Merchants Bancorp (Form: 10-Q, Received: 08/09/2019 16:10:39)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D. C. 20549

FORM 10-Q

(Mark One)

☒	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934


For the quarterly period ended	June 30, 2019

☐	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from ____________ to _______________

Commission File No. 001-38258

MERCHANTS BANCORP

(Exact name of registrant as specified in its charter)

Indiana		20‑5747400
(State or other jurisdiction of		(I.R.S. Employer
incorporation or organization)		Identification Number)

11555 North Meridian Street, Suite 400 Carmel, Indiana		46032
(Address of principal		(Zip Code)
executive office)

(317) 569‑7420

(Registrant’s telephone number, including area code)

N/A

(Former name or former address, if changed since last report)

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days.

Yes ☒ No ☐

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). ☒ Yes ☐ No

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b‑2 of the Exchange Act.

Large accelerated filer ☐	Accelerated filer ☒	Non-accelerated filer ☐	Smaller reporting company ☐
			Emerging growth company ☒

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b‑2 of the Exchange Act.).
Yes ☐ No ☒

Securities registered pursuant to Section 12(b) of the Act:

Title of each class

Trading Symbol(s)

Name of each exchange on which registered

Common Stock, without par value

Series A Preferred Stock, without par value

MBIN

MBINP

NASDAQ

As of August 5, 2019, the latest practicable date, 28,706,438 shares of the registrant’s common stock, without par value, were issued and outstanding.

Table of Contents

Merchants Bancorp

Index to Quarterly Report on Form 10‑Q

PART I – FINANCIAL INFORMATION

Item 1 Interim Financial Statements (Unaudited)

Condensed Consolidated Balance Sheets as of June 30, 2019 and December 31, 2018	3

Condensed Consolidated Statements of Income for the Three and Six Months Ended June 30, 2019 and 2018	4

Condensed Consolidated Statements of Comprehensive Income for the Three and Six Months Ended June 30, 2019 and 2018	5

Condensed Consolidated Statements of Shareholders’ Equity for the Six Months Ended June 30, 2019 and 2018	6

Condensed Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2019 and 2018	7

Notes to Condensed Consolidated Financial Statements	8

Item 2 Management’s Discussion and Analysis of Financial Condition and Results of Operations	38

Item 3 Quantitative and Qualitative Disclosures About Market Risk	52

Item 4 Controls and Procedures	52

PART II – OTHER INFORMATION	53

Item 1 Legal Proceedings	53

Item 1A Risk Factors	53

Item 2 Unregistered Sales of Equity Securities and Use of Proceeds	53

Item 3 Defaults Upon Senior Securities	53

Item 4 Mine Safety Disclosures	53

Item 5 Other Information	53

Item 6 Exhibits	54

SIGNATURES	56

Table of Contents

Part I – Financial Information

Item 1. Financial Statements

Merchants Bancorp

Condensed Consolidated Balance Sheets

June 30, 2019 (Unaudited) and December 31, 2018

(In thousands, except share data)


	June 30,		December 31,
	2019		2018
Assets
Cash and due from banks	$	15,176	$	25,855
Interest-earning demand accounts		445,713		310,669
Cash and cash equivalents		460,889		336,524
Securities purchased under agreements to resell		6,798		6,875
Trading securities		101,514		163,419
Available for sale securities		261,485		331,071
Federal Home Loan Bank (FHLB) stock		18,820		7,974
Loans held for sale (includes $9,592 and $11,886, respectively at fair value)		1,918,118		832,455
Loans receivable, net of allowance for loan losses of $12,604 and $12,704, respectively		2,347,906		2,045,423
Premises and equipment, net		26,580		15,136
Mortgage servicing rights		74,550		77,844
Interest receivable		17,415		13,827
Goodwill		15,574		17,477
Intangible assets, net		4,567		3,542
Other assets and receivables		33,174		32,596
Total assets	$	5,287,390	$	3,884,163
Liabilities and Shareholders' Equity
Liabilities
Deposits
Noninterest-bearing	$	192,521	$	182,879
Interest-bearing		4,463,469		3,048,207
Total deposits		4,655,990		3,231,086
Borrowings		62,225		195,453
Other liabilities		54,162		36,387
Total liabilities		4,772,377		3,462,926
Commitments and Contingencies
Shareholders' Equity
Common stock, without par value
Authorized - 50,000,000 shares
Issued and outstanding - 28,706,438 shares at June 30, 2019 and 28,694,036 shares at December 31, 2018		135,374		135,057
Preferred stock, without par value - 5,000,000 total shares authorized
8% Preferred stock - $1,000 per share liquidation preference
Authorized - 50,000 shares
Issued and outstanding - 41,625 shares		41,581		41,581
7% Series A Preferred stock - $25 per share liquidation preference
Authorized - 3,500,000 shares
Issued and outstanding - 2,955,800 shares		72,095		—
Retained earnings		265,323		244,909
Accumulated other comprehensive income (loss)		640		(310)
Total shareholders' equity		515,013		421,237
Total liabilities and shareholders' equity	$	5,287,390	$	3,884,163

See notes to condensed consolidated financial statements .

Table of Contents

Merchants Bancorp

Condensed Consolidated Statements of Income (Unaudited)

For the Three and Six Months Ended June 30, 2019 and 2018

(In thousands, except share data)


	Three Months Ended				Six Months Ended
	June 30,				June 30,
	2019		2018		2019		2018
Interest Income
Loans	$	42,365	$	28,790	$	76,820	$	53,402
Investment securities:
Trading		1,967		1,489		3,012		2,478
Available for sale - taxable		1,477		1,625		3,028		3,167
Available for sale - tax exempt		53		—		149		—
Federal Home Loan Bank stock		257		81		480		210
Other		2,642		2,138		4,946		3,904
Total interest income		48,761		34,123		88,435		63,161
Interest Expense
Deposits		19,344		9,741		33,571		16,757
Borrowed funds		1,495		2,176		2,811		4,090
Total interest expense		20,839		11,917		36,382		20,847
Net Interest Income		27,922		22,206		52,053		42,314
Provision for loan losses		105		998		754		2,404
Net Interest Income After Provision for Loan Losses		27,817		21,208		51,299		39,910
Noninterest Income
Gain on sale of loans		9,104		7,831		11,747		18,723
Loan servicing fees, net		(1,561)		2,555		(1,908)		2,233
Mortgage warehouse fees		1,138		684		1,891		1,170
Gains/(losses) on sale of investments available for sale (includes $(3), $0, $124, and $0, respectively, related to accumulated other comprehensive earnings reclassifications)		(3)		—		124		—
Other income		1,192		560		1,680		817
Total noninterest income		9,870		11,630		13,534		22,943
Noninterest Expense
Salaries and employee benefits		9,965		7,268		18,532		13,755
Loan expenses		1,345		1,302		2,279		2,258
Occupancy and equipment		946		761		1,822		1,326
Professional fees		453		677		992		1,165
Deposit insurance expense		218		236		495		482
Technology expense		629		293		1,101		584
Other expense		2,364		1,463		3,734		2,700
Total noninterest expense		15,920		12,000		28,955		22,270
Income Before Income Taxes		21,767		20,838		35,878		40,583
Provision for income taxes (includes $1, $0, $(31) and $0, respectively, related to income tax (expense)/benefit for reclassification items)		5,328		5,186		8,869		9,870
Net Income	$	16,439	$	15,652	$	27,009	$	30,713
Dividends on preferred stock		(1,743)		(832)		(2,576)		(1,665)
Net Income Allocated to Common Shareholders		14,696		14,820		24,433		29,048
Basic Earnings Per Share	$	0.51	$	0.52	$	0.85	$	1.01
Diluted Earnings Per Share	$	0.51	$	0.52	$	0.85	$	1.01
Weighted-Average Shares Outstanding
Basic		28,705,313		28,692,749		28,703,790		28,691,857
Diluted		28,746,297		28,720,805		28,741,877		28,715,687

See notes to condensed consolidated financial statements.

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Merchants Bancorp

Condensed Consolidated Statements of Comprehensive Income (Unaudited)

For the Three and Six Months Ended June 30, 2019 and 2018

(In thousands)


	Three Months Ended				Six Months Ended
	June 30,				June 30,
	2019		2018		2019		2018
Net Income	$	16,439	$	15,652	$	27,009	$	30,713
Other Comprehensive Income (Loss):
Net change in unrealized gains/(losses) on investment securities available for sale, net of tax (expense)/benefits of $(153), $(54), $(345), and $43, respectively		484		97		1,043		(221)
Less: Reclassification adjustment for gains/(losses) included in net income, net of tax (expense)/benefits of $1, $0, $(31), and $0, respectively		(2)		—		93		—
Other comprehensive income (loss) for the period		486		97		950		(221)
Comprehensive Income	$	16,925	$	15,749	$	27,959	$	30,492

See notes to condensed consolidated financial statements.

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Merchants Bancorp

Condensed Consolidated Statement of Shareholders’ Equity (Unaudited)

For the Six Months Ended June 30, 2019

(In thousands, except share data)


												Accumulated
												Other
	Common Stock			8% Preferred Stock			7% Preferred Stock			Retained		Comprehensive
	Shares	Amount		Shares	Amount		Shares	Amount		Earnings		Income (Loss)		Total
Balance, January 1, 2019	28,694,036	$	135,057	41,625	$	41,581	—	$	—	$	244,909	$	(310)	$	421,237
Net income	—		—	—		—	—		—		10,570		—		10,570
Shares issued for stock compensation plans	10,127		133	—		—	—		—		—		—		133
Issuance of 7% preferred stock, net of offering expenses of $1,731	—		—	—		—	2,000,000		48,269		—		—		48,269
Dividends on 8% preferred stock, $20.00 per share	—		—	—		—	—		—		(833)		—		(833)
Dividends on common stock, $0.07 per share	—		—	—		—	—		—		(2,009)		—		(2,009)
Other comprehensive income	—		—	—		—	—		—		—		464		464
Balance, March 31, 2019	28,704,163	$	135,190	41,625	$	41,581	2,000,000	$	48,269	$	252,637	$	154	$	477,831
Net income	—		—	—		—	—		—		16,439		—		16,439
Shares issued for stock compensation plans	2,275		184	—		—	—		—		—		—		184
Issuance of 7% preferred stock, net of offering expenses of $69	—		—	—		—	955,800		23,826		—		—		23,826
Dividends on 7% preferred stock, $0.4375 per share	—		—	—		—	—		—		(911)		—		(911)
Dividends on 8% preferred stock, $20.00 per share	—		—	—		—	—		—		(832)		—		(832)
Dividends on common stock, $0.07 per share	—		—	—		—	—		—		(2,010)		—		(2,010)
Other comprehensive income	—		—	—		—	—		—		—		486		486
Balance, June 30, 2019	28,706,438	$	135,374	41,625	$	41,581	2,955,800	$	72,095	$	265,323	$	640	$	515,013

For the Six Months Ended June 30, 2018

(In thousands, except share data)


												Accumulated
												Other
	Common Stock			8% Preferred Stock			7% Preferred Stock			Retained		Comprehensive
	Shares	Amount		Shares	Amount		Shares	Amount		Earnings		Income (Loss)		Total
Balance, January 1, 2018	28,685,167	$	134,891	41,625	$	41,581	—	$	—	$	192,008	$	(1,006)	$	367,474
Net income	—		—	—		—	—		—		15,061		—		15,061
Shares issued for stock compensation plans	7,039		50	—		—	—		—		—		—		50
Dividends on 8% preferred stock, $20.00 per share	—		—	—		—	—		—		(833)		—		(833)
Dividends on common stock, $0.06 per share	—		—	—		—	—		—		(1,721)		—		(1,721)
Reclassification of deferred tax asset due to tax reform	—		—	—		—	—		—		243		(243)		—
Other comprehensive loss	—		—	—		—	—		—		—		(318)		(318)
Balance, March 31, 2018	28,692,206	$	134,941	41,625	$	41,581	—	$	—	$	204,758	$	(1,567)	$	379,713
Net income	—		—	—		—	—		—		15,652		—		15,652
Shares issued for stock compensation plans	1,830		11	—		—	—		—		—		—		11
Dividends on 8% preferred stock, $20.00 per share	—		—	—		—	—		—		(832)		—		(832)
Dividends on common stock, $0.06 per share	—		—	—		—	—		—		(1,722)		—		(1,722)
Reclassification of deferred tax asset due to tax reform	—		—	—		—	—		—		—		—		—
Other comprehensive loss	—		—	—		—	—		—		—		97		97
Balance, June 30, 2018	28,694,036	$	134,952	41,625	$	41,581	—	$	—	$	217,856	$	(1,470)	$	392,919

See notes to condensed consolidated financial statements.

Table of Contents

Merchants Bancorp

Condensed Consolidated Statements of Cash Flows (Unaudited)

Six Months Ended June 30, 2019 and 2018

(In thousands)


	Six Months Ended
	June 30,
	2019		2018
Operating activities:
Net income	$	27,009	$	30,713
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation		285		213
Provision for loan losses		754		2,404
Gain on sale of securities		(124)		—
Gain on sale of loans		(11,747)		(18,723)
Proceeds from sales of loans		10,048,228		11,497,484
Loans and participations originated and purchased for sale		(11,124,623)		(11,440,254)
Change in mortgage servicing rights for paydowns and fair value adjustments		6,575		1,696
Net change in:
Trading securities		61,905		5,762
Other assets and receivables		(6,489)		(4,272)
Other liabilities		12,147		1,860
Other		2,713		680
Net cash provided by (used in) operating activities		(983,367)		77,563
Investing activities:
Net change in securities purchased under agreements to resell		77		89
Purchases of available-for-sale securities		(124,256)		(36,049)
Proceeds from the sale of available-for-sale securities		31,083		—
Proceeds from calls, maturities and paydowns of available-for-sale securities		164,128		60,963
Purchases of loans		(33,824)		(77,884)
Net change in loans receivable		(270,090)		(355,094)
Purchase of Federal Home Loan Bank stock		(12,926)		(130)
Proceeds from sale of Federal Home Loan Bank stock		2,080		—
Purchases of premises and equipment		(9,648)		(3,045)
Purchases of mortgage servicing rights		—		(790)
Purchase of limited partnership interests		—		(1,706)
Cash received in acquisition of subsidiary		—		6,505
Other investing activities		124		(72)
Net cash used in investing activities		(253,252)		(407,213)
Financing activities:
Net change in deposits		1,424,959		195,884
Proceeds from Federal Home Loan Bank borrowings		5,595,159		411,317
Repayment of Federal Home Loan Bank borrowings		(5,728,891)		(283,759)
Proceeds from issuance of preferred stock		72,095		—
Proceeds from notes payable		5,204		4,200
Payments on notes payable		(4,700)		—
Dividends		(2,842)		(5,108)
Net cash provided by financing activities		1,360,984		322,534
Net Change in Cash and Cash Equivalents		124,365		(7,116)
Cash and Cash Equivalents, Beginning of Period		336,524		359,519
Cash and Cash Equivalents, End of Period	$	460,889	$	352,403
Additional Cash Flows Information:
Interest paid	$	32,871	$	18,097
Income taxes paid		11,376		6,075
Dividends payable		3,753		—
The Company purchased all of the capital stock of FMBI on January 2, 2018 for $5,472. In conjunction with the acquisitions, liabilities were assumed as follows:
Fair value of assets acquired	$	—	$	44,217
Cash paid for the capital stock/fair value common stock issued		—		5,472
Fair value of liabilities assumed		—		38,745

See notes to condensed consolidated financial statements .

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Merchants Bancorp

Notes to Condensed Consolidated Financial Statements

(Unaudited)

Note 1: Basis of Presentation

The accompanying unaudited condensed consolidated financial statements include the accounts of Merchants Bancorp, a registered bank holding company (the “Company”) and its wholly owned subsidiaries, Merchants Bank of Indiana (“Merchants Bank”) and Farmers-Merchants Bank of Illinois (“FMBI”). Merchants Bank’s direct and indirect subsidiaries include Merchants Capital Corp. (“MCC”), Merchants Capital Servicing, LLC (“MCS”), Ash Realty Holdings, LLC (“Ash Realty”), MBI Midtown West, LLC (“MMW”), Natty Mac Funding, Inc. (“NMF”), and OneTrust Funding, Inc. The Company also acquired Farmers-Merchants National Bank of Paxton (‘FMNBP”) on October 1, 2018 through a merger with FMBI, with FMBI as the surviving entity. All these entities are collectively referred to as the “Company”.

The accompanying unaudited condensed consolidated balance sheet of the Company as of December 31, 2018, which has been derived from audited financial statements, and unaudited condensed consolidated financial statements of the Company as of June 30, 2019 and for the three and six months ended June 30, 2019 and 2018, were prepared in accordance with the instructions for Form 10‑Q and Article 10 of Regulation S-X and, therefore, do not include information or footnotes necessary for a complete presentation of financial position, results of operations and cash flows in conformity with accounting principles generally accepted in the United States of America. Accordingly, these condensed financial statements should be read in conjunction with the audited financial statements and notes thereto of the Company as of and for the year ended December 31, 2018 in its Annual Report on Form 10-K. Reference is made to the accounting policies of the Company described in the Notes to the Financial Statements contained in the Annual Report on Form 10-K.

In the opinion of management, all adjustments (consisting only of normal recurring adjustments) which are necessary for a fair presentation of the unaudited financial statements have been included to present fairly the financial position as of June 30, 2019 and the results of operations for the three and six months ended June 30, 2019 and 2018, and cash flows for the six months ended June 30, 2019 and 2018. All interim amounts have not been audited and the results of operations for the three and six months ended June 30, 2019, herein are not necessarily indicative of the results of operations to be expected for the entire year.

Principles of Consolidation

The unaudited condensed consolidated financial statements as of and for the period ended June 30, 2019 include the Company, and its wholly owned subsidiaries, Merchants Bank, and FMBI. Also included are Merchants Bank’s wholly owned subsidiaries, MCC, MCC’s wholly owned subsidiary, MCS, Ash Realty, NMF, MMW, and OneTrust Funding, Inc. The condensed financial statements as of and for the period ended June 30, 2018, include the Company and its wholly owned subsidiary, Merchants Bank, and Merchants Bank’s wholly owned subsidiaries, FMBI (after being acquired on January 2, 2018 and excluding results from FMNBP, which was acquired on October 1, 2018), MCC, MCC’s wholly owned subsidiary, MCS, Ash Realty, NMF, and MMW. All significant intercompany accounts and transactions have been eliminated in consolidation.

Use of Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

Material estimates that are particularly susceptible to significant change relate to the determination of the allowance for loan losses, loan servicing rights and fair values of financial instruments.

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Merchants Bancorp

Notes to Condensed Consolidated Financial Statements

(Unaudited)

Public Offering of Preferred Stock

On March 28, 2019 the Company issued 2,000,000 shares of 7.00% Fixed-to-Floating Rate Series A Non-Cumulative Perpetual Preferred Stock, without par value (the “Series A Preferred Stock”), and with a liquidation preference of $25.00 per share. The aggregate gross offering proceeds for the shares issued by the Company was $50.0 million, and after deducting underwriting discounts and commissions and offering expenses of approximately $1.7 million paid to third parties, the Company received total net proceeds of $48.3 million. On April 12, 2019, the Company issued an additional 81,800 shares of Series A Preferred Stock to the underwriters related to their exercise of an option to purchase additional shares under the associated underwriting agreement, resulting in an addition $2.0 million in net proceeds, after deducting $41,000 underwriting discounts. The Series A Preferred Stock have no voting rights with respect to matters that generally require the approval of our common shareholders. Dividends on the Series A Preferred Stock, to the extent declared by the Company’s board, are payable quarterly.

Private Placement Offering of Preferred Stock

On June 27, 2019 the Company issued an additional 874,000 shares of its 7.00% Series A Preferred Stock, without par value and with a liquidation preference of $25.00 per share, for aggregate proceeds of $21.85 million. No underwriter or placement agent was involved in this private placement and the Company did not pay any brokerage or underwriting fees or discounts in connection with the issuance of such shares. The shares were purchased primarily by related parties, including Michael Petrie, Chairman and Chief Executive Officer; Randall Rogers, Vice Chairman and a director and members of his family; Michael Dury, President of Merchants Capital; and other accredited investors.

Acquisitions

On May 8, 2017, the Company entered into a Stock Purchase Agreement to acquire FMBI (formerly known as Joy State Bank). The acquisition closed on January 2, 2018 at a total cost of approximately $5.5 million. At December 31, 2017 Joy State Bank had $43 million in assets. The Company recorded goodwill and intangible assets totaling $988,000 and $478,000, respectively, in connection with the acquisition. The intangible assets consisted of core deposit intangibles that are being amortized over 10 years on an accelerated basis. The acquired time deposits of $16.7 million were recorded at a fair value of $16.9 million. The fair value premium of $185,000 is being accreted against interest expense over 20 months. The acquired loan portfolio of $27.9 million was recorded at a fair value of $27.5 million. The fair value discount of $458,000 is being accreted to interest income on a straight-line basis over an average of 39 months in accordance with ASC 310-20. While there were some loans identified for potential classification under ASC 310-30, they were not material to the transaction. On October 22, 2018, the Company changed the name of Joy State Bank to Farmers-Merchants Bank of Illinois (“FMBI”). As a result of the acquisition, the Company increased its deposit base and benefited from economies of scale. The acquisition did not materially impact the Company’s financial position, results of operations or cash flows.

On October 1, 2018, the Company acquired FM Bancorp, Inc., a bank holding company, and its wholly owned subsidiary, Farmers-Merchants National Bank of Paxton (“FMNBP”). On that date, FM Bancorp, Inc. ultimately merged with and into the Company, with the Company as the surviving entity, and FMNBP merged with and into Joy State Bank, with Joy State Bank as the surviving bank. Effective October 22, 2018, Joy State Bank’s name changed to Farmers-Merchants Bank of Illinois (“FMBI”). Under the terms of the merger agreement, shareholders of the 27,537 outstanding shares of FM Bancorp, Inc. were compensated $795.29 per share, for a total purchase price of $21.9 million. As of September 30, 2018, FM Bancorp, Inc. and Farmers-Merchants National Bank of Paxton had total assets of approximately $110.0 million, available for sale securities of $66.3 million, deposits of approximately $95.7 million, and net loan receivables of approximately $35.0 million. The Company recorded goodwill and intangible assets totaling $6.9 million and $1.9 million. The intangible assets consisted of core deposit intangibles that are being amortized over 10 years on an accelerated basis. The acquired available for sale securities of $66.3 million were recorded at fair value. A fair value discount associated with securities of $1.0 million is being accreted into interest income, in accordance with ASC 310-20. While there were some loans identified for potential classification under ASC 310-30, they were not material to the transaction. The acquired gross loan portfolio of $35.4 million was recorded at a fair value of $34.8

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Merchants Bancorp

Notes to Condensed Consolidated Financial Statements

(Unaudited)

million. The fair value discount of $625,000 included a discount related to interest assumptions for $279,000 and to credit assumptions for $346,000. The portion related to interest assumptions is being accreted into interest income on a straight-line basis over an average of 72 months in accordance with ASC 310-20. The discount portion related to credit assumptions is being accreted into interest income over the life of the loan. The acquired deposits of $95.7 million were recorded at a fair value of $95.7 million. As a result of the acquisition, the Company increased its deposit base and benefited from economies of scale. The acquisition did not materially impact the Company’s financial position, results of operations or cash flows.

On December 31, 2018, the Company acquired the assets of NattyMac, LLC, a warehouse lender operating out of Clearwater, Florida, from Home Point Financial Corporation (“Home Point”). The Company also fully repaid Home Point the balance of, and all interest owed on, the $30 million subordinated debt it had previously invested in the Company. Goodwill and intangible assets of $3.4 million and $1.6 million, respectively, were recorded by the Company. The intangible assets consisted of customer lists that are being amortized over 21 months on a straight-line basis. As a result of the acquisition, the Company expects to increase its geographic footprint in the warehouse business, reduce its costs of borrowing, increase the earnings generated from its warehouse business, and benefit from its experienced talent pool. The acquisition did not materially impact the Company’s financial position, results of operations or cash flows.

Given the impact of the acquisitions was immaterial to the Company and its results of operations, pro forma information has not been included.

Reclassifications

Certain reclassifications have been made to the 2018 financial statements to conform to the financial statement presentation as of and for the three and six months ended June 30, 2019. These reclassifications had no effect net income.

Note 2: Securities

Trading Securities

Securities that are held principally for resale in the near term are recorded as trading securities at fair value with changes in fair value recorded in earnings. Trading securities include FHA and conventional Fannie Mae and Freddie Mac participation certificates. The unrealized gains included in trading securities totaled $944,000 and $493,000 at June 30, 2019 and 2018, respectively.

Securities Available-For-Sale

The amortized cost and approximate fair values, together with gross unrealized gains and losses, of securities are as follows:


	June 30, 2019
			Gross		Gross
	Amortized		Unrealized		Unrealized		Fair
	Cost		Gains		Losses		Value
	(In thousands)
Available-for-sale securities:
Treasury notes	$	2,992	$	21	$	1	$	3,012
Federal agencies		208,940		34		106		208,868
Municipals		11,994		628		—		12,622
Mortgage-backed - Government-sponsored entity (GSE) - residential		36,753		232		2		36,983
Total available-for-sale securities	$	260,679	$	915	$	109	$	261,485

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Notes to Condensed Consolidated Financial Statements

(Unaudited)


	December 31, 2018
			Gross		Gross
	Amortized		Unrealized		Unrealized		Fair
	Cost		Gains		Losses		Value
	(In thousands)
Available-for-sale securities:
Treasury notes	$	11,928	$	26	$	13	$	11,941
Federal agencies		237,894		8		972		236,930
Municipals		21,014		336		18		21,332
Mortgage-backed - Government-sponsored entity (GSE) - residential		60,693		254		79		60,868
Total available-for-sale securities	$	331,529	$	624	$	1,082	$	331,071

The amortized cost and fair value of available-for-sale securities at June 30, 2019 and December 31, 2018, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties. Securities not due at a single maturity date are shown separately.


	June 30, 2019				December 31, 2018
	Amortized		Fair		Amortized		Fair
	Cost		Value		Cost		Value
Contractual Maturity	(In thousands)
Within one year	$	94,936	$	94,869	$	179,323	$	178,581
After one through five years		118,971		119,057		72,470		72,282
After five through ten years		2,079		2,190		7,087		7,203
After ten years		7,940		8,386		11,956		12,137
		223,926		224,502		270,836		270,203
Mortgage-backed - Government-sponsored entity (GSE) - residential		36,753		36,983		60,693		60,868
	$	260,679	$	261,485	$	331,529	$	331,071

During the three months ended June 30, 2019, proceeds from sales of securities available-for-sale were $35,000, and a loss of $3,000 was recognized. During the six months ended June 30, 2019, proceeds from sales of securities available-for-sale were $31.1 million, and a net gain of $124,000 was recognized, consisting of $361,000 in gains and $237,000 of losses. During the three and six months ended June 30, 2018, no securities available-for-sale were sold.

The following tables show the Company’s investments’ gross unrealized losses and fair value of the Company’s investments with unrealized losses that are not deemed to be other-than-temporarily impaired, aggregated by investment class and length of time that individual securities have been in a continuous unrealized loss position at June 30, 2019 and December 31, 2018:


	June 30, 2019
					12 Months or
	Less than 12 Months				Longer				Total
			Gross				Gross				Gross
	Fair		Unrealized		Fair		Unrealized		Fair		Unrealized
	Value		Losses		Value		Losses		Value		Losses
	(In thousands)
Available-for-sale securities:
Treasury notes	$	—	$	—	$	499	$	1	$	499	$	1
Federal agencies		19,968		32		103,362		74		123,330		106
Mortgage-backed - Government-sponsored entity (GSE) - residential		776		2		—		—		776		2
	$	20,744	$	34	$	103,861	$	75	$	124,605	$	109

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Notes to Condensed Consolidated Financial Statements

(Unaudited)


	December 31, 2018
					12 Months or
	Less than 12 Months				Longer				Total
			Gross				Gross				Gross
	Fair		Unrealized		Fair		Unrealized		Fair		Unrealized
	Value		Losses		Value		Losses		Value		Losses
	(In thousands)
Available-for-sale securities:
Treasury notes	$	1,990	$	8	$	995	$	5	$	2,985	$	13
Federal agencies		28,296		97		191,280		875		219,576	$	972
Municipals		2,051		18		—		—		2,051	$	18
Mortgage-backed - Government-sponsored entity (GSE) - residential		15,543		79		—		—		15,543		79
	$	47,880	$	202	$	192,275	$	880	$	240,155	$	1,082

Other-than-temporary Impairment

Unrealized losses on securities have not been recognized to income because the Company has the intent and ability to hold the securities for the foreseeable future, and the decline in fair value is primarily due to increased market interest rates. The fair value is expected to recover as the securities approach the maturity date.

Note 3: Loans and Allowance for Loan Losses

Loans that management has the intent and ability to hold for the foreseeable future or until maturity or payoff are reported at their outstanding principal balances adjusted for unearned income, charge-offs, the allowance for loan losses, any unamortized deferred fees or costs on originated loans and unamortized premiums or discounts on purchased loans.

For loans amortized at cost, interest income is accrued based on the unpaid principal balance.

The accrual of interest on loans is discontinued at the time the loan is 90 days past due unless the credit is well-secured and in process of collection. Past-due status is based on contractual terms of the loan. In all cases, loans are placed on nonaccrual or charged off at an earlier date if collection of principal or interest is considered doubtful.

All interest accrued but not collected for loans that are placed on nonaccrual or charged off is reversed against interest income. The interest on these loans is applied to the principal balance until the loan can be returned to an accrual status. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.

For all loan portfolio segments, the Company promptly charges off loans, or portions thereof, when available information confirms that specific loans are uncollectable based on information that includes, but is not limited to, (1) the deteriorating financial condition of the borrower, (2) declining collateral values, and/or (3) legal action, including bankruptcy, that impairs the borrower’s ability to adequately meet its obligations. For impaired loans that are considered to be solely collateral dependent, a partial charge-off is recorded when a loss has been confirmed by an updated appraisal or other appropriate valuation of the collateral.

When cash payments are received on impaired loans in each loan class, the Company records the payment as interest income unless collection of the remaining recorded principal amount is doubtful, at which time payments are used to reduce the principal balance of the loan. Troubled debt restructured loans recognize interest income on an accrual basis at the renegotiated rate if the loan is in compliance with the modified terms.

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Merchants Bancorp

Notes to Condensed Consolidated Financial Statements

(Unaudited)

Loans receivable at June 30, 2019 and December 31, 2018 include:


	June 30,		December 31,
	2019		2018
	(In thousands)

Mortgage warehouse lines of credit	$	536,387	$	337,332
Residential real estate		402,035		410,871
Multi-family and healthcare financing		1,001,811		914,393
Commercial and commercial real estate		315,286		299,194
Agricultural production and real estate		84,080		79,255
Consumer and margin loans		20,911		17,082
		2,360,510		2,058,127
Less
Allowance for loan losses		12,604		12,704

Loans Receivable	$	2,347,906	$	2,045,423

Risk characteristics applicable to each segment of the loan portfolio are described as follows.

Mortgage Warehouse Lines of Credit (MTG WHLOC): Under its warehouse program, the Company provides warehouse financing arrangements to approved mortgage companies for the origination and sale of residential mortgage loans and to a lesser extent multi-family loans. Agency eligible, governmental and jumbo residential mortgage loans that are secured by mortgages placed on existing one-to-four family dwellings may be originated or purchased and placed on each mortgage warehouse line.

As a secured line of credit, collateral pledged to the Company secures each individual mortgage until the lender sells the loan in the secondary market. A traditional secured warehouse line of credit typically carries a base interest rate of 30 day LIBOR, plus a margin, or mortgage note rate, less a margin.

Risk is evident if there is a change in the fair value of mortgage loans originated by mortgage bankers in warehouse, the sale of which is the expected source of repayment of the borrowings under a warehouse line of credit.

Residential Real Estate Loans (RES RE): Real estate loans are secured by owner-occupied 1‑4 family residences. Repayment of residential real estate loans is primarily dependent on the personal income and credit rating of the borrowers. All-in-One mortgages included in this segment typically carry a base rate of 30-day LIBOR, plus a margin.

Multi-Family and Healthcare Financing (MF RE): The Company engages in multi-family and healthcare financing, including construction loans, specializing in originating and servicing loans for multi-family rental and senior living properties. In addition, the Company originates loans secured by an assignment of federal income tax credits by partnerships invested in multi-family real estate projects. Construction and land loans are generally based upon estimates of costs and estimated value of the completed project and include independent appraisal reviews and a financial analysis of the developers and property owners. Sources of repayment of these loans may include permanent loans, sales of developed property or an interim loan commitment from the Company until permanent agency-eligible financing is obtained. These loans are considered to be higher risk than other real estate loans due to their ultimate repayment being sensitive to interest rate changes, general economic conditions and the availability of long-term financing. Credit risk in these loans may be impacted by the creditworthiness of a borrower, property values and the local economy in the Company’s market area. Repayment of these loans depends on the successful operation of a business or property and the borrower’s cash flows.

Commercial Lending and Commercial Real Estate Loans (CML & CRE): The commercial lending and commercial real estate portfolio includes loans to commercial customers for use in financing working capital needs,

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Notes to Condensed Consolidated Financial Statements

(Unaudited)

equipment purchases and expansions, as well as loans to commercial customers to finance land and improvements. It also includes loans collateralized by mortgage servicing rights of mortgage warehouse customers. The loans in this category are repaid primarily from the cash flow of a borrower’s principal business operation. Credit risk in these loans is driven by creditworthiness of a borrower and the economic conditions that impact the cash flow stability from business operations.

Agricultural Production and Real Estate Loans (AG & AGRE): Agricultural production loans are generally comprised of seasonal operating lines of credit to grain farmers to plant and harvest corn and soybeans and term loans to fund the purchase of equipment. The Company also offers long term financing to purchase agricultural real estate. Specific underwriting standards have been established for agricultural-related loans including the establishment of projections for each operating year based on industry-developed estimates of farm input costs and expected commodity yields and prices. Operating lines are typically written for one year and secured by the crop and other farm assets as considered necessary. The Company is approved to sell agricultural loans in the secondary market through the Federal Agricultural Mortgage Corporation and uses this relationship to manage interest rate risk within the portfolio.

Consumer and Margin Loans (CON & MAR): Consumer loans are those loans secured by household assets. Margin loans are those loans secured by marketable securities. The term and maximum amount for these loans are determined by considering the purpose of the loan, the margin (advance percentage against value) in all collateral, the primary source of repayment, and the borrower’s other related cash flow.

Allowance for Loan Losses: The allowance for loan losses is established as losses are estimated to have occurred through a provision for loan losses charged to net interest income. Loan losses are charged against the allowance when management believes the uncollectability of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance.

The allowance for loan losses is evaluated on a regular basis by management and is based upon management’s periodic review of the collectability of the loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral and prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available.

The allowance consists of allocated and general components. The allocated component relates to loans that are classified as impaired. For those loans that are classified as impaired, an allowance is established when the discounted cash flows, collateral value, or observable market price of the impaired loan is lower than the carrying value of that loan. The general component covers non-impaired loans and is based on historical charge-off experience and expected loss given default derived from the Company’s internal risk rating process. Other adjustments may be made to the allowance for pools of loans after an assessment of internal or external influences on credit quality that are not fully reflected in the historical loss or risk rating data.

A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record and the amount of the shortfall in relation to the principal and interest owed. Impairment is measured on a loan-by-loan basis for commercial and construction loans by the fair value of the collateral if the loan is collateral dependent, the loan’s obtainable market price, or present value of expected future cash flows discounted at the loan’s effective interest rate. For impaired loans where the Company utilizes discounted cash flows to determine the level of impairment, the Company includes the entire change in the present value of cash flows as bad debt expense.

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Notes to Condensed Consolidated Financial Statements

(Unaudited)

Groups of loans with similar risk characteristics are collectively evaluated for impairment based on the group’s historical loss experience adjusted for changes in trends, conditions and other relevant factors that affect repayment of the loans. Accordingly, the Company does not separately identify individual consumer and residential loans for impairment measurements, unless such loans are the subject of a restructuring agreement due to financial difficulties of the borrower.

In the course of working with borrowers, the Company may choose to restructure the contractual terms of certain loans. In restructuring the loan, the Company attempts to work out an alternative payment schedule with the borrower in order to optimize collectability of the loan. A troubled debt restructuring (TDR) occurs when, for economic or legal reasons related to a borrower’s financial difficulties, the Company grants a concession to the borrower that it would not otherwise consider. Terms may be modified to fit the ability of the borrower to repay in line with its current financial status, and the restructuring of the loan may include the transfer of assets from the borrower to satisfy the debt, a modification of loan terms, or a combination of the two.

Nonaccrual loans, including TDRs that have not met the six month minimum performance criterion, are reported as nonperforming loans. For all loan classes, it is the Company’s policy to have any restructured loans which are on nonaccrual status prior to being restructured remain on nonaccrual status until three months of satisfactory borrower performance, at which time management would consider its return to accrual status. A loan is generally classified as nonaccrual when the Company believes that receipt of principal and interest is doubtful under the terms of the loan agreement. Most generally, this is at 90 or more days past due.

With regard to determination of the amount of the allowance for credit losses, restructured loans are considered to be impaired. As a result, the determination of the amount of impaired loans for each loan portfolio segment within troubled debt restructurings is the same as detailed previously above.

The following tables present, by loan portfolio segment, the activity in the allowance for loan losses for the three and six months ended June 30, 2019 and 2018 and the recorded investment in loans and impairment method as of June 30, 2019:


	At or For the Three Months Ended June 30, 2019
	MTG WHLOC		RES RE		MF RE		CML & CRE		AG & AGRE		CON & MAR		TOTAL
	(In thousands)
Allowance for loan losses
Balance, beginning of period	$	1,254	$	1,990	$	6,377	$	3,122	$	466	$	147	$	13,356
Provision (credit) for loan losses		311		(61)		(1,233)		1,003		52		33		105
Loans charged to the allowance		—		—		—		(854)		(3)		—		(857)
Recoveries of loans previously charged off		—		—		—		—		—		—		—
Balance, end of period	$	1,565	$	1,929	$	5,144	$	3,271	$	515	$	180	$	12,604
Ending balance: individually evaluated for impairment	$	225		—		—		500		27		—	$	752
Ending balance: collectively evaluated for impairment	$	1,340	$	1,929	$	5,144	$	2,771	$	488	$	180	$	11,852
Loans
Ending balance	$	536,387	$	402,035	$	1,001,811	$	315,286	$	84,080	$	20,911	$	2,360,510
Ending balance individually evaluated for impairment	$	566	$	5,026	$	—	$	7,884	$	302	$	53	$	13,831
Ending balance collectively evaluated for impairment	$	535,821	$	397,009	$	1,001,811	$	307,402	$	83,778	$	20,858	$	2,346,679

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Merchants Bancorp

Notes to Condensed Consolidated Financial Statements

(Unaudited)


	For the Three Months Ended June 30, 2018
	MTG WHLOC		RES RE		MF RE		CML & CRE		AG & AGRE		CON & MAR		TOTAL
	(In thousands)
Allowance for loan losses
Balance, beginning of period	$	506	$	1,664	$	4,250	$	2,685	$	333	$	267	$	9,705
Provision (credit) for loan losses		140		133		412		252		59		2		998
Loans charged to the allowance		—		—		—		(135)		—		(11)		(146)
Recoveries of loans previously charged off		—		15		—		1		—		15		31
Balance, end of period	$	646	$	1,812	$	4,662	$	2,803	$	392	$	273	$	10,588


	For the Six Months Ended June 30, 2019
	MTG WHLOC		RES RE		MF RE		CML & CRE		AG & AGRE		CON & MAR		TOTAL
	(In thousands)
Allowance for loan losses
Balance, beginning of period	$	1,068	$	1,986	$	6,030	$	3,051	$	429	$	140	$	12,704
Provision for loan losses		497		(57)		(886)		1,074		86		40		754
Loans charged to the allowance		—		—		—		(854)		(3)		—		(857)
Recoveries of loans previously charged off		—		—		—		—		3		—		3
Balance, end of period	$	1,565	$	1,929	$	5,144	$	3,271	$	515	$	180	$	12,604


	For the Six Months Ended June 30, 2018
	MTG WHLOC		RES RE		MF RE		CML & CRE		AG & AGRE		CON & MAR		TOTAL
	(In thousands)
Allowance for loan losses
Balance, beginning of period	$	283	$	1,587	$	3,502	$	2,362	$	320	$	257	$	8,311
Provision (credit) for loan losses		363		209		1,160		575		72		25		2,404
Loans charged to the allowance		—		—		—		(135)		—		(28)		(163)
Recoveries of loans previously charged off		—		16		—		1		—		19		36
Balance, end of period	$	646	$	1,812	$	4,662	$	2,803	$	392	$	273	$	10,588

The following table presents the allowance for loan losses and the recorded investment in loans and impairment method as of December 31, 2018:


	December 31, 2018
	MTG WHLOC		RES RE		MF RE		CML & CRE		AG & AGRE		CON & MAR		TOTAL
	(In thousands)
Allowance for loan losses
Balance, December 31, 2018	$	1,068	$	1,986	$	6,030	$	3,051	$	429	$	140	$	12,704
Ending balance: individually evaluated for impairment	$	225	$	—	$	—	$	400	$	20	$	—	$	645
Ending balance: collectively evaluated for impairment	$	843	$	1,986	$	6,030	$	2,651	$	409	$	140	$	12,059
Loans
Balance, December 31, 2018	$	337,332	$	410,871	$	914,393	$	299,194	$	79,255	$	17,082	$	2,058,127
Ending balance individually evaluated for impairment	$	575	$	1,606	$	—	$	8,576	$	370	$	58	$	11,185
Ending balance collectively evaluated for impairment	$	336,757	$	409,265	$	914,393	$	290,618	$	78,885	$	17,024	$	2,046,942

Internal Risk Categories

In adherence with policy, the Company uses the following internal risk grading categories and definitions for loans:

Average or above – Loans to borrowers of satisfactory financial strength or better. Earnings performance is consistent with primary and secondary sources of repayment that are well defined and adequate to retire the debt in a timely and orderly fashion. These businesses would generally exhibit satisfactory asset quality and liquidity with

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Notes to Condensed Consolidated Financial Statements

(Unaudited)

moderate leverage, average performance to their peer group and experienced management in key positions. These loans are disclosed as “Acceptable and Above” in the following table.

Acceptable – Loans to borrowers involving more than average risk and which contain certain characteristics that require some supervision and attention by the lender. Asset quality is acceptable, but debt capacity is modest and little excess liquidity is available. The borrower may be fully leveraged and unable to sustain major setbacks. Covenants are structured to ensure adequate protection. Borrower’s management may have limited experience and depth. This category includes loans which are highly leveraged due to regulatory constraints, as well as loans involving reasonable exceptions to policy. These loans are disclosed as “Acceptable and Above” in the following table.

Special Mention (Watch) – This is a loan that is sound and collectable but contains considerable risk. Loans classified as special mention have a potential weakness that deserves management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or of the institution’s credit position at some future date.

Substandard - Loans classified as substandard are inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. Loans so classified have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the institution will sustain some loss if the deficiencies are not corrected.

Doubtful - Loans classified as doubtful have all the weaknesses inherent in those classified as substandard, with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable.

The following tables present the credit risk profile of the Company’s loan portfolio based on internal rating category and payment activity as of June 30, 2019 and December 31, 2018:


	June 30, 2019
	MTG WHLOC		RES RE		MF RE		CML & CRE		AG & AGRE		CON & MAR		TOTAL
	(In thousands)

Special Mention (Watch)	$	—	$	643	$	42,563	$	11,957	$	2,567	$	20	$	57,750
Substandard		566		5,026		—		7,884		302		53		13,831
Doubtful		—		—		—		—		—		—		—
Acceptable and Above		535,821		396,366		959,248		295,445		81,211		20,838		2,288,929
Total	$	536,387	$	402,035	$	1,001,811	$	315,286	$	84,080	$	20,911	$	2,360,510


	December 31, 2018
	MTG WHLOC		RES RE		MF RE		CML & CRE		AG & AGRE		CON & MAR		TOTAL
	(In thousands)

Special Mention (Watch)	$	—	$	443	$	71,734	$	14,650	$	3,096	$	681	$	90,604
Substandard		575		1,606		—		8,576		370		58		11,185
Doubtful		—		—		—		—		—		—		—
Acceptable and Above		336,757		408,822		842,659		275,968		75,789		16,343		1,956,338
Total	$	337,332	$	410,871	$	914,393	$	299,194	$	79,255	$	17,082	$	2,058,127

The Company evaluates the loan risk grading system definitions and allowance for loan loss methodology on an ongoing basis. No significant changes were made to either during the past year.

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Notes to Condensed Consolidated Financial Statements

(Unaudited)

The following tables present the Company’s loan portfolio aging analysis of the recorded investment in loans as of June 30, 2019 and December 31, 2018:


	June 30, 2019
	30-59 Days		60-89 Days		Greater Than		Total				Total
	Past Due		Past Due		90 Days		Past Due		Current		Loans
	(In thousands)
MTG WHLOC	$	—	$	—	$	324	$	324	$	536,063	$	536,387
RES RE		614		246		1,606		2,466		399,569		402,035
MF RE		—		—		—		—		1,001,811		1,001,811
CML & CRE		480		741		325		1,546		313,740		315,286
AG & AGRE		264		41		943		1,248		82,832		84,080
CON & MAR		6		26		26		58		20,853		20,911
	$	1,364	$	1,054	$	3,224	$	5,642	$	2,354,868	$	2,360,510


	December 31, 2018
	30-59 Days		60-89 Days		Greater Than		Total				Total
	Past Due		Past Due		90 Days		Past Due		Current		Loans
	(In thousands)
MTG WHLOC	$	—	$	—	$	324	$	324	$	337,008	$	337,332
RES RE		579		178		825		1,582		409,289		410,871
MF RE		—		—		—		—		914,393		914,393
CML & CRE		245		52		253		550		298,644		299,194
AG & AGRE		91		—		588		679		78,576		79,255
CON & MAR		2		52		28		82		17,000		17,082
	$	917	$	282	$	2,018	$	3,217	$	2,054,910	$	2,058,127

A loan is considered impaired, in accordance with the impairment accounting guidance (ASC 310-10-35-16), when based on current information and events, it is probable the Company will be unable to collect all amounts due from the borrower in accordance with the contractual terms of the loan. Impaired loans include nonperforming commercial loans but also include loans modified in troubled debt restructurings.

The following tables present impaired loans and specific valuation allowance information based on class level as of June 30, 2019 and December 31, 2018:


	June 30, 2019
	MTG WHLOC		RES RE		MF RE		CML & CRE		AG & AGRE		CON & MAR		TOTAL
	(In thousands)
Impaired loans without a specific allowance:
Recorded investment	$	242	$	5,026	$	—	$	5,605	$	88	$	53	$	11,014
Unpaid principal balance		242		5,026		—		5,605		88		53		11,014
Impaired loans with a specific allowance:
Recorded investment		324		—		—		2,279		214		—		2,817
Unpaid principal balance		324		—		—		2,279		214		—		2,817
Specific allowance		225		—		—		500		27		—		752
Total impaired loans:
Recorded investment		566		5,026		—		7,884		302		53		13,831
Unpaid principal balance		566		5,026		—		7,884		302		53		13,831
Specific allowance		225		—		—		500		27		—		752

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Merchants Bancorp

Notes to Condensed Consolidated Financial Statements

(Unaudited)


	December 31, 2018
	MTG WHLOC		RES RE		MF RE		CML & CRE		AG & AGRE		CON & MAR		TOTAL
	(In thousands)
Impaired loans without a specific allowance:
Recorded investment	$	251	$	1,606	$	—	$	5,636	$	88	$	58	$	7,639
Unpaid principal balance		251		1,606		—		5,636		88		58		7,639
Impaired loans with a specific allowance:
Recorded investment		324		—		—		2,940		282		—		3,546
Unpaid principal balance		324		—		—		2,940		282		—		3,546
Specific allowance		225		—		—		400		20		—		645
Total impaired loans:
Recorded investment		575		1,606		—		8,576		370		58		11,185
Unpaid principal balance		575		1,606		—		8,576		370		58		11,185
Specific allowance		225		—		—		400		20		—		645

The following tables present by portfolio class, information related to the average recorded investment and interest income recognized on impaired loans for the three and six month periods ended June 30, 2019 and 2018:


	MTG WHLOC		RES RE		MF RE		CML & CRE		AG & AGRE		CON & MAR		TOTAL
	(In thousands)
Three Months Ended June 30, 2019
Average recorded investment in impaired loans	$	568	$	4,091	$	—	$	7,659	$	314	$	52	$	12,684
Interest income recognized		—		45		—		118		—		1		164

Three Months Ended June 30, 2018
Average recorded investment in impaired loans	$	774	$	1,095	$	112	$	6,674	$	634	$	196	$	9,485
Interest income recognized		40		30		2		79		39		1		191


	MTG WHLOC		RES RE		MF RE		CML & CRE		AG & AGRE		CON & MAR		TOTAL
	(In thousands)
Six Months Ended June 30, 2019
Average recorded investment in impaired loans	$	571	$	3,745	$	—	$	7,857	$	338	$	53	$	12,564
Interest income recognized		—		85		—		255		—		1		341

Six Months Ended June 30, 2018
Average recorded investment in impaired loans	$	1,137	$	1,051	$	114	$	6,657	$	634	$	189	$	9,782
Interest income recognized		59		33		5		125		39		1		262

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Merchants Bancorp

Notes to Condensed Consolidated Financial Statements

(Unaudited)

The following table presents the Company’s nonaccrual loans and loans past due 90 days or more and still accruing at June 30, 2019 and December 31, 2018.


	June 30,				December 31,
	2019				2018
			Total Loans >				Total Loans >
			90 Days &				90 Days &
	Nonaccrual		Accruing		Nonaccrual		Accruing
	(In thousands)
MTG WHLOC	$	566	$	—	$	575	$	—
RES RE		675		1,215		893		74
MF RE		—		—		—		—
CML & CRE		257		121		136		117
AG & AGRE		214		729		282		307
CON & MAR		19		6		18		9

	$	1,731	$	2,071	$	1,904	$	507

No troubled loans were restructured during the three or six months ended June 30, 2019 or 2018. No restructured loans defaulted during the three or six months ended June 30, 2019 or 2018. There were no residential loans in process of foreclosure at June 30, 2019 or December 31, 2018.

Note 4: Regulatory Matters

The Company, Merchants Bank, and FMBI are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory, and possibly additional discretionary, actions by federal and state banking regulators that, if undertaken, could have a direct material effect on the Company’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company, Merchants Bank, and FMBI must meet specific capital guidelines that involve quantitative measures of the Company’s, Merchants Bank, and FMBI’s assets, liabilities and certain off-balance-sheet items as calculated under regulatory accounting practices. The Company’s, Merchants Bank’s, and FMBI’s capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors. Furthermore, the Company’s, Merchants Bank’s, and FMBI’s regulators could require adjustments to regulatory capital not reflected in these financial statements.

Quantitative measures established by regulation to ensure capital adequacy require the Company, Merchants Bank, and FMBI to maintain minimum amounts and ratios (set forth in the table below). Management believes, as of June 30, 2019 and December 31, 2018, that the Company, Merchants Bank, and FMBI met all capital adequacy requirements to which they were subject.

As of June 30, 2019 and December 31, 2018, the most recent notifications from the Board of Governors of the Federal Reserve System (“Federal Reserve”) categorized the Company as well capitalized and most recent notifications from the Federal Deposit Insurance Corporation (“FDIC”) categorized Merchants Bank and FMBI as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, a company must maintain minimum total risk-based, Tier I risk-based and Tier I leverage ratios as set forth in the table. There are no conditions or events since that notification that management believes have changed the Company, Merchants Bank, or FMBI’s category.

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Merchants Bancorp

Notes to Condensed Consolidated Financial Statements

(Unaudited)

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


					Minimum Amount
					Required for				Minimum Amount
					Adequately				To Be Well
	Actual				Capitalized (1)				Capitalized (1)
	Amount		Ratio		Amount		Ratio		Amount		Ratio
	(Dollars in thousands)
June 30, 2019
Total capital (1) (to risk-weighted assets)
Company	$	491,226	10.7	%	$	367,624	8.0	%	$	—	N/A
Merchants Bank		516,390	11.6	%		357,588	8.0	%		446,985	10.0	%
FMBI		19,324	15.6	%		9,932	8.0	%		12,414	10.0	%
Tier 1 capital (1) (to risk-weighted assets)
Company		478,621	10.4	%		275,718	6.0	%		—	N/A
Merchants Bank		504,198	11.3	%		268,191	6.0	%		357,588	8.0	%
FMBI		18,911	15.2	%		7,449	6.0	%		9,932	8.0	%
Common Equity Tier 1 capital (1) (to risk-weighted assets)
Company		364,945	7.9	%		206,788	4.5	%		—	N/A
Merchants Bank		504,198	11.3	%		201,143	4.5	%		290,540	6.5	%
FMBI		18,911	15.2	%		5,586	4.5	%		8,069	6.5	%
Tier 1 capital (1) (to average assets)
Company		478,621	10.3	%		185,015	4.0	%		—	N/A
Merchants Bank		504,198	11.3	%		178,903	4.0	%		223,629	5.0	%
FMBI		18,911	11.7	%		6,492	4.0	%		8,115	5.0	%


					Minimum				Minimum
					Amount Required				Amount To Be
					for Adequately				Well
	Actual				Capitalized (1)				Capitalized (1)
	Amount		Ratio		Amount		Ratio		Amount		Ratio
	(Dollars in thousands)
December 31, 2018
Total capital (1) (to risk-weighted assets)
Company	$	393,654	12.3	%	$	255,884	8.0	%	$	—	N/A
Merchants Bank		412,386	13.3	%		248,290	8.0	%		310,363	10.0	%
FMBI		17,537	18.6	%		7,559	8.0	%		9,448	10.0	%
Tier 1 capital (1) (to risk-weighted assets)
Company		380,950	11.9	%		191,913	6.0	%		—	N/A
Merchants Bank		399,815	12.9	%		186,218	6.0	%		248,290	8.0	%
FMBI		17,404	18.4	%		5,669	6.0	%		7,559	8.0	%
Common Equity Tier 1 capital (1) (to risk-weighted assets)
Company		339,369	10.6	%		143,935	4.5	%		—	N/A
Merchants Bank		399,815	12.9	%		139,663	4.5	%		201,736	6.5	%
FMBI		17,404	18.4	%		4,252	4.5	%		6,141	6.5	%
Tier 1 capital (1) (to average assets)
Company		380,950	10.0	%		152,081	4.0	%		—	N/A
Merchants Bank		399,815	11.0	%		145,723	4.0	%		182,154	5.0	%
FMBI		17,404	10.8	%		6,453	4.0	%		8,066	5.0	%

As defined by regulatory agencies.

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Merchants Bancorp

Notes to Condensed Consolidated Financial Statements

(Unaudited)

Beginning January 1, 2015, the Basel III Capital Rule applied to Merchants Bank. The following table lists the capital categories and ratios determined by the Board of Governors of the Federal Reserve System and the FDIC.


					Common Equity
	Total Risk-based		Tier 1 Risk-based		Tier 1 Risk-based		Tier 1
Capital Category	Capital ratio		Capital ratio		Capital ratio		Leverage ratio
Well capitalized	10	%	8	%	6.5	%	5	%
Adequately capitalized	8		6		4.5		4
Undercapitalized	<8		<6		<4.5		<4
Significantly undercapitalized	<6		<4		<3		<3
Critically undercapitalized	Tangible Equity/Total Assets </= 2%

The Basel III Capital Rules, among other things, (i) introduced a new capital measure called “Common Equity Tier 1” (CET1), (ii) specified that Tier 1 capital consist of CET1 and “Additional Tier 1 Capital” instruments meeting specified requirements, (iii) defined CET1 narrowly by requiring that most deductions/adjustments to regulatory capital measures be made to CET1 and not to the other components of capital and (iv) expanded the scope of the deductions/adjustments as compared to existing regulations.

Implementation of the deductions and other adjustments to CET1 began on January 1, 2015, and were phased in over a four-year period, becoming fully phased in on January 1, 2019. Additionally, under the Basel III Capital Rules, in order to avoid limitations on capital distributions of dividend payments and certain discretionary bonus payments to executive officers, a banking organization must hold a capital conservation buffer composed of capital above its minimum risk-based capital requirements. On January 1, 2019 the capital conservation buffer became fully phased in at 2.5%.

Note 5: Derivative Financial Instruments

The Company uses derivative financial instruments to help manage exposure to interest rate risk and the effects that changes in interest rates may have on net income and the fair value of assets and liabilities. The Company enters into forward contracts for the future delivery of mortgage loans to third party investors and enters into interest rate locks with potential borrowers to fund specific mortgage loans that will be sold into the secondary market. The forward contracts are entered into in order to economically hedge the effect of changes in interest rates resulting from the Company’s commitment to fund the loans.

Each of these items are considered derivatives, but are not designated as accounting hedges, and are recorded at fair value with changes in fair value reflected in noninterest income on the condensed consolidated statements of income. The fair value of derivative instruments with a positive fair value are reported in other assets in the condensed consolidated balance sheets while derivative instruments with a negative fair value are reported in other liabilities in the condensed consolidated balance sheets.

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Merchants Bancorp

Notes to Condensed Consolidated Financial Statements

(Unaudited)

The following table presents the notional amount and fair value of interest rate locks and forward contracts utilized by the Company at June 30, 2019 and December 31, 2018.


		Notional			Fair Value
		Amount	Balance Sheet Location		Asset		(Liability)
June 30, 2019		(In thousands)			(In thousands)
Interest rate lock commitments	$	18,813	Other assets/liabilities	$	147	$	3
Forward contracts		26,125	Other assets/liabilities		1		19
				$	148	$	22


		Notional			Fair Value
		Amount	Balance Sheet Location		Asset		(Liability)
December 31, 2018		(In thousands)			(In thousands)
Interest rate lock commitments	$	8,812	Other assets/liabilities	$	70	$	—
Forward contracts		19,640	Other assets/liabilities		—		9
				$	70	$	9

Fair values of derivative financial instruments were estimated using changes in mortgage interest rates from the date the Company entered into the interest rate lock commitment and the balance sheet date. The following table summarizes the periodic changes in the fair value of the derivative financial instruments on the condensed consolidated statements of income for the three and six months ended June 30, 2019 and 2018.


	Three Months Ended				Six Months Ended
	June 30,				June 30,
	2019		2018		2019		2018
	(In thousands)					(In thousands)
Interest rate lock commitments	$	74	$	49	$	74	$	163
Forward contracts (1)		(50)		(197)		(55)		(92)
Net derivative gains (losses)	$	24	$	(148)		19	$	71

_ __________________________________

⁽¹⁾

Amount includes pair-off settlements.

Note 6: Disclosures about Fair Value of Assets and Liabilities

Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Fair value measurements must maximize the use of observable inputs and minimize the use of unobservable inputs. There is a hierarchy of three levels of inputs that may be used to measure fair value:

Level 1 Quoted prices in active markets for identical assets or liabilities

Level 2 Observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities

Level 3 Unobservable inputs supported by little or no market activity and are significant to the fair value of the assets or liabilities

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Merchants Bancorp

Notes to Condensed Consolidated Financial Statements

(Unaudited)

Recurring Measurements

The following tables present the fair value measurements of assets and liabilities recognized in the accompanying balance sheets measured at fair value on a recurring basis and the level within the fair value hierarchy in which the fair value measurements fall at June 30, 2019 and December 31, 2018:


	Fair Value Measurements Using
			Quoted Prices in		Significant
			Active Markets		Other		Significant
			for Identical		Observable		Unobservable
	Fair		Assets		Inputs		Inputs
Assets	Value		(Level 1)		(Level 2)		(Level 3)
	(In thousands)
June 30, 2019
Trading securities	$	101,514	$	—	$	101,514	$	—
Available-for-sale securities:
Treasury notes		3,012		3,012		—		—
Federal agencies		208,868		—		208,868		—
Municipals		12,622		—		12,622		—
Mortgage-backed - Government-sponsored entity (GSE) - residential		36,983		—		36,983		—
Loans held for sale		9,592		—		9,592		—
Mortgage servicing rights		74,550		—		—		74,550
Derivative assets - interest rate lock commitments		147		—		—		147
Derivative assets - forward contracts		1		—		1		—
Derivative liabilities - interest rate lock commitments		3		—		—		3
Derivative liabilities - forward contracts		19		—		19		—


December 31, 2018
Trading securities	$	163,419	$	—	$	163,419	$	—
Available-for-sale securities:
Treasury notes		11,941		11,941		—		—
Federal agencies		236,930		—		236,930		—
Municipals		21,332		—		21,332		—
Mortgage-backed - Government-sponsored entity (GSE) - residential		60,868		—		60,868		—
Loans held for sale		11,886		—		11,886		—
Mortgage servicing rights		77,844		—		—		77,844
Derivative assets - interest rate lock commitments		70		—		—		70
Derivative liabilities - forward contracts		9		—		9		—

Following is a description of the valuation methodologies and inputs used for assets measured at fair value on a recurring basis and recognized in the accompanying balance sheets, as well as the general classification of such assets pursuant to the valuation hierarchy. There have been no significant changes in the valuation techniques during the six months ended June 30, 2019 and the year ended December 31, 2018. For assets classified within Level 3 of the fair value hierarchy, the process used to develop the reported fair value is described below.

Trading and Available-for-Sale Securities

Where quoted market prices are available in an active market, securities are classified within Level 1 of the valuation hierarchy. If quoted market prices are not available, then fair values are estimated by using quoted prices of

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Merchants Bancorp

Notes to Condensed Consolidated Financial Statements

(Unaudited)

securities with similar characteristics or independent asset pricing services and pricing models, the inputs of which are market-based or independently sourced market parameters, including, but not limited to, yield curves, interest rates, volatilities, prepayments, defaults, cumulative loss projections and cash flows. Such securities are classified in Level 2 of the valuation hierarchy including federal agencies, mortgage-backed securities, U.S. Treasuries, Equities, and Federal Housing Administration participation certificates. In certain cases where Level 1 or Level 2 inputs are not available, securities are classified within Level 3 of the hierarchy.

Loans Held for Sale

Certain loans held for sale at fair value are saleable into the secondary mortgage markets and their fair values are estimated using observable quoted market or contracted prices, or market price equivalents, which would be used by other market participants. These saleable loans are considered Level 2.

Mortgage Servicing Rights

Mortgage servicing rights do not trade in an active, open market with readily observable prices. Accordingly, fair value is estimated using discounted cash flow models having significant inputs of discount rate, prepayment speed and default rate. Due to the nature of the valuation inputs, mortgage servicing rights are classified within Level 3 of the hierarchy.

The Chief Financial Officer’s (CFO) office contracts with a pricing specialist to generate fair value estimates on a quarterly basis. The CFO’s office challenges the reasonableness of the assumptions used and reviews the methodology to ensure the estimated fair value complies with accounting standards generally accepted in the United States.

Derivative Financial Instruments

The Company estimates the fair value of interest rate lock commitments based on the value of the underlying mortgage loan, quoted mortgage backed security prices, estimates of the fair value of the mortgage servicing rights, and an estimate of the probability that the mortgage loan will fund within the terms of the interest rate lock commitment, net of expenses. The Company estimates the fair value of forward sales commitments based on market quotes of mortgage backed security prices for securities similar to the ones used, which are considered Level 2. With respect to its interest rate lock commitments, management determined that a Level 3 classification was most appropriate based on the various significant unobservable inputs utilized in estimating the fair value of its interest rate lock commitments. Changes in fair value of the Company’s derivative financial instruments are recognized through noninterest income on its condensed consolidated statement of income.

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Merchants Bancorp

Notes to Condensed Consolidated Financial Statements

(Unaudited)

Level 3 Reconciliation

The following is a reconciliation of the beginning and ending balances of recurring fair value measurements recognized in the accompanying balance sheets using significant unobservable (Level 3) inputs:


	Three Months Ended June 30,				Six Months Ended June 30,
	2019		2018		2019		2018
	(In thousands)				(In thousands)
Mortgage servicing rights
Balance, beginning of period	$	76,249	$	67,268	$	77,844	$	66,079
Additions
Originated and purchased servicing		2,261		2,250		3,281		5,702
Subtractions
Paydowns		(1,079)		(1,239)		(2,189)		(2,609)
Changes in fair value due to changes in valuation inputs or assumptions used in the valuation model		(2,881)		1,806		(4,386)		913
Balance, end of period	$	74,550	$	70,085	$	74,550	$	70,085

Available-for-sale securities - Municipals
Balance, beginning of period	$	—	$	6,431	$	—	$	6,688
Additions
Purchased securities		—		—		—		—
Subtractions
Paydowns		—		—		—		(257)
Sales		—		—		—		—
Unrealized gains (losses) included in other comprehensive income		—		—		—		—
Balance, end of period	$	—	$	6,431	$	—	$	6,431

Derivative Assets - interest rate lock commitments
Balance, beginning of period	$	71	$	116	$	70	$	—
Purchases		—		—		—		—
Changes in fair value		76		54		77		170
Balance, end of period	$	147	$	170	$	147	$	170

Derivative Liabilities - interest rate lock commitments
Balance, beginning of period	$	1	$	2	$	—	$	—
Purchases		—		—		—		—
Changes in fair value		2		5		3		7
Balance, end of period	$	3	$	7	$	3		7

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Merchants Bancorp

Notes to Condensed Consolidated Financial Statements

(Unaudited)

Nonrecurring Measurements

The following table presents the fair value measurement of assets measured at fair value on a nonrecurring basis and the level within the fair value hierarchy in which the fair value measurements fall at June 30, 2019 and December 31, 2018.


	Fair Value Measurements Using
			Quoted Prices in		Significant
			Active Markets		Other		Significant
			for Identical		Observable		Unobservable
	Fair		Assets		Inputs		Inputs
Assets	Value		(Level 1)		(Level 2)		(Level 3)
	(In thousands)
June 30, 2019
Impaired loans (collateral-dependent)	$	1,600	$	—	$	—	$	1,600
December 31, 2018
Impaired loans (collateral-dependent)	$	2,639	$	—	$	—	$	2,639

Following is a description of the valuation methodologies and inputs used for assets measured at fair value on a nonrecurring basis and recognized in the accompanying balance sheet, as well as the general classification of such assets pursuant to the valuation hierarchy. For assets classified within Level 3 of the fair value hierarchy, the process used to develop the reported fair value is described below.

Collateral-Dependent Impaired Loans, Net of Allowance for Loan Losses

The estimated fair value of collateral-dependent impaired loans is based on the appraised fair value of the collateral, less estimated cost to sell. Collateral-dependent impaired loans are classified within Level 3 of the fair value hierarchy.

The Company considers the appraisal or evaluation as the starting point for determining fair value and then considers other factors and events in the environment that may affect the fair value. Appraisals of the collateral underlying collateral-dependent loans are obtained when the loan is determined to be collateral-dependent and subsequently as deemed necessary by the Company’s Chief Credit Officer’s (CCO) office. Appraisals are reviewed for accuracy and consistency by the CCO’s office. Appraisers are selected from the list of approved appraisers maintained by management. The appraised values are reduced by discounts to consider lack of marketability and estimated cost to sell if repayment or satisfaction of the loan is dependent on the sale of the collateral. These discounts and estimates are developed by the CCO’s office by comparison to historical results.

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Merchants Bancorp

Notes to Condensed Consolidated Financial Statements

(Unaudited)

Unobservable (Level 3) Inputs:

The following table presents quantitative information about unobservable inputs used in recurring and nonrecurring Level 3 fair value measurements other than goodwill.


			Valuation
	Fair Value		Technique	Unobservable Inputs	Range
	(In thousands)
At June 30, 2019:
Collateral-dependent impaired loans	$	1,600	Market comparable properties	Marketability discount	37%
Mortgage servicing rights	$	74,550	Discounted cash flow	Discount rate	8% - 13%
				Constant prepayment rate	1% - 35%
Derivative assets - interest rate lock commitments	$	147	Discounted cash flow	loan closing rates	73-99%
Derivative liabilities - interest rate lock commitments	$	3	Discounted cash flow	loan closing rates	73-99%

At December 31, 2018:
Collateral-dependent impaired loans	$	2,639	Market comparable properties	Marketability discount	17%-59%
Mortgage servicing rights	$	77,844	Discounted cash flow	Discount rate	8% - 13%
				Constant prepayment rate	1% - 30%
Derivative assets - interest rate lock commitments	$	70	Discounted cash flow	loan closing rates	95-100%

Sensitivity of Significant Unobservable Inputs

The following is a discussion of the sensitivity of significant unobservable inputs, the interrelationships between those inputs and other unobservable inputs used in recurring fair value measurement and of how those inputs might magnify or mitigate the effect of changes in the unobservable inputs on the fair value measurement.

Mortgage Servicing Rights

The significant unobservable inputs used in the fair value measurement of the Company’s mortgage servicing rights are discount rates and constant prepayment rates. Significant increases or decreases in any of those inputs in isolation would result in a significantly different fair value measurement.

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Merchants Bancorp

Notes to Condensed Consolidated Financial Statements

(Unaudited)

Fair Value of Financial Instruments

The following table presents the carrying amount and estimated fair values of the Company’s financial instruments not carried at fair value and the level within the fair value hierarchy in which the fair value measurements fall at June 30, 2019 and December 31, 2018.


			Fair Value Measurements Using
					Quoted Prices in		Significant
					Active Markets		Other		Significant
					for Identical		Observable		Unobservable
	Carrying		Fair		Assets		Inputs		Inputs
Assets	Value		Value		(Level 1)		(Level 2)		(Level 3)
	(In thousands)
June 30, 2019
Financial assets:
Cash and cash equivalents	$	460,889	$	460,889	$	460,889	$	—	$	—
Securities purchased under agreements to resell		6,798		6,798		—		6,798		—
FHLB stock		18,820		18,820		—		18,820		—
Loans held for sale		1,908,526		1,908,526		—		1,908,526		—
Loans, net		2,347,906		2,338,864		—		—		2,338,864
Interest receivable		17,415		17,415		—		17,415		—
Financial liabilities:
Deposits		4,655,990		4,656,744		2,919,671		1,737,073		—
Lines of credit		33,385		33,385		—		33,385		—
Short-term subordinated debt		11,086		11,086		—		11,086		—
FHLB advances		17,754		17,829		—		17,829		—
Interest payable		7,643		7,643		—		7,643		—


December 31, 2018
Financial assets:
Cash and cash equivalents	$	336,524	$	336,524	$	336,524	$	—	$	—
Securities purchased under agreements to resell		6,875		6,875		—		6,875		—
FHLB stock		7,974		7,974		—		7,974		—
Loans held for sale		820,569		820,569		—		820,569		—
Loans, net		2,045,423		2,041,772		—		—		2,041,772
Interest receivable		13,827		13,827		—		13,827		—
Financial liabilities:
Deposits		3,231,086		3,230,397		2,550,632		679,765		—
Lines of credit		33,150		33,150		—		33,150		—
Short-term subordinated debt		10,582		10,582		—		10,582		—
FHLB advances		151,721		151,723		—		151,723		—
Interest payable		4,132		4,132		—		4,132		—

The following methods were used to estimate the fair value of all other financial instruments recognized in the accompanying balance sheets at amounts other than fair value.

Cash and Cash Equivalents and Securities Purchased Under Agreement to Resell

The carrying amount approximates fair value.

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Notes to Condensed Consolidated Financial Statements

(Unaudited)

Federal Home Loan Bank Stock

The fair value of Federal Home Loan Bank of Indianapolis and Federal Home Loan Bank of Chicago (“FHLB”) stock is based on the price at which it may be sold to the FHLB.

Loans Held For Sale

The carrying amount approximates fair value due to the insignificant time between origination and date of sale.

Loans

Fair value is estimated by discounting the future cash flows using the market rates at which similar notes would be made to borrowers with similar credit ratings and for the same remaining maturities. The market rates used are based on current rates the Company would impose for similar loans and reflect a market participant assumption about risks associated with nonperformance, illiquidity, and the structure and term of the loans along with local economic and market conditions.

Interest Receivable and Payable

The carrying amount approximates fair value. The carrying amount is determined using the interest rate, balance and last payment date.

Deposits

The fair values of noninterest-bearing demand and savings accounts are equal to the amount payable on demand at the balance sheet date. Fair values for fixed-rate certificates and time deposits are estimated using a discounted cash flow calculation that applies interest rates currently being offered on certificates to a schedule of expected monthly maturities on such time deposits.

Line of Credit and Short-term Subordinated Debt

The carrying amount approximates fair value.

Federal Home Loan Bank Advances

Fair value is estimated by discounting the future cash flows using rates of similar advances with similar maturities. These rates were obtained from current rates offered by the FHLB.

Off-Balance Sheet Commitments

Commitments include commitments to purchase and originate mortgage loans, commitments to sell mortgage loans and standby letters of credit and are generally of a short-term nature. The fair value of such commitments are based on fees currently charged to similar agreements, taking into account the remaining terms of the agreements and the counterparties’ credit standing. The fair value of commitments to extend credit and letters of credit is not presented in the previous table since the fair value is considered to be insignificant.

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Notes to Condensed Consolidated Financial Statements

(Unaudited)

Note 7: Earnings Per Share

Earnings per share were computed as follows:


	Three Month Periods Ended June 30,
	2019					2018
			Weighted-	Per				Weighted-	Per
	Net		Average	Share		Net		Average	Share
	Income		Shares	Amount		Income		Shares	Amount
	(In thousands)					(In thousands)
Net income	$	16,439				$	15,652
Dividends on preferred stock		(1,743)					(832)
Net income allocated to common shareholders	$	14,696				$	14,820
Basic earnings per share			28,705,313	$	0.51			28,692,749	$	0.52
Effect of dilutive securities-restricted stock awards			40,984					28,056
Diluted earnings per share			28,746,297	$	0.51			28,720,805	$	0.52


	Six Month Periods Ended June 30,
	2019					2018
			Weighted-	Per				Weighted-	Per
	Net		Average	Share		Net		Average	Share
	Income		Shares	Amount		Income		Shares	Amount
	(In thousands)					(In thousands)
Net income	$	27,009				$	30,713
Dividends on preferred stock		(2,576)					(1,665)
Net income allocated to common shareholders	$	24,433				$	29,048
Basic earnings per share			28,703,790	$	0.85			28,691,857	$	1.01
Effect of dilutive securities-restricted stock awards			38,087					23,830
Diluted earnings per share			28,741,877	$	0.85			28,715,687	$	1.01

Note 8: Share-Based Payment Plans

Equity-based incentive awards are currently issued pursuant to the 2017 Equity Incentive Plan (the “2017 Incentive Plan”). Prior to the adoption of the 2017 Incentive Plan, the equity awards issued historically consisted of restricted stock awards issued pursuant to the Incentive Plan for Merchants Bank Executive Officers (the “Prior Incentive Plan”). As of the effective date of the 2017 Equity Incentive Plan, no further awards will be granted under the Prior Incentive Plan. However, any previously outstanding incentive award granted under the Prior Incentive Plan remains subject to the terms of such plans until the time it is no longer outstanding. During the three months ended June 30, 2019 and 2018, the Company did not issue any shares pursuant to awards issued under these plans. During the six months ended June 30, 2019 and 2018, the Company issued 10,127 and 7,039 shares, respectively, pursuant to the Prior Incentive Plan. As of June 30, 2019, the Company has not issued any shares pursuant to the 2017 Equity Incentive Plan.

During 2018, the Compensation Committee of the Board of Directors approved a plan for non-executive directors to receive a portion of their annual retainer fees in the form of shares of common stock equal to $10,000, rounded up to the nearest whole share. Accordingly, there were 2,275 and 1,830 shares issued to directors during the three and six months ended June 30, 2019 and 2018, respectively.

Note 9: Segment Information

Our business segments are defined as Multi-family Mortgage Banking, Mortgage Warehousing, and Banking. The reportable business segments are consistent with the internal reporting and evaluation of the principal lines of business of the Company. The Multi-family Mortgage Banking segment originates and services government sponsored mortgages for multi-family and healthcare facilities. The Mortgage Warehousing segment funds agency eligible residential loans from origination or purchase to sale in the secondary market, as well as commercial loans to non-depository financial institutions. The Banking segment provides a wide range of financial products and services to consumers and businesses,

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Notes to Condensed Consolidated Financial Statements

(Unaudited)

including retail banking, commercial lending, agricultural lending, retail and correspondent residential mortgage banking, and Small Business Administration (“SBA”) lending. Other includes general and administrative expenses that provide services to all segments; internal funds transfer pricing offsets resulting from allocations to/from the other segments; certain elimination entries and investments in qualified affordable housing limited partnerships. All operations are domestic.

The tables below present selected business segment financial information for the three and six months ended June 30, 2019 and 2018.


	Multi-family
	Mortgage		Mortgage
	Banking		Warehousing		Banking		Other		Total
	(In thousands)
Three Months Ended June 30, 2019
Total interest income	$	334	$	21,950	$	25,984	$	493	$	48,761
Total interest expense		—		11,595		11,209		(1,965)		20,839
Net interest income		334		10,355		14,775		2,458		27,922
Provision for loan losses		—		327		(222)		—		105
Net interest income after provision for loan losses		334		10,028		14,997		2,458		27,817
Total noninterest income		8,418		1,141		999		(688)		9,870
Total noninterest expense		5,327		2,790		4,862		2,941		15,920
Income before income taxes		3,425		8,379		11,134		(1,171)		21,767
Income taxes		908		2,059		2,726		(365)		5,328
Net income (loss)	$	2,517	$	6,320	$	8,408	$	(806)	$	16,439
Total assets	$	164,990	$	2,661,836	$	2,412,026	$	48,538	$	5,287,390


	Multi-family
	Mortgage		Mortgage
	Banking		Warehousing		Banking		Other		Total
	(In thousands)
Three Months Ended June 30, 2018
Total interest income	$	108	$	14,658	$	19,028	$	329	$	34,123
Total interest expense		—		5,413		7,320		(816)		11,917
Net interest income		108		9,245		11,708		1,145		22,206
Provision for loan losses		—		284		714		—		998
Net interest income after provision for loan losses		108		8,961		10,994		1,145		21,208
Total noninterest income		10,615		684		863		(532)		11,630
Noninterest expense		4,218		2,185		3,464		2,133		12,000
Income before income taxes		6,505		7,460		8,393		(1,520)		20,838
Income taxes		1,740		1,686		1,908		(148)		5,186
Net income (loss)	$	4,765	$	5,774	$	6,485	$	(1,372)	$	15,652
Total assets	$	146,262	$	1,550,255	$	2,071,022		19,143	$	3,786,682

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Notes to Condensed Consolidated Financial Statements

(Unaudited)


	Multi-family
	Mortgage		Mortgage
	Banking		Warehousing		Banking		Other		Total
	(In thousands)
Six Months Ended June 30, 2019
Total interest income	$	665	$	36,330	$	50,476	$	964	$	88,435
Total interest expense		—		19,124		20,191		(2,933)		36,382
Net interest income		665		17,206		30,285		3,897		52,053
Provision for loan losses		—		460		294		—		754
Net interest income after provision for loan losses		665		16,746		29,991		3,897		51,299
Total noninterest income		11,109		1,894		1,882		(1,351)		13,534
Total noninterest expense		9,304		5,126		8,982		5,543		28,955
Income before income taxes		2,470		13,514		22,891		(2,997)		35,878
Income taxes		665		3,362		5,714		(872)		8,869
Net income	$	1,805	$	10,152	$	17,177	$	(2,125)	$	27,009
Total assets	$	164,990	$	2,661,836	$	2,412,026	$	48,538	$	5,287,390


	Multi-family
	Mortgage		Mortgage
	Banking		Warehousing		Banking		Other			Total
	(In thousands)
Six Months Ended June 30, 2018
Total interest income	$	271	$	26,515	$	35,781	$	594	$	63,161
Total interest expense		—		9,210		12,913		(1,276)		20,847
Net interest income		271		17,305		22,868		1,870		42,314
Provision for loan losses		—		958		1,446		—		2,404
Net interest income after provision for loan losses		271		16,347		21,422		1,870		39,910
Total noninterest income		21,126		1,170		1,515		(868)		22,943
Noninterest expense		7,600		3,921		6,633		4,116		22,270
Income before income taxes		13,797		13,596		16,304		(3,114)		40,583
Income taxes		3,548		3,192		3,839		(709)		9,870
Net income	$	10,249	$	10,404	$	12,465	$	(2,405)	$	30,713
Total assets	$	146,262	$	1,550,255	$	2,071,022	$	19,143	$	3,786,682

Note 10: Recent Accounting Pronouncements

The Company is an emerging growth company and as such will be subject to the effective dates noted for the private companies if they differ from the effective dates noted for public companies.

FASB ASU 2014‑09, Revenue from Contracts with Customers

In May 2014, the Financial Accounting Standards Board (the “FASB”) issued Accounting Standards Update (“ASU”) 2014‑09, “Revenue from Contracts with Customers,” which requires an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers. The ASU will replace most existing revenue recognition guidance in U.S. GAAP when it becomes effective. In March 2016 the FASB issued ASU 2016‑08, “Principal versus Agent Considerations (Reporting Revenue Gross versus Net),” which clarifies the guidance in determining revenue recognition as principal versus agent. In April 2016, the FASB issued ASU 2016‑10, “Identifying Performance Obligations and Licensing,” which provides guidance in accounting for immaterial performance obligations and shipping and handling. In May 2016, the FASB issued ASU 2016‑12, “Narrow‑Scope Improvements and Practical Expedients,” which provides clarification on assessing the collectability criterion,

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Notes to Condensed Consolidated Financial Statements

(Unaudited)

presentation of sales taxes, measurement date for noncash consideration and completed contracts at transition. This ASU also provides a practical expedient for contract modifications.

As an emerging growth company, these amendments are effective for annual reporting periods beginning after December 15, 2018, and for interim periods within annual periods beginning after December 15, 2019. The Company’s revenue is primarily comprised of net interest income on financial assets and financial liabilities, which is explicitly excluded from the scope of ASU 2014-09. The Company has evaluated the impact of adopting ASU 2014-09 and does not expect it to have a material impact on the Company’s financial position or results of operations.

FASB ASU 2016‑01, Recognition and Measurement of Financial Assets and Financial Liabilities

In January 2016, the FASB issued ASU 2016‑01, “Recognition and Measurement of Financial Assets and Financial Liabilities.” For public business entities, the amendments in this update include the elimination of the requirement to disclose the method(s) and significant assumptions used to estimate fair value that is required to be disclosed for financial instruments measured at amortized cost on the balance sheet, the requirement to use the exit price notion when measuring fair value of financial instruments for disclosure purposes, the requirement to present separately in other comprehensive income the portion of the total change in the fair value of a liability resulting from a change in the instrument‑specific credit risk when the entity has elected to measure the liability at fair value in accordance with the fair value option for financial instruments, the requirement for separate presentation of financial assets and financial liabilities by measurement category and form of financial asset (that is, securities or loans and receivables) on the balance sheet or accompanying notes to the financial statements, and the amendments clarify that an entity should evaluate the need for a valuation allowance on a deferred tax asset related to available‑for‑sale securities in combination with the entity’s other deferred tax assets. An entity should apply the amendments to this update by means of a cumulative‑effect adjustment to the balance sheet as of the beginning of the fiscal year of adoption.

As an emerging growth company, the amendments in this update are effective for fiscal years beginning after December 15, 2018, and interim periods within years beginning after December 15, 2019. Early adoption of the amendments in the update is not permitted, except that early application by public business entities to financial statements of fiscal years or interim periods that have not yet been issued or, by all other entities, that have not yet been made available for issuance, are permitted as of the beginning of the fiscal year of adoption for the following amendment: An entity should present separately in other comprehensive income the portion of the total change in the fair value of a liability at fair value in accordance with the fair value option for financial instruments. An entity should apply the amendments to this update by means of a cumulative-effect adjustment to the balance sheet as of the beginning of the fiscal year of adoption. The Company is continuing to evaluate the impact of adopting this new guidance, but does not expect the adoption of ASU 2016-01 to have a material impact on the Company’s financial position or results of operation.

FASB ASU 2016‑02, Leases

In February 2016, the FASB issued ASU 2016‑02, “Leases.” Under the new guidance, lessees will be required to recognize the following for all leases (with the exception of short‑term leases) at the commencement date:

A lease liability, which is a lessee’s obligation to make lease payments arising from a lease, measured on a discounted basis; and

A right‑of‑use asset, which is an asset that represents the lessee’s right to use, or control the use of, a specified asset for the lease term.

Under the new guidance, lessor accounting is largely unchanged. Certain targeted improvements were made to align, where necessary, lessor accounting with the lessee accounting model and Topic 606, “Revenue from Contracts with Customers.” The new lease guidance simplified the accounting for sale and leaseback transactions primarily because lessees must recognize lease assets and lease liabilities. Lessees will no longer be provided with a source of

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Notes to Condensed Consolidated Financial Statements

(Unaudited)

off‑balance sheet financing. Lessees (for capital and operating leases) and lessors (for sales‑type, direct financing, and operating leases) must apply a modified retrospective transition approach for leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements. The modified retrospective approach would not require any transition accounting for leases that expired before the earliest comparative period presented. Lessees and lessors may not apply a full retrospective transition approach.

As an emerging growth company, the amendments in ASU 2016‑02 are effective, as an emerging growth company, beginning after December 15, 2019, and for interim periods for years beginning after January 1, 2020. The Company is continuing to evaluate the impact of adopting this new guidance, but it does not expect the adoption to have a material impact on the Company’s financial position or results of operations.

FASB ASU 2016‑13, Financial Instruments—Credit Losses

In June 2016, the FASB issued ASU 2016‑13, “Financial Instruments—Credit Losses”. The amendments in this ASU replace the incurred loss model with a methodology that reflects expected credit losses over the life of the loan and requires consideration of a broader range of reasonable and supportable information to calculate credit loss estimates. ASU 2016‑13 replaces the incurred loss impairment methodology with a new methodology that reflects expected credit losses over the lives of the loans and requires consideration of a broader range of information to form credit loss estimates. The ASU requires an organization to estimate all expected credit losses for financial assets measured at amortized cost, including loans and held‑to‑maturity debt securities, based on historical experience, current conditions, and reasonable and supportable forecasts. Additional disclosures are required.

As an emerging growth company, the amendments in ASU 2016‑13 are effective for fiscal years beginning after December 15, 2021, and interim periods within those fiscal years beginning after December 15, 2021. However, the FASB is considering a proposal to delay such effective dates by one year for certain companies, including the Company if it remains an emerging growth company until such time. The Company has established a cross-functional committee that is developing a project plan to review modeling data currently available and technology needed to ensure compliance of this standard. The committee has selected a vendor to assist in generating specific loan level details within our core systems, as well as compiling peer and industry data that would be useful in our modeling forecasts. While the Company generally expects to recognize a one-time cumulative effect adjustment to the allowance for loan losses as of the beginning of the first reporting period in which the new standard is effective, the Company cannot yet determine the magnitude of any such one-time adjustment or the overall impact of the new guidance on the Company’s consolidated financial statements. Management continues to recognize that the implementation of this ASU may increase the balance of the allowance for loan losses and is continuing to evaluate the potential impact on the Company’s financial position and results of operations.

FASB ASU No. 2017‑04, Intangibles—Goodwill and Other (Topic 350)

In January 2017, the FASB issued ASU 2017‑04, “Intangibles—Goodwill and Other (Topic 350).” This ASU simplifies the test for goodwill impairment. Specifically, these amendments eliminate Step 2 from the goodwill impairment test, and also eliminate the requirements for any reporting unit with a zero or negative carrying amount to perform a qualitative assessment and, if it fails that qualitative test, to perform Step 2 of the goodwill impairment test.

As an emerging growth company, the amendments in this ASU are effective for annual goodwill impairment tests in fiscal years beginning after December 15, 2021. Management continues to believe that the changes will not have a material effect on the Company’s financial position and results of operations.

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Notes to Condensed Consolidated Financial Statements

(Unaudited)

Forward-Looking Statements

Certain statements in this Form 10-Q, including, but not limited to, statements within Management’s Discussion and Analysis of Financial Condition and Results of Operations, are “forward-looking statements” within the meaning of the rules and regulations of the Securities and Exchange Commission (“SEC”). These forward-looking statements reflect our current views with respect to, among other things, future events and our financial performance. These statements are often, but not always, made through the use of words or phrases such as “may,” “might,” “should,” “could,” “predict,” “potential,” “believe,” “expect,” “continue,” “will,” “anticipate,” “seek,” “estimate,” “intend,” “plan,” “projection,” “goal,” “target,” “outlook,” “aim,” “would,” “annualized” and “outlook,” or the negative version of those words or other comparable words or phrases of a future or forward‑looking nature. These forward‑looking statements are not historical facts, and are based on current expectations, estimates and projections about our industry, management’s beliefs and certain assumptions made by management, many of which, by their nature, are inherently uncertain and beyond our control. Accordingly, we caution that any such forward‑looking statements are not guarantees of future performance and are subject to risks, assumptions, estimates and uncertainties that are difficult to predict. Although we believe that the expectations reflected in these forward‑looking statements are reasonable as of the date made, actual results may prove to be materially different from the results expressed or implied by the forward‑looking statements.

A number of important factors could cause our actual results to differ materially from those indicated in these forward‑looking statements, including those factors identified in the “Risk Factors” section of our Annual Report on Form 10-K for the year ended December 31, 2018 or “Item 2 - Management’s Discussion and Analysis of Financial Condition and Results of Operations” of this Form 10-Q or the following:

business and economic conditions, particularly those affecting the financial services industry and our primary market areas;

our ability to successfully manage our credit risk and the sufficiency of our allowance for loan loss;

factors that can impact the performance of our loan portfolio, including real estate values and liquidity in our primary market areas, the financial health of our commercial borrowers and the success of construction projects that we finance, including any loans acquired in acquisition transactions;

compliance with governmental and regulatory requirements, including the Dodd‑Frank Act and others relating to banking, consumer protection, securities and tax matters;

our ability to maintain licenses required in connection with multi‑family mortgage origination, sale and servicing operations;

our ability to identify and address cyber‑security risks, fraud and systems errors;

our ability to effectively execute our strategic plan and manage our growth;

changes in our senior management team and our ability to attract, motivate and retain qualified personnel;

governmental monetary and fiscal policies, and changes in market interest rates;

liquidity issues, including fluctuations in the fair value and liquidity of the securities we hold for sale and our ability to raise additional capital, if necessary;

incremental costs and obligations associated with operating as a public company;

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Notes to Condensed Consolidated Financial Statements

(Unaudited)

effects of competition from a wide variety of local, regional, national and other providers of financial, investment and insurance services;

the impact of any claims or legal actions to which we may be subject, including any effect on our reputation; and

changes in federal tax law or policy.

The foregoing factors should not be construed as exhaustive and should be read together with the other cautionary statements included in this Form 10-Q. Any forward‑looking statement speaks only as of the date on which it is made, and we do not undertake any obligation to update or review any forward‑looking statement, whether as a result of new information, future developments or otherwise.

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Management’s discussion and analysis of the financial condition at June 30, 2019 and results of operations for the three and six months ended June 30, 2019 and 2018, 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.

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 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 from the multi-family rental real estate loans servicing portfolio contribute to noninterest income. The funding source is primarily from mortgage custodial, municipal, and retail and commercial 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.

Financial Condition

As of June 30, 2019, we had approximately $5.3 billion in total assets, $4.7 billion in deposits, and $515.0 million in total shareholders’ equity. Total assets as of June 30, 2019, included approximately $460.9 million of cash and cash equivalents, $1.9 billion of loans held for sale and $2.4 billion of loans held for investment. It also includes $101.5 million of trading securities that represent pre-sold multi-family rental real estate loan originations in primarily Government National Mortgage Association (“GNMA”) mortgage backed securities pending settlements that typically occur within 30 days. There are $261.5 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 $74.6 million at June 30, 2019 based on the fair value of the multi-family rental real estate loan servicing, which are primarily GNMA servicing rights with 10-year call protection.

Comparison of Financial Condition at June 30, 2019 and December 31, 2018

Total Assets. Total assets increased $1.4 billion, or 36%, to $5.3 billion at June 30, 2019 from $3.9 billion at December 31, 2018. The increase was due primarily to increases in loans held for sale of $1.1 billion, net loans receivable of $302.5 million, and cash of $124.4 million, which were partially offset by decreases in available for sale securities of $69.6 million and trading securities of $61.9 million.

Cash and Cash Equivalents. Cash and cash equivalents increased $124.4 million, or 37%, to $460.9 million at June 30, 2019 from $336.5 million at December 31, 2018. The increase reflected cash levels consistent with balance sheet growth.

Trading Securities. Trading securities decreased $61.9 million, or 38%, to $101.5 million at June 30, 2019, from $163.4 million at December 31, 2018. The trading securities 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.

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Securities Available-for-Sale. Investment securities available-for-sale decreased $69.6 million, or 21%, to $261.5 million at June 30, 2019 from $331.1 million at December 31, 2018. The decrease in securities available-for-sale was primarily due to calls, maturities, sales, and repayments of securities totaling $195.2 million during the period, partially offset by purchases of $124.3 million. Our available for sale portfolio is funded with escrow deposits related to our multifamily mortgage GNMA servicing portfolio. These deposits must be either FDIC insured or invested in federal agency securities. The decline in available for sale securities compared with December 31, 2018 reflects a continuation of our strategy to increase the use of FDIC insurance for the deposits, as opposed to securities, which can be a more efficient approach to deploying deposits for the Company.

The available for sale securities are funded by, and paired with interest rates on 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 $10.8 million, or 136%, to $18.8 million at June 30, 2019 from $8.0 million at December 31, 2018. The increase in FHLB stock was due primarily to the additional borrowing 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 in our mortgage warehouse segment, increased $1.1 billion, or 130%, to $1.9 billion at June 30, 2019 from $832.5 million at December 31, 2018. The increase in loans held for sale was primarily due to significant growth in our mortgage warehouse business, resulting from lower mortgage interest rates that increased our origination volume in the single-family mortgage market.

Loans Receivable, Net. Loans receivable, net, which are comprised of loans held for investment, increased $302.5 million, or 15%, to $2.3 billion at June 30, 2019 compared to December 31, 2018. The increase in net loans was comprised primarily of:

an increase of $199.1 million, or 59%, in mortgage warehouse lines of credit, to $536.4 million at June 30, 2019,

an increase of $87.4 million, or 10%, in multi-family and healthcare financing loans, to $1.0 billion at June 30, 2019,

an increase of $16.1 million, or 5%, in commercial and commercial real estate loans, to $315.3 million at June 30, 2019.

The growth in mortgage warehouse lines of credit was substantially higher than the industry reported. There was a 4% industry increase in single-family residential loan volumes from the six months ended June 30, 2018 to the six months ended June 30, 2019, according to the Mortgage Bankers Association. This compares to the 36% increase in mortgage warehouse volumes we reported during the same period. The increase in multi-family and commercial loans was also due to higher origination volume d uring the six months ended June 30, 2019.

Mortgage Servicing Rights. Mortgage servicing rights decreased $3.3 million, or 4%, to $74.6 million at June 30, 2019 compared to December 31, 2018. During the six months ended June 30, 2019, additions included originated and purchased servicing of $3.3 million. These increases were offset by a reduction for paydowns of $2.2 million and a fair value decrease of $4.4 million. Mortgage servicing rights are recognized in connection with sales of multi-family 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 six months ended June 30, 2019 was driven primarily by the decline in multi-family 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.

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Deposits. Deposits increased $1.4 billion, or 44%, to $4.7 billion at June 30, 2019 compared with December 31, 2018. The increase was primarily due to our higher use of brokered certificates of deposits to support the significant growth in warehouse loans and to match the expected duration.

Certificates of deposit accounts increased $1.1 billion, or 155%, to $1.7 billion at June 30, 2019, while demand deposits increased $268.6 million, or 17%, to $1.8 billion at June 30, 2019, and savings deposits increased $100.5 million, or 10%, to $1.1 billion at June 30, 2019.

Brokered certificates of deposit accounts increased $1.0 billion, to $1.6 billion at June 30, 2019 from $578.5 million at December 31, 2018. Brokered savings deposits increased $100.8 million, or 92%, to $210.4 million at June 30, 2019 from $109.6 million at December 31, 2018. Brokered demand accounts decreased by $100.0 million, or 33%, to $200.1 million at June 30, 2019 compared to December 31, 2018. In total, brokered deposits increased $1.0 billion, or 102%, to $2.0 billion at June 30, 2019, from $988.2 million at December 31, 2018. Brokered deposits represented 43% of total deposits at June 30, 2019, compared with 31% at December 31, 2018.

Interest-bearing deposits increased $1.4 billion, or 46%, to $4.5 billion at June 30, 2019, and noninterest-bearing deposits increased $9.6 million, or 5%, to $192.5 million at June 30, 2019 from $182.9 million at December 31, 2018.

Borrowings. Borrowings totaled $62.2 million at June 30, 2019, a decrease of $133.2 million, or 68%, from December 31, 2018. The decrease reflected a shift towards utilizing more brokered deposits to appropriately match the duration of the new loans established during the period.

Total Shareholders’ Equity. Total shareholders’ equity increased $93.8 million, or 22%, to $515.0 million at June 30, 2019 from $421.2 million at December 31, 2018. The increase resulted primarily from the issuance of $72.1 million in preferred stock and net income of $27.0 million, which was partially offset by dividends paid on common and preferred shares of $4.0 million and $2.6 million, respectively, during the period.

Comparison of Operating Results for the Three Months Ended June 30, 2019 and 2018

General. Net income for the three months ended June 30, 2019 was $16.4 million, an increase of $787,000, or 5%, from net income of $15.7 million for the three months ended June 30, 2018. The increase was primarily due to a $6.6 million increase in net interest income after the provision for loan losses, which was partially offset by a $3.9 million increase in non-interest expense and a $1.8 million decrease in noninterest income.

Net Interest Income. Net interest income increased $5.7 million, or 26%, to $27.9 million for the three months ended June 30, 2019 compared to the three months ended June 30, 2018. The increase was due to the overall growth in our interest-earning assets period to period and a 19 basis point increase in our interest rate spread, to 2.22%, for the three months ended June 30, 2019 from 2.03% for the three months ended June 30, 2018. Our net interest margin decreased to 2.49% for the three months ended June 30, 2019 from 2.51% for the three months ended June 30, 2018.

Interest Income. Interest income increased $14.6 million, or 43%, to $48.8 million for the three months ended June 30, 2019, compared with the three months ended June 30, 2018. This increase was primarily attributable to a $13.6 million increase in interest on loans and loans held for sale, a $504,000 increase in interest on other interest-earning deposits, and a $478,000 increase in interest on trading securities.

The average balance of loans, including loans held for sale, during the three months ended June 30, 2019 increased $1.1 billion, or 46%, to $3.6 billion from $2.5 billion for the three months ended June 30, 2018, while the average yield on loans increased 4 basis points, to 4.75%, for the three months ended June 30, 2019, compared to 4.71% for the three months ended June 30, 2018. The increase was primarily driven by higher loan volume in our mortgage warehouse segment as a result of lower mortgage rates.

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The average balance of other interest-earning assets decreased $77.1 million, or 15%, to $440.5 million for the three months ended June 30, 2019 from $517.6 million for the three months ended June 30, 2018, while the average yield increased 92 basis points to 2.64% for the three months ended June 30, 2019.

The average balance of taxable securities available-for-sale decreased $140.9 million, or 35%, to $267.0 million for the three months ended June 30, 2019, compared with $407.9 million for the three months ended June 30, 2018, and the average yield increased 62 basis points to 2.22% for the three months ended June 30, 2019.

The average balance of trading securities increased $18.5 million, or 11%, to $194.4 million for the three months ended June 30, 2019, compared to $175.9 million for the three months ended June 30, 2018, while the average yield increased 66 basis points to 4.06% for the three months ended June 30, 2019.

Interest Expense. Total interest expense increased $8.9 million, or 75%, to $20.8 million for the three months ended June 30, 2019, compared with the three months ended June 30, 2018.

Interest expense on deposits increased $9.6 million, or 99%, to $19.3 million for the three months ended June 30, 2019 from the three months ended June 30, 2018. The increase was primarily attributable to a $1.3 billion, or 49%, increase in the average balance of interest-bearing deposits for the three months ended June 30, 2019, and a 51 basis point increase in the average cost of interest-bearing deposits, to 2.04% for the three months ended June 30, 2019 from 1.53% for the same period in 2018. The increase in the cost of deposits was primarily due to growth in the volume of interest-bearing checking accounts and certificates of deposits, as well as the overall increase in interest rates from period to period.

Interest expense on borrowings decreased $681,000, or 31%, to $1.5 million for the three months ended June 30, 2019 from $2.2 million for the three months ended June 30, 2018. The decrease was primarily due to a 747 basis point decrease in the 5.10% average cost of borrowings for the three months ended June 30, 2019 compared to 12.57% for the three months ended June 30, 2018, partially offset by a $48.2 million, or 69%, increase in the average balance of borrowings outstanding. The lower cost of borrowings was primarily due to the repayment of $30 million of subordinated debt associated with the acquisition of NattyMac assets on December 31, 2018. Our short-term subordinate debt instruments have carried a higher cost than our other categories of borrowing, as they include a variable interest rate equal to the one-month LIBOR rate plus an applicable margin. Additionally, our warehouse structured financing agreements provide for an additional interest payment for a portion of the earnings generated. As a result of these payments, cost of borrowings increased from a base rate of 3.31% and 4.38%, to an effective rate of 5.1% and 12.57% for the three months ended June 30, 2019 and 2018, respectively.

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


	Three Months Ended June 30,
	2019						2018
			Interest						Interest
	Average		Income/		Yield/		Average		Income/		Yield/
	Balance		Expense		Rate		Balance		Expense		Rate
	(Dollars in thousands)
Assets:
Interest-bearing deposits, and other	$	440,502	$	2,899	2.64	%	$	517,594	$	2,219	1.72	%
Securities available for sale - taxable		266,950		1,477	2.22	%		407,896		1,625	1.60	%
Securities available for sale - tax exempt		9,052		53	2.35	%		—		—	—	%
Trading securities		194,411		1,967	4.06	%		175,876		1,489	3.40	%
Loans and loans held for sale		3,580,620		42,365	4.75	%		2,451,061		28,790	4.71	%
Total interest-earning assets		4,491,535		48,761	4.35	%		3,552,427		34,123	3.85	%
Allowance for loan losses		(13,466)						(9,986)
Noninterest-earning assets		183,069						141,784
Total assets	$	4,661,138					$	3,684,225

Liabilities/Equity:
Interest-bearing checking	$	1,527,971		7,567	1.99	%	$	783,798		3,285	1.68	%
Savings deposits		144,315		81	0.23	%		264,343		190	0.29	%
Money market		959,296		4,725	1.98	%		796,217		3,265	1.64	%
Certificates of deposit		1,174,106		6,971	2.38	%		708,525		3,001	1.70	%
Total deposits		3,805,688		19,344	2.04	%		2,552,883		9,741	1.53	%
Borrowings		117,647		1,495	5.10	%		69,430		2,176	12.57	%
Total interest-bearing liabilities		3,923,335		20,839	2.13	%		2,622,313		11,917	1.82	%
Noninterest-bearing deposits		194,530						643,334
Noninterest-bearing liabilities		47,484						29,509
Total liabilities		4,165,349						3,295,156
Equity		495,789						389,069
Total liabilities and equity	$	4,661,138					$	3,684,225
Net interest income			$	27,922					$	22,206
Interest rate spread					2.22	%					2.03	%
Net interest-earning assets	$	568,200					$	930,114
Net interest margin					2.49	%					2.51	%
Average interest-earning assets to average interest-bearing liabilities					114.48	%					135.47	%

Provision for Loan Losses. We recorded a provision for loan losses of $105,000 for the three months ended June 30, 2019, a decrease of $893,000, over the three months ended June 30, 2018. The decrease reflected increases for loan growth that were offset by improvement in loss expectations for our multi-family loan portfolio based on historical loss experience. The allowance for loan losses was $12.6 million, or 0.53% of total loans, at June 30, 2019, compared to $12.7 million, or 0.62% of total loans, at December 31, 2018 and $10.6 million, or 0.58%, at June 30, 2018.

Total nonperforming loans (nonaccrual and greater than 90 days late but still accruing) were $3.8 million at June 30, 2019, compared to $2.4 million at December 31, 2018 and $4.3 million at June 30, 2018. The increase compared to December 31, 2018 reflected higher delinquencies in residential real estate loans, primarily related to the probate of the

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estate of a deceased borrower, from which we anticipate full repayment. Special Mention (Watch) loans were $57.8 million at June 30, 2019, compared to $90.6 million at December 31, 2018 and $52.4 million at June 30, 2018. The decrease compared to December 31, 2018 primarily reflected the completion of certain construction projects with cost over-runs that were funded by the borrowers. Classified (substandard, doubtful and loss) loans were $13.8 million at June 30, 2019, $11.2 million at December 31, 2018 and $9.4 million at June 30, 2018. Total loans greater than 30 days past due were $5.6 million at June 30, 2019, $3.2 million at December 31, 2018 and $8.2 million at June 30, 2018. The increase compared to December 31, 2018 primarily related to the probate of the estate of a deceased borrower.

We had $857,000 of charge-offs during the three months ended June 30, 2019. For the three months ended June 30, 2018 we had $146,000 of charge-offs and $31,000 in recoveries. The higher charge-offs in 2019 related to two loans, reflecting a borrower losing its primary sources of revenue, as opposed to general weakening in credit quality.

As a percentage of nonperforming loans, the allowance for loan losses was 331.5% at June 30, 2019 compared to 526.9% at December 31, 2018 and 245.0% at June 30, 2018. The decrease compared to December 31, 2018 was primarily due to the increase in nonperforming loans associated with the probate of the estate of a deceased borrower.

Noninterest Income. Noninterest income decreased $1.8 million, or 15%, to $9.9 million for the three months ended June 30, 2019 compared to the three months ended June 30, 2018. The decrease was primarily due to a decrease of $4.1 million in net loan servicing fees, partially offset by an increase of $1.3 million in gain on sale of loans. The decrease in l oan servicing fees reflected a $2.9 million decrease in the fair value of mortgage servicing rights for the three months ended June 30, 2019, compared with an increase of $1.8 million for the three months ended June 30, 2018 .

Noninterest Expense. Noninterest expense increased $3.9 million, or 33%, to $15.9 million for the three months ended June 30, 2019 compared with $12.0 million for the three months ended June 30, 2018. The increase was due primarily to a $2.7 million, or 37% increase in salaries and employee benefits. The increase in salaries and employee benefits was due primarily to an increase in the number of employees resulting from business growth and acquisitions that closed during the fourth quarter of 2018. The efficiency ratio was 42.1% in the three months ended June 30, 2019, compared with 35.5% for the three months ended June 30, 2018.

Income Taxes. Income tax expense increased $142,000, or 3%, to $5.3 million for the three months ended June 30, 2019 from the three months ended June 30, 2018. The increase was due primarily to the 4% increase in pretax income period to period. The effective tax rate was 24.5% for the three months ended June 30, 2019 and 24.9% for the three months ended June 30, 2018.

Comparison of Operating Results for the Six Months Ended June 30, 2019 and 2018

General. Net income for the six months ended June 30, 2019 was $27.0 million, a decrease of $3.7 million, or 12%, from net income of $30.7 million for the six months ended June 30, 2018. The decrease was due primarily to a $9.4 million decrease in noninterest income and a $6.7 million increase in noninterest expenses, partially offset by a $9.7 million increase in net interest income and a $1.0 million decrease in the provision for income taxes.

Net Interest Income. Net interest income increased $9.7 million, or 23%, to $52.1 million for the six months ended June 30, 2019 compared to the six months ended June 30, 2018. The increase was due to a 29 basis point increase in our interest rate spread, to 2.34%, for the six months ended June 30, 2019 from 2.05% for the six months ended June 30, 2018, coupled with the overall growth in our interest-earning assets period to period. Our net interest margin increased to 2.62% for the six months ended June 30, 2019 from 2.51% for the six months ended June 30, 2018.

Interest Income. Interest income increased $25.3 million, or 40%, to $88.4 million for the six months ended June 30, 2019 compared with the six months ended June 30, 2018. This increase was primarily attributable to a $23.4 million increase in interest on loans and loans held for sale.

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The average balance of loans, including loans held for sale, during the six months ended June 30, 2019 increased $816.4 million, or 35%, to $3.2 billion from $2.3 billion for the six months ended June 30, 2018, while the average yield on loans increased 31 basis points to 4.89% for the six months ended June 30, 2019 compared to 4.58% for the six months ended June 30, 2018. The increase in the average yield on loans was due to the overall increase in interest rates in the economy period to period.

The average balance of trading securities increased $3.5 million, or 2%, to $152.2 million for the six months ended June 30, 2019 compared to $148.6 million for the six months ended June 30, 2018, while the average yield increased 63 basis points to 3.99% for the six months ended June 30, 2019.

The average balance of other interest-earning assets decreased $82.3 million, or 17%, to $405.3 million for the six months ended June 30, 2019 from $487.6 million for the six months ended June 30, 2018, while the average yield increased 100 basis points to 2.70% for the six months ended June 30, 2019.

The average balance of taxable securities available-for-sale decreased $132.4 million, or 32%, to $279.7 million for the six months ended June 30, 2019, compared to the six months ended June 30, 2018, and the average yield increased 63 basis points to 2.18% for the six months ended June 30, 2019.

Interest Expense. Total interest expense increased $15.5 million, or 75%, to $36.4 million for the six months ended June 30, 2019 compared to the six months ended June 30, 2018.

Interest expense on deposits increased $16.8 million, or 100%, to $33.6 million for the six months ended June 30, 2019 from the six months ended June 30, 2018. The increase was primarily due to an increase in the average balance of interest-bearing deposits of $993.3 million, or 41%, to $3.4 billion for the six months ended June 30, 2019, and a 59 basis point increase in the average cost of interest-bearing deposits, to 2.00% for the six months ended June 30, 2019 from 1.41% for the same period in 2018. The increase in average balances was primarily due to the additional interest-bearing checking accounts and from the increase in brokered certificates of deposit. The increase in the cost of deposits was due to the overall increase in interest rates in the economy period to period.

Interest expense on borrowings decreased $1.3 million, or 31%, to $2.8 million for the six months ended June 30, 2019 from $4.1 million for the six months ended June 30, 2018. The decrease was due primarily to a 671 basis point decrease in the average cost of borrowings to 5.5% for the six months ended June 30, 2019, compared to 12.21% for the six months ended June 30, 2018. Partially offsetting the decrease in the average cost of borrowing was a $35.5 million, or 53%, increase in the average balance outstanding period to period. The lower cost of borrowings was primarily due to the repayment of $30 million of subordinated debt associated with the acquisition of NattyMac assets on December 31, 2018. Our short-term subordinated debt instruments have carried a higher cost than our other categories of borrowing, as they include a variable interest rate equal to the one-month LIBOR rate plus an applicable margin. Additionally, our warehouse structured financing agreements provide for an additional interest payment for a portion of the earnings generated. As a result of these payments, the cost of borrowings increased from a base rate of 3.47% and 4.30%, to 5.5% and 12.21% for the six months ended June 30, 2019 and 2018, respectively.

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	Six Months Ended June 30,
	2019						2018
			Interest						Interest
	Average		Income/		Yield/		Average		Income/		Yield/
	Balance		Expense		Rate		Balance		Expense		Rate
	(Dollars in thousands)
Assets:
Interest-bearing deposits, and other	$	405,315	$	5,426	2.70	%	$	487,581	$	4,114	1.70	%
Securities available for sale - taxable		279,654		3,028	2.18	%		412,058		3,167	1.55	%
Securities available for sale - tax exempt		10,747		149	2.80			—		—	—
Trading securities		152,152		3,012	3.99	%		148,604		2,478	3.36	%
Loans and loans held for sale		3,165,895		76,820	4.89	%		2,349,547		53,402	4.58	%
Total interest-earning assets		4,013,763		88,435	4.44	%		3,397,790		63,161	3.75	%
Allowance for loan losses		(13,087)						(9,531)
Noninterest-earning assets		181,527						136,821
Total assets	$	4,182,203					$	3,525,080

Liabilities/Equity:

Interest-bearing checking	$	1,421,941		14,001	1.99	%	$	714,951		5,710	1.61	%
Savings deposits		145,915		161	0.22	%		322,722		405	0.25	%
Money market		926,235		8,933	1.94	%		806,406		6,152	1.54	%
Certificates of deposit		897,910		10,476	2.35	%		554,614		4,490	1.63	%
Total deposits		3,392,001		33,571	2.00	%		2,398,693		16,757	1.41	%
Borrowings		103,081		2,811	5.50	%		67,543		4,090	12.21	%
Total interest-bearing liabilities		3,495,082		36,382	2.10	%		2,466,236		20,847	1.70	%
Noninterest-bearing deposits		174,982						649,773
Noninterest-bearing liabilities		49,445						26,656
Total liabilities		3,719,509						3,142,665
Equity		462,694						382,415
Total liabilities and equity	$	4,182,203					$	3,525,080
Net interest income			$	52,053					$	42,314
Interest rate spread					2.34	%					2.05	%
Net interest-earning assets	$	518,681					$	931,554
Net interest margin					2.62	%					2.51	%
Average interest-earning assets to average interest-bearing liabilities					114.84	%					137.77	%

Provision for Loan Losses. We recorded a provision for loan losses of $754,000 for the six months ended June 30, 2019, a decrease of $1.7 million, over the six months ended June 30, 2018. The decrease reflected increases for loan growth that were offset by improvement in loss expectations for our multi-family loan portfolio based on historical loss experience. The allowance for loan losses was $12.6 million, or 0.53% of total loans, at June 30, 2019, compared to $12.7 million, or 0.62% of total loans, at December 31, 2018 and $10.6 million, or 0.58%, at June 30, 2018.

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December 31, 2018 reflected higher delinquencies in residential real estate loans, primarily related to the probate of the estate of a deceased borrower, of which we anticipate full repayment. Special Mention (Watch) loans were $57.8 million at June 30, 2019, compared to $90.6 million at December 31, 2018 and $52.4 million at June 30, 2018. The decrease compared to December 31, 2018 primarily reflected the completion of certain construction projects with cost over-runs that were funded by the borrowers. Classified (substandard, doubtful and loss) loans were $13.8 million at June 30, 2019, $11.2 million at December 31, 2018 and $9.4 million at June 30, 2018. Total loans greater than 30 days past due were $5.6 million at June 30, 2019, $3.2 million at December 31, 2018 and $8.2 million at June 30, 2018. The increase compared to December 31, 2018 primarily related to the probate of the estate of a deceased borrower.

For the six months ended June 30, 2019, there were $857,000 charge-offs and $3,000 in recoveries. For the six months ended June 30, 2018 there were $163,000 in charge-offs and $36,000 in recoveries. The higher charge-offs in 2019 related to two loans, reflecting a borrower losing its primary sources of revenue, as opposed to general weakening in credit quality.

Noninterest Income. Noninterest income decreased $9.4 million, or 41%, to $13.5 million for the six months ended June 30, 2019 compared to the six months ended June 30, 2018, primarily due to a $7.0 million decrease in gain on sale of loans and a decrease of $4.1 million in loan servicing fees, partially offset by an $863,000 increase in other income and a $721,000 increase in mortgage warehouse fees. The gain on sale of loans was $11.7 million during the six months ended June 30, 2019, compared to $18.7 million in same period of 2018, a decrease of 37%, due primarily to a decrease in the volume of multi-family rental real estate loan sales in the secondary market. The lower gain on sale was also negatively impacted by loan processing delays caused by the federal government shutdown in January 2019. The decrease in loan servicing fees for the six months ended June 30, 2019 reflected a $4.4 million decrease in the fair value of mortgage servicing rights, compared to a $913,000 increase for the six months ended June 30, 2018.

Noninterest Expense. Noninterest expense increased $6.7 million, or 30%, to $29.0 million for the six months ended June 30, 2019 compared to $22.3 million for the six months ended June 30, 2018. The increase was due primarily to a $4.8 million, or 35% increase in salaries and employee benefits, reflecting an increase in the number of employees resulting from business growth and acquisitions that closed during the fourth quarter of 2018. The efficiency ratio was 44.1% for the six months ended June 30, 2019, compared with 34.1% for the six months ended June 30, 2018.

Income Taxes. Income tax expense decreased $1.0 million, or 10%, to $8.9 million for the six months ended June 30, 2019 from the six months ended June 30, 2018. The decrease was due primarily to a 12% decrease in pretax income period to period. The effective tax rate was 24.7% for the six months ended June 30, 2019 and 24.3% for the six months ended June 30, 2018.

Our Segments

We operate in three primary segments: Multi-family Mortgage Banking, Mortgage Warehousing, and Banking. We believe that Merchants 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. MCC originated and acquired $786.1 million of loans during the six months ended June 30, 2019. As of June 30, 2019, MCC also had a $10.7 billion servicing portfolio for banks and investors, including $1.4 billion serviced for Merchants 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

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$20 billion of loan principal annually since 2015. 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 and Illinois, except for correspondent mortgage banking which, like Multi-family Mortgage Banking and Mortgage Warehousing, is a national business. The Banking segment has a well-diversified customer and borrower base and has experienced significant growth over the past three years. These segments diversify the net income of Merchants Bank and provide synergies across the segments. The strategic opportunities include that MCC loans are funded by Merchants Banking segment and the Banking segment provides GNMA custodial services to MCC. The securities available for sale funded by MCC custodial deposits, as well as loans generated by Merchants Bank, are pledged to the FHLB to provide advance capacity during periods of high residential loan volume for mortgage warehousing. Mortgage Warehousing 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 ended June 30, 2019 and 2018, we had total net income of $16.4 million and $15.7 million, respectively, and for the six months ended June 30, 2019 and 2018, we had total net income of $27.0 million and $30.7 million, respectively. Net income for our three segments for the respective periods was as follows:


	For the three months ended				For the six months ended
	June 30,				June 30,
	2019		2018		2019		2018
	(In thousands)
Multi-family Mortgage Banking	$	2,517	$	4,765	$	1,805	$	10,249
Mortgage Warehousing		6,320		5,774		10,152		10,404
Banking		8,408		6,485		17,177		12,465
Other		(806)		(1,372)		(2,125)		(2,405)

Total	$	16,439	$	15,652	$	27,009	$	30,713

Multi-family Mortgage Banking. The Multi-family Mortgage Banking segment reported net income for the three months ended June 30, 2019, of $2.5 million, a decrease of $2.2 million, or 47%, from the $4.8 million reported for the three months ended June 30, 2018. The decrease was primarily due to a $2.2 million decrease in noninterest income, primarily associated with a decrease in loan servicing fees, which was partially offset by an increase in gain on sale of loans. During the three months ended June 30, 2019, loan servicing fees included a $2.9 million negative fair value adjustment to our mortgage service rights asset, compared with a $1.8 million positive adjustment for the three months ended June 30, 2018. Also contributing to the decrease in net income was a $1.1 million increase in noninterest expense, primarily associated with higher salaries and benefits to support future loan growth, including the recent opening of a new origination office in Chicago. This was partially offset by an $832,000 decrease in income taxes resulting from lower pre-tax net income. The volume of loans originated and acquired for sale in the secondary market decreased by $115.5 million, or 34%, to $226.4 million for the three months ended June 30, 2019 compared to the three months ended June 30, 2018.

The Multi-family Mortgage Banking segment reported net income for the six months ended June 30, 2019, of $1.8 million, a decrease of $8.4 million, or 82%, from the $10.2 million reported for the six months ended June 30, 2018. The decrease was primarily due to a decrease of $10.0 million in noninterest income associated with decreases in both gain on sale of loans and loan servicing fees. The lower gain on sale portion of noninterest income was primarily due to lower loan volume during the six months ended June 30, 2019 and was also negatively impacted by the federal government shutdown in January 2019 that resulted in loan processing delays. The lower loan servicing fees portion of n oninterest income was due to a $4.4 million negative fair value adjustment to our mortgage servicing rights asset for the six months ended June 30, 2019, compared with a $913,000 positive fair value adjustment for the six months ended June 30, 2018. Also contributing to the decrease in net income for the period was a $1.7 million increase in noninterest expenses primarily associated with higher salaries and benefits to support future loan growth, including the recent

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opening of a new origination office in Chicago. Partially offsetting the decreases in net income was a $2.9 million decrease in income taxes associated with the lower pre-tax net income. The volume of loans originated and acquired for sale in the secondary market decreased by $333.4 million, or 57%, to $250.8 million for the six months ended June 30, 2019, compared with the six months ended June 30, 2018.

Mortgage Warehousing. The Mortgage Warehousing segment reported net income for the three months ended June 30, 2019, of $6.3 million, an increase of $546,000, or 9%, over the $5.8 million reported for the three months ended June 30, 2018. The increase was primarily due to a $1.1 million, or 12%, increase in net interest income, primarily associated with the significant growth in loans receivable and loans held for sale. The higher origination volume in the single-family mortgage market was primarily attributable to lower mortgage interest rates and the recently added capital has given the company more capacity to manage capital balances within the well-capitalized classification. The volume of loans funded during the three months ended June 30, 2019 amounted to $9.5 billion, an increase of $3.7 billion, or 63%, compared to the same period in 2018. This compared favorably to the 11% industry growth in single-family residential loan volumes from the three months ended June 30, 2018 to the three months ended June 30, 2019, according to the Mortgage Bankers Association. Further interest rate cuts could lead to additional growth in these markets as borrowers seek funding and refinancing opportunities. Also contributing to the growth in net income was a $457,000 increase in noninterest income that was offset by a $605,000 increase in noninterest expenses for salaries and benefits of additional employees associated with an acquisition that were not included in the three months ended June 30, 2018, and to support planned business growth. A $373,000 increase in income taxes associated with a 12% increase in pe-tax net income also partially offset the increase in net income during the period.

The Mortgage Warehousing segment reported net income for the six months ended June 30, 2019, of $10.2 million, a decrease of $252,000, or 2%, over the six months ended June 30, 2018. The decrease was primarily due to a $1.2 million increase in noninterest expenses for salaries and benefits of additional employees associated with an acquisition that were not included in the six months ended June 30, 2018, and to support planned business growth. The higher expenses were partially offset by a $724,000 increase in noninterest income, and a $498,000 decrease in provision for loan losses. The volume of loans funded during the six months ended June 30, 2019 amounted to $14.9 billion, an increase of $4.0 billion, or 36%, compared to the same period in 2018. This compared favorably to the 4% industry increase in single-family residential loan volumes from the six months ended June 30, 2018 to the six months ended June 30, 2019, according to the Mortgage Bankers Association.

Banking. The Banking segment reported net income for the three months ended June 30, 2019 of $8.4 million, an increase of $1.9 million, or 30%, over the three months ended June 30, 2018. The increase was primarily due to a $3.1 million increase in net interest income and a $936,000 decrease in the provision for loan losses associated with improved loan loss risk factors in our multi-family loan portfolio. Partially offsetting these increases in net interest income was a $1.4 million increase in noninterest expenses that reflected higher salaries and benefits for additional employees associated with an acquisition that were not included in the three months ended June 30, 2018. Also partially offsetting the higher net interest income was a $818,000 increase in income taxes related to the 33% increase in pre-tax net income. The results of FMNBP in the Banking segment during the three months ended June 30, 2019 did not make a material contribution to the increase in net income compared to the three months ended June 30, 2018.

The Banking segment reported net income for the six months ended June 30, 2019, of $17.2 million, an increase of $4.7 million, or 38%, over the $12.5 million reported for the six months ended June 30, 2018. The increase was primarily due to a $7.4 million increase in net interest income and a $1.2 million decrease in the provision for loan losses associated with improved loan loss risk factors in our multi-family loan portfolio. Partially offsetting the increase in net interest income was a $2.3 million increase in noninterest expense associated with higher salaries and employee benefits that reflected additional employees associated with an acquisition that were not included in the prior period, as well as a $1.9 million increase in income taxes, reflecting a 40% increase in pre-tax net income.

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Merchants Bancorp

Liquidity and Capital Resources

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, trading securities 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 $(983.4) million and $77.6 million for the six months ended June 30, 2019 and 2018, 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 $(253.3) million and $(407.2) million for the six months ended June 30, 2019 and 2018, respectively. Net cash provided by financing activities, which is comprised primarily of net change in deposits and borrowings, was $1.4 billion and $322.5 million for the six months ended June 30, 2019 and 2018, respectively.

At June 30, 2019, we had outstanding commitments to originate loans of $601.5 million, unused lines of credit of $158.6 million and outstanding letters of credit of $16.0 million. We anticipate that we will have sufficient funds available to meet our current loan origination commitments. Certificates of deposit that are scheduled to mature in less than one year from June 30, 2019 totaled $1.7 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 or raise interest rates on deposits to attract new accounts, which may result in higher levels of interest expense. At June 30, 2019, based on available collateral and our ownership of FHLB stock we had access to additional FHLB advances of up to $648.5 million. Our line of credit with Huntington National Bank had a balance of $25 million at June 30, 2019 and was paid off in its entirety in July 2019. The line of credit matures on August 29, 2019 and we do not anticipate any borrowing prior to maturity or renewing the loan agreement.

At June 30, 2019, Merchants Bank exceeded all of its regulatory capital requirements with a Tier 1 leverage capital level of $504.2 million, or 11.3% of adjusted total assets, which is above the required level of $178.9 million, or 4.0%; total risk-based capital of $516.4 million, or 11.6% of risk-weighted assets, which is above the required level of $357.6 million, or 8.0%; and common equity Tier 1 capital of $504.2 million, or 11.3% of risk-weighted assets, which is above the required level of $201.1 million, or 4.5% of risk-weighted assets. Accordingly, Merchants Bank was categorized as well capitalized at June 30, 2019. Management is not aware of any conditions or events since the most recent notification that would change Merchants Bank’s category.

At June 30, 2019, FMBI exceeded all of its regulatory capital requirements with a Tier 1 leverage capital level of $18.9 million, or 11.7% of adjusted total assets, which is above the required level of $6.5 million, or 4.0%; total risk-based capital of $19.3 million, or 15.6% of risk-weighted assets, which is above the required level of $9.9 million, or 8.0%; and common equity Tier 1 capital of $18.9 million, or 15.2% of risk-weighted assets, which is above the required level of $5.6 million, or 4.5% of risk-weighted assets. Accordingly, FMBI was categorized as well capitalized at June 30, 2019. Management is not aware of any conditions or events since the most recent notification that would change FMBI’s category.

At June 30, 2019, the Company exceeded all of its regulatory capital requirements with a Tier 1 leverage capital level of $478.6 million, or 10.3% of adjusted total assets, which is above the required level of $185.0 million, or 4.0%; total risk-based capital of $491.2 million, or 10.7% of risk-weighted assets, which is above the required level of $367.6 million, or 8.0%; and common equity Tier 1 capital of $364.9 million, or 7.9% of risk-weighted assets, which is above the required level of $206.8 million, or 4.5% of risk-weighted assets. Management is not aware of any conditions or events since the most recent notification that would change the Company’s category .

On November 21, 2017, the Board of Governors of the Federal Reserve System, the Office of the Comptroller of the Currency, and the Federal Deposit Insurance Corporation finalized a joint proposal and adopted a final rule (the

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“Transitions Rule”) pursuant to which the current regulatory capital treatment for mortgage servicing rights (“MSRs”), certain temporary difference deferred tax assets, and significant investments in the capital of unconsolidated financial institutions will be indefinitely extended in anticipation of a subsequent notice of proposed rulemaking by such regulators to simplify the regulatory capital treatment of such items (the “Simplification Rule”). The extension of the capital rules with respect to MSRs is the only portion of the Transitions Rule that is material to the Company.

If the Transitions Rule had not been enacted, beginning January 1, 2018, the Company would have been required to make certain additional deductions and increases to its risk-weighting for the purposes of the Company’s capital calculations, which would have resulted in the Company reporting a lower amount of capital. As a result of the Transitions Rule, there were no and will not be any such adjustments to our capital.

On July 9, 2019, the Board of Governors of the Federal Reserve System, the Office of the Comptroller of the Currency, and the Federal Deposit Insurance Corporation finalized and adopted the final Simplification Rule. Under the existing rules, including the Transitions Rule, mortgage servicing rights, net of related deferred tax liabilities, that are in excess of 10% of common equity or when combined with certain other deduction items are in excess of 15% of common equity are deducted from Common Equity Tier 1 capital. Under the Simplification Rule, this threshold will be raised to 25% of common equity, which we expect to benefit the Company because it will reduce the deductions to capital that have traditionally been required. However, the Company will be required to risk-weight the non-deducted portion of its MSRs at 250%. The Simplification Rule will go into effect and the Transitions Rule will cease to be effective on April 1, 2020.

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, 2018. 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, 2018.

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.

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Interest Rate Risk

Our Asset-Liability Committee, or ALCO, is a management committee that manages our interest rate risk within broad policy limits established by our board of directors. In general, we seek to minimize the impact of changing interest rates on net interest income and the economic values of assets and liabilities. Our ALCO meets quarterly to monitor the level of interest rate risk sensitivity to ensure compliance with the board of directors’ approved risk limits.

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. 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 June 30, 2019 and December 31, 2018.


	Net Interest Income Sensitivity
	Twelve Months Forward
	- 200			- 100			+ 100			+ 200
	(Dollars in thousands)
June 30, 2019:
Dollar change	$	(34,561)		$	(18,202)		$	17,346		$	34,441
Percent change		(23.5)	%		(12.4)	%		11.8	%		23.5	%

December 31, 2018:
Dollar change	$	(25,230)		$	(11,716)		$	11,225		$	22,407
Percent change		(24.1)	%		(11.2)	%		10.7	%		21.4	%

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 June 30, 2019 we estimated that we are within policy limits set by our Board of Directors for the -200, -100, +100, and +200 basis point scenarios. The results reported as of June 30, 2019 show an asset sensitive position.

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The EVE results for Merchants Bank included in the table below reflect the analysis used quarterly by management. It models immediate -200, -100, +100 and +200 basis point parallel shifts in market interest rates.


	Economic Value of Equity
	Sensitivity (Shock)
	Immediate Change in Rates
	- 200			- 100			+ 100			+ 200
	(Dollars in thousands)
June 30, 2019:
Dollar change	$	(4,524)		$	(1,410)		$	(341)		$	(2,550)
Percent change		(0.9)	%		(0.3)	%		(0.1)	%		(0.5)	%

December 31, 2018:
Dollar change	$	4,746		$	3,193		$	(4,622)		$	(9,757)
Percent change		1.1	%		0.8	%		(1.1)	%		(2.3)	%

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 June 30, 2019 projects that as interest rates increase (decrease) immediately, the economic value of equity position will be expected to decrease (increase). When interest rates rise, fixed rate assets generally lose economic value; the longer the duration, the greater the value lost. The opposite is true when interest rates fall.

ITEM 3 Quantitative and Qualitative Disclosures About Market Risk

The information required under this item is included as part of “Management’s Discussion and Analysis of Financial Condition and Results of Operations” of this Form 10-Q under the headings “Liquidity and Capital Resources” and “Interest Rate Risk.”

ITEM 4 Controls and Procedures

(a) Evaluation of disclosure controls and procedures.

Our management, under the supervision and with the participation of our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a‑15(e) and 15d‑15(e) under the Exchange Act) as of the end of the period covered by this Form 10-Q. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that, as of June 30, 2019, the Company’s disclosure controls and procedures were effective.

(b) Changes in internal control.

There have been no changes in the Company's internal control over financial reporting during the period covered by this report that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

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Part II

Other Information

ITEM 1. Legal Proceedings

None.

ITEM 1A. Risk Factors

There have been no material changes from the risk factors previously disclosed in the “Risk Factors” section included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2018.

ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds

On June 27, 2019 the Company issued an additional 874,000 shares of its 7.00% Fixed-to-Floating Rate Series A Non-Cumulative Perpetual Preferred Stock , without par value (“Series A Preferred Stock”) , and with a liquidation preference of $25.00 per share, for aggregate proceeds of $21.85 million. No underwriter or placement agent was involved in this private placement and the Company did not pay any brokerage or underwriting fees or discounts in connection with the issuance of such shares. The shares were purchased primarily by related parties, including Michael Petrie, our Chairman and Chief Executive Officer; Randall Rogers, Vice Chairman and a director of the Company and members of his family; Michael Dury, President of MCC; and other accredited investors. Based in part on the representations of the investors as to their status as accredited investors under Rule 501 of Regulation D under the Securities Act of 1933 (the “Securities Act”), the Company offered and sold the shares of Series A Preferred Stock without registration, in reliance on the exemption from registration under the Securities Act for transactions not involving a public offering pursuant to Section 4(a)(2) under the Securities Act and Rule 506(b) of Regulation D.

ITEM 3. Defaults Upon Senior Securities

None.

ITEM 4. Mine Safety Disclosures

Not applicable.

ITEM 5. Other Information

None.

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ITEM 6. Exhibits


Exhibit
Number		Description

3.1		First Amended and Restated Articles of Incorporation of Merchants Bancorp. (incorporated herein by reference to Exhibit 3.1 to the Company’s Registration Statement on Form S-1, as amended (File No. 333- 220623) filed on September 25, 2018)

3.2		Articles of Amendment to the First Amended and Restated Articles of Incorporation dated March 27, 2019 designating the 7.00% Fixed-to-Floating Rate Series A Non-Cumulative Perpetual Preferred Stock. (incorporated by reference to Exhibit 3.2 of the registration statement on Form 8-A filed on March 28, 2019)

3.3		Second Amended and Restated By-Laws of Merchants Bancorp. (incorporated by reference to Exhibit 3.1 of the Company’s Current Report on Form 8-K filed on November 20, 2018)

10.1		Loan Agreement between Merchants Bancorp and The Huntington National Bank effective September 24, 2012 (incorporated by reference to Exhibit 10.1 of the registration statement on Form S-1, filed on September 25, 2017).
		(a) First Loan Modification and Reaffirmation Agreement by and among The Huntington National Bank, Merchants Bancorp, and Providence Bank effective as of August 1, 2013 (incorporated by reference to Exhibit 10.2 of the registration statement on Form S-1, filed on September 25, 2017).

		(b) Second Loan Modification Agreement by and among The Huntington National Bank, Merchants Bancorp, and Providence Bank effective as of September 23, 2013 (incorporated by reference to Exhibit 10.3 of the registration statement on Form S-1, filed on September 25, 2017).

		(c) Third Loan Modification Agreement by and among The Huntington National Bank, Merchants Bancorp, and Providence Bank effective as of September 22, 2014 (incorporated by reference to Exhibit 10.4 of the registration statement on Form S-1, filed on September 25, 2017).

		(d) Fourth Loan Modification Agreement by and among The Huntington National Bank, Merchants Bancorp, and Providence Bank dated June 5, 2015 (incorporated by reference to Exhibit 10.5 of the registration statement on Form S-1, filed on September 25, 2017).

		(e) Fifth Loan Modification Agreement by and among The Huntington National Bank, Merchants Bancorp, and Providence Bank effective as of June 3, 2016 (incorporated by reference to Exhibit 10.6 of the registration statement on Form S-1, filed on September 25, 2017).

		(f) Sixth Loan Modification Agreement by and among The Huntington National Bank, Merchants Bancorp, and Providence Bank effective as of June 2, 2017 (incorporated by reference to Exhibit 10.7 of the registration statement on Form S-1, filed on September 25, 2017).

		(g) Seventh Loan Modification Agreement by and among The Huntington National Bank, Merchants Bancorp, and Providence Bank effective as of June 1, 2018 (incorporated by reference to Exhibit 10.1 (g) of Form 10-K for the year ended December 31, 2018, filed on March 15, 2019).

		(h) Eighth Loan Modification Agreement by and among The Huntington National Bank, Merchants Bancorp, and Providence Bank effective as of May 31, 2019.

31.1		Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 .

31.2		Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 .

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32		Written Statement of Chief Executive Officer and Chief Financial Officer furnished pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

101.INS		XBRL Instance Document

101.SCH		XBRL Taxonomy Extension Schema Document

101.CAL		XBRL Taxonomy Extension Calculation Linkbase Document

101.DEF		XBRL Taxonomy Extension Definition Linkbase Document

101.LAB		XBRL Taxonomy Extension Label Linkbase Document

101.PRE		XBRL Taxonomy Extension Presentation Linkbase Document

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Merchants Bancorp

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.


			Merchants Bancorp

Date:	August 9, 2019	By:	/s/ Michael F. Petrie
			Michael F. Petrie
			Chairman & Chief Executive Officer (Principal Executive Officer)



Date:	August 9, 2019	By:	/s/ John F. Macke
			John F. Macke Chief Financial Officer
			(Principal Financial & Accounting Officer)

Exhibit 10.1 H

EIGHTH LOAN MODIFICATION AGREEMENT

This Eighth Loan Modification Agreement (“Agreement”) is made this 31 st day of May, 2019 and is entered into at Indianapolis, Indiana, by and among The Huntington National Bank , a national banking association (“Lender”), with a principal mailing address of 45 North Pennsylvania Street, Suite 200, Indianapolis, Indiana 46204; Merchants Bancorp , an Indiana corporation (“Borrower”), with a principal mailing address of 11711 North Meridian Street, Suite 528, Carmel, Indiana 46032; and Providence Bank , a Missouri state banking corporation (“Participating Lender”), with a principal mailing address of 815 West Stadium Boulevard, Jefferson City, Missouri 65109.

RECITALS:

A. Lender and Borrower entered into a certain Loan Agreement dated September 24, 2012 (the “Original Loan Agreement”) wherein which Lender agreed to make a Revolving Line of Credit Loan (as defined in the Original Loan Agreement) to Borrower in the original principal amount of Fifteen Million and 00/100 Dollars ( $15,000,000.00 ).

B. In connection with the Original Loan Agreement, Borrower executed and delivered to Lender and agreed to perform a certain Revolving Line of Credit Note (the “Original Note”) in the original principal amount of Fifteen Million and 00/100 Dollars ( $15,000,000.00 ) dated September 24, 2012 to evidence the Revolving Line of Credit Loan, a certain Stock Pledge Agreement (the “Original Stock Pledge Agreement”) dated September 24, 2012, and other Loan Documents (as defined in the Original Loan Agreement, the “Other Original Loan Documents”) dated on or about September 24, 2012 (the Original Loan Agreement, the Original Note, the Original Stock Pledge Agreement and the Other Original Loan Documents are collectively, the “Original Loan Documents”).

C. In connection with the Revolving Line of Credit Loan and the Original Loan Documents, Lender and Participating Lender executed that certain Participation Agreement (the “Participation Agreement”) dated to be effective as of September 24, 2012.

D. Borrower, CITBA Financial Corporation, an Indiana corporation (“CITBA”), Michael F. Petrie, individually and Randall D. Rogers, individually entered into that certain Agreement and Plan of Merger dated to be effective as of May 6, 2013 (the “Merger Agreement”) wherein which Borrower agreed to merge with and into CITBA and immediately thereafter, Citizens Bank, an Indiana chartered commercial bank and a wholly-owned subsidiary of CITBA (“Citizens Bank”) was to be merged with and into Merchants Bank of Indiana, an Indiana charted commercial bank and a wholly-owned subsidiary of Borrower.

E. In connection with the Merger Agreement, Lender, Borrower and Participating Lender entered into that certain First Loan Modification and Reaffirmation Agreement dated effective as of August 1, 2013 (the “First Loan Modification”) wherein which Lender and Participating Lender consented to the Merger Agreement and Borrower reaffirmed all of Borrower’s representations, warranties, obligations, covenants and liabilities under the Original

Loan Documents. Subsequent to the execution and delivery of the First Loan Modification, Borrower advised that the transaction subject to the Merger Agreement would not be consummated.

F. Lender, Borrower and Participating Lender entered into that certain Second Loan Modification Agreement dated October 24, 2013 to be effective September 23, 2013 (the “Second Loan Modification”) so as to: (i) amend and modify the Revolving Line of Credit Loan and the Original Note, the Original Loan Agreement, and to the extent necessary, the Other Original Loan Documents, so as to extend the maturity date of the Revolving Line of Credit Loan and the Original Note from September 23, 2013 to September 22, 2014; and (ii) make such further amendments and modifications pursuant to and upon the terms and conditions as more particularly described and set forth in the Second Loan Modification.

G. Lender, Borrower and Participating Lender entered into that certain Third Loan Modification Agreement dated September 30, 2014 to be effective September 22, 2014 (the “Third Loan Modification”) so as to: (i) amend and modify the Revolving Line of Credit Loan, the Original Note, the Original Loan Agreement, and to the extent necessary, the Other Original Loan Documents, so as to extend the maturity date of the Revolving Line of Credit Loan and the Original Note from September 22, 2014 to September 21, 2015; (ii) provide for a one-time waiver only of Borrower’s failure to satisfy and perform the terms, conditions and covenants of Section 10.12 Merchant’s Bank Tier-1 Leverage Ratio of the Original Loan Agreement for the period ending June 30, 2014; (iii) make certain amendments and modifications to Section 10.18 Line of Credit Annual Cleandown of the Original Loan Agreement; and (iv) make such further amendments and modifications pursuant to and upon the terms and conditions as more particularly described and set forth in the Third Loan Modification.

H. Lender, Borrower and Participating Lender entered into that certain Fourth Loan Modification Agreement dated June 5, 2015 (the “Fourth Loan Modification”) so as to: (i) amend and modify the Revolving Line of Credit Loan, the Original Note, the Original Loan Agreement, and to the extent necessary, the Other Original Loan Documents, so as to extend the maturity date of the Revolving Line of Credit Loan and the Original Note from September 21, 2015 to June 3, 2016; (ii) increase the principal amount of the Revolving Line of Credit Loan and the Note from Fifteen Million and 00/100 Dollars ($15,000,000.00) to the new principal amount of Twenty-five Million and 00/100 Dollars ($25,000,000.00); (iii) increase the Applicable Interest Rate (as defined in the Original Loan Agreement) on the Original Note from the LIBO Rate (as defined in the Original Loan Agreement) plus one hundred seventy-five (175) basis points (one hundred (100) basis points being equal to one percent (1%) per annum) to the LIBO Rate plus one hundred eighty-five (185) basis points; (iv) provide for an unused facility fee as more particularly described in the Fourth Loan Modification; (v) delete Section 10.18 Line of Credit Annual Cleandown of the Original Loan Agreement; (vi) amend and modify Section 11.1 Delivery of Information (b) of the Original Loan Agreement as more particularly described in the Fourth Loan Modification; and (vii) make such further amendments and modifications pursuant to and upon the terms and conditions as more particularly described and set forth in the Fourth Loan Modification.

I. In connection with the Fourth Loan Modification, Borrower executed and delivered to Lender and agreed to perform a certain Revolving Line of Credit Note (the

“2015 Note”) in the original principal amount of Twenty-five Million and 00/100 Dollars ($25,000,000.00) dated June 5, 2015 to evidence the increase of the Revolving Line of Credit Loan and the 2015 Note amended, modified, restated and replaced in its entirety the Original Note.

J. Lender, Borrower and Participating Lender entered into that certain Fifth Loan Modification Agreement dated May 25, 2016 to be effective June 3, 2016 (the “Fifth Loan Modification”) so as to: (i) amend and modify the Revolving Line of Credit Loan, the 2015 Note, the Original Loan Agreement, and to the extent necessary, the Other Original Loan Documents, so as to extend the maturity date of the Revolving Line of Credit Loan and the 2015 Note from June 3, 2016 to June 2, 2017; and (ii) make such further amendments and modifications pursuant to and upon the terms and conditions as more particularly described and set forth in the Fifth Loan Modification.

K. Lender, Borrower and Participating Lender entered into that certain Sixth Loan Modification Agreement dated June 23, 2017 to be effective June 2, 2017 (the “Sixth Loan Modification”) so as to: (i) amend and modify the Revolving Line of Credit Loan, the 2015 Note, the Original Loan Agreement, and to the extent necessary, the Original Loan Documents, so as to extend the maturity date of the Revolving Line of Credit Loan and the 2015 Note from June 2, 2017 to June 1, 2018; and (ii) make such further amendments and modifications pursuant to and upon the terms and conditions as more particularly described and set forth in the Sixth Loan Modification.

L. Lender delivered to Borrower that certain one-time waiver and consent letter dated October 13, 2017 (the “Consent and Waiver Letter”) wherein which Lender, notwithstanding certain terms and conditions of the Original Loan Agreement, as amended, consented to the following: (i) that Section 8.5 Ownership of Borrower, Merchants Bank and P/R Mortgage of the Original Loan Agreement needed to be updated to reference certain transactions involving such parties; (ii) that with regard to Section 10.3(c) Creation of Subsidiary of the Original Loan Agreement, that the creation of subsidiaries to acquire the business of Joy State Bank and RICHMAC was approved by Lender; (iii) that with regard to Section 10.13 No Change in Ownership of Borrower and Merchants Bank of the Original Loan Agreement that this prohibition would be cured upon the updating and changes to Section 8.5 Ownership of Borrower, Merchants Bank and P/R Mortgage of the Original Loan Agreement; (iv) that with regard to Section 10.14 No Change to Borrower’s or Merchant Bank’s or P/R Mortgage’s Organizational Documents of the Original Loan Agreement, Lender acknowledged receipt of the Articles of Restatement of the Articles of Incorporation of Merchants Bancorp with a filing date of July 7, 2017; and (v) that with regard to Section 11.1(b) Delivery of Information of the Original Loan Agreement, Lender acknowledged receipt of the audited consolidated financial statements of Merchants Bancorp and its subsidiaries versus the requirement of the audited financial statements of Merchants Bank and P/R Mortgage.

M. Lender, Borrower and CALCON Mutual Mortgage, LLC, a Delaware limited liability company, d/b/a OneTrust Home Loans entered into that certain Subordination Agreement dated April 17, 2018 (the “CALCON Subordinated Agreement”).

N. Borrower previously notified Lender that it acquired FM Bancorp of Illinois and in accordance with Section 10.9 No Acquisitions of the Loan Agreement , that Lender must and hereunder desires to consent to such acquisition.

O. Lender, Borrower and Participating Lender entered into that certain Seventh Loan Modification Agreement dated June 28, 2018 (the “Seventh Loan Modification”) so as to: (i) amend and modify the Revolving Line of Credit Loan, the Note, the Loan Agreement, and to the extent necessary, the Loan Documents, so as to extend the maturity date of the Revolving Line of Credit Loan and the Note from June 1, 2018 to May 31, 2019; and (ii) amend and modify Section 8.5 Ownership of Borrower, Merchants Bank and P/R Mortgage of the Loan Agreement to read as set forth in this Agreement; (iii) to amend and modify Section 11.1(b) and (e) Delivery of Information of the Loan Agreement as more particularly described in the Seventh Loan Modification; (iv) provide for the consent of Lender to the acquisition by Borrower of FM Bancorp of Illinois; and (v) make such further amendments and modifications pursuant to and upon the terms and conditions as more particularly described and set forth in the Seventh Loan Modification. The Original Loan Agreement, the 2015 Note, the Original Stock Pledge Agreement and the Other Original Loan Documents, as and to the extent amended and modified by the First Loan Modification, the Second Loan Modification, the Third Loan Modification, the Fourth Loan Modification, the Fifth Loan Modification, the Sixth Loan Modification and the Seventh Loan Modification, the Consent and Waiver Letter and the CALCON Subordination Agreement are the “Loan Agreement,” the “Note,” the “Stock Pledge Agreement” and the “Other Loan Documents” and the Loan Agreement, the Note, the Stock Pledge Agreement, the Other Loan Documents, the Participation Agreement, the First Loan Modification, the Second Loan Modification, the Third Loan Modification, the Fourth Loan Modification, the Fifth Loan Modification, the Sixth Loan Modification, the Seventh Loan Modification, the Consent and Waiver Letter and the CALCON Subordination Agreement are collectively, the “Loan Documents.”

P. Lender, Borrower and Participating Lender desire to amend and modify the Revolving Line of Credit Loan, the Note, the Loan Agreement, and to the extent necessary, the Loan Documents so as to: (i) extend the maturity date of the Revolving Line of Credit Loan and the Note from May 31, 2019 to August 29, 2019.

NOW, THEREFORE, IN CONSIDERATION of the above Recitals, and other good and valuable consideration, the receipt and sufficiency of which is hereby acknowledged, and further, to induce Lender, Borrower and Participating Lender to consent to the amendments and modifications set forth in this Agreement, Lender, Borrower and Participating Lender hereby agree, jointly and severally, as follows:

1. The Recitals set forth in the beginning of this Agreement are true and correct and are hereby incorporated as a material part of this Agreement.

2. The Revolving Line of Credit Loan, the Note, the Loan Agreement, and to the extent necessary, the Loan Documents, are hereby amended and modified so as to extend the maturity date of the Revolving Line of Credit Loan and the Note from May 31, 2019 to August 29, 2019.

3. Participating Lender hereby consents to the amendments and modifications set forth in this Agreement. Participating Lender acknowledges receipt of a copy of this Agreement.

4. Borrower hereby reaffirms all representations and warranties of Borrower in the Loan Documents.

5. Borrower hereby represents and warrants to Lender that there is no default or Event of Default (as defined in the Loan Agreement) nor event which with the giving of notice, the passage of time or both, would become an Event of Default under or in connection with the Loan Documents.

6. Lender, Borrower and Participating Lender hereby agree that the Loan Documents, to the extent necessary, are hereby amended and modified to reflect the amendments and modifications set forth in this Agreement.

7. This Agreement is a modification only and not a novation or accord and satisfaction. Except for the above-referenced amendments and modifications, the Loan Agreement, the Note, the Stock Pledge Agreement, the Loan Documents, the Participation Agreement and any other agreement or security document, and all the terms and conditions thereof, shall be and remain in full force and effect with the amendments and modifications herein deemed to be incorporated therein.

8. Borrower for itself and its successors and assigns (collectively, the “Releasing Parties”), hereby release and discharge Lender, its officers, directors, agents, employees, attorneys, participants, legal representatives, successors and assigns (collectively, the “Released Parties”) from any and all claims, demands, actions, damages and causes of action which any of the Releasing Parties have asserted or claimed or might now or hereafter assert or claim against all or any of the Released Parties, whether known or unknown, arising out of, related to or in any way connected with or based upon any Prior Related Event (as defined hereafter). As used herein, the term “Prior Related Event” shall mean any act, omission, circumstance, agreement, loan, extension of credit, transaction, transfer, payment, event, action or occurrence between, among or involving Borrower or any of the property of Borrower and all or any of the Released Parties and which was made or extended or which occurred at any time or times prior to the execution of this Agreement. Borrower agrees and acknowledges that this release is not to be construed as or deemed an acknowledgement or admission on the part of any of the Released Parties of liability for any matter or as precedent upon which any liability may be asserted.

Notwithstanding the amendments and modifications set forth in this Agreement, Borrower does hereby reaffirm and ratify to Lender its continuing liability and responsibility, and agrees to pay, perform, observe and be bound by all of the terms, conditions, covenants, agreements, stipulations, representations, warranties, obligations and liabilities under the Note, the Loan Agreement and the Loan Documents, as and to the extent amended and modified hereby, and this Agreement, and further, the Note, the Loan Agreement and the Loan Documents, as and to the extent amended and modified hereby, and this Agreement are the legal, valid and binding obligations of Borrower, enforceable against Borrower in accordance with their respective terms, without the right of offset, defense or counterclaim thereto, and further, nothing herein contained, and nothing done pursuant to this Agreement shall affect or shall be construed as

affecting or is intended to release or affect the liability of Borrower under the Note, the Loan Agreement and the Loan Documents, respectively, as may be applicable, and except for the specific amendments and modifications set forth herein, shall not alter, waive, amend, vary or affect any provision, condition or covenant contained in the Note, the Loan Agreement and the Loan Documents, and except for the specific amendments and modifications set forth herein, shall not affect or impair any rights, powers or remedies of Lender as contained in the Note, the Loan Agreement and the Loan Documents, it being the intent of Borrower that the Note, the Loan Agreement and the Loan Documents, as and to the extent amended and modified hereby, and this Agreement are hereby confirmed and ratified in all respects as of the date hereof.

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LENDER

The Huntington National Bank,

a national banking association

By: /s/ Andrew M. Cardimen

Andrew M. Cardimen, Senior Vice President

BORROWER

Merchants Bancorp,

an Indiana corporation

By: /s/ Michael F. Petrie

Michael F. Petrie, Chairman and CEO

PARTICIPATING LENDER

Providence Bank,

a Missouri state banking corporation

By: /s/ Eric R. Morrison

Eric R. Morrison, Columbia Market President

eXHIBIT 31.1

Certification of the Chief EXECUTIVE Officer

Pursuant to Section 302 of the sarbanes-oxley act of 2002

I, Michael F. Petrie, the Chief Executive Officer of Merchants Bancorp, certify that:

I have reviewed this quarterly report on Form 10-Q of Merchants Bancorp;

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

a) designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

b) designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

c) evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

d) disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent functions):

a) all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.


August 9, 2019		/s/Michael F. Petrie
Date		Michael F. Petrie
		Chief Executive Officer

eXHIBIT 31.2

Certification of the Chief FINANCIAL Officer

Pursuant to Section 302 of the sarbanes-oxley act of 2002

I, John F. Macke, the Principal Financial Officer of Merchants Bancorp, certify that:

I have reviewed this quarterly report on Form 10-Q of Merchants Bancorp;

b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.


August 9, 2019		/s/John F. Macke
Date		John F. Macke
		Principal Financial Officer

EXHIBIT 32

CERTIFICATION OF CHIEF EXECUTIVE OFFICER AND CHIEF FINANCIAL OFFICER

PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

Michael F. Petrie, Chief Executive Officer, and John F. Macke, Principal Financial Officer, of Merchants Bancorp (the “Registrant”), each hereby certify, in their capacity as an officer of the Registrant that he has reviewed the quarterly report of the Registrant on Form 10-Q for the quarter ended June 30, 2019 (the “Report”), and that to the best of his knowledge:

(1) The Report fully complies with the requirements of Sections 13(a) or 15(d) of the Securities Exchange Act of 1934; and

(2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Registrant.


August 9, 2019		/s/ Michael F. Petrie
Date		Michael F. Petrie
		Chief Executive Officer


August 9, 2019		/s/John F. Macke
Date		John F. Macke
		Principal Financial Officer

A signed original of this written statement required by Section 906 has been provided to the Registrant and will be retained by the Registrant and furnished to the SEC or its staff upon request.