Metro Bank Plc
New Coverage: Metro Bank on Advisors Radar Due to Regulatory Risks After £5.4M Accounting Blunder Fine, Underperformance, Risky Assets Weighting; T2 Notes in High-50s
Thu 08/25/2022 11:41 AM
Relevant Documents:
H1’22 Presentation
H1’22 Trading Update
2021 Annual Report
Metro Bank regulatory risk: Some financial advisors are monitoring the U.K.-based high street lender Metro Bank, which ran into regulatory troubles recently, raising concerns about its financial health in an economic downturn, sources told Reorg. The bank has been reporting annual losses since 2019.
Metro Bank’s £250 million 5.5% Tier 2 2028 notes have dropped from mid-60s at the beginning of the year to high-50s on Aug. 25 and its £350 million 9.5% 2025 MREL senior non-preferred notes dropped around 10 points from low-90s at the start of the year to the low-80s, according Solve Advisors. The lender earned bad press in recent months over an accounting blunder, which caused finance chief David Arden to step down in February.
In December 2021, the U.K.’s Prudential Regulation Authority, or PRA, slapped Metro Bank with a £5.4 million fine, saying the lender failed “to act with due skill, care and diligence” in reporting its capital position and for shortcomings in its governance and controls between May 2016 and January 2019.
The regulator found errors in the accounting treatment of Metro Bank’s professional buy-to-let loans, or PBTL, and loans secured by commercial mortgages, which meant it had to increase its risk-weighted assets by £900 million and was not holding enough capital.
The incorrect risk weighting of certain commercial real estate, or CRE, loans and PBTLs by the lender understated its capital requirement by approximately £12 million in two reports submitted to the PRA. In a separate exchange, the PRA informed the lender that the application of a 44% average risk weighting to the “CRE Other” loan book appeared low on the basis that it included unsecured commercial loans and commercial investment loans, and the March 2018 COREP return recorded £1.1 billion of exposures to commercial loans secured on commercial immovable property, aka CLIPs, at 50% risk weight.
Over the past two years, there have been rumors about a potential capital raise of Metro Bank but nothing has materialized so far, sources told Reorg. Investors are puzzled over the destiny of the lender’s bonds in case performance does not improve and raising capital becomes an impellent necessity. Some believe that an equitization or a bail-in of part of its notes cannot be excluded, especially in the case of a potential takeover by a bigger bank, while others think that the bank has enough value and talent in its franchise to turn the performance around and avoid any drastic interventions.
One source highlighted that a full bail-in of the bonds coupled with an investment by the U.K. government - similar to what happened with Northern Rock or the two Veneto banks bought by Intesa Sanpaolo for a symbolic sum - is highly unlikely in the current political and economic context.
Some sources believe it’s likely that the regulator will give the bank more time to fix its issues. The government may ease the regulation for capital adequacy ratio and Metro Bank could benefit from it, one source said, adding the Bank of England already reduced their requirement for the MREL – the minimum amount of equity and subordinated debt a firm must maintain to support effective resolution – by over a half, which enabled Metro Bank not to raise any more capital.
The PRA reduced the bank’s Pillar 2A capital requirement to 0.5% from 1.11%, effective June 27, 2022. The Resolution Directorate of the central bank also agreed that Metro Bank’s binding MREL, applicable from June 27, shall be equal to the lower of 18% of the bank’s risk weighted assets or twice the sum of the lender’s Pillar 1 and Pillar 2A. Therefore, the bank’s minimum MREL requirement has been reduced to 17%. As of June 30, the bank’s MREL was 18.3%.
Some sources highlighted Metro Bank’s “problematic” business model based on a high number of branches (78 as of 2021-end), which goes in the opposite direction to the branchless-banking or fintech model other companies are following. Others referred to its loan book which presents some risks especially in its SMEs segment. Below is a snapshot of the bank’s total gross lending mix:
The Financial Times reported that Carlyle pulled out of talks to acquire Metro Bank in November 2021 within a fortnight, adding that the bank’s expensive branch network was a deterrent to bidders.
In the first half of 2022, the lender saw its net interest income jump 35% year over year to £181 million, but it reported a pretax loss of £48 million compared with a pretax loss of £110 million in the corresponding period of 2021. Cost of risk increased to 0.29% from 0.12% at the end of 2021.
At the end of June, the lender’s CET1 ratio was 10.6%, down from 13.9% a year ago, but still higher than the minimum required 4.8%. The LCR was 257% at the end of June 2022 compared to 309% a year ago. As of June 30, the bank’s nonperforming loans comprised 2.76% of the portfolio compared to 3.71% on Dec. 31, 2021.
According to a July-28 report by the Financial Times, Metro Bank is one of the banks that submitted claims to avail the U.K. government’s £47 billion Covid -19 loan scheme as default rates rose to as high as 25%. Metro Bank claimed £122 million of the £1.4 billion it issued in loans, the report said.
In a trading update, the bank said it has built a sustainable business and now expects to reach monthly breakeven during the first quarter of 2023 in regards to profitability. This guidance is subject to an assumption that there will be no material deterioration in the macroeconomic environment.
The bank also reaffirmed its guidance for the financial year 2022. The bank expects higher growth in the balance sheet in 2022 compared to the previous year and expects a low single-digit percentage reduction in total underlying operating expenses. However, the bank said it remains cognisant of the potential for unexpected adverse macroeconomic developments, which may impact its ability to deliver on the guidance. Loan growth expectations are now higher for the year as the bank continues to optimize balance sheet growth within capital constraints, it said.
The bank also said it is comfortable operating in buffers and remains above regulatory minima adding that the bank’s advanced internal rating-based application is progressing. Alternative capital actions remain available, it said.
“We have delivered a strong first-half performance and I am encouraged by the continued momentum we are seeing across the bank,” CEO Daniel Frumkin said in a July 28 trading update. He added the initiatives they put in place as part of a turnaround strategy over the past two years helped improve net interest margin, lending yield and cost to income ratio. Metro Bank also appointed a new CFO in July. James Hopkinson will start from Sept. 5, subject to regulatory approval.
When it launched in 2010, Metro claimed to be the first new main street bank to open in the U.K. in more than 100 years, saying it aimed to challenge the major retail banks. It offers retail, business, commercial, and private banking services. The lender achieved its first annual profit in 2017. Since its foundation, the bank has rapidly expanded and now has a network of 78 branches (as of December 2021), servicing 2.4 million customer accounts across the U.K. with a total loan book of £12.4 billion.
-- Farooq Balooq, Luca Rossi, Declan Bush
H1’22 Presentation
H1’22 Trading Update
2021 Annual Report
Metro Bank regulatory risk: Some financial advisors are monitoring the U.K.-based high street lender Metro Bank, which ran into regulatory troubles recently, raising concerns about its financial health in an economic downturn, sources told Reorg. The bank has been reporting annual losses since 2019.
Metro Bank’s £250 million 5.5% Tier 2 2028 notes have dropped from mid-60s at the beginning of the year to high-50s on Aug. 25 and its £350 million 9.5% 2025 MREL senior non-preferred notes dropped around 10 points from low-90s at the start of the year to the low-80s, according Solve Advisors. The lender earned bad press in recent months over an accounting blunder, which caused finance chief David Arden to step down in February.
In December 2021, the U.K.’s Prudential Regulation Authority, or PRA, slapped Metro Bank with a £5.4 million fine, saying the lender failed “to act with due skill, care and diligence” in reporting its capital position and for shortcomings in its governance and controls between May 2016 and January 2019.
The regulator found errors in the accounting treatment of Metro Bank’s professional buy-to-let loans, or PBTL, and loans secured by commercial mortgages, which meant it had to increase its risk-weighted assets by £900 million and was not holding enough capital.
The incorrect risk weighting of certain commercial real estate, or CRE, loans and PBTLs by the lender understated its capital requirement by approximately £12 million in two reports submitted to the PRA. In a separate exchange, the PRA informed the lender that the application of a 44% average risk weighting to the “CRE Other” loan book appeared low on the basis that it included unsecured commercial loans and commercial investment loans, and the March 2018 COREP return recorded £1.1 billion of exposures to commercial loans secured on commercial immovable property, aka CLIPs, at 50% risk weight.
Over the past two years, there have been rumors about a potential capital raise of Metro Bank but nothing has materialized so far, sources told Reorg. Investors are puzzled over the destiny of the lender’s bonds in case performance does not improve and raising capital becomes an impellent necessity. Some believe that an equitization or a bail-in of part of its notes cannot be excluded, especially in the case of a potential takeover by a bigger bank, while others think that the bank has enough value and talent in its franchise to turn the performance around and avoid any drastic interventions.
One source highlighted that a full bail-in of the bonds coupled with an investment by the U.K. government - similar to what happened with Northern Rock or the two Veneto banks bought by Intesa Sanpaolo for a symbolic sum - is highly unlikely in the current political and economic context.
Some sources believe it’s likely that the regulator will give the bank more time to fix its issues. The government may ease the regulation for capital adequacy ratio and Metro Bank could benefit from it, one source said, adding the Bank of England already reduced their requirement for the MREL – the minimum amount of equity and subordinated debt a firm must maintain to support effective resolution – by over a half, which enabled Metro Bank not to raise any more capital.
The PRA reduced the bank’s Pillar 2A capital requirement to 0.5% from 1.11%, effective June 27, 2022. The Resolution Directorate of the central bank also agreed that Metro Bank’s binding MREL, applicable from June 27, shall be equal to the lower of 18% of the bank’s risk weighted assets or twice the sum of the lender’s Pillar 1 and Pillar 2A. Therefore, the bank’s minimum MREL requirement has been reduced to 17%. As of June 30, the bank’s MREL was 18.3%.
Some sources highlighted Metro Bank’s “problematic” business model based on a high number of branches (78 as of 2021-end), which goes in the opposite direction to the branchless-banking or fintech model other companies are following. Others referred to its loan book which presents some risks especially in its SMEs segment. Below is a snapshot of the bank’s total gross lending mix:
The Financial Times reported that Carlyle pulled out of talks to acquire Metro Bank in November 2021 within a fortnight, adding that the bank’s expensive branch network was a deterrent to bidders.
In the first half of 2022, the lender saw its net interest income jump 35% year over year to £181 million, but it reported a pretax loss of £48 million compared with a pretax loss of £110 million in the corresponding period of 2021. Cost of risk increased to 0.29% from 0.12% at the end of 2021.
At the end of June, the lender’s CET1 ratio was 10.6%, down from 13.9% a year ago, but still higher than the minimum required 4.8%. The LCR was 257% at the end of June 2022 compared to 309% a year ago. As of June 30, the bank’s nonperforming loans comprised 2.76% of the portfolio compared to 3.71% on Dec. 31, 2021.
According to a July-28 report by the Financial Times, Metro Bank is one of the banks that submitted claims to avail the U.K. government’s £47 billion Covid -19 loan scheme as default rates rose to as high as 25%. Metro Bank claimed £122 million of the £1.4 billion it issued in loans, the report said.
In a trading update, the bank said it has built a sustainable business and now expects to reach monthly breakeven during the first quarter of 2023 in regards to profitability. This guidance is subject to an assumption that there will be no material deterioration in the macroeconomic environment.
The bank also reaffirmed its guidance for the financial year 2022. The bank expects higher growth in the balance sheet in 2022 compared to the previous year and expects a low single-digit percentage reduction in total underlying operating expenses. However, the bank said it remains cognisant of the potential for unexpected adverse macroeconomic developments, which may impact its ability to deliver on the guidance. Loan growth expectations are now higher for the year as the bank continues to optimize balance sheet growth within capital constraints, it said.
The bank also said it is comfortable operating in buffers and remains above regulatory minima adding that the bank’s advanced internal rating-based application is progressing. Alternative capital actions remain available, it said.
“We have delivered a strong first-half performance and I am encouraged by the continued momentum we are seeing across the bank,” CEO Daniel Frumkin said in a July 28 trading update. He added the initiatives they put in place as part of a turnaround strategy over the past two years helped improve net interest margin, lending yield and cost to income ratio. Metro Bank also appointed a new CFO in July. James Hopkinson will start from Sept. 5, subject to regulatory approval.
When it launched in 2010, Metro claimed to be the first new main street bank to open in the U.K. in more than 100 years, saying it aimed to challenge the major retail banks. It offers retail, business, commercial, and private banking services. The lender achieved its first annual profit in 2017. Since its foundation, the bank has rapidly expanded and now has a network of 78 branches (as of December 2021), servicing 2.4 million customer accounts across the U.K. with a total loan book of £12.4 billion.
-- Farooq Balooq, Luca Rossi, Declan Bush
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