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

Welcome to the Metropolitan Commercial Bank's Third Quarter 2022 Earnings Call. Hosting the call today from Metropolitan Commercial Bank are Mark DeFazio, President and Chief Executive Officer; and Greg Sigrist, Executive Vice President and Chief Financial Officer. Today's call is being recorded. [Operator Instructions] During today's presentation, reference will be made to the company's earnings release and investor presentation, copies of which are made 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. It is now my pleasure to turn the floor over to Mark DeFazio, President and Chief Executive Officer. You may begin.

Thank you, Katie, and good morning and welcome to MCB's third quarter earnings call. I'm pleased with MCB's strong and sustained performance as evidenced by a 17.1% return on average tangible common equity this quarter, powered by the strength of our sustained loan growth and NIM expansion. Amid a backdrop of rising interest rates and increasing economic uncertainty, the MCB team has remained engaged with our clients and that commitment shows in our financial performance. We set out over 23 years ago to build a branch-lite commercial bank. In doing so, managing the funding side of our balance sheet by adding optionality has been a cornerstone of successful net interest margin management. Fast forward, MCB remains focused on the management and the development of a diversified lower cost funding base, while looking out 2 years or more to expand our funding strategies to support the balance sheet growth we have seen over the past 20 years. The third quarter was no exception. We saw total deposit growth apart from expected crypto-related deposit outflows, as we were able to source lower cost deposits that would more than offset outflows from the positive seeking treasury rates or looking to substantially reprice existing arrangements. This highlights the pricing discipline that underpins our margin management. Margin management is reflected in our ability to drive top line growth in net interest income, with high-quality loan growth, funded by lower cost and scalable deposit verticals. We have had success moving our new loan production yields up during this unprecedented rate environment along with raising floor rates that will provide net interest margin and net interest income protection when rates reverse. I would like to spend a moment on our Global Payments business. As a reminder, we provide basic retail banking services to our digital currency clients, which we often refer to as being crypto-related businesses. For sake of absolute clarity, the services we provide do not include custody or lending against any digital assets, nor are we involved in any stable coin issuances. Further, as many of you have heard me say, we have not onboarded a new digital currency client since 2019. Revenues from this sector currently represents roughly 2% of MCB's total revenues, or 13% of our total deposits. We remain strategically focused on expanding our banking-as-a-service offerings to fintechs, who are well positioned to continue taking retail market share from banks of all sizes. I'm pleased to report that banking-as-a-service revenues of $2.5 million in the third quarter are up 21% over the prior year quarter. Our ability to scale banking-as-a-service related deposits over time is clearly a differentiator for us as well. Now turning to a few third quarter highlights as compared to the prior year. Total loans were up $1 billion or 28%. Total deposits were up $274 million or 5%, including DDAs, which were up $254 million or 9%. Net interest income of $63.3 million was up 55%. Return on average assets was 1.51% as compared to 1.09% a year ago. As mentioned, the return on average tangible common equity was 17.1% in the quarter, and our efficiency ratio improved to 45.1% from 47.1%. I will now turn it over to Greg for more comments.

Thank you, Mark, and good morning, everyone. We reported strong third quarter net income of $25 million, or $2.23 of fully diluted earnings per share. Loan growth and NIM expansion led net interest income higher in the third quarter, with NII increasing 50% to $63.3 million as compared to the prior quarter. Let me take you through a few of the key drivers this quarter. Commercial bank performance remained strong with net loan growth of $242.1 million, or 5.5%, bringing year-to-date net loan growth of 23.7%. Though down from a record second quarter, loan originations remained strong at $424 million, bringing total originations for the first 9 months of 2022 to $1.4 billion. Credit quality remains pristine with no charge-offs to date and non-performing loans effectively at 0. The provision in the quarter was in line with loan growth. As expected, crypto-related deposits were down $486 million, led by the efforts to promptly return funds to Voyager customers once approved by the bankruptcy court. This was our second consecutive quarter of measurable inflows of retail deposits, including those with loan customers, with an increase of $151 million in the third quarter. Credit goes to our retail and commercial lending teams for the sustained client engagement. We also saw strong inflows of $162 million related to our fintech banking-as-a-service clients. The inflows I mentioned more than offset the expected outflows from deposit categories seeking higher yields, which is consistent with our disciplined approach to deposit pricing and margin management. Noninterest-bearing deposits remained robust at 53% of total deposits. Net interest margin was up 58 basis points in the quarter to 3.85%. Asset yields benefited from rising rates as well as deployment of liquidity into loans with interest-earning asset yields increasing 76 basis points to 4.26%. Importantly, the total cost of funds increased a modest 20 basis points, while remaining low at 45 basis points, given our patience and ability to hold deposit betas low to this point in the cycle. We do expect to see NIM expansion into next year on the strength of our pricing discipline on both sides of the balance sheet and given the funding options available to us. While being mindful of the current interest rate forecast, we are looking further down the field to position for an eventual decline in rates. We have increased asset duration gradually over the past several quarters. For securities, duration is naturally extended with rising rates. For loans, we have taken on a bit more duration, which is evidenced by a modest decline in the floating rate portion of the portfolio to 41% at September 30 as compared to 44% to begin the quarter. This also shows in our net interest income sensitivity modeling, which has come in a bit this quarter, particularly in the rates down scenarios highlighted in our IR deck. We've had continued success in moving floors up on new origination, floating rate loans, where the majority of loans are subject to floors. These structural benefits are important elements of our margin management, which provides stability as rates continue to move up and will provide a significant level of NIM protection when the rates inevitably begin to move back down. GPG revenues were down $1.1 million quarter-over-quarter, given the expected decline in crypto-related GPR card volumes. Partially offsetting this decline were fintech banking-as-a-service revenues, which were up $312,000, or 14% in the quarter on a 11% increase in related-transaction volumes. Overall, expenses continue to be well managed as we are building for scale with a focus on generating near-term returns on the investments we make. This has been clearly evident in human capital, where compensation and benefits has continued to scale along with MCB's growth and profitability, reflecting the continued investments being made, particularly in control and infrastructure functions. Apart from our core run rate, professional fees did increase in the quarter. The primary driver was legal fees, which were elevated by approximately $4 million, with outside council engagement focused on Voyager's bankruptcy proceedings as well as other matters. We do expect legal fees to moderate back to historic levels as we move through the fourth quarter with our expected first quarter run rate for legal fees in line with historic trends. Touching on taxes briefly. We would expect the effective tax rate for the balance of the year to be in the range of 31% to 32%, excluding discrete items recognized in the first quarter. Our capital levels remained strong with all capital ratios significantly above well-capitalized levels. And I will now turn the call back to our operator for Q&A.

[Operator Instructions] Our first question will come from Chris O'Connell with KBW.

So just wanted to start out with the legal or professional fees being elevated and see if you guys give any additional color around the issue or how you think the trajectory will be between now and 1Q '23?

As Greg mentioned -- this is Mark DeFazio. As Greg mentioned, we think the legal fees will start to normalize through the fourth quarter and we should -- hopefully, we'll be behind it starting in the first quarter in '23. Voyager, as everyone knows, was a bankruptcy, so we had to represent ourselves there. And we also have one other matter that is a 2020 matter, which we're working through as well. So we expect these 2 matters hopefully will be behind us by the end of this year, and we'll be back to normal trends as it relates to professional fees.

Okay. Got it. And then just on the rest of the expenses, there is a disclosure around locking some gains that will help offset licensing fees going forward. Is there any idea given that offset, where those licensing fees trend in the fourth quarter given the recent rate hikes?

Yes. There's only a portion of that line, which is licensing fees. It's subject to any sort of rate variability. And we substantially hedged that rate risk out with the interest rate cap that we disclosed, Chris. So I think what you're really going to see in the fourth quarter should largely be in line with third quarter. That rate cap, the $12.7 million we referenced in the earnings release, that will come in to P&L in that line over the remaining balance of the hedge period, which I think was in that 28 to 30-month period. It's probably down to closer to 25 months at this point in time. So we will see some continued protection from that as it comes in the income.

Okay. Great. And then on the loan growth side of the balance sheet. Obviously, a strong quarter of growth. Just any update on what you're hearing from your customers as far as demand and then any areas that you're more aggressive on or pulling back on at this point in the cycle?

No. We're very fortunate as a commercial bank, and as you see, the level of diversification we have in our loan portfolio, our clients are very active in this market, looking for opportunities. And we're not pulling back on any asset class at the moment, and we're just a bit more careful in certain decisions we make regarding certain asset classes. But no, we see very little headwinds ahead of us and looking forward to continuing to support our commercial clients.

Okay. Great. And then any pushback on the substantial change in origination rates over the past couple of quarters, given the upward move in rates and any pushback on that or the raising of the floors?

I wouldn't just call it pushback. I mean, obviously, there's a conversation. But one of the things I think we benefit from, again, being a commercial bank and having a significant optionality of diversification on the commercial loan side, our clients are very high net worth individuals and we're assisting them in generating significant internal rate of returns on their investments. So they acknowledge that. Funding costs are going up, and therefore, loan yields have to rise. And someone told me once, it's not a cost [ among, it’s a cost of ] not having it. So they still see our funding as very strategic in their ability to generate generational wealth. So you have to have a discussion about it, but I wouldn't suggest in any way it's a headwind.

Great. And then I may have missed it, but I know in the past, you guys have assumed roughly like a 70% beta in interest rate sensitivity tables. I mean any changes you've seen in the magnitude and the pace of rate hikes? And what you guys have seen in 3Q and in conversations so far in 4Q as to when you get to that beta over the course of the cycle? And I guess, like what you're seeing in the near term in terms of betas on the deposit side?

Yes. We -- just to first to confirm, we -- for interest-bearing deposits, we do run our NII sensitivities with a 70% beta. Early in the cycle, we talked about how that might be a bit conservative. To this point, our betas have remained low. I think [ trying to try ] and when we hit the 70% though, Chris, it's more to us an issue of we do have not only funding options on the table right now, but a pretty robust pipeline of deposit opportunities we're looking at. I still think we're going to stay inside of that, what I still think is a fairly conservative 70% beta. Because, again, to Mark's point, I think it's a key theme this quarter, just the optionality we have as we kind of think about managing the balance sheet and the margin.

Got it. So I mean, based on your commentary, I mean, it's safe to assume, at least for the next couple of quarters, pretty fairly positive NIM trends going forward still?

Yes. And to pay back another way, I mean, even if that deposit base on interest-bearing deposits does trend into the 50% to 60% or slightly higher range, I still think we're going to continue to see some uplift on them just, again, given our disciplines and what we're able to do on the asset side of the sheet as well, combined with just our overall deposit pricing initiatives.

Great. And last one for me. Just any update you can give on where you think the $1.6 million of GPG fees related to the digital currency business and the $762 million remaining of the digital currency-related deposits, trends that you've seen so far in 4Q or kind of the outlook that you see on that in the near term?

As it relates to the crypto deposits, I think we're a bit stable at this point. We're seeing a bit pickup in crypto-related transactions that we play such a small role in that space in any event. So the transaction volumes, therefore, the revenue generated from it won't be significant either way, up or down. And on the deposit side, I think they're a bit stable. Our volatility last quarter came from Voyager, which is obviously a bankruptcy, so that speaks for itself. But GPG, excluding crypto, we continue to see expansion there. We see our banking-as-a-service business continuing to grow. Remember, that business is a retail business. It's a retail digital bank within a commercial bank. So it's in a marathon. It takes a lot of time. Client acquisition takes a bit of time. But once you have those clients, they're here for a while. So we expect to see a continued steady increase in our banking-as-a-service business for the foreseeable future.

Our next question will come from Alex Lau with JPMorgan.

In the past, you've talked about growing loans in that mid-teens range. Are you feeling confident continuing in this historical loan growth range given a more challenging deposit environment?