Metropolitan Bank Holding Corp. (MCB) Earnings Call Transcript & Summary

Welcome to Metropolitan Commercial Bank Second Quarter 2026 Earnings Call. Hosting the call today from Metropolitan Commercial Bank are Mark DeFazio, President and Chief Executive Officer; and Daniel Dougherty, Executive Vice President and Chief Financial Officer. [Operator Instructions] Today's call is being recorded. During today's presentation, reference will be made to the company's earnings release and investor presentation, copies of which are available at mcbankny.com. Today's presentation may include forward-looking statements that are subject to risks and uncertainties that may cause actual results to differ materially. Please refer to the company's notices regarding forward-looking statements and non-GAAP measures that appear in the earnings release and investor presentation. It is now my pleasure to turn the floor over to Mark DeFazio, President and Chief Executive Officer. You may begin.

Thank you. Good morning, and thank you for joining us. I am pleased with the continued progress across the franchise. Balance sheet growth remains consistent with our guidance. The lending pipeline is strong, and loan yields continue to hold. . On the funding side, our deposit forecast remains on track, and we expect core funding to support balance sheet growth through the second half of 2026. Although our core operating trends remain strong, this quarter's earnings were impacted by several isolated items, primarily tied to legacy asset quality matters and investments we decided to move forward with. I want to address these directly and provide additional context before Dan reviews the financials in great detail. Asset quality. With respect to the Kansas City loan we have been speaking about for the last few years, the original loan balance was $24 million. After posting a specific reserve of $2 million, the carrying balance was reduced to $22 million. We have reached a $27 million settlement, which includes full principal repayment, interest at the note rate and the partial reimbursement of out-of-pocket expenses. We also expect a significant principal paydown by year-end with the remaining balance being amortized over time and is collateralized and supported by full recourse. We do expect a recovery with this particular loan. We also resolved the legacy out-of-market multifamily matter that we've been discussing also for the last 2 years. In the third quarter of 2025, we established a $20 million specific reserve for this credit. As I mentioned then, I was confident that we took the adequate amount of reserves and no further reserves would be needed. A full settlement has now been reached, and we charged off the prior specific reserve during the quarter. The remaining $14 million loan balance provides for P&I payment, collateral and full recourse. We will allow this credit to season before placing the restructured loan back on an accrual status. In connection with the high net worth client exposed -- exposure associated with the matter I just mentioned, we recorded a $4 million charge-off during this quarter. We remain in active settlement discussions with the borrower. While we rejected a $2 million all-cash settlement, offer, we are confident that a resolution will be reached by year-end, likely involving a substantial paydown and fully amortizing the remaining obligation. We also placed a new credit on nonperforming status during the second quarter. This credit relates to a window and door manufacturer that had historically been stable and profitable, but experienced execution challenges following an expansion of its business from its core Minnesota market into Texas. The Minnesota company's core business remains mature and stable. We recorded a $10 million charge-off during this quarter. We are cautiously optimistic that the remaining $16 million term loan balance can be supported and repaid through the company's ongoing operations in Minnesota. Importantly, we view these matters as largely discrete and legacy in nature. Based on our current portfolio review and ongoing monitoring, we expect nonperforming loan levels to normalize and remain in line with long-term historical levels going forward. I'll spend a minute on some noninterest expense and strategic investments. Dan will provide the details around noninterest expense as well as guidance for the remainder of 2026. But I want to highlight the strategic investments we are making to position the company for future operating leverage and further profitability gains. We have launched an ambitious end-to-end artificial intelligence initiative across the organization. To date, we have hired an AI lead officer, 2 AI analysts and 1 AI engineer. We have also extended office to 2 additional AI scientists and 1 additional engineer. Only 2 of the above hires were in our current run rate. Our objective is for MCB to be fully AI-enabled within 24 months. We expect to begin quantifying the return on investment by year-end and report progress in our quarterly investor presentation beginning in 2027. We recorded a $1.8 million loss in connection with an adverse ruling resulting from an administrative error. The matter has been submitted to our insurance company as well as pending appeal to reverse the outcome. Our payments platform initiative. We continue to make meaningful progress leveraging our payments platform and our extensive payment settlement experience. We are currently holding demonstrations, which settle well established and emerging gaming operators. And the feedback to date has been positive. We expect to move into live testing by the end of the third quarter and be in the market during the fourth quarter. In 2026, we invested approximately $3.4 million in this initiative, which was not in our budget, and we expect a meaningful return on investment, which should become quantifiable in early 2027. Retail expansion. MCB expanded its government banking subject matter experts in New Jersey. We launched our West Coast expansion, focusing on specialty deposits. And we established a new branch location in West Palm Beach, Florida. None of this was in our noninterest expense run rate. These were opportunities that presented themselves to us. We have taken this opportunity in the past, and we can convert them to a good investment for long-term benefits to MCB. In all cases, our branch expansion is primarily driven by expanding our specialty deposit franchise. We are seeing deposit contributions already and expect a meaningful return on investment in a short period of time. Dan will address any additional onetime items in his financial review. Thank you.

Okay. Thanks, Mark. Good morning, everyone, and thanks for joining the call. I'm going to start with a few comments on the evolution of the balance sheet during the second quarter and year-to-date. In the second quarter, the loan book increased by about $282 million. It's important to highlight the timing of the second quarter growth, as it had a noticeable impact on the income statement for the quarter. Loan growth came late in the quarter, such that the average balance change, approximately $103 million was significantly less than the linked quarter change. Year-to-date loan growth had been about $518 million. The pace of loan growth continues to be aligned with our guidance of $1 billion in growth for the year. We remain confident that the $1 billion goal remains achievable. Our loan pipeline is currently about $1 billion. We have signed term sheets of more than $625 million and term sheets out for signature of more than $375 million. Importantly, we have not materially modified our credit standards in any way to support continued growth. First quarter originations and draws of approximately $847 million were printed at a weighted average coupon of about 7.03%. Remember that deferred fees typically add about 25 basis points to the loan yield. Payoffs and paydowns totaled approximately $525 million at a WACC of 7.75%. The healthy payoff of some very high coupon adjustable rate C&I loans drove the payoff WACC above recent experience. We don't expect that going forward. Our current loan spread guidance continues to drive new volume coupons well above 7%. It is noteworthy that increasing competition for loans was evident during the quarter. We have seen new entrants in the market, which, of course, has the expected impact on pricing, structure and covenants. We embrace the competition and expect to win our share through determination, discipline and the certainty of execution that our customers rely on. Our liability side of the balance sheet, quarter-over-quarter deposit balances were essentially flat. There's a couple of reasons for that. We had late quarter deposit outflows related to muni deposits seasonality, and the intentional offloading of a $100 million high-cost treasury relationship that caused the drop at the end of the quarter. On a spot basis, quarter-over-quarter, the cost of interest-bearing deposits declined by about 4 basis points. Importantly, funding for loan and securities growth in the quarter was sourced entirely from an oversized cash position at the FRB. Cash in view from banks declined by about $430 million in the quarter. These seasonal outflows of muni deposit balances will be recouped over the next several months. The EB5 HOA and title and escrow verticals combined for over $200 million of growth in the quarter. Municipal deposit growth was about $100 million, offset by about $200 million in seasonal outflows. The outlook for continued deposit growth in our existing verticals remain strong, and our intent to continue funding all 2026 loan growth with deposits remains unchanged. Deposit competition is certainly a prevalent theme in our space. While we are not immune to such pressures, so far, our exposure has been limited in scope and isolated to discrete subsets of certain verticals. Our reported net interest margin was 4.08% in the quarter, unchanged from the prior period. However, conservatively adjusting for excess cash held at the FRB, which was almost $750 million on average, the normalized NIM would have been above 4.15%. Now, let's move on to some high-level comments on our income statement. Our second quarter interest income was up about $6 million or 4.5% compared to the first quarter. Once again, the back-loaded nature of our loan growth was a governor on the interest income expansion. Importantly, on the other side of the ledger, interest expense was up only about $1.4 million or 3%, resulting in exceptional unannualized top line growth of $4.5 million or 5.3%. Going forward, it is our expectation that top line growth will continue with at least 20% net interest income growth forecast for the full year. We expect that the NIM will press higher toward 4.20% as the year progresses. Importantly, our expanding NIM forecast is not relied on rate cutting assumptions. We have no movement in the Fed funds target rate as the baseline assumption in our current 2026 forecast model. Mark walked you through the credit details previously, so I'm simply going to add that our ongoing surveillance does not indicate any systemic or out of the ordinary credit stress across the loan book. And our noninterest income continues to be stable. We remain optimistic that our new initiatives related to payments and HUD activity will drive meaningful uplift in fee income beginning gradually later in the year and scaling up materially in 2027. Noninterest expense was $51.8 million, up $5.4 million versus the prior quarter. The elevated quarterly increase in OpEx included about $3.3 million in isolated or onetime expenses. The isolated expenses include the previously mentioned onetime legal accrual of $1.8 million. We also had elevated expense of about $650,000 related to comp and benefits and about $950,000 of onetime professional and legal fees. Far more importantly, our commitment to investment in AI and the expansion of the branch network were significant drivers of the remaining quarter-over-quarter delta. Our AI team is currently 4 FTEs with 3 more hires in the pipeline. In addition, our retail expansion has accelerated, new initiatives in the Western U.S., Florida and New Jersey are in flight with branches in North Carolina, Connecticut, Flush and Queens plans for opening later this year or early 2027. The retail expansion has included 5 new key hires so far. These investments in operational scale and efficiency and in human capital, which appears as expenses today are critical pillars of our strategic plan and demonstrate our willingness to make targeted investments to enhance the value of our franchise. For this quarter and next OpEx run rate should probably settle in at about $48.5 million per quarter. And then finally, the Modern Banking and Motion core conversion was executed in May. Related second quarter expenses totaled about $1.1 million. And trailing expenses related to that conversion are expected to be minimal going forward. I will now turn the call back to our operator for Q&A.

[Operator Instructions] Our first question today comes from David Konrad with KBW.

On your outlook for the quarter, I guess maybe first, on the cash balances, maybe how do you think that, that works down over the next 2 quarters and then maybe each quarter kind of how the NIM will progress?

Okay. So you saw the cash balance normalized become very close to a normalized balance at the end of the second quarter. I think there's a little bit of room to work that down further slightly, albeit slightly. Assuming the timing of deposit inflows and loan production are aligned, I don't anticipate using any wholesale funds at this point in time. But again, that depends on the timing of each of those cash flows. At the end of the day, I think that we're going to print north of 4.15 in the third quarter based on that normalization of the cash position as well as the late loan funding that we saw. And then we're going to press our towards 4.20 in the fourth quarter.

Got it. Okay. And then maybe with the expenses trending, how do you think the efficiency ratio might work out the next couple of quarters? .

I don't see any dramatic movement in efficiency ratio, the top line should support it. The increase -- the modest increase in the back half of the year. So I don't see any -- expect any material movement there.

Got it. And then my last question, I think we talked about in the spring around a 15% exit ROTC and in 4Q '27, any changes in that as we stand right now? .

Well, it was a little bit less of that after the capital raise towards 13%. I think it was in the low teens. And no, we stand by those numbers.

Our next question will come from Samuel Varga with UBS.

I just wanted to go back to the deposit trends a little bit. You noted the deposits bringing the balances a little bit. Can you size a bit more specifically what that isolated muni seasonality impact was?

The seasonal movement in munis was $200 million. And it all came really at the tail end of the quarter. I can see that in the average balance sheet. We expect those seasonal balances to come back to the bank over the next couple of months. And we have continued to have great expectations for gaining traction in New Jersey. We hired 2 salespeople in New Jersey that have a long history in state, and we're looking forward to them getting traction there and continued success in New York, which we've seen tremendous uplift so far. Florida is on the come. And then, as I mentioned, we've got these other 2 branches, Connecticut, North Carolina, that we haven't penciled in any growth to date with those geographies.

Great. And just as you touched on that on the branch footprint, and you've noted that some of these decisions are more opportunistic. If we look out into mid- to late 2027, what does the branch footprint look like? And how does that -- I guess, how aggressive are you happy to be to build that out versus it being dependent on top line growth?