Merchants Bancorp 10Q 2022 Q3 Quarterly report

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	September 30, 2022


☐	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)

410 Monon Blvd. 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	MBIN	NASDAQ
Series A Preferred Stock, without par value Depositary Shares, each representing a 1/40^th interest in a share of Series B Preferred Stock, without par value	MBINP MBINO	NASDAQ NASDAQ
Depositary Shares, each representing a 1/40^th interest in a share of Series C Preferred Stock, without par value Depositary Shares, each representing a 1/40^th interest in a share of Series D Preferred Stock, without par value	MBINN MBINM	NASDAQ NASDAQ

As of November 1, 2022, the latest practicable date, 43,109,578 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 September 30, 2022 and December 31, 2021	3

Condensed Consolidated Statements of Income for the Three and Nine Months Ended September 30, 2022 and 2021	4

Condensed Consolidated Statements of Comprehensive Income for the Three and Nine Months Ended September 30, 2022 and 2021	5

Condensed Consolidated Statements of Shareholders’ Equity for the Three and Nine Months Ended September 30, 2022 and 2021	6

Condensed Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2022 and 2021	7

Notes to Condensed Consolidated Financial Statements	8

Item 2 Management’s Discussion and Analysis of Financial Condition and Results of Operations	48

Item 3 Quantitative and Qualitative Disclosures About Market Risk	71

Item 4 Controls and Procedures	71

PART II – OTHER INFORMATION	72

Item 1 Legal Proceedings	72

Item 1A Risk Factors	72

Item 2 Unregistered Sales of Equity Securities and Use of Proceeds	72

Item 3 Defaults Upon Senior Securities	72

Item 4 Mine Safety Disclosures	72

Item 5 Other Information	72

Item 6 Exhibits	73

SIGNATURES	74

Table of Contents

Part I – Financial Information

Item 1. Financial Statements

Merchants Bancorp

Condensed Consolidated Balance Sheets

September 30, 2022 (Unaudited) and December 31, 2021

(In thousands, except share data)


	September 30,		December 31,
	2022		2021
Assets
Cash and due from banks	$	13,796	$	14,030
Interest-earning demand accounts		310,165		1,018,584
Cash and cash equivalents		323,961		1,032,614
Securities purchased under agreements to resell		3,497		5,888
Mortgage loans in process of securitization		137,448		569,239
Available for sale securities		322,069		310,629
Held to maturity securities (includes $1,005,487 and $0, respectively at fair value)		1,005,487		—
Federal Home Loan Bank (FHLB) stock		39,130		29,588
Loans held for sale (includes $68,785 and $48,583, respectively at fair value)		2,844,750		3,303,199
Loans receivable, net of allowance for credit losses on loans of $38,996 and $31,344, respectively		6,919,128		5,751,319
Premises and equipment, net		35,492		31,212
Servicing rights		144,984		110,348
Interest receivable		40,170		24,103
Goodwill		15,845		15,845
Intangible assets, net		1,307		1,707
Other assets and receivables		145,454		92,947
Total assets	$	11,978,722	$	11,278,638
Liabilities and Shareholders' Equity
Liabilities
Deposits
Noninterest-bearing	$	315,868	$	641,442
Interest-bearing		10,003,611		8,341,171
Total deposits		10,319,479		8,982,613
Borrowings		97,279		1,033,954
Deferred and current tax liabilities, net		19,124		19,170
Other liabilities		130,250		87,492
Total liabilities		10,566,132		10,123,229
Commitments and Contingencies
Shareholders' Equity
Common stock, without par value⁽¹⁾
Authorized - 75,000,000 shares at September 30, 2022 and 50,000,000 shares at December 31, 2021
Issued and outstanding - 43,109,578 shares at September 30, 2022 and 43,180,079 shares at December 31, 2021		137,226		137,565
Preferred stock, without par value - 5,000,000 total shares authorized
7% Series A Preferred stock - $25 per share liquidation preference
Authorized - 3,500,000 shares
Issued and outstanding - 2,081,800 shares		50,221		50,221
6% Series B Preferred stock - $1,000 per share liquidation preference
Authorized - 125,000 shares
Issued and outstanding - 125,000 shares (equivalent to 5,000,000 depositary shares)		120,844		120,844
6% Series C Preferred stock - $1,000 per share liquidation preference
Authorized - 200,000 shares
Issued and outstanding - 196,181 shares (equivalent to 7,847,233 depositary shares)		191,084		191,084
8.25% Series D Preferred stock - $1,000 per share liquidation preference
Authorized - 300,000 shares
Issued and outstanding - 142,500 shares (equivalent to 5,700,000 depositary shares)		137,371		—
Retained earnings		787,530		657,149
Accumulated other comprehensive loss		(11,686)		(1,454)
Total shareholders' equity		1,412,590		1,155,409
Total liabilities and shareholders' equity	$	11,978,722	$	11,278,638

(1)	The number of shares have been restated to reflect the 3-for-2 common stock split, effective on January 17, 2022.

See notes to condensed consolidated financial statements.

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Merchants Bancorp

Condensed Consolidated Statements of Income (Unaudited)

For the Three and Nine Months Ended September 30, 2022 and 2021

(In thousands, except share data)


	Three Months Ended				Nine Months Ended
	September 30,				September 30,
	2022		2021		2022		2021
Interest Income
Loans	$	129,101	$	72,924	$	287,291	$	216,717
Mortgage loans in process of securitization		2,162		2,868		5,856		8,728
Investment securities:
Available for sale - taxable		485		1,115		2,103		2,302
Available for sale - tax exempt		—		12		—		32
Held to maturity		970		—		970		—
Federal Home Loan Bank stock		379		190		932		966
Other		1,015		205		2,242		556
Total interest income		134,112		77,314		299,394		229,301
Interest Expense
Deposits		45,002		6,981		68,583		19,764
Borrowed funds		3,725		1,452		7,670		4,286
Total interest expense		48,727		8,433		76,253		24,050
Net Interest Income		85,385		68,881		223,141		205,251
Provision for credit losses		2,225		1,079		10,888		2,427
Net Interest Income After Provision for Credit Losses		83,160		67,802		212,253		202,824
Noninterest Income
Gain on sale of loans		13,354		29,013		52,883		82,755
Loan servicing fees, net		8,169		5,313		27,507		14,991
Mortgage warehouse fees		1,105		2,732		4,313		9,927
Syndication and asset management fees		3,073		643		5,286		1,178
Other income		3,485		2,570		12,965		8,211
Total noninterest income		29,186		40,271		102,954		117,062
Noninterest Expense
Salaries and employee benefits		23,027		20,197		66,795		60,340
Loan expenses		1,226		1,734		3,621		6,178
Occupancy and equipment		1,967		1,861		5,792		5,296
Professional fees		2,429		901		5,326		2,102
Deposit insurance expense		755		664		2,184		1,986
Technology expense		1,325		1,169		3,865		3,077
Other expense		4,222		2,946		11,358		8,760
Total noninterest expense		34,951		29,472		98,941		87,739
Income Before Income Taxes		77,395		78,601		216,266		232,147
Provision for income taxes		18,907		20,098		53,701		60,244
Net Income	$	58,488	$	58,503	$	162,565	$	171,903
Dividends on preferred stock		(5,729)		(5,729)		(17,186)		(15,145)
Net Income Allocated to Common Shareholders		52,759		52,774		145,379		156,758
Basic Earnings Per Share⁽¹⁾	$	1.22	$	1.22	$	3.37	$	3.63
Diluted Earnings Per Share⁽¹⁾	$	1.22	$	1.22	$	3.36	$	3.62
Weighted-Average Shares Outstanding⁽¹⁾
Basic		43,107,975		43,176,296		43,182,380		43,169,618
Diluted		43,258,925		43,314,755		43,331,148		43,300,688

(1)	The number of shares and per share amounts have been restated to reflect the 3-for-2 common stock split, effective on January 17, 2022.

See notes to condensed consolidated financial statements.

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Merchants Bancorp

Condensed Consolidated Statements of Comprehensive Income (Unaudited)

For the Three and Nine Months Ended September 30, 2022 and 2021

(In thousands)


	Three Months Ended				Nine Months Ended
	September 30,				September 30,
	2022		2021		2022		2021
Net Income	$	58,488	$	58,503	$	162,565	$	171,903
Other Comprehensive Income (Loss):
Net change in unrealized gain/(losses) on investment securities available for sale, net of tax (expense)/benefits of $1,210, $(96), $3,413 and $34, respectively		(3,616)		266		(10,232)		(112)
Other comprehensive income (loss) for the period		(3,616)		266		(10,232)		(112)
Comprehensive Income	$	54,872	$	58,769	$	152,333	$	171,791

See notes to condensed consolidated financial statements.

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Merchants Bancorp

Condensed Consolidated Statement of Shareholders’ Equity (Unaudited)

For the Three and Nine Months Ended September 30, 2022 and 2021

(In thousands, except share data)



	Three Months Ended						Nine Months Ended
	September 30,						September 30,
	2022			2021			2022			2021
	Shares		Amount	Shares		Amount	Shares		Amount	Shares		Amount
Common Stock
Balance beginning of period⁽¹⁾	43,106,505	$	136,671	43,175,398	$	136,836	43,180,079	$	137,565	43,120,625	$	135,857
Repurchase of common stock	-		-				(165,037)		(1,761)
Cash paid in lieu of fractional shares for stock split	-		-				(29)		(1)
Distribution to employee stock ownership plan	-		-	-		-	20,709		653	29,149		537
Shares issued for stock compensation plans, net of taxes withheld to satisfy tax obligations	3,073		555	2,663		364	73,856		770	28,287		806
Balance end of period	43,109,578		137,226	43,178,061		137,200	43,109,578		137,226	43,178,061		137,200

8% Preferred Stock
Balance beginning of period	-		-	-		-	-		-	41,625		41,581
Redemption of 8% preferred stock	-		-	-		-	-		-	(41,625)		(41,581)
Balance end of period	-		-	-		-	-		-	-		-

7% Series A Preferred Stock
Balance at beginning and end of period	2,081,800		50,221	2,081,800		50,221	2,081,800		50,221	2,081,800		50,221

6% Series B Preferred Stock
Balance at beginning and end of period	125,000		120,844	125,000		120,844	125,000		120,844	125,000		120,844

6% Series C Preferred Stock
Balance beginning of period	196,181		191,084	196,181		191,084	196,181		191,084	-		-
Issuance of 6% Series C preferred stock, net of $5.1 million in offering expenses	-		-	-		-	-		-	150,000		144,926
Private issuance of 6% Series C preferred stock, net of $23 in offering expenses	-		-	-		-	-		-	46,181		46,158
Balance end of period	196,181		191,084	196,181		191,084	196,181		191,084	196,181		191,084

8.25% Series D Preferred Stock
Balance beginning of period	-		-	-		-	-		-	-		-
Issuance of 8.25% Series D preferred stock, net of $5.1 million in offering expenses	142,500		137,371	-		-	142,500		137,371	-		-
Balance end of period	142,500		137,371	-		-	142,500		137,371	-		-

Retained Earnings
Balance beginning of period			737,789			560,083			657,149			461,744
Net income			58,488			58,503			162,565			171,903
Impact from adoption of ASU 2016-13 (Credit Losses)			-			-			(3,648)			-
Impact from adoption of ASU 2016-02 (Leases)			-			-			(110)			-
Dividends on 8% preferred stock, $80.00 per share, annually			-			-			-			(833)
Final dividend for redemption of 8% preferred stock, $3.33 per share			-			-			-			(139)
Dividends on 7% Series A preferred stock, $1.75 per share, annually			(911)			(911)			(2,732)			(2,732)
Dividends on 6% Series B preferred stock, $60.00 per share, annually			(1,875)			(1,875)			(5,625)			(5,625)
Dividends on 6% Series C preferred stock, $60.00 per share, annually			(2,943)			(2,943)			(8,829)			(5,816)
Dividends on common stock, $0.28 per share, annually in 2022 and $0.24 per share, annually in 2021			(3,018)			(2,590)			(9,066)			(7,771)
Deconsolidation of entities			-			-			-			(419)
Redemption of 8% preferred stock			-			-			-			(45)
Repurchase of common stock			-			-			(2,174)			-
Balance end of period			787,530			610,267			787,530			610,267

Accumulated Other Comprehensive Income (Loss)
Balance beginning of period			(8,070)			(4)			(1,454)			374
Other comprehensive income (loss)			(3,616)			266			(10,232)			(112)
Balance end of period			(11,686)			262			(11,686)			262

Total shareholders' equity		$	1,412,590		$	1,109,878		$	1,412,590		$	1,109,878

(1)	The number of shares have been restated to reflect the 3-for-2 common stock split, effective on January 17, 2022.

See notes to condensed consolidated financial statements

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Merchants Bancorp

Condensed Consolidated Statements of Cash Flows (Unaudited)

Nine Months Ended September 30, 2022 and 2021

(In thousands)


	Nine Months Ended
	September 30,
	2022		2021
Operating activities:
Net income	$	162,565	$	171,903
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation		1,832		1,616
Provision for credit losses		10,888		2,427
Gain on sale of loans		(52,883)		(82,755)
Proceeds from sales of loans		21,488,416		44,276,199
Loans and participations originated and purchased for sale		(20,209,971)		(44,463,275)
Purchases of low-income housing tax credits for sale		(22,122)		—
Proceeds from sale of low-income housing tax credits		8,556		—
Change in servicing rights for paydowns and fair value adjustments		(11,974)		526
Net change in:
Mortgage loans in process of securitization		431,791		(295,294)
Other assets and receivables		(20,958)		(1,209)
Other liabilities		50,630		3,007
Other		(2,854)		(980)
Net cash provided by operating activities		1,833,916		(387,835)
Investing activities:
Net change in securities purchased under agreements to resell		2,391		657
Purchases of available for sale securities		(50,274)		(195,206)
Purchases of held to maturity securities		(1,005,487)		—
Proceeds from the sale of available for sale securities		11,379		34,469
Proceeds from calls, maturities and paydowns of available for sale securities		12,755		128,502
Purchases of loans		(289,030)		(312,992)
Net change in loans receivable		(1,675,505)		(16,240)
Proceeds from sale of loans receivable		—		262,086
Purchase of FHLB stock		(10,326)		(111)
Proceeds from sale of FHLB stock		784		—
Proceeds from sale of servicing rights		—		438
Purchases of premises and equipment		(6,178)		(3,281)
Purchase of servicing rights		(2,057)		—
Purchase of limited partnership interests		(42,710)		(12,149)
Cash paid in deconsolidation of subsidiary		—		(464)
Other investing activities		4,314		404
Net cash used in investing activities		(3,049,944)		(113,887)
Financing activities:
Net change in deposits		1,336,866		1,537,148
Proceeds from borrowings		44,950,000		28,803,270
Repayment of borrowings		(45,890,075)		(29,342,391)
Proceeds from notes payable		3,400		—
Proceeds from issuance of preferred stock		137,371		191,084
Repurchase of preferred stock		—		(41,625)
Repurchase of common stock		(3,935)		—
Dividends		(26,252)		(22,916)
Net cash provided by (used in) financing activities		507,375		1,124,570
Net Change in Cash and Cash Equivalents		(708,653)		622,848
Cash and Cash Equivalents, Beginning of Period		1,032,614		179,728
Cash and Cash Equivalents, End of Period	$	323,961	$	802,576
Supplemental Cash Flows Information:
Interest paid	$	63,917	$	23,049
Income taxes paid, net of refunds		47,174		57,692
Transfer of loans from loans receivable to loans held for sale		788,849		131,563
Deconsolidation of debt fund entities		—		See Note 1

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”), Farmers-Merchants Bank of Illinois (“FMBI”) and Merchants Asset Management, LLC (“MAM”). Merchants Bank’s primary operating subsidiaries include Merchants Capital Corp. (‘MCC”), Merchants Capital Servicing, LLC (“MCS”), and Merchants Capital Investments, LLC (“MCI”). All direct and indirectly owned subsidiaries owned by Merchants Bancorp are collectively referred to as the “Company”.

The accompanying unaudited condensed consolidated balance sheet of the Company as of December 31, 2021, which has been derived from audited financial statements, and unaudited condensed consolidated financial statements of the Company as of September 30, 2022 and for the three and nine months ended September 30, 2022 and 2021, 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, 2021 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 September 30, 2022 and the results of operations for the three and nine months ended September 30, 2022 and 2021, and cash flows for the nine months ended September 30, 2022 and 2021. All interim amounts have not been audited and the results of operations for the three and nine months ended September 30, 2022, 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 September 30, 2022 and 2021 include results from the Company, and its wholly owned subsidiaries, Merchants Bank, FMBI and MAM. Also included are Merchants Bank’s primary operating subsidiaries, MCC, MCS and MCI, as well as all direct and indirectly owned subsidiaries owned by Merchants Bancorp.

In addition, when the Company makes an equity investment in or has a relationship with an entity for which it holds a variable interest, it is evaluated for consolidation requirements under Accounting Standards Update of Topic 810. Accordingly, the entity is assessed for potential consolidation under the variable interest entity (“VIE”) model and would only consolidate those entities for which it is a primary beneficiary. A primary beneficiary is defined as the party that has both the power to direct the activities that most significantly impact the entity, and an interest that could be significant to the entity. To determine if an interest could be significant to the entity, both qualitative and quantitative factors regarding the nature, size and form of our involvement with the entity are evaluated. Alternatively, under the voting interest model, it would only consolidate those entities for which it has a controlling interest. Because the variable interest investments held by the Company as of September 30, 2022 are not deemed to be primary beneficiaries or controlling interests, the entities are not consolidated and the equity method or proportional method of accounting has been applied. The Company will analyze whether its entities are the primary beneficiary on an ongoing basis. Changes in facts and circumstances occurring since the previous primary beneficiary determination will be considered as part of this ongoing assessment. See Note 5: Variable Interest Entities (VIEs) for additional information about VIEs.

All significant intercompany accounts and transactions have been eliminated in consolidation.

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Merchants Bancorp

Notes to Condensed Consolidated Financial Statements

(Unaudited)

Deconsolidation

The unaudited condensed consolidated financial statements included consolidated results from certain entities primarily involved in single-family debt financing until January 30, 2021, while the Company was deemed to be a primary beneficiary. On February 1, 2021, the Company’s single-family debt fund entities were restructured in such a way that its ownership and participation was significantly reduced with the inclusion of additional, unrelated investors and the Company was no longer classified as a primary beneficiary. Accordingly, results from these entities were no longer consolidated after this date, in accordance with the consolidation guidelines of the Accounting Standards Update of Topic 810.

Following the deconsolidation, the carrying value of assets and liabilities of these entities were removed from the consolidated balance sheet, and the continuing investments were recorded at fair value at the date of deconsolidation. The total amount deconsolidated from the balance sheet included net assets of approximately $10 million, consisting primarily of $66.6 million in loans receivable, and $52.7 million in borrowings with Merchants Bank that was previously eliminated in consolidation. The fair value of its continuing investments was approximately $10 million on the deconsolidation date and has been reported in Other Assets after deconsolidation. The estimated fair value was determined based on third-party evaluations of similar assets in the underlying business. The difference between the fair value of these deconsolidated entities and their carrying value was deemed to be immaterial, resulting in no gain or loss on deconsolidation. These continuing investments after deconsolidation are classified as variable interest entities, have not been consolidated, and are accounted for under the equity method of accounting. See Note 5: Variable Interest Entities (VIEs) for additional information about VIEs.

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 credit losses on loans, servicing rights and fair values of financial instruments.

Significant Accounting Policies

The significant accounting policies followed by the Company for interim financial reporting are consistent with the accounting policies followed for annual financial reporting. However, on January 1, 2022, the Company adopted FASB Accounting Standards Update (ASU) No. 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments ("CECL"). The Company revised certain accounting policies and implemented certain accounting policy elections, related to the adoption of CECL, which are described below. All adjustments, which are of a normal recurring nature and are, in the opinion of management, necessary for a fair statement of the results for the periods reported, have been included in the accompanying Condensed Consolidated Financial Statements.

CECL replaces the previous "allowance for loan and lease losses" model for measuring credit losses, which encompassed allowances for current known and inherent losses within the portfolio, with an "expected loss" model for measuring credit losses, which encompasses allowances for losses expected to be incurred over the life of the included assets. The new CECL model requires the measurement of all expected credit losses for financial assets measured at amortized cost and certain off-balance sheet credit exposures (“OBCEs”) based on historical experiences, current conditions, and reasonable and supportable forecasts. CECL also requires enhanced disclosures related to the significant estimates and judgments used in estimating credit losses, as well as credit quality and underwriting standards of an organization's portfolio. In addition, CECL includes certain changes to the accounting for investment securities available for sale depending on whether management intends to sell the securities or believes that it is more likely than not they will be required to sell.

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Merchants Bancorp

Notes to Condensed Consolidated Financial Statements

(Unaudited)

As of adoption date on January 1, 2022, the Company recorded a $3.6 million decrease, net of taxes, to retained earnings for the cumulative effect of adopting CECL. The transition adjustment included a $0.3 million increase to retained earnings related to allowance for credit losses on loans (“ACL-Loans”) and a $5.2 million decrease to retained earnings related to allowance for OBCEs (“ACL-OBCEs”). The following table summarizes the impact of the adoption of CECL on the Company’s balance sheet as of January 1, 2022.


			Impact of			January 1, 2022
			CECL			Post-CECL
	December 31, 2021		Adoption		Adoption

Assets:	(In thousands)
MTG WHLOC	$	1,955	$	41	$	1,996
RES RE		4,170		275		4,445
MF FIN		14,084		520		14,604
HC FIN		4,461		139		4,600
CML & CRE		5,879		(1,277)		4,602
AG & AGRE		657		(18)		639
CON & MAR		138		21		159
ACL - Loans	$	31,344	$	(299)	$	31,045

Liabilities:
ACL - OBCEs (in Other Liabilities)	$	—	$	5,176	$	5,176

Stockholders' Equity:
Retained earnings, net of tax	$	657,149	$	(3,648)	$	653,501

ACL-Loans - the ACL-Loans is a valuation account that is deducted from the loans’ amortized cost basis to present the net amount expected to be collected on loans over the contractual term. Loans are charged off against the allowance when the uncollectibility of the loan is confirmed. Expected recoveries do not exceed the aggregate of amounts previously charged off and expected to be charged off. Adjustments to the ACL-Loans are reported in the income statement as a provision for credit loss. Further information regarding the policies and methodology used to estimate the ACL-Loans is detailed in Note 4: Loans and Allowance for credit losses on loans of these Notes to Consolidated Condensed Financial Statements.

ACL-OBCEs – the ACL–OBCEs is a liability account representing expected credit losses over the contractual period for which the Company is exposed to credit risk resulting from a contractual obligation to extend credit. No allowance is recognized if the Company has the unconditional right to cancel the obligation. OBCEs primarily consist of amounts available under outstanding lines of credit. For the period of exposure, the estimate of expected credit losses considers both the likelihood that funding will occur and the amount expected to be funded over the estimated remaining life of the commitment. The likelihood and expected amount of funding are based on historical utilization rates. The amount of the allowance represents management’s best estimate of expected credit losses on commitments expected to be funded over the contractual life of the commitment. The ACL–OBCEs is adjusted through the income statement as a component of provision for credit loss.

The Company adopted CECL using the modified retrospective method for loans and OBCEs. Therefore, results for reporting periods beginning after January 1, 2022 are presented in accordance with CECL, while prior period amounts continue to be reported in accordance with previously applicable Generally Accepted Accounting Principles (“GAAP”).

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Merchants Bancorp

Notes to Condensed Consolidated Financial Statements

(Unaudited)

Reclassifications

Certain reclassifications may have been made to the 2021 financial statements to conform to the financial statement presentation as of and for the three and nine months ended September 30, 2022. These reclassifications had no effect on net income.

Note 2: Investment Securities

The amortized cost and approximate fair values, together with gross unrealized gains and losses, of available for sale and held to maturity securities as of September 30, 2022 and December 31, 2021 were as follows:


	September 30, 2022
			Gross		Gross
	Amortized		Unrealized		Unrealized		Fair
	Cost		Gains		Losses		Value

	(In thousands)
Available for sale securities:
Treasury notes	$	37,288	$	—	$	976	$	36,312
Federal agencies		284,982		—		14,629		270,353
Mortgage-backed - Government-sponsored entity (GSE)		15,405		10		11		15,404
Total available for sale securities	$	337,675	$	10	$	15,616	$	322,069
Held to maturity securities:
Mortgage-backed - Non-GSE multi-family	$	1,005,487	$	—	$	—	$	1,005,487
Total held to maturity securities	$	1,005,487	$	—	$	—	$	1,005,487


	December 31, 2021
			Gross		Gross
	Amortized		Unrealized		Unrealized		Fair
	Cost		Gains		Losses		Value

	(In thousands)
Available for sale securities:
Treasury notes	$	8,232	$	4	$	27	$	8,209
Federal agencies		264,970		—		1,675		263,295
Municipals		4,300		—		—		4,300
Mortgage-backed - Government-sponsored entity (GSE)		18,664		32		336		18,360
Mortgage-backed - Non-GSE multi-family		16,424		41		—		16,465
Total available for sale securities	$	312,590	$	77	$	2,038	$	310,629

At September 30, 2022 and December 31, 2021, GSE mortgage-backed securities included in the tables above are primarily backed by multi-family loans. The September 30, 2022 table includes a held to maturity security that was purchased following a September 2022 loan sale and securitization transaction as described in Note 4: Loans and Allowance for Credit Losses on Loans. The December 31, 2021 table above also included 2 securities purchased from Freddie Mac following the loan sale and securitization arrangement with Freddie Mac described in Note 4: Loans and Allowance for Credit Losses on Loans. One of these securities was subsequently sold at book value resulting in no gain

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Merchants Bancorp

Notes to Condensed Consolidated Financial Statements

(Unaudited)

or loss during the three and nine months ended September 30, 2022, and the other security was fully amortized resulting in no gain loss during the three and nine months ended September 30, 2022.

Accrued interest on available for sale securities totaled $0.6 million at September 30, 2022 and $0.4 million at December 31, 2021, respectively, and is excluded from the estimate of credit losses.

Accrued interest on held to maturity securities totaled $2.3 million at September 30, 2022 and $0 at December 31, 2021, respectively, and is excluded from the estimate of credit losses.

The amortized cost and fair value of available for sale and held to maturity securities at September 30, 2022 and December 31, 2021, 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.


	September 30, 2022				December 31, 2021
	Amortized		Fair		Amortized		Fair
	Cost		Value		Cost		Value

Available for sale securities:	(In thousands)
Within one year	$	73,994	$	71,805	$	6,548	$	6,551
After one through five years		248,276		234,860		270,954		269,253
After five through ten years		—		—		—		—
After ten years		—		—		—		—
		322,270		306,665		277,502		275,804
Mortgage-backed - Government-sponsored entity (GSE)		15,405		15,404		18,664		18,360
Mortgage-backed - Non-GSE multi-family		—		—		16,424		16,465
	$	337,675	$	322,069	$	312,590	$	310,629
Held to maturity securities:
Within one year	$	—	$	—	$	—	$	—
After one through five years		1,005,487		1,005,487		—		—
After five through ten years		—		—		—		—
After ten years		—		—		—		—
	$	1,005,487	$	1,005,487	$	—	$	—

During the three and nine months ended September 30, 2022, one of the mortgage-backed – non-GSE multi-family securities available for sale was sold for $11.4 million resulting in no gain or loss. During the three and nine months ended September 30, 2021 proceeds from sales of $34.5 million securities available for sale were sold, and no gain or loss was recognized.

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Merchants Bancorp

Notes to Condensed Consolidated Financial Statements

(Unaudited)

The following tables show the Company’s investments’ gross unrealized losses and fair value of the Company’s investment securities with unrealized losses for which an allowance for credit losses has not been recorded, aggregated by investment class and length of time that individual securities have been in a continuous unrealized loss position at September 30, 2022 and December 31, 2021:


	September 30, 2022
					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	$	34,357	$	931	$	1,955	$	45	$	36,312	$	976
Federal agencies		62,372		2,628		207,981		12,001		270,353		14,629
Mortgage-backed - Government-sponsored entity (GSE)		768		11		—		—		768		11
	$	97,497	$	3,570	$	209,936	$	12,046	$	307,433	$	15,616


	December 31, 2021
					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	$	7,957	$	27	$	—	$	—	$	7,957	$	27
Federal agencies		238,489		1,503		24,806		172		263,295		1,675
Mortgage-backed - Government-sponsored entity (GSE)		719		336		—		—		719		336
	$	247,165	$	1,866	$	24,806	$	172	$	271,971	$	2,038

For available for sale securities with an unrealized loss position, the Company evaluates the securities to determine whether the decline in the fair value below the amortized cost basis (impairment) is due to credit-related factors or non-credit related factors. Any impairment that is not credit-related is recognized in AOCI, net of tax. Credit-related impairment is recognized as an ACL for available for sale securities on the balance sheet, limited to the amount by which the amortized cost basis exceeds the fair value, with a corresponding adjustment to earnings. Accrued interest receivable is excluded from the estimate of credit losses. Both the ACL and the adjustment to net income may be reversed if conditions change. However, if the Company expects, or is required, to sell an impaired available for sale security before recovering its amortized cost basis, the entire impairment amount would be recognized in earnings with a corresponding adjustment to the security’s amortized cost basis. Because the security’s amortized cost basis is adjusted to fair value, there is no ACL in this situation.

In evaluating available for sale securities in unrealized loss positions for impairment and the criteria regarding its intent or requirement to sell such securities, the Company considers the extent to which fair value is less than amortized cost, whether the securities are issued by the federal government or its agencies, whether downgrades by bond rating agencies have occurred, and the results of reviews of the issuers’ financial condition, among other factors. Unrealized losses on the Company’s investment securities portfolio have not been recognized as an expense because the securities are of high credit quality, and the decline in fair values is attributable to changes in the prevailing interest rate environment since the purchase date. Fair value is expected to recover as securities reach maturity and/or the interest rate environment returns to conditions similar to when these securities were purchased. There were no credit related factors underlying unrealized losses on available for sale debt securities at September 30, 2022 and December 31, 2021.

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Merchants Bancorp

Notes to Condensed Consolidated Financial Statements

(Unaudited)

Note 3: Mortgage Loans in Process of Securitization

Mortgage loans in process of securitization are recorded at fair value with changes in fair value recorded in earnings. These include multi-family rental real estate loan originations to be sold as Government National Mortgage Association (“Ginnie Mae”) mortgage-backed securities and Federal National Mortgage Association (“Fannie Mae”) and Federal Home Loan Mortgage Corporation (“Freddie Mac”) participation certificates, all of which are pending settlement with firm investor commitments to purchase the securities, typically occurring within 30 days. The fair value increases recorded in earnings for mortgage loans in process of securitization totaled $1.1 million and $4.9 million at September 30, 2022 and 2021, respectively.

Note 4: Loans and Allowance for Credit Losses on Loans

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 ACL-Loans, any unamortized deferred fees or costs on originated loans and unamortized premiums or discounts on purchased loans.

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

The Company has made a policy election to exclude accrued interest from the amortized cost basis of loans and reports accrued interest separately from the related loan balance in the consolidated balance sheets. Accrued interest on loans totaled $26.5 million and $15.4 million at September 30, 2022 and December 31, 2021, respectively.

The Company also elected not to measure an allowance for credit losses for accrued interest receivables. 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 collected 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.

When cash payments for accrued interest are received on nonaccrual loans in each loan class, the Company records a reduction in principle on the 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.

The Company offers warehouse lines of credit to fund mortgage loans held for sale from closing until sale to an investor. Under a warehousing arrangement the Company funds a mortgage loan as secured financing. The warehousing arrangement is secured by the underlying mortgages and a combination of deposits, personal guarantees and advance rates. The Company typically holds the collateral until it is sent under a bailee arrangement instructing the investor to send proceeds to the Company. Typical investors are large financial institutions or government agencies. Interest earned from the time of funding to the time of sale is recognized as interest income as accrued. Fees earned agreements are recognized when collected as noninterest income.

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Merchants Bancorp

Notes to Condensed Consolidated Financial Statements

(Unaudited)

Loan Portfolio Summary‌

Loans receivable at September 30, 2022 and December 31, 2021 include:


	September 30,		December 31,
	2022		2021

	(In thousands)

Mortgage warehouse lines of credit	$	815,084	$	781,437
Residential real estate		1,030,075		843,101
Multi-family financing⁽¹⁾		2,766,950		2,702,042
Healthcare financing⁽¹⁾		1,429,675		826,157
Commercial and commercial real estate		810,731		520,199
Agricultural production and real estate		91,913		97,060
Consumer and margin loans		13,696		12,667
		6,958,124		5,782,663
Less:
ACL-Loans		38,996		31,344

Loans Receivable	$	6,919,128	$	5,751,319

(1)

In 2022, the Company started presenting these two loan types on separate lines for reporting purposes.

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 repurchase agreement, 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 London Interbank Offered Rate (“LIBOR”) or the Federal Reserve’s Secured Overnight Financing Rate (“SOFR”), or mortgage note rate and 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. However, the warehouse customers are required to hedge the change in value of these loans to mitigate the risk.

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. First-lien HELOC mortgages included in this segment typically carry a base rate of 30-day LIBOR or the One-Year Constant Maturity Treasury (“CMT”), plus a margin.

Multi-Family Financing (MF FIN): The Company engages in multi-family financing, including construction loans, specializing in originating and servicing loans for multi-family rental 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 are dependent on the cash flow of the property, and may include permanent loans, sales of developed property or an interim loan commitment from the Company until permanent agency-eligible financing is obtained. Credit risk in these loans may be impacted by the creditworthiness of a borrower, property values

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Merchants Bancorp

Notes to Condensed Consolidated Financial Statements

(Unaudited)

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. Loans included in this segment typically carry a base rate of SOFR that adjusts on a monthly basis and a margin.

Healthcare Financing (HC FIN): The healthcare financing portfolio includes customized loan products for independent living, assisted living, memory care and skilled nursing projects. A variety of loan products are available to accommodate rehabilitation, acquisition, and refinancing of healthcare properties. Credit risk in these loans are primarily driven by local demographics and the expertise of the operators of the facilities. 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, as well as successful operation of a business or property and the borrower’s cash flows. Loans included in this segment typically carry a base rate of SOFR that adjusts on a monthly basis and a margin.

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, equipment purchases and expansions, as well as loans to commercial customers to finance land and improvements. It also includes loans collateralized by servicing rights and loan sale proceeds 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. PPP loans and Small Business Administration (“SBA”) loans are included in this category.

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. Agricultural real estate loans included in this segment are typically structured with a one-year ARM, 3-year ARM or 5-year ARM CMT and a margin. Agriculture production, livestock, and equipment loans are structured with variable rates that are indexed to prime or fixed for terms not exceeding 5 years.

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.

ACL-Loans

The Company adopted CECL on January 1, 2022. CECL replaces the previous “Allowance for Loan and Lease Losses” standard for measuring credit losses. Upon adoption of CECL, the difference in the two measurements was recorded in the ACL-Loans and retained earnings.

The ACL-Loans is the Company’s estimate of expected credit losses. Loans receivable is presented net of the allowance to reflect the principal balance expected to be collected over the contractual term of the loans. This life of loan allowance is established through a provision for credit losses charged to net interest income as loans are recorded in the financial statements. The provision for a reporting period also reflects increases or decreases in the allowance related to changes in credit loss expectations. Actual credit losses are charged against the allowance when management believes the uncollectability of a loan balance, or a portion thereof, is confirmed. Subsequent recoveries, if any, are credited to the allowance.

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Merchants Bancorp

Notes to Condensed Consolidated Financial Statements

(Unaudited)

The ACL-Loans is evaluated on a regular basis by management and is based upon management’s periodic review of the collectability of the loans considering relevant available information from internal and external sources, including 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. The allowance also incorporates reasonable and supportable forecasts. There have been no changes to the credit quality components used to assess risk during the nine months ended September 30, 2022. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available. The level of the ACL is believed to be adequate to absorb innate expected future losses in the loan portfolio as of the measurement date.

The ACL-Loans consists of individually evaluated loans and pooled loan components. The Company’s primary portfolio segmentation is by credit risk grade. Loans risk graded substandard and worse are individually evaluated for expected credit losses. For individually evaluated loans that are collateral dependent, an allowance is established when the fair value of the collateral, the loan’s obtainable market price, or the present value of expected future cash flows discounted at the loan’s effective interest rate, is lower than the carrying value of that loan. A loan is considered to be collateral dependent when repayment is expected to be provided substantially through the operation or the sale of the collateral.

To calculate the allowance for expected credit losses on loans risk graded pass through special mention, the loan portfolio is segmented into 14 segments comprised of loans with similar risk characteristics.


Loan Portfolio Segment		ACL-Loans Methodology

Ag loans		Remaining Life Method
Ag real estate loans		Remaining Life Method
Commercial loans		Discounted Cash Flow
Commercial real estate loans		Discounted Cash Flow
Consumer and margin loans		Remaining Life Method
HELOC loans		Discounted Cash Flow
Multi-family healthcare loans		Discounted Cash Flow
Multi-family non-management loans		Discounted Cash Flow
Multi-family construction loans		Discounted Cash Flow
Multi-family loans		Discounted Cash Flow
Residential real estate loans		Discounted Cash Flow
SBA commercial loans		Discounted Cash Flow
SBA real estate commercial loans		Discounted Cash Flow
Single-family warehouse lines of credit		Remaining Life Method

Loan characteristics used in determining the segmentation included the underlying collateral, type or purpose of the loan, and expected credit loss patterns. The estimation of expected credit losses for each segment is primarily based on historical credit loss experience. Given the Company’s modest historical credit loss experience, peer and industry data was incorporated into the measurement. Expected life of loan credit losses are quantified using discounted cash flows and remaining life methodologies. For the ten portfolio segments where the discounted cash flow method was employed, econometric models are utilized to determine a Probability of Default (“PD”). Macroeconomic factors utilized in the modeling process include the national unemployment rate and the home price index. A risk index was then utilized to predict the Loss Given Default (“LGD”). The PD is then multiplied by the LGD to determine the expected loss that is incorporated into the discounted cash flow calculations. Within the discount cash flow calculation, an effective yield of the instrument is calculated, net of the impacts of prepayment assumptions, and the instrument expected cash flows are then discounted at that effective yield to produce an instrument-level net present value of expected cash flows. An ACL is established for the difference between the instrument’s net present value and amortized cost basis. The remaining life method applies average loss rates for each segment to estimated loan balances for the remaining life of the segment.

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Merchants Bancorp

Notes to Condensed Consolidated Financial Statements

(Unaudited)

The estimate includes a four-quarter reasonable and supportable economic forecast period followed by an eight-quarter, straight-line reversion period to the historical mean for the remaining life of the loans. Model results are supplemented by qualitative adjustments for risk factors relevant in assessing the expected credit losses within the portfolio segments. These adjustments may increase or decrease the estimate of expected credit losses based upon the assessed level of risk for each qualitative factor. The various risks that are considered in making qualitative adjustments include (i) changes in the value of underlying collateral for collateral dependent loans, (ii) the effect of other external factors such as regulatory and legal requirements, the impact of (i) changes in national, regional and local economic conditions, (ii) changes in lending policies and procedures, (iii) changes in the volume and severity of past due loans, (iv) changes in the nature and volume of the loan portfolio, (v) changes in the experience, depth and ability of lending management, (vi) the existence and effect of any concentrations in credit, (vii) changes in the quality of the credit review function.

The models utilized and the applicable qualitative adjustments require assumptions and management judgement that can be subjective in nature. The above measurement approach is also used to estimate the expected credit losses associated with unfunded loan commitments, which also incorporates expected utilization rates.

The following tables present, by loan portfolio segment, the activity in the ACL-Loans for the three and nine months ended September 30, 2022:


	For the Three Months Ended September 30, 2022
	MTG WHLOC		RES RE		MF FIN		HC FIN		CML & CRE		AG & AGRE		CON & MAR		TOTAL

	(In thousands)
ACL-Loans
Balance, beginning of period	$	2,422	$	4,910	$	16,364	$	7,936	$	5,195	$	551	$	96	$	37,474
Provision for credit losses		(230)		1,370		(2,365)		1,061		1,821		1		51		1,709
Loans charged to the allowance		—		(4)		—		—		(275)		—		—		(279)
Recoveries of loans previously charged off		—		—		—		—		92		—		—		92
Balance, end of period	$	2,192	$	6,276	$	13,999	$	8,997	$	6,833	$	552	$	147	$	38,996


	For the Nine Months Ended September 30, 2022
	MTG WHLOC		RES RE		MF FIN		HC FIN		CML & CRE		AG & AGRE		CON & MAR		TOTAL

	(In thousands)
ACL-Loans
Balance, beginning of period	$	1,955	$	4,170	$	14,084	$	4,461	$	5,879	$	657	$	138	$	31,344
Impact of adopting CECL		41		275		520		139		(1,277)		(18)		21		(299)
Provision for credit losses		196		1,835		(605)		4,397		2,726		(87)		(4)		8,458
Loans charged to the allowance		—		(4)		—		—		(1,238)		—		(15)		(1,257)
Recoveries of loans previously charged off		—		—		—		—		743		—		7		750
Balance, end of period	$	2,192	$	6,276	$	13,999	$	8,997	$	6,833	$	552	$	147	$	38,996

The Company recorded a provision for credit losses of $2.2 million for the three months ended September 30, 2022. The $2.2 million provision for credit losses consisted of $1.7 million for the ACL-Loans, $0.5 million for the ACL-OBCE’s and $0 for the contingent reserve related to the Freddie Mac-sponsored Q-series securitization transaction.

The Company recorded a provision for credit losses of $10.9 million for the nine months ended September 30, 2022. The $10.9 million provision for credit losses consisted of $8.5 million for the ACL-Loans, $1.2 million for the ACL-OBCE’s, and $1.2 million for the contingent reserve related to the Freddie Mac-sponsored Q-series securitization transaction.

Prior to the adoption of CECL, the Company maintained an allowance for loan losses in accordance with the incurred loss model as disclosed in the Company’s 2021 Annual Report on Form 10-K.

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Merchants Bancorp

Notes to Condensed Consolidated Financial Statements

(Unaudited)

The following tables present the allowance for loan losses for the three and nine months ended September 30, 2021:


	For the Three Months Ended September 30, 2021
	MTG WHLOC		RES RE		MF FIN		HC FIN		CML & CRE		AG & AGRE		CON & MAR		TOTAL

	(In thousands)
Allowance for loan losses
Balance, beginning of period	$	2,935	$	3,969	$	11,678	$	4,104	$	5,239	$	611	$	160	$	28,696
Provision for credit losses		(705)		105		1,105		324		296		(2)		(44)		1,079
Loans charged to the allowance		—		—		—		—		(650)		—		—		(650)
Recoveries of loans previously charged off		—		—		—		—		—		—		9		9
Balance, end of period	$	2,230	$	4,074	$	12,783	$	4,428	$	4,885	$	609	$	125	$	29,134


	For the Nine Months Ended September 30, 2021
	MTG WHLOC		RES RE		MF FIN		HC FIN		CML & CRE		AG & AGRE		CON & MAR		TOTAL

	(In thousands)
Allowance for loan losses
Balance, beginning of period	$	4,018	$	3,334	$	12,041	$	2,690	$	4,641	$	636	$	140	$	27,500
Provision for credit losses		(1,788)		742		742		1,738		1,046		(27)		(26)		2,427
Loans charged to the allowance		—		(2)		—		—		(802)		—		(6)		(810)
Recoveries of loans previously charged off		—		—		—		—		—		—		17		17
Balance, end of period	$	2,230	$	4,074	$	12,783	$	4,428	$	4,885	$	609	$	125	$	29,134

The following table presents the allowance for loan losses and the recorded investment in loans and impairment method as of December 31, 2021:


	December 31, 2021
	MTG WHLOC		RES RE		MF FIN		HC FIN		CML & CRE		AG & AGRE		CON & MAR		TOTAL

	(In thousands)
Allowance for loan losses
Balance, December 31, 2021	$	1,955	$	4,170	$	14,084	$	4,461	$	5,879	$	657	$	138	$	31,344
Ending balance: individually evaluated for impairment	$	—	$	16	$	—	$	—	$	867	$	—	$	7	$	890
Ending balance: collectively evaluated for impairment	$	1,955	$	4,154	$	14,084	$	4,461	$	5,012	$	657	$	131	$	30,454
Loans
Balance, December 31, 2021	$	781,437	$	843,101	$	2,702,042	$	826,157	$	520,199	$	97,060	$	12,667	$	5,782,663
Ending balance individually evaluated for impairment	$	—	$	419	$	36,760	$	—	$	6,055	$	158	$	13	$	43,405
Ending balance collectively evaluated for impairment	$	781,437	$	842,682	$	2,665,282	$	826,157	$	514,144	$	96,902	$	12,654	$	5,739,258

The below table presents the amortized cost basis and ACL-Loans allocated for collateral dependent loans, which are individually evaluated to determine expected credit losses:


	September 30, 2022
	Real Estate		Accounts Receivable / Equipment		Other		Total		ACL-Loans Allocation

	(In thousands)
RES RE	$	196	$	—	$	6	$	202	$	22
MF FIN		36,760		—		—		36,760		167
CML & CRE		—		5,036		745		5,781		611
AG & AGRE		147		—		—		147		1
CON & MAR		—		—		3		3		—
Total collateral dependent loans	$	37,103	$	5,036	$	754	$	42,893	$	801

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Merchants Bancorp

Notes to Condensed Consolidated Financial Statements

(Unaudited)

There has been no significant changes to the types of collateral securing the Company’s collateral dependent loans compared to September 30, 2021.

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 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 potential 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.

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Merchants Bancorp

Notes to Condensed Consolidated Financial Statements

(Unaudited)

The following tables present the credit risk profile of the Company’s loan portfolio based on internal risk rating category as of September 30, 2022 and December 31, 2021:


	As of September 30, 2022
	2022		2021		2020		2019		2018		Prior		Revolving Loans		TOTAL

	(In thousands)
MTG WHLOC
Acceptable and Above	$	—	$	—	$	—	$	—	$	—	$	—	$	815,084	$	815,084
Total	$	—	$	—	$	—	$	—	$	—	$	—	$	815,084	$	815,084
RES RE
Acceptable and Above		12,903		7,999		24,802		3,534		730		10,696		968,275		1,028,939
Special Mention (Watch)		—		—		—		61		74		799		—		934
Substandard		—		—		—		—		—		202		—		202
Total	$	12,903	$	7,999	$	24,802	$	3,595	$	804	$	11,697	$	968,275	$	1,030,075
MF FIN
Acceptable and Above		714,724		742,079		245,382		46,557		7,631		7,287		928,462		2,692,122
Special Mention (Watch)		28,529		5,000		4,539		—		—		—		—		38,068
Substandard		36,760		—		—		—		—		—		—		36,760
Total	$	780,013	$	747,079	$	249,921	$	46,557	$	7,631	$	7,287	$	928,462	$	2,766,950
HC FIN
Acceptable and Above		710,459		310,464		183,047		13,860		—		—		112,288		1,330,118
Special Mention (Watch)		30,051		43,903		15,623		9,980		—		—		—		99,557
Total	$	740,510	$	354,367	$	198,670	$	23,840	$	—	$	—	$	112,288	$	1,429,675
CML & CRE
Acceptable and Above		75,569		87,709		28,353		54,185		12,855		9,111		534,600		802,382
Special Mention (Watch)		45		20		971		124		101		230		1,077		2,568
Substandard		—		1,779		604		75		—		671		2,652		5,781
Total	$	75,614	$	89,508	$	29,928	$	54,384	$	12,956	$	10,012	$	538,329	$	810,731
AG & AGRE
Acceptable and Above		9,782		7,716		15,990		6,010		3,255		20,803		26,608		90,164
Special Mention (Watch)		14		64		471		425		163		408		57		1,602
Substandard		—		—		—		—		—		147		—		147
Total	$	9,796	$	7,780	$	16,461	$	6,435	$	3,418	$	21,358	$	26,665	$	91,913
CON & MAR
Acceptable and Above		4,582		575		345		114		4,683		14		3,356		13,669
Special Mention (Watch)		—		—		21		—		—		3		—		24
Substandard		—		—		—		—		—		3		—		3
Total	$	4,582	$	575	$	366	$	114	$	4,683	$	20	$	3,356	$	13,696

Total Acceptable and Above	$	1,528,019	$	1,156,542	$	497,919	$	124,260	$	29,154	$	47,911	$	3,388,673	$	6,772,478
Total Special Mention (Watch)	$	58,639	$	48,987	$	21,625	$	10,590	$	338	$	1,440	$	1,134	$	142,753
Total Substandard	$	36,760	$	1,779	$	604	$	75	$	—	$	1,023	$	2,652	$	42,893
Total Loans	$	1,623,418	$	1,207,308	$	520,148	$	134,925	$	29,492	$	50,374	$	3,392,459	$	6,958,124


	December 31, 2021
	MTG WHLOC		RES RE		MF FIN		HC FIN		CML & CRE		AG & AGRE		CON & MAR		TOTAL

	(In thousands)
Special Mention (Watch)	$	—	$	946	$	27,155	$	66,406	$	2,483	$	3,820	$	21	$	100,831
Substandard		—		419		36,760		—		6,055		158		13		43,405
Acceptable and Above		781,437		841,736		2,638,127		759,751		511,661		93,082		12,633		5,638,427
Total	$	781,437	$	843,101	$	2,702,042	$	826,157	$	520,199	$	97,060	$	12,667	$	5,782,663

The Company did not have any material revolving loans converted to term loans at September 30, 2022.

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

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Merchants Bancorp

Notes to Condensed Consolidated Financial Statements

(Unaudited)

Delinquent Loans

The following tables present the Company’s loan portfolio aging analysis of the recorded investment in loans as of September 30, 2022 and December 31, 2021. There was one loan totaling $36.8 million at September 30, 2022 and December 31, 2021 that had been modified in accordance with the CARES Act and therefore not classified as delinquent. This loan has been granted extended dates to make payments and no payments were due as of September 30, 2022. Also excluded from the tables below are government guaranteed commercial SBA loans totaling $0 and $3.2 million that were 30-59 days past due and government guaranteed commercial SBA loans with balances of $0 and $274,000 that were over 90 days past due as of September 30, 2022 and December 31, 2021, respectively.


	September 30, 2022
	30-59 Days		60-89 Days		Greater Than		Total				Total
	Past Due		Past Due		90 Days		Past Due		Current		Loans

	(In thousands)
MTG WHLOC	$	—	$	—	$	—	$	—	$	815,084	$	815,084
RES RE		627		109		125		861		1,029,214		1,030,075
MF FIN		—		—		—		—		2,766,950		2,766,950
HC FIN		—		—		21,783		21,783		1,407,892		1,429,675
CML & CRE		—		—		3,778		3,778		806,953		810,731
AG & AGRE		59		73		—		132		91,781		91,913
CON & MAR		90		—		5		95		13,601		13,696
	$	776	$	182	$	25,691	$	26,649	$	6,931,475	$	6,958,124


	December 31, 2021
	30-59 Days		60-89 Days		Greater Than		Total				Total
	Past Due		Past Due		90 Days		Past Due		Current		Loans

	(In thousands)
MTG WHLOC	$	—	$	—	$	—	$	—	$	781,437	$	781,437
RES RE		1,252		287		186		1,725		841,376		843,101
MF FIN		—		—		—		—		2,702,042		2,702,042
HC FIN		—		—		—		—		826,157		826,157
CML & CRE		591		8		149		748		519,451		520,199
AG & AGRE		37		21		—		58		97,002		97,060
CON & MAR		43		5		40		88		12,579		12,667
	$	1,923	$	321	$	375	$	2,619	$	5,780,044	$	5,782,663

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Merchants Bancorp

Notes to Condensed Consolidated Financial Statements

(Unaudited)

Impaired Loans

The following table presents impaired loans and specific valuation allowance information based on class level as of December 31, 2021:


	December 31, 2021
	MTG WHLOC		RES RE		MF FIN		HC FIN		CML & CRE		AG & AGRE		CON & MAR		TOTAL

	(In thousands)
Impaired loans without a specific allowance:
Recorded investment	$	—	$	372	$	36,760	$	—	$	3,912	$	158	$	4	$	41,206
Unpaid principal balance		—		372		36,760		—		3,912		158		4		41,206
Impaired loans with a specific allowance:		—						—
Recorded investment		—		47		—		—		2,143		—		9		2,199
Unpaid principal balance		—		47		—		—		2,143		—		9		2,199
Specific allowance		—		16		—		—		867		—		7		890
Total impaired loans:
Recorded investment		—		419		36,760		—		6,055		158		13		43,405
Unpaid principal balance		—		419		36,760		—		6,055		158		13		43,405
Specific allowance		—		16		—		—		867		—		7		890

The following table presents by portfolio class, information related to the average recorded investment and interest income recognized on impaired loans for the three and nine months ended September 30, 2021:


		For the Three Months Ended September 30, 2021
	MTG WHLOC		RES RE		MF FIN		HC FIN		CML & CRE		AG & AGRE		CON & MAR		TOTAL


Average recorded investment in impaired loans	$	—	$	595	$	9,190	$	—	$	6,731	$	158	$	6	$	16,680
Interest income recognized		—		30		—		—		82		—		—		112


		For the Nine Months Ended September 30, 2021
	MTG WHLOC		RES RE		MF RE		HC FIN		CML & CRE		AG & AGRE		CON & MAR		TOTAL


Average recorded investment in impaired loans	$	—	$	1,885	$	7,352	$	—	$	7,307	$	747	$	7	$	17,298
Interest income recognized		—		57		—		—		341		—		—		398

Nonperforming Loans

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

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Merchants Bancorp

Notes to Condensed Consolidated Financial Statements

(Unaudited)

agreement. Most generally, this is at 90 or more days past due. The amount of interest income recognized on nonaccrual financial assets during the nine months ended September 30, 2022 was immaterial.

The following table presents the Company’s nonaccrual loans and loans past due 90 days or more and still accruing at September 30, 2022 and December 31, 2021.


	September 30,				December 31,
	2022				2021
			Total Loans >				Total Loans >
			90 Days &				90 Days &
	Nonaccrual		Accruing		Nonaccrual		Accruing

	(In thousands)
RES RE	$	201	$	21	$	362	$	22
MF RE		21,783		—		—		—
CML & CRE		4,393		—		—		149
AG & AGRE		147		—		158		30
CON & MAR		3		2		4		36
	$	26,527	$	23	$	524	$	237

The Company did not have any nonperforming loans without an estimated ACL at September 30, 2022.

No troubled loans were modified during the three or nine months ended September 30, 2022 or 2021. No restructured loans defaulted during the three or nine months ended September 30, 2022 or 2021. Loan modifications or forbearances related to the COVID-19 pandemic will generally not be considered TDRs.

The CARES Act included several provisions designed to help financial institutions like the Company in working with their customers. Section 4013 of the CARES Act, as extended, allows a financial institution to elect to suspend generally accepted accounting principles and regulatory determinations with respect to qualifying loan modifications related to COVID-19 that would otherwise be categorized as a TDR until January 1, 2022. The Company has taken advantage of this provision to extend certain payment modifications to loan customers in need. As of September 30, 2022, the Company has only one loan totaling $36.8 million that was modified during 2020 or 2021 under the CARES Act guidance, that remain on modified terms. The Company modified other loans under the guidance that have since returned to normal repayment status as of September 30, 2022.

There were no residential loans in process of foreclosure as of September 30, 2022 and December 31, 2021.

Significant Loan Sales

Loan Sale and Securitization - 2022 Activity

On September 22, 2022, the Company completed a private securitization by which a $1.2 billion portfolio of multi-family bridge loans was sold into a real estate mortgage investment conduit (“REMIC”) and ultimately sold to investors as securities. The Company purchased one of the securities for a total of $1.0 billion and classified it as a held to maturity security at September 30, 2022. An unaffiliated, third-party institutional investor purchased the remaining subordinate interests and maintains the first-loss position on 13.4% of the losses in the loan portfolio.

As part of the securitization transaction, the Company will be both Master Servicer and Special Servicer of the loans. As Master Servicer and Special Servicer, the Company will have obligations to collect and remit payments of principal and interest, manage payments of taxes and insurance, and otherwise administer the underlying loans.

Beyond servicing the loans, the Company’s ongoing involvement in this transaction is limited to customary obligations of loan sales, including any material breach in representation. In connection with the securitization, the Company received proceeds and accrued interest on loans, net of the acquired securities, of $150.6 million. No allowance for credit losses was recognized in connection with purchase of the security, in accordance with ASC 326.

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Merchants Bancorp

Notes to Condensed Consolidated Financial Statements

(Unaudited)

However, the $4.0 million allowance for credit losses associated with the loans sold was released through the provision for credit losses.

The transfer of these loans was accounted for as a sale for financial reporting purposes, in accordance with ASC 860, and a $525,000 net loss on sale was recognized. The net loss on sale included a $5.4 million pricing loss and $4.9 million in transaction expenses partially offset by a $6.7 million positive impact of capitalizing servicing rights associated with this transaction and a $3.2 million release of deferred fees on loans sold.

Freddie Mac Q Series Securitization - 2022 Activity

On May 5, 2022, the Company entered into an arrangement through a third-party trust and Freddie Mac, by which a $214.0 million portfolio of multi-family loans were sold to the trust and ultimately securitized through Freddie Mac and sold to investors. The Company did not purchase any of the securities. The transfer of these loans was accounted for as a sale for financial reporting purposes, in accordance with ASC 860, and a $2.3 million net gain on sale was recognized, which included establishing a contingent and noncontingent reserve and servicing rights associated with this transaction.

The Company’s ongoing involvement in this transaction is limited to customary obligations of loan sales, including any material breach in representation. In connection with the securitization, the Company also entered into a reimbursement agreement for a first loss position in the underlying loan portfolio, not to exceed 12% of the unpaid principal amount of the loans comprising the securitization pool at settlement, or approximately $25.7 million. A contingent reserve of $1.2 million for estimated losses was established with respect to the first loss obligation on May 5, 2022, which was included in provision for credit losses on the consolidated statement of income and other liabilities on the consolidated balance sheet. A noncontingent reserve of $2.5 million related to the Company’s reimbursement obligation was included in other liabilities on the consolidated balance sheet and offset through gain on sale in the consolidated statement of income. The Company was also required to hold collateral against the reimbursement agreement. Accordingly, $27.0 million of U.S. Treasury securities were acquired as part of the transaction.

As part of the securitization transaction, the Company released all mortgage servicing obligations and rights to Freddie Mac, who was designated as the Master Servicer. Freddie Mac appointed the Company with sub-servicing obligations, which include obligations to collect and remit payments of principal and interest, manage payments of taxes and insurance, and otherwise administer the underlying loans. Accordingly, the Company recognized a mortgage servicing asset of $1.2 million on the sale date.

Freddie Mac Q Series Securitization - 2021 Activity

On May 7, 2021, the Company entered into an arrangement through a third-party trust and Freddie Mac, by which a $262.0 million portfolio of multi-family loans were sold to the trust and ultimately securitized through Freddie Mac and sold to investors. The Company purchased two of the securities for a total of $28.7 million. The transfer of these loans was accounted for as a sale for financial reporting purposes, in accordance with ASC 860, and a $676,000 net loss on sale was recognized, which included the impact of establishing a risk share allowance and servicing rights associated with this transaction.

Beyond holding the two securities, the Company’s ongoing involvement in this transaction is limited to customary obligations of loan sales, including any material breach in representation. In connection with the securitization and purchase of one of the securities, Merchants maintains a first loss position in the underlying loan portfolio not to exceed 10% of the unpaid principal amount of the loans comprising the securitization pool at settlement, or approximately $26.2 million. Therefore, a reserve of $1.4 million for estimated losses was established with respect to the first loss obligation at May 7, 2021, which was included in other liabilities on the consolidated balance sheets. These estimated losses were consistent with the amount in allowance for loan losses that was released when the loans were sold. If the Company sells one of the securities, this first loss obligation would be eliminated.

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Merchants Bancorp

Notes to Condensed Consolidated Financial Statements

(Unaudited)

As part of the securitization transaction, Merchants released all mortgage servicing obligations and rights to Freddie Mac who was designated as the Master Servicer. As Master Servicer, Freddie Mac appointed the Company with sub-servicing obligations, which include obligations to collect and remit payments of principal and interest, manage payments of taxes and insurance, and otherwise administer the underlying loans. Accordingly, the company recognized a mortgage servicing asset of $730,000 on the sale date.

During the three and nine months ended September 30, 2022, one of these securities was sold at book value resulting in no gain or loss, and the other security was fully amortized resulting in no gain or loss.

Loans Purchased

The Company purchased $289.0 million and $313.0 million of loans during the nine months ended September 30, 2022 and 2021, respectively.

Note 5: Variable Interest Entities (VIEs)

A VIE is a corporation, partnership, limited liability company, or any other legal structure used to conduct activities or hold assets generally that either:

●

Does not have equity investors with voting rights that can directly or indirectly make decisions about the entity’s activities through those voting rights or similar rights; or

●

Has equity investors that do not provide sufficient equity for the entity to finance its activities without additional subordinated financial support.

The Company has invested in single-family, multi-family, and healthcare debt financing entities, as well as low-income housing syndicated funds that are deemed to be VIEs. The Company also has deemed as a VIE, a real estate mortgage investment conduit (“REMIC”) trust that was established in conjunction with the September 2022 multi-family loan sale and securitization described in Note 4: Loans and Allowance for Credit Losses on Loans. Accordingly, the entities were assessed for potential consolidation under the VIE model that requires primary beneficiaries to consolidate the entity’s results. A primary beneficiary is defined as the party that has both the power to direct the activities that most significantly impact the entity, and an interest that could be significant to the entity. To determine if an interest could be significant to the entity, both qualitative and quantitative factors regarding the nature, size and form of involvement with the entity are evaluated.

At September 30, 2022 the Company determined it was not the primary beneficiary of its VIEs, primarily because the Company did not have the obligation to absorb losses or the rights to receive benefits from the VIE that could potentially be significant to the VIE. Evaluation and assessment of VIEs for consolidation is performed on an ongoing basis by management. Any changes in facts and circumstances occurring since the previous primary beneficiary determination will be considered as part of this ongoing assessment.

The Company’s maximum exposure to loss associated with its VIEs consists of the capital invested plus any unfunded equity commitments. These investments are recorded in other assets and other liabilities on our consolidated balance sheet. The table below reflects the size of the VIEs as well as our maximum exposure to loss in connection with VIEs at September 30, 2022, and December 31, 2021.

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Merchants Bancorp

Notes to Condensed Consolidated Financial Statements

(Unaudited)


	Total		Total		Maximum
Assets ($ in thousands)	Assets		Liabilities		Exposure to Loss

	(In thousands)
September 30, 2022
Unconsolidated VIEs	$	56,289	$	30,660	$	55,014
December 31, 2021
Unconsolidated VIEs	$	36,573	$	21,014	$	36,164

In addition to the table above, the Company also has a VIE in a REMIC trust that was established in September 2022 in conjunction with a loan sale and securitization. Although the trust is not recognized on the balance sheet, the maximum exposure to loss is the carrying value of the security acquired as part of the securitization transaction, which was $1.0 billion at September 30, 2022. This transaction is described in Note 4: Loans and Allowance for Credit Losses on Loans.

Note 6: 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’s, 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, 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.

On November 13, 2019, the federal regulators finalized and adopted a regulatory capital rule establishing a new community bank leverage ratio (“CBLR”), which became effective on January 1, 2020. Eligibility criteria to utilize CBLR included having total assets less than $10 billion and off-balance sheet exposures that were less than 25% of total assets, among others. The Company, Merchants Bank, and FMBI elected to begin using CBLR in the first quarter of 2020 and utilized this measure of reporting through June 30, 2022.

At September 30, 2022 the Company’s total assets exceeded $10 billion, off-balance sheets exposures exceeded 25% of total assets, and the allowable grace periods under the CBLR rules expired. Accordingly, the Company began reporting fully phased-in Basel III risk-based capital ratios at September 30, 2022.

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 September 30, 2022 and December 31, 2021, that the Company, Merchants Bank, and FMBI met all capital adequacy requirements to which they were subject.

As of September 30, 2022 and December 31, 2021, 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. There are no conditions or events since that notification that management believes have changed the Company’s, Merchants Bank’s, or FMBI’s category.

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Merchants Bancorp

Notes to Condensed Consolidated Financial Statements

(Unaudited)

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


					Minimum				Minimum
					Amount Required				Amount To Be
					for Adequately				Well
	Actual				Capitalized⁽¹⁾				Capitalized⁽¹⁾
	Amount		Ratio		Amount		Ratio		Amount		Ratio

	(Dollars in thousands)
September 30, 2022
Total capital⁽¹⁾ (to risk-weighted assets)
Company	$	1,454,722	12.5	%	$	932,855	8.0	%	$	—	N/A	%
Merchants Bank		1,376,248	12.0	%		915,426	8.0	%		1,144,283	10.0
FMBI		33,514	11.5	%		23,351	8.0	%		29,189	10.0	%
Tier I capital⁽¹⁾ (to risk-weighted assets)
Company		1,405,621	12.1	%		699,641	6.0	%		—	N/A	%
Merchants Bank		1,327,929	11.6	%		686,570	6.0	%		915,426	8.0
FMBI		32,732	11.2	%		17,513	6.0	%		23,351	8.0	%
Common Equity Tier I capital⁽¹⁾ (to risk-weighted assets)
Company		906,102	7.8	%		524,731	4.5	%		—	N/A	%
Merchants Bank		1,327,929	11.6	%		514,927	4.5	%		743,784	6.5
FMBI		32,732	11.2	%		13,135	4.5	%		18,973	6.5	%
Tier I capital⁽¹⁾ (to average assets)
Company		1,405,621	12.3	%		456,766	4.0	%		—	N/A	%
Merchants Bank		1,327,929	11.9	%		446,683	4.0	%		558,354	5.0
FMBI		32,732	10.5	%		12,499	4.0	%		15,624	5.0	%

(1)

As defined by regulatory agencies.


					Minimum Amount
					To Be Well
	Actual				Capitalized⁽¹⁾
	Amount		Ratio		Amount		Ratio

	(Dollars in thousands)
December 31, 2021
CBLR (Tier 1) capital⁽¹⁾ (to average assets)
(i.e., CBLR - leverage ratio)
Company	$	1,138,090	10.4	%	$	928,731	> 8.5	%
Merchants Bank		1,088,621	10.3	%		901,188	> 8.5	%
FMBI		28,958	9.7	%		25,499	> 8.5	%

(1)

As defined by regulatory agencies.

Table of Contents

Merchants Bancorp

Notes to Condensed Consolidated Financial Statements

(Unaudited)

Note 7: 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.

Forward Sales Commitments, Interest Rate Lock Commitments, and Interest Rate Swaps

The Company enters into forward contracts for the future delivery of mortgage loans to third party investors and enters into interest rate lock commitments 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.

Interest rate swaps are also used by the Company to reduce the risk that significant increases in interest rates may have on the value of certain loans held for sale and the respective loan payments received from borrowers. All changes in the fair market value of these interest rate swaps and loans held for sale have been included in gain on sale of loans. Any difference between the fixed and floating interest rate components of these transactions have been included in interest income.

All 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.

The following table presents the notional amount and fair value of interest rate locks, forward contracts, and interest rate swaps utilized by the Company at September 30, 2022 and December 31, 2021. This table excludes the fair market value adjustment on loans associated with these derivatives.


		Notional			Fair Value
		Amount	Balance Sheet Location		Asset		Liability

September 30, 2022		(In thousands)			(In thousands)
Interest rate lock commitments	$	22,266	Other assets/liabilities	$	24	$	438
Forward contracts	$	29,213	Other assets/liabilities		1,046		2
Interest rate swaps	$	50,080	Other assets/liabilities		3,405		—
				$	4,475	$	440


		Notional			Fair Value
		Amount	Balance Sheet Location		Asset		Liability

December 31, 2021		(In thousands)			(In thousands)
Interest rate lock commitments	$	58,701	Other assets/liabilities	$	264	$	41
Forward contracts	$	81,250	Other assets/liabilities		86		118
				$	350	$	159

Fair values of these 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 nine months ended September 30, 2022 and 2021.

Table of Contents

Merchants Bancorp

Notes to Condensed Consolidated Financial Statements

(Unaudited)


	Three Months Ended				Nine Months Ended
	September 30,				September 30,
	2022		2021		2022		2021

	(In thousands)					(In thousands)
Derivative gain (loss) included in other income:
Interest rate lock commitments	$	(592)	$	(691)	$	(637)	$	(6,389)
Forward contracts (includes pair-off settlements)		1,091		(322)		5,550		5,785
Net derivative gains (loss)	$	499	$	(1,013)	$	4,913	$	(604)
Gain (loss) included in gain on sale of loans:
Interest rates swaps - change in fair value		3,245		—		3,405		—
Loans held for sale - change in fair value		(3,138)		—		(3,303)		—
Net gain (loss)	$	107	$	—	$	102	$	—

Derivatives on Behalf of Customers

The Company offers derivative contracts to some customers in connection with their risk management needs. These derivatives include back-to-back interest rate swaps. The Company manages the risk associated with these contracts by entering into an equal and offsetting derivative with a third-party dealer. These derivatives generally work together as an economic interest rate hedge, but the Company does not designate them for hedge accounting treatment. Consequently, changes in fair value of the corresponding derivative financial asset or liability were recorded as either a charge or credit to current earnings during the period in which the changes occurred, typically resulting in no net earnings impact. The fair values of derivative assets and liabilities related to derivatives for customers with back-to-back interest rate swaps were recorded in the condensed consolidated balance sheets as follows:


		Notional			Fair Value
		Amount	Balance Sheet Location		Asset		Liability

		(In thousands)			(In thousands)
September 30, 2022	$	78,346	Other assets/liabilities	$	3,413	$	3,413
December 31, 2021	$	135,686	Other assets/liabilities	$	1,131	$	1,131

The gross gains and losses on these derivative assets and liabilities were recorded in other noninterest income and other noninterest expense in the condensed consolidated statements of income as follows:


	Three Months Ended				Nine Months Ended
	September 30,				September 30,
	2022		2021		2022		2021

	(In thousands)					(In thousands)
Gross swap gains	$	249	$	371	$	2,282	$	1,452
Gross swap losses		249		371		2,282		1,452
Net swap gains (losses)	$	—	$	—	$	—	$	—

The Company pledged $2.9 million and $3.9 million in collateral to secure its obligations under back-to-back swap contracts at September 30, 2022 and December 31, 2021, respectively.

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Merchants Bancorp

Notes to Condensed Consolidated Financial Statements

(Unaudited)

Note 8: 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

Table of Contents

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 September 30, 2022 and December 31, 2021:


	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)
September 30, 2022
Mortgage loans in process of securitization	$	137,448	$	—	$	137,448	$	—
Available for sale securities:
Treasury notes		36,312		36,312		—		—
Federal agencies		270,353		—		270,353		—
Mortgage-backed - Government-sponsored entity (GSE)		15,404		—		15,404		—
Loans held for sale		68,785		—		68,785		—
Servicing rights		144,984		—		—		144,984
Derivative assets - interest rate lock commitments		24		—		—		24
Derivative assets - forward contracts		1,046		—		1,046		—
Derivative assets - interest rate swaps		3,405		—		3,405		—
Derivative assets - interest rate swaps (back-to-back)		3,413		—		3,413		—
Derivative liabilities - interest rate lock commitments		438		—		—		438
Derivative liabilities - forward contracts		2		—		2		—
Derivative liabilities - interest rate swaps (back-to-back)		3,413		—		3,413		—


December 31, 2021
Mortgage loans in process of securitization	$	569,239	$	—	$	569,239	$	—
Available for sale securities:
Treasury notes		8,209		8,209		—		—
Federal agencies		263,295		—		263,295		—
Municipals		4,300		—		4,300		—
Mortgage-backed - Government-sponsored entity (GSE)		18,360		—		18,360		—
Mortgage-backed - Non-GSE multi-family		16,465		—		16,465		—
Loans held for sale		48,583		—		48,583		—
Servicing rights		110,348		—		—		110,348
Derivative assets - interest rate lock commitments		264		—		—		264
Derivative assets - forward contracts		86		—		86		—
Derivative assets - interest rate swaps (back-to-back)		1,131		—		1,131		—
Derivative liabilities - interest rate lock commitments		41		—		—		41
Derivative liabilities - forward contracts		118		—		118		—
Derivative liabilities - interest rate swaps (back-to-back)		1,131		—		1,131		—

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 nine months ended September 30, 2022 and the year ended December 31, 2021. For assets classified within Level 3 of the fair value hierarchy, the process used to develop the reported fair value is described below.

Table of Contents

Merchants Bancorp

Notes to Condensed Consolidated Financial Statements

(Unaudited)

Mortgage Loans in Process of Securitization and Available for Sale Securities

Where quoted market prices are available in an active market, securities such as U.S. Treasuries 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 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, municipal securities 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.

Servicing Rights

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, cost of servicing, interest rates, and default rate. Due to the nature of the valuation inputs, 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 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. 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. 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. The fair value of interest rate swaps is based on prices that are obtained from a third party that uses observable market inputs, thereby supporting a Level 2 classification. Changes in fair value of the Company’s derivative financial instruments are recognized through noninterest income and/or noninterest expenses on its condensed consolidated statement of income.

Table of Contents

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 September 30,				Nine Months Ended September 30,
	2022		2021		2022		2021

	(In thousands)				(In thousands)
Servicing rights
Balance, beginning of period	$	130,710	$	98,331	$	110,348	$	82,604
Additions
Originated servicing		11,667		7,125		22,662		23,833
Subtractions
Paydowns		(1,946)		(2,955)		(7,963)		(11,030)
Sales of servicing		—		—		—		(438)
Changes in fair value due to changes in valuation inputs or assumptions used in the valuation model		4,553		2,972		19,937		10,504
Balance, end of period	$	144,984	$	105,473	$	144,984	$	105,473

Derivative Assets - interest rate lock commitments
Balance, beginning of period	$	299	$	487	$	264	$	6,131
Changes in fair value		(275)		(280)		(240)		(5,924)
Balance, end of period	$	24	$	207	$	24	$	207

Derivative Liabilities - interest rate lock commitments
Balance, beginning of period	$	121	$	54	$	41	$	—
Changes in fair value		317		411		397		465
Balance, end of period	$	438	$	465	$	438	$	465

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 September 30, 2022 and December 31, 2021.


	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)
September 30, 2022
Collateral dependent loans	$	4,140	$	—	$	—	$	4,140
December 31, 2021
Impaired loans (collateral-dependent)	$	4,263	$	—	$	—	$	4,263

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.

Table of Contents

Merchants Bancorp

Notes to Condensed Consolidated Financial Statements

(Unaudited)

Collateral Dependent Loans, Net of ACL-Loans

The estimated fair value of collateral dependent loans is based on the appraised fair value of the collateral, less estimated cost to sell. Collateral dependent 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 Chief Credit Officer’s (“CCO)” office. Appraisals and evaluations 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.

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			Weighted
	Fair Value		Technique	Unobservable Inputs	Range	Average
	(In thousands)
At September 30, 2022:
Collateral dependent loans	$	4,140	Market comparable properties	Marketability discount	14% - 22%	22%
Servicing rights - Multi-family	$	109,923	Discounted cash flow	Discount rate	8% - 13%	9%
				Constant prepayment rate	0% - 40%	8%
Servicing rights - Single-family	$	30,274	Discounted cash flow	Discount rate	9% - 10%	9%
				Constant prepayment rate	5% - 9%	7%
Servicing rights - SBA	$	4,787	Discounted cash flow	Discount rate	16%	16%
				Constant prepayment rate	3% - 12%	8%
Derivative assets - interest rate lock commitments	$	24	Discounted cash flow	Loan closing rates	65% - 99%	85%
Derivative liabilities - interest rate lock commitments	$	438	Discounted cash flow	Loan closing rates	65% - 99%	85%

At December 31, 2021:
Collateral-dependent impaired loans	$	4,263	Market comparable properties	Marketability discount	44% - 76%	73%
Servicing rights - Multi-family	$	84,567	Discounted cash flow	Discount rate	8% - 13%	9%
				Constant prepayment rate	0 - 50%	4%
Servicing rights - Single-family	$	23,012	Discounted cash flow	Discount rate	9% - 10%	9%
				Constant prepayment rate	10 - 13%	11%
Servicing rights - SBA	$	2,769	Discounted cash flow	Discount rate	16%	16%
				Constant prepayment rate	10% - 13%	12%
Derivative assets - interest rate lock commitments	$	264	Discounted cash flow	Loan closing rates	63% - 99%	83%
Derivative liabilities - interest rate lock commitments	$	41	Discounted cash flow	Loan closing rates	63% - 99%	83%

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.

Table of Contents

Merchants Bancorp

Notes to Condensed Consolidated Financial Statements

(Unaudited)

Servicing Rights

The significant unobservable inputs used in the fair value measurement of the Company’s servicing rights are discount rates and constant prepayment rates. These two inputs can drive a significant amount of a market participant’s valuation of servicing rights. Significant increases (decreases) in the discount rate or assumed constant prepayment rates used to value servicing rights would decrease (increase) the value derived.

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 September 30, 2022 and December 31, 2021.


				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)
September 30, 2022
Financial assets:
Cash and cash equivalents	$	323,961		$	323,961	$	323,961	$	—	$	—
Securities purchased under agreements to resell		3,497			3,497		—		3,497		—
Securities held to maturity		1,005,487			1,005,487		—		1,005,487		—
FHLB stock		39,130			39,130		—		39,130		—
Loans held for sale		2,775,965			2,775,965		—		2,775,965		—
Loans receivable, net		6,919,128			6,879,724		—		—		6,879,724
Interest receivable		40,170			40,170		—		40,170		—
Financial liabilities:
Deposits		10,319,479			10,310,126		7,877,318		2,432,808		—
Short-term subordinated debt		20,400			20,400		—		20,400		—
FHLB advances		76,879			76,263		—		76,263		—
Other borrowing		—			—		—		—		—
Interest payable		13,804			13,804		—		13,804		—

December 31, 2021
Financial assets:
Cash and cash equivalents	$	1,032,614		$	1,032,614	$	1,032,614	$	—	$	—
Securities purchased under agreements to resell		5,888			5,888		—		5,888		—
FHLB stock		29,588			29,588		—		29,588		—
Loans held for sale		3,254,616			3,254,616		—		3,254,616		—
Loans receivable, net		5,751,319	��		5,731,500		—		—		5,731,500
Interest receivable		24,103			24,103		—		24,103		—
Financial liabilities:
Deposits		8,982,613			8,982,680		7,783,553		1,199,127		—
Short-term subordinated debt		17,000			17,000		—		17,000		—
FHLB advances		556,954			556,925		—		556,925		—
Other borrowing		460,000			460,000		—		460,000		—
Interest payable		1,469			1,469		—		1,469		—

Table of Contents

Merchants Bancorp

Notes to Condensed Consolidated Financial Statements

(Unaudited)

Note 9: Leases

The Company has operating leases for various locations with terms ranging from two to eleven years. Some operating leases included in the right-of-use asset include options to extend the leases if the likelihood of extension was fairly certain. The Company elected not to separate non-lease components from lease components for its operating leases.

The Company has operating lease right-of-use assets of $11.6 million and operating lease liabilities of $12.3 million as of September 30, 2022.

Balance sheet, income statement and cash flow detail regarding operating leases follows:


		September 30, 2022
Balance Sheet		(In thousands)
Operating lease right-of-of use asset (in other assets)	$	11,569
Operating lease liability (in other liabilities)		12,292

Weighted average remaining lease term (years)		6.8
Weighted average discount rate		2.63%

Maturities of lease liabilities:
2022 remaining	$	453
2023		2,129
2024		2,297
2025		1,881
2026		1,911
Thereafter		4,754
Total future minimum lease payments		13,425
Less: imputed interest		1,133
Total	$	12,292

		Three Months Ended
		September 30, 2022
Income Statement		(In thousands)
Components of lease expense:
Operating lease cost (in occupancy and equipment expense)	$	482

		Nine Months Ended
		September 30, 2022
Income Statement		(In thousands)
Components of lease expense:
Operating lease cost (in occupancy and equipment expense)	$	1,274

		Nine Months Ended
		September 30, 2022
Cash Flow Statement		(In thousands)
Supplemental cash flow information:
Operating cash flows from operating leases	$	1,061

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Notes to Condensed Consolidated Financial Statements

(Unaudited)

Note 10: Earnings Per Share

Earnings per share were computed as follows:


	Three Month Periods Ended September 30,
	2022					2021
			Weighted-	Per				Weighted-	Per
	Net		Average	Share		Net		Average	Share
	Income		Shares	Amount		Income		Shares	Amount
	(In thousands)					(In thousands)
Net income	$	58,488				$	58,503
Dividends on preferred stock		(5,729)					(5,729)
Net income allocated to common shareholders	$	52,759				$	52,774
Basic earnings per share⁽¹⁾			43,107,975	$	1.22			43,176,296	$	1.22
Effect of dilutive securities-restricted stock awards⁽¹⁾			150,950					138,459
Diluted earnings per share⁽¹⁾			43,258,925	$	1.22			43,314,755	$	1.22


	Nine Month Periods Ended September 30,
	2022					2021
			Weighted-	Per				Weighted-	Per
	Net		Average	Share		Net		Average	Share
	Income		Shares	Amount		Income		Shares	Amount
	(In thousands)					(In thousands)
Net income	$	162,565				$	171,903
Dividends on preferred stock		(17,186)					(15,145)
Net income allocated to common shareholders	$	145,379				$	156,758
Basic earnings per share			43,182,380	$	3.37			43,169,618	$	3.63
Effect of dilutive securities-restricted stock awards			148,768					131,070
Diluted earnings per share			43,331,148	$	3.36			43,300,688	$	3.62

(1)	The number of shares and per share amounts have been restated to reflect the 3-for-2 common stock split, effective on January 17, 2022.

Note 11: Common Stock

Stock Splits:

On November 17, 2021, the Company approved a 3-for-2 common stock split. Shareholders of record at the close of business on January 3, 2022 received one additional share of Merchants Bancorp common stock for every two shares owned. These additional shares were distributed on or around January 17, 2022. Cash was distributed in lieu of fractional shares based on the closing price of Merchants’ common stock on Nasdaq on January 3, 2022. The presentation of authorized common shares has been retrospectively adjusted to give effect to the increase, and all share and per share amounts have been retrospectively adjusted to give effect to the split.

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Notes to Condensed Consolidated Financial Statements

(Unaudited)

Repurchase of Common Stock:

The Company did not have any repurchases of common stock during the three months ended September 30, 2022. During the nine months ended September 30, 2022, the Company repurchased 165,037 shares for $3.9 million at an average price of $23.85 per share of common stock. The Company did not have any repurchases of common stock during the three and nine months ended September 30, 2021. The following table presents our repurchase activity on a cash basis:


		Three Months Ended		Nine Months Ended
		September 30,		September 30,
		2022		2022
Dollar value of shares repurchased	$	—	$	3,935,333
Shares repurchased⁽¹⁾		—		165,037
Average price paid per share	$	—	$	23.85

(1)

On November 17, 2021, the Company announced an increase in authorization for its stock repurchase program, up to $75,000,000 of common stock, expiring December 31, 2023. On April 29, 2022, the Company entered into a Rule 10b5-1 plan (the “10b5-1 Plan”) with a broker for the repurchase of shares of its common stock commencing on May 3, 2022. The details of this repurchase plan were provided in the Form 8-K filed by the Company on May 24, 2022.

Note 12: Share-Based Payment Plans

Equity-based incentive awards for Company officers are currently issued pursuant to the 2017 Equity Incentive Plan (the “2017 Incentive Plan”). During the three months ended September 30, 2022 and 2021, the Company did not issue any shares. During the nine months ended September 30, 2022 and 2021, the Company issued 64,962 and 23,435 shares, respectively.

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. In January 2021, the Board of Directors amended the plan for nonexecutive directors to receive a portion of their annual fees, issued quarterly, in the form of restricted common stock equal to $50,000 per member, rounded up to the nearest whole share, to be effective after the Company’s annual meeting of shareholders held in May 2021. There were 3,073 and 8,894 shares issued to non-executive directors during the three and nine months ended September 30, 2022, respectively and there were 2,663 and 4,853 shares issued to non-executive directors during the three and nine months ended September 30, 2021, respectively.

Note 13: Preferred Stock

Public Offerings 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, and with a liquidation preference of $25.00 per share (the “Series A Preferred Stock”). 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 additional $2.0 million in net proceeds, after deducting $41,000 in 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. The Company may redeem the Series A

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Notes to Condensed Consolidated Financial Statements

(Unaudited)

Preferred Stock, in whole or in part, at its option, on any dividend payment date on or after April 1, 2024, subject to the approval of the appropriate federal banking agency, at the liquidation preference, plus any declared and unpaid dividends (without regard to any undeclared dividends) to, but excluding, the date of redemption.

On August 19, 2019, the Company issued 5,000,000 depositary shares, each representing a 1/40^th interest in a share of its 6.00% Fixed-to-Floating Rate Series B Non-Cumulative Perpetual Preferred Stock, without par value (the “Series B Preferred Stock”), and with a liquidation preference of $1,000.00 per share (equivalent to $25.00 per depositary share). The aggregate gross offering proceeds for the shares issued by the Company was $125.0 million, and after deducting underwriting discounts and commissions and offering expenses of approximately $4.2 million paid to third parties, the Company received total net proceeds of $120.8 million. The Series B Preferred Stock have no voting rights with respect to matters that generally require the approval of our common shareholders. Dividends on the Series B Preferred Stock, to the extent declared by the Company’s board, are payable quarterly. The Company may redeem the Series B Preferred Stock, in whole or in part, at its option, on any dividend payment date on or after October 1, 2024, subject to the approval of the appropriate federal banking agency, at the liquidation preference, plus any declared and unpaid dividends (without regard to any undeclared dividends) to, but excluding, the date of redemption.

On March 23, 2021, the Company issued 6,000,000 depositary shares, each representing a 1/40^th interest in a share of its 6.00% Fixed-to-Floating Rate Series C Non-Cumulative Perpetual Preferred Stock, without par value (the “Series C Preferred Stock”), and with a liquidation preference of $1,000.00 per share (equivalent to $25.00 per depositary share). The aggregate gross offering proceeds for the shares issued by the Company was $150.0 million, and after deducting underwriting discounts and commissions and offering expenses of approximately $5.1 million paid to third parties, the Company received total net proceeds of $144.9 million. The Series C Preferred Stock have no voting rights with respect to matters that generally require the approval of our common shareholders. Dividends on the Series C Preferred Stock, to the extent declared by the Company’s board, are payable quarterly. The Company may redeem the Series C Preferred Stock, in whole or in part, at its option, on any dividend payment date on or after April 1, 2026, subject to the approval of the appropriate federal banking agency, at the liquidation preference, plus any declared and unpaid dividends (without regard to any undeclared dividends) to, but excluding, the date of redemption.

On September 27, 2022, the Company issued 5,200,000 depositary shares, each representing a 1/40^th interest in a share of its 8.25% Fixed-to-Floating Rate Series D Non-Cumulative Perpetual Preferred Stock, without par value (the “Series D Preferred Stock”), and with a liquidation preference of $1,000.00 per share (equivalent to $25.00 per depositary share). The aggregate gross offering proceeds for the shares issued by the Company was $130.0 million, and after deducting underwriting discounts and commissions and offering expenses of approximately $4.7 million paid to third parties, the Company received total net proceeds of $125.3 million. On September 30, 2022, the Company issued an additional 500,000 depositary shares of Series D Preferred Stock to the underwriters related to their exercise of an option to purchase additional shares under the associated underwriting agreement, resulting in an additional $12.1 million in net proceeds, after deducting $0.4 million in underwriting discounts. The Series D Preferred Stock have no voting rights with respect to matters that generally require the approval of our common shareholders. Dividends on the Series D Preferred Stock, to the extent declared by the Company’s board, are payable quarterly. The Company may redeem the Series D Preferred Stock, in whole or in part, at its option, on any dividend payment date on or after October 1, 2027, subject to the approval of the appropriate federal banking agency, at the liquidation preference, plus any declared and unpaid dividends (without regard to any undeclared dividends) to, but excluding, the date of redemption.

Private Placement Offerings of Preferred Stock

The Company previously issued a total of 41,625 shares of 8% Non-Cumulative, Perpetual Preferred Stock, without par value, with a liquidation preference of $1,000.00 per share (8% Preferred Stock”) in private placement offerings.

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

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Notes to Condensed Consolidated Financial Statements

(Unaudited)

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 and Chief Executive Officer of MCC; and other accredited investors.

On April 15, 2021, all 41,625 shares of the Company’s 8% preferred stock were redeemed for $41.6 million, plus unpaid dividends of $139,000. On May 6, 2021 these 8% preferred shareholders participated in a private offering to replace their redeemed shares with Series C Preferred Stock. Accordingly, 46,181 shares (1,847,233 depositary shares) of Series C Preferred Stock were issued at a price of $25 per depositary share. The total capital raised from the private offering was $46.2 million, net of $23,000 in expenses.

Repurchase of Preferred Stock:

On September 23, 2019 the Company repurchased and subsequently retired 874,000 shares of its 7.00% Series A Preferred Stock, for its liquidation preference of $25 per share, at an aggregate cost of $21.85 million. There were no brokerage fees in connection with the transaction.

On April 15, 2021, all 41,625 shares of the 8% Preferred Stock were redeemed for $41.6 million, plus unpaid dividends of $139,000, as noted above.

Note 14: Segment Information

Our Company’s 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 the date of origination or purchase, until the date of 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, 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 nine months ended September 30, 2022 and 2021.

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Notes to Condensed Consolidated Financial Statements

(Unaudited)


	Multi-family
	Mortgage		Mortgage
	Banking		Warehousing		Banking		Other		Total

	(In thousands)
Three Months Ended September 30, 2022
Interest income	$	589	$	31,240	$	99,982	$	2,301	$	134,112
Interest expense		—		15,089		34,513		(875)		48,727
Net interest income		589		16,151		65,469		3,176		85,385
Provision for credit losses		—		222		2,003		—		2,225
Net interest income after provision for credit losses		589		15,929		63,466		3,176		83,160
Noninterest income		39,421		1,106		(8,317)		(3,024)		29,186
Noninterest expense		21,741		2,332		3,752		7,126		34,951
Income (loss) before income taxes		18,269		14,703		51,397		(6,974)		77,395
Income taxes		4,903		2,902		12,053		(951)		18,907
Net income (loss)	$	13,366	$	11,801	$	39,344	$	(6,023)	$	58,488
Total assets	$	343,443	$	2,735,278	$	8,760,416	$	139,585	$	11,978,722


	Multi-family
	Mortgage		Mortgage
	Banking		Warehousing		Banking		Other		Total

	(In thousands)
Three Months Ended September 30, 2021
Interest income	$	272	$	33,153	$	42,561	$	1,328	$	77,314
Interest expense		—		2,334		6,904		(805)		8,433
Net interest income		272		30,819		35,657		2,133		68,881
Provision for credit losses		—		(585)		1,664		—		1,079
Net interest income after provision for credit losses		272		31,404		33,993		2,133		67,802
Noninterest income		35,022		2,734		3,803		(1,288)		40,271
Noninterest expense		15,569		2,971		6,304		4,628		29,472
Income (loss) before income taxes		19,725		31,167		31,492		(3,783)		78,601
Income taxes		5,277		7,950		8,029		(1,158)		20,098
Net income (loss)	$	14,448	$	23,217	$	23,463	$	(2,625)	$	58,503
Total assets	$	280,927	$	4,685,037	$	5,950,316	$	35,753	$	10,952,033

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Notes to Condensed Consolidated Financial Statements

(Unaudited)


	Multi-family
	Mortgage		Mortgage
	Banking		Warehousing		Banking		Other		Total

	(In thousands)
Nine Months Ended September 30, 2022
Interest income	$	1,229	$	74,816		217,285	$	6,064	$	299,394
Interest expense		—		22,686		55,066		(1,499)		76,253
Net interest income		1,229		52,130		162,219		7,563		223,141
Provision for credit losses		1,153		849		8,886		—		10,888
Net interest income after provision for credit losses		76		51,281		153,333		7,563		212,253
Noninterest income		121,037		4,316		(16,380)		(6,019)		102,954
Noninterest expense		60,231		7,699		12,960		18,051		98,941
Income (loss) before income taxes		60,882		47,898		123,993		(16,507)		216,266
Income taxes		16,468		11,070		29,953		(3,790)		53,701
Net income	$	44,414	$	36,828	$	94,040	$	(12,717)	$	162,565
Total assets	$	343,443	$	2,735,278	$	8,760,416	$	139,585	$	11,978,722


	Multi-family
	Mortgage		Mortgage
	Banking		Warehousing		Banking		Other			Total

	(In thousands)
Nine Months Ended September 30, 2021
Interest income	$	683	$	101,675	$	123,084	$	3,859	$	229,301
Interest expense		—		5,657		20,559		(2,166)		24,050
Net interest income		683		96,018		102,525		6,025		205,251
Provision for credit losses		—		(1,709)		4,136		—		2,427
Net interest income after provision for credit losses		683		97,727		98,389		6,025		202,824
Noninterest income		96,828		9,930		14,094		(3,790)		117,062
Noninterest expense		45,639		8,570		20,925		12,605		87,739
Income (loss) before income taxes		51,872		99,087		91,558		(10,370)		232,147
Income taxes		14,492		25,239		23,329		(2,816)		60,244
Net income	$	37,380	$	73,848	$	68,229	$	(7,554)	$	171,903
Total assets	$	280,927	$	4,685,037	$	5,950,316	$	35,753	$	10,952,033

Note 15: Recent Accounting Pronouncements

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

FASB ASU 2016-13, Financial Instruments—Credit Losses

The Company adopted FASB Accounting Standards Update (ASU) 2016-13, Financial Instruments—Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments (“CECL”) on January 1, 2022. The amendments in this ASU replace the incurred loss model with a methodology that reflects the “current 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

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Notes to Condensed Consolidated Financial Statements

(Unaudited)

measured at amortized cost, including loans and held-to-maturity debt securities, based on historical experience, current conditions, and reasonable and supportable forecasts.

As of the adoption date on January 1, 2022, the Company recorded a $3.6 million decrease, net of taxes, to retained earnings for the cumulative effect of adopting CECL. The transition adjustment included a $0.3 million increase to retained earnings related to ACL-Loans and a $5.2 million decrease to retained earnings related to ACL-OBCEs.

FASB ASU 2016-02, Leases

In February 2016, the Financial Accounting Standards Board (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 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.

The Company adopted this new guidance on January 1, 2022 and has elected the alternative transition method whereby comparative periods will not be restated. The Company also elected the package of practical expedients permitted under the transition guidance within the new standard. At the adoption date, the Company reported increased assets of approximately $7.1 million, liabilities of approximately $7.2 million, and retained earnings, net of tax of $110,000 on its consolidated balance sheets as a result of recognizing right-of-use assets and lease liabilities related to non-cancelable operating lease agreements.

FASB ASU 2020-04 - Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting

In March 2020, the FASB issued ASU 2020-04, Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting, which provides temporary, optional guidance to ease the potential burden in accounting for, or recognizing the effects of, the transition away from the LIBOR or other interbank offered rate on financial reporting. To help with the transition to new reference rates, the ASU provides optional expedients and exceptions for applying GAAP to affected contract modifications and hedge accounting relationships. The main provisions include:

●

A change in a contract’s reference interest rate would be accounted for as a continuation of that contract rather than as the creation of a new one for contracts, including loans, debt, leases, and other arrangements, that meet specific criteria.

●

When updating its hedging strategies in response to reference rate reform, an entity would be allowed to preserve its hedge accounting.

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Notes to Condensed Consolidated Financial Statements

(Unaudited)

Entities may apply this ASU as of the beginning of an interim period that includes the March 12, 2020 issuance date of the ASU, through December 31, 2022. The Company has organized a committee and implemented a transition plan to identify and modify its loans and other financial instruments with attributes that are either directly or indirectly influenced by LIBOR. All new contracts have incorporated language to address any required transition from LIBOR. The Company will continue to monitor and evaluate existing contracts throughout 2022. The Company believes the adoption of this guidance will not have a material impact on the consolidated financial statements.

FASB ASU 2022-02 - Financial Instruments — Credit Losses (Topic 326): Troubled Debt Restructurings and Vintage Disclosures

In February 2022, the FASB issued an ASU update to eliminate the recognition and measurement guidance on troubled debt restructurings for creditors that have adopted CECL and require enhanced disclosures about loan modifications for borrowers experiencing financial difficulty. The new guidance also requires public business entities to present current-period gross write-offs (on a current year-to-date basis for interim-period disclosures) by year of origination in their vintage disclosures. These changes would be applied on a prospective basis. Disclosure would not be required to prior period comparative periods.

The updates in ASU 2022-02 are effective for interim and annual periods beginning after December 15, 2022. The Company is continuing to evaluate the impact of adopting this new guidance but does not expect it to have a material impact on the Company’s financial position or results of operations.

Note 16: Subsequent Events

No material events were noted.

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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, such as the potential impacts of the COVID-19 pandemic. 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, 2021 or “Item 2 - Management’s Discussion and Analysis of Financial Condition and Results of Operations” of this Form 10-Q or the following:

●

impacts of the COVID-19 pandemic, such as the severity, magnitude, duration, and businesses’ and governments’ responses thereto, on the Company’s operations and personnel, and on activity and demand across its businesses;

●

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 and calculation assumptions of our allowance for credit losses on loans;

●

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 and residential 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;

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●

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 September 30, 2022 and results of operations for the three and nine months ended September 30, 2022 and 2021, is intended to assist in understanding the financial condition and results of operations of the Company. The information contained in this section should be read in conjunction with the unaudited condensed consolidated financial statements and the notes thereto, appearing in Part I, Item 1 of this Form 10-Q.

The words “the Company,” “we,” “our” and “us” refer to Merchants Bancorp and its consolidated subsidiaries, unless we indicate otherwise.

Financial Highlights for the Three Months Ended September 30, 2022

●

Net income of $58.5 million was equal to the three months ended September 30, 2021.

●

Diluted earnings per share of $1.22 was equal to the three months ended September 30, 2021.

●

Net income of $58.5 million for the three months ended September 30, 2022 was equal to the three months ended September 30, 2021, but reflected a $16.5 million, or 24% increase in net interest income that was offset by an $11.1 million, or 28% decrease in noninterest income and a $5.5 million, or 19%, increase in noninterest expenses.

●

Total assets of $12.0 billion increased 8% compared to June 30, 2022, and increased 6% compared to December 31, 2021.

●

Return on average assets was 2.05% compared to 2.29% for the three months ended September 30, 2021.

●

Results reflected a $4.6 million positive fair market value adjustment to servicing rights compared to a $3.0 million positive fair market value adjustment in the three months ended September 30, 2021.

●

Nonperforming loans (nonaccrual and accruing loans greater or equal to 90 days past due) represented 0.38% of loans receivable at September 30, 2022, compared to 0.05% at September 30, 2021 and 0.01% at December 31, 2021.

●

Completed 8.25% Series D preferred stock offering in September 2022, raising approximately $137.4 million of new capital, net of $5.1 million in offering costs.

●

Sold $1.2 billion of multi-family bridge loans into a private securitization via a real estate mortgage investment conduit (“REMIC”) in September 2022. As part of the transaction, purchased a $1.0 billion senior investment security classified as held to maturity. Also see Note 4: Loans and Allowance for Credit Losses on Loans.

●

The volume of loans originated and acquired for sale in the secondary market through our multi-family business decreased by $197.8 million, or 35%, to $367.0 million, compared to $564.8 million for the three months ended September 30, 2021.

●

The volume of warehouse loans funded during the three months ended September 30, 2022 amounted to $8.8 billion, a decrease of $10.9 billion, or 55%, compared to the three months ended September 30, 2021. This compared to the 55% industry decrease in single-family residential loan volumes for the three months ended September 30, 2022 to the same period in 2021, according to an estimate of industry volume by the Mortgage Bankers Association.

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Business Overview

We are a diversified bank holding company headquartered in Carmel, Indiana and registered under the Bank Holding Company Act of 1956, as amended. We currently operate in and service multiple lines of business, including multi-family housing, mortgage warehouse financing, retail and correspondent residential mortgage banking, agricultural lending, Small Business Administration (“SBA”) lending, and traditional community banking. The Company is also a syndicator of low-income housing tax credit and debt funds.

Our business consists primarily of funding low risk loans that sell within 90 days of origination. The gain on sale of loans and servicing fees generated primarily from the multi-family rental real estate loans servicing portfolio contribute to noninterest income. The funding source is primarily from mortgage custodial, municipal, retail, commercial, and brokered deposits. We believe that the combination of net interest income and noninterest income from the sale of low risk profile assets results in lower than industry charge offs and a lower expense base which serves to maximize net income and shareholder return.

Critical Accounting Policies and Estimates

The preparation of our consolidated financial statements requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues, and expenses. These estimates are based upon historical experience and on various other assumptions that management believes are reasonable under the current circumstances. These estimates form the basis for making judgments about the carrying value of certain assets and liabilities that are not readily available from other sources. Actual results may differ from these estimates under different assumptions or conditions.

The Jumpstart Our Business Startups Act of 2012 (“JOBS Act”) contains provisions that, among other things, reduce certain reporting requirements for qualifying public companies. As an “emerging growth company” we may delay adoption of new or revised accounting pronouncements applicable to public companies until such pronouncements are made applicable to private companies. We intend to take advantage of the benefits of this extended transition period until December 31, 2022. 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, 2021. 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, 2021, with the exception of CECL as discussed in Note 1: Basis of Presentation.

Financial Condition

As of September 30, 2022, we had approximately $12.0 billion in total assets, $10.3 billion in deposits and $1.4 billion in total shareholders’ equity. Total assets as of September 30, 2022 included approximately $324.0 million of cash and cash equivalents, $2.8 billion of loans held for sale and $6.9 billion of loans receivable, net of ACL-loans. Assets also included $137.4 million of mortgage loans in process of securitization that represent pre-sold multi-family rental real estate loan originations in primarily Government National Mortgage Association (“GNMA”) mortgage backed securities pending settlements that typically occur within 30 days. There was also a $1.0 billion held to maturity security that was acquired in September 2022 as part of the securitization described in Note 4: Loans and Allowance for Credit Losses on Loans. Additionally, there was $322.1 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. Servicing rights were $145.0

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million at September 30, 2022 based on the fair value of the loan servicing, which are primarily GNMA servicing rights with 10-year call protection.

Comparison of Financial Condition at September 30, 2022 and December 31, 2021

Total Assets. Total assets increased 6% to $12.0 billion at September 30, 2022 from $11.3 billion at December 31, 2021. The increase was due primarily to increases net loans receivable of $1.2 billion and held to maturity securities of $1.0 billion. Partially offsetting the increases were decreases in cash and cash equivalents of $708.7 million, loans held for sale of $458.4 million, and mortgage loans in process of securitization of $431.8 million

Cash and Cash Equivalents. Cash and cash equivalents decreased $708.7 million, or 69%, to $324.0 million at September 30, 2022 from $1.0 billion at December 31, 2021. The 69% decrease reflected intentional reductions in cash levels to manage sources of liquidity in the most cost-effective manner.

Mortgage Loans in Process of Securitization. Mortgage loans in process of securitization decreased $431.8 million, or 76%, to $137.4 million at September 30, 2022, from $569.2 million at December 31, 2021. These represent loans that our banking subsidiary, Merchants Bank, has funded and are held pending settlement, primarily as GNMA mortgage-backed securities with a firm investor commitment to purchase the securities. The 76% decline was primarily due to the industry decline in volume of loans that had not yet settled with government agencies.

Available for Sale Securities. Available for sale securities increased $11.4 million, or 4%, to $322.1 million at September 30, 2022, from $310.6 million at December 31, 2021. The increase in available for sale securities was primarily due to purchases of $50.3 million, partially offset by calls, maturities, and repayments of securities totaling $24.1 million during the period.

Held to Maturity Securities. Held to maturity securities of $1.0 billion were acquired in September 2022 as part of a private securitization described in Note 4: Loans and Allowance for Credit Losses on Loans.

Loans Held for Sale. Loans held for sale, comprised primarily of single-family residential real estate loan participations that meet Federal National Mortgage Association (“Fannie Mae”), Federal Home Loan Mortgage Corporation (“Freddie Mac”), or Ginnie Mae (“GNMA”) eligibility, decreased $458.4 million, or 14%, to $2.8 billion at September 30, 2022 from $3.3 billion at December 31, 2021. The decrease in loans held for sale was due primarily to a decrease in warehouse participations, as the industry experienced lower volume associated with the recent increase in market interest rates. Also contributing to the decrease was the September 2022 loan sale described in Note 4: Loans and Allowance for Credit Losses on Loans.

Loans Receivable, Net. Loans receivable, net, which are comprised of loans held for investment, increased $1.2 billion, or 20%, to $6.9 billion at September 30, 2022 compared to December 31, 2021. The increase in net loans was comprised primarily of:

●

an increase of $64.9 million, or 2%, in multi-family financing loans, to $2.8 billion at September 30, 2022, which reflected significant growth during 2022 that was partially offset by the $1.2 billion multi-family loan sale and private securitization in September 2022 as described in Note 4: Loans and Allowance for Credit Losses on Loans.

●

an increase of $603.5 million, or 73%, in healthcare financing loans, to $1.4 billion at September 30, 2022,

●

an increase of $290.5 million, or 56%, in commercial and commercial real estate loans, to $810.7 million at September 30, 2022, and

●

an increase of $187.0 million, or 22%, in residential real estate loans, to $1.0 billion at September 30, 2022.

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The $64.9 million increase in multi-family financing was due to significantly higher origination volume for construction, bridge and other loans generated through our multi-family segment that will remain on our balance sheet until they convert to permanent financing or are otherwise paid off over an average of one to three years. The growth was offset by the $1.2 billion sale and private securitization in September 2022, as described in Note 4: Loans and Allowance for Credit Losses on Loans.

The $603.5 million increase in healthcare financing was due to higher origination volume for healthcare loans generated through our multi-family segment that typically remain on our balance sheet until they convert to permanent financing or are otherwise paid off over an average of one to three years.

The $290.5 million increase in commercial and commercial real estate was also due to higher origination volume during the period.

The $187.0 million increase in residential real estate loans was primarily due an increase in All-in-One®, first-lien HELOCs.

As of September 30, 2022, approximately 95% of the total net loans at Merchants Bank reprice within three months, which reduces the risk of market rate increases.

Allowance for Credit Losses on Loans. The ACL-Loans of $39.0 million at September 30, 2022 increased $7.7 million compared to December 31, 2021, primarily reflecting increases associated with loan growth and portfolio mix. For additional information on the impact of CECL see Note 4: Loans and Allowance for Credit Losses on Loans.

We have minimal direct exposure to consumer, commercial, and other small businesses that may be negatively impacted by COVID-19, but continue to assist customers facing financial setbacks. As of September 30, 2022, the Company had one loan remaining in a payment deferral arrangement, with an unpaid balance of $36.8 million.

Also influencing the overall level of the ACL-Loans is our differentiated strategy to typically hold loans with shorter durations and to maintain strict underwriting standards that enable us to sell the majority of our loans to government agencies.

Goodwill. Goodwill of $15.8 million at September 30, 2022 remained unchanged compared to December 31, 2021. At this time, we do not believe there exists any impairment to goodwill or intangible assets.

Servicing Rights. Servicing rights increased 31%, to $145.0 million at September 30, 2022 compared to $110.3 million at December 31, 2021. The increase reflected an increase of $22.7 million for originated and purchased servicing and a fair value increase of $19.9 million, which was partially offset by paydowns of $8.0 million. The increase in originated servicing reflected the establishment of a $6.6 million servicing right associated with the September 2022 loan sale described in Note 4: Loans and Allowance for Credit Losses on Loans. The positive fair market value adjustment reflected $6.3 million for single-family and SBA mortgages and $13.6 million for multi-family mortgages during the nine months ended September 30, 2022.

Servicing rights are recognized in connection with sales of loans when we retain servicing of the sold loans, as well as upon purchases of loan servicing portfolios. The servicing rights are recorded and carried at fair value. The fair value increase recorded during the nine months ended September 30, 2022 was driven by higher loan balances of mortgages serviced and higher interest rates that impacted fair market value adjustments. The value of servicing rights generally increases in rising interest rate environments and declines in falling interest rate environments due to expected prepayments.

Other Assets and Receivables. Other assets and receivables of $145.5 million at September 30, 2022 increased $52.5 million, or 56%, compared to $92.9 million at December 31, 2021. The increase was primarily due to the increase to investments in low income housing tax credit funds and investments in variable interest entities involved in single-

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family, multi-family, and healthcare debt financing. See Note 5: Variable Interest Entities (VIEs) for additional information about VIEs. The increase also reflected the establishment of a lease right of use asset on January 1, 2022, in accordance with ASU 2016-02 - “Leases”.

Deposits. Deposits increased $1.3 billion, or 15%, to $10.3 billion at September 30, 2022 from $9.0 billion at December 31, 2021. The 15% increase in total deposits was primarily due to a $1.2 billion increase in certificates of deposit, a $90.2 million increase in demand deposits and a $3.6 million increase in savings deposits.

We increased our use of brokered deposits by $58.9 million, or 3%, to $2.2 billion at September 30, 2022 compared to December 31, 2021. Brokered deposits represented 22% of total deposits at September 30, 2022, compared to 24% of total deposits at December 31, 2021.

●

Brokered certificates of deposit accounts increased by $1.5 billion, or 277%, to $2.1 billion at September 30, 2022 compared to December 31, 2021.

●

Brokered demand deposit accounts decreased by $1.3 billion, or 100%, to $15,000 at September 30, 2022 compared to December 31, 2021.

●

Brokered savings deposits accounts decreased $222.3 million, or 62%, to $135.6 million at September 30, 2022 compared to December 31, 2021.

Although our brokered deposits are short-term in nature, they may be more rate sensitive compared to other sources of funding. In the future, those depositors may not replace their brokered deposits with us as they mature, or we may have to pay a higher rate of interest to keep those deposits or to replace them with other deposits or other sources of funds. Not being able to maintain or replace those deposits as they mature would adversely affect our liquidity. Additionally, if Merchants Bank does not maintain its well-capitalized position, it may not accept or renew any brokered deposits without a waiver granted by the Federal Deposit Insurance Corporation (“FDIC”).

Compared to December 31, 2021, interest-bearing deposits increased $1.6 billion, or 20%, to $10.0 billion at September 30, 2022, and noninterest-bearing deposits decreased $325.6 million, or 51%, to $315.9 million at September 30, 2022.

Borrowings. Borrowings totaled $97.3 million at September 30, 2022, a decrease of $936.7 million, or 91%, from $1.0 billion at December 31, 2021. Depending on rates and timing, borrowing can be a more effective liquidity management alternative than utilizing brokered certificates of deposits. The Company utilizes borrowing facilities from the FHLB, the Federal Reserve’s discount window, and the American Financial Exchange (“AFX”).

The Company continues to have significant borrowing capacity based on available collateral. As of September 30, 2022, unused lines of credit totaled $2.8 billion, compared to $2.4 billion at December 31, 2021.

Total Shareholders’ Equity. Total shareholders’ equity was $1.4 billion as of September 30, 2022, compared to $1.2 billion as of December 31, 2021. The $257.2 million, or 22%, increase resulted primarily from the 8.25% Series D preferred stock offerings that raised $137.4 million in new capital, net of $5.1 million in offering costs, as well as net income of $162.6 million, which was partially offset by dividends paid on common and preferred shares of $26.3 million during the period, as well as $3.6 million adjustment to retained earnings associated with the adoption of CECL. The CECL adjustment related primarily to OBCEs. Additionally, common stock repurchase activity reduced shareholders’ equity in total by $3.9 million.

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Asset Quality

Total nonperforming loans (nonaccrual and greater than 90 days late but still accruing) were $26.6 million, or 0.38%, of total loans at September 30, 2022, compared to $0.8 million, or 0.01%, of total loans at December 31, 2021 and $2.9 million, or 0.05%, at September 30, 2021. The increase compared to both periods was primarily due to the delinquency of one healthcare loan customer that is fully collateralized and full repayment is expected.

As a percentage of nonperforming loans, the ACL-Loans was 147% at September 30, 2022 compared to 4,119% at December 31, 2021 and 1,008.1% at September 30, 2021. The decrease compared to December 31, 2021 was primarily due to increases in the nonperforming loans.

Total loans greater than 30 days past due were $26.6 million at September 30, 2022, $2.6 million at December 31, 2021, and $3.5 million at September 30, 2021.

Special Mention (Watch) loans were $142.8 million at September 30, 2022, compared to $100.8 million at December 31, 2021 and $87.4 million at September 30, 2021.

During the three months ended September 30, 2022 there were $279,000 of charge-offs and $92,000 of recoveries, compared to $650,000 of charge-offs and $9,000 recoveries for the three months ended September 30, 2021.

For the nine months ended September 30, 2022, there were $1.3 million of charge-offs and $750,000 of recoveries, compared to $810,000 of charge-offs and $17,000 of recoveries for the nine months ended September 30, 2021.

Comparison of Operating Results for the Three Months Ended September 30, 2022 and 2021

General. Net income of $58.5 million for the three months ended September 30, 2022 was equal to net income for the three months ended September 30, 2021. However, the results reflected a $16.5 million, or 24%, increase in net interest income that was offset by an $11.1 million, or 28%, decrease in noninterest income and a $5.5 million, or 19%, increase in noninterest expense.

Net Interest Income. Net interest income increased $16.5 million, or 24%, to $85.4 million for the three months ended September 30, 2022, compared with $68.9 million for the three months ended September 30, 2021. The 24% increase reflected a $56.8 million, or 73% increase in interest income from higher yields and average loan balances, partially offset by a $40.3 million increase in interest expense from higher interest rates and average balances of deposits and borrowings. The interest rate spread of 2.77% for the third quarter of 2022 increased 10 basis points compared to 2.67% in the third quarter of 2021.

Our net interest margin increased 32 basis points, to 3.05%, for the three months ended September 30, 2022 from 2.73% for the three months ended September 30, 2021. The increase in net interest margin reflected higher average loan balances at higher average yields.

Interest Income. Interest income increased $56.8 million, or 73%, to $134.1 million for the three months ended September 30, 2022, compared with the three months ended September 30, 2021. This increase was primarily attributable to an increase in both higher average yields and balances of loans and loans held for sale.

The average balance of loans, including loans held for sale, during the three months ended September 30, 2022 increased $1.6 billion, or 18%, to $10.2 billion compared to the three months ended September 30, 2021, and the average yield on loans increased 167 basis points, to 5.00% for the three months ended September 30, 2022, compared to 3.33% for the three months ended September 30, 2021. The increase in average balances of loans and loans held for sale was primarily due to increases in the multi-family and healthcare portfolios, which were partially offset by decreases in the mortgage warehouse portfolios.

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The average balance of securities held to maturity acquired in September 2022 was $98.4 million, while the average yield was 3.91% for the three months ended September 30, 2022.

The average balance of interest-earning deposits and other decreased $368.7 million, or 64%, to $211.7 million for the three months ended September 30, 2022 from $580.4 million for the three months ended September 30, 2021, while the average yield increased 234 basis points, to 2.61% for the three months ended September 30, 2022, compared to 0.27% for the three months ended September 30, 2021.

The average balance of mortgage loans in process of securitization decreased $202.4 million, or 46%, to $235.2 million for the three months ended September 30, 2022 compared to the three months ended September 30, 2021, while the average yield increased 105 basis points, to 3.65% for the three months ended September 30, 2022, compared to 2.60% for the three months ended September 30, 2021.

Interest Expense. Total interest expense increased $40.3 million, or 478%, to $48.7 million for the three months ended September 30, 2022, from $8.4 million for the three months ended September 30, 2021.

Interest expense on deposits increased $38.0 million, or 545%, to $45.0 million for the three months ended September 30, 2022 from $7.0 million for the three months ended September 30, 2021. The increase was primarily due to higher rates on interest-bearing checking, money market, and certificates of deposit accounts.

The average balance of interest-bearing checking accounts of $4.2 billion for the three months ended September 30, 2022 decreased $547.4 million, or 12%, compared to $4.8 billion for the three months ended September 30, 2021. The average yield of interest-bearing checking accounts was 2.07% for the three months ended September 30, 2022, which was a 194 basis point increase compared to 0.13% for three months ended September 30, 2021.

The average balance of money market accounts of $2.5 billion for the three months ended September 30, 2022 increased $263.5, or 12%, compared to the three months ended September 30, 2021. The average yield of money market accounts was 2.06% for the three months ended September 30, 2022, which was a 129 basis point increase compared to 0.77% for three months ended September 30, 2021.

The average balance of certificates of deposit of $2.0 billion for the three months ended September 30, 2022 increased $1.4 billion, or 243%, compared to the three months ended September 30, 2021. The average yield of certificates of deposit was 1.91% for the three months ended September 30, 2022, which was a 125 basis point increase compared to 0.66% for three months ended September 30, 2021.

Interest expense on borrowings increased 157%, to $3.7 million for the three months ended September 30, 2022 from $1.5 million for the three months ended September 30, 2021. The increase reflected a 166 basis points increase in the average cost of borrowings, to 2.51% compared to 0.85% for the three months ended September 30, 2021. Offsetting the higher rates on borrowing was an $88.6 million, or 13%, decrease in the average balance of borrowings of a $588.6 million compared to $677.2 million for the three months ended September 30, 2021. Also included in borrowings, our warehouse structured financing agreement provides for an additional interest payment for a portion of the earnings generated. As a result, the cost of borrowings increased from a base rate of 1.98% and 0.33%, to an effective rate of 2.51% and 0.85% for the three months ended September 30, 2022 and 2021, 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 September 30,
	2022						2021
			Interest						Interest
	Average		Income/		Yield/		Average		Income/		Yield/
	Balance		Expense		Rate		Balance		Expense		Rate

	(Dollars in thousands)
Assets:
Interest-bearing deposits, and other	$	211,653	$	1,394	2.61	%	$	580,397	$	395	0.27	%
Securities available for sale - taxable		331,796		485	0.58	%		308,476		1,115	1.43	%
Securities available for sale - tax exempt		—		—	—	%		1,361		12	3.50	%
Held to maturity securities		98,363		970	3.91	%		—		—	—	%
Mortgage loans in process of securitization		235,230		2,162	3.65	%		437,601		2,868	2.60	%
Loans and loans held for sale		10,245,294		129,101	5.00	%		8,689,144		72,924	3.33	%
Total interest-earning assets		11,122,336		134,112	4.78	%		10,016,979		77,314	3.06	%
Allowance for credit losses on loans		(39,325)						(28,679)
Noninterest-earning assets		354,794						248,191
Total assets	$	11,437,805					$	10,236,491

Liabilities/Equity:
Interest-bearing checking	$	4,207,217	$	21,980	2.07	%	$	4,754,633	$	1,561	0.13	%
Savings deposits		239,262		162	0.27	%		211,494		39	0.07	%
Money market		2,523,315		13,094	2.06	%		2,259,786		4,394	0.77	%
Certificates of deposit		2,030,152		9,766	1.91	%		591,093		987	0.66	%
Total interest-bearing deposits		8,999,946		45,002	1.98	%		7,817,006		6,981	0.35	%
Borrowings		588,582		3,725	2.51	%		677,201		1,452	0.85	%
Total interest-bearing liabilities		9,588,528		48,727	2.02	%		8,494,207		8,433	0.39	%
Noninterest-bearing deposits		474,925						586,981
Noninterest-bearing liabilities		107,192						67,628
Total liabilities		10,170,645						9,148,816
Equity		1,267,160						1,087,675
Total liabilities and equity	$	11,437,805					$	10,236,491
Net interest income			$	85,385					$	68,881
Interest rate spread					2.77	%					2.67	%
Net interest-earning assets	$	1,533,808					$	1,522,772
Net interest margin					3.05	%					2.73	%
Average interest-earning assets to average interest-bearing liabilities					116.00	%					117.93	%

Increases and decreases in interest income and interest expense result from changes in average balances (volume) of interest-earning assets and interest-bearing liabilities, as well as changes in weighted average interest rates. The following table sets forth the effects of changing rates and volumes on our net interest income during the periods shown. Information is provided with respect to (i) effects on interest income attributable to changes in volume (changes in volume multiplied by prior rate) and (ii) effects on interest income attributable to changes in rate (changes in rate

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multiplied by prior volume). Changes applicable to both volume and rate have been allocated to volume. Yields have been calculated on a pre-tax basis.

The following table summarizes the increases and decreases in interest income and interest expense resulting from changes in average balances (volume) and changes in average interest rates:


	Three Months Ended September 30, 2022
	compared to September 30, 2021
	Increase (Decrease)
	Due to
(Dollars in thousands)	Volume		Rate		Total
Interest income
Interest-bearing deposits and other	$	(251)	$	1,250	$	999
Securities available for sale - taxable		84		(714)		(630)
Securities available for sale - tax exempt		(12)		—		(12)
Securities held to maturity		970		—		970
Mortgage loans in process of securitization		(1,326)		620		(706)
Loans and loans held for sale		13,060		43,117		56,177
Total interest income		12,525		44,273		56,798
Interest expense
Deposits
Interest-bearing checking		(180)		20,599		20,419
Savings deposits		5		118		123
Money market deposits		512		8,188		8,700
Certificates of deposit		2,403		6,376		8,779
Total Deposits		2,740		35,281		38,021
Borrowings		(190)		2,463		2,273
Total interest expense		2,550		37,744		40,294
Net interest income	$	9,975	$	6,529	$	16,504

Provision for Credit Losses. We recorded a provision for credit losses of $2.2 million for the three months ended September 30, 2022, an increase of $1.1 million, compared to the three months ended September 30, 2021. The $2.2 million provision for credit losses consisted of $1.7 million for the ACL-Loans, $0.5 million for the ACL-OBCE’s and $0 million for the contingent reserve related to the Freddie Mac-sponsored Q-series securitization transaction. The ACL-Loans was $39.0 million, or 0.56% of total loans, at September 30, 2022, compared to $31.3 million, or 0.54% of total loans, at December 31, 2021, and $29.1 million, or 0.53% at September 30, 2021. The increases in the ACL-Loans compared to both prior periods reflected increases associated with loan growth and portfolio mix, partially offset by a release of the $4.0 million allowance for credit losses associated with the loan sale and private securitization in September 2022. Additional details are provided in the ACL-Loans portion of the Comparison of Financial Condition at September 30, 2022 and December 31, 2021 and in Note 4: Loans and Allowance for Credit Losses on Loans.

Noninterest Income. Noninterest income decreased $11.1 million, or 28%, to $29.2 million for the three months ended September 30, 2022 compared to $40.3 million for the three months ended September 30, 2021. The decrease was primarily due to a $15.7 million decrease in gain on sale of loans associated with a shift in business mix to programs with lower average trade pricing in the multi-family loan portfolio, as well as lower single-family, SBA, and multi-family secondary market volumes.

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A summary of the gain on sale of loans for the three months ended September 30, 2022 and 2021 is below:


		Gain on Sale of Loans
		Three Months Ended
		September 30,		September 30,
		2022		2021

		(in thousands)
Loan Type
Multi-family	$	12,002	$	24,309
Single-family		138		1,592
Small Business Association (SBA)		1,214		3,112
Total	$	13,354	$	29,013

The decrease in gain on sale of loans was partially offset by a $2.9 million increase in loan servicing fees. Included in loan servicing fees was a $4.6 million positive adjustment to the fair value of servicing rights for the three months ended September 30, 2022, compared to a positive adjustment of $3.0 million for the three months ended September 30, 2021. Additionally, syndication and asset management fees of $3.1 million for the three months ended September 30, 2022 increased by 378% compared to the three months ended September 30, 2021, and is becoming a meaningful source of noninterest income.

Noninterest Expense. Noninterest expense increased $5.5 million, or 19%, to $35.0 million for the three months ended September 30, 2022 compared to $29.5 million for the three months ended September 30, 2021. The increase was due primarily to a $2.8 million, or 14% increase in salaries and employee benefits, including commissions, to support higher loan production volume as well as a $1.5 million, or 170%, increase in professional fees. The efficiency ratio was at 30.51% in the three months ended September 30, 2022, compared with 27.00% in the three months ended September 30, 2021.

Income Taxes. Income tax expense decreased 6%, to $18.9 million for the three months ended September 30, 2022 from the three months ended September 30, 2021. The decrease was due primarily to a 2% decrease in pretax income period to period. The effective tax rate was 24.4% for the three months ended September 30, 2022 and 25.6% for the three months ended September 30, 2021.

Comparison of Operating Results for the Nine Months Ended September 30, 2022 and 2021

General. Net income for the nine months ended September 30, 2022 was $162.6 million, a decrease of $9.3 million, or 5%, from net income of $171.9 million for the nine months ended September 30, 2021. The decrease was primarily due to a $14.1 million decrease in noninterest income and an $11.2 million increase in noninterest expense, which was partially offset by a $9.4 million increase in net interest income and a $6.5 million decrease in provision for income taxes.

Net Interest Income. Net interest income increased $17.9 million, or 9%, to $223.1 million for the nine months ended September 30, 2022, compared with the nine months ended September 30, 2021. The 9% increase reflected a $70.1 million, or 31% increase in interest income from higher yields and average loan balances, partially offset by an $52.2 million, or 217%, increase in interest expense from higher interest rates and average balances of deposits. The interest rate spread of 2.73% for the nine months ended September 30, 2022 decreased 3 basis points compared to 2.76% in the nine months ended September 30, 2021.

Our net interest margin increased 8 basis points, to 2.90%, for the nine months ended September 30, 2022 from 2.82% for the nine months ended September 30, 2021.

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Interest Income. Interest income increased $70.1 million, or 31%, to $299.4 million for the nine months ended September 30, 2022, compared with $229.3 million for the nine months ended September 30, 2021. This increase was primarily attributable to an increase in higher average yields and loan balances.

The average balance of loans, including loans held for sale, during the nine months ended September 30, 2022 increased $661.7 million, or 8%, to $9.0 billion compared to $8.3 billion for the nine months ended September 30, 2021, and the average yield on loans increased 79 basis points, to 4.27% for the nine months ended September 30, 2022, compared to 3.48% for the nine months ended September 30, 2021.

The average balance of interest-earning deposits and other increased $15.7 million, or 2%, to $675.3 million for the nine months ended September 30, 2022, from the nine months ended September 30, 2021, and the average yield increased 32 basis points, to 0.63% for the nine months ended September 30, 2022, compared to 0.31% for the nine months ended September 30, 2021.

The average balance of securities held to maturity that were acquired in September 2022 was $33.1 million, while the average yield was 3.91% for the nine months ended September 30, 2022.

The average balance of mortgage loans in process of securitization decreased $190.8 million, or 42%, to $260.5 million for the nine months ended September 30, 2022, compared to the nine months ended September 30, 2021, while the average yield increased 42 basis points, to 3.01% for the nine months ended September 30, 2022, compared to 2.59% for the nine months ended September 30, 2021.

The average balance of taxable available for sale securities increased $35.5 million, or 12%, to $322.8 million for the nine months ended September 30, 2022, from $287.3 million for the nine months ended September 30, 2021, and the average yield decreased 20 basis points, to 0.87% for the nine months ended September 30, 2022, compared to 1.07% for the nine months ended September 30, 2021.

Interest Expense. Total interest expense increased $52.2 million, or 217%, to $76.3 million for the nine months ended September 30, 2022, compared with $24.1 million for the nine months ended September 30, 2021.

Interest expense on deposits increased $48.8 million, or 247%, to $68.6 million for the nine months ended September 30, 2022, from the nine months ended September 30, 2021. The increase was primarily due to increases in interest rates on interest-bearing checking and money market accounts, as well as higher average balances for certificates of deposit and money market accounts.

The average balance of interest-bearing checking accounts of $4.0 billion for the nine months ended September 30, 2022 decreased $653.0, or 14%, compared to $4.7 billion for the nine months ended September 30, 2021. The average yield of interest-bearing checking accounts was 1.03% for the nine months ended September 30, 2022, which was a 91 basis point increase compared to 0.12% for nine months ended September 30, 2021.

The average balance of money market accounts of $2.6 billion for the nine months ended September 30, 2022 increased $444.8, or 20%, compared to the nine months ended September 30, 2021. The average yield of money market accounts was 1.27% for the nine months ended September 30, 2022, which was a 51 basis point increase compared to 0.76% for nine months ended September 30, 2021.

The average balance of certificates of deposit of $1.3 billion for the nine months ended September 30, 2022 increased $746.3, or 147%, compared to the nine months ended September 30, 2021. The average yield of certificates of deposit was 1.31% for the nine months ended September 30, 2022, which was a 46 basis point increase compared to 0.85% for nine months ended September 30, 2021.

Interest expense on borrowings increased $3.3 million, or 79%, to $7.7 million for the nine months ended September 30, 2022 from the nine months ended September 30, 2021. The increase was due primarily to a 74 basis

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points increase in the average cost of borrowings to 1.60% compared to 0.86% for the nine months ended September 30, 2021. The increase in average rates was partially offset by a $27.6 million decrease in average balances compared to the nine months ended September 30, 2021. Additionally, borrowings include our warehouse structured financing agreement that provides for an additional interest payment for a portion of the earnings generated. As a result, the cost of borrowings increased from a base rate of 1.03% and 0.42%, to an effective rate of 1.60% and 0.86% for the nine months ended September 30, 2022 and 2021, respectively.


	Nine Months Ended September 30,
	2022						2021
			Interest						Interest
	Average		Income/		Yield/		Average		Income/		Yield/
	Balance		Expense		Rate		Balance		Expense		Rate

	(Dollars in thousands)
Assets:
Interest-bearing deposits, and other	$	675,318	$	3,174	0.63	%	$	659,649	$	1,522	0.31	%
Securities available for sale - taxable		322,814		2,103	0.87	%		287,297		2,302	1.07	%
Securities available for sale - tax exempt		—		—	—	%		1,363		32	3.14	%
Held to maturity securities		33,148		970	3.91	%		—		—	—	%
Mortgage loans in process of securitization		260,452		5,856	3.01	%		451,235		8,728	2.59	%
Loans and loans held for sale		8,987,526		287,291	4.27	%		8,325,848		216,717	3.48	%
Total interest-earning assets		10,279,258		299,394	3.89	%		9,725,392		229,301	3.15	%
Allowance for credit losses on loans		(34,614)						(28,590)
Noninterest-earning assets		324,068						237,355
Total assets	$	10,568,712					$	9,934,157

Liabilities/Equity:

Interest-bearing checking	$	4,024,969	$	31,128	1.03	%	$	4,677,992	$	4,133	0.12	%
Savings deposits		236,334		257	0.15	%		203,262		114	0.07	%
Money market		2,619,729		24,914	1.27	%		2,174,964		12,307	0.76	%
Certificates of deposit		1,253,527		12,284	1.31	%		507,252		3,210	0.85	%
Total interest-bearing deposits		8,134,559		68,583	1.13	%		7,563,470		19,764	0.35	%
Borrowings		642,599		7,670	1.60	%		670,177		4,286	0.86	%
Total interest-bearing liabilities		8,777,158		76,253	1.16	%		8,233,647		24,050	0.39	%
Noninterest-bearing deposits		464,973						638,995
Noninterest-bearing liabilities		107,276						70,048
Total liabilities		9,349,407						8,942,690
Equity		1,219,305						991,467
Total liabilities and equity	$	10,568,712					$	9,934,157
Net interest income			$	223,141					$	205,251
Interest rate spread					2.73	%					2.76	%
Net interest-earning assets	$	1,502,100					$	1,491,745
Net interest margin					2.90	%					2.82	%
Average interest-earning assets to average interest-bearing liabilities					117.11	%					118.12	%

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The following table summarizes the increases and decreases in interest income and interest expense resulting from changes in average balances (volume) and changes in average interest rates:


	Nine Months Ended September 30, 2022
	compared to September 30, 2021
	Increase (Decrease)
	Due to
(Dollars in thousands)	Volume		Rate		Total
Interest income
Interest-bearing deposits and other	$	36	$	1,616	$	1,652
Securities available for sale - taxable		285		(484)		(199)
Securities available for sale - tax exempt		(32)		—		(32)
Securities held to maturity		970		—		970
Mortgage loans in process of securitization		(3,690)		818		(2,872)
Loans and loans held for sale		17,223		53,351		70,574
Total interest income		14,792		55,301		70,093
Interest expense
Deposits
Interest-bearing checking		(577)		27,572		26,995
Savings deposits		19		124		143
Money market deposits		2,517		10,090		12,607
Certificates of deposit		4,723		4,351		9,074
Total Deposits		6,682		42,137		48,819
Borrowings		(176)		3,560		3,384
Total interest expense		6,506		45,697		52,203
Net interest income	$	8,286	$	9,604	$	17,890

Provision for Loan Losses. We recorded a provision for credit losses of $10.9 million for the nine months ended September 30, 2022, an increase of $8.5 million, compared to $2.4 million for the nine months ended September 30, 2021. The $10.9 million provision for credit losses consisted of $8.5 million for the ACL-Loans, $1.2 million for the ACL-OBCE’s, and $1.2 million for the contingent reserve related to the Freddie Mac-sponsored Q-series securitization transaction. The ACL-Loans was $39.0 million, or 0.56% of total loans, at September 30, 2022, compared to $31.3 million, or 0.54% of total loans, at December 31, 2021, and $29.1 million, or 0.53% at September 30, 2021. The increases in the ACL-Loans compared to both prior periods reflected increases associated with loan growth and portfolio mix, partially offset by a release of the $4.0 million allowance for credit losses associated with the loan sale and private securitization in September 2022. Additional details are provided in the ACL-Loans portion of the Comparison of Financial Condition at September 30, 2022 and December 31, 2021 and in Note 4: Loans and Allowance for Credit Losses on Loans.

Noninterest Income. Noninterest income decreased $14.1 million, or 12%, to $103.0 million for the nine months ended September 30, 2022 compared to $117.1 million the nine months ended September 30, 2021. The decrease was primarily due to a $29.9 million, or 36%, decrease in gain on sale of loans associated with a shift in business mix to programs with lower average trade pricing in the multi-family loan portfolio, as well as lower single-family and multi-family secondary market volumes.

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Partially offsetting the decrease in gain on sale was a $12.5 million increase in loan servicing fees compared to million the nine months ended September 30, 2021. Included in loan servicing fees was a $19.9 million positive adjustment to the fair value of servicing rights for the nine months ended September 30, 2022, compared to a positive adjustment of $10.5 million for the nine months ended September 30, 2021. Syndication and asset management fees of $5.3 million increased by $4.1 million compared to the nine months ended September 30, 2021 and are becoming a meaningful source of noninterest income.

A summary of the gain on sale of loans for the nine months ended September 30, 2022 and 2021 is below:


		Gain on Sale of Loans
		Nine Months Ended
		September 30,		September 30,
		2022		2021

		(in thousands)
Loan Type
Multi-family	$	46,578	$	68,553
Single-family		1,001		7,677
Small Business Association (SBA)		5,304		6,525
Total	$	52,883	$	82,755

Noninterest Expense. Noninterest expense increased $11.2 million, or 13%, to $98.9 million for the nine months ended September 30, 2022 compared to the nine months ended September 30, 2021. The increase was due primarily to a $6.5 million, or 11%, increase in salaries and employee benefits, including commissions, to support higher loan production volumes, as well as a $3.2 million, or 153%, increase in professional fees. Partially offsetting the increases was a $2.6 million, or 41%, decrease in loan expenses for the nine months ended September 30, 2022 compared to the nine months ended September 30, 2021. The efficiency ratio was at 30.34% in the nine months ended September 30, 2022, compared with 27.22% in the nine months ended September 30, 2021.

Income Taxes. Income tax expense decreased $6.5 million, or 11%, to $53.7 million for the nine months ended September 30, 2022, from $60.2 million for the nine months ended September 30, 2021. The decrease was due primarily to a 7% decrease in pretax income period to period. The effective tax rate was 24.8% for the nine months ended September 30, 2022, and 26.0% for the nine months ended September 30, 2021.

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. As of September 30, 2022 the Company’s total servicing portfolio had an unpaid principal balance of $20.6 billion, primarily managed in the Multi-Family Mortgage Banking segment. Included in this amount was an unpaid principal balance of loans serviced for others of $12.6 billion, an unpaid principal balance of loans sub-serviced for others of $1.7 billion, and other servicing balances of $0.7 billion at September 30, 2022. These loans are not included in the accompanying balance sheets. The Company also manages $5.6 billion of loans for customers that have loans on the balance sheet at September 30, 2022. The servicing portfolio is primarily GNMA, Fannie Mae, and Freddie Mac loans and is a significant source of our noninterest income and deposits.

Our Mortgage Warehousing segment funds agency eligible loans for non-depository financial institutions from the date of origination or purchase until the date of sale to an investor, which typically takes less than 30 days and is a significant source of our net interest income, loans, and deposits. Mortgage Warehousing has grown to fund over $111 billion in 2020, $78 billion in 2021, and $26.9 billion for the nine months ended September 30, 2022. Mortgage Warehousing also provides commercial loans and collects deposits related to the mortgage escrow accounts of its customers.

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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.

Our segments diversify the net income of Merchants Bank and provide synergies across the segments. The strategic opportunities include that MCC loans are funded by the Merchant 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. MCC also provides leads to Merchants Bank for core deposit opportunities. 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 September 30, 2022 and 2021, we had total net income of $58.5 million for each period, and for the nine months ended September 30, 2022 and 2021, we had total net income of $162.6 million and $171.9 million, respectively. Net income for our three segments for the respective periods was as follows:


	For the Three Months Ended				For the Nine Months Ended
	September 30,				September 30,
	2022		2021		2022		2021

	(In thousands)
Multi-family Mortgage Banking	$	13,366	$	14,448	$	44,414	$	37,380
Mortgage Warehousing		11,801		23,217		36,828		73,848
Banking		39,344		23,463		94,040		68,229
Other		(6,023)		(2,625)		(12,717)		(7,554)

Total	$	58,488	$	58,503	$	162,565	$	171,903

Multi-family Mortgage Banking.

Comparison of results for the three months ended September 30, 2022 and 2021:

The Multi-family Mortgage Banking segment reported net income of $13.4 million for the three months ended September 30, 2022, a decrease of $1.1 million, or 7%, from the $14.5 million net income reported for the three months ended September 30, 2021. The decrease was primarily due to a $4.5 million increase in increase in salaries and employee benefits, including commissions, to support higher loan production volumes, as well as a $4.3 million decrease in gain on sale of loans.

Partially offsetting the decreases to net income compared to the prior period was a $4.9 million increase in loan servicing fees and a $2.4 million increase in syndication and asset management fees. The increase in loan servicing fees reflected a positive fair market value adjustment of $3.7 million on servicing rights for the three months ended September 30, 2022 compared to a positive fair market value adjustment of $0.7 million for the three months ended September 30, 2021.

The volume of loans originated and acquired for sale in the secondary market decreased by $197.8 million, or 35%, to $367.0 million, for the three months ended September 30, 2022, compared to $564.8 million for the three months ended September 30, 2021.

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Comparison of results for the nine months ended September 30, 2022 and 2021:

The Multi-family Mortgage Banking segment reported net income of $44.4 million for the nine months ended September 30, 2022, an increase of $7.0 million, or 19%, from the $37.4 million of net income reported for the nine months ended September 30, 2021. The growth was primarily due to a $24.2 million increase in noninterest income, reflecting $14.9 million higher loan servicing fees. The increase in loan servicing fees reflected a positive fair market value adjustment of $13.6 million on servicing rights for the nine months ended September 30, 2022 compared to a positive fair market value adjustment of $2.9 million for the nine months ended September 30, 2021. Syndication and asset management fees also increased by $4.1 million compared to the prior period.

Partially offsetting the increases to noninterest income was a $14.6 million increase in noninterest expenses, primarily due to an increase in salaries and employee benefits, including commissions, to support higher loan production volumes, in addition to a $2.0 million increase in income taxes associated with higher pre-tax income compared to the nine months ended September 30, 2021.

The volume of loans originated and acquired for sale in the secondary market decreased by $625.4 million, or 32%, to $1.3 billion, for the nine months ended September 30, 2022 compared to $1.9 billion for the nine months ended September 30, 2021.

Mortgage Warehousing.

Comparison of results for the three months ended September 30, 2022 and 2021:

The Mortgage Warehousing segment reported net income for the three months ended September 30, 2022 of $11.8 million, a decrease of $11.4 million, or 49%, over the $23.2 million reported for the three months ended September 30, 2021. The lower net income reflected lower net interest income and mortgage warehouse fees as industry volumes declined as market interest rates increased. There was a 55% decrease in warehouse loan volume of $8.8 billion compared to $19.7 billion for the three months ended September 30, 2021, which was in line with the industry volume decrease of 55%, according to the Mortgage Bankers Association.

Comparison of results for the nine months ended September 30, 2022 and 2021:

The Mortgage Warehousing segment reported net income for the nine months ended September 30, 2022 of $36.8 million, a decrease of $37.0 million, or 50%, over the $73.8 million reported for the nine months ended September 30, 2021. The lower net income reflected lower net interest income and mortgage warehouse fees as industry volumes declined as market interest rates increased. There was a 54% decrease in warehouse loan volume of $26.9 billion compared to $58.1 billion for the nine months ended September 30, 2021, which was greater than the industry volume decrease of 46%, according to the Mortgage Bankers Association.

Banking.

Comparison of results for the three months ended September 30, 2022 and 2021:

The Banking segment reported net income of $39.3 million for the three months ended September 30, 2022, an increase of $15.9 million, or 68%, compared to the three months ended September 30, 2021. The increase was primarily due to a $29.8 million increase in net interest income that was partially offset by a decrease in noninterest income of $12.1 million, primarily from lower gains on sale of loans.

Noninterest income for the three months ended September 30, 2022 included a positive fair market value adjustment of $.9 million on single-family servicing rights, compared to a positive fair market value adjustment of $2.3 million for the three months ended September 30, 2021.

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Comparison of results for the nine months ended September 30, 2022 and 2021:

The Banking segment reported net income of $94.0 million for the nine months ended September 30, 2022, an increase of $25.8 million, or 38%, over the nine months ended September 30, 2021. The increase was primarily due to a $59.7 million increase in net interest income that was partially offset by a decrease in noninterest income of $30.5 million, primarily from lower gains on sale of loans.

Noninterest income for the nine months ended September 30, 2022 included a positive fair market value adjustment of $6.3 million on single-family servicing rights, compared to a positive fair market value adjustment of $7.6 million for the nine months ended September 30, 2021.

Liquidity and Capital Resources

Liquidity.

Our primary sources of funds are business and consumer deposits, escrow and custodial deposits, brokered deposits, borrowings, principal and interest payments on loans, and proceeds from sale of loans. While maturities and scheduled amortization of loans are predictable sources of funds, deposit flows and mortgage prepayments are greatly influenced by market interest rates, economic conditions, and competition. Our most liquid assets are cash, short-term investments, including interest-bearing demand deposits, mortgage loans in process of securitization, and loans held for sale, and warehouse lines of credit included in loans receivable, all of which represent 34% of total assets at September 30, 2022. The levels of these assets are dependent on our operating, financing, lending, and investing activities during any given period.

Our cash flows are comprised of three primary classifications: cash flows from operating activities, investing activities, and financing activities. Net cash provided by (used in) operating activities was $1.8 billion and $(387.8) million for the nine months ended September 30, 2022 and 2021, respectively. Net cash (used in) investing activities, which consists primarily of net change in loans receivable and purchases, sales and maturities of investment securities, was $(3.0) billion and $(113.9) million for the nine months ended September 30, 2022 and 2021, respectively. Net cash provided by financing activities, which is comprised primarily of net change in deposits, borrowings and preferred stock offerings, was $507.3 million and $1.1 billion for the nine months ended September 30, 2022 and 2021, respectively.

At September 30, 2022 we had $3.2 billion in outstanding commitments to extend credit that are subject to credit risk and $4.0 billion outstanding commitments subject to certain performance criteria and cancellation by the Company, including loans pending closing, unfunded construction draws, and unfunded lines of warehouse credit. We anticipate that we will have sufficient funds available to meet our current loan origination commitments. Additionally, the Company’s business model is designed to continuously sell a significant portion of its loans, which provides flexibility in managing its liquidity.

Certificates of deposit that are scheduled to mature in less than one year from September 30, 2022 totaled $2.4 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, the Federal Reserve discount window, brokered deposits, or raise interest rates on deposits to attract new accounts, which may result in higher levels of interest expense.

Off-Balance Sheet Arrangements.

In the normal course of operations, we engage in a variety of financial transactions that, in accordance with U.S. generally accepted accounting principles, are not recorded in our financial statements. These transactions involve, to varying degrees, elements of credit, interest rate and liquidity risk. Such transactions are used primarily to manage customers’ requests for funding and take the form of loan commitments, lines of credit and standby letters of credit.

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Capital Resources.

At September 30, 2022, based on available collateral, we had $2.8 billion in available unused borrowing capacity with the FHLB and the Federal Reserve discount window. While the amounts available fluctuate daily, we also had $500 million in credit lines through our membership in the AFX as of September 30, 2022. This liquidity enhances the ability to effectively manage interest expense and asset levels in the future.

The access to and cost of funding for new business initiatives, the ability to engage in expanded business activities, the ability to pay dividends, the level of deposit insurance costs and the level and nature of regulatory oversight depend, in part, on our capital position. The Company filed a shelf registration statement on Form S-3 with the SEC on August 8, 2022, which was declared effective on August 17, 2022, under which we can issue up to $500 million aggregate offering amount of registered securities to finance our growth objectives.

The assessment of capital adequacy depends on a number of factors, including asset quality, liquidity, earnings performance, changing competitive conditions and economic forces. We seek to maintain a strong capital base to support our growth and expansion activities, to provide stability to our current operations and to promote public confidence in our Company.

Shareholders’ Equity. Shareholders’ equity was $1.4 billion as of September 30, 2022, compared to $1.2 billion as of December 31, 2021. The $257.2 million, or 22%, increase resulted primarily from the 8.25% Series D preferred stock offerings that raised $137.4 million in new capital, net of $5.1 million in offering costs, as well as net income of $162.6 million, which was partially offset by dividends paid on common and preferred shares of $26.3 million during the period, as well as $3.6 million adjustment to retained earnings associated with the adoption of CECL. The CECL adjustment related primarily to OBCEs. Additionally, common stock repurchase activity reduced shareholders’ equity in total by $3.9 million.

7% Series A Preferred Stock. In March 2019 the Company issued 2,000,000 shares of 7.00% Fixed-to-Floating Rate Series A Non-Cumulative Perpetual Preferred Stock, without par value, and with a liquidation preference of $25.00 per share (“Series A Preferred Stock”). The Company received net proceeds of $48.3 million after underwriting discounts, commissions and direct offering expenses. In April 2019, the Company issued an additional 81,800 shares of Series A Preferred Stock to the underwriters related to their exercise of an option to purchase additional shares under the associated underwriting agreement, resulting in an addition $2.0 million in net proceeds, after underwriting discounts.

In June 2019 the Company issued an additional 874,000 shares of Series A Preferred Stock for net proceeds of $21.85 million.

In September 2019 the Company repurchased and subsequently retired 874,000 shares of Series A Preferred Stock at an aggregate cost of $21.85 million. There were no brokerage fees in connection with the transaction.

Dividends on the Series A Preferred Stock, to the extent declared by the Company’s board, are payable quarterly at an annual rate of $1.75 per share through March 31, 2024. After such date, quarterly dividends will accrue and be payable at a floating rate equal to three-month LIBOR plus a spread of 460.5 basis points per year. In the event that three-month LIBOR is less than zero, three-month LIBOR shall be deemed to be zero. The Company may redeem the Series A Preferred Stock at its option, subject to regulatory approval, on or after April 1, 2024, as described in the prospectus supplement relating to the offering filed with the SEC on March 22, 2019. The terms of the Series A Preferred Stock permit us to replace LIBOR with a substitute index once LIBOR is no longer considered an acceptable market index. However, because the Series A Preferred Stock is still in its fixed rate period, we have not transitioned to a substitute index and likely will not do so until closer to the end of the fixed rate period, allowing additional time for us to determine whether SOFR or another index has become an acceptable market index and is appropriate.

6% Series B Preferred Stock. In August 2019 the Company issued 5,000,000 depositary shares, each representing a 1/40^th interest in a share of its 6.00% Fixed-to-Floating Rate Series B Non-Cumulative Perpetual Preferred Stock,

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without par value, and with a liquidation preference of $1,000.00 per share (equivalent to $25.00 per depositary share)(“Series B Preferred Stock”). After deducting underwriting discounts, commissions, and direct offering expenses, the Company received total net proceeds of $120.8 million.

Dividends on the Series B Preferred Stock, to the extent declared by the Company’s board, are payable quarterly at an annual rate of $60.00 per share (equivalent to $1.50 per depositary share) through September 30, 2024. After such date, quarterly dividends will accrue and be payable at a floating rate equal to three-month LIBOR plus a spread of 456.9 basis points per year. In the event that three-month LIBOR is less than zero, three-month LIBOR shall be deemed to be zero. The Company may redeem the Series B Preferred Stock at its option, subject to regulatory approval, on or after October 1, 2024, as described in the prospectus supplement relating to the offering filed with the SEC on August 13, 2019. The terms of the Series B Preferred Stock permit us to replace LIBOR with a substitute index once LIBOR is no longer considered an acceptable market index. However, because the Series B Preferred Stock is still in its fixed rate period, we have not transitioned to a substitute index and likely will not do so until closer to the end of the fixed rate period, allowing additional time for us to determine whether SOFR or another index has become an acceptable market index and is appropriate.

8% Preferred Stock. The Company previously issued a total of 41,625 shares of 8% Non-Cumulative, Perpetual Preferred Stock, without par value, with a liquidation preference of $1,000.00 per share (“8% Preferred Stock”) in private placement offerings.

Dividends on the 8% Preferred Stock, to the extent declared by the Company’s board, were payable quarterly at an annual rate of $80.00 per share. As of December 31, 2020, the 8% Preferred Stock became redeemable by the Company at any time, subject to regulatory approval and upon at least 30 days’ prior notice to the holders thereof.

On April 15, 2021, all 41,625 shares of the Company’s 8% preferred stock were redeemed for $41.6 million, plus unpaid dividends of $139,000.

6% Series C Preferred Stock. On March 23, 2021, the Company issued 6,000,000 depositary shares, each representing a 1/40^th interest in a share of its 6.00% Fixed Rate Series C Non-Cumulative Perpetual Preferred Stock, without par value (the “Series C Preferred Stock”), and with a liquidation preference of $1,000.00 per share (equivalent to $25.00 per depositary share). The aggregate gross offering proceeds for the shares issued by the Company was $150.0 million, and after deducting underwriting discounts and commissions and offering expenses of approximately $5.1 million paid to third parties, the Company received total net proceeds of $144.9 million.

On May 6, 2021, our 8% preferred shareholders participated in a private offering to replace their redeemed 8% preferred shares with the Company’s 6% Series C preferred stock. Accordingly, 46,181 shares (1,847,233 depositary shares) of the Company’s 6% Series C preferred stock were issued at a price of $25 per depositary share. The total capital raised from the private offering was $46.2 million, net of $23,000 in expenses.

Dividends on the Series C Preferred Stock, to the extent declared by the Company’s board, are payable quarterly. The Company may redeem the Series C Preferred Stock, in whole or in part, at our option, on any dividend payment date on or after April 1, 2026, subject to the approval of the appropriate federal banking agency, at the liquidation preference, plus any declared and unpaid dividends (without regard to any undeclared dividends) to, but excluding, the date of redemption.

8.25% Series D Preferred Stock. On September 27, 2022, the Company issued 5,200,000 depositary shares, each representing a 1/40^th interest in a share of its 8.25% Fixed Rate Series D Non-Cumulative Perpetual Preferred Stock, without par value (the “Series D Preferred Stock”), and with a liquidation preference of $1,000.00 per share (equivalent to $25.00 per depositary share). The aggregate gross offering proceeds for the shares issued by the Company was $130.0 million, and after deducting underwriting discounts and commissions and offering expenses of approximately $4.7 million paid to third parties, the Company received total net proceeds of $125.3 million. On September 30, 2022, the Company issued an additional 500,000 shares of Series D Preferred Stock to the underwriters related to their exercise

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of an option to purchase additional shares under the associated underwriting agreement, resulting in an additional $12.1 million in net proceeds, after deducting $0.4 million in underwriting discounts.

Dividends on the Series D Preferred Stock, to the extent declared by the Company’s board, are payable quarterly. The Company may redeem the Series D Preferred Stock, in whole or in part, at our option, on any dividend payment date on or after October 1, 2027, subject to the approval of the appropriate federal banking agency, at the liquidation preference, plus any declared and unpaid dividends (without regard to any undeclared dividends) to, but excluding, the date of redemption.

Common Shares/Dividends. As of September 30, 2022, the Company had 43,109,578 common shares issued and outstanding. The Board expects to declare a quarterly dividend of $0.07 per share in each quarter of 2022. On November 17, 2021, the Company announced an increase in authorization for its stock repurchase program, up to $75,000,000 of common stock, expiring December 31, 2023. On April 29, 2022, the Company entered into a Rule 10b5-1 plan (the “10b5-1 Plan”) with a broker for the repurchase of shares of its common stock commencing on May 3, 2022. The following table summarizes our share repurchase authorizations and repurchase activity of our common stock through September 30, 2022:


		Nine Months Ended
		September 30,
		2022
Remaining authorization at December 31, 2021	$	75,000,000
Dollar value of shares repurchased	$	3,935,333
Shares repurchased⁽¹⁾		165,037
Average price paid per share	$	23.85
Remaining authorization at June 30, 2022	$	71,064,667

The timing and actual number of additional shares repurchased will depend on a variety of factors, including cash requirements to meet the operating needs of the business, legal requirements, as well as the share price and economic and market conditions.

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Capital Adequacy.

The following tables present the Company’s capital ratios at September 30, 2022 and December 31, 2021:


					Minimum				Minimum
					Amount Required				Amount To Be
					for Adequately				Well
	Actual				Capitalized⁽¹⁾				Capitalized⁽¹⁾
	Amount		Ratio		Amount		Ratio		Amount		Ratio

	(Dollars in thousands)
September 30, 2022
Total capital⁽¹⁾ (to risk-weighted assets)
Company	$	1,454,722	12.5	%	$	932,855	8.0	%	$	—	N/A	%
Merchants Bank		1,376,248	12.0	%		915,426	8.0	%		1,144,283	10.0
FMBI		33,514	11.5	%		23,351	8.0	%		29,189	10.0	%
Tier I capital⁽¹⁾ (to risk-weighted assets)
Company		1,405,621	12.1	%		699,641	6.0	%		—	N/A	%
Merchants Bank		1,327,929	11.6	%		686,570	6.0	%		915,426	8.0
FMBI		32,732	11.2	%		17,513	6.0	%		23,351	8.0	%
Common Equity Tier I capital⁽¹⁾ (to risk-weighted assets)
Company		906,102	7.8	%		524,731	4.5	%		—	N/A	%
Merchants Bank		1,327,929	11.6	%		514,927	4.5	%		743,784	6.5
FMBI		32,732	11.2	%		13,135	4.5	%		18,973	6.5	%
Tier I capital⁽¹⁾ (to average assets)
Company		1,405,621	12.3	%		456,766	4.0	%		—	N/A	%
Merchants Bank		1,327,929	11.9	%		446,683	4.0	%		558,354	5.0
FMBI		32,732	10.5	%		12,499	4.0	%		15,624	5.0	%

(1)

As defined by regulatory agencies.


					Minimum Amount
					To Be Well
	Actual				Capitalized⁽¹⁾
	Amount		Ratio		Amount		Ratio

	(Dollars in thousands)
December 31, 2021
CBLR (Tier 1) capital⁽¹⁾ (to average assets)
(i.e., CBLR - leverage ratio)
Company	$	1,138,090	10.4	%	$	928,731	> 8.5	%
Merchants Bank		1,088,621	10.3	%		901,188	> 8.5	%
FMBI		28,958	9.7	%		25,499	> 8.5	%

(1)

As defined by regulatory agencies.

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Quantitative and Qualitative Disclosures About Market Risk

Market Risk. Market risk represents the risk of loss due to changes in market values of assets and liabilities. We incur market risk in the normal course of business through exposures to market interest rates, equity prices, and credit spreads. We have identified two primary sources of market risk: interest rate risk and price risk related to market demand.

Interest Rate Risk

Overview. Interest rate risk is the risk to earnings and value arising from changes in market interest rates. Interest rate risk arises from timing differences in the repricings and maturities of interest-earning assets and interest-bearing liabilities (reprice risk), changes in the expected maturities of assets and liabilities arising from embedded options, such as borrowers’ ability to prepay residential mortgage loans at any time and depositors’ ability to redeem certificates of deposit before maturity (option risk), changes in the shape of the yield curve where interest rates increase or decrease in a nonparallel fashion (yield curve risk), and changes in spread relationships between different yield curves, such as U.S. Treasuries, LIBOR or SOFR.

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.

Interest rate risk management is an active process that encompasses monitoring loan and deposit flows complemented by investment and funding activities. Effective management of interest rate risk begins with understanding the dynamic characteristics of assets and liabilities and determining the appropriate interest rate risk posture given business forecasts, management objectives, market expectations, and policy constraints.

An asset sensitive position refers to a balance sheet position in which an increase in short-term interest rates is expected to generate higher net interest income, as rates earned on our interest-earning assets would reprice upward more quickly than rates paid on our interest-bearing liabilities, thus expanding our net interest margin. Conversely, a liability sensitive position refers to a balance sheet position in which an increase in short-term interest rates is expected to generate lower net interest income, as rates paid on our interest-bearing liabilities would reprice upward more quickly than rates earned on our interest-earning assets, thus compressing our net interest margin.

Income Simulation and Economic Value Analysis. Interest rate risk measurement is calculated and reported to the ALCO at least quarterly. The information reported includes period-end results and identifies any policy limits exceeded, along with an assessment of the policy limit breach and the action plan and timeline for resolution, mitigation, or assumption of the risk.

We use two approaches to model interest rate risk: Net Interest Income at Risk (NII at Risk) and Economic Value of Equity (“EVE”). Under NII at Risk, net interest income is modeled utilizing various assumptions for assets, liabilities,

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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 September 30, 2022 and December 31, 2021.


	Net Interest Income Sensitivity
	Twelve Months Forward
	- 200			- 100			+ 100			+ 200

	(Dollars in thousands)
September 30, 2022:
Dollar change	$	(101,926)		$	(60,980)		$	29,143		$	73,018
Percent change		(26.0)	%		(15.6)	%		7.4	%		18.6	%

December 31, 2021:
Dollar change	$	(13,810)		$	(17,991)		$	21,895		$	65,010
Percent change		(4.9)	%		(6.3)	%		7.7	%		22.9	%

Our interest rate risk management policy limits the change in our net interest income to 20% for a +/- 100 basis point move in interest rates, and 30% for a +/- 200 basis point move in rates. At September 30, 2022 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 EVE results for Merchants Bank included in the following table reflect the analysis used quarterly by management. It models immediate -200, -100, +100 and +200 basis point parallel shifts in market interest rates.


	Economic Value of Equity
	Sensitivity (Shock)
	Immediate Change in Rates
	- 200			- 100			+ 100			+ 200

	(Dollars in thousands)
September 30, 2022:
Dollar change	$	(47,920)		$	(63,522)		$	(72,000)		$	(76,673)
Percent change		(3.6)	%		(4.8)	%		(5.4)	%		(5.8)	%

December 31, 2021:
Dollar change	$	3,703		$	42,983		$	(6,817)		$	(6,288)
Percent change		0.3	%		4.0	%		(0.6)	%		(0.6)	%

Our interest rate risk management policy limits the change in our EVE to 15% for a +/- 100 basis point move in interest rates, and 20% for a +/- 200 basis point move in rates. We are within policy limits set by our board of directors for the -200, -100, +100 and +200 basis point scenarios. The EVE reported at September 30, 2022 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.

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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 September 30, 2022, 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, 2021.

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

None.

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		Second Amended and Restated Articles of Incorporation of Merchants Bancorp. (incorporated by reference to Exhibit 3.1 of the registration statement on Form 8-K, filed on May 24, 2022).

3.2		Articles of Amendment to the Second Amended and Restated Articles of Incorporation dated September 27, 2022 designating the 8.25% Fixed Rate Reset Series D Non-Cumulative Perpetual Preferred Stock (incorporated by reference to Exhibit 3.2 of the registration statement on Form 8-A filed on September 27, 2022).

3.3		Second Amended and Restated By-Laws of Merchants Bancorp (incorporated by reference to Exhibit 3.1 of the Current Report on Form 8-K, filed on November 20, 2017).
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.

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 – the instance document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL 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

104		Cover Page Interactive Data File – The cover page interactive data file does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document

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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:	November 8, 2022	By:	/s/ Michael F. Petrie
			Michael F. Petrie
			Chairman & Chief Executive Officer



Date:	November 8, 2022	By:	/s/ John F. Macke
			John F. Macke Chief Financial Officer
			(Principal Financial & Accounting Officer)

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