Merchants Bancorp: Form 10-Q for the period ended Sep 30, 2024

Management’s discussion and analysis of the financial condition at September 30, 2024 and results of operations for the three and nine months ended September 30, 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 September 30, 2024

• Net income of $61.3 million decreased $20.2 million, or 25%, compared to the three months ended September 30, 2023. The decrease was primarily driven by an increase in specific reserves on loans as part of the allowance for credit losses and unfavorable fair market value adjustments to derivatives and servicing rights.
• Diluted earnings per share of $1.17 decreased 30% compared to the three months ended September 30, 2023.
• Tangible book value per common share of $32.38 increased 25% compared to $25.82 at September 30, 2023.
• Total assets of $18.7 billion increased 2% compared to June 30, 2024, and increased 10% compared to December 31, 2023.
• Loans receivable, net of allowance for credit losses on loans, of $10.3 billion, decreased $671.3 million, or 6%, compared to June 30, 2024, and increased $134.1 million, or 1%, compared to December 31, 2023.
• In September 2024 the Company sold $629 million of healthcare bridge loans into a private securitization via a real estate mortgage investment conduit (REMIC). As part of the transaction, the Company purchased $535 million senior investment security that is classified as held to maturity and carries an 80% lower capital requirement than the bridge loans.
• As of September 30, 2024, approximately 94% of loans reprice within three months, which reduces the risk of market rate increases.
• Net interest margin was 2.99% and remain unchanged compared to the three months ended September 30, 2023.
• Efficiency ratio was 41.00% compared to 27.97% for the three months ended September 30, 2023.
• As of September 30, 2024, the Company had $5.1 billion in unused borrowing capacity with the Federal Home Loan Bank and the Federal Reserve Discount window, based on available collateral. The Company’s line of credit with the Federal Reserve Bank of Chicago, alone, could fund 120% of uninsured deposits.
• The Company’s most liquid assets are in unrestricted cash, short-term investments, including interest-earning demand deposits, mortgage loans in process of securitization, loans held for sale, and warehouse repurchase agreements included in loans receivable. Taken together, with unused borrowing capacity, these totaled $11.1 billion, or 59%, of the $18.7 billion in total assets as of September 30, 2024.
• The volume of warehouse loans funded during the three months ended September 30, 2024 amounted to $13.1 billion, an increase of $2.4 billion, or 22%, compared to the three months ended September 30, 2023. This compared to the 21% industry increase in single-family residential loan volumes for the three months ended September 30, 2024 for the same period in 2023, according to an estimate of industry volume by the Mortgage Bankers Association.

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 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 September 30, 2024, we had approximately $18.7 billion in total assets, $12.9 billion in deposits and $1.9 billion in total shareholders’ equity. Total assets as of September 30, 2024 included approximately $10.3 billion of loans receivable, net of allowance for credit losses on loans (“ACL-Loans”) and $3.8 billion of loans held for sale. There were also $1.8 billion in securities classified as held to maturity, most of which were acquired through loan securitizations. Assets also included $953.1 million in securities available for sale, the majority of which were acquired from a warehouse customer through loan securitizations, and others are match funded or required to collateralize our credit-linked notes. Additionally, we had $601.9 million of cash and cash equivalents, $431.0 million of mortgage loans in process of securitization that represent pre-sold multi-family rental real estate loan originations in primarily Government National Mortgage Association (“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. Other assets at September 30, 2024 totaled $329.4 million, which primarily represents low-income housing tax credits. Servicing rights at September 30, 2024 totaled $177.3 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 September 30, 2024 and December 31, 2023

Total Assets. Total assets of $18.7 billion at September 30, 2024 increased $1.7 billion, or 10%, compared to $17.0 billion at December 31, 2023. The increase was due primarily to growth in loans held for sale and in the warehouse and multi-family loan portfolios. There was also an increase in securities held to maturity compared to December 31, 2023, primarily due to the purchase of a security representing healthcare loans sold into a securitization in the third quarter of 2024 that was offset by a decline in loans in the healthcare portfolio that were sold into the securitization.

Cash and Cash Equivalents. Cash and cash equivalents of $601.9 million at September 30, 2024 increased $17.5 million, or 3%, compared to $584.4 million at December 31, 2023. Included in cash equivalents was $45.7 million in restricted cash associated with the March 2023 issuance of senior credit linked notes described in Note 1: Basis of Presentation and the Company’s 2023 Annual Report on Form 10–K.

Mortgage Loans in Process of Securitization. Mortgage loans in process of securitization of $431.0 million at September 30, 2024 increased $320.4 million, or 290%, 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 290% increase was primarily due to a higher origination volume of loans pending settlement date.

Securities Available for Sale. Securities available for sale of $953.1 million at September 30, 2024 decreased $160.6 million, or 14%, compared to December 31, 2023. The decrease in securities available for sale was primarily due to $662.2 in calls, maturities, repayments, sales and other adjustments, partially offset by purchases of $501.6 million during the period.

Included in securities available for sale were $683.0 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 September 30, 2024, Accumulated Other Comprehensive Income (“AOCI”) of $0.1 million, related to securities available for sale, increased $2.6 million, or 104%, compared to accumulated losses of $2.5 million at December 31, 2023.

Securities Held to Maturity. Securities held to maturity of $1.8 billion at September 30, 2024 increased $550.8 million, or 46%, compared to $1.2 billion at December 31, 2023. The increase was due to purchases of $689.8 million partially offset by remittances of loan payments underlying the securities during the period.

Loans Held for Sale. Loans held for sale of $3.8 billion at September 30, 2024 increased $663.5 million, or 21%, 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 pool eligibility. It also includes a growing contribution of multi-family loans that are expected to be sold or securitized within the next year.

Loans Receivable, Net. Loans receivable, net of ACL-Loans, of $10.3 billion at September 30, 2024, which are comprised of loans held for investment, increased $134.1 million, or 1%, compared to $10.1 billion at December 31, 2023. The increase in net loans was comprised primarily of:

• an increase of $461.0 million, or 61%, in mortgage warehouse repurchase agreements, which totaled $1.2 billion at September 30, 2024, reflecting higher loan volume from increased sales efforts and market exits or reductions of competitors.
• an increase of $450.0 million, or 11%, in multi-family financing loans, which totaled $4.5 billion at September 30, 2024, reflecting higher origination volume for construction and other loans generated through 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.
• Partially offset by a decrease of $623.0 million, or 26%, in healthcare financing loans, which totaled $1.7 billion at September 30, 2024, primarily due to the sale of healthcare loans into a securitization.

As of September 30, 2024, approximately 94% of the total net loans reprice within three months, which reduces the risk of market rate increases.

Allowance for Credit Losses on Loans. The ACL-Loans of $84.5 million at September 30, 2024 increased $12.8 million, or 18%, compared to December 31, 2023, reflecting an $8.0 million increase in specific reserves, primarily related to two customers, and loan growth in both the warehouse and multi-family loan portfolios. Additional details provided in the ACL-Loans portion of the Comparison of Financial Condition at September 30, 2024 and December 31, 2023 and in Note 4: Loans and Allowance for Credit Losses on Loans.

Also influencing the overall level of the ACL-Loans is our differentiated strategy to primarily hold loans with shorter durations while maintaining agency underwriting standards that enable us to sell or refinance the majority of our loans under agency and government programs.

Goodwill. Goodwill of $8.0 million at September 30, 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 $177.3 million at September 30, 2024 increased $18.9 million, or 12%, compared to December 31, 2023. During the nine months ended September 30, 2024, originated servicing of $13.3 million and a positive fair market value adjustment of $12.3 million were partially offset by paydowns of $6.7 million. The $12.3 million positive fair market value adjustment reflected a positive fair market value adjustment of $12.6 million for multi-family mortgages and a negative fair market value adjustment of $0.3 million for single-family mortgages and SBA loans during the nine months ended September 30, 2024.

Servicing rights are recognized in connection with sales of loans when we retain servicing of the sold loans. The servicing rights are recorded and carried at fair value. The fair value increase recorded during the nine months ended September 30, 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 and Receivables. Other assets and receivables of $329.4 million at September 30, 2024 increased $22.3 million, or 7%, compared to December 31, 2023. The increase in other assets and receivables was primarily due to receivables associated with low-income housing tax credit investments.

Deposits. Deposits of $12.9 billion at September 30, 2024 decreased $1.2 billion, or 8%, compared to $14.1 billion at December 31, 2023. The decrease was primarily due to a $1.0 billion decrease in certificates of deposit, a $150.2 million decrease in demand deposits and a decrease of $12.5 million in savings deposits. As of September 30, 2024, approximately 81% of the total deposits reprice within three months.

Core deposits increased by $2 billion, or 25%, to $10.1 billion at September 30, 2024 compared to December 31, 2023. Core deposits represented 78% of total deposits at September 30, 2024 compared to 58% of total deposits at December 31, 2023.

We have decreased our use of brokered deposits by $3.2 million, or 53%, to $2.8 billion at September 30, 2024 compared to $6.0 billion at December 31, 2023. Brokered deposits represented 22% of total deposits at September 30, 2024 compared to 42% of total deposits at December 31, 2023. The shift away from brokered deposits was primarily due to more cost-effective funding options that utilized our collateralized borrowing capacity. As of September 30, 2024, brokered certificates of deposit had a weighted average remaining duration of 56 days.

• Brokered certificates of deposit accounts of $2.8 billion at September 30, 2024 decreased by $1.7 billion, or 37%, compared to December 31, 2023.
• Brokered demand deposit accounts decreased by $1.5 billion, or 100%, compared to December 31, 2023.

Compared to December 31, 2023, interest-bearing deposits decreased $960.9 million, or 7%, to $12.6 billion at September 30, 2024, and noninterest-bearing deposits decreased $208.7 million, or 40%, to $311.4 million at September 30, 2024.

Uninsured deposits represented approximately 20% of total deposits. Since 2018, the Company has offered its customers an opportunity to insure balances in excess of $250,000 through our insured cash sweep program that extends FDIC protection up to $100 million. The balance of deposits in this program was $1.5 billion as of September 30, 2024 compared to $1.6 billion as of December 30, 2023 and $1.8 billion as of September 30, 2023. The Company’s line of credit with the Federal Reserve Bank of Chicago could fund 120% of uninsured deposits.

Borrowings. Borrowings increased $2.6 billion, or 270%, to $3.6 billion at September 30, 2024, compared to $964.1 million at December 31, 2023. The increase was primarily due to $2.6 billion in additional FHLB advances. The higher level of collateralized borrowing was primarily due to it being a more cost effective funding option than utilizing brokered deposits. The Company primarily utilizes borrowing facilities from the FHLB, the Federal Reserve’s discount window, and AFX. See Note 12: Borrowings for further information.

The Company continues to have significant borrowing capacity based on available collateral. As of September 30, 2024, unused lines of credit totaled $5.1 billion, compared to $6.0 billion at December 31, 2023.

Total Shareholders’ Equity. Total shareholders’ equity of $1.9 billion at September 30, 2024, increased $238.0 million, or 14%, compared to $1.7 billion as of December 31, 2023. The $238.0 million increase resulted primarily from net income of $224.7 million and net proceeds of $97.7 million from a common stock offering, which was partially offset by redemption of 7% Series A Preferred Stock for $52.0 million and dividends paid on common and preferred shares of $36.3 million during the period.

Asset Quality

Although there has been an increase in adversely classified loans, asset values remain strong overall and loans are well-collateralized. Loans are underwritten to strict agency guidelines. We have continued to strengthen our various levels of credit and risk management.

Total nonperforming loans (nonaccrual and greater than 90 days late but still accruing) were $210.9 million, or 2.04%, of total loans at September 30, 2024, compared to $82.0 million, or 0.80%, of total loans at December 31, 2023 and $60.2 million, or 0.60%, at September 30, 2023. The increase in non-performing loans compared to both periods was driven by multi-family and healthcare customers with delinquent payments on variable rate loans that have required higher payments largely due to elevated interest rates. The increase was also attributable to the financial deterioration of a few sponsors. Credit quality is expected to improve with the recent reduction in interest rates. After six months of consecutive loan performance, the loans are placed back on accrual status.

As a percentage of nonperforming loans, the ACL-Loans was 40% at September 30, 2024 compared to 87% at December 31, 2023 and 111% at September 30, 2023. The decrease in percentage compared to both periods was due to an increase in nonperforming loans, all of which have been individually evaluated for impairment.

Total loans greater than 30 days past due were $257.5 million at September 30, 2024, $183.5 million at December 31, 2023, and $125.4 million at September 30, 2023. The increase in non-performing loans compared to both periods was primarily driven by multi-family customers with delinquent payments on variable rate loans that have required higher payments due to interest rates remaining at elevated levels.

Loans classified as Special Mention totaled $351.4 million at September 30, 2024, compared to $191.3 million at December 31, 2023. The increase was primarily due to the increase in interest rates for our borrowers and the related levels of net operating income on certain properties in the multi-family and healthcare financing loan portfolios.

Loans classified as Substandard totaled $287.8 million at September 30, 2024, compared to $128.6 million at December 31, 2023. The increase was primarily due to the increase in interest rates for our borrowers and the related levels of net operating income on certain properties in the multi-family financing loan portfolio. All substandard loans as of September 30, 2024 have been evaluated for impairment and these loans have specific reserves of $19.2 million.

During the three months ended September 30, 2024 there were $2.1 million of charge-offs and $7,000 of recoveries, compared to $21,000 of charge-offs and $31,000 recoveries for the three months ended September 30, 2023.

For the nine months ended September 30, 2024, there were $6.4 million of charge-offs and $23,000 of recoveries, compared to $9.6 million of charge-offs and $40,000 of recoveries for the nine months ended September 30, 2023.

The $84.5 million allowance for credit losses on loans as of September 30, 2024, compared to the net charge-offs of $6.7 million over the last twelve months ended September 30, 2024, could absorb 13 years of losses if recent loss levels continued into the future.

In addition to the elevated ACL-loans, the Company has been making efforts to minimize its credit risk through loan sale and securitization activities since 2019. In April 2023 and March 2024, the Company strategically entered into credit protection arrangements through a credit linked note and credit default swap, respectively, for $1.7 billion in loans to reduce our risk of losses with incremental coverage of approximately 14% on those covered loans. The balance of loans in those covered portfolios as of September 30, 2024 was $1.3 billion.

Comparison of Operating Results for the Three Months Ended September 30, 2024 and 2023

General. Net income of $61.3 million for the three months ended September 30, 2024 decreased by $20.2 million, or 25%, compared with $81.5 million for the three months ended September 30, 2023. The decrease reflected

• a $15.4 million, or 13%, increase in net interest income,
• a $6.0 million, or 56%, increase in gain on sale of loans,
• a $5.0 million, or 20%, decrease in provision for income taxes,
• an $18.9 million, or 109%, decrease in loan servicing fees, primarily due to negative fair market value adjustments to derivatives and servicing rights,
• an $18.4 million, or 43%, increase in noninterest expense, primarily driven by salaries and employee benefits that reflected higher commissions on higher production volume, and increases in deposit insurance expenses, and ongoing premium expense associated with the credit default swap,
• a $5.6 million decrease in other income, reflecting negative fair market value adjustments to derivatives, and
• a $2.9 million, or 72%, increase in the provision for credit losses primarily related to increased specific reserves.

Net Interest Income. Net interest income of $132.8 million for the three months ended September 30, 2024 increased $15.4 million, or 13%, compared with $117.4 million for the three months ended September 30, 2023. The 13% increase reflected an increase in average balances on loans and loans held for sale, which were partially offset by higher average balances on borrowings. The interest rate spread of 2.43% for the three months ended September 30, 2024 decreased 1 basis points compared to 2.44% for the three months ended September 30, 2023.

Our net interest margin of 2.99% for the three months ended September 30, 2024 remain unchanged compared to the three months ended September 30, 2023. The margin was negatively impacted by approximately 6 basis points in the third quarter of 2024 from the net reversal of $2.9 million in accrued interest income associated with the movement of loans into nonaccrual status.

Interest Income. Interest income of $338.9 million for the three months ended September 30, 2024 increased 14%, compared with $296.7 million for the three months ended September 30, 2023. This increase primarily reflecting an increase in average balances of loans and loans held for sale, as well as increased average yields and balances on securities available for sale.

Interest income of $290.3 million for the three months ended September 30, 2024 for loans and loans held for sale increased $23.7 million, or 9%, compared to $266.6 million for the three months ended September 30, 2023. The average balance of loans, including loans held for sale, during the three months ended September 30, 2024 increased $1.2 billion, or 9%, to $14.6 billion compared to $13.4 billion for the three months ended September 30, 2023. The average yield on loans increased 2 basis points, to 7.91% for the three months ended September 30, 2024, compared to 7.89% for the three months ended September 30, 2023. The increase in average balances of loans and loans held for sale was primarily due to increases in the loans held for sale, warehouse and multi-family loan portfolios.

Interest income of $14.9 million for the three months ended September 30, 2024 on securities available for sale increased $8.7 million, or 140%, compared to $6.2 million for the three months ended September 30, 2023. The average balance of securities available for sale of $1.0 billion increased $354.6 million, or 54%, compared to $656.6 million for the three months ended September 30, 2023. The average yield increased 210 basis points, to 5.84% for the three months ended September 30, 2024, compared to 3.74% for the three months ended September 30, 2023. The increase in average balances of securities available for sale was primarily associated with the acquisition of certain securities 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 $22.1 million for the three months ended September 30, 2024 for securities held to maturity increased $4.7 million, or 27%, compared to $17.4 million for the three months ended September 30, 2023. The average balance of securities held to maturity, during the three months ended September 30, 2024 increased $248.4 million, or 24%, to $1.3 billion compared to $1.0 billion for the three months ended September 30, 2023. The average yield on securities held to maturity increased 17 basis points, to 6.82% for the three months ended September 30, 2024, compared to 6.65% for the three months ended September 30, 2023. The increase in average balance of securities held to maturity was primarily related to securities held to maturity acquired as part of loan securitizations.

Interest income of $7.7 million for the three months ended September 30, 2024 on interest-earning deposits, and other interest or dividends increased $3.7 million, or 96%, compared to the three months ended September 30, 2023. The average balance of interest-earning deposits and other of $484.7 million increased $225.1 million, or 87%, compared to $259.6 million for the three months ended September 30, 2023. The average yield increased 31 basis points, to 6.30% for the three months ended September 30, 2024, compared to 5.99% for the three months ended September 30, 2023.

Interest Expense. Total interest expense of $206.1 million for the three months ended September 30, 2024 increased $26.9 million, or 15%, compared to $179.2 million for the three months ended September 30, 2023. The increase reflected higher average balances on borrowings and interest-bearing checking accounts, partially offset by lower average rates on borrowings and lower average balances on certificates of deposit. Also included in borrowings, our warehouse structured financing agreements provided for additional interest payments for a portion of earnings generated.

Interest expense of $40.4 million for the three months ended September 30, 2024 on borrowings increased $24.1 million, or 148%, compared to $16.3 million for the three months ended September 30, 2023. The increase reflected an increase of $1.8 billion, or 254%, in the average balance of borrowings, to $2.5 billion compared to the three months ended September 30, 2023, partially offset by a decrease of 271 basis points in the average rate of borrowings, to 6.39% compared to 9.10% for the three months ended September 30, 2023. The higher level of collateralized borrowing was primarily due to it being a more cost-effective funding option than utilizing brokered deposits.

Interest expense on deposits increased $2.8 million, or 2%, to $165.7 million for the three months ended September 30, 2024 compared to $162.9 million for the three months ended September 30, 2023. The increase was primarily due to higher average balances on interest-bearing checking accounts partially offset by lower average balances on certificates of deposit.

Interest expense of $62.6 million for the three months ended September 30, 2024 on interest-bearing checking accounts increased $4.0 million, or 7%, compared to $58.6 million for the three months ended September 30, 2023. The average balance of interest-bearing checking accounts of $5.3 billion for the three months ended September 30, 2024 increased $415.2 million, or 9%, compared to $4.9 billion for the three months ended September 30, 2023. The average yield of interest-bearing checking accounts was 4.70% for the three months ended September 30, 2024, which was a 6 basis point decrease compared to 4.76% for three months ended September 30, 2023.

Interest expense of $69.2 million for the three months ended September 30, 2024 on certificates of deposit decreased $1.5 million, or 2%, compared to $70.7 million for the three months ended September 30, 2023. The average balance of certificates of deposit of $5.0 billion for the three months ended September 30, 2024 decreased $223.4 million, or 4%, compared to the three months ended September 30, 2023. The average rate on certificates of deposit was 5.47% for the three months ended September 30, 2024, which was a 13 basis point increase compared to 5.34% for three months ended September 30, 2023.

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.

(Dollars in thousands)

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.

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:

(In thousands)

Provision for Credit Losses. We recorded a total provision for credit losses of $6.9 million for the three months ended September 30, 2024, an increase of $2.9 million, or 72%, compared to the three months ended September 30, 2023. The 72% increase reflected higher specific reserves on a relatively small number of borrowers.

The provision for the three months ended September 30, 2024 reflected $8.0 million for specific reserves, primarily related to two customers, and $1.9 million related to charge-offs in excess of reserves, partially offset by a reduction of $3.8 million due to lower loan balances associated with the corresponding healthcare loan securitization.

The $6.9 million provision for credit losses consisted of $5.6 million for the ACL-Loans, $2.1 million for the ACL-OBCE’s, net of $0.7 million for the release of non-contingent reserves related to a loan securitization. The ACL-Loans was $84.5 million, or 0.82%, of total loans, at September 30, 2024, compared to $71.8 million, or 0.70%, of total loans, at December 31, 2023, and $66.9 million, or 0.67%, at September 30, 2023.

Noninterest Income. Noninterest income of $16.7 million for the three months ended September 30, 2024 decreased $19.3 million, or 54%, compared to $36.1 million for the three months ended September 30, 2023. The decrease was primarily due to a $18.9 million, or 109%, decrease in net loan servicing fees and a $5.6 million, or 152%, decrease in other income, partially offset by a $6.0 million, or 56%, increase in gain on sale of loans.

Loan servicing fees included a $6.7 million negative fair market value adjustment to servicing rights for the three months ended September 30, 2024, compared to a $11.6 million positive adjustment to fair value of servicing rights for the three months ended September 30, 2023. The value of servicing rights generally increases in rising interest rate environments and declines in falling interest rate environments due to expected prepayments and earning rates on escrow deposits.

Other income included a $7.7 million negative fair market value adjustment to interest rate floor derivatives on loans that didn’t occur in the prior comparative period.

A summary of the gain on sale of loans for the three months ended September 30, 2024 and 2023 is below:

(In thousands)

Noninterest Expense. Noninterest expense of $61.3 million for the three months ended September 30, 2024 increased $18.4 million, or 43%, compared to $42.9 million for the three months ended September 30, 2023. The increase was primarily due to increases in salaries and employee benefits that reflected higher commissions on higher production volume, as well as a $5.4 million, or 152%, increase in deposit insurance expenses. The higher noninterest expense also reflected a $3.4 million increase in other expenses primarily associated with ongoing premium expense for the credit default swap that was executed in March 2024.

The efficiency ratio was at 41.00% for the three months ended September 30, 2024, compared with 27.97% for the three months ended September 30, 2023.

Income Taxes. Income tax expense of $20.1 million for the three months ended September 30, 2024 decreased $5.0 million, or 20%, compared to the three months ended September 30, 2023. The decrease was primarily due to a 24% decrease in pretax income period to period. The effective tax rate was 24.7% for the three months ended September 30, 2024 and 23.5% for the three months ended September 30, 2023.

Comparison of Operating Results for the Nine Months Ended September 30, 2024 and 2023

General. Net income of $224.7 million for the nine months ended September 30, 2024 increased $23.0 million, or 11%, compared to the nine months ended September 30, 2023. The increase was primarily due to a $64.3 million increase in net interest income, an $11.9 million decrease in the provision for credit losses, and an $8.8 million increase in noninterest income, partially offset by a $38.6 million increase in noninterest expense and a $23.4 million increase in the provision for income taxes.

Net Interest Income. Net interest income of $388.0 million for the nine months ended September 30, 2024 increased $64.3 million, or 20%, compared to $323.7 million for the nine months ended September 30, 2023. The increase reflected both higher average balances and average yields on loans and loans held for sale, securities available for sale, and securities held to maturity, partially offset by an increase in interest expense from both higher average balances and rates on certificates of deposit accounts, interest-bearing checking, and higher average balances on borrowings. The interest rate spread of 2.48% for the nine months ended September 30, 2024 decreased 4 basis points compared to 2.52% for the nine months ended September 30, 2023.

Our net interest margin decreased 3 basis points, to 3.04% for the nine months ended September 30, 2024 from 3.07% for the nine months ended September 30, 2023. The margin was negatively impacted by approximately 4 basis points from the net reversal of $5.7 million in accrued interest income associated with the movement of loans into nonaccrual status.

Interest Income. Interest income of $981.4 million for the nine months ended September 30, 2024 increased $215.3 million, or 28%, compared to the nine months ended September 30, 2023. This increase was primarily attributable to an increase in average balances and higher yields of loans and loans held for sale, securities available for sale, securities held to maturity, and interest earning deposits and other interest or dividends.

Interest income of $846.7 million for the nine months ended September 30, 2024 on loans and loans held for sale increased $161.9 million, or 24%, compared to the nine months ended September 30, 2023. The average balance of loans, including loans held for sale, during the nine months ended September 30, 2024 increased $2.2 billion, or 18%, to $14.2 billion compared to $12.0 billion for the nine months ended September 30, 2023, and the average yield on loans increased 36 basis points, to 7.99% for the nine months ended September 30, 2024, compared to 7.63% for the nine months ended September 30, 2023.

Interest income of $44.0 million for the nine months ended September 30, 2024 on securities available for sale increased $30.0 million, or 214%, compared to the nine months ended September 30, 2023. The average balance of securities available for sale increased $452.6 million, or 76%, to $1.0 billion for the nine months ended September 30, 2024 compared to $592.5 million for the nine months ended September 30, 2023, and the average yield increased 247 basis points, to 5.63% for the nine months ended September 30, 2024, compared to 3.16% for the nine months ended September 30, 2023.

Interest income of $62.4 million for the nine months ended September 30, 2024 on securities held to maturity increased $11.9 million, or 24%, compared to $50.5 million for the nine months ended September 30, 2023. The average balance of securities held to maturity, during the nine months ended September 30, 2024 increased $132.9 million, or 12%, to $1.2 billion compared to the nine months ended September 30, 2023. The average yield on securities held to maturity increased 62 basis points, to 6.86% for the nine months ended September 30, 2024 ended, compared to 6.24% for the nine months ended September 30, 2023.

Interest income of $19.4 million for the nine months ended September 30, 2024 on interest-earning deposits and other interest or dividends increased $10.0 million, or 106%, compared to the nine months ended September 30, 2023. The average balance of interest-earning deposits and other increased $191.8 million, or 83%, to $423.3 million for the nine months ended September 30, 2024, from $231.5 million for the nine months ended September 30, 2023, and the average yield increased 68 basis points, to 6.13% for the nine months ended September 30, 2024, compared to 5.45% for the nine months ended September 30, 2023.

Interest Expense. Total interest expense of $593.4 million for the nine months ended September 30, 2024 increased $151.1 million, or 34%, compared to $442.3 million for the nine months ended September 30, 2023. The higher interest expense reflected increases in both deposits and borrowings, with a shift towards higher collateralized borrowings that has become a more cost-effective option that utilizing brokered deposits.

Interest expense on deposits increased $111.2 million, or 27%, to $516.3 million for the nine months ended September 30, 2024, compared to $405.1 million for the nine months ended September 30, 2023. The increase was primarily due to higher average balances and higher rates for certificate of deposit accounts and interest-bearing checking accounts, as well as higher rates on money market accounts.

Interest expense of $234.0 million for the nine months ended September 30, 2024 for certificates of deposits increased $69.7 million, or 42%, compared to $164.3 million for the nine months ended September 30, 2023. The average balance of certificates of deposit accounts was $5.8 billion for the nine months ended September 30, 2024, an increase of $1.3 billion, or 29%, compared to the nine months ended September 30, 2023. The average rate on certificates of deposit accounts was 5.43% for the nine months ended September 30, 2024, which was a 49 basis point increase compared to 4.94% for the nine months ended September 30, 2023.

Interest expense of $181.4 million for the nine months ended September 30, 2024 for interest-bearing checking accounts increased $33.8 million, or 23%, compared to $147.6 million for the nine months ended September 30, 2023. The average balance of interest-bearing checking accounts of $5.1 billion for the nine months ended September 30, 2024 increased $684.6 million, or 15%, compared to $4.4 billion for the nine months ended September 30, 2023. The average rate on interest-bearing checking accounts was 4.75% for the nine months ended September 30, 2024, which was a 28 basis point increase compared to 4.47% for the nine months ended September 30, 2023.

Interest expense of $100.7 million for the nine months ended September 30, 2024 for money market accounts increased $8.3 million, or 9%, compared to $92.4 million for the nine months ended September 30, 2023. The average balance of money market accounts of $2.8 billion for the nine months ended September 30, 2024 increased $9.0 million compared to the nine months ended September 30, 2023. The average rate on money market accounts was 4.79% for the nine months ended September 30, 2024, which was a 38 basis point increase compared to 4.41% for the nine months ended September 30, 2023.

Interest expense of $77.0 million for the nine months ended September 30, 2024 for borrowings increased $39.9 million, or 107%, compared to $37.1 million for the nine months ended September 30, 2023. The increase was primarily due to a $830.0 million, or 139%, increase in average balances, partially offset by a decrease of 112 basis points in the average rate of borrowings, to 7.21% compared to 8.33% for the nine months ended September 30, 2023. Also included in borrowings, is our warehouse structured financing agreements that provide for additional interest payments for a portion of the earnings generated. As a result, the cost of borrowings increased from a base rate of 6.89% and 8.12%, to an effective rate of 7.21% and 8.33% for the nine months ended September 30, 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.

(Dollars in thousands)

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.

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:

(In thousands)

Provision for Credit Losses. We recorded a provision for credit losses of $21.6 million for the nine months ended September 30, 2024, a decrease of $11.9 million, or 36%, compared to $33.5 million for the nine months ended September 30, 2023. The decrease was primarily due to lower loan charge-offs and fewer relative changes to qualitative factors.

Noninterest Income. Noninterest income of $89.0 million for the nine months ended September 30, 2024 increased $8.8 million, or 11%, compared to $80.2 million for the nine months ended September 30, 2023. The increase was primarily due to a $8.4 million, or 29%, increase in gain on sale of loans and a $2.9 million, or 39%, increase in syndication and asset management fees compared to the nine months ended September 30, 2023.

A summary of the gain on sale of loans for the nine months ended September 30, 2024 and 2023 is below:

(In thousands)

The $2.9 million increase in syndication and asset management fees increased as we continue to experience growth in this line of business.

Noninterest income also included a $0.4 million increase in loan servicing fees due to higher positive adjustments to fair value of servicing rights. Included in loan servicing fees was a $12.3 million positive adjustment to the fair value of servicing rights for the nine months ended September 30, 2024, compared to a positive adjustment of $12.2 million for the nine months ended September 30, 2023.

Noninterest Expense. Noninterest expense of $160.6 million for the nine months ended September 30, 2024 increased $38.6 million, or 32%, compared to $122.0 million for the nine months ended September 30, 2023. The increase was primarily due to an $18.3 million, or 24%, increase in salaries and employee benefits reflecting higher commissions associated with loan growth, as well as a $10.1 million, or 106%, increase in deposit insurance. Other expenses increased $6.5 million, or 44%, primarily due to ongoing premium expense on the credit default swap that was executed in March 2024.

The efficiency ratio was at 33.67% for the nine months ended September 30, 2024, compared with 30.21% for the nine months ended September 30, 2023.

Income Taxes. Provision for income taxes of $70.0 million for the nine months ended September 30, 2024 increased $23.4 million, or 50%, compared to the nine months ended September 30, 2023. The increase reflected a 19% higher pre-tax income during the nine months ended September 30, 2024, as well as a $13.0 million tax benefit recorded in the second quarter of 2023 related to tax refunds and changes to state tax apportionment calculations. The effective tax rate was 23.8% for the nine months ended September 30, 2024 and 18.8% for the nine months ended September 30, 2023.

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 through Merchants Capital. Merchants Capital is also a fully integrated syndicator of low-income housing tax credit and debt funds. As one of the top ranked agency affordable lenders in the nation, our licenses with Fannie Mae, Freddie Mac, and FHA, coupled with our bank financing products, provide sponsors with 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 September 30, 2024 the Company’s total servicing portfolio had an unpaid principal balance of $28.2 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 $17.0 billion, an unpaid principal balance of loans sub-serviced for others of $2.6 billion, and other servicing balances of $0.8 billion at September 30, 2024. These loans are not included in the accompanying balance sheets. The Company also manages $7.8 billion of loans for customers that have loans on the balance sheet at September 30, 2024. The servicing portfolio primarily consists of 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 grown to fund over $33.2 billion in 2022, $33.0 billion in 2023, and $32.0 billion for the nine months ended September 30, 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 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. Merchants Mortgage is a risk mitigant to Mortgage Warehousing because it provides us with a ready platform to sell or refinance the underlying collateral to secure repayment. These and other synergies form a part of our strategic plan.

The Other segment presented below, in Note 17: 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.

For the three months ended September 30, 2024 and 2023, we had total net income of $61.3 million and $81.5 million, respectively. For the nine months ended September 30, 2024 and 2023, we had total net income of $224.7 million and $201.8 million, respectively. Net income and assets for our segments for the respective periods was as follows:

(In thousands)

Multi-family Mortgage Banking.

Comparison of results for the three months ended September 30, 2024 and 2023:

The Multi-family Mortgage Banking segment reported net income of $8.1 million for the three months ended September 30, 2024, a decrease of $6.6 million, or 45%, compared to $14.7 million for the three months ended September 30, 2023. The decrease in net income was primarily due to a decrease in loan servicing fees related to negative fair market value adjustments, as well as increased salaries and employee benefits reflecting higher commissions on higher production volume, partially offset by increased gain on sale of loans.

Results included a $5.1 million negative fair market value adjustment to servicing rights for the three months ended September 30, 2024 compared to a $10.4 million positive fair market value adjustment for the three months ended September 30, 2023. Excluding fair market value adjustments to servicing rights, loan servicing fees increased compared to the three months ended September 30, 2023.

The volume of loans originated and acquired for sale in the secondary market increased by $341.5 million, or 81%, to $763.7 million, for the three months ended September 30, 2024, compared to the three months ended September 30, 2023.

Comparison of results for the nine months ended September 30, 2024 and 2023:

The Multi-family Mortgage Banking segment reported net income of $33.7 million for the nine months ended September 30, 2024, an increase of $5.8 million, or 21%, from the $27.9 million of net income reported for the nine months ended September 30, 2023. The increase in net income was primarily due to a $13.3 million increase in gain on sale of loans from higher production volume, a $6.0 million increase in loan servicing fees, as well as a $2.8 million increase in syndication and asset management fees as we continue to see growth in our Low-Income Housing Tax Credits (“LIHTC”) syndication of business. These increases to net income were partially offset by a $12.2 million increase in noninterest expenses, primarily due to increased salaries and employee benefits related to higher commissions on higher production volume, and increased income tax expense primarily associated with a tax benefit recorded in the second quarter of 2023 related to tax refunds and changes in state tax apportionment calculations.

Loan servicing fees for the nine months ended September 30, 2024 included a positive fair market value adjustment of $12.6 million on servicing rights, compared to a positive fair market value adjustment of $10.4 million for the nine months ended September 30, 2023.

The volume of loans originated and acquired for sale in the secondary market increased by $150.7 million, or 13%, to $1.4 billion, for the nine months ended September 30, 2024, compared to $1.2 billion. for the nine months ended September 30, 2023.

Mortgage Warehousing.

Comparison of results for the three months ended September 30, 2024 and 2023:

The Mortgage Warehousing segment reported net income of $15.9 million for the three months ended September 30, 2024, a decrease of $4.0 million, or 20%, compared to $19.9 million for the three months ended September 30, 2023. The decrease in net income reflected negative fair value adjustments on derivatives that were partially offset by higher net interest income associated with increased volumes.

There was a 22% increase in warehouse loan volume of $13.1 billion compared to $10.8 billion for the three months ended September 30, 2023, which compared to an industry volume increase of 21% according to the Mortgage Bankers Association.

Comparison of results for the nine months ended September 30, 2024 and 2023:

The Mortgage Warehousing segment reported net income for the nine months ended September 30, 2024 of $58.4 million, an increase of $11.2 million, or 24%, compared to $47.2 million for the nine months ended September 30, 2023. The increase in net income reflected higher net interest income as volumes increased, which was partially offset by a negative fair value adjustment on derivatives.

There was a 30% increase in warehouse loan volume of $32.0 billion compared to $24.6 billion for the nine months ended September 30, 2023, which compared to an industry volume increase of 17% according to the Mortgage Bankers Association. The increase compared to the industry reflected higher loan volume from increased sales efforts and market exits or reductions of competitors.

Banking.

Comparison of results for the three months ended September 30, 2024 and 2023:

The Banking segment reported net income of $45.0 million for the three months ended September 30, 2024, a decrease of $7.5 million, or 14%, compared to the three months ended September 30, 2023. The decrease was primarily due to a lower gain on sale of loans and loan servicing fees, as well as an increase in noninterest expense, partially offset by an increase in net interest income.

Noninterest income for the three months ended September 30, 2024 included a negative fair market value adjustment of $1.6 million on servicing rights, compared to a positive fair market value adjustment of $1.2 million for the three months ended September 30, 2023.

Comparison of results for the nine months ended September 30, 2024 and 2023:

The Banking segment reported net income of $153.8 million for the nine months ended September 30, 2024, an increase of $9.4 million, or 6%, compared to $144.4 million for the nine months ended September 30, 2023. The increase in net income was primarily due to higher net interest income and lower provision for loan losses, which was partially offset by a higher provision for income taxes and higher noninterest expense that reflected increased deposit insurance premiums and ongoing premium expenses on the credit default swap executed in March 2024. Lower gain on sale of loans also partially offset the increases to net income.

Noninterest income for the nine months ended September 30, 2024 included a negative fair market value adjustment of $0.3 million on servicing rights, compared to a positive fair market value adjustment of $1.8 million for the nine months ended September 30, 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 September 30, 2024, based on collateral, we had $5.1 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-earning demand deposits, mortgage loans in process of securitization, loans held for sale, and warehouse lines of credit included in loans receivable. Taken together with its unused borrowing capacity of $5.1 billion described above, these totaled $11.1 billion, or 59%, of its $18.7 billion total assets at September 30, 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 represent approximately 20% of total deposits. Our line of credit with Federal Reserve Bank of Chicago, alone, could fund 120% of uninsured 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 $1.5 billion and $1.6 billion as of September 30, 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 September 30, 2024, Accumulated Other Comprehensive Income (“AOCI”) of $0.1 million, related to securities available for sale, increased $2.6 million, or 104%, compared to accumulated losses of $2.5 million as of December 31, 2023.

Our cash flows are comprised of three primary classifications: cash flows from operating activities, investing activities, and financing activities. Net cash used in operating activities was ($825.3) million and $(1.1) billion for the nine months ended September 30, 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 $(830.8) million and $(2.3) billion for the nine months ended September 30, 2024 and 2023, respectively. Net cash provided by financing activities, which is comprised primarily of net change in borrowings and deposits was $1.7 billion and $3.6 billion for the nine months ended September 30, 2024 and 2023, respectively.

Certificates of deposit that are scheduled to mature in less than one year from September 30, 2024 totaled $4.1 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 September 30, 2024, we had $4.1 billion in outstanding commitments to extend credit that are subject to credit risk and $3.5 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 $1.9 billion as of September 30, 2024, compared to $1.7 billion as of December 31, 2023. The $238.0 million or 14%, increase resulted primarily from net income of $224.7 million and net proceeds of $97.7 million from a common stock offering, which was partially offset by redemption of 7% Series A Preferred Stock for $52.0 million and dividends paid on common and preferred shares of $36.3 million during the period.

7% Series A Preferred Stock. In March 2019 the Company issued 2,000,000 shares of 7.00% Fixed-to-Floating Rate Series A Non-Cumulative Perpetual Preferred Stock, without par value, and with a liquidation preference of $25.00 per share (“Series A Preferred Stock”). The Company received net proceeds of $48.3 million after underwriting discounts, commissions and direct offering expenses. In April 2019, the Company issued an additional 81,800 shares of Series A

Preferred Stock to the underwriters related to their exercise of an option to purchase additional shares under the associated underwriting agreement, resulting in an addition $2.0 million in net proceeds, after underwriting discounts.

The Company redeemed all outstanding shares of the Series A Preferred Stock on April 1, 2024 for $52 million at a price equal to the liquidation preference of $25.00 per share, using cash on hand.

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.

On October 1, 2024, the dividends on the Series B Preferred stock started to accrue at a floating rate of 3-month SOFR plus 4.831% and will reset quarterly. The rate will be 9.42% for the fourth quarter 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.

Common Shares/Dividends. As of September 30, 2024, the Company had 45,764,023 common shares issued and outstanding. The Board expects to declare a quarterly dividend of $0.09 per share in each quarter of 2024.

On May 13, 2024, the Company issued 2.4 million shares of the Company’s common stock, without par value, at a public offering price of $43.00 per share in an underwritten public offering. The aggregate gross offering proceeds for the shares issued by the Company was $103.2 million, and after deducting underwriting discounts, commissions, and offering expenses of $5.5 million paid to third parties, the Company received total net proceeds of $97.7 million.

Capital Adequacy.

The following tables present the Company’s capital ratios at September 30, 2024 and December 31, 2023:

(Dollars in thousands)

(1) As defined by regulatory agencies.

Merchants Bancorp

(Dollars in thousands)

(1) As defined by regulatory agencies.

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 September 30, 2024 and December 31, 2023, that the Company and Merchants Bank met all capital adequacy requirements to which they were subject. For additional information regarding dividend restrictions, see the Company’s 2023 Annual Report on Form 10–K.

As of September 30, 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 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 September 30, 2024 and December 31, 2023.

Our interest rate risk management policy limits the change in our net interest income to 20% for a +/- 100 basis point move in interest rates, and 30% for a +/- 200 basis point move in rates. At September 30, 2024 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.

Our interest rate risk management policy limits the change in our EVE to 15% for a +/- 100 basis point move in interest rates, and 20% for a +/- 200 basis point move in rates. We are within policy limits set by our board of directors for the -200, -100, +100 and +200 basis point scenarios. The EVE reported at September 30, 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.

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.”

(a) Evaluation of disclosure controls and procedures.

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

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.