2023-06-12 23:54:34 ET
Summary
- Merchants Bancorp's Q1 earnings show stability, with net income reaching $55 million, $5 million higher than the prior year and six times higher than preferred dividend obligations.
- The bank's balance sheet is unique compared to other regional banks due to its $2.8 billion in loans held for sale, primarily residential mortgages that are agency-backed.
- Merchants Bancorp has managed higher interest rates well, with a 21-basis point increase in interest rate spread, and has taken a unique approach to banking by holding a larger portion of its loan portfolio for sale combined with offering high-rate certificates of deposit.
Merchants Bancorp ( MBIN ) is an Indiana based regional bank that is facing the same headwinds of so many in regional banking. In addition to shares selling off during the regional banking crisis, the bank’s four preferred share offerings sold off. I picked up the Series D 8.25% preferred shares ( MBINM ) due to them offering the highest income of all the preferred securities. Based on the bank’s first quarter earnings, I believe the Series D preferred shares are a strong option for income investors.
Merchant’s first quarter earnings highlighted the stability of the bank. Merchant's interest income nearly tripled to $211 million compared to the same quarter in 2022. Interest expenses grew by $100 million, led by the increased cost of deposits. Ultimately, net interest income increased by $35 million to $100 million. The bank’s earnings on loan sales declined, but costs remained under control and Merchants finished the quarter with $55 million of net income, $5 million higher than the prior year and six times higher than the preferred dividend obligations.
Merchant’s balance sheet is typical of a regional bank with one exception. The bank’s balance sheet primarily consists of loans and deposits. The bank’s total loans increased by about $1 billion in the first quarter. These loans were financed by a $1.2 billion increase in the bank’s deposits and a $300 million increase in borrowings. The bank also increased its cash position by $100 million and increased their securities holdings by approximately $300 million. Ultimately, shareholder equity improved by $50 million in the first quarter to $1.5 billion. What’s different about Merchant’s balance sheet compared to many of the regional banks I’ve reviewed is the $2.8 billion in loans held for sale. These are primarily residential mortgages that are agency backed. Selling these loans creates a source of cash for the bank.
A deeper dive into the bank’s loans shows they are managing higher interest rates very well. While the cost of the bank’s interest-bearing liabilities increased by 362 basis points compared to a year ago, the income yield on the bank’s interest-bearing assets increased by 383 basis points. The 21-basis point increase in interest rate spread was a leading driver to improved interest rate margins, demonstrating that in the face of higher interest rates, Merchants Bancorp was continuing to grow earnings.
The key to Merchant’s success is in the loan portfolio. Most of the bank’s loans are with residential and multi-family housing, with other loans in healthcare and commercial real estate. Nearly half of the bank’s loans are revolving loans, meaning they mature in a short period of time. Furthermore, only 1/8 th of the bank’s loans were underwritten in the low rate environment of 2020 and 2021. Currently, just over 99% of the bank’s loans are current.
When it comes to risk, Merchant has two different risks involving deposits. First, the bank’s increase in deposits comes from offering high interest rate, short duration certificates of deposit. The bank acknowledges that it must compete regularly to retain these deposits as the interest rate being offered is the sole reason these depositors are there. It’s possible these deposits could mature with no renewal. Secondly, the bank has $2 billion in uninsured deposits, which can trigger a run. Fortunately, with both risks, the bank has $7.8 billion in liquidity to tap into should it need to.
Merchants Bancorp has taken a unique approach to banking by holding a larger portion of its loan portfolio for sale combined with offering high-rate certificates of deposit. Additionally, lending using revolver loans has protected the bank from swings in interest rates. The bank’s flexibility provides additional assurance that preferred shareholders can collect good income while waiting for their shares to be called.
For further details see:
Merchants Bancorp: Attractive 8.6% Yielding Series D Preferred Share