Metro Bank’s Hectic Week Came After Months of Slow-Burn Concern

Long before this week, executives inside Metro Bank Holdings Plc were fixated on an impending cliff edge for the challenger bank’s funding.

(Bloomberg) — Long before this week, executives inside Metro Bank Holdings Plc were fixated on an impending cliff edge for the challenger bank’s funding.

Top staffers and board members alike have spent months weighing what they will do when a £350 million ($427 million) bond is no longer allowed to count toward key capital requirements beginning next year. For starters, they’d hoped to convince regulators to let them use a new, internal model for calculating risk-weighted assets that would likely boost the firm’s capital ratios. This summer, existing investors were being sounded out about potential options for raising capital.

But those plans were thrown into disarray in recent weeks after the Bank of England’s Prudential Regulatory Authority informed Metro Bank that it had more work to do before it would be allowed to use these new models. That sent executives back to the drawing board as they raced to figure out how to fill the impending hole on its balance sheet. 

Against a backdrop of seesawing shares and falling bond prices, the lender is exploring a variety of options. The company is in talks to offload a portion of its mortgage portfolio to rivals and there have been discussions with investors about raising more than £500 million through a mix of equity and debt, according to two people familiar with the matter.

“The company continues to consider how best to enhance its capital resources, with particular regard to the £350 million senior non-preferred notes,” Metro Bank said in a statement on Thursday. “The company is evaluating the merits of a range of options.” 

The company’s CET1 ratio, a core measure of capital strength, stood at 10.4% at the end of June. That’s above the 8.2% the company is required to maintain, though European lenders typically operate with a bigger buffer above their regulatory minimums.  

Dog Bowls

Metro Bank opened its doors in 2010 to take on incumbents such as Barclays Plc and Lloyds Banking Group Plc, making it the UK’s first new consumer bank in more than a century. While other challenger banks focused on expanding their online offerings, Metro Bank became known for building a network of branches in tony locations like the King’s Road in Chelsea.

The company clung to an outlandish image, even famously offering water bowls and treats for customers with dogs. Vernon Hill, the firm’s outspoken American founder who previously started Commerce Bancorp Inc. in New Jersey, delighted in snubbing his nose at the argument that customers would only flock to banks with a slick app and high savings rates. 

“People give us more of their low-cost deposits for service and convenience,” Hill said in 2016, the year Metro Bank went public. “The same reason you buy an iPhone 6: not because it’s cheap, because you’re buying the Apple world. Our entire model, whether it’s in America or Metro Bank in Britain, is built around that fundamental idea.” 

It was in 2016 that Metro first began thinking about trying to convince the Prudential Regulation Authority to let it use a new approach — known as AIRB, or advanced internal rating-based method — to assess the risk weighting on mortgage loans. 

Metro has long argued that being able to use that approach would allow it to grow its residential mortgage business. But it also had another key benefit: By reducing the amount of risk-weighted assets it assigns to mortgages, adopting the new model would also boost Metro Bank’s capital ratios. 

“That will take a little while,” Michael Brierly, the bank’s chief financial officer at the time, warned investors. 

Willett Advisors LLC, the investment arm for the personal and philanthropic assets of Michael Bloomberg, founder and majority owner of Bloomberg News parent Bloomberg LP, held shares in Metro Bank as of November 2021, according to a regulatory filing.

City Toast

Two years on from its initial public offering, Metro Bank was the toast of the City of London. The lender’s shares were trading at an all-time high, giving it a market capitalization of more than £3.5 billion and cementing its status as the biggest of the UK challenger banks. Deposit levels were soaring and the company was looking to expand in new forms of lending. 

But critics soon emerged. In April 2018, the now disgraced British hedge fund manager Crispin Odey announced his fund had begun shorting Metro shares, pointing to the firm’s escalating costs.

Within weeks, the bank reported a surprise drop in a core capital ratio, which ultimately meant the firm had to raise more equity. Even with the extra cash, doubts remained about the bank’s prospects. It ended 2018 with a share price that had been snapped in half. 

In early 2019, new issues appeared: The company announced it had been mistakenly applying a risk weighting that was too low on some of its mortgages, resulting in the need to put more capital behind its existing positions.  

The moves caused a monthslong selloff in Metro Bank’s shares. Ultimately, the company was forced to raise another £375 million through a new share placement to fix the capital shortfall.

The scandal sparked the departures of both Hill and then-Chief Executive Officer Craig Donaldson. The PRA eventually fined Metro Bank £5.38 million for the errors, while the Financial Conduct Authority hit it with £10 million in penalties.

What Bloomberg Intelligence Says:

Metro’s future as an independent lender remains in doubt amid its poor profitability prospects, with 2023-24 consensus ROE 1-2% and four years of losses now exacerbated by margin pressure and now the potential for £600 million in new capital and a debt raise. The sale of part of its mortgage book could provide some near-term relief but would also weigh on profitability and growth.

— Tomasz Noetzel, banks analyst

Through it all, Metro Bank executives have been engaged with regulators at the PRA on its application for using the AIRB approach. As recently as August, executives were touting the fact that regulators remained “very responsive” to the request.

“We have answered all of the questions that we’ve been asked, and we’ve submitted lots of paperwork as you’d expect, and we just need to let that process play out,” CEO Daniel Frumkin told investors on a conference call at the time. 

But just weeks later, the company changed its tune after the PRA had indicated that more work was needed on the company’s application, meaning it wouldn’t get the necessary approvals anytime this year. 

That, combined with the looming maturity for the £350 million senior bail-in bond, is what ultimately led the company to hire Morgan Stanley to advise it on ways to boost its capital. 

“It is a cliff edge, and we’re fully aware of it,” Frumkin said in August. “We’re all very aware of its existence, and we continue to talk to bankers and holders about what we do when the call date comes. In terms of accessing debt and equity capital markets, I think we’ll be opportunistic. And if there’s a moment in time where we think it makes sense, we’ll do something.”

–With assistance from Katherine Griffiths, Jan-Henrik Förster, Ruth David, Libby Cherry, Abhinav Ramnarayan and Gillian Tan.

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