Metropolitan Bank: Near-Term Challenges, But An Interesting Longer-Term Story

With funding and operating costs rising and credit quality likely to worsen from here (not to mention a likely slowdown in loan demand), these are challenging times for almost any bank. Add in the decision to wind down a business that was contributing a meaningful amount of low-to-no-cost deposits, and 2023 will be even more challenging for New York’s Metropolitan Bank (NYSE:MCB). Look beyond the short term, though, and I think there’s an interesting story here between a growth-focused commercial lending operation and a fee-generating banking-as-a-service platform.

I think today’s valuation already factors in a lot of risks, both real and perceived. Metropolitan is exposed to the New York City commercial real estate market but doesn’t have overwhelming retail or office exposure. And while Metropolitan is still technically in the crypto banking business, they’re getting out. Likewise, Metropolitan is likely to have a higher deposit beta than the prior cycle (and higher than average), but I believe that’s already in the price. I can’t say that readers won’t get another chance to buy at similar or better prices, but the shares do look more interesting for long-term investors interested in growth at a reasonable price

A Core Miss On Higher Expenses

It doesn’t exactly make for the smoothest transition to go from claiming the shares are undervalued to talking about how the company missed its fourth quarter numbers at a core level, but I think the primary drivers of the miss aren’t likely to be enduring headwinds.

Revenue rose more than 35% year over year and close to 2% quarter over quarter, beating expectations by about 1% (or $0.07/share). Net interest income rose almost 43% yoy and about 1% qoq, a very modest beat as better-than-expected earning asset performance (down 4% qoq) compensated for a slightly lower-than-expected net interest margin (up 146bp yoy and 20bp qoq to 4.05%).

Non-interest income fell 10% but rose more than 8% qoq, driving the bulk of the revenue beat. The Global Payments business was down 19% yoy and up 5% qoq, with revenue from the fintech banking-as-a-service (or BaaS) business up 48% yoy and 24% qoq to $3.1M, or close to half of non-interest income.

Operating expenses rose 36% yoy and close to 2% qoq, missing by more than $0.13/share, as the bank incurred higher legal and professional fees. Management booked $35M for a regulatory settlement (excluded from opex) tied to a fintech client that engaged in fraudulent activity in 2020 around the CARES Act unemployment benefits, but I would expect this to be the “high-water” mark for reserving and legal expenses as the bank winds up this issue.

Pre-provision profits rose 35% yoy and about 2% qoq, missing by close to $0.07/share. While Metropolitan did post a $0.09/share core earnings beat, that beat was driven by lower provisioning and a lower effective tax rate, so a lower-quality beat.

Good Growth, Though Funding Will Remain A Challenge

Metropolitan posted above-average loan growth in the quarter, with loans growing about 5% qoq on an end-of-period basis and more than 6% on an average balance basis. Both C&I lending (up 4.6% qoq) and CRE lending (up 4.9% qoq) continue to grow nicely and above the average of similarly-sized banks.

Loan yields improved again this quarter, rising 118bp yoy and 68bp qoq to 5.98%, and credit quality remains pristine (no non-performing loans or charge-offs). Only about a third of the bank’s loans are floating rate, and the bank is now more neutrally-positioned from an asset sensitivity standpoint.

Deposits were a mixed bag and require some further explanation. As reported, deposits declined 8% qoq (EOP basis) and more than 7% on an average basis, with non-interest-bearing deposits down 21% at period end. That’s far worse than the norms seen this quarter, but it’s also tied in part to the bank’s decision to exit its crypto banking business activities. Deposits from crypto customers were 13% of Q3’22 deposits and are now around 6% of deposits, so there were significant and exceptional outflows in the period.

At the same time, the bank is deliberately reducing its exposure to bankruptcy and property manager deposits, further pressuring deposit balances. Looking more at “high-priority” deposits, BaaS fintech deposits rose 6% (14% of the total), loan customer deposits fell 3% (16% of the total), and retail deposits rose 11% (35% of the total).

Deposit costs rose 87bp yoy and 68bp qoq to 1.12% this quarter, with interest-bearing deposit costs up 171bp yoy and 127bp qoq to 2.26%. Metropolitan’s cumulative beta is now a comparatively good 21% (40% for interest-bearing deposits), but is likely to continue heading higher. Non-interest-bearing deposits are around 46% of total deposits, but the loan/deposit ratio is effectively at 100% now (excluding crypto deposits) and continuing to attract no-to-low-cost deposits in this environment will be challenging.

The Outlook

Metropolitan was one of the first banks to offer banking and payment services to crypto companies, but as the bank had a ringside seat to the crypto business, management decided that the volatility didn’t really suit their business model. With that, the bank hasn’t added any crypto clients since 2019 and announced earlier this month (January 9) that it was exiting the crypto vertical.

In the near term, this will cost the bank around 10% of its EPS in 2023 and 2024 (relative to prior expectations), as the business contributed high-margin fee revenue and low-cost deposits. I expect readers with more long-term faith in crypto to view this as a short-sighted move, but I think Metropolitan can do without the volatility. Moreover, I still see a significant long-term opportunity for providing a BaaS platform to fintech clients looking to address retail or specialty commercial markets (I’m also bullish on Synovus‘ (SNV) efforts here for much the same reason).

Longer term, I’m also bullish on the company’s efforts to grow its commercial lending franchise. High concentration in New York City is a risk, but about a third of the CRE loan book is in skilled nursing facilities, and offices, retail, and hospitality are collectively about a quarter of the CRE book. I see ongoing opportunities to grow lending to multifamily builders/operators, as well as small/mid-sized businesses that aren’t as well-served by larger banks, and I think the core payments functionality of its BaaS platform could also be used to offer more payment/treasury services to commercial clients over time.

I’m expecting basically flat earnings in 2023, and I can see a path to a modest year-over-year decline if funding costs rise more than I expect. I do expect a rebound in 2024/2025, though, and I think there could be an upside to my 7% long-term core earnings growth rate.

Metropolitan shares look undervalued to me today. Discounted core earnings support a fair value around $70 and both ROTCE-driven P/TBV and P/E support $70-plus fair values even with a “haircut” applied to the multiple I use to account for elevated risk/volatility in numbers (like the NYC commercial concentration and the exit from the crypto business).

The Bottom Line

Deposit outflows and weak near-term pre-provision profit growth could weigh on these shares well into 2023 and sentiment is likely to remain challenging until the Fed signals it’s finished with rate hikes. For patient investors, though, I think Metropolitan is worth a closer look – a like the focus on commercial lending growth, the quality deposit base, and the opportunity to generate lucrative fees from its BaaS platform. I don’t dispute that these shares could underperform in the short term, but I see less credit risk here, and I think the longer-term growth opportunity is pretty compelling, particularly relative to the valuation.