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Metro Bank returns don't justify high rating

The challenger bank has had to return to the market twice since listing to bolster its capital levels
September 13, 2018

Metro Bank (MTRO) is an oddity among the challenger banks that have listed on the London markets post-financial crisis. Rather than targeting specialist, higher-margin areas of lending that the mainstream banks have pulled back from, it’s trying to compete with high-street banks for retail deposits and lending business. However, the rapid rise in lending – which has been pursued via a costly branch expansion strategy – has not been backed by the same rate of deposit growth. That has forced the group to boost its regulatory capital levels earlier than expected, pushing down targeted return on equity in the process. Despite this, the shares are valued higher than any UK-listed mainstream or challenger bank, which we don’t think is warranted given shifting return-on-equity targets, margin pressure and the threat of further capital-raisings.

IC TIP: Sell at 2708p
Tip style
Sell
Risk rating
High
Timescale
Medium Term
Bull points

Now profitable

High lending growth

Bear points

Highly rated compared with peers

Reduced return on equity target

High-cost operating model

Forced to raised capital 

Metro Bank’s loan book grew 160 per cent to £12bn during the two years to mid-2018. However, deposit growth was not able to keep pace, rising by – an admittedly still impressive – 108 per cent. Low levels of interest payable on retail deposits has made them a cheap source of funding for lenders, increasing competition for current and savings account customers. That’s meant the bank’s loan to deposit ratio had also risen to 87 per cent by the end of June, from 79 per cent at the same time in the prior year and 70 per cent in 2016.

Of more concern, accelerating loan growth has weighed on the common equity tier one ratio (CET1), which had dropped to 12.7 per cent by the end of June – close to a targeted minimum of 12 per cent – from 21 per cent two years earlier. The leverage ratio – of tangible assets to tangible equity – had also risen to 20.6 by the end of June, from 17.1 a year earlier. 

Diminishing regulatory capital levels forced management to undertake a share placing at 3,422p in July, raising gross proceeds of £303m, just three months after chief executive Craig Donaldson told analysts that the lender had no plans to raise further equity until next year. That followed a share placing at 3,465p the same month a year earlier, raising £278m in gross proceeds and the issuance of £250m in subordinated tier two debt in June this year to “facilitate growth”. If Metro had had the proceeds of the most recent placing at the end of June, the CET1 ratio would have stood at 17 per cent. The enlarged capital base also led management to reduce the return-on-equity target for 2020 to 11.5 per cent from the 14 per cent guided to in February. However, for now management is sticking by a 2023 target of 17-19 per cent.  

Admittedly, Metro Bank turned a corner last year, achieving its first statutory pre-tax profit of £18.7m, against a £17.2m loss in the prior year. That’s despite the group opening new branches at expensive high-street locations, owning the freehold on around a fifth of the branch network at the end of last year, up from 13 per cent in 2016. However, the net interest margin has continued to come under pressure due to rising competition within the residential mortgage market, contracting from 1.97 per cent to 1.85 per cent in the first half.  

METRO BANK (MTRO)    
ORD PRICE:2,708pMARKET VALUE:£2.64bn
TOUCH:2,704-2,708p12-MONTH HIGH:4,056pLOW: 2,674p
FW DIVIDEND YIELD:nilFW PE RATIO:15
NET ASSET VALUE:1,126pLEVERAGE:20.6
Year to 31 DecTotal operating income (£m)Pre-tax profit (£m)**Earnings per share (p)**Dividend per share (p)
2015*120-56.8-83.1nil
2016195-17.2-21.8nil
201729415.912.8nil
2018**41659.947.7nil
2019**610155177nil
% change+47+159+271-
Normal market size:500   
Matched bargain trading    
Beta:0.46   
*Pre-IPO
**Investec Securities forecasts, adjusted PTP and EPS figures