$57.40
$98.50
bear $57.40
base $79.20
bull $98.50
margin of safety $36.00
market price* $48.77
Business condition attached to the margin of safety
Nonperforming assets keep falling from the $258.0 million reported at year-end 2025, with net charge-offs running below the 0.85% of average loans recorded in 2025.
Merchants Bancorp (Carmel, Indiana) earns money in three ways: originating and servicing government-backed multi-family and healthcare mortgages (Fannie Mae, Freddie Mac, FHA/HUD) and syndicating low-income housing tax credits; funding other lenders' home mortgages through its Mortgage Warehousing line (it funded $66.3 billion in 2025, $45.6 billion in 2024 and $33.0 billion in 2023); and a bank that holds deposits and loans, including multi-family and healthcare bridge and construction loans. In 2025 the three segments earned $40.2 million, $96.9 million and $122.0 million respectively; group net income was $218.8 million, down from $320.4 million in 2024. How we measured earnings. Because this company originates and sells billions of dollars of loans each year, its reported operating cash flow swings by hundreds of millions with the size of its loan inventory (2025: -$341.2 million; 2024: -$835.3 million). We removed the working-capital effects of that inventory (loans originated for sale net of sales proceeds, excluding the gain on sale, which is real earnings), mortgages awaiting securitization, tax-credit purchases and sales, and other assets and liabilities. What remains reconciles exactly to net income plus depreciation and other non-cash items. Two judgements matter. First, we treat the provision for credit losses as a real cost rather than adding it back, because it stands in for actual loan losses: it was $117.8 million in 2025 against $24.3 million in 2024, and net charge-offs rose to 0.85% of average loans from 0.07%. Second, dividends on the company's preferred stock ($41.1 million in 2025) rank ahead of common shareholders, so we deduct them and express results per diluted common share. Stock compensation is deducted; capital spending on premises (about $21 million in 2025) is treated in full as maintenance because it is small relative to earnings. Purchases of tax credits ($142.8 million in 2025) were treated as working capital; the 2025 tax rate fell to 17.1% from 24.2%, partly because of originated and purchased tax credits; taxed at the 2024 rate, 2025 earnings would have been roughly $0.40 per share lower. That is one reason we anchor on a multi-year median rather than on 2025. Owner earnings per common share, 2020 to 2025: $4.13, $5.02, $4.27, $5.58, $5.91, $4.48. We anchor on the median of these six years, $4.75. Six years is used because net income more than doubled from $77.3 million in 2019 to $180.5 million in 2020, so earlier years describe a much smaller company; the window spans a very strong mortgage year (2020-21), the rate-driven slowdown (2022-23) and the credit-cost spike of 2025, so it is not a peak or a trough. Growth-path check. Owner earnings per share fell 24.1% in 2025 ($4.48 versus $5.91). Our base case starts at the $4.75 anchor, about 6% above 2025, which is a return to the normal level rather than new growth. The specific reasons the 2025 dip should reverse: nonperforming loans fell 29% to $197.8 million by year-end 2025 (from $279.7 million), and the most recent quarterly filing shows net income of $146.0 million for the first half of 2026 versus $96.2 million a year earlier, with the second quarter at $78.3 million versus $38.0 million. Two consecutive stronger quarters corroborate the normalization. We credit no further growth in any case: rising mortgage volumes and the added production staff depend on markets or events that have not yet happened. Base case, $79.2 per share: owner earnings hold at $4.75 per share and the franchise (agency lending licences, deposit base and warehouse customer relationships built since the company's 1990 founding) keeps producing that level, valued at 6%. Bear case, $57.4 per share: credit problems are the named risk. Nonperforming assets were $258.0 million at year-end 2025 (including $60.1 million of foreclosed property), reserves cover only 42% of nonperforming loans, and loan modifications rose to $188.7 million from $106.1 million. Expenses tied to credit-default-swap premiums, collateral preservation and new production staff were $46.4 million and lifted the efficiency ratio to 44.0% from 33.4%. We assume two years at $3.00 per share as losses on those loans are recognized, then a permanently lower $3.50, below the lowest year in our record, as warehouse volume (which doubled from 2023 to 2025) reverts and the higher cost base persists. Bull case, $98.5 per share: credit costs return to the $24-40 million a year seen in 2023 and 2024, which lifts owner earnings to the 2024 level of $5.91 per share, and stay there. Margin-of-safety price: $36 per share, roughly 37% below the bear case and less than half the base case. This is a leveraged, complex lender with a live credit problem, so the margin-of-safety price carries a wide cushion: from $36, reaching the base value in about four years implies about 22% a year in the base case. What could make this wrong: charge-offs on the multi-family and healthcare loans running well above the 2025 pace; another year of provisions near $118 million; a fall in warehouse volumes back toward 2023 levels; or the tax-credit benefit not recurring. Not reconciled from the filings: a $30.5 million "other" operating cash-flow item in 2025, which we left in.