MERCHANTS BANCORP Management's discussion and analysis of the financial condition atSeptember 30, 2020 and results of operations for the three and nine months endedSeptember 30, 2020 and 2019, is intended to assist in understanding the financial condition and results of operations of the Company. The information contained in this section should be read in conjunction with the unaudited condensed consolidated financial statements and the notes thereto, appearing in Part I, Item 1 of this Form 10-Q.
The words "the Company," "we," "our" and "us" refer to
Financial Highlights for the Three Months Ended
? Net income per common share of
months ended
The
ended
? increase in net interest income that reflected significant growth in mortgage
warehouse loans, and a 255% increase in gain on sale of loans, primarily from
higher growth in both single-family and multi-family mortgages.
Partially offsetting the increases to net income was a
in the provision for income taxes due to the 179% increase in pre-tax income,
? and a
higher salaries and employee benefits to support the strong growth in our
businesses, as well as increases in loan expenses.
? Total assets of
? Return on average assets was 2.34% for the third quarter 2020 compared to 1.35%
for the third quarter of 2019.
Asset quality remained strong, as delinquent loans (greater than or equal to 30
days past due) declined by 3.9 million, or 31%, since
? Nonperforming loans (nonaccrual and accruing loans greater or equal to 90 days
past due) represented
30, 2020, compared to
31, 2019.
As of
existing customers related to the COVID-19 pandemic. The Company had only 11
loans remaining in payment deferral arrangements, with unpaid balances of
? million that represented less than 0.02% of total loans and loans held for sale
at
million at
in our allowance for loan loss reserves for COVID-19 uncertainties as ofSeptember 30, 2020 .
The net interest margin of 2.81% increased 59 basis points compared to 2.22%
for the three months ended
increased by 76 basis points compared to 1.98% for the three months ended
?
profitability in both rising and falling interest rate environments, and unlike
many other banks and holding companies, our future profitability relies less
upon changes in net interest margin.
38
Table of Contents
Merchants Bancorp We began borrowing from the Paycheck Protection Program Liquidity Facility
? ("PPPLF") during the third quarter of 2020 and the
window during the second quarter 2020, which has contributed to lower interest
expenses and increased borrowing capacity.
A 134% increase in warehouse loan volume compared to the three months ended
? according to the
increased loan origination and refinancing activity due to lower market interest rates.
The volume of loans originated and acquired for sale in the secondary market
? through our multi-family business increased by
to the three months ended
Business Overview
We are a diversified bank holding company headquartered inCarmel, Indiana and registered under the Bank Holding Company Act of 1956, as amended. We currently operate in and service multiple lines of business, including multi-family housing, mortgage warehouse financing, retail and correspondent residential mortgage banking, agricultural lending, and traditional community banking. Our business consists primarily of funding low risk loans that sell within 90 days of origination. The sale of loans and servicing fees generated primarily from the multi-family rental real estate loans servicing portfolio contribute to noninterest income. The funding source is primarily from mortgage custodial, municipal, retail, commercial, and brokered deposits. We believe that the combination of net interest income and noninterest income from the sale of low risk profile assets results in lower than industry charge offs and a lower expense base serving to maximize net income and shareholder return.
Critical Accounting Policies and Estimates
The preparation of our consolidated financial statements requires management to
make estimates and judgments that affect the reported amounts of assets,
liabilities, revenues, and expenses. These estimates are based upon historical
experience and on various other assumptions that management believes are
reasonable under the current circumstances. These estimates form the basis for
making judgments about the carrying value of certain assets and liabilities that
are not readily available from other sources. Actual results may differ from
these estimates under different assumptions or conditions.
The Jumpstart Our Business Startups Act of 2012 ("JOBS Act") contains provisions
that, among other things, reduce certain reporting requirements for qualifying
public companies. As an "emerging growth company" we may delay adoption of new
or revised accounting pronouncements applicable to public companies until such
pronouncements are made applicable to private companies. We are taking advantage
of the benefits of this extended transition period. Accordingly, our financial
statements may not be comparable to companies that comply with such new or
revised accounting standards.
The estimates and judgments that management believes have the most effect on its
reported financial position and results of operations are set forth within
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" in our Annual Report on Form 10-K for the fiscal year ended December
31, 2019 . There have been no significant changes in critical accounting policies
or the assumptions and judgments utilized in applying these policies since those
reported for the year ended December 31, 2019 .
Financial Condition
As ofSeptember 30, 2020 , we had approximately$9.5 billion in total assets,$7.1 billion in deposits,$1.6 billion in borrowings, and$757.1 million in total shareholders' equity. Total assets as ofSeptember 30, 2020 included approximately$429.2 million of cash and cash equivalents,$3.3 billion of loans held for sale and$4.9 billion of loans 39 Table of ContentsMerchants Bancorp held for investment. It also included$374.7 million of mortgage loans in process of securitization that primarily represent pre-sold multi-family rental real estate loan originations in primarilyGovernment National Mortgage Association ("GNMA") mortgage backed securities pending settlements that typically occur within 30 days. There were$278.9 million of available for sale securities that are match funded with related custodial deposits. There are restrictions on the types of securities, as these are funded by certain custodial deposits where we set the cost of deposits based on the yield of the related securities. Mortgage servicing rights were$75.8 million atSeptember 30, 2020 based on the fair value of the loan servicing, which are primarily GNMA servicing rights with 10-year call protection.
Comparison of Financial Condition at
Total Assets. Total assets increased$3.2 billion , or 50%, to$9.5 billion atSeptember 30, 2020 from$6.4 billion atDecember 31, 2019 . The increase was due primarily to increases in loans held for sale of$1.2 billion , net loans receivable of$1.8 billion , mortgage loans in process of securitization of$104.8 million , and FHLB stock of$50.3 million . Partially offsetting the increase was a$77.5 million decrease in cash and cash equivalents and a$11.4 million decrease in securities available for sale. Cash and Cash Equivalents. Cash and cash equivalents decreased$77.5 million , or 15%, to$429.2 million atSeptember 30, 2020 from$506.7 million atDecember 31, 2019 . The 15% decrease reflected strategies to manage cash and borrowings most cost-effectively for our increased funding activities. Less cash is required to be on hand, as our available lines of credit have increased. Mortgage Loans in Process of Securitization. Mortgage loans in process of securitization increased$104.8 million , or 39%, to$374.7 million atSeptember 30, 2020 , from$269.9 million atDecember 31, 2019 . These represent loans that our banking subsidiary,Merchants Bank , has funded and are held pending settlement, primarily as GNMA mortgage-backed securities with a firm investor commitment to purchase the securities. The 39% increase was primarily due to a significant increase in the volume of loans that had not yet settled with government agencies. Securities Available for Sale. Securities available for sale decreased$11.4 million , or 4%, to$278.9 million atSeptember 30, 2020 . The decrease in securities available for sale was primarily due to purchases of$434.3 million , offset by calls, maturities, sales, and repayments of securities totaling$445.5 million during the period. We invest in available for sale securities primarily using funds from escrow deposits held atMerchants Bank , received in connection with our multi-family mortgage servicing activities. The available for sale securities are funded by, and paired with as to interest rates, escrow custodial deposits held at the Company on loans serviced by us. This portfolio of securities is structured to achieve a favorable interest rate spread.Federal Home Loan Bank ("FHLB") stock. FHLB stock increased$50.3 million , or 247%, to$70.7 million atSeptember 30, 2020 . The increase in FHLB stock was due primarily to additional borrowing from the FHLB that allows us to manage our liquidity and funding costs more effectively. Additional stock purchases are required by the FHLB in order to facilitate increased borrowing capacity. Loans Held for Sale. Loans held for sale, comprised primarily of single-family residential real estate loan participations that meet Fannie Mae, Freddie Mac, or GNMA eligibility, increased$1.2 billion , or 59%, to$3.3 billion atSeptember 30, 2020 from$2.1 billion atDecember 31, 2019 . The increase in loans held for sale was due primarily to higher warehouse volumes for the nine months endedSeptember 30, 2020 . Loans Receivable, Net. Loans receivable, net, which are comprised of loans held for investment, increased$1.8 billion , or 61%, to$4.9 billion atSeptember 30, 2020 compared to$3.0 billion atDecember 31, 2019 . The increase in net loans receivable was comprised primarily of:
? an increase of
to
40
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Merchants Bancorp ? an increase of
loans, to
? an increase of
million at
? an increase of
The increase in mortgage warehouse lines of credit was primarily due to an increase in single-family refinancing activity associated with lower market interest rates. Our growth in this business was higher than the industry overall. We reported a 169% increase in mortgage warehouse volumes for the nine months endedSeptember 30, 2020 compared to the nine months endedSeptember 30, 2019 , while the forecast is for an 59% industry increase in single-family residential loan volumes for the same period, according to theMortgage Bankers Association . The increase in multi-family and healthcare financing was due to higher origination volume for construction, bridge and other loans generated through our multi-family segment that will remain on our balance sheet until they convert to permanent financing or are otherwise paid off over an average of one to three years.
The increase in residential real estate loans was primarily due to growth in first-lien HELOC loans.
The increase in commercial and commercial real estate was due to a significant increase in SBA loans that offset declines in traditional commercial loans. PPP loans totaled$87 million atSeptember 30, 2020 .
As of
Allowance for Loan Losses. The allowance for loan losses of$23.4 million atSeptember 30, 2020 increased$7.6 million compared toDecember 31, 2019 , primarily reflecting increases associated with loan growth and uncertainties surrounding the COVID-19 pandemic. Loan growth drove approximately$6.5 million , or 85%, of the$7.6 million increase, while additional provision associated with the COVID-19 pandemic represented approximately$628,000 , or 8% of the increase. The$6.5 million increase in the allowance for loan losses associated with loan growth compared toDecember 31, 2019 was largely driven by the 115% growth in mortgage warehouse loans and 58% growth in multi-family & healthcare financing loans compared toDecember 31, 2019 . Loss factors applied to mortgage warehouse loans have traditionally represented the lowest loss factors of all loan categories utilized to compute allowances for loan losses. AtSeptember 30, 2020 , the higher concentration of warehouse loans, which have lower loss factors in the allowance, has contributed to the overall percentage of the allowance for loan losses to total loans to decrease by 3 basis points, from .52% atDecember 31, 2019 , to .48% atSeptember 30, 2020 . The Company has minimal direct exposure to consumer, commercial, and other small businesses that may be negatively impacted by COVID-19, but management has analyzed and increased the qualitative factors in these and other loan categories for potential future loan losses attributable to COVID-19. Accordingly, the Company increased the allowance by approximately$628,000 sinceDecember 31, 2019 . As ofSeptember 30, 2020 , management did not see significant disruption with existing customers related to COVID-19. As ofSeptember 30, 2020 , the Company had only 11 loans remaining in payment deferral arrangements, with unpaid balances of$1.6 million that represented less than 0.02% of total loans and loans held for sale. This compared favorably to the unpaid balances of$80.6 million atJune 30, 2020 . If any of these 11 loans were not already classified on the Special Mention (Watch) list, they have been added to a new category of Special Mention (Watch) loans specifically related to COVID-19 deferral arrangements. Because it is still too early to know the full extent of potential future losses associated with the impact of COVID-19, the Company continues to monitor the situation and may need to adjust future expectations with additional increases to its provision for loan losses as developments occur throughout the remainder of 2020. 41 Table of ContentsMerchants Bancorp
Also influencing the overall level of the allowance for loan losses is our differentiated strategy to typically hold loans with shorter durations and to maintain strict underwriting standards that enable us to sell the majority of our loans while meeting the criteria of government agencies.Goodwill .Goodwill of$15.8 million atSeptember 30, 2020 remained unchanged compared toDecember 31, 2019 . As ofSeptember 30, 2020 , the Company's market capitalization was above its book value, despite stock market volatility related to the COVID-19 pandemic. Given the continued strength of the Company's results, we do not believe there exists any impairment to goodwill or intangible assets. Mortgage Servicing Rights. Mortgage servicing rights increased$1.4 million , or 2%, to$75.8 million atSeptember 30, 2020 compared to$74.4 million atDecember 31, 2019 . During the nine months endedSeptember 30, 2020 , originated and purchased servicing of$14.4 million was offset by paydowns of$5.1 million and a fair value decrease of$8.0 million . Mortgage servicing rights are recognized in connection with sales of loans when we retain servicing of the sold loans, as well as upon purchases of loan servicing portfolios. The mortgage servicing rights are recorded and carried at fair value. The fair value decrease recorded during the nine months endedSeptember 30, 2020 was driven primarily by the decline in short term interest rates that drive the valuation of escrow deposits held in conjunction with the servicing, and the decline in mortgage rates that increased borrower prepayment assumptions. Further decreases in interest rates could result in additional reductions to fair market values. The opposite could occur if interest rates increase. Deposits. Deposits increased$1.6 billion , or 29%, to$7.1 billion atSeptember 30, 2020 from$5.5 billion atDecember 31, 2019 . The increase was primarily due to growth in traditional and brokered demand accounts that were partially offset by lower levels of brokered certificates of deposits, as we shifted to utilize more cost-effective funding to match the expected duration of our loans, including borrowing through theFederal Reserve discount window. Demand deposits increased$2.0 billion , or 97%, to$4.1 billion atSeptember 30, 2020 , while savings deposits increased$557.8 million , or 46%, to$1.8 billion atSeptember 30, 2020 . Certificates of deposit accounts decreased$987.5 million , or 45%, to$1.2 billion atSeptember 30, 2020 , primarily driven by the decrease in brokered deposits outstanding period to period.
We have decreased our use of total brokered deposits by 20%, to
Brokered certificates of deposit accounts decreased
? The decrease reflected our shift to utilize more cost-effective funding to
match the expected duration of our loans, including borrowing through the
? Brokered savings deposits increased
at
? Brokered demand deposit accounts increased by
at
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, ifMerchants Bank does not maintain its well-capitalized position, it may not accept or renew any brokered deposits without a waiver granted by theFDIC . 42 Table of ContentsMerchants Bancorp Total interest-bearing deposits increased$1.2 billion , or 23%, to$6.4 billion atSeptember 30, 2020 , primarily due to the increase in custodial deposits from customers that are experiencing significant refinancing activity. Total noninterest-bearing deposits increased$394.0 million , or 145%, to$666.0 million atSeptember 30, 2020 . Borrowings. Borrowings totaled$1.6 billion atSeptember 30, 2020 , an increase of$1.4 billion , or 792%, fromDecember 31, 2019 , in order to maintain an appropriate level of cash to fund our businesses. Depending on rates and timing, borrowing can be, and has been during the nine months endedSeptember 30, 2020 , a more effective liquidity management alternative than utilizing brokered certificates of deposits. The Company has also started utilizing theFederal Reserve's discount window and PPPLF which is contributing to lower interest expenses. During this time of unprecedented loan growth at Merchants, we also increased our borrowing capacity based on available collateral. As ofSeptember 30, 2020 , we had$2.5 billion in unused lines of credit, compared to$1.5 billion atDecember 31, 2019 . Total Shareholders' Equity. Total shareholders' equity increased$103.4 million , or 16%, to$757.1 million atSeptember 30, 2020 compared toDecember 31, 2019 . The increase resulted primarily from net income of$120.7 million , which was partially offset by dividends paid on common and preferred shares of$6.9 million and$10.9 million , respectively, during the period.
Asset Quality
In response to the COVID-19 pandemic, we migrated employees to work-from-home arrangements inmid-March 2020 and continued operating without disruption to our customers. Most employees returned to the office part-time as ofSeptember 2020 . We have also assessed our internal control environment and believe we have the necessary precautions in place to ensure business continuity. The Company believes it has minimal direct exposure to consumer, commercial and other small businesses that may be negatively impacted by COVID-19. As ofSeptember 30, 2020 , we had only 11 loans remaining in payment deferral arrangements, with unpaid balances of$1.6 million that represented less than 0.02% of total loans and loans held for sale. This compared favorably to the unpaid balances of$80.6 million atJune 30, 2020 . Management has also assisted small businesses that could benefit from the CARES Act, particularly in the SBA's Paycheck Protection Program ("PPP"). As ofSeptember 30, 2020 , the Company has funded approximately$87 million in loans to small businesses under this program since it launched onApril 3, 2020 . Total nonperforming loans (nonaccrual and greater than 90 days late but still accruing) were$7.9 million , or 0.16%, of loans receivable atSeptember 30, 2020 , compared to$4.7 million , or 0.15%, of loans receivable atDecember 31, 2019 and$6.1 million , or 0.22%, atSeptember 30, 2019 . The increase compared toDecember 31, 2019 was primarily related to one collateralized agricultural loan that was delinquent greater than 90 days, with repayment still anticipated. As a percentage of nonperforming loans, the allowance for loan losses was 295.9% atSeptember 30, 2020 compared to 338.6% atDecember 31, 2019 and 223.5% atSeptember 30, 2019 . The changes compared to both periods were primarily due to the changes in the nonperforming loans.
Total loans greater than 30 days past due were
Traditional Special Mention (Watch) loans were$107.4 million atSeptember 30, 2020 , compared to$60.3 million atDecember 31, 2019 and$56.1 million atSeptember 30, 2019 . The increases primarily reflected outstanding balances of certain multi-family projects that have experienced cost over-runs funded by the borrower and lower than projected rent collections and occupancy levels, all of which have contributed to lower than projected cash flow of the projects. An additional category of Special Mention (Watch) loans was added as ofJune 30, 2020 , and as ofSeptember 30, 2020 included$1.0 million in arrangements related to COVID-19 deferral plans that were not already included in the 43 Table of ContentsMerchants Bancorp traditional Special Mention loans category. Classified (substandard, doubtful and loss) loans were$16.0 million atSeptember 30, 2020 ,$12.5 million atDecember 31, 2019 and$14.1 million atSeptember 30, 2019 . Although we currently do not anticipate COVID-19 to have a material increase to Special Mention or Classified loans, given the industries in which we provide funding, we continue to monitor the situation.
During the three months ended
For the nine months endedSeptember 30, 2020 , there were$236,000 of charge-offs and$106,000 of recoveries, compared to$964,000 of charge-offs and$18,000 of recoveries for the nine months endedSeptember 30, 2019 .
Comparison of Operating Results for the Three Months Ended
General. Net income for the three months endedSeptember 30, 2020 was$55.0 million , an increase of$34.7 million , or 171%, from net income of$20.3 million for the three months endedSeptember 30, 2019 . The increase was primarily due to a$32.7 million , or 100% increase in net interest income that reflected significant growth in mortgage warehouse and multi-family loans, and an increase of$21.2 million , or 255% increase in gain on sale of loans, primarily from higher growth in single-family and multi-family mortgages. Also contributing to the increase in net income was a$4.1 million , or 153%, increase in mortgage warehouse fees and a$767,000 increase in loan servicing fees that reflected a lower negative fair market value adjustment to mortgage servicing rights. Partially offsetting the increases to net income was a$13.1 million increase in the provision for income taxes due to the 179% increase in pre-tax income, and a$10.9 million increase in noninterest expenses, reflecting higher salaries and employee benefits to support the strong growth in our businesses, as well as increases in loan expenses from higher volume. Net Interest Income. Net interest income increased$32.7 million , or 100%, to$65.3 million for the three months endedSeptember 30, 2020 , compared with the three months endedSeptember 30, 2019 . The 100% increase was due to a$3.4 billion increase in our average interest earning assets and a 76 basis point increase in our interest rate spread, to 2.74%, for the three months endedSeptember 30, 2020 from 1.98% for the three months endedSeptember 30, 2019 . Our net interest margin increased 59 basis points, to 2.81%, for the three months endedSeptember 30, 2020 from 2.22% for the three months endedSeptember 30, 2019 . The increase in net interest margin reflected lower funding costs that outpaced the lower overall market interest rates on loans. Interest Income. Interest income increased$16.5 million , or 28%, to$76.3 million for the three months endedSeptember 30, 2020 , compared with the three months endedSeptember 30, 2019 . This increase was primarily attributable to a$19.1 million increase in interest on loans and loans held for sale from higher volumes and was partially offset by lower overall market interest rates. The average balance of loans, including loans held for sale, during the three months endedSeptember 30, 2020 increased$3.2 billion , or 68%, to$7.9 billion from$4.7 billion for the three months endedSeptember 30, 2019 , while the average yield on loans decreased 83 basis points, to 3.61%, for the three months endedSeptember 30, 2020 , compared to 4.44% for the three months endedSeptember 30, 2019 . The increase in average balances of loans and loans held for sale was primarily due to significant increases in warehouse funding and multi-family volume. The decrease in the average yield on loans was due to the overall decrease in interest rates in the economy period to period. The average balance of mortgage loans in process of securitization increased$286.4 million , or 176%, to$449.3 million for the three months endedSeptember 30, 2020 , compared to$162.9 million for the three months endedSeptember 30, 2019 , while the average yield decreased 58 basis points to 2.88% for the three months endedSeptember 30, 2020 . 44 Table of ContentsMerchants Bancorp
The average balance of interest-earning deposits and other decreased$82.6 million , or 12%, to$587.8 million for the three months endedSeptember 30, 2020 compared to the three months endedSeptember 30, 2019 , while the average yield decreased 184 basis points, to 0.46%, for the three months endedSeptember 30, 2020 . Interest Expense. Total interest expense decreased$16.2 million , or 60%, to$10.9 million for the three months endedSeptember 30, 2020 , compared with the three months endedSeptember 30, 2019 . Interest expense on deposits decreased$16.9 million , or 65%, to$9.1 million for the three months endedSeptember 30, 2020 from the three months endedSeptember 30, 2019 . The decrease was attributable to a 152 basis point decrease in the average cost of interest-bearing deposits, to 0.50% for the three months endedSeptember 30, 2020 from 2.02% for the same period in 2019. The decrease in the cost of deposits was primarily due to custodial interest-bearing checking accounts that are tied to lower short-term LIBOR rates, lower rates on brokered certificates of deposits, and the overall decrease in interest rates in the economy period to period. The lower rates were partially offset by a$2.1 billion , or 42%, increase in the average balance of interest-bearing deposits, to$7.2 billion compared to the balance atSeptember 30, 2019 . The increase in the average balance of interest-bearing deposits was primarily due to interest-bearing checking accounts and money market accounts. Interest expense on borrowings increased$734,000 or 67%, to$1.8 million for the three months endedSeptember 30, 2020 from$1.1 million for the three months endedSeptember 30, 2019 . The increase was due primarily to a$740.4 million , or 1,243%, increase in the average balance of borrowings outstanding for the three months endedSeptember 30, 2020 that was partially offset by a 640 basis point decrease in the average cost of borrowings to 0.91%, compared to 7.31% for the three months endedSeptember 30, 2019 . The higher average balances for the three months endedSeptember 30, 2020 reflected an increase in borrowing from the FHLB, theFederal Reserve discount window, and the PPPLF at much lower rates. 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 0.40% and 3.29%, to an effective rate of 0.91% and 7.31% for the three months endedSeptember 30, 2020 and 2019, respectively. 45 Table of ContentsMerchants Bancorp
The following table presents, for the periods indicated, information about (i)
average balances, the total dollar amount of interest income from
interest-earning assets and the resultant average yields; (ii) average balances,
the total dollar amount of interest expense on interest-bearing liabilities and
the resultant average rates; (iii) net interest income; (iv) the interest rate
spread; and (v) the net interest margin. Yields have been calculated on a
pre-tax basis. Nonaccrual loans are included in loans and loans held for sale.
Three Months Ended September 30,
2020 2019
Interest Interest
Average Income/ Yield/ Average Income/ Yield/
Balance Expense Rate Balance Expense Rate
(Dollars in thousands)
Assets:
Interest-bearing deposits,
and other $ 587,804 $ 683 0.46 % $ 670,399 $ 3,888 2.30 %
Securities available for sale
- taxable 269,896 431 0.64 % 278,314 1,604 2.29 %
Securities available for sale
- tax exempt 5,145 37 2.86 % 9,032 68 2.99 %
Mortgage loans in process of
securitization 449,336 3,250 2.88 % 162,915 1,422 3.46 %
Loans and loans held for sale 7,923,726 71,857 3.61 % 4,718,771 52,779 4.44 %
Total interest-earning assets 9,235,907 76,258 3.28 % 5,839,431 59,761 4.06 %
Allowance for loan losses (21,585) (12,990)
Noninterest-earning assets 195,128 183,399
Total assets $ 9,409,450 $ 6,009,840
Liabilities/Equity:
Interest-bearing checking $ 3,890,865 $ 1,368 0.14 % $ 1,951,613 $ 9,253 1.88 %
Savings deposits 180,931 34 0.07 % 152,509 85 0.22 %
Money market 1,578,956 3,861 0.97 % 977,228 4,698 1.91 %
Certificates of deposit 1,589,852 3,841 0.96 % 2,032,619 12,003 2.34 %
Total interest-bearing
deposits 7,240,604 9,104 0.50 % 5,113,969 26,039 2.02 %
Borrowings 800,021 1,832 0.91 % 59,585 1,098 7.31 %
Total interest-bearing
liabilities 8,040,625 10,936 0.54 % 5,173,554 27,137 2.08 %Noninterest-bearing deposits 579,145 198,832 Noninterest-bearing liabilities 57,147 69,722 Total liabilities 8,676,917 5,442,108 Equity 732,533 567,732 Total liabilities and equity$ 9,409,450 $ 6,009,840 Net interest income$ 65,322 $ 32,624 Interest rate spread 2.74 % 1.98 % Net interest-earning assets$ 1,195,282 $
665,877 Net interest margin 2.81 % 2.22 % Average interest-earning assets to average
interest-bearing liabilities 114.87 %
112.87 %
Provision for Loan Losses. We recorded a provision for loan losses of$3.0 million for the three months endedSeptember 30, 2020 , an increase of$1.8 million , over the three months endedSeptember 30, 2019 . The allowance for loan losses was$23.4 million , or 0.48% of loans receivable, atSeptember 30, 2020 , compared to$15.8 million , or 0.52% of loans receivable atDecember 31, 2019 , and$13.7 million , or 0.50%, atSeptember 30, 2019 . The increases in the allowance for loan losses compared to both prior periods reflected increases associated with loan growth and uncertainties surrounding COVID-19. Additional details are provided in the Allowance for Loan Losses portion of the Comparison of Financial Condition atSeptember 30, 2020 andDecember 31, 2019 . While it is too early to know the full extent of potential future losses associated with the impact of COVID-19, the Company continues to monitor the situation and may need to adjust future expectations as developments occur throughout the remainder of 2020. 46 Table of ContentsMerchants Bancorp Noninterest Income. Noninterest income increased$27.8 million , or 256%, to
$38.7 million for the three months endedSeptember 30, 2020 compared to the three months endedSeptember 30, 2019 . The increase was primarily due to a$21.2 million , or 255%, increase in gain on sale of loans, to$29.5 million , for the three months endedSeptember 30, 2020 compared to$8.3 million for the three months endedSeptember 30, 2019 , primarily from an increase in volume from single-family and multi-family mortgage loans. A summary of the gain on sale of loans for the three months endedSeptember 30, 2020 and 2019 is below: Gain on Sale of Loans Three Months Ended September 30, June 30, September 30, 2020 2020 2019 (in thousands) Loan Type Multi-family$ 14,872 $ 6,839 $ 7,582 Single-family 14,093 10,059 724
Small Business Association (SBA) 533 186 6
Total$ 29,498 $ 17,084 $ 8,312
Also contributing to the increase in noninterest income was a
Additionally, a$767,000 increase in loan servicing fees included a$971,000 negative adjustment to the fair value of mortgage servicing rights for the three months endedSeptember 30, 2020 , compared to a negative adjustment of$1.5 million for the three months endedSeptember 30, 2019 . Noninterest Expense. Noninterest expense increased$10.9 million , or 70%, to$26.4 million for the three months endedSeptember 30, 2020 compared to the three months endedSeptember 30, 2019 . The increase was due primarily to a$7.4 million , or 81% increase in salaries and employee benefits to support business growth, with commissions representing$4.6 million of that increase. Also contributing to the increase was a$1.7 million increase in loan expenses. The efficiency ratio was at 25.4% in the three months endedSeptember 30, 2020 , compared with 35.7% in the three months endedSeptember 30, 2019 . Income Taxes. Income tax expense increased$13.1 million , or 202%, to$19.6 million for the three months endedSeptember 30, 2020 from the three months endedSeptember 30, 2019 . The increase was due primarily to a 179% increase in pretax income period to period. The effective tax rate was 26.3% for the three months endedSeptember 30, 2020 and 24.3% for the three months endedSeptember 30, 2019 .
Comparison of Operating Results for the Nine Months Ended
General. Net income for the nine months endedSeptember 30, 2020 was$120.7 million , an increase of$73.5 million , or 155%, compared to the nine months endedSeptember 30, 2019 . The increase was primarily due to a$70.2 million increase in net interest income, a$47.7 million increase in gain on sale of loans, and a$10.5 million increase in mortgage warehouse fees. Partially offsetting the increases was a$26.9 million increase in the provision for income taxes, a$24.5 million increase in noninterest expenses, a$5.8 million increase in the provision for loan losses, and a$1.6 million decrease in loan servicing fees related primarily to negative fair market value adjustments to mortgage servicing rights. 47 Table of ContentsMerchants Bancorp Net Interest Income. Net interest income increased$70.2 million , or 83%, to
$154.9 million for the nine months endedSeptember 30, 2020 , compared with the nine months endedSeptember 30, 2019 . The increase was due to a$3.4 billion increase in our average interest earning assets and a 25 basis point increase in our interest rate spread, to 2.45%, for the nine months endedSeptember 30, 2020 from 2.20% for the nine months endedSeptember 30, 2019 . Our net interest margin increased 11 basis points, to 2.56%, for the nine months endedSeptember 30, 2020 from 2.45% for the nine months endedSeptember 30, 2019 . The increase in net interest margin reflected lower funding costs that outpaced the lower overall market interest rates on loans compared to the nine months endedSeptember 30, 2019 . Interest Income. Interest income increased$56.7 million , or 38%, to$204.9 million for the nine months endedSeptember 30, 2020 , compared with the nine months endedSeptember 30, 2019 . This increase was primarily attributable to a$59.8 million increase in interest on loans and loans held for sale and a$4.1 million increase in interest on mortgage loans in process of securitization, which was partially offset by a decrease of securities available for sale and other interest-bearing assets. The average balance of loans, including loans held for sale, during the nine months endedSeptember 30, 2020 increased$2.9 billion , or 80%, to$6.6 billion from$3.7 billion for the nine months endedSeptember 30, 2019 , reflecting significant increases in warehouse funding and multi-family volume. The average yield on loans decreased 88 basis points, to 3.82%, for the nine months endedSeptember 30, 2020 , compared to 4.70% for the nine months endedSeptember 30, 2019 , due to the overall decrease in interest rates in the economy period to period. The average balance of interest-earning deposits and other increased$283.6 million , or 57%, to$778.3 million for the nine months endedSeptember 30, 2020 from$494.6 million for the nine months endedSeptember 30, 2019 , while the average yield decreased 182 basis points, to 0.70%, for the nine months endedSeptember 30, 2020 . The average balance of mortgage loans in process of securitization increased$220.2 million , or 141%, to$376.0 million for the nine months endedSeptember 30, 2020 , compared to$155.8 million for the nine months endedSeptember 30, 2019 , while the average yield decreased 76 basis points to 3.05% for the nine months endedSeptember 30, 2020 . Interest Expense. Total interest expense decreased$13.5 million , or 21%, to$50.0 million for the nine months endedSeptember 30, 2020 , compared with the nine months endedSeptember 30, 2019 . Interest expense on deposits decreased$14.5 million , or 24%, to$45.1 million for the nine months endedSeptember 30, 2020 from the nine months endedSeptember 30, 2019 . The decrease was attributable to 108 basis point decrease in the average cost of interest-bearing deposits, to 0.92% for the nine months endedSeptember 30, 2020 from 2.00% for the same period in 2019, primarily due to the overall decrease in interest rates in the economy period to period. Offsetting the lower average cost was an increase in the average balance of interest-bearing deposits of$2.5 billion , or 64%, to$6.5 billion for the nine months endedSeptember 30, 2020 , reflecting growth in interest-bearing checking accounts and certificates of deposit. Interest expense on borrowings increased$929,000 , or 24%, to$4.8 million for the nine months endedSeptember 30, 2020 from$3.9 million for the nine months endedSeptember 30, 2019 . The increase was due primarily to a$448.4 million , or 507%, increase in the average balance of borrowings outstanding for the nine months endedSeptember 30, 2020 that was nearly offset by a 471 basis point decrease in the average cost of borrowings of 1.20%, compared to 5.91% for the nine months endedSeptember 30, 2019 . The higher average balances for the nine months endedSeptember 30, 2020 reflected an increase in borrowing from the FHLB,Federal Reserve discount window, and PPPLF at much lower rates. 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 0.52% and 3.43%, to an effective rate of 1.20% and 5.91% for the nine months endedSeptember 30, 2020 and 2019, respectively. 48 Table of ContentsMerchants Bancorp
The following table presents, for the periods indicated, information about (i)
average balances, the total dollar amount of interest income from
interest-earning assets and the resultant average yields; (ii) average balances,
the total dollar amount of interest expense on interest-bearing liabilities and
the resultant average rates; (iii) net interest income; (iv) the interest rate
spread; and (v) the net interest margin. Yields have been calculated on a
pre-tax basis. Nonaccrual loans are included in loans and loans held for sale.
Nine Months Ended September 30,
2020 2019
Interest Interest
Average Income/ Yield/ Average Income/ Yield/
Balance Expense Rate Balance Expense Rate
(Dollars in thousands)
Assets:
Interest-bearing deposits,
and other $ 778,293 $ 4,062 0.70 % $ 494,647 $ 9,314 2.52 %
Securities available for
sale - taxable 280,225 2,725 1.30 % 279,203 4,632 2.22 %
Securities available for
sale - tax exempt 5,248 112 2.85 % 10,169 217 2.85 %
Mortgage loans in process of
securitization 375,993 8,580 3.05 % 155,779 4,434 3.81 %
Loans and loans held for
sale 6,628,883 189,400 3.82 % 3,689,208 129,599 4.70 %
Total interest-earning
assets 8,068,642 204,879 3.39 % 4,629,006 148,196 4.28 %
Allowance for loan losses (18,977) (13,054)
Noninterest-earning assets 188,976 182,158
Total assets $ 8,238,641 $ 4,798,110
Liabilities/Equity:
Interest-bearing checking $ 2,874,370 $ 10,586 0.49 % $ 1,617,221 $ 23,255 1.92 %
Savings deposits 173,570 120 0.09 % 148,137 246 0.22 %
Money market 1,375,667 12,400 1.20 % 943,420 13,631 1.93 %
Certificates of deposit 2,104,225 22,026 1.40 % 1,280,303 22,478 2.35 %
Total interest-bearing
deposits 6,527,832 45,132 0.92 % 3,989,081 59,610 2.00 %
Borrowings 536,794 4,838 1.20 % 88,423 3,909 5.91 %
Total interest-bearing
liabilities 7,064,626 49,970 0.94 % 4,077,504 63,519 2.08 %Noninterest-bearing deposits 396,124
166,238 Noninterest-bearing liabilities 79,820 56,277 Total liabilities 7,540,570 4,300,019 Equity 698,071 498,091 Total liabilities and equity$ 8,238,641 $ 4,798,110 Net interest income$ 154,909 $ 84,677 Interest rate spread 2.45 % 2.20 %
Net interest-earning assets$ 1,004,016 $
551,502 Net interest margin 2.56 % 2.45 % Average interest-earning assets to average
interest-bearing liabilities 114.21 %
113.53 %
Provision for Loan Losses. We recorded a provision for loan losses of$7.7 million for the nine months endedSeptember 30, 2020 , an increase of$5.8 million , over the nine months endedSeptember 30, 2019 . The allowance for loan losses was$23.4 million , or 0.48% of loans receivable atSeptember 30, 2020 , compared to$15.8 million , or 0.52% of loans receivable atDecember 31, 2019 , and$13.7 million , or 0.50%, atSeptember 30, 2019 . The increases in the allowance for loan losses compared to both prior periods reflected increases associated with loan growth and uncertainties surrounding COVID-19. Additional details are provided in the Allowance for Loan Losses portion of the Comparison of Financial Condition atSeptember 30, 2020 andDecember 31, 2019 . While it is too early to know the full 49 Table of ContentsMerchants Bancorp
extent of potential future losses associated with the impact of COVID-19, the Company continues to monitor the situation and may need to adjust future expectations as developments occur throughout the remainder of 2020.
Noninterest Income. Noninterest income increased$60.4 million , or 248%, to$84.7 million for the nine months endedSeptember 30, 2020 compared to the nine months endedSeptember 30, 2019 . The increase was primarily due to a$47.7 million , or 238%, increase in gain on sale of loans, to$67.7 million , for the nine months endedSeptember 30, 2020 compared to$20.1 million for the same period in 2019, from an increase in the volume of single-family mortgage loans and multi-family rental real estate. A summary of the gain on sale of loans for the nine months endedSeptember 30, 2020 and 2019 is below: Gain on Sale of Loans Nine Months Ended September 30, 2020 2019 (in thousands) Loan Type Multi-family$ 40,563 $ 18,714 Single-family 26,225 1,280 Small Business Association (SBA) 960 65 Total$ 67,748 $ 20,059
Also contributing to the increase in noninterest income was a
These increases were partially offset by a
Noninterest Expense. Noninterest expense increased$24.5 million , or 55%, to$69.0 million for the nine months endedSeptember 30, 2020 compared to the nine months endedSeptember 30, 2019 . The increase was due primarily to a$15.0 million , or 54%, increase in salaries and employee benefits, reflecting an increase in commission expense associated with higher volume and additional employees to support business growth. Also contributing to the increase was a$3.7 million increase in deposit insurance expense related to the growth in deposits and assets. The efficiency ratio was at 28.8% in the nine months endedSeptember 30, 2020 , compared with 40.8% in the nine months endedSeptember 30, 2019 . Income Taxes. Income tax expense increased$26.9 million , or 175%, to$42.2 million for the nine months endedSeptember 30, 2020 from the nine months endedSeptember 30, 2019 . The increase was due primarily to a 160% increase in pretax income period to period. The effective tax rate was 25.9% for the nine months endedSeptember 30, 2020 and 24.5% for the nine months endedSeptember 30, 2019 .
Our Segments
We operate in three primary segments: Multi-family Mortgage Banking, Mortgage Warehousing, and Banking. We believe thatMerchants Bank's subsidiary,Merchants Capital Corp. ("MCC"), which operates in our Multi-Family Mortgage Banking segment, is one of the largest FHA lenders and GNMA servicers in the country based on aggregate loan principal value. As ofSeptember 30, 2020 , MCC also had a$15.0 billion servicing portfolio for banks and 50 Table of Contents Merchants Bancorp investors, including$2.6 billion serviced forMerchants Bank . The servicing portfolio is primarily GNMA loans and is a significant source of our noninterest income and deposits. Our Mortgage Warehousing segment funds agency eligible loans for non-depository financial institutions from the date of origination or purchase until the date of sale to an investor, which typically takes less than 30 days and is a significant source of our net interest income, loans, and deposits. Mortgage Warehousing has grown to fund over$20 billion of loan principal annually since 2015 and exceeded$46 billion in 2019. Mortgage Warehousing also provides commercial loans and collects deposits related to the mortgage escrow accounts of its customers. The Banking segment includes retail banking, commercial lending, agricultural lending, retail and correspondent residential mortgage banking, and SBA lending. Banking operates primarily inIndiana andIllinois , 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 ofMerchants Bank and provide synergies across the segments. The strategic opportunities include that MCC loans are funded by Merchants Banking segment and the Banking segment provides GNMA custodial services to MCC. The securities available for sale funded by MCC custodial deposits, as well as loans generated byMerchants Bank , are pledged to the FHLB to provide advance capacity during periods of high residential loan volume for Mortgage Warehousing. Mortgage Warehousing provides leads to correspondent residential lending in the banking segment. Retail and commercial customers provide cross selling opportunities within the banking segment. These and other synergies form a part of our strategic plan. For the three months endedSeptember 30, 2020 and 2019, we had total net income of$55.0 million and$20.3 million , respectively, and for the nine months endedSeptember 30, 2020 and 2019, we had total net income of$120.7 million and$47.3 million , respectively. Net income for our three segments for the respective periods was as follows: For the Three Months Ended For the Nine Months Ended September 30, September 30, 2020 2019 2020 2019 (In thousands) Multi-family Mortgage Banking$ 5,891 $
2,741$ 14,941 $ 4,546 Mortgage Warehousing 33,793 10,924 73,942 21,076 Banking 17,486 7,649 37,248 24,826 Other (2,168) (1,055) (5,384) (3,180) Total$ 55,002 $ 20,259 $ 120,747 $ 47,268
Multi-family Mortgage Banking.
Comparison of results for the three months ended
The Multi-family Mortgage Banking segment reported net income of$5.9 million for the three months endedSeptember 30, 2020 , an increase of$3.2 million , or 115%, from the$2.7 million net income reported for the three months endedSeptember 30, 2019 . The growth was primarily due to an increase in gain on sale of loans. Partially offsetting the increase in gain on sale of loans was a$5.9 million increase in noninterest expenses, primarily due to an increase in salaries and employee benefits associated with higher commissions and additional employees to support growth in volume, in addition to a$1.6 million increase in the provision for income taxes associated with higher pre-tax income compared to the three months endedSeptember 30, 2019 . 51 Table of ContentsMerchants Bancorp
The three months ended
The volume of loans originated and acquired for sale in the secondary market
increased by
Comparison of results for the nine months ended
The Multi-family Mortgage Banking segment reported net income of$14.9 million for the nine months endedSeptember 30, 2020 , an increase of$10.4 million , or 229%, from the$4.5 million of net income reported for the nine months endedSeptember 30, 2019 . The growth was primarily due to an increase in gain on sale of loans. Partially offsetting the increase in gain on sale of loans was an$14.4 million increase in noninterest expenses, primarily due to an increase in salaries and employee benefits associated with higher commissions and additional employees to support growth in volume, in addition to a$4.4 million increase in the provision for income taxes associated with significantly higher pre-tax income compared to the nine months endedSeptember 30, 2019 . Also partially offsetting the increase in gain on sale of loans compared to the prior year's period were higher negative fair market value adjustments to mortgage servicing rights. The nine months endedSeptember 30, 2020 included a$8.0 million negative fair value adjustment to mortgage servicing rights, compared with a$5.9 million negative adjustment for the nine months endedSeptember 30, 2019 .
The volume of loans originated and acquired for sale in the secondary market
increased by
Mortgage Warehousing.
Comparison of results for the three months ended
The Mortgage Warehousing segment reported net income for the three months endedSeptember 30, 2020 of$33.8 million , an increase of$22.9 million , or 209%, over the$10.9 million reported for the three months endedSeptember 30, 2019 . The higher net income was primarily due to a$27.7 million , or 193%, increase in net interest income after provision for loan losses, associated with significantly higher volume. The volume of loans funded during the three months endedSeptember 30, 2020 amounted to$35.2 billion , an increase of$20.1 billion , or 134%, compared to the same period in 2019. This compared favorably to the 32% industry increase in single-family residential loan volumes from the three months endedSeptember 30, 2019 to the three months endedSeptember 30, 2020 , according to theMortgage Bankers Association . Also contributing to the increase in net income for the three months endedSeptember 30, 2020 compared to the prior year's period was a$4.1 million , or 153%, increase in noninterest income that was offset by a$8.3 million increase in the provision for income taxes associated with a 219% higher pre-tax income.
Comparison of results for the nine months ended
The Mortgage Warehousing segment reported net income for the nine months endedSeptember 30, 2020 of$73.9 million , an increase of$52.9 million , or 251%, over the$21.1 million reported for the nine months endedSeptember 30, 2019 . The higher net income was primarily due to a$62.9 million , or 202%, increase in net interest income after provision for loan losses, associated with significantly higher volume. The volume of loans funded during the nine months endedSeptember 30, 2020 amounted to$80.5 billion , an increase of$50.6 billion , or 169%, compared to the same period in 2019. This compared favorably to the 59% industry increase in single-family residential loan volumes from the nine months endedSeptember 30, 2019 to the nine months endedSeptember 30, 2020 , according to theMortgage Bankers Association . Also contributing to the increase in net income for the nine months endedSeptember 30 , 52 Table of ContentsMerchants Bancorp
2020 compared to the prior year's period was a
Banking.
Comparison of results for the three months ended
The Banking segment reported net income of$17.5 million for the three months endedSeptember 30, 2020 , an increase of$9.8 million , or 129%, over the three months endedSeptember 30, 2019 . The increase was primarily due to an$13.2 million increase in noninterest income, reflecting significant growth in gain on sale of single-family mortgage loans. There was also an increase of$3.7 million in net interest income after provision for loan losses. Partially offsetting these increases was a$3.7 million increase in the provision for income tax associated with a 137% increase in pre-tax income, and a$3.4 million increase in noninterest expenses associated with higher loan expenses and salaries to support the increase in single family volume.
Comparison of results for the nine months ended
The Banking segment reported net income of$37.2 million for the nine months endedSeptember 30, 2020 , an increase of$12.4 million , or 50%, over the nine months endedSeptember 30, 2019 . The increase was primarily due to a$21.2 million increase in noninterest income, reflecting significant growth in gain on sale of single-family mortgage loans. Partially offsetting this increase was a$5.6 million increase in the provision for loan losses reflecting loan growth and uncertainties associated with COVID-19, as well as a$6.2 million increase in noninterest expenses that reflected higher loan expenses and higher deposit insurance related to the growth in deposits and assets compared to the prior year period.
Liquidity and Capital Resources
Liquidity.
Our primary sources of funds are business and consumer deposits, escrow and custodial deposits, principal and interest payments on loans, and proceeds from sale of loans. While maturities and scheduled amortization of loans are predictable sources of funds, deposit flows and mortgage prepayments are greatly influenced by market interest rates, economic conditions, and competition. Our most liquid assets are cash, short-term investments, including interest-bearing demand deposits, mortgage loans in process of securitization, and loans held for sale. The levels of these assets are dependent on our operating, financing, lending, and investing activities during any given period. Our cash flows are comprised of three primary classifications: cash flows from operating activities, investing activities, and financing activities. Net cash provided by (used in) operating activities was$(1.2) billion and$(1.7) billion for the nine months endedSeptember 30, 2020 and 2019, respectively. Net cash provided by (used in) investing activities, which consists primarily of net change in loans receivable and purchases, sales and maturities of investment securities, was$(1.9) billion and$(698.9) million for the nine months endedSeptember 30, 2020 and 2019, respectively. Net cash provided by financing activities, which is comprised primarily of net change in deposits and borrowings, was$3.0 billion and$2.4 billion for the nine months endedSeptember 30, 2020 and 2019, respectively. AtSeptember 30, 2020 , we had$1.3 billion in outstanding commitments to extend credit that are subject to credit risk and$2.7 billion outstanding commitments subject to certain performance criteria and cancellation by the Company, including loans pending closing, unfunded construction draws, and unfunded lines of warehouse credit. We anticipate that we will have sufficient funds available to meet our current loan origination commitments.
Within our role as a multi-family mortgage servicer for other banks and investors, we may be obligated to remit principal and interest payments to investors on certain loans regardless of the borrower's ability to make payments, which could become more likely as a result of the COVID-19 pandemic. If there are situations where a borrower is
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Merchants Bancorp granted a forbearance, the Company believes it has sufficient liquidity to cover these required advances. We have not received any requests for forbearance in our multi-family portfolio that is serviced for others as ofSeptember 30, 2020 but remain confident in our ability to fund potential advances we may be required to make as a result of the COVID-19 pandemic. Certificates of deposit that are scheduled to mature in less than one year fromSeptember 30, 2020 totaled$1.1 billion . Management expects that a substantial portion of the maturing certificates of deposit will be renewed. However, if a substantial portion of these deposits is not retained, we may decide to utilize FHLB advances, theFederal Reserve's discount window, and PPPLF, or raise interest rates on deposits to attract new accounts, which may result in higher levels of interest expense. Based on available collateral atSeptember 30, 2020 , we had access of up to an additional$2.5 billion in unused lines of credit. This liquidity enhances the ability to effectively manage interest expense and assets levels in the future. The Company began utilizing the PPPLF during the three months endedSeptember 30, 2020 , and theFederal Reserve's discount window from the second quarter 2020, which has contributed to lowering interest expenses.
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 registration statement on Form S-3 with theSEC onDecember 30, 2019 , which was declared effective onJanuary 9, 2020 , and which provides a means to allow us to issue registered securities to finance our growth objectives. The assessment of capital adequacy depends on a number of factors, including asset quality, liquidity, earnings performance, changing competitive conditions and economic forces. We seek to maintain a strong capital base to support our growth and expansion activities, to provide stability to our current operations and to promote public confidence in our Company. Shareholders' Equity. Shareholders' equity was$757.1 million as ofSeptember 30, 2020 , compared to$653.7 million as ofDecember 31, 2019 . The$103.4 million increase resulted primarily from the net income of$120.7 million , which was partially offset by dividends paid on common and preferred shares of$6.9 million and$10.9 million , respectively, during the period. 7% Preferred Stock. InMarch 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. InApril 2019 , the Company issued an additional 81,800 shares of Series A Preferred Stock to the underwriters related to their exercise of an option to purchase additional shares under the associated underwriting agreement, resulting in an addition$2.0 million in net proceeds, after underwriting discounts.
In
In
Dividends on the Series A Preferred Stock, to the extent declared by the Company's board, are payable quarterly at an annual rate of$1.75 per share throughMarch 31, 2024 . After such date, quarterly dividends will accrue and be payable at a floating rate equal to three-month LIBOR plus a spread of 460.5 basis points per year. In the event that three-month LIBOR is less than zero, three-month LIBOR shall be deemed to be zero. The Company may redeem the 54 Table of ContentsMerchants Bancorp
Series A Preferred Stock at its option, subject to regulatory approval, on or afterApril 1, 2024 , as described in the prospectus supplement relating to the offering filed with theSEC onMarch 22, 2019 . 6% Preferred Stock. InAugust 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) throughDecember 31, 2024 . After such date, quarterly dividends will accrue and be payable at a floating rate equal to three-month LIBOR plus a spread of 456.9 basis points per year. In the event that three-month LIBOR is less than zero, three-month LIBOR shall be deemed to be zero. The Company may redeem the Series B Preferred Stock at its option, subject to regulatory approval, on or afterOctober 1, 2024 , as described in the prospectus supplement relating to the offering filed with theSEC onAugust 13, 2019 . 8% Preferred Stock. The Company previously issued a total of 41,625 shares of 8% Non-Cumulative, Perpetual Preferred Stock, without par value, with a liquidation preference of$1,000.00 per share ("8% Preferred Stock") in private placement offerings. Dividends on the 8% Preferred Stock, to the extent declared by the Company's board, are payable quarterly at an annual rate of$80.00 per share. The Company may redeem the 8% Preferred Stock at its option, subject to regulatory approval, on or afterDecember 31, 2020 . Common Shares/Dividends. As ofSeptember 30, 2020 , the Company had 28,745,614 common shares issued and outstanding. InFebruary 2020 , the board of directors declared quarterly dividends at an annual rate of$0.32 per share.
Capital Adequacy.
OnNovember 13, 2019 , the federal regulators finalized and adopted a regulatory capital rule establishing a new community bank leverage ratio ("CBLR"), which became effective onJanuary 1, 2020 . The intent of CBLR is to provide a simple alternative measure of capital adequacy for electing qualifying depository institutions and depository institution holding companies, as directed under the Economic Growth, Regulatory Relief, and Consumer Protection Act. Under CBLR, if a qualifying depository institution or depository institution holding company elects to use such measure, such institution or holding company will be considered well capitalized if its ratio of Tier 1 capital to average total consolidated assets (i.e., leverage ratio) exceeds 9%, subject to a limited two quarter grace period, during which the leverage ratio cannot go 100 basis points below the then applicable threshold, and will not be required to calculate and report risk-based capital ratios. InApril 2020 , under the CARES Act, the 9% leverage ratio threshold was temporarily reduced to 8% in response to the COVID-19 pandemic. The threshold will increase to 8.5% in 2021 and return to 9% in 2022. The Company,Merchants Bank , and FMBI elected to begin using CBLR in the first quarter of 2020 and all intend to utilize this measure for the foreseeable future. Eligibility criteria to utilize CBLR includes the following:
? Total assets of less than
? Total trading assets plus liabilities of 5% or less of consolidated assets,
? Total off-balance sheet exposures of 25% or less of consolidated assets,
? Cannot be an advanced approaches banking organization, and
? Leverage ratio greater than 9%, or temporarily prescribed threshold established
in response to COVID-19.
At
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Merchants Bancorp events since the most recent regulatory notification that would change the
Company's,
AtSeptember 30, 2020 , the Company reported a Tier 1 leverage capital level of$738.5 million , or 7.9% of adjusted total assets, which is slightly below the required level of$744.3 million , or 8.0%. The Company is expected to reach the 8% required level within the permitted two-quarter grace period.Merchants Bank reported a Tier 1 leverage capital level of$727.8 million , or 8.0% of adjusted total assets, which is above the required level of$725.0 million , or 8.0%; FMBI reported a Tier 1 leverage capital level of$23.8 million , or 9.5% of adjusted total assets, which is above the required level of$20.1 million , or 8.0%.
Failure to exceed the leverage ratio threshold required under CBLR in the
future, subject to any applicable grace period, would require the Company,
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