Metropolitan Bank Holding Corp. (MCB) Q4 2022 Earnings Report, Transcript and Summary

Welcome to Metropolitan Commercial Bank's Fourth Quarter and Full Year 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. At this time, all participants have been placed in a listen-only mode, and the floor will be open for your questions following the prepared remarks. [Operator Instructions] 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. It is now my pleasure to turn the floor over to Mark DeFazio, President and Chief Executive Officer. You may begin.

Thank you, and good morning, and welcome to MCB's fourth quarter earnings call. On an operating basis, MCB had a record year with adjusted net income of $94.4 million, up from $38.4 million in 2021, and adjusted efficiency ratio of 44.5% versus 48.2% in 2021. Our fourth quarter net interest margin of 4.05% versus 2.59% in the prior year quarter. The commercial bank along with our banking-as-a-service initiatives saw growth along all lines of business contributing to our operating results. While 2022 was a challenging year for our industry, we worked through rising interest rates, increased cost of funds, fierce competition for deposit, a material correction in the digital asset industry and, with that, increased regulatory scrutiny. Our early intuition that we should pivot away from crypto -- the crypto industry has served us well. Our minimum exposure coming into 2022 allowed us to efficiently replace the deposits we have foregone to-date, along with generate efficient liquidity to sustain loan growth. As we previously announced, we will fully exit the industry in 2023 with minimal impact to earnings and liquidity. We are also very close to bringing closure to ongoing investigation from the DFS and the New York Fed regarding a fintech client MCB banked in 2020. As a result of the investigation, MCB has reserved $35 million toward a joint settlement. MCB's decision to settle was a conscious effort to move forward with the business of MCB and reduce our professional fees to a more normalized run rate. There were lessons learned here throughout the experience and we have implemented improved oversight of consumer compliance for our banking-as-a-service business. This was an unfortunate situation that occurred during an unprecedented time. On balance, we successfully covered tremendous ground in 2022 and are entering 2023 in a strong position to support our clients with enhanced resilience and strong capital levels. Our operating performance in 2022 continues to demonstrate the strength and sustainability of our business along with the dedication and execution of the MCB's employees and clients. We have effectively managed through the challenging environment [indiscernible] are in a good position to support our clients with enhanced resilience and strong capital levels. Now, for a few financial highlights for 2022. Loans increased $1.1 billion or 30%. Net interest income of $229.2 million was up 46%. Total revenues were up 42% to $255.8 million. Net interest margin improved to 3.49% from 2.77% in '21. And return on tangible common equity from operations remained very strong at 16.6%. And our efficiency ratio improved to 44.5% from 48.3%. I will now turn the call over to Greg Sigrist.

Thank you, Mark, and good morning, everyone. MCB's core business continued to scale as it reported adjusted fourth quarter net income of $27.3 million or diluted EPS of $2.44. Reported net income inclusive of the regulatory settlement was a $7.7 million loss with a $0.71 loss per common share. Turning to key drivers in the quarter. The Commercial Bank posted a strong quarter with net loan growth of $223.2 million or 4.8% on loan originations of $411 million. We saw growth across all loan verticals. Loan yields increased to 5.98% from 5.3% in the prior linked quarter. The credit environment remains benign with no charge-offs in 2022, and non-performing loans effectively at zero. The provision in the quarter was in line with loan growth. I do want to spend a moment on deposits. We have successfully managed the transition to a leaner, more efficient balance sheet. As certain core deposit clients looking for higher yields have moved into treasuries or other money market investments, we have onboarded efficient, lower cost deposits. This is evidenced in the fourth quarter with outflows from bankruptcy trustees and property managers being offset by strong inflows from retail deposits, up $178 million in the quarter, and fintech banking-as-a-service deposits, which were up $40 million in the quarter. As expected, digital asset related deposits were down in the quarter by $268 million to $494 million at year-end. Of that remaining $494 million deposit balance, $326 million or 6% of total deposits are related to MCB's four active institutional crypto asset related clients, which are subject to wind down in 2023. To support a more efficient balance sheet, particularly as deposits related to these active crypto clients wind down, we may, at times, utilize FHLB advances for other funding sources in advance of executing on strategic core deposit initiatives. We did have $250 million of FHLB advances and Fed funds purchased at year-end, which in part reflects the strategy, but it's also reflective of the timing of normal client cash flows around year-end. While deposit competition has increased, we remain thoughtful and patient both on pricing of existing deposits as well on execution on funding alternatives. Our pricing discipline is evident in the success we have had in moving our new production loan yields up, raising loan floors and in our net interest margin of 4.05% in the fourth quarter, which is up from 3.85% in the prior linked quarter. The interest-earning asset yield increased 86 basis points to 5.12% in the quarter. Asset yields benefited from the impact of rising rates on floating rate loans and overnight deposits as well as increasing new production loan yields. Given the extent of rate increases since late September and as a result of our active management, total cost of funds has increased by 72 basis points, but remains at a low 1.17%, which is particularly notable in light of our branch-light model. We have also moved for much more neutral stance from an NII perspective, which will allow stability to the extent rates do continue to rise this year, but we are also well positioned for eventual rate cuts. For our Global Payments business, revenues were up $244,000 in the quarter to $4.3 million. To give you more color, fintech banking-as-a-service revenues were up $569,000 to $3.1 million, while crypto-related revenues were down $324,000 to $1.2 million in the quarter. We're very pleased to see the continued scaling of our banking-as-a-service revenues. Turning to operating expenses. Compensation and benefits were up modestly in the quarter, reflecting our continued investment in human capital, particularly into risk and infrastructure teams. Legal fees remained elevated by approximately $2.4 million in the quarter and $6.2 million for the full year, with outside counsel engagement focused on the regulatory matter as well as carry over on Voyager's bankruptcy proceedings. We do expect legal fees to moderate back to historic levels during the fourth quarter -- sorry, first quarter. Despite the elevated legal fees, our adjusted efficiency ratio remained low at 45.1%. The effective tax rate was impacted by the regulatory settlement reserve as well as discrete tax items that came through in the quarter. This includes the impact of vesting date fair values of employee stock-based compensation and refined state apportionment rates. Going forward, we would expect the effective tax rate to be in the range of 31% to 32% excluding discrete items. Our capital levels remained very strong, with all capital ratios significantly above well capitalized levels. I will now turn the call back to our operator for Q&A.

[Operator Instructions] Thank you. Our first question is from Alex Lau with J.P. Morgan.

Hi, good morning.

Good morning, Alex.

I wanted to start off with the regulatory settlement reserve. Can you provide some additional color on that reserve? And can you just confirm that it was a fintech client and not a crypto-related client? And how does this change how you approach the business going forward? And as a follow-up, how do you think about the risk of needing additional regulatory reserves on top of that $35 million? Thanks.

Okay. So, there was a lot there, so if I miss anything, just follow-up with that. So, working backwards, this is a specific fintech client. It was not a crypto client. We will announce the name of the client at some point. But this particular banking-as-a-service client is no longer and hasn't been a client of the bank since the summer, I believe, of 2020. I think this made us a better bank. I think the regulators are good partners of ours, and I think they pointed out. You got to remember when this occurred -- this occurred in March of 2020 as I reported, it was an extraordinary time under extraordinary circumstances, and we were trying to manage through an extraordinary initiative from the federal government as part of the CARES Act with unemployment benefits. And this was a small amount of the level of fraud that actually took place regarding the $1 trillion that the government put out there regarding unemployment benefits. This was a virtually a rounding error; however, it did occur. Working with the regulators over the last several months, actually over the last two-and-a-half years on and off talking about this, I think they brought some really good insight and gave us some really good suggestions on how to improve our oversight. I think the regulators and MCB clearly realize that banking-as-a-service is going to stay and the way in which a retail banking is being done today is digitized, it is inclusive, and it's very scalable. And I think working alongside the regulators going forward would only add to our ability to grow the business efficiently, and in a way that speaks to very safe and sound banking practices. So, I don't think it's a headwind at all. I think it's a positive, although painful, it's a positive.

Thanks, Mark. And moving on to the crypto business exit, can you talk about the sense of timing of the rundown of the crypto-related deposits for the four accounts? And could that come with potential security sales? Thanks.

One, it will not come with any -- we've not planned on any security sales at all, there should be no reason for that. And we are anticipating over the course of 2023 that these four clients will be off our balance sheet. Now, our -- we'll wind down relationship with them and the agreement we have in place. They seem to be making a lot of progress in talking to other banks. So, it could accelerate, but we're planning that will be a smooth transition over the next two, two-and-a-half quarters.

Thanks, Mark. And what about outside of those four relationships in terms of crypto-related clients? I think there's about 3% of total deposits. How do you think about those balances moving forward with those exchange clients moving out?

They're not exchange, they're corporate funds, they're operating accounts. We just have operating accounts for, let's say, a hedge fund who has raised some equity and they're running their business payroll, etcetera. So, these are just real operating accounts that they don't touch crypto in any way.

Thanks, Mark. And one more before I step in the queue. On loan growth, when you exclude the crypto-related deposits, your loan to deposit ratio is approaching 100%. Can you talk about your expectations for loan growth in 2023? And if we should expect the pullback of growth relative to that historical growth level given a more challenging deposit environment? Thanks.

I have probably a much clear line of sight in '24 and beyond. I'm very confident that we will go back to normal -- a lower loan to deposit ratios. We have a lot of optionality on that side of the balance sheet, and we're bringing in new initiatives, which the market will hear about in the upcoming quarters. So, for '23, we could be a bit higher, a bit lower, but I think on balance, we will come into '24 and continue to be a very efficiently-funded bank and core-funded. So, I'm very optimistic that, that loan to deposit ratio will come back down significantly in '24 and beyond.

Thank you. I'll step back in the queue.

We'll take our next question from Chris O'Connell of KBW.

Hey, good morning.

Good morning, Chris.

I just wanted to circle back quickly to the regulatory settlement reserve. And if you guys could comment on how confident you are that, that reserve is adequate and I guess how close to kind of final settlement you might be?

Yes. I think, I'm very, very confident that this is the high watermark on the $35 million [Technical Difficulty] in settling with both regulatory agencies. Both of us are working and I have to say that the regulators are working in really good faith to finalize this settlement, and I think we're really close. Again, it's [Technical Difficulty] contentious situation at all. We're working with them. We always had great relationships with regulators my entire career, never mind the 23 years here at MCB. So, we kind of put the fine point on some enhancements and some changes that they would like, which we are in agreement with. And we'll get this behind us, but that's why we fully reserved for this. Is there a chance that it could be slightly lower? Yes, it's possible. We all are working in good faith, as are the regulators. But I wanted to fully reserve for an amount that I think is absolutely the high watermark.

Okay, great. As far as the expenses and once this falls out of the expense run rate going forward, how -- I think the regular professional -- sorry, professional and legal line is also still a bit elevated in this quarter as well relative to where it's been in the past. Can you just talk about kind of where the [indiscernible] expense run rate might drop down to once this behind you?

Yes, sure, Chris. I mean, you touched on the professional fees. I really think that we're going to moderate back to the level we saw late in '21 through probably the first half of '22, maybe split the difference between when you take the legal fees out versus where we were then. We've worked with a lot of initiatives over the last year, year-and-a-half. So, I do expect that line to kind of moderate a little bit. As you know, we're still a growth company though. So, comp and benefits, we are -- we will still continue to invest in human capital. I think we've brought on and onboarded a very substantial team over the last year or two. You're going to continue to see expansion in that line. We're going to continue to invest in human capital. I think it might moderate a little bit from the level you saw in 2022 in terms of growth. I think the other key thing is it's really just the efficiency ratio, as we always talk about. We are going to be very focused on continuing to work that ratio down from current levels. So, it's as much about getting the leverage out of what we're bringing on those investments -- on the investments, the return on the investments we're making and making sure we keep an eye on overall expense growth.

Okay. Got it. All right. And then, as far as what you guys have been -- you mentioned a few things on the deposit side some initiatives kind of as you head into the front end of this year. I guess, how are you thinking about deposit growth if you exclude the crypto -- the expected crypto runoff for the next quarter or two?

I think, it will be robust. I think if you remove the crypto, we would be very pleased if all crypto ran off in the first quarter, just so we don't have to talk about it again. And then, obviously, I have to fill that bucket up, if you will. But I'm feeling really comfortable with the initiatives we have. Everybody in the company whose client-facing is working really hard. And as I think we will always be a core-funded institution. We always have been. We will continue to be a core-funded institution. And this is the first time in, I think, 15 or 16 years that we dipped into the Federal Home Loan Bank. So, this is not something that we tend to want to rely on long-term. It's good bridge funding, but it will not be a core strategy of what's going forward.

Yes. And just to add to that, Chris, I mean, around year-end, we have a very active successful client base. So, we also saw just some normal flows around year-end. I think the important takeaway is we've really hit business as usual in terms of managing a leaner, more efficient balance sheet. We could always bring on more deposits to manage the loan to deposit ratio or other metrics. We're staying focused on our pricing discipline and our margin management. And we have the options to bring funding on. And we have a lot of strategic initiatives that are above and beyond our existing deposit verticals that are actionable, they're in the queue, and I think Mark kind of touched on this that we're going to be executing on over the balance of the year. So, I think we're all very confident and comfortable with our ability to continue supporting high-quality, prudent loan growth with low quality -- or low cost deposits.

And Chris, I should -- I really should point down and should not go unnoticed, two deposit verticals that we developed internally and the property management business, which is a nationwide business, and the U.S. Trustee business, and there's only a handful of banks that actually could hold U.S. Trustee's deposits on balance sheet. You got to keep in mind, we chose to let those deposits runoff. We replaced them. We decided to be a much leaner, operate as a much-leaner balance sheet. We can dial that up anytime we want. We can bring those deposits back. We have wonderful relationships with these companies. When we find that that's an efficient source of liquidity for us to maintain the discipline we have toward knowledge and management, we'll bring it back. So, it's not like it's an investment. There's no capital investment to bring on and replace those deposits. And we're working really hard to add to our supply of deposit verticals. And by the way, this rate cycle will pass. Those rates will [Technical Difficulty] and they'll find their sweet spot. We have a significant advantage as being one of the few banks in the country that actually can hold U.S. Trustee deposits on balance sheet based on the investment [go] (ph). So, those are just deposit verticals we can fill up anytime we want, so we can bring that loan to deposit ratio down anytime we want. But we are a bank that likes mid-teens and higher return on tangible common equity. We think that's our mandate and that's where we've been historically and that's where we're going to stay.

Got it. Circling back to one of the earlier questions on the crypto runoff over -- in the next couple of quarters, and whether the offset of that is coming from cash or securities. Can you just walk me through what the decision-making process is, and how you guys landed on the decision to do solely cash, given where the securities yields are on the [AFS] (ph) book?

Yes, we -- I think in part, Chris, it goes back to just the opportunity we see in the deposit side. I mean, we obviously have $7 million or $8 million a month of principal cash flows coming off the securities portfolio that's available to us. We're still generating a tremendous level of cash just on an operating basis, it will be part of the mix. GPG, if you're looking at the banking-as-a-service deposits, those have continued to tick up quarter-on-quarter and we still see a lot of runway for growth in that vertical. And we feel that we don't have to rush out to fill the bucket, right? We are targeting between $200 million and $250 million of on-balance sheet cash at any moment in time, such as part of using the FHLB advances, as an example, to fill that bucket. But we are thinking over the balance of the year that we're going to be able to continue to support loan growth and replace crypto deposits with existing verticals and initiatives we've touched on.

Okay, understood. Thank you. And then, last two quick ones from me. One, is there any discussions internally, or have you guys thought about the potential for a buyback authorization? And then, two, I believe that the office book for you guys is around 8% of total CRE. But maybe if you could just walk us through some of the characteristics of that book and where it's located, et cetera, that'd be great.

All right. I'll start with the buyback, and then Mark, I think, can pick up the composition on the CRE side. Obviously, we evaluate a lot of capital alternatives, including dividends and a lot of things. I think anytime you trade close to book value -- your tangible book value in this sort of the market, you really have to think hard about it. All I can say is, yes, we're absolutely having the conversations. And if anything becomes actionable or reportable, we'll let you know about it. But it's certainly been on our mind.

As far as the office building market, as you said, we have small exposure, but most of it is the suburban office building market in different geographies, strong sponsorships, strong cash flows, low LTVs. We're not in those Class A office building markets -- office building assets here in New York City with low occupancies. But keep in mind, the occupancy level, the actual people coming into the buildings is rising every single month. It's around 50% or so, but the default rate is still very low in the industry. However, we don't really play in that space. So, we're very comfortable with the ownership, the sponsorship and the position of our office building portfolio.

Great. That's all I had. Appreciate the color. Thanks, guys.

Okay, Chris. Thank you.

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

Just really quickly, I know a lot of people were a bit taken back by the regulatory settlement, but looking forward, I do want to stress that, this is behind us. We're a better bank today, and we're positioned well to continue doing what we've done in the past. And I look forward to a continued good working relationship with the regulators as we move forward, become best in practice when it comes to banking-as-a-service. And thank you very much for joining us today, and we look forward to continuing the conversation.

This does conclude today's conference and webcast. A webcast archive of this call can be found at www.mcbankny.com. Please disconnect your line at this time, and have a wonderful day.