Table of Contents
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
FORM 10-Q
(Mark One)
☒
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended
March 31, 2024
OR
☐
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ____________ to _______________
Commission File No. 001-38258
MERCHANTS BANCORP
(Exact name of registrant as specified in its charter)
Indiana
20-5747400
(State or other jurisdiction of
(I.R.S. Employer
incorporation or organization)
Identification Number)
410 Monon Blvd. Carmel, Indiana
46032
(Address of principal
(Zip Code)
executive office)
(317) 569-7420
(Registrant’s telephone number, including area code)
N/A
(Former name or former address, if changed since last report)
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). ☒ Yes ☐ No
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer ☐
Accelerated filer ☒
Non-accelerated filer ☐
Smaller reporting company ☐
Emerging growth company ☐
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act.). Yes ☐ No ☒
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
Trading Symbol(s)
Name of each exchange on which registered
Common Stock, without par value
MBIN
NASDAQ
Series A Preferred Stock, without par value
Depositary Shares, each representing a 1/40th interest in a share of Series B Preferred Stock, without par value
MBINP
MBINO
NASDAQ (Redeemed April 1, 2024)
Depositary Shares, each representing a 1/40th interest in a share of Series C Preferred Stock, without par value
Depositary Shares, each representing a 1/40th interest in a share of Series D Preferred Stock, without par value
MBINN
MBINM
As of May 1, 2024, the latest practicable date, 43,354,718 shares of the registrant’s common stock, without par value, were issued and outstanding.
Merchants Bancorp
Index to Quarterly Report on Form 10-Q
PART I – FINANCIAL INFORMATION
Item 1 Interim Financial Statements (Unaudited)
Condensed Consolidated Balance Sheets as of March 31, 2024 and December 31, 2023
3
Condensed Consolidated Statements of Income for the Three Months Ended March 31, 2024 and 2023
4
Condensed Consolidated Statements of Comprehensive Income for the Three Months Ended March 31, 2024 and 2023
5
Condensed Consolidated Statements of Shareholders’ Equity for the Three Months Ended March 31, 2024 and 2023
6
Condensed Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2024 and 2023
7
Notes to Condensed Consolidated Financial Statements
8
Item 2 Management’s Discussion and Analysis of Financial Condition and Results of Operations
47
Item 3 Quantitative and Qualitative Disclosures About Market Risk
65
Item 4 Controls and Procedures
PART II – OTHER INFORMATION
66
Item 1 Legal Proceedings
Item 1A Risk Factors
Item 2 Unregistered Sales of Equity Securities and Use of Proceeds
Item 3 Defaults Upon Senior Securities
Item 4 Mine Safety Disclosures
Item 5 Other Information
Item 6 Exhibits
67
SIGNATURES
68
2
Part I – Financial Information
Item 1. Financial Statements
Condensed Consolidated Balance Sheets
March 31, 2024 (Unaudited) and December 31, 2023
(In thousands, except share data)
March 31,
December 31,
2024
2023*
Assets
Cash and due from banks
$
17,924
15,592
Interest-earning demand accounts
490,831
568,830
Cash and cash equivalents
508,755
584,422
Securities purchased under agreements to resell
3,329
3,349
Mortgage loans in process of securitization
142,629
110,599
Securities available for sale ($700,640 and $722,497 utilizing fair value option, respectively)
1,061,288
1,113,687
Securities held to maturity ($1,176,178 and $1,203,535 at fair value, respectively)
1,175,167
1,204,217
Federal Home Loan Bank (FHLB) stock
64,215
48,578
Loans held for sale (includes $84,513 and $86,663 at fair value, respectively)
3,503,131
3,144,756
Loans receivable, net of allowance for credit losses on loans of $75,712 and $71,752, respectively
10,690,513
10,127,801
Premises and equipment, net
42,450
42,342
Servicing rights
172,200
158,457
Interest receivable
90,303
91,346
Goodwill
8,014
15,845
Intangible assets, net
149
742
Other assets and receivables
360,433
306,375
Total assets
17,822,576
16,952,516
Liabilities and Shareholders' Equity
Liabilities
Deposits
Noninterest-bearing
319,872
520,070
Interest-bearing
13,655,789
13,541,390
Total deposits
13,975,661
14,061,460
Borrowings
1,835,985
964,127
Deferred and current tax liabilities, net
43,935
19,923
Other liabilities
190,527
205,922
Total liabilities
16,046,108
15,251,432
Commitments and Contingencies
Shareholders' Equity
Common stock, without par value
Authorized - 75,000,000 shares
Issued and outstanding - 43,354,718 shares at March 31, 2024 and 43,242,928 shares at December 31, 2023
139,950
140,365
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
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
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
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
Retained earnings
1,138,083
1,063,599
Accumulated other comprehensive loss
(1,173)
(2,488)
Total shareholders' equity
1,776,468
1,701,084
Total liabilities and shareholders' equity
* Derived from audited consolidated financial statements.
See notes to condensed consolidated financial statements.
Condensed Consolidated Statements of Income (Unaudited)
For the Three Months Ended March 31, 2024 and 2023
Three Months Ended
2023
Interest Income
Loans
271,998
189,450
1,720
1,648
Investment securities:
Available for sale
14,388
2,266
Held to maturity
20,522
15,754
Federal Home Loan Bank stock
844
427
Other
4,701
1,749
Total interest income
314,173
211,294
Interest Expense
171,022
104,442
Borrowed funds
16,095
6,159
Total interest expense
187,117
110,601
Net Interest Income
127,056
100,693
Provision for credit losses
4,726
6,867
Net Interest Income After Provision for Credit Losses
122,330
93,826
Noninterest Income
Gain on sale of loans
9,356
6,733
Loan servicing fees, net
19,402
2,360
Mortgage warehouse fees
982
1,028
Loss on sale of investments available for sale (includes $(108) and $0, respectively, related to accumulated other comprehensive loss reclassifications)
(108)
—
Syndication and asset management fees
5,303
1,212
Other income
5,939
2,931
Total noninterest income
40,874
14,264
Noninterest Expense
Salaries and employee benefits
29,596
22,146
Loan expenses
956
804
Occupancy and equipment
2,237
2,232
Professional fees
4,099
2,269
Deposit insurance expense
5,125
2,178
Technology expense
1,854
1,577
Other expense
5,045
3,566
Total noninterest expense
48,912
34,772
Income Before Income Taxes
114,292
73,318
Provision for income taxes (includes $26 and $0, respectively, related to income tax benefit for reclassification items)
27,238
18,363
Net Income
87,054
54,955
Dividends on preferred stock
(8,667)
Net Income Allocated to Common Shareholders
78,387
46,288
Basic Earnings Per Share
1.81
1.07
Diluted Earnings Per Share
1.80
Weighted-Average Shares Outstanding
Basic
43,305,985
43,179,604
Diluted
43,466,647
43,290,779
Condensed Consolidated Statements of Comprehensive Income (Unaudited)
(In thousands)
Other Comprehensive Income:
Net unrealized gain on investment securities available for sale, net of tax expense of $(384) and $(934), respectively
1,233
2,792
Add: Reclassification adjustment for losses included in net income, net of tax benefit of $26 and $0, respectively
82
Other comprehensive income for the period
1,315
Comprehensive Income
88,369
57,747
Condensed Consolidated Statement of Shareholders’ Equity (Unaudited)
Shares
Amount
Common Stock
Balance beginning of period
43,242,928
43,113,127
137,781
Distribution to employee stock ownership plan
23,414
997
33,293
810
Shares issued for stock compensation plans, net of taxes withheld to satisfy tax obligations
88,376
(1,412)
87,198
(486)
Balance end of period
43,354,718
43,233,618
138,105
7% Series A Preferred Stock
Balance at beginning and end of period
2,081,800
(All shares were redeemed as of April 1, 2024)
6% Series B Preferred Stock
125,000
6% Series C Preferred Stock
196,181
8.25% Series D Preferred Stock
142,500
Retained Earnings
832,871
Net income
Dividends on 7% Series A preferred stock, $1.75 per share, annually
(910)
Dividends on 6% Series B preferred stock, $60.00 per share, annually
(1,875)
Dividends on 6% Series C preferred stock, $60.00 per share, annually
(2,943)
Dividends on 8.25% Series D preferred stock, $82.50 per share, annually
(2,939)
Dividends on common stock, $0.36 per share, annually in 2024 and $0.32 per share, annually in 2023
(3,903)
(3,459)
875,700
Accumulated Other Comprehensive Loss
(10,521)
Other comprehensive income
(7,729)
1,505,684
Condensed Consolidated Statements of Cash Flows (Unaudited)
Three Months Ended March 31, 2024 and 2023
Operating activities:
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation
725
686
Loss on sale of securities
108
(9,356)
(6,733)
Proceeds from sales of loans
4,694,759
3,356,860
Loans and participations originated and purchased for sale
(5,078,607)
(3,674,484)
Proceeds from sale of low-income housing tax credits
25,861
8,670
Purchases of low-income housing tax credits for sale
(21,113)
(7,932)
Change in servicing rights for paydowns and fair value adjustments
(11,577)
4,554
Net change in:
(32,030)
(42,880)
(58,186)
(8,116)
14,595
7,607
(731)
(1,587)
Net cash used in operating activities
(383,772)
(301,533)
Investing activities:
Net change in securities purchased under agreements to resell
20
26
Purchases of securities available for sale
(193,957)
(353,249)
Purchases of securities held to maturity
(1,540)
Proceeds from the sale of securities available for sale
9,983
Proceeds from calls, maturities and paydowns of securities available for sale
231,585
832
Proceeds from calls, maturities and paydowns of securities held to maturity
29,050
15,783
Purchases of loans
(27,727)
(98,791)
Net change in loans receivable
(552,568)
(678,522)
Proceeds from loans held for sale previously classified as loans receivable
1,600
Purchase of FHLB stock
(16,031)
Proceeds from sale of FHLB stock
394
Purchases of premises and equipment
(2,306)
(1,041)
Purchase of limited partnership interests
(4,157)
(4,580)
Net cash paid on sale of branches
(171,319)
Other investing activities
414
906
Net cash used in investing activities
(695,019)
(1,120,176)
Financing activities:
Net change in deposits
144,036
1,273,886
Proceeds from borrowings
26,751,878
22,335,000
Repayment of borrowings
(25,871,971)
(22,185,180)
Proceeds from credit linked notes
153,546
Payment of credit linked notes
(8,249)
Dividends
(12,570)
(12,126)
Other financing activities
Net cash provided by financing activities
1,003,124
1,565,131
Net Change in Cash and Cash Equivalents
(75,667)
143,422
Cash and Cash Equivalents, Beginning of Period
226,164
Cash and Cash Equivalents, End of Period
369,586
Supplemental Cash Flows Information:
Interest paid
178,751
101,381
Income taxes paid, net of refunds
783
966
Change in ROU assets due to lease renegotiation
(1,349)
Transfer of loans from loans held for sale to loans receivable
31,350
377,460
Transfer of loans from loans receivable to loans held for sale
(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”) (whose branches were sold to unaffiliated third parties and its remaining charter collapsed into Merchants Bank on January 26, 2024), 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, 2023, which has been derived from audited financial statements, and unaudited condensed consolidated financial statements of the Company as of March 31, 2024 and for the three months ended March 31, 2024 and 2023, 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 unaudited 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, 2023 in its Annual Report on Form 10-K. Reference is made to the accounting policies of the Company described in the Notes to the Financial Statements contained in the Annual Report on Form 10-K.
In the opinion of management, all adjustments (consisting only of normal recurring adjustments) which are necessary for a fair presentation of the unaudited financial statements have been included to present fairly the financial position as of March 31, 2024 and the results of operations, cash flows, and changes in shareholders’ equity for the three months ended March 31, 2024 and 2023. All interim amounts have not been audited and the results of operations for the three months ended March 31, 2024, herein are not necessarily indicative of the results of operations to be expected for the entire year.
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.
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.
On January 26, 2024, the transaction was completed after having met customary closing conditions, including regulatory approval.
In addition to the branches, Bank of Pontiac acquired approximately $164.8 million in deposits and $19.2 million in loans, and CBI Bank & Trust acquired approximately $65.1 million in deposits and $28.6 million in loans.
Total assets and liabilities of approximately $60.8 million and $230.6 million, respectively, were sold. A net gain of $715,000 was recognized from the transactions, which includes a $10.1 million deposit premium and the extinguishment of $7.8 million in goodwill and $0.5 million in intangibles during the three months ended March 31, 2024.
Principles of Consolidation
The unaudited condensed consolidated financial statements as of and for the period ended March 31, 2024 and 2023 include results from the Company, and its wholly owned subsidiaries, Merchants Bank, FMBI (until its branches were sold and its bank charter merged into Merchants Bank on January 26, 2024) 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.
During 2022, Merchants Foundation, Inc., a nonprofit corporation, was incorporated and its results are consolidated with the Company’s consolidated financial statements in all periods presented.
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 (“ASU”) 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 our 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 March 31, 2024 and December 31, 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.
Use of Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Material estimates that are particularly susceptible to significant change relate to the determination of the allowance for credit losses on loans, servicing rights and fair values of financial instruments.
Significant Accounting Policies
The significant accounting policies followed by the Company for interim financial reporting are consistent with the accounting policies followed for annual financial reporting.
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. The balance of the notes as of March 31, 2024 was $115.6 million. As of March 31, 2024, there was $39.2 million in restricted cash. Also see Note 11: Borrowings.
9
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:
Gross
Amortized
Unrealized
Fair
Cost
Gains
Losses
Value
Securities available for sale:
Treasury notes
109,146
15
58
109,103
Federal agencies
240,000
1,499
238,501
Mortgage-backed - Government Agency ("Agency") (2) - multi-family
13,044
Mortgage-backed - Non-Agency residential - fair value option (1)
472,192
Mortgage-backed - Agency - residential - fair value option (1)
228,448
Total securities available for sale
1,062,830
1,557
Securities held to maturity:
Mortgage-backed - Non-Agency - multi-family
710,024
419
709,605
Mortgage-backed - Non-Agency - residential
453,167
2,385
87
455,465
Mortgage-backed - Agency
11,976
868
11,108
Total securities held to maturity
1,374
1,176,178
(1)
For fair value option securities, the amortized cost reflects the carrying value, which is also equal to the fair value.
(2)
Agency includes government sponsored agencies, such as Federal National Mortgage Association (“Fannie Mae”), Federal Home Loan Mortgage Corporation (“Freddie Mac”), and Government National Mortgage Association (“Ginnie Mae”).
December 31, 2023
129,261
45
338
128,968
250,731
2,976
247,755
14,465
14,467
485,500
236,997
1,116,954
50
3,317
719,662
415
719,247
472,539
973
418
473,094
12,016
822
11,194
1,655
1,203,535
Agency includes government sponsored agencies, such as Fannie Mae, Freddie Mac, and Ginnie Mae.
Accrued interest on securities available for sale totaled $5.1 million at March 31, 2024 and $6.7 million at December 31, 2023, and is excluded from the estimate of credit losses.
10
Accrued interest on securities held to maturity totaled $5.6 million at March 31, 2024 and $5.8 million at December 31, 2023, and is excluded from the estimate of credit losses.
The amortized cost and fair value of available for sale securities at March 31, 2024 and December 31, 2023, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties. Securities not due at a single maturity date are shown separately.
Within one year
209,146
207,796
308,474
305,406
After one through five years
140,000
139,808
71,518
71,317
349,146
347,604
379,992
376,723
Mortgage-backed - Non-Agency residential - fair value option
Mortgage-backed - Agency - residential - fair value option
During the three months ended March 31, 2024, the Company recognized a net loss of $108,000 from sales of securities available for sale. The $108,000 net loss consisted of $10,000 in gains and $118,000 of losses. During the three months ended March 31, 2023, no securities available for sale were sold.
The following tables show the Company’s gross unrealized losses and fair value of the Company’s investment securities with unrealized losses, for which an allowance for credit losses (“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 March 31, 2024 and December 31, 2023:
12 Months or
Less than 12 Months
Longer
Total
3,092
1
26,938
57
30,030
192
98,693
1,307
142,900
193
125,631
1,364
268,531
11
3,052
32,080
332
35,132
60,541
189
167,213
2,787
227,754
364
186
550
63,957
196
199,479
3,121
263,436
Allowance for Credit Losses (ACL)
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 noncredit 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 March 31, 2024 and December 31, 2023.
Securities held to maturity are comprised of non-agency mortgage-backed securities secured by multi-family or single-family properties, and agency mortgage-backed securities secured by multi-family properties. The agency securities are 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-agency 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-agency securities.
Note 3: Mortgage Loans in Process of Securitization
Mortgage loans in process of securitization are recorded at fair value with changes in fair value recorded in earnings. These include multi-family rental real estate loan originations to be sold as Ginnie Mae mortgage-backed securities, and Fannie Mae and Freddie Mac participation certificates, all of which are pending settlements under firm
12
investor commitments to purchase the securities, typically occurring within 30 days. The fair value increases recorded in earnings for mortgage loans in process of securitization totaled $0.7 million and $4.0 million for the three months ended March 31, 2024 and 2023, 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 unaudited condensed consolidated balance sheets. Accrued interest on loans totaled $60.2 million and $60.4 million at March 31, 2024 and December 31, 2023, 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 principal 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 repurchase agreements to fund mortgage loans held for sale from closing until sale to an investor. Under a warehousing arrangement the Company funds a mortgage loan through 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.
13
Loan Portfolio Summary
Loans receivable at March 31, 2024 and December 31, 2023 include:
Mortgage warehouse repurchase agreements
1,142,994
752,468
Residential real estate(1)
1,321,300
1,324,305
Multi-family financing
4,096,606
4,006,160
Healthcare financing
2,464,685
2,356,689
Commercial and commercial real estate(2)(3)
1,666,751
1,643,081
Agricultural production and real estate
65,977
103,150
Consumer and margin loans
7,912
13,700
10,766,225
10,199,553
Less:
ACL-Loans
75,712
71,752
Loans Receivable
Risk characteristics applicable to each segment of the loan portfolio are described as follows.
Mortgage Warehouse Repurchase Agreements (MTG WHRA): Under its warehouse program, the Company provides warehouse financing arrangements to approved mortgage companies for their origination and sale of residential mortgage and multi-family loans. Loans secured by mortgages placed on existing one-to-four family dwellings may be originated or purchased and placed through each mortgage warehouse facility.
As a secured repurchase agreement, collateral pledged to the Company secures each individual mortgage until the mortgage company sells the loan in the secondary market. A traditional secured warehouse facility 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 companies in warehouse, the sale of which is the expected source of repayment under a warehouse facility. 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 one-to-four family residences. Repayment of residential real estate loans is primarily dependent on the personal income and credit rating of the borrowers. First-lien HELOC mortgages included in this segment typically carried a base rate of 30-day LIBOR, plus a margin. With the sunset of LIBOR, loans have been transitioned to the One-Year Constant Maturity Treasury (“CMT”), plus a margin.
14
Multi-Family Financing (MF FIN): The Company specializes in originating multi-family financing that can be market rate or affordable. The portfolio includes loans for construction, acquisition, refinance, or permanent financing. Loans are typically secured by real estate mortgages, assignment of Low-Income Housing Tax Credits (“LIHTC”), and/or equity interest in the underlying properties. All loans are assessed and reviewed at a minimum based on borrower strength/experience, historical property performance, market trends, projected financial performance with regards to intended strategy, and source of repayment. Independent third-party reports are used to ensure legal conformity and support valuations of the assets. Exit strategies and sources of repayment are provided through the secondary market via governmental programs, strategic refinances, LIHTC equity installments, and cashflow from the properties. Repayment of these loans depends on the successful operation of a business or property and the borrower’s cash flows. Credit risk in these loans may be impacted by the creditworthiness of a borrower, property values and the local economy in the related market area. These loans are well-collateralized and underwritten to agency guidelines. Loans included in this segment typically carry a base rate of 30-day SOFR, that adjusts on a monthly basis, and a margin. The Company strategically focuses on loan classes that are government backed or can be sold in the secondary market.
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. These loans are well-collateralized and underwritten to agency guidelines. Loans included in this segment typically carry a base rate of 30-day SOFR, that adjusts on a monthly basis, and a margin. The Company strategically focuses on loan classes that are government backed or can be sold in the secondary market.
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 that are assessed for fair value quarterly at the Company’s request. 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.
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 adjustable rate mortgage (“ARM”), three-year ARM or five-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 five 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.
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 included in 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 three months ended March 31, 2024. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available. The level of the ACL is believed to be adequate to absorb innate expected future losses in the loan portfolio as of the measurement date.
The ACL-Loans consists of individually evaluated loans and pooled loan components. The Company’s primary portfolio segmentation is by 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 ACL-Loans risk graded pass through special mention, the portfolio is segmented by loans with similar risk characteristics.
Loan Portfolio Segment
ACL-Loans Methodology
Remaining Life Method
Residential real estate loans
Discounted Cash Flow
Commercial and commercial real estate
Loan characteristics used in determining the segmentation included the underlying collateral, type or purpose of the loan, and expected credit loss patterns. The initial estimate 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 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.
16
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 table presents, by loan portfolio segment, the activity in the ACL-Loans for the three months ended March 31, 2024 and 2023:
For the Three Months Ended March 31, 2024
MTG WHRA
RES RE
MF FIN
HC FIN
CML & CRE
AG & AGRE
CON & MAR
TOTAL
Balance, beginning of period
2,070
7,323
26,874
22,454
12,243
619
169
FMBI's ACL for loans sold
(55)
(186)
(92)
(246)
(12)
(593)
952
(363)
1,976
2,135
763
77
(63)
5,477
Loans charged to the allowance
(925)
Recoveries of loans previously charged-off
Balance, end of period
3,022
6,905
28,664
24,587
11,990
450
94
For the Three Months Ended March 31, 2023
1,249
7,029
16,781
9,882
8,326
565
182
44,014
349
3,070
1,871
2,149
(22)
(15)
7,817
1,664
7,378
19,851
11,753
10,482
543
167
51,838
The Company recorded a total provision for credit losses of $4.7 million for the three months ended March 31, 2024. The $4.7 million total provision for credit losses consisted of $4.9 million for the ACL-Loans as shown above and $(0.2) million for the ACL-Off-Balance Sheet Credit Exposures (“OBCE’s”). The $4.9 million total provision for ACL-Loans reflected an elimination of $593,000 from the sale of FMBI branches in January 2024.
The Company recorded a total provision for credit losses of $6.9 million for the three months ended March 31, 2023. The $6.9 million total provision for credit losses consisted of $7.8 million for the ACL-Loans as shown above and $(0.9) million for the ACL-OBCE’s.
The following table presents, by loan portfolio segment, the activity in the ACL-Loans for the twelve months ended December 31, 2023:
For the Year Ended December 31, 2023
821
328
18,493
12,572
5,232
54
37,488
(34)
(8,400)
(1,356)
(9,791)
41
17
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 as of March 31, 2024 and December 31, 2023:
Real Estate
Accounts Receivable / Equipment
ACL-Loans Allocation
1,272
53,200
581
63,283
5,652
168
2,628
2,657
5,453
1,780
147
Total collateral dependent loans
118,070
123,355
8,022
There were no significant changes to the types of collateral securing the Company’s collateral dependent loans compared to December 31, 2023.
1,560
21
46,575
521
73,909
6,289
146
3,603
2,684
6,433
1,132
122,334
2,690
128,627
7,964
Internal Risk Categories
The Company evaluates the loan risk grading system definitions and ACL-Loans methodology on an ongoing basis. As of December 31, 2023, the Company created a newly defined special mention risk rating category to be consistent with industry practices. Loans with a Watch classification are now included in the Pass risk rating category as of December 31, 2023. This updated policy was approved by the Company’s Management Committee, to be effective as of December 31, 2023 on a prospective basis.
In adherence with policy, the Company uses the following internal risk grading categories and definitions for loans since December 31, 2023:
Pass - Loans that are considered to be of acceptable credit quality, and not classified as Special Mention, Substandard or Doubtful. Also included are loans classified as watch loans, which represent loans that remain sound and collectible but contain elevated risk that requires management’s attention.
Special Mention – Loans classified as special mention have potential weaknesses that deserve management’s attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the asset or in the institution’s credit position at some future date. Special mention loans are not adversely classified and do
18
not warrant adverse classification. Loans with questions or concerns regarding collateral, adverse market conditions impacting future performance, and declining financial trends would be considered for special mention.
Substandard - Loans classified as substandard are inadequately protected by the current net worth and paying capacity of the borrower or of the collateral pledged, if any. Loans so classified must 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. When a loan in the form of a line of credit is downgraded to substandard, it is evaluated for impairment and future draws under the line of credit require the approval of an officer of Senior Credit Officer or above.
Doubtful - Loans classified as doubtful have all the weaknesses inherent in those classified as substandard, with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable.
19
The following tables present the credit risk profile of the Company’s loan portfolio based on internal risk rating category as of March 31, 2024 and December 31, 2023:
2022
2021
2020
Prior
Revolving Loans
Pass
Charge-offs
32,353
9,793
6,175
21,315
7,400
1,240,994
1,319,810
Special Mention
218
Substandard
7,618
1,242,266
298,730
957,019
734,071
114,353
9,070
34,587
1,731,470
3,879,300
8,000
96,900
28,559
8,400
1,470
20,777
164,106
11,667
28,360
6,534
6,639
306,730
1,065,586
790,990
129,287
36,057
1,758,886
258,604
626,388
936,880
98,815
14,459
398,904
2,334,050
24,319
20,900
9,502
12,631
67,352
25,600
28,783
8,900
282,923
672,888
946,382
127,598
420,435
4,469
54,002
116,479
71,824
19,203
34,169
1,360,706
1,660,852
289
157
446
92
776
850
60
3,675
116,571
72,889
20,210
34,229
1,364,381
925
7,833
7,875
5,103
2,722
8,566
15,515
18,216
65,830
15,662
109
28
25
4,268
3,480
Total Pass
571,416
1,677,746
1,802,354
293,914
58,156
110,398
5,896,764
10,410,748
Total Special Mention
32,319
117,800
38,061
8,689
1,688
33,408
232,122
Total Substandard
37,267
28,452
36,093
207
20,486
Total Doubtful
Total Loans
603,735
1,832,813
1,868,867
338,696
59,163
112,293
5,950,658
Total Charge-offs
2019
31,011
10,086
6,573
22,725
3,298
9,340
1,239,161
1,322,194
59
492
551
288
3,357
10,120
1,240,433
34
1,094,698
762,448
208,343
77,340
29,764
8,455
1,646,445
3,827,493
94,973
3,189
1,477
24,052
132,091
11,682
46,576
1,201,353
793,997
223,277
9,932
1,670,497
752,591
996,273
110,197
14,563
351,110
2,224,734
35,869
9,520
12,658
58,047
10,625
73,908
814,060
1,016,418
138,980
372,668
51,110
119,386
77,316
21,154
21,088
17,066
1,328,980
1,636,100
292
172
84
548
70
1,701
878
62
3,672
6,383
Doubtful
119,456
79,309
22,204
21,150
17,200
1,332,652
496
274
586
1,356
16,850
9,825
6,490
14,267
5,237
16,606
33,728
103,003
16,753
748
4,329
247
115
27
4,339
3,862
13,667
30
130
42
4,342
1,947,008
1,902,347
409,166
135,601
73,977
55,806
5,355,754
9,879,659
130,842
12,709
8,692
187
74
2,053
36,710
191,267
37,282
39,055
37,018
438
13,844
128,577
2,115,132
1,954,111
454,876
136,666
74,113
58,347
5,406,308
8,896
22
9,791
The Company did not have any material revolving loans converted to term loans at March 31, 2024 or December 31, 2023.
Delinquent Loans
The following tables present the Company’s loan portfolio aging analysis of the recorded investment in loans as of March 31, 2024 and December 31, 2023.
30-59 Days
60-89 Days
Greater Than
Past Due
90 Days
Current
4,588
682
5,488
1,315,812
24,870
78,910
103,780
3,992,826
48,733
74,333
2,390,352
1,922
3,006
4,928
1,661,823
44
159
213
65,764
31,424
26,292
131,026
188,742
10,577,483
4,557
2,379
6,936
1,317,369
38,218
11,055
39,609
88,882
3,917,278
47,275
35,999
83,274
2,273,415
393
3,665
4,230
1,638,851
185
102,965
13,678
42,975
58,737
81,817
183,529
10,016,024
The above tables do not include two delinquent loans that were classified as held for sale at March 31, 2024, totaling $30.2 million.
Nonperforming Loans
Nonaccrual loans, including modified loans to borrowers experiencing financial difficulty 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 modified loans which are on nonaccrual status prior to being modified 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 three months ended as of March 31, 2024 and 2023, respectively, was immaterial.
The following table presents the Company’s nonaccrual loans and loans past due 90 days or more and still accruing at March 31, 2024 and December 31, 2023.
Total Loans >
90 Days &
Nonaccrual
Accruing
760
1,486
894
46,248
32,662
39,608
19,950
7,216
2,866
140
3,820
43
78,804
52,982
73,847
8,168
The Company did not have any nonperforming loans without an estimated ACL at March 31, 2024.
Modifications to Borrowers Experiencing Financial Difficulty
On January 1, 2023, the Company adopted FASB 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.
There were no new loans modified for borrowers experiencing financial difficulty during the three months ended March 31, 2024.
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 Company did not have loans modified in the last twelve months that were delinquent as of March 31, 2024.
Foreclosures
There were no residential loans in the process of foreclosure as of March 31, 2024 and December 31, 2023.
Loans Purchased
The Company purchased $27.7 million and $98.8 million of loans during the three months ended March 31, 2024 and 2023, respectively.
23
Note 5: Variable Interest Entities
A VIE is a corporation, partnership, limited liability company, or any other legal structure used to conduct activities or hold assets generally that either:
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 VIEs a REMIC trust that was established in conjunction with the September 2022 multi-family loan sale and securitization transaction, as well as a second REMIC trust that was established in December 2023 with a related party in conjunction with a loan sale and securitization. Accordingly, the entities were assessed for potential consolidation under the VIE model that requires primary beneficiaries to consolidate the entity’s results. A primary beneficiary is defined as the party that has both the power to direct the activities that most significantly impact the entity, and an interest that could be significant to the entity. To determine if an interest could be significant to the entity, both qualitative and quantitative factors regarding the nature, size and form of involvement with the entity are evaluated.
At March 31, 2024 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 is considered as part of this ongoing assessment.
The table below reflects the assets and liabilities of the VIEs as well as our maximum exposure to loss in connection with VIEs at March 31, 2024 and December 31, 2023. 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 unaudited condensed consolidated balance sheet. Also included in the maximum loss exposure are bridge loans to VIEs and securities acquired as part of securitization transactions. The bridge loans are included in loans receivable and the securities are included in securities held to maturity.
Investments
Bridge loans
Securities
Maximum
in VIEs
to VIEs
for VIEs
Exposure to Loss
($ in thousands)
Low-income housing tax credit investments
96,675
136,197
232,872
32,171
Debt funds
33,997
305,998
339,995
2,752
Off-balance-sheet REMIC trusts
1,163,191
Total Unconsolidated VIEs
130,672
442,195
1,736,058
34,923
118,741
232,407
351,148
35,099
33,221
86,416
119,637
1,192,201
151,962
318,823
1,662,986
37,851
24
Note 6: Regulatory Matters
The Company, Merchants Bank and FMBI (prior to the January 26, 2024 sale of its branches and merger of its remaining charter into Merchants Bank) 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 and Merchants Bank must meet specific capital guidelines that involve quantitative measures of the Company’s and Merchants Bank’s assets, liabilities and certain off-balance-sheet items as calculated under regulatory accounting practices. The Company’s and Merchants Bank’s capital amounts and classification are also subject to qualitative judgments by the regulators about components, and other factors. Furthermore, the Company’s and Merchants Bank’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 and Merchants Bank to maintain minimum amounts and ratios (set forth in the table below). Management believes, as of March 31, 2024 and December 31, 2023, that the Company and Merchants Bank met all capital adequacy requirements.
As of March 31, 2024 and December 31, 2023, 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 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 or Merchants Bank’s category.
FMBI was subject to these same requirements and guidelines prior to the sale of its branches and the merger of its remaining charter into Merchants Bank in January 2024. As of December 31, 2023, FMBI met all capital adequacy requirements (as set forth in the table below). The FDIC categorized FMBI as well capitalized at that time and there are no conditions or events since that notification that management believes would have changed that category.
The Company’s, Merchants Bank’s, and FMBI’s actual capital amounts and ratios are presented in the following tables.
Minimum
Amount to be Well
Minimum Amount
Capitalized with
To Be Well
Actual
Basel III Buffer(1)
Capitalized(1)
Ratio
(Dollars in thousands)
Total capital(1) (to risk-weighted assets)
Company
1,858,348
11.7
%
1,662,302
10.5
Merchants Bank
1,801,020
11.4
1,660,561
1,581,487
10.0
Tier I capital(1) (to risk-weighted assets)
1,768,553
11.2
1,345,673
8.5
1,711,225
10.8
1,344,264
1,265,189
8.0
Common Equity Tier I capital(1) (to risk-weighted assets)
1,268,945
1,108,202
7.0
1,107,041
1,027,966
6.5
Tier I capital(1) (to average assets)
839,199
5.0
10.2
837,560
1,772,195
11.6
1,598,260
1,724,505
11.5
1,577,434
1,502,318
FMBI
40,613
21.1
20,209
19,247
1,686,202
11.1
1,293,830
1,639,171
10.9
1,276,970
1,201,854
39,953
20.8
16,360
15,398
1,186,594
7.8
1,065,507
1,051,623
976,507
13,473
12,511
10.1
832,706
815,191
17,391
Note 7: Derivative Financial Instruments
The Company uses non-hedging, 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.
Internal Interest Rate Risk Management
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.
The Company entered into a contract containing put options and interest rate floors on securities it acquired from a warehouse customer. These provide protection and prevent losses in value of certain available for sale securities. The Company also entered into interest rate floor contracts with two warehouse loan customers to minimize interest rate risk. All changes in the fair market value of these options and floors have been included in other noninterest income.
Credit Risk Management
In March 2024, the Company entered into a contract as the buyer of credit protection through the credit derivative market. A credit default swap was purchased to manage credit risk associated with specific multifamily mortgage loans. Under the terms of the contract, the Company will be compensated for certain credit-related losses on a pool of multifamily mortgage loans. The protection seller has posted aggregate collateral of $76.1 million related to their obligations under the contract. There was no value associated with the credit default swap as of March 31, 2024, as there was no consideration provided to the seller. All changes in the fair market value of this instrument will be included in other noninterest 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 unaudited condensed consolidated statements of income. The fair value of derivative instruments with a positive fair value are reported in other assets in the unaudited condensed consolidated balance sheets while derivative instruments with a negative fair value are reported in other liabilities in the unaudited condensed consolidated balance sheets.
The following table presents the notional amount and fair value of interest rate locks, forward contracts, interest rate swaps, put options and interest rate floors utilized by the Company at March 31, 2024 and December 31, 2023. This table excludes the fair market value adjustment on loans associated with these derivatives.
Notional
Fair Value
Balance Sheet Location
Asset
Liability
Interest rate lock commitments
31,888
Other assets/liabilities
174
Forward contracts
33,375
110
Interest rate swaps
57,531
3,985
Put options
734,130
Other assets
33,490
Interest rate floors
1,229,918
8,910
Credit derivatives
76,092
46,568
132
16,526
25,500
391
57,540
2,610
748,374
25,877
6,576
35,207
395
The following table summarizes the periodic changes in the fair value of the derivative financial instruments on the condensed consolidated statements of income for the three months ended March 31, 2024 and 2023.
Derivative gain (loss) included in gain on sale of loans:
209
Forward contracts (includes pair-off settlements)
(96)
Interest rates swaps
1,375
(1,336)
Net gain (loss)
1,485
(1,223)
Derivative gain (loss) included in other income:
7,613
2,334
9,947
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 swap arrangements. 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 offsetting 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 material net earnings impact.
The fair values of derivative assets and liabilities related to derivatives for customers with back-to-back interest rate swaps were recorded in the unaudited condensed consolidated balance sheets as follows:
657,572
15,259
607,169
12,426
The gross gains and losses on these derivative assets and liabilities were recorded in other noninterest income and other noninterest expense in the unaudited condensed consolidated statements of income as follows:
Gross swap gains
2,833
580
Gross swap losses
Net swap gains (losses)
The Company pledged $0 in collateral to secure its obligations under swap contracts at both March 31, 2024 and December 31, 2023.
Note 8: Disclosures about Fair Value of Assets and Liabilities
Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Fair value measurements must maximize the use of observable inputs and minimize the use of unobservable inputs. There is a hierarchy of three levels of inputs that may be used to measure fair value:
Level 1 Quoted prices in active markets for identical assets or liabilities
Level 2 Observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities
Level 3 Unobservable inputs supported by little or no market activity and are significant to the fair value of the assets or liabilities
29
Recurring Measurements
The following tables present the fair value measurements of assets and liabilities recognized in the accompanying unaudited condensed consolidated balance sheets measured at fair value on a recurring basis and the level within the fair value hierarchy in which the fair value measurements fall at March 31, 2024 and December 31, 2023:
Fair Value Measurements Using
Quoted Prices in
Significant
Active Markets
for Identical
Observable
Unobservable
Inputs
(Level 1)
(Level 2)
(Level 3)
Mortgage-backed - Non-agency residential - fair value option
Mortgage-backed - Agency - fair value option
Loans held for sale
84,513
Derivative assets:
Interest rate swaps (back-to-back)
10,514
22,976
Derivative liabilities:
86,663
7,223
18,654
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 unaudited condensed consolidated balance sheets, as well as the general classification of such assets pursuant to the valuation hierarchy. There have been no significant changes in the valuation techniques during the three months ended March 31, 2024 and the year ended December 31, 2023. For assets classified within Level 3 of the fair value hierarchy, the process used to develop the reported fair value is described below.
Mortgage Loans in Process of Securitization, Securities Available for Sale, and Securities with a Fair Value Option Election
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
Interest rate lock commitments - 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.
Forward sales 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.
Interest rate swaps – The Company estimates the fair value of interest rate swaps based on prices that are obtained from a third party that uses observable market inputs, thereby supporting a Level 2 classification.
31
Put options - The fair value of put options are linked to securities available for sale that are accounted for using the fair value option and are classified as either Level 2 or Level 3 on the hierarchy. The put options are classified as Level 2 or Level 3 in the hierarchy, depending upon the magnitude of observable inputs in the valuation of the securities. These valuations are estimated by a third party.
Interest rate floors - The fair value of certain interest rate floors is linked to securities available for sale that are accounted for using the fair value option. Other interest rate floors are linked to loans with warehouse customers. The value of the interest rate floors is based on estimated discounted cash flows that are based on inputs that are not readily observable and, thus, are classified as Level 3 on the hierarchy. These valuations are estimated by a third party.
Credit Default Swap – The fair value of the credit default swap is linked to the value of its underlying mortgage loans. The Company estimates the fair value based on estimated discounted cash flows that are derived from inputs that are not readily observable and, thus, are classified as Level 3 on the hierarchy. These valuations are estimated by a third party.
The fair value of the credit default swap was equal to the transaction price of zero at inception on March 27, 2024. The Company will subsequently measure the fair value of the credit default swap each reporting period.
32
Level 3 Reconciliation
The following is a reconciliation of the beginning and ending balances of recurring fair value measurements recognized in the accompanying balance sheets using significant unobservable (Level 3) inputs:
Three Months Ended March 31,
146,248
Additions
Originated servicing
2,166
2,173
Subtractions
Paydowns
(2,387)
(1,698)
Changes in fair value due to changes in valuation inputs or assumptions used in the valuation model
13,964
(2,856)
143,867
Available for sale securities - Mortgage-backed - Non-Agency residential - fair value option
(8,986)
Changes in fair value
(4,322)
Derivative Assets - put options
4,322
Derivative Assets - interest rate floors
Derivative Assets - interest rate lock commitments
190
Derivative Liabilities - interest rate lock commitments
(19)
33
Nonrecurring Measurements
The following table presents the fair value measurement of assets measured at fair value on a nonrecurring basis and the level within the fair value hierarchy in which the fair value measurements fall at March 31, 2024 and December 31, 2023.
Active Markets for
Other Observable
Identical Assets
Collateral dependent loans
420
47,026
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 unaudited condensed consolidated balance sheets, 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.
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
Technique
Unobservable Inputs
Range
Average
At March 31, 2024:
Discounted cash flow
Market credit spread
2%
Market comparable properties
Marketability discount
24% - 27%
26%
Servicing rights - Multi-family
135,314
Discount rate
8% - 13%
9%
Constant prepayment rate
0% - 73%
7%
Servicing rights - Single-family
31,898
10% - 11%
10%
6% - 15%
Servicing rights - SBA
4,988
16%
3% - 14%
Loan closing rates
50% - 99%
82%
Intrinsic option value
6%-8%
Derivative liabilities - interest rate lock commitments
At December 31, 2023:
0% - 100%
122,218
0% - 50%
30,959
6% - 16%
5,280
45% - 99%
78%
6%-7%
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.
Securities Available for Sale with a Fair Value Option Election, Loans, and Related Derivative Financial Instruments
The significant unobservable input used in the fair value measurement of certain securities available for sale and their related put options include market credit spreads that can be impacted by market conditions and drive a significant amount of a market participant’s valuation of the security and its related put option. The impact of changes to the unobservable inputs for the securities is mitigated by changes to the unobservable inputs for the put options, which are valued in opposite directions, so as to minimize the financial impact to the Company.
35
The significant unobservable input used in the fair value measurement of interest rate floor derivatives associated with certain securities available for sale and loans include the discount rate that can have a significant impact on the value of the derivative. Another variable that affects the floor value is the forward interest curve, which is observable, but changes with market conditions as interest rates and future interest rate expectations change.
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.
36
Fair Value of Financial Instruments
The following table presents the carrying amount and estimated fair values of the Company’s financial instruments not carried at fair value and the level within the fair value hierarchy in which the fair value measurements fall at March 31, 2024 and December 31, 2023.
Carrying
Financial assets:
Securities held to maturity
466,573
FHLB stock
3,418,618
Loans receivable, net
10,646,477
Financial liabilities:
13,973,624
8,018,126
5,955,498
Short-term subordinated debt
64,922
FHLB advances
1,426,299
1,425,888
Other borrowing
232,934
Credit linked notes
111,830
111,828
Interest payable
51,790
484,288
3,058,093
10,088,468
14,062,457
8,894,058
5,168,399
771,392
771,029
7,934
119,879
119,878
43,423
37
Note 9: Leases
The Company has operating leases for various locations with terms ranging from one to seven years. Some operating leases include options to extend. The extensions were included in the right-of-use asset if the likelihood of extension was reasonably 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 $8.2 million and $10.1 million as of March 31, 2024 and December 31, 2023, respectively, and operating lease right-of-use liabilities of $9.4 million and $11.3 million as of March 31, 2024 and December 31, 2023, respectively.
Unaudited condensed consolidated balance sheet, income statement and cash flow detail regarding operating leases follows:
Balance Sheet
Operating lease right-of-of use asset (in other assets)
8,211
10,060
Operating lease liability (in other liabilities)
9,386
11,251
Weighted average remaining lease term (years)
4.8
6.0
Weighted average discount rate
3.19%
2.89%
Maturities of lease liabilities:
One year or less
2,359
2,441
Year two
2,073
2,064
Year three
1,951
2,100
Year four
1,805
2,046
Year five
1,123
1,438
Thereafter
824
2,128
Total future minimum lease payments
10,135
12,217
Less: imputed interest
749
March 31, 2023
Income Statement
Components of lease expense:
Operating lease cost (in occupancy and equipment expense)
604
583
Cash Flow Statement
Supplemental cash flow information:
Operating cash flows from operating leases
594
426
38
Note 10: Deposits
Deposits were comprised of the following at March 31, 2024 and December 31, 2023:
Noninterest-bearing deposits
Demand deposits
Total noninterest-bearing deposits
Interest-bearing deposits
4,680,405
5,381,067
Savings deposits
3,017,849
2,992,921
Certificates of deposit
5,957,535
5,167,402
Total interest-bearing deposits
Maturities for certificates of deposit are as follows:
Due within one year
5,865,446
Due in one year to two years
76,281
Due in two years to three years
15,808
Due in three years to four years
Due in four years to five years
Due in five years to six years
Brokered deposit amounts at March 31, 2024 and December 31, 2023, were as follows:
Brokered certificates of deposit
5,351,397
4,465,825
Brokered savings deposits
1,338
589
Brokered deposit on demand accounts
400,159
1,504,230
5,752,894
5,970,644
39
Note 11: Borrowings
Borrowings were comprised of the following at March 31, 2024 and December 31, 2023:
Federal Reserve discount window borrowings
50,000
American Financial Exchange borrowing
175,000
Credit linked notes, net of debt discount
Other borrowings
Total borrowings
On March 22, 2024, the Company entered into a new variable rate debt agreement with the FHLB for an advance that has put and call options attached to it. The balance of the advance was $500.0 million as of March 31, 2024, and matures on June 20, 2024. The variable interest rate is based on the Federal Funds effective rate, plus 10 basis points, which was 5.43% as of March 31, 2024. The FHLB has an option to cancel the agreement 60 days after the initial execution date and the Company has an option to cancel the agreement at any time, with one day’s notice.
Note 12: Earnings Per Share
Earnings per share were computed as follows:
Three Month Periods Ended March 31,
Weighted-
Per
Net
Share
Income
Net income allocated to common shareholders
Basic earnings per share
Effect of dilutive securities-restricted stock awards
160,662
111,175
Diluted earnings per share
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”). The Company issued 85,212 and 84,335 shares during the three months ended March 31, 2024 and 2023, 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. In November 2023, 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 $70,000 per member, rounded up to the nearest whole share, to be effective as of January 1, 2024. Accordingly, there were 3,164 and 2,863 shares, issued to non-executive directors during the three months ended March 31, 2024 and 2023, respectively.
40
The Company established an employee stock ownership plan (“ESOP”) effective as of January 1, 2020 to provide certain benefits for all employees who meet certain requirements. Expense recognized for the contribution to the ESOP totaled $287,000 and $267,000 for the three months ended March 31, 2024 and 2023, respectively. The Company contributed 23,414 shares and 33,293 shares to the ESOP for the three months ended March 31, 2024 and 2023, respectively.
Note 14: Preferred Stock
Public Offerings of Preferred Stock:
Series A – On March 28, 2019, the Company issued 2,000,000 shares of 7.00% Fixed-to-Floating Rate Series A Non-Cumulative Perpetual Preferred Stock, without par value, and with a liquidation preference of $25.00 per share (the “Series A Preferred Stock”). The aggregate gross offering proceeds for the shares issued by the Company was $50.0 million, and after deducting underwriting discounts and commissions and offering expenses of approximately $1.7 million paid to third parties, the Company received total net proceeds of $48.3 million. On April 12, 2019, the Company issued an additional 81,800 shares of Series A Preferred Stock to the underwriters related to their exercise of an option to purchase additional shares under the associated underwriting agreement, resulting in an additional $2.0 million in net proceeds, after deducting $41,000 in underwriting discounts.
The Company redeemed all outstanding shares of the Series A Preferred Stock on April 1, 2024 at a price equal to the liquidation preference of $25.00 per share, using cash on hand. As of the redemption date, the Series A Preferred Stock did not have any accrued but unpaid dividends.
Series B – On August 19, 2019, the Company issued 5,000,000 depositary shares, each representing a 1/40th interest in a share of its 6.00% Fixed-to-Floating Rate Series B Non-Cumulative Perpetual Preferred Stock, without par value (the “Series B Preferred Stock”), and with a liquidation preference of $1,000.00 per share (equivalent to $25.00 per depositary share). The aggregate gross offering proceeds for the shares issued by the Company was $125.0 million, and after deducting underwriting discounts and commissions and offering expenses of approximately $4.2 million paid to third parties, the Company received total net proceeds of $120.8 million.
The Series B Preferred Stock have no voting rights with respect to matters that generally require the approval of our common shareholders. Dividends on the Series B Preferred Stock, to the extent declared by the Company’s board, are payable quarterly. The Company may redeem the Series B Preferred Stock, in whole or in part, at its option, on any dividend payment date on or after October 1, 2024, subject to the approval of the appropriate federal banking agency, at the liquidation preference, plus any declared and unpaid dividends (without regard to any undeclared dividends) to, but excluding, the date of redemption.
Series C – 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-to-Floating 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.
The Series C Preferred Stock have no voting rights with respect to matters that generally require the approval of our common shareholders. 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 its 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.
Series D – 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 Reset 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 depositary 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.
The Series D Preferred Stock have no voting rights with respect to matters that generally require the approval of our common shareholders. 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 its 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.
Note 15: Segment Information
The Company’s business segments are defined as Multi-family Mortgage Banking, Mortgage Warehousing, and Banking. The reportable business segments are consistent with the internal reporting and evaluation of the principal lines of business of the Company. The Multi-family Mortgage Banking segment originates and services government sponsored mortgages for multi-family and healthcare facilities. It is also a fully integrated syndicator of low-income housing tax credit and debt funds. The Mortgage Warehousing segment funds agency eligible residential loans from the date of origination or purchase, until the date of sale in the secondary market, as well as commercial loans to non-depository financial institutions. The Banking segment provides a wide range of financial products and services to consumers and businesses, including retail banking, commercial lending, agricultural lending, retail and correspondent residential mortgage banking, and Small Business Administration (“SBA”) lending. 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 or LLCs and certain debt funds. All operations are domestic.
The tables below present selected business segment financial information for the three months ended March 31, 2024 and 2023.
Multi-family
Mortgage
Banking
Warehousing
Three Months Ended March 31, 2024
Interest income
1,746
84,901
224,288
3,238
Interest expense
56,140
131,723
(766)
Net interest income
1,726
28,761
92,565
4,004
940
3,786
Net interest income after provision for credit losses
27,821
88,779
Noninterest income
40,467
429
(3,339)
Noninterest expense
19,571
4,798
15,578
8,965
Income (loss) before income taxes
22,622
26,340
73,630
(8,300)
Income taxes
6,013
6,150
17,205
(2,130)
Net income (loss)
16,609
20,190
56,425
(6,170)
416,454
5,369,299
11,760,028
276,795
Three Months Ended March 31, 2023
1,106
42,318
166,726
1,144
27,794
84,526
(1,719)
14,524
82,200
2,863
5,503
13,160
76,697
16,597
1,033
(1,189)
(2,177)
14,631
2,755
10,170
3,072
11,438
65,338
(6,530)
2,797
16,031
(1,571)
1,966
8,641
49,307
(4,959)
341,487
3,318,491
10,430,293
150,695
14,240,966
Note 16: Recent Accounting Pronouncements
The Company continually monitors potential accounting pronouncement and SEC release changes. The following pronouncements and releases have been deemed to have the most applicability to the Company’s financial statements:
FASB ASU 2023-07 - Segment Reporting (Topic 280): Improvements to Reportable Segment Disclosures
In November 2023, the FASB issued an ASU update that will require public entities’ disclosures, on an annual and interim basis, to include additional details on reportable segments so financial statement users may better understand an entity’s overall performance and assist in assessing potential future cash flows. The new guidance will require public entities to present information regarding significant segment expenses that are regularly provided to the chief operating decision maker (CODM) as well as details regarding segment’s profit and loss.
The updates in ASU 2023-07 are effective for annual periods beginning after December 15, 2023 and interim periods for years beginning after December 15, 2024. An entity shall apply the ASU retrospectively to financial statements for periods beginning after the effective date. The Company is continuing to evaluate the impact of adopting this new guidance but does not expect it to have a material impact on the Company’s financial position or results of operations.
FASB ASU 2023-09 - Income Taxes (Topic 740): Improvements to Income Tax Disclosures
In December 2023, the FASB issued an ASU update that will require public business entity’s disclosures to include a tabular tax rate reconciliation. The update will also require all public entities disclose income tax expense and taxes paid broken down by federal, state, and foreign with a disaggregation for jurisdictions that exceed 5% of income for taxes paid.
The updates in ASU 2023-09 are effective for annual periods beginning after December 15, 2024. An entity shall apply the ASU on a prospective basis to financial statements for annual periods beginning after the effective date. The Company is continuing to evaluate the impact of adopting this new guidance but does not expect it to have a material impact on the Company’s financial position or results of operations.
Note 17: Subsequent Events
The Company redeemed all outstanding shares of the Series A Preferred Stock on April 1, 2024 at a price equal to the liquidation preference of $25.00 per share, or $52 million, using cash on hand. As of March 31, 2024, the cash to redeem the shares was delivered to the Company’s transfer agent, resulting in a prepaid asset reported in other assets. As of the redemption date the Series A Preferred Stock did not have any accrued, but unpaid dividends.
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, 2023 or “Item 2 - Management’s Discussion and Analysis of Financial Condition and Results of Operations” of this Form 10-Q or the following:
The foregoing factors should not be construed as exhaustive and should be read together with the other cautionary statements included in this Form 10-Q. Any forward-looking statement speaks only as of the date on which it is made, and we do not undertake any obligation to update or review any forward-looking statement, whether as a result of new information, future developments, or otherwise.
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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Management’s discussion and analysis of the financial condition at March 31, 2024 and results of operations for the three months ended March 31, 2024 and 2023, is intended to assist in understanding the financial condition and results of operations of the Company. The information contained in this section should be read in conjunction with the unaudited condensed consolidated financial statements and the notes thereto, appearing in Part I, Item 1 of this Form 10-Q.
The words “the Company,” “we,” “our,” and “us” refer to Merchants Bancorp and its consolidated subsidiaries, unless we indicate otherwise.
Financial Highlights for the Three Months Ended March 31, 2024
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, 2023. There have been no
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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, 2023.
Financial Condition
As of March 31, 2024, we had approximately $17.8 billion in total assets, $14.0 billion in deposits, and $1.8 billion in total shareholders’ equity. Total assets as of March 31, 2024 included approximately $508.8 million of cash and cash equivalents, $3.5 billion of loans held for sale and $10.7 billion of loans receivable, net of ACL-Loans. Assets also included $142.6 million of mortgage loans in the process of securitization that represent pre-sold multi-family rental real estate loan originations in primarily Government National Mortgage Association (“Ginnie Mae”), Federal National Mortgage Association (“Fannie Mae”), and Federal Home Loan Mortgage Corporation (“Freddie Mac”) mortgage-backed securities pending settlements that typically occur within 30 days. There were also $1.2 billion in securities classified as held to maturity. Additionally, we had $1.1 billion in securities available for sale, the majority of which were acquired from a warehouse customer, and others are typically match funded with related custodial deposits or required to collateralize our credit-linked notes. There are restrictions on the types of securities we hold, as these are funded by certain custodial deposits where we set the cost of deposits based on the yield of the related securities. Other assets at March 31, 2024 were $360.4 million which primarily represents low-income housing tax credits and prepaid assets associated with the April 1, 2024 redemption of Series A Preferred Stock. Servicing rights at March 31, 2024 were $172.2 million based on the fair value of the loan servicing, which are primarily Ginnie Mae multi-family servicing rights with 10-year call protection.
Comparison of Financial Condition at March 31, 2024 and December 31, 2023
Total Assets. Total assets of $17.8 billion at March 31, 2024 increased $870.1 million, or 5%, compared to $17.0 billion at December 31, 2023. The increase was due primarily to growth in the warehouse, healthcare, and multi-family loan portfolios as well as loans held for sale.
Cash and Cash Equivalents. Cash and cash equivalents of $508.8 million at March 31, 2024 decreased $75.7 million, or 13%, compared to December 31, 2023. The 13% decrease reflected $52 million in cash delivered to our Transfer Agent for the April 1, 2024 redemption of Series A Preferred Stock described in Note 14: Preferred Stock and Note 17: Subsequent Events. Included in cash equivalents was $39.2 million in restricted cash associated with the March 2023 issuance of senior credit linked notes described in Note 1: Basis of Presentation and Note 11: Borrowings.
Mortgage Loans in Process of Securitization. Mortgage loans in process of securitization of $142.6 million at March 31, 2024 increased $32.0 million, or 29%, compared to $110.6 million at December 31, 2023. These represent loans that our banking subsidiary, Merchants Bank, has funded and are held pending settlement, primarily as Ginnie Mae, Fannie Mae, and Freddie Mac mortgage-backed securities with a firm investor commitment to purchase the securities. The 29% increase was primarily due to a higher origination volume of loans that had not yet settled with government agencies.
Securities Available for Sale. Securities available for sale of $1.1 billion at March 31, 2024 decreased $52.4 million, or 5%, compared to December 31, 2023. The decrease in securities available for sale was primarily due to $246.4 in calls, maturities, repayments, sales and other adjustments, partially offset by purchases of $194.0 million during the period.
Included in securities available for sale were $700.6 million of investments for which a fair value option was elected. Fair value option securities represent securities which the Company has elected to carry at fair value and are separately identified on the unaudited condensed consolidated balance sheets with changes in the fair value recognized in earnings as they occur.
As of March 31, 2024, Accumulated Other Comprehensive Losses (“AOCL”) of $1.2 million, related to securities available for sale, improved $1.3 million, or 53%, compared to losses of $2.5 million at December 31, 2023. The $1.2
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million of AOCL as of March 31, 2024 represented less than 1% of total equity and 1% of total securities available for sale.
Securities Held to Maturity. Securities held to maturity of $1.2 billion at March 31, 2024 decreased $29.1 million, or 2%, compared to December 31, 2023. The decrease was due to remittances of loan payments underlying the securities during the period. These securities were acquired in 2022 and 2023 as part of securitization transactions.
Loans Held for Sale. Loans held for sale of $3.5 billion at March 31, 2024 increased $358.4 million, or 11%, compared to $3.1 billion at December 31, 2023. The increase in loans held for sale was due primarily to an increase in warehouse participations, as we experienced higher volume. Loans held for sale are comprised primarily of single-family residential real estate loan participations that meet Fannie Mae, Freddie Mac, or Ginnie Mae eligibility. It also includes a growing portfolio of multi-family loans.
Loans Receivable, Net. Loans receivable, net, of $10.7 billion at March 31, 2024, which are comprised of loans held for investment, increased $562.7 million, or 6%, compared to $10.1 billion at December 31, 2023. The increase in net loans was comprised primarily of:
The $390.5 million increase in mortgage warehouse lines of credit was due to higher loan volume from increased sales efforts and market exits of competitors.
The $108.0 million increase in healthcare financing was due to higher loan originations.
The $90.4 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.
As of March 31, 2024, 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 $75.7 million at March 31, 2024 increased $4.0 million, or 6%, compared to December 31, 2023, primarily reflecting increases associated with growth in the multi-family and healthcare portfolios, as well as changes in specific reserves and loss factors to reflect industry conditions.
Also influencing the overall level of the ACL-Loans is our differentiated strategy to typically hold loans with shorter durations and to maintain agency underwriting standards that enable us to sell the majority of our loans under government programs.
Goodwill. Goodwill of $8.0 million at March 31, 2024 decreased $7.8 million, or 49%, compared to $15.8 million at December 31, 2023. The goodwill associated with FMBI was eliminated upon the sale of their branches to unaffiliated third parties on January 26, 2024.
Servicing Rights. Servicing rights of $172.2 million at March 31, 2024 increased $13.7 million, or 9%, compared to $158.5 million at December 31, 2023. During the three months ended March 31, 2024, a positive fair market value
adjustment of $14.0 million and originated or purchased servicing of $2.2 million were partially offset by paydowns of $2.4 million. The $14.0 million positive fair market value adjustment reflected $13.2 million for multi-family mortgages and $0.8 million for single-family and SBA mortgages during the three months ended March 31, 2024.
Servicing rights are recognized in connection with sales of loans when we retain servicing of the sold loans, as well as upon purchases of loan servicing portfolios. The servicing rights are recorded and carried at fair value. The fair value increase recorded during the three months ended March 31, 2024 was driven by higher interest rates that impacted fair market value adjustments. The value of servicing rights generally increases in rising interest rate environments and declines in falling interest rate environments due to expected prepayments and earnings rates on escrow deposits.
Other Assets & Receivables. Other assets and receivables of $360.4 million at March 31, 2024 increased by $54.1 million, or 18%, compared to December 31, 2023. The increase was primarily due to $52.0 million prepaid funding for the April 1, 2024, Series A Preferred Stock redemption.
Deposits. Deposits of $14.0 billion at March 31, 2024 decreased $85.8 million, or 1%, compared to $14.1 billion December 31, 2023. The decrease was primarily due to a $1.1 billion decrease in brokered demand deposit accounts partially offset by an increase of $885.6 million in brokered certificate of deposits. Total demand deposits decreased $900.9 million, partially offset by an increase in total certificates of deposit of $790.1 million and an increase in total savings deposits of $24.9 million. As of March 31, 2024, approximately 88% of the total deposits at Merchants Bank reprice within three months.
Core deposits increased by $132.0 million, or 2%, to $8.2 billion at March 31, 2024 compared to December 31, 2023. Core deposits represented 59% of total deposits at March 31, 2024 compared to 58% of total deposits at December 31, 2023.
We have decreased our use of brokered deposits by $217.8 million, or 4%, to $5.8 billion at March 31, 2024 compared to $6.0 billion at December 31, 2023. Brokered deposits represented 41% of total deposits at March 31, 2024, compared to 42% of total deposits at December 31, 2023. As of March 31, 2024, brokered certificates of deposit had a weighted average remaining duration of 57 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, 2023, interest-bearing deposits increased $114.4 million, or 1%, to $13.7 billion at March 31, 2024, and noninterest-bearing deposits decreased $200.2 million, or 38%, to $319.9 million at March 31, 2024.
Uninsured deposits totaled approximately $2.1 billion as of March 31, 2024, representing less than 15% of total deposits. Since 2018, the Company has offered its customers an opportunity to insure balances in excess of $250,000 through our Insured Cash Sweep program that extends FDIC protection up to $100 million. The balance of deposits in this program was $1.7 billion as of March 31, 2024.
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Borrowings. Borrowings of $1.8 billion at March 31, 2024 increased $871.9 million, or 90%, compared to $964.1 million at December 31, 2023. The increase was primarily due to an increase of $654.9 million in FHLB advances, an increase of $50.0 million in the usage of the Federal Reserve’s discount window and an increase of $175.0 million in American Financial Exchange (“AFX”) 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 AFX. See Note 11: Borrowings for further information.
The Company continues to have significant borrowing capacity based on available collateral. As of March 31, 2024, unused lines of credit totaled $5.6 billion, compared to $6.0 billion at December 31, 2023.
Total Shareholders’ Equity. Total shareholders’ equity was $1.8 billion as of March 31, 2024. The $75.4 million increase compared to December 31, 2023 resulted primarily from the net income of $87.1 million, which was partially offset by dividends paid on common and preferred shares of $12.6 million during the period.
Asset Quality
Total nonperforming loans (nonaccrual and greater than 90 days past due but still accruing) were $131.8 million, or 1.22% of loans receivable at March 31, 2024, compared to $82.0 million, or 0.80%, of total loans at December 31, 2023 and $65.3 million, or 0.76%, at March 31, 2023. The increase in non-performing loans compared to December 31, 2023 was primarily due to three customers with delinquent payments of 90 days or more. As of March 31, 2024, only 13 customers were classified in nonaccrual status and eight were delinquent by 90 days or more, but still accruing interest, with full payment expected.
As a percentage of nonperforming loans, the ACL-Loans was 57% at March 31, 2024 compared to 87% at December 31, 2023 and 79% at March 31, 2023. The changes compared to both periods were primarily due to an increase in nonperforming loans.
Total loans greater than 30 days past due were $188.7 million at March 31, 2024, $183.5 million at December 31, 2023, and $83.5 million at March 31, 2023. The increase compared to March 31, 2023 was due to the delinquency of six multi-family customers and four healthcare customers.
Special Mention (Watch) loans were $232.1 million at March 31, 2024, compared to $191.3 million at December 31, 2023. The increase was primarily due to higher interest rates that negatively impact our borrowers’ ability to make higher required payments.
During the three months ended March 31, 2024, there was one charge-off of a commercial loan for $925,000 and $1,000 of recoveries, compared to no charge-offs and $7,000 of recoveries for the three months ended March 31, 2023.
Comparison of Operating Results for the Three Months Ended March 31, 2024 and 2023
General. Net income of $87.1 million for the three months ended March 31, 2024 increased by $32.1 million, or 58%, compared with $55.0 million for the three months ended March 31, 2023, primarily driven by a $26.4 million, or 26%, increase in net interest income and a $17.0 million, or 722%, increase in loan servicing fees that was partially offset by a $14.1 million, or 41%, increase in noninterest expense. Results for the three months ended March 31, 2024 included a $14.0 million positive fair market value adjustment to servicing rights compared to a $2.9 million negative adjustment for the three months ended March 31, 2023.
Net Interest Income. Net interest income of $127.1 million for the three months ended March 31, 2024 increased $26.4 million, or 26%, compared with $100.7 million for the three months ended March 31, 2023. The increase reflected higher average balances and yields on loans and loans held for sale, as well as higher average yields and average balances of securities available for sale, which were partially offset by higher average balances and interest rates on
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deposits, as well as higher rates on borrowings. The interest rate spread of 2.58% for the three months ended March 31, 2024 decreased 18 basis points compared to 2.76% for the three months ended March 31, 2023.
Our net interest margin decreased 13 basis points, to 3.14%, for the three months ended March 31, 2024 compared to 3.27% for the three months ended March 31, 2023.
Interest Income. Interest income of $314.2 million for the three months ended March 31, 2024 increased $102.9 million, or 49%, compared with $211.3 million for the three months ended March 31, 2023. This increase reflected an increase in both average balances and yields of loans and loans held for sale, as well as securities available for sale and held to maturity. The higher yields were in response to higher interest rates set by the Federal Reserve.
Interest income of $272.0 million for the three months ended March 31, 2024 for loans and loans held for sale increased $82.5 million, or 44%, compared to the three months ended March 31, 2023. The average balance of loans, including loans held for sale, of $13.5 billion increased $2.9 billion, or 27%, compared $10.6 billion for the three months ended March 31, 2023. The average yield on loans increased 86 basis points to 8.11%, for the three months ended March 31, 2024, compared to 7.25% for the three months ended March 31, 2023. The increase in average balances of loans and loans held for sale was primarily due to increases in warehouse, multi-family, and healthcare loans, as well as loans held for sale, during the period.
Interest income of $14.4 million for the three months ended March 31, 2024 on securities available for sale increased $12.1 million, or 535%, compared to the three months ended March 31, 2023. The average balance of securities available for sale of $1.1 billion increased $639.5 million, or 144%, compared to $445.6 million for the three months ended March 31, 2023. The average yield increased 327 basis points to 5.33%, for the three months ended March 31, 2024 compared to 2.06% for the three months ended March 31, 2023. The increase in average balances of securities available for sale was primarily associated with the acquisition of certain securities in from a warehouse customer in December 2023 that provide protective put options and interest rate floor derivatives to prevent losses in value.
Interest income of $20.5 million for the three months ended March 31, 2024 for securities held to maturity increased $4.8 million, or 30%, compared to the three months ended March 31, 2023. The average balance of securities held for maturity of $1.2 billion increased $81.4 million, or 7%, compared to $1.1 billion for the three months ended March 31, 2023. The average yield increased 117 basis points 6.90% for the three months ended March 31, 2024 compared to 5.73% for the three months ended March 31, 2023. The increase in average balance of securities held to maturity was primarily related to held to maturity securities acquired as part of loan securitizations.
Interest income of $5.5 million for the three months ended March 31, 2024 on interest-bearing deposits and other increased $3.4 million, or 155%, compared to the three months ended March 31, 2023. The average balance of interest-earning deposits and other of $346.2 million increased $161.7 million, or 88%, compared to $184.5 million for the three months ended March 31, 2023. The average yield increased 166 basis points to 6.44%, for the three months ended March 31, 2024 compared to 4.78% for the three months ended March 31, 2023.
Interest Expense. Total interest expense of $187.1 for the three months ended March 31, 2024 increased $76.5 million, or 69%, compared with $110.6 million for the three months ended March 31, 2023.
Interest expense on deposits increased $66.6 million, or 64%, to $171.0 million for the three months ended March 31, 2024, from $104.4 million for the three months ended March 31, 2023. The increase was primarily due to higher rates average balances and rates on certificates of deposit and interest-bearing checking, as well as higher rates on borrowings.
Interest expense of $76.5 million for the three months ended March 31, 2024 for certificate of deposit accounts increased $41.5 million, or 119%, compared to $34.9 million for the three months ended March 31, 2023. The average balance of certificates of deposits was $5.7 billion for the three months ended March 31, 2024, which increased $2.4 billion, or 71%, compared to the three months ended March 31, 2023. The average interest rate on certificates of deposits
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was 5.40% for the three months ended March 31, 2024, which was a 114 basis point increase compared to 4.26% for the three months ended March 31, 2023.
Interest expense of $60.7 million for the three months ended March 31, 2024 for interest-bearing checking accounts increased $20.0 million, or 49%, compared to the three months ended March 31, 2023. The average balance of interest-bearing checking accounts was $5.1 billion for the three months ended March 31, 2024, which increased $1.0 billion, or 25%, compared to the three months ended March 31, 2023. The average yield of interest-bearing checking was 4.81% for the three months ended March 31, 2024, which was a 74 basis point increase compared to 4.07% for the three months ended March 31, 2023.
Interest expense on borrowings of $16.1 million for the three months ended March 31, 2024 increased $9.9 million, or 161%, compared to $6.2 million the three months ended March 31, 2023. The increase was due primarily to a 386 basis point increase in the average cost of borrowings to 9.03%, compared to 5.17% for the three months ended March 31, 2023. Also included in borrowings, our warehouse structured financing agreements provide for an additional interest payment for a portion of the earnings generated. As a result, the cost of borrowings increased from a base rate of 8.50% and 4.82%, to an effective rate of 9.03% and 5.17% for the three months ended March 31, 2024 and 2023, 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.
Interest
Income/
Yield/
Balance
Expense
Rate
Assets:
Interest-bearing deposits, and other
346,150
5,545
6.44
184,470
2,176
4.78
Securities available for sale - taxable
1,085,114
5.33
445,614
2.06
1,196,633
6.90
1,115,243
5.73
137,890
5.02
159,333
4.19
Loans and loans held for sale
13,494,961
8.11
10,595,669
7.25
Total interest-earning assets
16,260,748
7.77
12,500,329
6.86
Allowance for credit losses on loans
(71,544)
(45,190)
Noninterest-earning assets
603,868
430,596
16,793,072
12,885,735
Liabilities/Equity:
Interest-bearing checking
5,070,393
60,688
4.81
4,052,081
40,647
4.07
201,860
219
0.44
237,289
265
0.45
Money market
2,817,382
33,644
4.80
2,848,500
28,608
5,694,933
76,471
5.40
3,322,991
34,922
4.26
13,784,568
4.99
10,460,861
4.05
716,853
9.03
482,723
5.17
Total interest-bearing liabilities
14,501,421
5.19
10,943,584
4.10
332,172
304,119
Noninterest-bearing liabilities
211,819
141,422
15,045,412
11,389,125
Equity
1,747,660
1,496,610
Total liabilities and equity
Interest rate spread
2.58
2.76
Net interest-earning assets
1,759,327
1,556,745
Net interest margin
3.14
3.27
Average interest-earning assets to average interest-bearing liabilities
112.13
114.23
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). 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:
compared to March 31, 2023
Increase (Decrease)
Due to
Volume
1,907
1,462
3,369
3,252
8,870
12,122
1,150
3,618
4,768
(222)
294
72
51,839
30,709
82,548
57,926
44,953
102,879
10,215
9,826
20,041
(40)
(6)
(46)
Money market deposits
(313)
5,349
5,036
24,927
16,622
41,549
Total Deposits
34,789
31,791
66,580
2,988
6,948
9,936
37,777
38,739
76,516
20,149
6,214
26,363
Provision for Credit Losses. We recorded a provision for credit losses of $4.7 million for the three months ended March 31, 2024, a decrease of $2.1 million, or 31%, over the three months ended March 31, 2023. The $4.7 million provision for credit losses consisted of $4.9 million for the ACL-Loans and a negative provision of $0.2 million for the ACL-OBCE’s. The ACL-Loans was $75.7 million, or 0.70% of total loans, at March 31, 2024, compared to $71.8 million, or 0.70% of total loans, at December 31, 2023, and $51.8 million, or 0.60%, at March 31, 2023. The increases in the ACL-Loans compared to both prior periods reflected increases associated with loan growth in the multi-family and healthcare portfolios, as well as changes in specific reserves and loss factors to reflect industry conditions. Additional details are provided in the ACL-Loans portion of the Comparison of Financial Condition at March 31, 2024 and December 31, 2023 and in Note 4: Loans and Allowance for Credit Losses on Loans.
Noninterest Income. Noninterest income of $40.9 million for the three months ended March 31, 2024 increased $26.6 million, or 187%, compared to $14.3 million for the three months ended March 31, 2023. The increase was primarily due to a $17.0 million, or 722%, increase in loan servicing fees, a $4.1 million, or 338%, increase in syndication and asset management fees, a $3.0 million, or 103%, increase in other income and a $2.6 million, or 39%, increase in gain on sale of loans.
Loan servicing fees included a $14.0 million positive fair market value adjustment to servicing rights for the three months ended March 31, 2024, compared to a $2.9 million negative adjustment to fair value of servicing rights for the three months ended March 31, 2023. The $2.6 million, or 39%, increase in gain on sale of loans resulted from higher interest rates across the industry that have led lower multi-family volumes sold in the secondary market. The $3.0 million increase in other income included a $2.3 million gain on derivatives for interest rate protection.
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A summary of the gain on sale of loans for the three months ended March 31, 2024 and 2023 is below:
For the Three Months Ended March 31,
(in thousands)
Loan Type
8,423
4,920
Single-family
280
277
Small Business Association (SBA)
653
1,536
Noninterest Expense. Noninterest expense of $48.9 million for the three months ended March 31, 2024 increased $14.1 million, or 41%, compared to $34.8 million for the three months ended March 31, 2023. The increase was due primarily to a $7.5 million, or 34%, increase in salaries and employee benefits associated with higher commissions on higher production volume. Also contributing to the higher expenses was a $2.9 million, or 135%, increase in FDIC deposit insurance expenses reflecting our growth in assets and the change in fee structure, as we are now classified as a large financial institution over $10 billion. Also, impacting the higher expenses was a $1.8 million, or 81%, increase in professional fees. The efficiency ratio was at 29.1% in the three months ended March 31, 2024, compared with 30.3% in the three months ended March 31, 2023.
Income Taxes. Income tax expense increased $8.9 million, or 48%, to $27.2 million for the three months ended March 31, 2024 from the three months ended March 31, 2023. The increase was due primarily to a 56% increase in pretax income period to period. The effective tax rate was 23.8% and 25.0% for the three months ended March 31, 2024 and March 31, 2023, respectively.
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 Ginnie Mae servicers in the country based on aggregate loan principal value. As of March 31, 2024 the Company’s total servicing portfolio had an unpaid principal balance of $26.4 billion, primarily managed in the Multi-Family Mortgage Banking segment. Included in this amount was an unpaid principal balance of loans serviced for others of $15.4 billion, an unpaid principal balance of loans sub-serviced for others of $2.2 billion, and other servicing balances of $0.7 billion at March 31, 2024. These loans are not included in the accompanying unaudited condensed consolidated balance sheet. The Company also manages $8.1 billion of loans on the balance sheet at March 31, 2024. The servicing portfolio is primarily Ginnie Mae, 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 funded over $33.2 billion in 2022, $33.0 billion in 2023 and $7.9 billion in the three months ended March 31, 2024. Mortgage Warehousing also provides commercial loans and collects deposits related to the mortgage escrow accounts of its customers.
The Banking segment includes retail banking, commercial lending, agricultural lending, retail and correspondent residential mortgage banking, and SBA lending. Banking operates primarily in Indiana, 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. Strategic opportunities come from MCC and MCS, where loans are funded by the Banking segment and the Banking segment provides Ginnie Mae custodial services to MCC and MCS. Low-income tax credit syndication and debt fund offerings complement the lending activities of new and existing multi-family mortgage customers. The securities available for sale and held to maturity funded by MCC custodial deposits or purchases of securitized loans originated by MCC are pledged to FHLB to provide advance capacity during periods of high residential loan volume for Mortgage Warehousing. Mortgage Warehousing provides leads to Correspondent Residential Lending in the Banking segment. Retail and commercial customers provide cross selling opportunities within the banking segment. Merchants Mortgage is a risk mitigant to Mortgage Warehousing because it provides us with a ready platform to sell the underlying collateral to secure repayment. These and other synergies form a part of our strategic plan.
The Other segment presented below, in Note 15: Segment Information, and elsewhere in this report includes general and administrative expenses for provision of services to all segments, internal funds transfer pricing offsets resulting from allocations to or from the other segments, certain elimination entries, and investments in low-income housing tax credit limited partnerships or Limited Liability Companies (“LLC”).
For the three months ended March 31, 2024 and 2023, we had total net income of $87.1 million and $55.0 million, respectively. Net income for our three segments for the respective periods was as follows:
For the Three Months Ended
Multi-family Mortgage Banking
Mortgage Warehousing
Multi-family Mortgage Banking. The Multi-family Mortgage Banking segment reported net income of $16.6 million for the three months ended March 31, 2024, an increase of $14.6 million, or 745%, from net income of $2.0 million reported for the three months ended March 31, 2023. The increase in net income was primarily due to a $16.4 million increase in servicing fees, as well as higher syndication and asset management fees, and higher gain on sale of loans.
Servicing fees included a $13.2 million positive fair market value adjustment to servicing rights for the three months ended March 31, 2024, compared to a $2.2 million negative adjustment to fair value of servicing rights for the three months ended March 31, 2023.
Mortgage Warehousing. The Mortgage Warehousing segment reported net income of $20.2 million for the three months ended March 31, 2024, an increase of $11.5 million, or 134%, compared to $8.6 million for the three months ended March 31, 2023. The increase in net income reflected higher net interest income as volumes increased.
There was a 46% increase in warehouse loan volume of $7.9 billion compared to $5.4 billion for the three months ended March 31, 2023, which significantly exceeded industry volume increases of 13%, according to the Mortgage Bankers Association.
Banking. The Banking segment reported net income of $56.4 million for the three months ended March 31, 2024, an increase of $7.1 million, or 14%, compared to $49.3 million for the three months ended March 31, 2023. The increase in net income was primarily due to higher net interest income from higher yields and average balances on loans.
The results included a $0.8 million positive fair market value adjustment to servicing rights for the three months ended March 31, 2024, compared to a $0.7 million negative adjustment to fair value of servicing rights for the three months ended March 31, 2023.
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, interest on investment securities, 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 March 31, 2024, based on collateral, we had $5.6 billion in available unused borrowing capacity with the FHLB and the Federal Reserve discount window. This compared to $6.0 billion at December 31, 2023. While the amounts available fluctuate daily, we also had available capacity 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 repurchase agreements included in loans receivable. Taken together with its unused borrowing capacity of $5.6 billion described above, these totaled $10.9 billion, or 61%, of its $17.8 billion total assets at March 31, 2024. 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 $2.1 billion as of March 31, 2024, representing less than 15% of total deposits. Since 2018, the Company has offered its customers an opportunity to insure balances in excess of $250,000 through our insured cash sweep program that extends FDIC protection up to $100 million. The balance of deposits in this program was $1.7 billion and $1.6 billion as of March 31, 2024 and December 31, 2023, respectively.
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. As of March 31, 2024, Accumulated Other Comprehensive Losses (“AOCL”) of $1.2 million, related to securities available for sale, decreased $1.3 million, or 53%, compared to losses of $2.5 million as of December 31, 2023. The $1.2 million of AOCL as of March 31, 2024 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 by operating activities was $(383.8) million and $(301.5) million for the three months ended March 31, 2024 and 2023, 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 $(695.0) million and $(1.1) billion for the three months ended March 31, 2024 and 2023, respectively. Net cash provided by financing activities, which is comprised primarily of net change in borrowings and deposits was $1.0 billion and $1.6 billion for the three months ended March 31, 2024 and 2023, respectively.
Certificates of deposit that are scheduled to mature in less than one year from March 31, 2024 totaled $5.9 billion, or 98% 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.
Off-Balance Sheet Arrangements.
In the normal course of operations, we engage in a variety of financial transactions that, in accordance with U.S. generally accepted accounting principles, are not recorded in our financial statements. These transactions involve, to varying degrees, elements of credit, interest rate and liquidity risk. Such transactions are used primarily to manage customers’ requests for funding and take the form of loan commitments, lines of credit and standby letters of credit.
At March 31, 2024, we had $3.8 billion in outstanding commitments to extend credit that are subject to credit risk and $4.1 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, the Company’s business model is designed to continuously sell a significant portion of its loans, which provides flexibility in managing its liquidity.
Capital Resources.
The access to and cost of funding new business initiatives, the ability to engage in expanded business activities, the ability to pay dividends, the level of deposit insurance costs and the level and nature of regulatory oversight depend, in part, on our capital position. The Company filed a shelf registration statement on Form S-3 with the SEC on August 8, 2022, which was declared effective on August 17, 2022, under which we can issue up to $500 million aggregate offering amount of registered securities to finance our growth objectives. As previously demonstrated, the Company also has the ability to utilize securitization transactions to free up capital as needed.
The assessment of capital adequacy depends on a number of factors, including asset quality, liquidity, earnings performance, changing competitive conditions and economic forces. We seek to maintain a strong capital base to support our growth and expansion activities, to provide stability to our current operations and to promote public confidence in our Company.
Shareholders’ Equity. Shareholders’ equity was $1.8 billion as of March 31, 2024, compared to $1.7 billion as of December 31, 2023. The $75.4 million, or 4%, increase resulted primarily from net income of $87.1 million, which was partially offset by dividends paid on common and preferred shares of $12.6 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.
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 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 has replaced 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, if the Series B Preferred Stock remains outstanding on or after October 1, 2024, in addition to using three-month SOFR as the benchmark, the Company will increase 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 October 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 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 Reset 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. If the Series D Preferred Stock remains outstanding on October 1, 2027, its dividend rate would reset to the 5-year Treasury rate, plus 4.34% and would remain at that level for an additional 5 years.
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Common Shares/Dividends. As of March 31, 2024, the Company had 43,354,718 common shares issued and outstanding. The Board declared a quarterly dividend of $0.09 per share for the first quarter of 2024.
Capital Adequacy.
The following tables present the Company’s capital ratios at March 31, 2024 and December 31, 2023:
Quantitative measures established by regulation to ensure capital adequacy require the Company and Merchants Bank to maintain minimum amounts and ratios (set forth in the table above). Management believes, as of March 31, 2024 and December 31, 2023, that the Company and Merchants Bank met all capital adequacy requirements to which they were subject.
As of March 31, 2024 and December 31, 2023, the most recent notifications from the Federal Reserve categorized the Company as well capitalized and most recent notifications from the FDIC categorized Merchants Bank 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 or Merchants Bank’s category.
FMBI was subject to these measures prior to the sale of its branches and the merger of its remaining charter into Merchants Bank in January 2024. As of December 31, 2023, FMBI met all capital adequacy requirements (as set forth in the table above). The FDIC categorized FMBI as well capitalized at that time and there are no conditions or events since that notification that management believes would have changed that 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 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 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, at a minimum, to monitor the level of interest rate risk sensitivity to ensure compliance with the board of directors’ approved risk limits. Additionally, the Risk Committee meets quarterly, in conjunction with Board meetings, to assess risks associated with interest rate sensitivity.
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
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liability sensitive position refers to a balance sheet position in which an increase in short-term interest rates is expected to generate lower net interest income, as rates paid on our interest-bearing liabilities would reprice upward more quickly than rates earned on our interest-earning assets, thus compressing our net interest margin.
Income Simulation and Economic Value Analysis. Interest rate risk measurement is calculated and reported to the ALCO at least quarterly. The information reported includes period-end results and identifies any policy limits exceeded, along with an assessment of the policy limit breach and the action plan and timeline for resolution, mitigation, or assumption of the risk.
We use two approaches to model interest rate risk: Net Interest Income at Risk (NII at Risk) and Economic Value of Equity (“EVE”). Under NII at Risk, net interest income is modeled utilizing various assumptions for assets, liabilities, and derivatives and excludes non-interest income. EVE measures the period end market value of assets minus the market value of liabilities and the change in this value as rates change. EVE is a period end measurement.
We report NII at Risk to isolate the change in income related solely to interest-earning assets and interest-bearing liabilities. The NII at Risk results reflect the analysis used quarterly by management. It models gradual -200, -100, +100 and +200 basis point parallel shifts in market interest rates, implied by the forward yield curve over the next one-year period.
The following table presents NII at Risk for Merchants Bank as of March 31, 2024 and December 31, 2023.
Net Interest Income Sensitivity
Twelve Months Forward
- 200
- 100
+ 100
+ 200
March 31, 2024:
Dollar change
(75,217)
(37,381)
29,134
56,508
Percent change
(14.5)
(7.2)
5.6
December 31, 2023:
(73,311)
(36,576)
29,601
57,294
(15.0)
(7.5)
Our interest rate risk management policy limits the change in our net interest income to 20% for a +/-100 basis point move in interest rates, and 30% for a +/-200 basis point move in rates. At March 31, 2024 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
173,967
90,058
(31,781)
(77,259)
5.3
(1.9)
(4.6)
180,864
92,793
(34,800)
(79,455)
5.5
(2.1)
(4.7)
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Our interest rate risk management policy limits the change in our EVE to 15% for a +/-100 basis point move in interest rates, and 20% for a +/-200 basis point move in rates. We are within policy limits set by our board of directors for the -200, -100, +100 and +200 basis point scenarios. The EVE reported at March 31, 2024 projects that as interest rates increase (decrease) immediately, the economic value of equity position will be expected to decrease (increase). When interest rates rise, fixed rate assets generally lose economic value; the longer the duration, the greater the value lost. The opposite is true when interest rates fall.
ITEM 3 Quantitative and Qualitative Disclosures About Market Risk
The information required under this item is included as part of “Management’s Discussion and Analysis of Financial Condition and Results of Operations” of this Form 10-Q under the headings “Liquidity and Capital Resources” and “Interest Rate Risk.”
ITEM 4 Controls and Procedures
(a) Evaluation of disclosure controls and procedures.
Our management, under the supervision and with the participation of our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15(e) and 15d-15(e) under the Exchange Act) as of the end of the period covered by this Form 10-Q. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that, as of March 31, 2024, 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.
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, 2023.
ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds
ITEM 3. Defaults Upon Senior Securities
ITEM 4. Mine Safety Disclosures
Not applicable.
ITEM 5. Other Information
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.
Written Statement of Chief Executive Officer and Chief Financial Officer furnished pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
101.INS
XBRL Instance Document – the instance document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document
101.SCH
XBRL Taxonomy Extension Schema Document
101.CAL
XBRL Taxonomy Extension Calculation Linkbase Document
101.DEF
XBRL Taxonomy Extension Definition Linkbase Document
101.LAB
XBRL Taxonomy Extension Label Linkbase Document
101.PRE
104
XBRL Taxonomy Extension Presentation Linkbase Document
Cover Page Interactive Data File – The cover page interactive data file does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document
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.
Date:
May 10, 2024
By:
/s/ Michael F. Petrie
Michael F. Petrie
Chairman & Chief Executive Officer
/s/ John F. Macke
John F. Macke
Chief Financial & Accounting Officer
(Principal Financial Officer)