The very costly and unpleasant business of saving Metro Bank

In war and bank rescues, whichever side may call itself the victor, there are no winners — but all are losers. That’s the upshot of Metro Bank’s announcement overnight that it has found a possible way to structure its second emergency cash injection in four years.

There’s £150mn in new equity, nearly all of which is backstopped by Metro’s biggest shareholder, the Colombian billionaire Jaime Gilinski Bacal. There’s the issue of bail-in notes with a value of £175mn. And there’s a £600mn debt refinancing involving term extensions that, awkwardly, mean a 40 per cent haircut on the £250mn of outstanding Tier 2 bonds.

Bondholders taking the hit before equity is zeroed is an echo of the Credit Suisse AT1 write-off, as it raises similar questions about seniority. But preserving some equity value was presumably in the demands of Spaldy Investments, Gilinski’s shareholding vehicle. The compromise casts Gilinski as the Saudi National Bank in this particular saga.

His Spaldy fund has committed to spend £102mn on new shares priced at 30p, a 33 per cent discount to Friday’s close. This would raise its stake from 9.2 per cent to 53 per cent so completion will need a waiver from the Takeover Panel to avoid triggering a mandatory offer, as well as giving Metro a post-rescue free float that for most institutions will be unacceptably low.

CEO Daniel Frumkin is adding a further £2mn to the equity raise — a “smaller related party transaction” that “does not require the approval of independent ordinary shareholders” apparently — with CFO James Hopkinson stumping up a token £60k. Dilution for shareholders who don’t subscribe will be extreme, with the cash call increasing Metro’s share count by approximately fourfold.

Metro will also extend its existing £350mn MREL-eligible senior non-preferred notes to April 2029, with the coupon upped to a hefty 12 per cent, and raise £175mn by issuing new MREL notes on the same terms. (MREL stands for minimum requirement for own funds and eligible liabilities and are effectively bail-in debt). The bank says “a number” of existing noteholders have committed to subscribe for the new MREL debt, which doesn’t tell us much since zero is a number.

The notes needing extended have a 9.5 per cent coupon and a call date of October 2024. These are the ones it issued in 2019 after it used the wrong risk weighting on a commercial loan portfolio. Digging itself out of that hole also required a £350mn share issue and a sale of £3bn of residential mortgages, the loss of which contributed to Metro remaining unprofitable until the first half 2023.

This latest package will probably pass because something is better than nothing, says Goodbody analyst John Cronin . . . albeit not by much:

On our calculations, were this a standard rights issue (which this is NOT), the theoretical ex-rights price of c.34p (Friday closing price: 45.25p) is more than the 30p per share rights issue meaning that element should garner some reasonable support at least. However, that doesn’t dovetail with Spaldy getting to a 53% shareholding it must be noted so we do expect broader shareholder resistance — though we are conscious that recent deposit outflows and, possibly, consumer book impairments, might be enough to garner shareholder support. Indeed, the difficulties in achieving an agreed coordinated alternative plan quickly (with no alternatives being entirely obvious and a ‘gun to the head’ of debtholders re terms to incentivise take-up) means it is likely to reluctantly secure the requisite supports in our initial view (though it may require some alteration, particularly from a shareholder perspective).

Metro’s crisis came to a head after it spent years lobbying to change its calculation of capital requirement from standardised risk-weights to a lower internal measure, known as an advanced internal ratings-based approach or AIRB. The Prudential Regulation Authority said in September that “more work is required” and there was no chance of AIRB taking effect in 2023.

With regulatory forbearance expired, bridging finance was needed so the MREL notes had to be extended. But since the PRA update, Metro shares and Tier 2 bonds collapsed on fears that shareholders would refuse to put in new money and accept crushing dilution to effectively rescue senior bondholders.

The result is a TINA proposal, barring some miracle such as a takeover offer from a rival. Stories about Metro takeover interest were exclusive to all media over the weekend, but appear to have come to nothing. What they have done for deposit flows is not yet known.

Why no bid? Per Citigroup, it’s partly that the overbuilt branch network looks like a poison pill:

We note that under IFRS 3 M&A accounting any acquirer would have to value all assets and liabilities at fair value. In note 33 of the annual report the fair value of assets is noted to be £1,115m lower and liabilities £158m lower. Although these assets might be expected to pull to par over time, it would impact on any would be acquirer’s capital ratios upfront, alongside the consolidation of RWAs, while any offset would likely come from badwill recognition (Metro tangible book £763m).

. . . with the other poison pill being that it’s Metro Bank:

Metro Bank has a lower starting capital position and weaker organic capital generation vs large-cap listed peers, making it harder to absorb subsequent regulatory developments (higher buffers).  We therefore see no read-across to the incumbent UK banks. We estimate an acquisition scenario of the whole of Metro Bank based on Friday’s closing price would dilute Lloyds CET1 ratio by ~70bps and Natwest by ~80bps, but view this as an unlikely outcome. Should any of these banks instead acquire portfolios of assets then this is likely to have a much smaller capital impact (when Natwest acquired the £3bn portfolio in 2020 it was a 15bps hit to CET1R).

If the rescue goes through, Metro’s MREL ratio will rise to 21.5 per cent versus 18.1 per cent at the end of June — so will remain uncomfortably close to a minimum regulatory requirement that was 21.2 per cent at the start of July.

Metro is also in talks to sell about £3bn of mortgages, though this seems less to do with capital and more an attempt to shift low-fixed-interest loans. A sale will improve risk-weighted asset ratios by £1bn while recycling cash into more profitable lending, but cash raised from disposals is not central to the plan.

The bank’s CET1 ratio has never been worryingly near the 9 per-cent-ish regulatory threshold and will rise to at least 13 per cent under the proposals set out. Assuming a speculative £100mn loss, the mortgage book disposals would be of only incremental benefit, raising CET1 to proforma 13.4 per cent and MREL to 24.3 per cent, KBW estimates.

So what might a new Metro look like?

KBW analyst Edward Firth says the assumptions built in to management’s medium-term guidance look “heroic” given its restructuring requirements and liabilities, such as the need to refinance £3.25bn of term funding drawn down under a Bank of England SME scheme by between 2025 and 2027. Unclear guidance on cost savings and associated expenses in the statement don’t help build much confidence in the recovery, he says:

Taking management projections at face value and applying peer multiples does suggest a potential fair value of 55p-65p. However, considerable uncertainties remain. In particular, we struggle to square double-digit loan growth, strong margin expansion and low cost growth with the current UK banking environment. Furthermore, with only 9% ROTE targeted for 2025 capital generation versus growth remains tight.

For many analysts and commentators, this is same-old-same-old. Not only did Metro Bank’s focus on community banking never make much sense, its guidance and targeting have only sometimes been considered reliable.

Goodbody’s Cronin takes a slightly different view, saying that while Metro’s own failings are numerous its struggles over MREL are evidence that UK challenger banks have been over-regulated:

Stepping back completely, MTRO will have loan assets of <£10bn to fund if it strikes the asset sales it is contemplating. While one can call out various explanations for why the bank is in a bind and in need of a significant capital support package without undue delay (i.e., we can debate causation all night long), it is undeniably the uncertainty surrounding the impending refinancing of the £350m MREL instrument that has been the key trigger for this announcement. Casting our minds back to late 2019, the need to issue MREL debt almost pushed the bank into resolution. MTRO had a solid stable deposit funding base in late 2019 and it had a solid stable deposit funding base less than one month ago (not to say it still doesn’t but, rather unsurprisingly, the RNS does reference a recent increase in deposit outflow rates — which we have seen before).

Why on earth does a tiny bank of this size need to have such a complex capital structure comprising MREL — and even Tier 2 if it comes to it — debt? Why can’t it just be funded with equity and deposits, obviating the need for loads of fees to bankers and avoiding the enormous profitability suppression that such issuance entails? Unnecessary complication for my simple mind. Another lens through which to look at MTRO’s travails in our view and hardly an unreasonable question to boot, especially if we want competition in UK banking. The varying layers of bank capital stacks (not to mention the ridiculous complexity in relation to the constitution of capital requirements across the entire sector) are simply constructed solely to achieve structural subordination. Is there not an easier way? What’s wrong with just ordinary equity and deposits for such a small bank? OK, we get the arguments on Tier 2. But MREL? MREL is what almost pushed MTRO over the edge in late 2019 and is fundamentally the reason for this panicked package as well as the recent deposit outflows — the irony is that it has had an absolutely destabilising, not a stabilising, effect.

Indeed, shareholders — and bondholders (to a lesser extent) — will feel aggrieved at this outcome. We expect some resistance, particularly among shareholders (though we qualify that with what information they might learn about recent deposits migration and consumer book performance). Indeed, the shares and the bonds were trading at much higher values until very recently. We had envisaged asset sales as a stopgap to IRB accreditation with MTRO potentially then on a more offensive footing with respect to equity capital raising and debt restructuring. So, why can’t this happen? It clearly seems like the reason is because events of the past few weeks have pushed MTRO into an unavoidable alternative solution (possibly meaning substantial deposit outflows (which they probably can’t say much on) — and, perhaps, an acceptance that IRB accreditation is a dim prospect at best). The CEO and Board, notwithstanding the outcome, have done the best they could in terms of reinvigorating the business. That I am in no doubt. So, maybe it’s just the least worst outcome now and a bitter pill that just needs to be necked. However, the equity raising specifics need to be more transparent.

 Then again, without getting overly philosophical, sometimes in life a deal just needs to be struck to shelve the torrid past and allow everyone turn a new leaf with renewed vigour and restored relations (though, with that said, I’m sure everyone is prepared for battle). The financial targets have some credibility (though the mid-teens RoTE objective will meet with cynicism). MTRO survives to fight another day in an independent capacity our view. We look forward to continuing to track its progress — there is a sensible business model underneath it all (a credit to Vernon Hill’s vision despite all the mishaps along the journey) as we have always said (even when we were highly vocal in relation to our opposition to the historical strategy from coverage initiation in May 2017 through 2020). But this is far from an ideal outcome for the majority of shareholders and debtholders.

Further reading
— The Metro Bank Coin Caper (FTAV)
— A brief look at Metro Bank’s offer document (FTAV)
— The misregulation of Vernon Hill (FT)
— How Metro’s challenging week unfolded (FT)
— Lex readers weigh in (FT)