

 

 

 

HC FIN

21,783

21,783

CML & CRE

 

4,095

 

4,390

AG & AGRE

 

147

 

 

147

 

CON & MAR

 

3

 

16

 

6

 

16

$

59,091

$

1,074

$

26,571

$

112

The Company did not have any nonperforming loans without an estimated ACL at September 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 September 30, 2023 that were both experiencing financial difficulty and modified during the nine months ended September 30, 2023, by class and by type of modification. There were no new loans modified for borrowers experiencing financial difficulty during the three months ended September 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 Nine Months Ended September 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

$

$

$

$

N/M

%

Total

$

$

3,778

$

$

$

$

N/M

%

24

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 twelve months. As part of our ACL analysis, these loans were individually evaluated for impairment and no specific reserve was recorded. 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 and nine months ended September 30, 2023.

Foreclosures

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

Significant Loan Sales

Freddie Mac Q Series Securitization – 2023 Activity

On August 31, 2023, the Company completed a $303.6 million securitization of 11 multi-family mortgage loans through a Freddie Mac-sponsored Q-Series transaction. The transfer of these loans was accounted for as a sale for financial reporting purposes, in accordance with ASC 860, and a $60,000 loss on sale was recognized. The Company was retained as the mortgage sub-servicer for Freddie Mac on the entire $303.6 million pool of loans. Beyond sub-servicing the loans, the Company’s ongoing involvement in this transaction is limited to customary obligations of loan sales, including any material breach in representation. In connection with this transaction, a mortgage servicing right of $1.5 million was established.

Loans Purchased

The Company purchased $329.0 million and $289.0 million of loans during the nine months ended September 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.

25

Table of Contents

Merchants Bancorp

Notes to Condensed Consolidated Financial Statements

(Unaudited)

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 September 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 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 September 30, 2023 and December 31, 2022.

Total

Total

Maximum

Assets ($ in thousands)

    

Assets

    

Liabilities

    

Exposure to Loss

(In thousands)

September 30, 2023

 

  

 

  

 

  

Unconsolidated VIEs

$

82,346

$

37,964

$

82,346

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 $794.6 million and $871.8 million at September 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 September 30, 2023 and December 31, 2022, that the Company, Merchants Bank, and FMBI met all capital adequacy requirements.

26

Table of Contents

Merchants Bancorp

Notes to Condensed Consolidated Financial Statements

(Unaudited)

As of September 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.

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

Minimum

Minimum

Amount to be Well

Amount To Be

Capitalized with

Well

Actual

Basel III Buffer(1)

Capitalized(1)

    

Amount

    

Ratio

    

Amount

    

Ratio

Amount

    

Ratio

    

(Dollars in thousands)

September 30, 2023

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

 

  

 

  

 

  

 

  

 

Company

$

1,699,507

 

11.5

%  

$

1,556,494

 

10.5

%  

$

 

N/A

%  

Merchants Bank

1,669,849

 

11.5

%  

 

1,526,849

 

10.5

%  

 

1,454,142

 

10.0

FMBI

 

38,995

 

11.2

%  

 

36,546

 

10.5

%  

 

34,806

 

10.0

%  

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

 

  

 

  

 

  

 

  

 

  

 

  

Company

 

1,620,024

 

10.9

%  

 

1,260,019

 

8.5

%  

 

 

N/A

%  

Merchants Bank

1,591,057

 

10.9

%  

 

1,236,021

 

8.5

%  

 

1,163,314

 

8.0

FMBI

 

38,303

 

11.0

%  

 

29,585

 

8.5

%  

 

27,845

 

8.0

%  

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

Company

 

1,120,416

 

7.6

%  

 

1,037,663

 

7.0

%  

 

 

N/A

%  

Merchants Bank

1,591,057

 

10.9

%  

 

1,017,899

 

7.0

%  

 

945,192

 

6.5

FMBI

 

38,303

 

11.0

%  

 

24,364

 

7.0

%  

 

22,624

 

6.5

%  

Tier I capital(1) (to average assets)

 

 

  

 

  

 

 

  

 

  

Company

 

1,620,024

 

10.1

%  

 

640,543

 

4.0

%  

 

 

N/A

%  

Merchants Bank

1,591,057

 

10.1

%  

 

628,478

 

4.0

%  

 

785,597

 

5.0

FMBI

 

38,303

 

10.6

%  

 

14,440

 

4.0

%  

 

18,050

 

5.0

%  

(1)As defined by regulatory agencies.

27

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.

28

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 September 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

September 30, 2023

(In thousands)

(In thousands)

Interest rate lock commitments

$

24,495

Other assets/liabilities

$

44

$

141

Forward contracts

$

34,376

Other assets/liabilities

236

1

Interest rate swaps

$

57,548

Other assets/liabilities

 

5,792

$

6,072

$

142

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 nine months ended September 30, 2023 and 2022.

Three Months Ended

Nine Months Ended

September 30, 

September 30, 

    

2023

    

2022

    

2023

    

2022

(In thousands)

(In thousands)

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

Interest rate lock commitments

$

(123)

$

(592)

$

(102)

$

(637)

Forward contracts (includes pair-off settlements)

595

1,091

875

5,550

Interest rates swaps

2,501

3,245

2,762

3,405

Net derivative gains

$

2,973

$

3,744

$

3,535

$

8,318

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.

29

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)

September 30, 2023

$

270,427

Other assets/liabilities

$

11,588

$

11,588

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

Nine Months Ended

September 30, 

September 30, 

    

2023

    

2022

    

2023

    

2022

(In thousands)

(In thousands)

Gross swap gains

$

2,111

$

249

$

8,547

$

2,282

Gross swap losses

2,111

249

 

8,547

2,282

Net swap gains (losses)

$

$

$

$

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

30

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 September 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)

September 30, 2023

Mortgage loans in process of securitization

$

476,047

$

$

476,047

$

Securities available for sale:

 

  

 

  

 

  

 

  

Treasury notes

 

137,886

 

137,886

 

 

Federal agencies

 

224,398

 

 

224,398

 

Mortgage-backed - Government-sponsored entity (GSE)

 

262,302

 

 

262,302

 

Loans held for sale

 

90,875

 

 

90,875

 

Servicing rights

 

162,141

 

 

 

162,141

Derivative assets - interest rate lock commitments

 

44

 

 

 

44

Derivative assets - forward contracts

 

236

 

 

236

 

Derivative assets - interest rate swaps

5,792

5,792

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

 

11,588

 

 

11,588

 

Derivative liabilities - interest rate lock commitments

 

141

141

Derivative liabilities - forward contracts

 

1

1

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

 

11,588

11,588

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 nine months ended September 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.

31

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.

32

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 September 30, 

Nine Months Ended September 30, 

    

2023

    

2022

    

2023

    

2022

(In thousands)

(In thousands)

Servicing rights

Balance, beginning of period

$

147,288

$

130,710

$

146,248

$

110,348

Additions

 

  

 

  

 

 

  

Originated servicing

 

4,867

 

11,667

 

9,164

 

22,662

Subtractions

 

  

 

  

 

  

 

  

Paydowns

 

(1,660)

 

(1,946)

 

(5,431)

 

(7,963)

Sales of servicing

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

 

11,646

 

4,553

 

12,160

 

19,937

Balance, end of period

$

162,141

$

144,984

$

162,141

$

144,984

Derivative Assets - interest rate lock commitments

Balance, beginning of period

$

94

$

299

$

28

$

264

Changes in fair value

 

(50)

 

(275)

 

16

 

(240)

Balance, end of period

$

44

$

24

$

44

$

24

Derivative Liabilities - interest rate lock commitments

Balance, beginning of period

$

68

$

121

$

23

$

41

Changes in fair value

 

73

 

317

 

118

 

397

Balance, end of period

$

141

$

438

$

141

$

438

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 September 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)

September 30, 2023

 

  

 

  

 

  

 

  

Impaired loans (collateral-dependent)

$

40,809

$

$

$

40,809

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.

33

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 September 30, 2023:

 

  

 

  

 

Collateral dependent loans

$

40,809

 

Market comparable properties

 

Marketability discount

0% - 54%

 

2%

Servicing rights - Multi-family

$

125,111

 

Discounted cash flow

 

Discount rate

8% - 13%

 

9%

Constant prepayment rate

1% - 25%

 

7%

Servicing rights - Single-family

$

31,898

 

Discounted cash flow

 

Discount rate

9% - 10%

9%

Constant prepayment rate

7% - 12%

7%

Servicing rights - SBA

$

5,132

 

Discounted cash flow

 

Discount rate

16%

 

16%

Constant prepayment rate

3% - 14%

8%

Derivative assets - interest rate lock commitments

$

44

 

Discounted cash flow

 

Loan closing rates

62% - 99%

 

80%

Derivative liabilities - interest rate lock commitments

$

141

 

Discounted cash flow

 

Loan closing rates

62% - 99%

 

80%

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.

34

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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 September 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)

September 30, 2023

Financial assets:

 

  

 

  

 

  

 

  

 

  

Cash and cash equivalents

$

407,238

$

407,238

$

407,238

$

$

Securities purchased under agreements to resell

 

3,385

 

3,385

 

 

3,385

 

Securities held to maturity

 

1,012,801

 

1,010,745

 

 

216,281

 

794,464

FHLB stock

 

48,219

 

48,219

 

 

48,219

 

Loans held for sale

 

3,386,161

 

3,386,161

 

 

3,386,161

 

Loans receivable, net

 

9,910,681

 

9,871,660

 

 

 

9,871,660

Interest receivable

 

78,401

 

78,401

 

 

78,401

 

Financial liabilities:

 

  

 

 

  

 

  

 

  

Deposits

 

13,007,338

 

13,005,483

 

7,961,135

 

5,044,348

 

Short-term subordinated debt

 

81,000

 

81,000

 

 

81,000

 

FHLB advances

 

1,063,445

 

1,063,139

 

 

1,063,139

 

Other borrowing

362,934

362,934

362,934

Credit linked notes

146,696

146,694

146,694

Interest payable

 

49,757

 

49,757

 

 

49,757

 

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

 

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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 $10.6 million and operating lease right-of-use liabilities of $11.8 million as of September 30, 2023.

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

September 30, 2023

December 31, 2022

Balance Sheet

(In thousands)

(In thousands)

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

$

10,556

$

10,969

Operating lease liability (in other liabilities)

11,790

11,992

Weighted average remaining lease term (years)

6.1

6.5

Weighted average discount rate

2.88%

2.65%

Maturities of lease liabilities:

One year or less

$

622

$

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

12,839

13,049

Less: imputed interest

1,049

1,057

Total

$

11,790

$

11,992

Three Months Ended

Three Months Ended

September 30, 2023

September 30, 2022

Income Statement

(In thousands)

(In thousands)

Components of lease expense:

Operating lease cost (in occupancy and equipment expense)

$

591

$

482

Nine Months Ended

Nine Months Ended

September 30, 2023

September 30, 2022

Income Statement

(In thousands)

(In thousands)

Components of lease expense:

Operating lease cost (in occupancy and equipment expense)

$

1,840

$

1,274

Nine Months Ended

Nine Months Ended

September 30, 2023

September 30, 2022

Cash Flow Statement

(In thousands)

(In thousands)

Supplemental cash flow information:

Operating cash flows from operating leases

$

1,506

$

1,061

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Merchants Bancorp

Notes to Condensed Consolidated Financial Statements

(Unaudited)

Note 10: Deposits

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

September 30,

December 31,

    

2023

    

2022

(In thousands)

Noninterest-bearing deposits

Demand deposits

$

287,846

$

326,875

Total noninterest-bearing deposits

287,846

326,875

Interest-bearing deposits

Demand deposits

$

4,616,742

$

3,720,363

Savings deposits

 

3,056,547

 

3,034,818

Certificates of deposit

 

5,046,203

 

2,989,289

Total interest-bearing deposits

12,719,492

9,744,470

Total deposits

$

13,007,338

$

10,071,345

Maturities for certificates of deposit are as follows:

    

September 30, 2023

(In thousands)

Due within one year

$

4,903,831

Due in one year to two years

 

92,483

Due in two years to three years

 

48,520

Due in three years to four years

 

961

Due in four years to five years

408

Due in five years to six years

 

$

5,046,203

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

September 30, 

December 31, 

    

2023

    

2022

(In thousands)

Brokered certificates of deposit

$

4,393,282

$

2,681,198

Brokered savings deposits

 

6,715

 

81,532

Brokered deposit on demand accounts

 

306

 

13

$

4,400,303

$

2,762,743

Note 11: Borrowings

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

September 30, 

December 31, 

    

2023

    

2022

(In thousands)

Federal Reserve discount window borrowings

$

210,000

$

20,000

Short-term subordinated debt

 

81,000

 

21,000

FHLB advances

1,063,445

859,392

American Financial Exchange borrowing

145,000

30,000

Credit linked notes

146,696

Other borrowings

 

7,934

 

Total borrowings

$

1,654,075

$

930,392

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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 September 30, 2023, the account included $52.2 million of restricted cash and the acquisition of $98.8 million in short-term Treasury securities. These are reported as cash equivalents and securities available for sale in the consolidated balance sheets.

Note 12:   Earnings Per Share

Earnings per share were computed as follows:

Three Month Periods Ended September 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

$

81,504

 

  

 

  

$

58,488

 

  

 

  

Dividends on preferred stock

 

(8,668)

 

  

 

  

 

(5,729)

 

  

 

  

Net income allocated to common shareholders

$

72,836

 

  

 

  

$

52,759

 

  

 

  

Basic earnings per share

 

  

 

43,238,724

$

1.68

 

  

 

43,107,975

$

1.22

Effect of dilutive securities-restricted stock awards

 

  

 

112,484

 

  

 

  

 

150,950

 

  

Diluted earnings per share

 

  

 

43,351,208

$

1.68

 

  

 

43,258,925

$

1.22

Nine Month Periods Ended September 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

$

201,761

 

  

 

  

$

162,565

 

  

 

  

Dividends on preferred stock

 

(26,003)

 

  

 

  

 

(17,186)

 

  

 

  

Net income allocated to common shareholders

$

175,758

 

  

 

  

$

145,379

 

  

 

  

Basic earnings per share

 

  

 

43,218,125

$

4.07

 

  

 

43,182,380

$

3.37

Effect of dilutive securities-restricted stock awards

 

  

 

99,218

 

  

 

  

 

148,768

 

  

Diluted earnings per share

 

  

 

43,317,343

$

4.06

 

  

 

43,331,148

$

3.36

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 September 30, 2023 and 2022, the Company did not issue any shares. During the nine months ended September 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 2,912 and 3,073 shares, issued to non-executive directors during the three months ended September 30, 2023 and 2022, respectively and there were 9,457 and 8,894 shares, issued to non-executive directors during the nine months ended September 30, 2023 and 2022, respectively.

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Merchants Bancorp

Notes to Condensed Consolidated Financial Statements

(Unaudited)

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 contribution to the ESOP during the three months ended September 30, 2023 and 2022. Expenses associated with the contribution to the ESOP totaled $810,000 and $653,000 for the nine months ended September 30, 2023 and 2022, respectively. The Company contributed 33,293 shares and 20,709 shares to the ESOP for the nine months ended September 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. The Other segment 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.

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

Multi-family

    

 

Mortgage 

Mortgage

 

    

Banking

    

Warehousing

    

Banking

    

Other

    

Total

Three Months Ended September 30, 2023

(In thousands)

Interest income

$

1,580

$

85,280

$

208,307

$

1,509

 

$

296,676

Interest expense

 

19

 

57,633

 

123,594

 

(2,006)

 

 

179,240

Net interest income

 

1,561

 

27,647

 

84,713

 

3,515

 

 

117,436

Provision for credit losses

 

 

(495)

 

4,509

 

 

 

4,014

Net interest income after provision for credit losses

 

1,561

 

28,142

 

80,204

 

3,515

 

 

113,422

Noninterest income

 

37,266

 

1,884

 

(536)

 

(2,546)

 

 

36,068

Noninterest expense

 

19,169

 

4,014

 

10,945

 

8,802

 

 

42,930

Income (loss) before income taxes

 

19,658

 

26,012

 

68,723

 

(7,833)

 

 

106,560

Income taxes

 

4,973

 

6,086

 

16,278

 

(2,281)

 

 

25,056

Net income (loss)

$

14,685

$

19,926

$

52,445

$

(5,552)

 

$

81,504

Total assets

$

392,754

$

4,757,817

$

11,135,651

$

209,014

 

$

16,495,236

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Merchants Bancorp

Notes to Condensed Consolidated Financial Statements

(Unaudited)

Multi-family

 

Mortgage 

Mortgage

 

    

Banking

    

Warehousing

    

Banking

    

Other

    

Total

Three Months Ended September 30, 2022

(In thousands)

Interest income

$

589

$

31,240

$

99,982

$

2,301

 

$

134,112

Interest expense

 

 

15,089

 

34,513

 

(875)

 

 

48,727

Net interest income

 

589

 

16,151

 

65,469

 

3,176

 

 

85,385

Provision for credit losses

 

 

222

 

2,003

 

 

 

2,225

Net interest income after provision for credit losses

 

589

 

15,929

 

63,466

 

3,176

 

 

83,160

Noninterest income

 

39,421

 

1,106

 

(8,317)

 

(3,024)

 

 

29,186

Noninterest expense

 

21,741

 

2,332

 

3,752

 

7,126

 

 

34,951

Income (loss) before income taxes

 

18,269

 

14,703

 

51,397

 

(6,974)

 

 

77,395

Income taxes

 

4,903

 

2,902

 

12,053

 

(951)

 

 

18,907

Net income (loss)

$

13,366

$

11,801

$

39,344

$

(6,023)

 

$

58,488

Total assets

$

343,443

$

2,735,278

$

8,760,416

$

139,585

 

$

11,978,722

Multi-family

    

 

Mortgage 

Mortgage

 

    

Banking

    

Warehousing

    

Banking

    

Other

    

Total

(In thousands)

Nine Months Ended September 30, 2023

Interest income

$

3,934

$

191,865

566,439

$

3,801

 

$

766,039

Interest expense

 

32

 

128,411

 

319,431

 

(5,581)

 

 

442,293

Net interest income

 

3,902

 

63,454

 

247,008

 

9,382

 

 

323,746

Provision for credit losses

 

 

3,189

 

30,295

 

 

 

33,484

Net interest income after provision for credit losses

 

3,902

 

60,265

 

216,713

 

9,382

 

 

290,262

Noninterest income

 

84,188

 

5,789

 

(2,485)

 

(7,278)

 

 

80,214

Noninterest expense

 

53,762

 

10,386

 

33,233

 

24,641

 

 

122,022

Income (loss) before income taxes

 

34,328

 

55,668

 

180,995

 

(22,537)

 

 

248,454

Income taxes

 

6,435

 

8,505

 

36,593

 

(4,840)

 

 

46,693

Net income (loss)

$

27,893

$

47,163

$

144,402

$

(17,697)

 

$

201,761

Total assets

$

392,754

$

4,757,817

$

11,135,651

$

209,014

 

$

16,495,236

Multi-family

 

Mortgage 

Mortgage

 

    

Banking

    

Warehousing

    

Banking

    

Other

    

Total

(In thousands)

Nine Months Ended September 30, 2022

Interest income

$

1,229

$

74,816

$

217,285

$

6,064

 

$

299,394

Interest expense

 

 

22,686

 

55,066

 

(1,499)

 

 

76,253

Net interest income

 

1,229

 

52,130

 

162,219

 

7,563

 

 

223,141

Provision for credit losses

 

1,153

 

849

 

8,886

 

 

 

10,888

Net interest income after provision for credit losses

 

76

 

51,281

 

153,333

 

7,563

 

 

212,253

Noninterest income

 

121,037

 

4,316

 

(16,380)

 

(6,019)

 

 

102,954

Noninterest expense

 

60,231

 

7,699

 

12,960

 

18,051

 

 

98,941

Income (loss) before income taxes

 

60,882

 

47,898

 

123,993

 

(16,507)

 

 

216,266

Income taxes

 

16,468

 

11,070

 

29,953

 

(3,790)

 

 

53,701

Net income (loss)

$

44,414

$

36,828

$

94,040

$

(12,717)

 

$

162,565

Total assets

$

343,443

$

2,735,278

$

8,760,416

$

139,585

 

$

11,978,722

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Merchants Bancorp

Notes to Condensed Consolidated Financial Statements

(Unaudited)

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.

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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 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

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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.

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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 September 30, 2023 and results of operations for the three and nine months ended September 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 September 30, 2023

Net income of $81.5 million increased 39% compared to September 30, 2022 and diluted earnings per share of $1.68 increased 38% compared to September 30, 2022.
The 39% increase in net income was primarily driven by a $32.1 million, or 38%, increase in net interest income.
Total assets of $16.5 billion increased 4% compared to June 30, 2023, and increased 31% compared to December 31, 2022.
As of September 30, 2023, the Company had $5.4 billion, or 32%, 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 $10.7 billion, or 65%, of the $16.5 billion in total assets as of September 30, 2023.
Uninsured deposits totaled approximately $2 billion as of September 30, 2023, representing less than 20% of total deposits.
Loans receivable of $9.9 billion, net of allowance for credit losses on loans increased $2.5 billion, or 33%, compared to December 31, 2022.
Efficiency ratio was 28.0% compared to 30.5% for the three months ended September 30, 2022.
As of September 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 $25.82 increased 24% compared to $20.78 for the three months ended September 30, 2022.
On August 31, 2023, the Company completed a $303.6 million securitization of 11 multi-family mortgage loans through a Freddie Mac-sponsored Q-Series transaction.
On September 7, 2023, the Company entered into an agreement with Bank of Pontiac to sell its Farmers-Merchants Bank of Illinois branch locations in Paxton, Melvin and Piper City, Illinois and an agreement with CBI Bank & Trust, to sell its Farmers-Merchants Bank of Illinois branch located in Joy, Illinois.

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The volume of warehouse loans funded during the three months ended September 30, 2023 amounted to $10.8 billion, an increase of $2.0 billion, or 23%, compared to the three months ended September 30, 2022. This compared to the 10% industry decrease in single-family residential loan volumes for the three months ended September 30, 2023 according to an estimate of industry volume by the Mortgage Bankers Association.
The total volume of loans originated and acquired through our multi-family business was $1.4 billion, a decrease of $869.4 million, or 39%, compared to $2.2 billion for the three months ended September 30, 2022. Many of these loans are bridge loans housed in our banking segment while borrowers await conversion to permanent financing. The volume of bridge loans was $785.8 million, a decrease of $705.7 million, or 47%, compared to $1.5 billion for the three months ended September 30, 2022. The volume of loans originated and acquired for sale in the secondary market increased by $55.1 million, or 15%, to $422.1 million, compared to $367.0 million for the three months ended September 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, and 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 September 30, 2023, we had approximately $16.5 billion in total assets, $13.0 billion in deposits and $1.6 billion in total shareholders’ equity. Total assets as of September 30, 2023 included approximately $407.2 million of cash and cash equivalents, $3.5 billion of loans held for sale and $9.9 billion of loans receivable, net of ACL-loans.

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Assets also included $476.0 million of mortgage loans in process of securitization that represent pre-sold multi-family rental real estate loan originations in primarily Federal National Mortgage Association (“Fannie Mae”), Federal Home Loan Mortgage Corporation (“Freddie Mac”), or Government National Mortgage Association (“GNMA”) mortgage backed securities pending settlements that typically occur within 30 days. There was also $1.0 billion in securities held to maturity that were primarily acquired in conjunction with the securitization of loans that the Company originated. Additionally, we had $624.6 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 September 30, 2023 were $162.1 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 September 30, 2023 and December 31, 2022

Total Assets.   Total assets of $16.5 billion at September 30, 2023 increased $3.9 billion, or 31%, compared to $12.6 billion at December 31, 2022. The increase was due primarily to significant growth in the healthcare, commercial lines of credit collateralized by mortgage servicing rights, multi-family, and mortgage warehouse loan portfolios.

Cash and Cash Equivalents.  Cash and cash equivalents of $407.2 million at September 30, 2023 increased $181.1 million, or 80%, compared to December 31, 2022. The 80% increase reflected higher liquidity to fund anticipated loan growth. Included in cash equivalents was $52.2 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 of $476.0 million at September 30, 2023 increased $321.9 million, or 209%, compared to 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 209% 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 of $624.6 million at September 30, 2023 increased $301.2 million, or 93%, compared to December 31, 2022. The increase in available for sale securities was primarily due to purchases of $631.7 million, partially offset by calls, maturities, repayments, sales and other adjustments of $330.5 million during the period. The purchases were primarily related to securities with protections against any loss in fair value.

As of September 30, 2023, Accumulated Other Comprehensive Losses (“AOCL”) of $4.8 million losses, related to securities available for sale, decreased $5.7 million, or 55%, compared to losses of $10.5 million at December 31, 2022. The $4.8 million of AOCL losses as of September 30, 2023 represented less than 1% of total equity and less than 1% of total securities available for sale.

Securities Held to Maturity.   Securities held to maturity of $1.0 billion at September 30, 2023 decreased $106.3 million, or 9%, compared to $1.1 billion at December 31, 2022. The decrease was primarily due to purchases of $9.8 million offset by calls, maturities and repayments of securities totaling $116.1 million during the period.

Loans Held for Sale.   Loans held for sale, comprised primarily of single-family residential real estate loan participations that meet Fannie Mae, Freddie Mac, or GNMA eligibility, of $3.5 billion at September 30, 2023 increased $566.5 million, or 19%, compared to $2.9 billion at December 31, 2022. The increase in loans held for sale was due primarily to an increase in warehouse participations, partially offset by loans associated with credit linked notes that were transferred to loans receivable during the first quarter of 2023.

Loans Receivable.   Loans receivable, which are comprised of loans held for investment, of $9.9 billion at September 30, 2023 increased $2.5 billion, or 33%, compared to $7.4 billion at December 31, 2022. The increase was comprised primarily of:

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an increase of $614.2 million, or 38%, in healthcare financing loans, to $2.2 billion at September 30, 2023,
an increase of $581.4 million, or 59%, in commercial and commercial real estate loans, to $1.6 billion at September 30, 2023,
an increase of $573.8 million, or 18%, in multi-family financing loans, to $3.7 billion at September 30, 2023,
an increase of $557.9 million, or 120%, in mortgage warehouse lines of credit, to $1.0 billion at September 30, 2023, and
an increase of $180.5 million, or 15%, in residential real estate loans, to $1.4 billion at September 30, 2023.

The $614.2 million increase in healthcare financing was due to increased volume associated with the credit link notes transaction where loans were transferred from loans held for sale during the first quarter of 2023.

The $581.4 million increase in commercial and commercial real estate was primarily due to higher revolving lines of credit on collateralized mortgage servicing rights during the period.

The $573.8 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 $557.9 million increase in mortgage warehouse lines of credit was due to higher loan volume from increased sales efforts and market exits of several competitors.

The $180.5 million increase in residential real estate loans was primarily due an increase in All-in-One® first-lien home equity line of credit.

As of September 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 $66.9 million at September 30, 2023 increased $22.9 million compared to $44.0 million at December 31, 2022. The increase was primarily due to loan growth in the period, as well as credit events and increases in qualitative factors and forecasted loss rates to reflect changes in industry conditions that were reported during the three months ended September 30, 2023.

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 September 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 of $162.1 million at September 30, 2023 increased $15.9 million, or 11%, compared to $146.2 million at December 31, 2022. During the nine months ended September 30, 2023, originated servicing of $9.2 million and a positive fair market value adjustment of $12.2 million were partially offset by paydowns of $5.4 million. Servicing rights are recognized in connection with sales of loans when we retain servicing of the sold loans. The servicing rights are recorded and carried at fair value. The fair value increase recorded during the nine months ended September 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

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environments which impact the value of escrow deposits, and declines in falling interest rate environments due to expected prepayments.

Other Assets and Receivables. Other assets and receivables of $241.3 million at September 30, 2023 increased $83.8 million, or 53%, compared to December 31, 2022. The 53% increase in other assets and receivables was primarily due to the acquisition of low-income housing tax credit investments.

Deposits.   Deposits of $13.0 billion at September 30, 2023 increased $2.9 billion, or 29%, compared to $10.1 billion at December 31, 2022. The 29% increase in total deposits was primarily due to a $2.1 billion increase in certificates of deposit, a $857.4 million increase in demand deposits and an increase of $21.7 million in savings deposits. As of September 30, 2023, approximately 88% of the total deposits at Merchants Bank reprice within three months.

Uninsured deposits totaled approximately $2 billion as of September 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 $1.8 billion as of September 30, 2023.

Core deposits increased by $1.3 billion, or 18%, to $8.6 billion at September 30, 2023 compared to December 31, 2022. Core deposits represented 66% of total deposits at September 30, 2023 compared to 73% of total deposits at December 31, 2022.

We increased our use of brokered deposits by $1.6 billion, or 59%, to $4.4 billion at September 30, 2023 compared to December 31, 2022. Brokered deposits represented 34% of total deposits at September 30, 2023 compared to 27% of total deposits at December 31, 2022.

Brokered certificates of deposit accounts of $4.4 billion at September 30, 2023 increased by $1.7 billion, or 64%, compared to December 31, 2022.
Brokered demand deposit accounts of $0.3 million at September 30, 2023 increased by $0.3 million, compared to December 31, 2022.
Brokered savings deposits accounts of $6.7 million at September 30, 2023 decreased $74.8 million, compared to December 31, 2022.

As of September 30, 2023, brokered certificates of deposit had a weighted average remaining duration of 49 days. 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 31%, to $12.7 billion at September 30, 2023, and noninterest-bearing deposits decreased $39.0 million, or 12%, to $287.8 million at September 30, 2023.

Borrowings.   Borrowings of $1.7 billion at September 30, 2023, an increase of $723.7 million, or 78%, compared to December 31, 2022. The increase was primarily due to additional borrowings from the FHLB and Federal Reserve, along with 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”).

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The Company continues to have significant borrowing capacity based on available collateral. As of September 30, 2023, unused lines of credit totaled $5.4 billion, compared to $3.1 billion at December 31, 2022.

Other Liabilities. Other liabilities of $183.1 million at September 30, 2023 increased $49.0 million, or 37%, compared to $134.1 million at December 31, 2022. The 37% increase in other liabilities was primarily due to interest payable and unfunded commitments for low-income housing tax credit investments.

Total Shareholders’ Equity.   Total shareholders’ equity of $1.6 billion at September 30, 2023, increased $173.0 million, or 12%, compared to $1.5 billion as of December 31, 2022. The $173.0 million increase resulted primarily from net income of $201.8 million, which was partially offset by dividends paid on common and preferred shares of $36.4 million during the period.

Asset Quality

Total nonperforming loans (nonaccrual and greater than 90 days late but still accruing) were $60.2 million, or 0.60%, of total loans at September 30, 2023, compared to $26.7 million, or 0.36%, of total loans at December 31, 2022 and $26.6 million, or 0.38%, at September 30, 2022. The increase in nonperforming 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 111% at September 30, 2023 compared to 165% at December 31, 2022 and 147% at September 30, 2022. The decrease in percentage was due to an increase in nonperforming loans. While this percentage decreased compared to both periods, the increase in nonperforming loans was primarily related to increases in the nonaccrual classification and have all been individually evaluated for impairment.

Total loans greater than 30 days past due were $125.4 million at September 30, 2023, $39.8 million at December 31, 2022, and $26.6 million at September 30, 2022. Since the majority of loans to customers have variable rates, the rapid increase in interest rates over the last several quarters has negatively impacted borrowers by increasing their required payment amounts.

Special Mention (including Watch) loans were $322.0 million at September 30, 2023, compared to $137.8 million at December 31, 2022 and $142.8 million at September 30, 2022. The increase to both periods was primarily due to the increase in interest rates for our borrowers.

During the three months ended September 30, 2023 there were $21,000 of charge-offs and $31,000 of recoveries, compared to $279,000 of charge-offs and $92,000 recoveries for the three months ended September 30, 2022.

For the nine months ended September 30, 2023, there were $9.6 million of charge-offs, primarily related to one customer, and $40,000 of recoveries, compared to $1.3 million of charge-offs and $750,000 of recoveries for the nine months ended September 30, 2022.

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

General.   Net income of $81.5 million for the three months ended September 30, 2023 increased by $23.0 million, or 39%, compared to the three months ended September 30, 2022. The increase was primarily driven by a $32.1 million, or 38%, increase in net interest income and a $6.9 million, or 24%, increase in noninterest income. The increases were partially offset by an $8.0 million, or 23%, increase in noninterest expense and a $6.2 million, or 33%, increase in provision for income tax.

Net Interest Income.    Net interest income of $117.4 million for the three months ended September 30, 2023 increased $32.1 million, or 38%, compared to the three months ended September 30, 2022. The 38% increase reflected a $162.6 million, or 121%, increase in interest income from higher yields and average loan balances as well as higher

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average balances of securities held to maturity. The increases were partially offset by a $130.5 million, or 268%, increase in interest expense from higher rates and average balances on deposits, as well as higher rates on borrowings that were primarily related to the credit linked notes issued by the Company in March 2023. The interest rate spread of 2.44% for the three months ended September 30, 2023 decreased 33 basis points compared to 2.77% in the three months ended September 30, 2022.

Our net interest margin decreased 6 basis points, to 2.99%, for the three months ended September 30, 2023 from 3.05% for the three months ended September 30, 2022.

Interest Income.   Interest income of $296.7 million for the three months ended September 30, 2023 increased $162.6 million, or 121%, compared to $134.1 million for the three months ended September 30, 2022. This increase was primarily attributable to an increase in both higher average yields and average balances of loans and loans held for sale, as well as higher average balances in securities held to maturity. The higher yields were in response to higher interest rates set by the Federal Reserve.

The average balance of loans, including loans held for sale, during the three months ended September 30, 2023 increased $3.2 billion, or 31%, to $13.4 billion compared to the three months ended September 30, 2022. The average yield on loans increased 289 basis points, to 7.89% for the three months ended September 30, 2023, compared to 5.00% for the three months ended September 30, 2022. The increase in average balances of loans and loans held for sale was primarily due to increases in the healthcare, commercial lines of credit collateralize by mortgage servicing rights real estate and multi-family 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 September 30, 2023 increased $941.7 million, to $1.1 billion compared to the three months ended September 30, 2022. The average yield on securities held to maturity increased 274 basis points, to 6.65% for the three months ended September 30, 2023, compared to 3.91% for the three months ended September 30, 2022. The increase in average balance of securities held to maturity was primarily related to held maturity securities acquired as part of loan securitizations that the Company originated.

The average balance of securities available for sale increased $324.8 million, or 98%, to $656.6 million for the three months ended September 30, 2023 compared to the three months ended September 30, 2022. The average yield increased 316 basis points, to 3.74% for the three months ended September 30, 2023, compared to 0.58% for the three months ended September 30, 2022.

The average balance of interest-earning deposits and other increased $48.0 million, or 23%, to $259.6 million for the three months ended September 30, 2023 from the three months ended September 30, 2022, while the average yield increased 338 basis points, to 5.99% for the three months ended September 30, 2023, compared to 2.61% for the three months ended September 30, 2022.

The average balance of mortgage loans in process of securitization decreased $26.5 million, or 11%, to $208.8 million for the three months ended September 30, 2023 compared to the three months ended September 30, 2022, while the average yield increased 126 basis points, to 4.91% for the three months ended September 30, 2023, compared to 3.65% for the three months ended September 30, 2022.

Interest Expense.   Total interest expense of $179.2 million for the three months ended September 30, 2023 increased $130.5 million, or 268%, compared to $48.7 million for the three months ended September 30, 2022.

Interest expense on deposits increased $117.9 million, or 262%, to $162.9 million for the three months ended September 30, 2023 from $45.0 million for the three months ended September 30, 2022. The increase was primarily due to higher rates on certificates of deposit, interest-bearing checking, and money market accounts. The higher rates on our deposits were in response to higher interest rates set by the Federal Reserve.

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The average balance of certificates of deposit of $5.3 billion for the three months ended September 30, 2023 increased $3.2 billion, or 159%, compared to the three months ended September 30, 2022. The average rate on certificates of deposit was 5.34% for the three months ended September 30, 2023, which was a 343 basis point increase compared to 1.91% for three months ended September 30, 2022.

The average balance of interest-bearing checking accounts of $4.9 billion for the three months ended September 30, 2023 increased $675.5 million, or 16%, compared to $4.2 billion for the three months ended September 30, 2022. The average yield of interest-bearing checking accounts was 4.76% for the three months ended September 30, 2023, which was a 269 basis point increase compared to 2.07% for three months ended September 30, 2022.

The average balance of money market accounts of $2.8 billion for the three months ended September 30, 2023 increased $275.0, or 11%, compared to $2.5 billion for the three months ended September 30, 2022. The average yield of money market accounts was 4.71% for the three months ended September 30, 2023, which was a 265 basis point increase compared to 2.06% for three months ended September 30, 2022.

Interest expense on borrowings increased $12.6 million, or 338%, to $16.3 million for the three months ended September 30, 2023 from $3.7 million for the three months ended September 30, 2022. The increase reflected a 659 basis points increase in the average cost of borrowings, to 9.10% compared to 2.51% for the three months ended September 30, 2022. The increase was primarily related to the credit linked notes issued by the Company in 2023. Also contributing to the increase in borrowings was an increase of $123.4 million, or 21%, in the average balance of borrowings $711.9 million compared to the three months ended September 30, 2022. Also included in borrowings, our warehouse structured financing agreements provide for additional interest payments for a portion of the earnings generated.

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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 September 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

$

259,630

$

3,923

 

5.99

%  

$

211,653

$

1,394

 

2.61

%

Securities available for sale - taxable

 

656,561

 

6,182

 

3.74

%  

 

331,796

 

485

 

0.58

%

Securities held to maturity

1,040,070

17,427

6.65

%  

98,363

 

970

 

3.91

%  

Mortgage loans in process of securitization

 

208,767

 

2,583

 

4.91

%  

 

235,230

 

2,162

 

3.65

%

Loans and loans held for sale

 

13,399,854

 

266,561

 

7.89

%  

 

10,245,294

 

129,101

 

5.00

%

Total interest-earning assets

 

15,564,882

 

296,676

 

7.56

%  

 

11,122,336

 

134,112

 

4.78

%

Allowance for credit losses on loans

 

(63,449)

 

  

 

  

 

(39,325)

 

  

 

  

Noninterest-earning assets

 

529,582

 

  

 

  

 

354,794

 

  

 

  

Total assets

$

16,031,015

 

  

 

  

$

11,437,805

 

  

 

  

Liabilities/Equity:

 

  

 

  

 

  

 

  

 

  

 

  

Interest-bearing checking

$

4,882,727

$

58,642

 

4.76

%  

$

4,207,217

$

21,980

 

2.07

%

Savings deposits

 

241,861

 

340

 

0.56

%  

 

239,262

 

162

 

0.27

%

Money market

 

2,798,325

 

33,235

 

4.71

%  

 

2,523,315

 

13,094

 

2.06

%

Certificates of deposit

 

5,255,573

 

70,689

 

5.34

%  

 

2,030,152

 

9,766

 

1.91

%

Total interest-bearing deposits

 

13,178,486

 

162,906

 

4.90

%  

 

8,999,946

 

45,002

 

1.98

%

Borrowings

 

711,948

 

16,334

 

9.10

%  

 

588,582

 

3,725

 

2.51

%

Total interest-bearing liabilities

 

13,890,434

 

179,240

 

5.12

%  

 

9,588,528

 

48,727

 

2.02

%

Noninterest-bearing deposits

 

333,155

 

  

 

  

 

474,925

 

  

 

  

Noninterest-bearing liabilities

 

199,647

 

  

 

  

 

107,192

 

  

 

  

Total liabilities

 

14,423,236

 

  

 

  

 

10,170,645

 

  

 

  

Equity

 

1,607,779

 

  

 

  

 

1,267,160

 

  

 

  

Total liabilities and equity

$

16,031,015

 

  

 

  

$

11,437,805

 

  

 

  

Net interest income

 

  

$

117,436

 

  

 

  

$

85,385

 

  

Interest rate spread

 

  

 

  

 

2.44

%  

 

  

 

  

 

2.77

%

Net interest-earning assets

$

1,674,448

 

  

 

  

$

1,533,808

 

  

 

Net interest margin

 

  

 

  

 

2.99

%  

 

  

 

  

 

3.05

%

Average interest-earning assets to average interest-bearing liabilities

 

  

 

  

 

112.05

%  

 

  

 

  

 

116.00

%

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 September 30, 2023

compared to September 30, 2022

Increase (Decrease)

Due to

(Dollars in thousands)

    

Volume

    

Rate

    

Total

Interest income

 

  

 

  

 

  

Interest-bearing deposits, and other

$

316

$

2,213

$

2,529

Securities available for sale - taxable

 

475

 

5,222

 

5,697

Securities held to maturity

9,287

7,170

16,457

Mortgage loans in process of securitization

 

(243)

 

664

 

421

Loans and loans held for sale

 

39,751

 

97,709

 

137,460

Total interest income

 

49,586

 

112,978

 

162,564

Interest expense

 

  

 

  

 

  

Deposits

 

  

 

  

 

  

Interest-bearing checking

 

3,529

 

33,133

 

36,662

Savings deposits

 

2

 

176

 

178

Money market deposits

 

1,427

 

18,714

 

20,141

Certificates of deposit

 

15,516

 

45,407

 

60,923

Total Deposits

 

20,474

 

97,430

 

117,904

Borrowings

 

781

 

11,828

 

12,609

Total interest expense

 

21,255

 

109,258

 

130,513

Net interest income

$

28,331

$

3,720

$

32,051

Provision for Credit Losses.   We recorded a total provision for credit losses of $4.0 million for the three months ended September 30, 2023, an increase of $1.8 million, compared to the three months ended September 30, 2022. The increase was primarily due to loan growth in the period and increases in qualitative factors and forecasted loss rates to reflect changes in industry conditions.

The $4.0 million total provision for credit losses consisted of $3.9 million for the ACL-Loans and $0.1 million for the ACL-OBCE’s. The ACL-Loans was $66.9 million, or 0.67%, of total loans, at September 30, 2023, compared to $44.0 million, or 0.59%, of total loans, at December 31, 2022, and $39.0 million, or 0.56%, at September 30, 2022.

Noninterest Income.   Noninterest income of $36.1 million for the three months ended September 30, 2023 increased $6.9 million, or 24%, compared to $29.2 million for the three months ended September 30, 2022. The increase was primarily due to a $9.2 million, or 113%, increase in loan servicing fees that were partially offset by a $2.6 million, or 19%, 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 September 30, 2023 and 2022 is below:

Gain on Sale of Loans

Three Months Ended

September 30, 

September 30, 

2023

2022

(in thousands)

Loan Type

Multi-family

$

8,616

$

12,002

Single-family

951

138

Small Business Association (SBA)

1,191

1,214

Total

$

10,758

$

13,354

Loan servicing fees included a $11.6 million positive fair market value adjustment to servicing rights for the three months ended September 30, 2023, compared to a $4.6 million positive adjustment to fair value of servicing rights for the three months ended September 30, 2022.

Noninterest Expense.   Noninterest expense of $42.9 million for the three months ended September 30, 2023 increased $8.0 million, or 23%, compared to $35.0 million for the three months ended September 30, 2022. The increase was due primarily to a $4.0 million, or 17%, increase in salaries and employee benefits to support loan growth, as well as a $2.8 million, or 373%, increase in FDIC deposit insurance expenses. The efficiency ratio was at 28.0% for the three months ended September 30, 2023, compared with 30.5% for the three months ended September 30, 2022.

Income Taxes.   Provision for income tax of $25.1 million for the three months ended September 30, 2023 increased $6.1 million, or 33%, compared to the three months ended September 30, 2022. The increase primarily reflected a 38% increase in net income for the three months ended September 30, 2023.

The effective tax rate was 23.5% for the three months ended September 30, 2023 and 24.4% for the three months ended September 30, 2022.

Comparison of Operating Results for the Nine Months Ended September 30, 2023 and 2022

General.   Net income of $201.8 million for the nine months ended September 30, 2023 increased $39.2 million, or 24%, from net income of $162.6 million for the nine months ended September 30, 2022. The increase was primarily due to a $100.6 million increase in net interest income and a $7.0 million decrease in provision for income taxes that was partially offset by a $23.1 million increase in noninterest expense, a $22.7 million decrease in noninterest income and a $22.6 million increase in provision for credit losses.

Net Interest Income.    Net interest income of $323.7 million for the nine months ended September 30, 2023 increased $100.6 million, or 45%, compared to $223.1 million for the nine months ended September 30, 2022. The 45% increase reflected a $466.6 million, or 156%, increase in interest income from higher yields and average loan balances, partially offset by a $366.0 million, or 480%, increase in interest expense from higher rates and average balances of deposits. The interest rate spread of 2.52% for the nine months ended September 30, 2023 decreased 21 basis points compared to 2.73% for the nine months ended September 30, 2022.

Our net interest margin increased 17 basis points, to 3.07%, for the nine months ended September 30, 2023 from 2.90% for the nine months ended September 30, 2022.

Interest Income.   Interest income of $766.0 million for the nine months ended September 30, 2023 increased $466.6 million, or 156%, compared with $299.4 million for the nine months ended September 30, 2022. This increase

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was primarily attributable to an increase in higher average yields and average loan balances, as well as higher average balances of held to maturity securities that were acquired after September 30, 2022.

The average balance of loans, including loans held for sale, during the nine months ended September 30, 2023 increased $3.0 billion, or 33%, to $12.0 billion compared to $9.0 billion for the nine months ended September 30, 2022, and the average yield on loans increased 336 basis points, to 7.63% for the nine months ended September 30, 2023, compared to 4.27% for the nine months ended September 30, 2022.

The average balance of securities held to maturity, during the nine months ended September 30, 2023 increased $1.0 billion to $1.1 billion compared to the nine months ended September 30, 2022. The average yield on securities held to maturity increased 233 basis points, to 6.24% for the nine months ended September 30, 2023 ended, compared to 3.91% for the nine months ended September 30, 2022.

The average balance of securities available for sale increased $269.6 million, or 84%, to $592.5 million for the nine months ended September 30, 2023 compared to the nine months ended September 30, 2022, and the average yield increased 229 basis points, to 3.16% for the nine months ended September 30, 2023, compared to 0.87% for the nine months ended September 30, 2022.

The average balance of interest-earning deposits and other decreased $443.8 million, or 66%, to $231.5 million for the nine months ended September 30, 2023, from $675.3 million for the nine months ended September 30, 2022, and the average yield increased 482 basis points, to 5.45% for the nine months ended September 30, 2023, compared to 0.63% for the nine months ended September 30, 2022.

Interest Expense.   Total interest expense of $442.3 million for the nine months ended September 30, 2023 increased $366.0 million, or 480%, compared to $76.3 million for the nine months ended September 30, 2022.

Interest expense on deposits increased $336.6 million, or 491%, to $405.1 million for the nine months ended September 30, 2023, compared to the nine months ended September 30, 2022. The increase was primarily due to increases in rates on certificates of deposit, interest-bearing checking and money market accounts.

The average balance of certificates of deposit accounts was $4.4 billion for the nine months ended September 30, 2023, an increase of $3.2 billion, or 254%, compared to the nine months ended September 30, 2022. The average rate on certificates of deposit accounts was 4.94% for the nine months ended September 30, 2023, which was a 363 basis point increase compared to 1.31% for the nine months ended September 30, 2022.

The average balance of interest-bearing checking accounts of $4.4 billion for the nine months ended September 30, 2023 increased $392.3 million, or 10%, compared to $4.0 billion for the nine months ended September 30, 2022. The average rate on interest-bearing checking accounts was 4.47% for the nine months ended September 30, 2023, which was a 344 basis point increase compared to 1.03% for the nine months ended September 30, 2022.

The average balance of money market accounts of $2.8 billion for the nine months ended September 30, 2023 increased $179.0 million, or 7%, compared to $2.6 million for the nine months ended September 30, 2022. The average rate on money market accounts was 4.41% for the nine months ended September 30, 2023, which was a 314 basis point increase compared to 1.27% for the nine months ended September 30, 2022.

Interest expense on borrowings increased $29.5 million, or 384%, to $37.1 million for the nine months ended September 30, 2023 from the nine months ended September 30, 2022. The increase was due primarily to a 673 basis points increase in the average rate of borrowings to 8.33% compared to 1.60% for the nine months ended September 30, 2022. The increase was primarily related to the credit linked notes issued by the Company in 2023. The higher average rates were partially offset by a $46.4 million decrease in average balances compared to the nine months ended September 30, 2022. Additionally, borrowings include our warehouse structured financing agreements that provide for

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additional interest payments for a portion of the earnings generated. As a result, the cost of borrowings increased from a base rate of 8.12% and 1.03%, to an effective rate of 8.33% and 1.60% for the nine months ended September 30, 2023 and 2022, respectively.

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

Nine Months Ended September 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

$

231,549

$

9,434

 

5.45

%  

$

675,318

$

3,174

 

0.63

%  

Securities available for sale - taxable

 

592,460

 

14,012

 

3.16

%  

 

322,814

 

2,103

 

0.87

%  

Held to maturity securities

1,082,502

50,492

6.24

%  

33,148

 

970

 

3.91

%  

Mortgage loans in process of securitization

 

216,245

 

7,358

 

4.55

%  

 

260,452

 

5,856

 

3.01

%  

Loans and loans held for sale

 

11,998,301

 

684,743

 

7.63

%  

 

8,987,526

 

287,291

 

4.27

%  

Total interest-earning assets

 

14,121,057

 

766,039

 

7.25

%  

 

10,279,258

 

299,394

 

3.89

%  

Allowance for credit losses on loans

 

(54,417)

 

  

 

  

 

(34,614)

 

  

 

  

Noninterest-earning assets

 

474,883

 

  

 

  

 

324,068

 

  

 

  

Total assets

$

14,541,523

 

  

 

  

$

10,568,712

 

  

 

  

Liabilities/Equity:

 

  

 

  

 

  

 

  

 

  

 

  

Interest-bearing checking

$

4,417,224

$

147,585

 

4.47

%  

$

4,024,969

$

31,128

 

1.03

%  

Savings deposits

 

238,404

 

905

 

0.51

%  

 

236,334

 

257

 

0.15

%  

Money market

 

2,798,622

 

92,364

 

4.41

%  

 

2,619,729

 

24,914

 

1.27

%  

Certificates of deposit

 

4,443,014

 

164,295

 

4.94

%  

 

1,253,527

 

12,284

 

1.31

%  

Total interest-bearing deposits

 

11,897,264

 

405,149

 

4.55

%  

 

8,134,559

 

68,583

 

1.13

%  

Borrowings

 

596,174

 

37,144

 

8.33

%  

 

642,599

 

7,670

 

1.60

%  

Total interest-bearing liabilities

 

12,493,438

 

442,293

 

4.73

%  

 

8,777,158

 

76,253

 

1.16

%  

Noninterest-bearing deposits

 

328,143

 

  

 

  

 

464,973

 

  

 

  

Noninterest-bearing liabilities

 

169,746

 

  

 

  

 

107,276

 

  

 

  

Total liabilities

 

12,991,327

 

  

 

  

 

9,349,407

 

  

 

  

Equity

 

1,550,196

 

  

 

  

 

1,219,305

 

  

 

  

Total liabilities and equity

$

14,541,523

 

  

 

  

$

10,568,712

 

  

 

  

Net interest income

 

  

$

323,746

 

  

 

  

$

223,141

 

  

Interest rate spread

 

  

 

  

 

2.52

%

 

  

 

  

 

2.73

%

Net interest-earning assets

$

1,627,619

 

  

 

  

$

1,052,100

 

  

 

Net interest margin

 

  

 

  

 

3.07

%

 

  

 

  

 

2.90

%

Average interest-earning assets to average interest-bearing liabilities

 

  

 

  

 

113.03

%

 

  

 

  

 

117.11

%

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

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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.

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:

Nine Months Ended September 30, 2023

compared to September 30, 2022

Increase (Decrease)

Due to

(Dollars in thousands)

    

Volume

    

Rate

    

Total

Interest income

 

  

 

  

 

  

Interest-bearing deposits, and other

$

(2,086)

$

8,346

$

6,260

Securities available for sale - taxable

 

1,757

 

10,152

 

11,909

Securities held to maturity

30,707

18,815

 

49,522

Mortgage loans in process of securitization

 

(994)

 

2,496

 

1,502

Loans and loans held for sale

 

96,241

 

301,211

 

397,452

Total interest income

 

125,625

 

341,020

 

466,645

Interest expense

 

  

 

  

 

  

Deposits

 

  

 

  

 

  

Interest-bearing checking

 

3,034

 

113,423

 

116,457

Savings deposits

 

2

 

646

 

648

Money market deposits

 

1,701

 

65,749

 

67,450

Certificates of deposit

 

31,256

 

120,755

 

152,011

Total Deposits

 

35,993

 

300,573

 

336,566

Borrowings

 

(554)

 

30,028

 

29,474

Total interest expense

 

35,439

 

330,601

 

366,040

Net interest income

$

90,186

$

10,419

$

100,605

Provision for Credit Losses.   We recorded a provision for credit losses of $33.5 million for the nine months ended September 30, 2023, an increase of $22.6 million, or 208%, compared to $10.9 million for the nine months ended September 30, 2022. The increase was primarily due to loan growth in the period, as well as credit events and increases in qualitative factors and forecasted loss rates to reflect changes in industry conditions that were reported during the three months ended June 30, 2023, including:

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 $33.5 million total provision for credit losses consisted of $32.4 million for the ACL-Loans and $1.1 million for the ACL-OBCE’s. The ACL-Loans was $66.9 million, or 0.67%, of total loans, at September 30, 2023, compared to $44.0 million, or 0.59%, of total loans, at December 31, 2022, and $39.0 million, or 0.56%, at September 30, 2022.

Noninterest Income.   Noninterest income of $80.2 million for the nine months ended September 30, 2023 decreased $22.7 million, or 22%, compared to $103.0 million for the nine months ended September 30, 2022. The decrease was primarily due to a $24.0 million, or 45%, decrease in gain on sale of loans associated with a shift in

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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.

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

Gain on Sale of Loans

Nine Months Ended

September 30, 

September 30, 

2023

2022

(in thousands)

Loan Type

Multi-family

$

23,897

$

46,578

Single-family

1,430

1,001

Small Business Association (SBA)

3,514

5,304

Total

$

28,841

$

52,883

Partially offsetting the decreases in noninterest income was a $2.2 million increase in syndication and asset management fees compared to the nine months ended September 30, 2022. This line of business is becoming a more meaningful source of noninterest income.

Also offsetting the decreases in noninterest income was a $0.9 million increase in loan servicing fees compared to the nine months ended September 30, 2022. The decrease reflected lower positive adjustments to fair value of servicing rights partially offset by higher servicing fees. Included in loan servicing fees was a $12.2 million positive adjustment to the fair value of servicing rights for the nine months ended September 30, 2023, compared to a positive adjustment of $19.9 million for the nine months ended September 30, 2022.

Noninterest Expense.   Noninterest expense of $122.0 million for the nine months ended September 30, 2023 increased $23.1 million, compared to $98.9 million for the nine months ended September 30, 2022. The increase was primarily due to a $8.1 million, or 12%, increase in salaries and employee benefits as well as a $7.4 million, or 337%, increase in deposit insurance expense, reflecting asset growth. The efficiency ratio was at 30.2% for the nine months ended September 30, 2023, compared with 30.3% in the nine months ended September 30, 2022.

Income Taxes.   Provision for income taxes of $46.7 million for the nine months ended September 30, 2023 decreased $7.0 million, or 13%, compared to $53.7 million for the nine months ended September 30, 2022. The decrease reflected a $13.0 million tax benefit related to tax refunds receivable and changes to state tax apportionment calculations that were partially offset by taxes on higher pre-tax income.

The effective tax rate was 18.8% for the nine months ended September 30, 2023 and 24.8% for the nine months ended September 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 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 September 30, 2023 the Company’s total servicing portfolio had an unpaid principal balance of $24.5 billion, primarily managed in the Multi-Family Mortgage Banking segment. Included in this amount was an

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unpaid principal balance of loans serviced for others of $14.5 billion, an unpaid principal balance of loans sub-serviced for others of $2.1 billion, and other servicing balances of $0.7 billion at September 30, 2023. These loans are not included in the accompanying balance sheets. The Company also manages $7.2 billion of loans for customers that have loans on the balance sheet at September 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 $78.3 billion in 2021, $33.2 billion in 2022, and $24.6 billion for the nine months ended September 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 warehouse lender ranked by total 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 and Correspondent Mortgage Banking share customer leads. 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 September 30, 2023 and 2022, we had total net income of $81.5 million and $58.5 million, respectively. For the nine months ended September 30, 2023 and 2022, we had total net income of $201.8 million and $162.6 million, respectively. Net income for our segments for the respective periods was as follows:

For the Three Months Ended

For the Nine Months Ended

September 30, 

September 30, 

    

2023

    

2022

    

2023

    

2022

    

(In thousands)

Multi-family Mortgage Banking

$

14,685

$

13,366

$

27,893

$

44,414

Mortgage Warehousing

 

19,926

 

11,801

 

47,163

 

36,828

Banking

 

52,445

 

39,344

 

144,402

 

94,040

Other

 

(5,552)

 

(6,023)

 

(17,697)

 

(12,717)

Total

$

81,504

$

58,488

$

201,761

$

162,565

Multi-family Mortgage Banking.    

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

The Multi-family Mortgage Banking segment reported net income of $14.7 million for the three months ended September 30, 2023, an increase of $1.3 million, or 10%, compared to the three months ended September 30, 2022. The

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increase was primarily due to a $1.0 million increase in net interest income and a $2.6 million decrease in noninterest expenses, that was partially offset by a $2.2 million decrease in noninterest income.

Noninterest income included a $9.3 million increase in loan servicing fees that was offset by a $10.7 million decrease on gain on sale of loans for the three months ended September 30, 2023. Loan servicing fees included a positive fair market value adjustment of $10.4 million on servicing rights, compared to a positive fair market value adjustment of $3.7 million for the three months ended September 30, 2022.

The total volume of loans originated and acquired through our multi-family business was $1.4 billion for the three months ended September 30, 2023, a decrease of $869.4 million, or 39%, compared to $2.2 billion for the three months ended September 30, 2022. Many of these loans are bridge loans housed in our banking segment while borrowers await conversion to permanent financing. The volume of bridge loans was $785.8 million for the three months ended September 30, 2023, a decrease of $705.7 million, or 47%, compared to $1.5 billion for the three months ended September 30, 2022. The volume of loans originated and acquired for sale in the secondary market increased by $55.1 million, or 15%, to $422.1 million, compared to $367.0 million for the three months ended September 30, 2022.

Comparison of results for the nine months ended September 30, 2023 and 2022:

The Multi-family Mortgage Banking segment reported net income of $27.9 million for the nine months ended September 30, 2023, a decrease of $16.5 million, or 37%, from the $44.4 million of net income reported for the nine months ended September 30, 2022. The decrease was primarily due to a $36.8 million decrease in noninterest income, including a $42.9 million decrease in gain on sale of loans that was partially offset by a $8.1 million increase in loan servicing fees.

Loan servicing fees for the nine months ended September 30, 2023 included a positive fair market value adjustment of $10.4 million on servicing rights, compared to a positive fair market value adjustment of $13.6 million for the nine months ended September 30, 2022.

The lower noninterest income was partially offset by a $10.0 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 a $6.5 million decrease in noninterest expense that was associated with lower commission expenses on lower gain on sale for the nine months ended September 30, 2023.

The total volume of loans originated and acquired through our multi-family business was $3.7 billion for the nine months ended September 30, 2023, a decrease of $3.1 billion, or 46%, compared to $6.8 billion for the nine months ended September 30, 2022. Many of these loans are bridge loans housed in our banking segment while borrowers await conversion to permanent financing. The volume of bridge loans was $1.8 billion for the nine months ended September 30, 2023, a decrease of $3.0 billion, or 62%, compared to $4.8 billion for the nine months ended September 30, 2022. The volume of loans originated and acquired for sale in the secondary market decreased by $110.6 million, or 8%, to $1.2 billion, compared to $1.3 billion for the nine months ended September 30, 2022.

Mortgage Warehousing.  

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

The Mortgage Warehousing segment reported net income of $19.9 million for the three months ended September 30, 2023, an increase of $8.1 million, or 69%, compared to the three months ended September 30, 2022. The higher net income reflected a $11.5 million increase in net interest income primarily from higher yields and volumes on loans held for sale and revolving lines of credit that are collateralized by mortgage servicing rights.

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There was a 23% increase in warehouse loan volume of $10.8 billion compared to $8.8 billion for the three months ended September 30, 2022, which compared to an industry volume decrease of 10%, according to the Mortgage Bankers Association.

Comparison of results for the nine months ended September 30, 2023 and 2022:

The Mortgage Warehousing segment reported net income for the nine months ended September 30, 2023 of $47.2 million, an increase of $10.3 million, or 28%, over the nine months ended September 30, 2022. The higher net income was primarily due to a $11.3 million increase in net interest income associated with higher interest income due to higher yields and volume on loans held for sale and revolving lines of credit that are collateralized by mortgage servicing rights.

There was a 9% decrease in warehouse loan volume of $24.6 billion compared to $26.9 billion for the nine months ended September 30, 2022, which compared to an industry volume decrease of 35% according to the Mortgage Bankers Association.

Banking.   

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

The Banking segment reported net income of $52.4 million for the three months ended September 30, 2023, an increase of $13.1 million, or 33%, compared to the three months ended September 30, 2022. The increase was primarily due to a $19.2 million increase in net interest income and a $7.8 million increase in noninterest income, which were partially offset by a $7.2 million increase in noninterest expense and a $4.2 million increase in the provision for income taxes.

Noninterest income for the three months ended September 30, 2023 included a positive fair market value adjustment of $1.2 million on single-family servicing rights, compared to a positive fair market value adjustment of $0.9 million for the three months ended September 30, 2022.

Comparison of results for the nine months ended September 30, 2023 and 2022:

The Banking segment reported net income of $144.4 million for the nine months ended September 30, 2023, an increase of $50.4 million, or 54%, compared to $94.0 million for the nine months ended September 30, 2022. The increase was primarily due to a $84.8 million increase in net interest income and a $13.9 million increase in noninterest income, partially offset by a $21.4 million increase in the provision for credit losses, and a $20.3 million increase in noninterest expense.

Noninterest income for the nine months ended September 30, 2023 included a positive fair market value adjustment of $1.8 million on single-family servicing rights, compared to a positive fair market value adjustment of $6.3 million for the nine months ended September 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 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 September 30, 2023, based on available collateral, we had $5.4 billion in available unused borrowing capacity with the FHLB and the Federal Reserve discount window. While the amounts available fluctuate daily, we also had

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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 $5.4 billion described below, these totaled $10.7 billion, or 65%, of its $16.5 billion total assets at September 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 September 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 $1.8 billion as of September 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 September 30, 2023, Accumulated Other Comprehensive Losses (“AOCL”) of $4.8 million losses, related to securities available for sale, decreased $5.8 million, or 55%, compared to losses of $10.5 million as of December 31, 2022. The $4.8 million loss in AOCL as of September 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 $(1.1) billion and $1.8 billion for the nine months ended September 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 $(3.0) billion for the nine months ended September 30, 2023 and 2022, respectively. Net cash provided by financing activities, which is comprised primarily of net change in borrowings and deposits was $3.6 billion and $507.4 million for the nine months ended September 30, 2023 and 2022, respectively.

At September 30, 2023 we had $3.4 billion in outstanding commitments to extend credit that are subject to credit risk and $5.7 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. Additionally, our business model is designed to sell a significant portion of our loans, which provides flexibility in managing liquidity.

Certificates of deposit that are scheduled to mature in less than one year from September 30, 2023 totaled $4.9 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.

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,

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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 September 30, 2023, compared to $1.5 billion as of December 31, 2022. The $173.0 million increase resulted primarily from net income of $201.8 million, which was partially offset by dividends paid on common and preferred shares of $36.4 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 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

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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 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 September 30, 2023, the Company had 43,240,212 common shares issued and outstanding. The Board expects to declare a quarterly dividend of $0.08 per share in each quarter of 2023.

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Capital Adequacy.

The following tables present the Company’s capital ratios at September 30, 2023 and December 31, 2022:

Minimum

Minimum

Amount to be Well

Amount To Be

Capitalized with

Well

Actual

Basel III Buffer(1)

Capitalized(1)

    

Amount

    

Ratio

    

Amount

    

Ratio

Amount

    

Ratio

    

(Dollars in thousands)

September 30, 2023

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

 

  

 

  

 

  

 

  

 

Company

$

1,699,507

 

11.5

%  

$

1,556,494

 

10.5

%  

$

 

N/A

%  

Merchants Bank

1,669,849

 

11.5

%  

 

1,526,849

 

10.5

%  

 

1,454,142

 

10.0

FMBI

 

38,995

 

11.2

%  

 

36,546

 

10.5

%  

 

34,806

 

10.0

%  

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

 

  

 

  

 

  

 

  

 

  

 

  

Company

 

1,620,024

 

10.9

%  

 

1,260,019

 

8.5

%  

 

 

N/A

%  

Merchants Bank

1,591,057

 

10.9

%  

 

1,236,021

 

8.5

%  

 

1,163,314

 

8.0

FMBI

 

38,303

 

11.0

%  

 

29,585

 

8.5

%  

 

27,845

 

8.0

%  

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

Company

 

1,120,416

 

7.6

%  

 

1,037,663

 

7.0

%  

 

 

N/A

%  

Merchants Bank

1,591,057

 

10.9

%  

 

1,017,899

 

7.0

%  

 

945,192

 

6.5

FMBI

 

38,303

 

11.0

%  

 

24,364

 

7.0

%  

 

22,624

 

6.5

%  

Tier I capital(1) (to average assets)

 

 

  

 

  

 

 

  

 

  

Company

 

1,620,024

 

10.1

%  

 

640,543

 

4.0

%  

 

 

N/A

%  

Merchants Bank

1,591,057

 

10.1

%  

 

628,478

 

4.0

%  

 

785,597

 

5.0

FMBI

 

38,303

 

10.6

%  

 

14,440

 

4.0

%  

 

18,050

 

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 September 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 September 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.

Quantitative and Qualitative Disclosures About Market Risk

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

Interest Rate Risk

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

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a nonparallel fashion (yield curve risk), and changes in spread relationships between different yield curves, such as U.S. Treasuries 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 September 30, 2023 and December 31, 2022.

Net Interest Income Sensitivity

 

Twelve Months Forward

 

- 200

    

- 100

    

+ 100

    

+ 200

 

(Dollars in thousands)

 

September 30, 2023:

  

 

  

 

  

 

  

Dollar change

$

(82,126)

$

(40,859)

$

26,931

$

51,728

Percent change

 

(16.7)

%  

 

(8.3)

%  

 

5.5

%  

 

10.5

%

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 September 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)

 

September 30, 2023:

  

 

  

 

  

 

  

Dollar change

$

34,279

$

19,426

$

(25,408)

$

(65,764)

Percent change

 

2.2

%  

 

1.2

%  

 

(1.6)

%  

 

(4.2)

%

December 31, 2022:

 

  

 

  

 

  

 

  

Dollar change

$

22,855

$

11,640

$

(10,925)

$

(26,385)

Percent change

 

1.6

%  

 

0.8

%  

 

(0.8)

%  

 

(1.9)

%

Our interest rate risk management policy limits the change in our EVE to 15% for a +/- 100 basis point move in interest rates, and 20% for a +/- 200 basis point move in rates. We are within policy limits set by our board of directors for the -200, -100, +100 and +200 basis point scenarios. The EVE reported at September 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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Merchants Bancorp

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 September 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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Merchants Bancorp

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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Merchants Bancorp

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:

November 9, 2023

By:

/s/ Michael F. Petrie

Michael F. Petrie

Chairman & Chief Executive Officer

Date:

November 9, 2023

By:

/s/ John F. Macke

John F. Macke

Chief Financial Officer

(Principal Financial & Accounting Officer)

72