10-Q: Merchants Bancorp Q3 Profit Plunges Amid Soaring Credit Losses

Merchants Bancorp reported an 11% drop in Q3 net income and a 324% surge in credit loss provisions, driven by multi-family property value declines and mortgage fraud investigations, alongside a new regulatory Memorandum of Understanding.

Summary

• Net income for the three months ended September 30, 2025, decreased by 11% to $54.7 million, down from $61.3 million in the prior year period.
• Diluted earnings per share fell 17% to $0.97 for Q3 2025, compared to $1.17 for Q3 2024.
• For the nine months ended September 30, 2025, net income decreased 33% to $150.9 million, and diluted EPS dropped 44% to $2.50.
• The provision for credit losses dramatically increased by 324% to $29.2 million for Q3 2025, and by 317% to $90.0 million for the nine months, primarily due to multi-family property value declines and mortgage fraud investigations.
• Total assets grew 3% to $19.4 billion as of September 30, 2025, compared to $18.8 billion at December 31, 2024.
• Core deposits increased 36% to $12.8 billion, now representing 92% of total deposits, the highest level since March 2022.
• Brokered deposits decreased 55% to $1.1 billion, reducing their share of total deposits from 21% to 8%.
• Loans receivable, net, increased 2% to $10.5 billion, while loans held for sale increased 9% to $4.1 billion.
• Nonperforming loans increased to $298.3 million (2.81% of total loans) at September 30, 2025, up from $279.7 million (2.68%) at December 31, 2024.
• The efficiency ratio worsened to 45.16% for Q3 2025 and 43.58% for the nine months, negatively impacted by credit risk transfer premiums, collateral preservation costs, and new production staff expenses.
• The Bank entered into a confidential Memorandum of Understanding (MOU) with the FDIC and DFI on June 30, 2025, agreeing to maintain capital thresholds, manage asset concentrations, and implement risk mitigation plans.
• The Company executed a credit default swap on a $557.1 million pool of healthcare mortgage loans on September 17, 2025, to provide credit protection and reduce risk-based capital requirements.
• The 6% Series B Preferred Stock was redeemed on January 2, 2025, for $125.0 million.

Sentiment

Score: 3

Explanation: The sentiment is negative due to significant declines in net income and EPS, a substantial increase in credit loss provisions driven by asset quality issues (property value declines, fraud investigations), and a worsening efficiency ratio. While there are positives like strong core deposit growth and increased loan volumes in some segments, these are overshadowed by the material financial deterioration and the regulatory Memorandum of Understanding, which signals heightened scrutiny and potential operational limitations.

Positives

• Core deposits increased significantly by $3.4 billion, or 36%, to $12.8 billion, reaching 92% of total deposits, the highest level since March 2022.
• Brokered deposits decreased substantially by $1.4 billion, or 55%, to $1.1 billion, indicating a shift to more stable funding sources.
• Mortgage Warehousing loan volume funded increased by 33% to $17.4 billion for Q3 2025, outpacing the estimated 20% industry increase in single-family residential loan volumes.
• Multi-family business loan origination and acquisition volume increased by 12% to $2.0 billion for Q3 2025.
• Loan servicing fees, net, saw a significant increase to $7.986 million for Q3 2025, compared to a negative $1.509 million in Q3 2024, partly due to a positive fair market value adjustment to servicing rights.
• Gain on sale of loans increased by 47% to $24.671 million for Q3 2025, driven by higher volume in the multi-family loan portfolio, including a Freddie Mac securitization.
• Syndication and asset management fees increased by 165% to $4.864 million for Q3 2025, reflecting growth in managed projects and new equity raises.
• Unused borrowing capacity with FHLB and Federal Reserve discount window increased 37% to $5.9 billion, enhancing liquidity management.
• Approximately 96% of total loans reprice within three months, reducing interest rate risk from market rate increases.

Negatives

• Net income decreased by 11% for the three months and 33% for the nine months ended September 30, 2025, compared to the prior year periods.
• Diluted earnings per share decreased by 17% for the three months and 44% for the nine months ended September 30, 2025.
• The provision for credit losses surged by 324% to $29.2 million for Q3 2025 and 317% to $90.0 million for the nine months, primarily due to declines in multi-family property values and ongoing mortgage fraud investigations.
• Net interest margin decreased by 17 basis points to 2.82% for Q3 2025 and 20 basis points to 2.84% for the nine months, impacted by a shift in business mix towards lower-margin loans.
• Noninterest expense increased by 26% for Q3 2025 and 35% for the nine months, driven by higher salaries, credit risk transfer premiums, and legal fees for collateral preservation of nonperforming loans.
• The efficiency ratio worsened to 45.16% for Q3 2025 and 43.58% for the nine months, indicating higher operational costs relative to revenue.
• Nonperforming loans increased to $298.3 million (2.81% of total loans) at September 30, 2025, from $279.7 million (2.68%) at December 31, 2024, primarily due to one multi-family relationship.
• Substandard loans increased to $426.5 million at September 30, 2025, from $317.3 million at December 31, 2024, with specific reserves of $31.1 million.
• Total shareholders' equity decreased by 1% to $2.2 billion, primarily due to preferred stock redemptions and dividends, partially offset by net income.

Risks

• Credit risk, particularly in the multi-family loan portfolio, due to declines in property values and ongoing investigations of borrowers involved in mortgage fraud or suspected fraud.
• Interest rate risk arising from timing differences in repricings and maturities of interest-earning assets and interest-bearing liabilities, changes in expected maturities from embedded options, yield curve shifts, and changes in spread relationships.
• Liquidity issues, including fluctuations in the fair value and liquidity of securities held for sale and the ability to raise additional capital if necessary.
• Compliance with governmental and regulatory requirements relating to banking, consumer protection, securities, and tax matters.
• Ability to maintain licenses required for residential and multi-family mortgage origination, sale, and servicing operations.
• Cyber-security risks, fraud, and systems errors.
• Ability to effectively execute the strategic plan and manage growth.
• Changes in the senior management team and the ability to attract, motivate, and retain qualified personnel.
• Governmental monetary and fiscal policies, and changes in market interest rates.
• Effects of competition from a wide variety of local, regional, national, and other providers of financial, investment, and insurance services.
• Impact of any claims or legal actions, including any effect on reputation.
• Changes in federal tax law or policy.
• The confidential Memorandum of Understanding (MOU) with the FDIC and DFI may limit or delay the Company's or the Bank's ability or plans to expand.

Future Outlook

Management expects the addition of production staff to be accretive to earnings and to elevate production, gain on sale, and expenses in future quarters. The confidential Memorandum of Understanding (MOU) with the FDIC and DFI, while not expected to materially adversely impact financial performance or day-to-day operations, may limit or delay the Company's or the Bank's ability or plans to expand. The Company will continue to evaluate revenue recognition for LIHTC general partner fees, which are contingent on performance obligations extending until 2043. The Company also anticipates future redemptions of its Series C, D, and E Preferred Stocks on or after their respective call dates in 2026, 2027, and 2030.

Management Comments

• Core deposits now represent 92% of total deposits, reaching the highest level the Company has reported since March 2022.
• Approximately 96% of total loans reprice within three months, which reduces the risk of market rate increases.
• The increases in provision expenses and charge-offs were primarily associated with declines on multi-family property values, after receiving new appraisals, and the ongoing investigation of borrowers involved in mortgage fraud or suspected fraud.
• The increases were also attributable to certain types of subordinated loans that the Company no longer offers to borrowers.
• The $10.0 million in total expenses associated with credit default swap premiums, the collateral preservation of nonperforming loans, and the addition of production staff had a negative 584 basis point impact on the efficiency ratio for the three months ended September 30, 2025.
• Management does not expect the actions called for by these regulatory actions to have a material adverse impact on the Company's financial performance or the Bank's ongoing day-to-day operations, although they may have the effect of limiting or delaying the Company's or the Bank's ability or plans to expand.

Industry Context

The Company's Mortgage Warehousing segment's loan funding volume increased by 33% for the three months ended September 30, 2025, significantly outpacing the estimated 20% industry increase in single-family residential loan volumes for the same period, as reported by the Mortgage Bankers Association. This suggests the Company is gaining market share or benefiting more from specific market conditions than the broader industry.

Comparison to Industry Standards

• The Mortgage Warehousing segment's loan funding volume growth of 33% for Q3 2025 significantly exceeded the estimated 20% industry increase in single-family residential loan volumes, as per the Mortgage Bankers Association.
• The Company positions itself as one of the top-ranked agency affordable lenders in the nation and one of the largest Ginnie Mae servicers in the country based on aggregate loan principal value.
• The Company's business model aims for lower than industry charge-offs and a lower expense base, though recent increases in provision for credit losses and efficiency ratio suggest challenges in maintaining this standard in the current period.

Corporate Governance

Stakeholder Impact

• Shareholders: Negative impact on common shareholders due to decreased net income and diluted EPS, and the reduction in retained earnings from preferred stock redemptions. Potential for future capital raises could dilute common shareholders.
• Employees: Positive impact from ESOP contributions and the addition of production staff, though increased expenses related to staff additions impact overall profitability.
• Customers: Continued provision of mortgage warehouse financing, multi-family and healthcare financing, and traditional banking services. Credit default swaps aim to manage credit risk on certain loan pools.
• Regulators: Increased scrutiny and oversight through the Memorandum of Understanding (MOU) with the FDIC and DFI, requiring adherence to specific capital and asset concentration limits and risk mitigation plans.
• Creditors: The redemption of preferred stock and management of borrowings impact the Company's capital structure and debt profile.

Next Steps

• Continue to evaluate the impact of adopting FASB ASU 2024-03 on income statement expense disaggregation, effective for annual periods beginning after December 15, 2026.
• Apply FASB ASU 2023-09 on income tax disclosures on a prospective basis for annual periods beginning after December 15, 2024.
• Management expects new production staff to elevate production, gain on sale, and expenses in future quarters.
• The Bank will continue to operate under the confidential Memorandum of Understanding with the FDIC and DFI until it is modified or terminated.
• The Company may redeem its 6% Series C Preferred Stock on or after April 1, 2026, subject to federal banking agency approval.
• The Company may redeem its 8.25% Series D Preferred Stock on or after October 1, 2027, subject to federal banking agency approval.
• The Company may redeem its 7.625% Series E Preferred Stock on or after January 1, 2030, subject to federal banking agency approval.
• The Company will continuously evaluate revenue recognition for LIHTC general partner fees, which are contingent upon achieving certain performance obligations that could extend until 2043.
• Ongoing assessment of Variable Interest Entities (VIEs) for primary beneficiary designation based on changes in facts and circumstances.

Key Dates

Recommendation

The significant year-over-year decline in net income and diluted EPS, coupled with a dramatic increase in the provision for credit losses driven by multi-family property value declines and mortgage fraud investigations, signals material deterioration in asset quality and profitability. The worsening efficiency ratio and the imposition of a regulatory Memorandum of Understanding (MOU) by the FDIC and DFI further highlight operational and compliance challenges. While core deposit growth and strong loan volumes in some segments are positive, they are insufficient to offset the substantial financial headwinds and increased risk profile. A seasoned investor would likely view these developments as a strong indicator to reduce or exit their position due to heightened risk and diminished earnings prospects.

Keywords

Merchants Bancorp, MBIN, SEC Filing, 10-Q, Financial Results, Q3 2025, Net Income, EPS, Credit Losses, Mortgage Banking, Mortgage Warehousing, Banking Segment, Deposits, Loans, Nonperforming Loans, Regulatory Compliance, FDIC, DIF, Memorandum of Understanding, Capital Adequacy, Interest Rate Risk, Credit Default Swap, Preferred Stock Redemption, Financial Services, Commercial Real Estate, Multi-family Financing, Healthcare Financing