Metropolitan Bank - Q3 2023
October 20, 2023
Transcript
Operator (participant)
Welcome to Metropolitan Commercial Bank's Q3 2023 earnings call. Hosting the call today for 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. If you would like to ask a question at that time, please press star one on your telephone keypad. If at any point your question has been answered, you may remove yourself from the queue by pressing star two. We ask that you please pick up your handset to allow optimal sound quality. Lastly, if you should require operator assistance, please press star zero.
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 risk 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.
Mark DeFazio (President and CEO)
Thank you, Shelby, and good morning, and thank you all for joining our Q3 earnings call. I will be brief today because I'd like to leave more time for Q&A. To get started, I am pleased with MCB's Q3 and year-to-date results. To say the last nine months have been challenging is an understatement. However, as you can see, MCB has been able to navigate through these challenging times, primarily because we were as prepared as we can be for them. Along with our ability to grow alongside of these challenges, year-to-date, we have experienced reasonable balance sheet growth funded by new core deposits while maintaining our underwriting and pricing disciplines. All deposit verticals contributed to our growth in liquidity, as well as early contributions from our latest initiatives in 1031, Title and EB-5 lines.
Excess liquidity this quarter also allowed us to pay down our Federal Home Loan Bank borrowings, which were used specifically to off-ramp our previous on-balance sheet crypto deposits. We are confident we will see further reductions of these borrowings over the coming quarters. We are also confident that each of our deposit verticals will continue to set us aside from others and maintain MCB as a core funded institution. We are working on a number of other deposit and fee income initiatives, which we will start discussing in the coming months, and are confident they will all add to our liquidity arsenal, which will not only stave off margin compression, but will start to expand it.
Finally, as many of you may have seen online last night, we issued a press release related to the settlement with the Federal Reserve and the New York State Department of Financial Services pertaining to a matter from March 2020. The amount of the fine has been fully reserved for, and enhancements to our processes and procedures have been well on the way for some time. I will now turn the call over to Greg for more detail.
Greg Sigrist (EVP and CFO)
Thank you, Mark, and good morning, everyone. We are pleased to report strong Q3 net income of $22.1 million and fully diluted EPS of $1.97. Despite a challenging operating environment for banks, net interest income remained steady at $53.6 million. Significant expansion in total interest income was driven both by strong loan growth through the first nine months of the year, as well as the impact of two rate increases since May of 2023. While funding costs have largely offset this increase in the quarter, we were able to substantially pay down borrowings late in the quarter and remain confident in our ability to drive lower cost deposits through 2024 and beyond.
MCB saw deposit growth across all verticals, as Mark had mentioned, with total deposit verticals increasing $291 million, or nearly 6%, despite the challenges of an evolving rate environment and its influence on customers. Net inflows were particularly strong for retail deposits, including those with loan customers, which collectively were up $188 million, reflecting growth from both existing new and new customers. We did see outflows of $58 million, representing the return of remaining corporate and reserve deposits with former crypto clients. For additional color, net of those outflows, non-interest-bearing deposits increased in the quarter by $75 million, or just over 4%. We had a very strong quarter for lending, with net loan growth of $205 million, or 4% on $333 million of loan production.
Bigger picture, year-to-date, net loan growth of $514 million has been fully funded by $738 million of net inflows from our deposit verticals. The excess liquidity in the quarter has been used to reduce borrowings. New loan production came in at an average yield of 8.7% versus a Q2 portfolio yield of 6.54%, which showcases MCB's pricing discipline and the resilience of the lending franchise. There was 17 basis points of net interest margin compression in the quarter, primarily as a result of liabilities repricing more quickly than assets in the short run. There are several factors that give comfort that we are at, or very near the inflection point for NIM, assuming, of course, a stable rate environment.
Loan pricing discipline has been maintained, which is evident in our new production yields. We do expect to see the continued repricing of the loan book, which is a relatively short duration book. Borrowings have been substantially paid down, and while that is apparent in the spot balance sheets, the average balance sheet for the Q3 shows we've incurred interest expense on a much higher average balance for borrowed funds. We do expect to see the benefit of those reduced borrowings to benefit NIM and more importantly, P&L as we move forward. We entered the year with $250 million in borrowings, and as we've said for the past few quarters, we do expect to reduce borrowings close to this level by year-end.
We did see an opportunity late in the Q3 to lock in funding costs on $300 million of FHLB borrowings, using a pay-fixed swap at an average rate of approximately 5% versus the Q3 average borrowing rate of 5.66%. That benefit will start to come into NIM and P&L. in the Q4. The goal would be to exit 2023 with only the $300 million of hedged FHLB borrowings remaining on the balance sheet. As Mark has already mentioned, we expect MCB's newest deposit verticals to provide a funding advantage well into the future. Touching briefly on credit, asset quality remains strong. Strong loan growth drove credit provisioning in the quarter, which was partially offset by improvement in the economic forecast underlying our CECL model.
Total non-interest income was down approximately $1.3 million from the prior linked quarter, due largely to the exit from crypto. We were particularly pleased, however, to see corporate disbursement client revenues continue to scale, with revenues up 22% from the prior linked quarter and up 104% from the prior year quarter. Non-interest expense in the quarter did benefit from the settlement reserve related release of $3 million. Legal fees came down substantially from the prior quarter, but remained elevated by roughly $600,000, which we would expect to drop out of the run rate prospectively. Lastly, the increase in compensation benefits reflects our continued investment in human capital.
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Operator (participant)
Thank you. The floor is now open for questions. At this time, if you have a question or a comment, please press star one on your telephone keypad. If at any point your question has been answered, you may remove yourself from the queue by pressing star two. Again, we do ask that while you pose your question, that you pick up your handset to provide optimal sound quality. We'll take our first question from Nick Kuljurgis with Hovde Group. Your line is open.
Nick Karurgis (Senior Managing Principal)
Good morning, everyone.
Mark DeFazio (President and CEO)
Morning, Nick.
Nick Karurgis (Senior Managing Principal)
I wanted to start on the expense front. Nice to see a material reduction in the professional fees this quarter. You know, given the resolution of the regulatory issues, is it your expectation that this line continues to normalize? I heard the $600,000 you expect to drop out in the Q3, but or the Q4, but is there more to come in the near term there?
Greg Sigrist (EVP and CFO)
I wouldn't expect any upward movement that, on the professional fee line, Nick, you know, the next couple of quarters, particularly from a core perspective. You know, I think legal expense will settle out largely in the Q4, but maybe into the Q1, just given some timing. You know, given the announcement yesterday, I think you'd still expect to see some in the quarter. Longer term, though, I mean, we've talked for many quarters and many years now about investments we make in the business. That's not just, you know, human capital, which I mentioned in my prepared remarks, but also investments in technology and our digital strategies. You know, we did announce the Finzly partnership earlier this week, so I think some people have seen that.
There's over the last several quarters been some spend in that line related to our digital initiatives. I think you're going to continue to see that. You know, as we get through the budget process and Mark and team have a chance to, you know, finalize the plans around, I think you'll get more guidance in the Q1, you know, in January, I should say, around what that looks like. Again, that's non-core to me. You know, and I think where you're kind of probably going with this is what should you expect from a, you know, core run rate perspective on expenses. You know, I think we've been pretty consistent as we've talked over the last couple of years. We can really drive core efficiency ratio in the 40s.
You know, right now, if you did look at it on a core basis and stripped out legal fees in particular and some of the technology spend, I think you'd see it's in the high 40s. I think the expectation would be to continue driving that lower as we go through time. The investments we're making in this quarter, particularly in people, it helps to do that. There's client-facing people in those numbers, and the team's working hard. As we've seen over the last couple of years, we typically see a pretty quick return on those types of investments. Probably more than you asked for in the question, Nick, but I thought I'd give it to you all at once.
Nick Karurgis (Senior Managing Principal)
No, that's great color. I appreciate it. I know we're in the early innings, and you touched on it briefly in your opening remarks, but could you update us on your newest deposit verticals, you know, 1031, Title, EB-5, et cetera?
Mark DeFazio (President and CEO)
They're well on their way. The infrastructure, setting those two, specifically with 1031, we can start with that. There are two or three actually technologies that we have to integrate in order to be very competitive in that space, and we're well on our way. We have our I.T. team working with our 1031 team in implementing these new technologies. We didn't expect much out of 1031 or EB-5 in 2023. These were 2024 big initiatives for us. We'll be fully prepared and fully in the market for 1031 and Title in 2024, early January. EB-5 also. There's a lot that goes behind it.
It's a complicated business from a documentation perspective, policies, procedures, and getting out into the marketplace. They're fully stood up. So we expect it to have a good runway in 2024 and beyond.
Nick Karurgis (Senior Managing Principal)
Fantastic. Loan growth was strong again this quarter. Are pipelines at similar levels relative to the previous quarter?
Mark DeFazio (President and CEO)
Yeah, I would say so. Yes.
Greg Sigrist (EVP and CFO)
Yeah. Pipeline remains robust.
Nick Karurgis (Senior Managing Principal)
Fantastic. Thank you for taking my questions.
Greg Sigrist (EVP and CFO)
Nick, thank you, and thanks for joining.
Operator (participant)
We'll take our next question from Chris O'Connell with KBW. Your line is open.
Chris O'Connell (Director and Equity Research Analyst)
Hey, good morning.
Greg Sigrist (EVP and CFO)
Morning, Chris.
Chris O'Connell (Director and Equity Research Analyst)
Wanted to follow up on that last question there regarding, you know, loan growth and overall balance sheet growth. It sounds like, you know, the pipeline's on the deposit side and the loan side remain full. Do you expect going forward on the deposit side that there's any kind of remaining core non-interest-bearing deposit mix shift, you know, remaining, or that the growth from these new deposit verticals can offset any kind of, you know, related mix shift on a go-forward basis?
Greg Sigrist (EVP and CFO)
Well, in the quarter, Chris, I mean, we're really pleased to see in the quarter, you know, the existing verticals all contributed. You know, that was largely it's a lot of existing clients. It was also new clients through clean retail and with our lending clients. Importantly, though, I mean, we're really focused on the mix side. The mix I'm thinking on focused on the most is that DDA versus interest-bearing mix. You know, with the $75 million of DDA growth in the quarter, that's a direct reflection of how hard the teams are working, right? They get it, and they're really focused on, you know, working with our clients and bringing in the operating accounts. I think looking ahead, I really think that the mix is going to be pretty consistent.
I would expect to see all deposit verticals continuing to contribute. The teams are working really hard. I'd like to see that DDA mix of existing verticals, you know, continue to scale as well. You know, the new verticals, EB-5 and Title and Escrow 1031, that to me, I mean, that's a long runway for those just to continue to scale and scope. I mean, they contributed this quarter. They've contributed for the last two quarters, actually. They're going to continue to contribute Q4 and beyond. But you're really going to see those verticals scale in the latter half of next year.
That, to me, is just the real exciting part here in terms of what you're going to see from a mix shift perspective. That's going to impact that cost of funds over time.
Chris O'Connell (Director and Equity Research Analyst)
Yeah. For the new verticals and the deposit production coming on there, any sense, even in general terms, you know, what the blended cost of the new deposit pipelines are coming on at?
Greg Sigrist (EVP and CFO)
cost of deposits. You know, that's going to give you some comfort that as we continue to put on, you know, new production yield loans, which frankly, right now are over 9%, what we see in the pipeline, you're going to see healthy loan yields coming on, you know, the asset side repricing. You're going to see those newer deposits starting to come in inside of our current funding base, and that's a good place to be." Wait, "ED5" in the original. "Uh, e- except I would say for ED5 in particular..." If I change "ED5" to "EB-5", I am correcting a phonetic error. If I change "nine percent" to "9%", I am following the number and percent rules. If I remove "Uh, e-", "of, of, of", "So", "uh", "But", "our, our", "cu-", "that's, that's", I am following the filler/stutter/starter conjunction rules. If I keep "Yeah, I mean, as you know", "you know", "frankly", I am following the meaningful filler rule. Wait
Chris O'Connell (Director and Equity Research Analyst)
Yeah. I guess said another way, I mean, interest-bearing deposit costs are at, you know, now at 4.10. How much higher do you think that those will go over the next, you know, two or three quarters?
Greg Sigrist (EVP and CFO)
My crystal ball's broken, Chris. I mean, I think you've already largely seen the pull-through effect of rate impacts to this point. You might see a little bit more impact in the third, in the Q4, in October, potentially. I would actually expect to see that number starting to hold steady, particularly if you think we're through the rate hike cycle, right? You know, we are liability sensitive, you know, state that as it is. If over the next two quarters, assuming the rate hikes kind of settle out, I think we're pretty close to the high end of that number.
Chris O'Connell (Director and Equity Research Analyst)
Got it. Just given that outlook and, you know, some of the, you know, borrowing dynamics that you discussed in the prepared remarks, how do you see the NIM progressing near term into the Q4 and, you know, over the next, you know, several quarters if the rate environment kind of remains steady?
Greg Sigrist (EVP and CFO)
Yeah, I really truly feel we might have seen the inflection point in the Q3 on NIM, Chris. I think that's going to go back to kind of your embedded last question, which is: Is there any upward pressure on the existing, you know, interest-bearing deposit side? I'm not seeing it right now. I would expect us, frankly, to start that inflection point, you know, if not already, then into the Q4. You might see some modest uplift in the Q4 in NIM.
By the time we get into the Q1 next year, again, combination of a more stable rate environment, you know, and the connotation that would have on our funding cost, combined with just the ability to continue to reprice the asset side, you'll start to see that uplift certainly by the Q1 at the latest.
Chris O'Connell (Director and Equity Research Analyst)
Got it. On the GPG pipeline, you know, I know you guys announced that partnership and have some, you know, things that, you know, you'll update us on as we get into 2024. How do you see the GPG fees, you know, trending into the Q4? Should we expect those, you know, to be up on a quarter-over-quarter basis?
Greg Sigrist (EVP and CFO)
I would still expect to see GPG revenues trending as they have historically, Chris. You know, if you call that 15%, you know, 20%, you know, whatever range you're looking at historically, I'm not seeing anything that would say otherwise. I mean, we're obviously still continuing to focus on the quality, you know, clients we want, you know, have in the portfolio there. I think, as you know, though, anybody we onboard now, it's really, you're not going to see any substantial revenue generation, fee generation for at least 12-18 months. It takes some time to get them through the process and ramped up. But just with the existing portfolio clients we've got, you know, you're starting to see, you know, I called out on my prepared remarks, the corporate disbursement clients.
You're starting to see some of those partners really hit their stride, and as they're building out, you know, their client base, it's filtering through. I would say, you know, continue to look at the historic run rate. I think that's a good place to start.
Chris O'Connell (Director and Equity Research Analyst)
Got it. Just lastly, on the consent order and the impact going forward, you know, obviously the actual, you know, monetary penalty came in below expectations. Do you have any color or detail as to, you know, how much of the kind of internal investments related to that are needed on a go-forward basis?
Mark DeFazio (President and CEO)
I don't think there's any more additional internal investments. We have been working on improving the policies and procedures, as I mentioned in my prepared remarks. There will be no incremental increase in costs associated with addressing the concerns of the regulators. We may have some outside validation done through some consulting work to validate what we have done. We're in a pretty good shape to address the concerns of the regulators.
Chris O'Connell (Director and Equity Research Analyst)
Great. That's all I had. Thank you for taking my questions.
Mark DeFazio (President and CEO)
Thank you, Chris.
Operator (participant)
We'll take our last question from Alex Lau with JP Morgan. Your line is open.
Alex Lau (Analyst)
Hi. Good morning, everyone.
Mark DeFazio (President and CEO)
Morning.
Alex Lau (Analyst)
Just to follow up on the previous topic, can you walk through the two consent orders and how you expect to respond to these, if this changes how you approach the GPG business at all? Thanks.
Mark DeFazio (President and CEO)
Well, the consent orders are pretty straightforward. They're specific to different areas of compliance oversight, specifically for the consumer-facing part of GPG. We have been addressing as, you know, this is a 2020 matter, so we have been addressing and working alongside very productively with our regulators. We have a very good relationship with the regulators. Open communication, good transparency. They've had some very good ideas and some suggestions on how to address these type of business relationships. You saw recently, there was joint agency guidance that came out on third-party oversight for these types of relationships, so that's been very helpful. We'll address them, you know, one by one. It's no different than findings in any report of exam.
You know, we'll address them, we'll evaluate them, we'll have discussions with the regulators, and then we will make the changes necessary. We will likely get some of the changes looked at by outside companies to validate, and then we'll present them to the regulators for their review and consideration. We don't find it to be a heavy lift. We've addressed many of these already, because this wasn't a very acute challenge in March of 2020, specifically because of the global pandemic and the circumstances around that. No, we're in a good place, and we have good dialogue with the regulators on this.
Greg Sigrist (EVP and CFO)
Yeah, the only thing I would add, Alex, is, I mean, we from an investment perspective at Human Capital, we've almost doubled the number of folks in that, you know, the control function since that time, since early 2020. I think that speaks to Mark's point in terms of, you know, the level of focus on this internally since that time.
Alex Lau (Analyst)
Thanks, guys. Just to follow up to that, does this impact the near-term growth potential of the GPG business with regards to gathering deposits and fee income at that historical growth pace?
Mark DeFazio (President and CEO)
I don't think so. As I sort of signaled many times over the last several quarters, we're repositioning and looking primarily at more B2B business in GPG as it relates to the payment space and not really looking to expand the consumer side of the business. No, we don't expect any interruption of business at all.
Alex Lau (Analyst)
Thank you. My last question was on the non-performing loans. There's a tick up in the quarter. Can you share some color on what that loan was? Also maybe just refresh us on the health of the existing non-performer. Thanks.
Mark DeFazio (President and CEO)
Working backwards, we are still going through the foreclosure process on that one loan that's in Mission, Kansas. We're still fairly optimistic on a positive outcome, likely to be a 2024 event. As it relates to the tick-up, it was two small loans actually with the same principal, I think roughly $3.5 million each. We have no concerns at all on at least half of it of one loan at $3.5 million. The other loan, we are highly confident we'll get paid 100 cents on the dollar. No concerns at all. Overall, the health of the book is very good.
Greg Sigrist (EVP and CFO)
Yeah, and staying in the obvious, the non-performing, the ratio there is still incredibly low, even with that modest uptick of those two small loans.
Alex Lau (Analyst)
Appreciate it. Thanks for taking my questions.
Greg Sigrist (EVP and CFO)
Yeah. Before Mark does any closing remarks, I just want to thank Mark for the time I've spent here at MCB. It's a remarkable franchise. It's an incredible team. Mark, thank you to you, thank you to the board. I really enjoyed working here and working with everybody.
Mark DeFazio (President and CEO)
Yeah, we feel the same, Greg, and we wish you all the best in your new initiatives, and hopefully we'll keep in touch and work together as well, again, as well.
Greg Sigrist (EVP and CFO)
Without a doubt. Chris and Alex, it's been a pleasure working with you guys the last couple of years. Nick, sorry for the timing on it. It's been really good getting to know you as you've gotten up the curve here. As you know, it's a remarkable franchise, so good luck.
Operator (participant)
This concludes the allotted time for questions. I would like to turn the call over to Mark DeFazio for any additional or closing remarks.
Mark DeFazio (President and CEO)
I have nothing other than thank you again for your support and interest in MCB. As I've said many times, we are here, and we're available to anybody, any investor or analyst who would like to chat with us offline. Have a nice day.
Operator (participant)
This does conclude today's conference call 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.