Metropolitan Bank Q2 2023 Earnings Call Transcript

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July 21, 2023

There are 5 speakers on the call.

Operator

Welcome to Metropolitan Commercial Bank's Second Quarter 2023 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 During today's presentation, reference will be made to the company's earnings release and investor presentation, copies of which are available at mcbank ny.com. Today's presentation may include forward looking statements that are subject to risks and uncertainties that may cause 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 DiFazio, President and Chief Executive Officer.

Operator

You may begin.

Speaker 1

Thank you and good morning, and thank you for joining our Q2 earnings call. The first 6 months of this year was a very interesting but disruptive time. Bank management teams were challenged to prove how prepared they were to manage their business And balance sheet in a sustained high rate environment. It's clear there is no quick fix to this problem For those banks like NCB who prepared for such an environment and have the capital, core funding strategies And growth opportunities will continue to secure more organic market share, driving material shareholder value. I believe that identifying these well prepared banks will be easier than in the past and the focus will be on true fundamentals and a strategy to I am pleased with MCB's 2nd quarter as well as year to date results.

Speaker 1

We continue to achieve critical objectives, including but not limited to demonstrating margin stability, driving lower cost funding, Reducing the reliance on higher cost borrowings, bringing our crypto deposits to 0, sustained loan growth Very attractive loan yields, margin compression has been a core challenge for the industry since the start of rate hikes. What has been evident in MCB's fundamentals is that we have absorbed a portion of this compression By managing a diversified earning assets balance sheet that allowed us to maintain lending spreads as well as various deposit verticals That continue to drive lower cost core funding. It is important to recognize that MCB caused In 2022, MCB moved off balance sheet a total of 754,000,000 In 0 cost deposits from their peak at June 30 and year to date, June 30, 2023, we moved off an additional $436,000,000 of crypto related deposits now at 0. As well as having the ability to absorb the temporary margin compression that came with replacing these deposits. Looking forward with the addition of lower cost deposits that are coming in from the new verticals we have announced In the Q2, along with the many diversified core deposit verticals we already have embedded into the franchise, we are very close To add an inflection point, we'll win NIM compression from replacing crypto deposits with borrowings will transition to I will now turn the call over to Greg, who will share some specific results with you.

Speaker 2

Thank you, Mark, and good morning, everyone. While the Q2 was a turbulent one for the industry, MCB had a very strong quarter for deposit and loan growth, which is evident in our June 30 balance sheet. In the quarter, MCB's deposit verticals grew $377,000,000 or nearly 8% as we successfully expanded our existing deposit Thanks to the dedication and hard work of the MCB team in what was a very challenging time for the industry. Net inflows were particularly strong for retail deposits, Crypto deposits were substantially reduced by $220,000,000 in the quarter. What remained at quarter end was $58,000,000 of corporate and reserve deposits with crypto related companies, which we expect to be fully transitioned away from MCB within the next few weeks.

Speaker 2

While borrowings were utilized to manage those expected outflows, growth of our deposit verticals has allowed us to reduce borrowings from an average balance of $568,000,000 during the Q2 to $443,000,000 at the end of June. We expect to further reduce borrowings over the balance of the year. We also had a very strong quarter for lending with loan growth in the quarter of $297,000,000 or 6% on $425,000,000 of loan production. Notably, loan pay down and payoff activity occurred largely early in the second quarter, While loan closings generally occurred late in the quarter, combined this had an obvious muting effect on net interest income in the quarter. New loan production came in at an average yield of 8.19% versus the portfolio rate for the Q1 of 6.34% As we have stayed focused on our pricing discipline.

Speaker 2

While we did see 42 basis points of net interest margin compression in the quarter, Replacing non interest bearing crypto deposits with borrowing did drive half of that compression. The remainder of the compression came from the impact of rising short term market rates on deposit costs, Only partially offset by increasing asset yields. The lag in asset yield uplift was magnified by the timing of loan closings in the quarter. Through the industry's recent turbulence, MCB has emerged with a well positioned balance sheet, thanks to the success of our historical funding strategies And strong capital levels, which demonstrates the strength and stability of the franchise. Asset quality remained strong.

Speaker 2

Loan growth drove the majority of the 2nd quarter credit provision with the remainder being driven by macroeconomic factors in our CECL model. Our Global Payments business also performed quite well in the quarter with revenues from non bank financial service companies up 21% from the Q1 of 2023 as our partners Within that growth, we are particularly pleased to see corporate disbursement client revenues up 27% in the quarter. Overall, Non interest expenses remained very well managed, but I do want to give color on a few items. The decline in compensation and benefits and technology. We do expect professional fees to revert back to historical levels.

Speaker 2

While legal fees were elevated, Outside counsel engagement on open matters wound down in the Q2. We've also been making investments in several corporate initiatives, including strategic planning technology consultants, which will begin winding down in the Q3. Collectively, we would expect approximately $2,000,000 to drop out of the run rate for professional fees in the Q3 of 2023. Lastly, there was a discrete item in the quarter that increased income tax expense by $1,700,000 We will see a discrete tax benefit of $1,700,000 in the 3rd quarter on the conversion of stock awards that have already occurred. Going forward, we would expect the effective tax rate to be in the range of 31% to 32%, excluding discrete items.

Speaker 2

I will now turn the call back to Shelby for Q and A.

Operator

The floor is now open for your questions. And we'll take our first question from Alex Lau with JPMorgan.

Speaker 3

Hi, good morning.

Speaker 2

Good morning, Alex.

Speaker 3

Greg, last quarter you mentioned you thought the NIM could get back to the 1.2 level, call it 3.80 to 3.90 range. Is it fair to assume that with NIM expanding for the next quarter 2 quarters, we could see that move back to that level or has that exit rate changed? Thanks.

Speaker 2

I think it's possible, Alex. I mean, obviously, the balance sheet is still slightly liability sensitive. So That rates would be a bit of a headwind going forward. I mean, if we have 25 bps next week, that's one conversation. But to me, it's really the uplift is going to come a combination of asset yields, obviously, we've had a lot of success maintaining loan yields in the quarter.

Speaker 2

We expect that to continue. We are taking $20,000,000 to $25,000,000 a quarter of investment securities, which are rolling off at a very low rate, putting those into loans at a higher rate. I think getting back to that level is going to be dependent upon what we think is very possible, which is continuing to bring in low cost deposits, particularly from our new verticals, Which will come in at a much lower rate. So I think we can get back to that level, if not in the Q4, then very early next year Q1. I think To Mark's point though in his prepared remarks, we are at that inflection point.

Speaker 2

I really think if we haven't hit that floor, we'll hit that floor early in the Q3. And With the build in the low cost deposits, I think we get back up to that prior rate pretty quickly. But this is a marathon, right, not a sprint for

Speaker 3

Where did that come from in terms of deposit verticals? And has this shown any signs of moderating?

Speaker 2

Frankly, it was just normal flows in the quarter. Some of that was coming from retail clients, commercial lending clients as they deploy liquidity. So it kind of came across a number of different verticals, Alex, and it wasn't re pricing wholesale re Pricing of DDAs into interest bearing, so it's really more of a timing issue. I think some of that will come back in normal course as DDAs again. But as I kind of parse through it, I didn't really see

Speaker 3

you give some colors in terms of the rates that you're paying on those balances that you brought on board?

Speaker 2

I mean, as you know, we don't publish our money market rates or rates on individual customers. I would say we brought it in well inside of what our borrowing cost So if we're out with our borrowings that fund is effective plus a spread, we'd be well inside of that. I think As part of that, you would see just naturally and not just to the growth in the quarter, but we certainly had up in the Q1 and Q2. You'll start to see continue to see a little bit of just pull through in the cost of funds or cost of deposits End of the Q3, but again, I think it's going to be offset very well by what we're able to do on the loan pricing side.

Speaker 3

Thanks. And you mentioned in the last few months, you've added a couple of deposit gathering teams, the EB-five teams, title and escrow and charter schools. Can you give some colors on these deposit opportunities in terms with these teams? And when should these deposit gathering pick up and contribute? And if you could also touch on briefly about the type of costs that are associated with these deposits.

Speaker 3

Thanks.

Speaker 1

Increase in deposits in the Q3. We've been working on these new channels for quite a while. So as we reported in the past, We get a return on investment pretty quickly at this stage of our operating efficiency. So, we're very The one item you did mention was our 1031 and title escrow as well is really hitting their stride. And we're doing a fair amount of technology integration.

Speaker 1

So we have the human capital in place. We're doing the legal framework around

Speaker 2

these structures, which are fairly complex as well.

Speaker 1

And we are which are fairly complex as well. And we are doing a technology integration with this required as well to be very Competitive. So I think we're not sure if we're going to report specifically on these line items in the 3rd and Q4 and beyond, but we do believe they are going to be meaningful and can assist us with going back to our traditional Funding strategy, which is very, very core and rely very little at a minimum level To borrowed funds, as I said, in the Q1, we would expect by year end to be back at The original levels of borrowed funds than we were when we came into 2023. So we're optimistic. And all in on the cost, Greg, keep me honest here, I think they'll be well on the inside of our on our total deposit costs tonight.

Speaker 1

Yes, I agree with that.

Speaker 3

Thanks for all that color there. And then just one on loan growth. You're close to 100% loan to deposit ratio now. How do you think about loan growth For the rest of the year, considering you're at this 100% mark, are you comfortable running above 100% level? Thanks.

Speaker 1

I am comfortable at running above 100%, but I as we have been talking this 6 months was a disruptive six Munson, we relied more on borrowed funds than we have in 2 decades. So I think as I just mentioned, we will go back to normal trends. So I would expect you will see that number stay south of 100% in the future. Yes.

Speaker 2

And again, I think we've said this conversation before. If we thought that if we didn't have the ability to grow our deposit verticals and to bring in The new verticals which will contribute significantly over the balance of the year, Alex, I think that might be one conversation. It might lead us down the path of slowing down loan growth. The reality is we see the runway not only to fund loan growth, but to also significantly reduce the borrowings balances over the next quarter or 2. So we're comfortable at a short term at a moment in time being closer to 100% on that loan to deposit ratio because I think over the next several quarters, whether it's 2 to quarters.

Speaker 2

I think to Mark's point, that will come down to a more historic level.

Speaker 3

Thanks. And then just on the GPG Group, the fee income was Up nicely in the quarter. Is there anything one time in nature in that increase or was that mostly transaction volume related?

Speaker 2

It was mostly transaction related volumes. I mean, there's always quarter on quarter you might have a little bit of contractual revenues peak into it. There might have been a little bit of that. But frankly, on balance, it was really just transaction revenues, Alan.

Speaker 3

Thank you. And then just last one for me. On the GPG deposits, it's been holding in that $700,000,000 range in deposits. Is this still a deposit growth vertical for you in the near term? Or is that Expect it to be in that similar range moving forward.

Speaker 2

Well, I think it is still a deposit growth For us, I mean, this goes back and ties into your question on non interest bearing deposits. It's the one vertical where it's a very active Flows, we see a fair amount of ins and outs in that vertical. Average balances for the quarter, I got to tell you, we're definitely above the spot at the end of the quarter. And again, those are non interest bearing flows that kind of came out as well near the end of the quarter. So it's absolutely a growth vertical over as we think longer term.

Operator

And we'll take our next question from Chris O'Connell with KBW.

Speaker 4

Good morning. I think in the second quarter about $1,500,000 was identified as being crypto related Within the 5,700,000 GPG fees, does that fully fall out next quarter or Does some of that stick around? How should we be thinking about kind of the new baseline level starting in 3Q?

Speaker 2

Yes. Having that business wound down by June 30, Chris, you'd expect that to go 0 for the Q3.

Speaker 4

Okay, great. And then I appreciate the color on the loan deposit ratio and the overall growth. Obviously, you guys have had strong growth this quarter and now are getting the deposits to be able to Effectively fund that going forward. I mean, how are you thinking about the level of balance sheet growth overall on the loan and deposit side into the second half of the year? Are the pipelines winding down a little bit or slowing given the broader economic environment?

Speaker 4

How are you thinking about the overall balance sheet growth as a whole?

Speaker 1

Yes. So The pipeline is still fairly robust. Times like this are very opportunistic Also, notwithstanding some of the obvious headwinds in various different industries or Real Estate asset classes, our clients are very active across the franchise. They are very opportunistic. So I think we are finding the right deals to involve ourselves in.

Speaker 1

So I think, historical, I think our balance sheet growth will be In line with what we have said in the beginning of the year, closer to historical trends. I think the second half of the year, Our borrowings to be at or even less than where we were when we came into the year in January. So We're really optimistic. Again, we're not growing for the sake of growing. If we're not getting the kind of net interest margin and the operating efficiencies By leveraging our capital, we just won't do it, but we clearly are demonstrating that stability.

Speaker 4

Great. Got it. And you mentioned, I mean, obviously, the securities yield is still really low. It should migrate pretty substantially upward over time. I'm just trying to think about the timeline of how that occurs.

Speaker 4

If you could give any color around kind of the monthly or quarterly portfolio cash flow and how quickly that can kind of turn over, that'd be great.

Speaker 2

Yes. Quarterly, we're seeing somewhere between $20,000,000 $25,000,000 of principal cash flow coming off the portfolio, Chris. So it's still a fairly rate is still a fairly long duration book. At points in time, we've looked at maybe doing some restructuring around it. I don't see that being imminent.

Speaker 2

We might be down the road as rates start to come back down in terms of rebalancing the portfolio. But frankly, I don't see that in the near term. So in the meantime, That's cash flow coming off the portfolio is just going back into the pool to be deployed into lending at a much more attractive rate.

Speaker 4

Okay. Yes, Makes sense. And I think you said for in 3Q, The professional fees should benefit about $2,000,000 downward, but they're showing the overall expense growth. And on a net basis, do you have an idea as to whether you think overall expenses will be up or down in the Q3, just how you're thinking about kind of expense growth going forward, recognizing that you guys have Hired a bunch of teams at different points throughout the past quarter or so. Just trying to See what the new starting point might be there?

Speaker 2

Yes. Once you've normalized for that professional fee, $2,000,000 run rate. When you think about the rest of the lines, I think comp and benefits is the one where you're absolutely going to continue to see the investments coming through from what we're doing I think if you look at that and you kind of look at our trends over the last historically last call it 6 to 8 quarters before this, will give you a pretty good idea how we're going to look there. I mean, I think the teams that have come on are going to take some time to ramp up. Yes.

Speaker 2

But I think that will get reflected in that run rate as well. As you always hear us talk too, we don't focus on the efficiency ratio. We're much more focused on driving ROTCE and the expense base it takes to get there is just part of the sausage making. But I would tell you in the quarter, the efficiency ratio was obviously elevated just Then both the little bit of compression that happened on the Net interest side combined with the elevated professional fees, 1st 6 months of the year, we're still right around 50 on the efficiency ratio. We do a very good job managing expenses.

Speaker 2

So I think the other lens you should look at is look through is Over the next several quarters, we're going to continue to push that efficiency ratio back down toward the historic levels, which are more in that mid-40s, so call it 45 47%, that's what my goal would be.

Speaker 4

Okay, really helpful. And then as far as the human capital you mentioned and you guys have obviously hired a bunch of teams and Deposit related, how are you thinking about opportunities going forward? I mean, I know that you're always looking, But is there any specific types of teams that you are seeing opportunities with or having discussions with As those opportunities kind of increased or decelerated over the past few weeks, Given the immediate opportunities that were present after the M and A disruption last quarter?

Speaker 1

Yes. We're not out there seeking any new teams. Obviously, we're open to new opportunities, but I think, Our Plate is fairly full right now and we want to get the real value out of the new partners we've brought on And really give them the attention and time and resources to get into the market. These are not Simple business lines, they are very much aligned alongside of our core competency. That's something else that everyone should keep in mind.

Speaker 1

We're not the type of franchise to bolt on just teams for the sake of Adding people or products, we try to leverage off of our core competencies. So what we announced in the Q1 is standing up quite well. I think you're going to see material contributions going forward, but our focus right now is to assist those teams in being as successful as they possibly can. So we're not interested in any other distractions, but obviously we're open to an opportunity if it falls in front of us.

Speaker 4

Okay. Yes, I hear you. And On the credit side, I mean, everything was very clean this quarter, not much movement around at all and obviously no charge offs I mean, how are you guys what are you guys seeing within your portfolio? Is there any sense of stress anywhere that you're keeping a close eye on As far as loan demand or desire to put on loans, is there any particular areas that You're seeing that Arch still attractive versus shying away from and anything that you're seeing from others in your local markets I guess, concerning on the credit side.

Speaker 1

Yes. Chris, it's not an all or nothing. MCB has always been in the market. The question is finding the right spot and with the right sponsor around what deal in real estate or what industry we want to support. So We're just very careful.

Speaker 1

We're just more careful than we are conservative. And are we paying more attention today As it relates to certain asset classes in real estate as opposed to an industry in the Yes, of course. But we've noticed that a long time ago. We've noticed some of those tea leaves us what you can call weaknesses and concerns. So Doesn't mean we exited those industries or those asset classes.

Speaker 1

It just means that we have to look at them a bit differently to lean on the side of being more For a lot of different reasons, so we're filling that void as well. So the pipeline is full. We're very careful, very happy with our Independent risk management process around managing the portfolio, stress testing the portfolio, I'm very Pleased with that. It's fairly robust, as you know, and we continue to throw a lot of resources behind the risk management side of the business. So I'm opportunistic that we can continue to manage the portfolio and manage the new business we bring on well.

Operator

This concludes the allotted time for questions. I would like to turn the call over to Mark D'Fazio for any additional or closing remarks.

Speaker 1

Thank you. I'd just like to take a moment to thank everyone. I would like to thank all of our investors who have hung in there with us during this challenging time And for those who have increased their positions for their continued confidence in MCB. For the new shareholders that came in at a very At the entry point, welcome to MCB. I would also like to thank our entire MCB team and our directors who continue to step up And recognize the challenges our industry face and what it takes to keep MCB a top performing and relevant financial institution.

Speaker 1

Thank you again and I look forward to our next call.

Operator

This does conclude today's conference call and webcast. A webcast archive of this call can be found at www.mcbankny

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