Metropolitan Bank Holding Corp. Q2 FY2022 Earnings Call

Welcome to the Metropolitan Commercial Bank Second 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. 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. 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.

Good morning and welcome to MCB's second quarter earnings call. MCB celebrated its 23rd anniversary in June, and I am pleased to announce at this time record quarterly earnings and return on average tangible common equity of 16.7%. Our business thesis to assist clients in building and sustaining generational wealth has been the foundation of our growth and success. That focus is evident in our long history of strong credit quality, low charge-offs and the strength of our long-term financial performance. Our liquidity position remains strong. We have a proven track record on efficiently funding balance sheet growth. We have also maintained our pricing discipline, as is evident in our NIM expansion. It should be noted that along with dealing with a higher rate environment, we are already preparing for when the Fed will reverse its costs by lifting out floors on floating rate loans alongside resetting rates on automatic renewals. MCB has a solid track record of not reaching its floors. Loan floors have historically been an instrumental strategy for us in managing NIM when rates decline to near zero. I would like to also remind all investors that MCB's internal policy is to limit the crypto-related deposits to 50% of the total available for investment or lending. However, as we've stated many times over the past few years, due to the volatility in this asset class, MCB has maintained 100% of crypto-related deposits in all Federal Reserve accounts. We are comfortable with our liquidity position and our proven ability to efficiently source funding to maintain loan growth and our investment strategy. Again, as a branch-light franchise, we have spent 23 years focused on the liability side of the balance sheet to not only fund the growth of the bank but to protect against economic and industry disruptions. Now for some financial highlights as compared to where we were a year ago. Operating leverage continues to be sustainable with revenues up 44%, non-interest expense up 21%, and our efficiency ratio dropped to 42.2% from 50.3%. Total loans were 926 million or 27%. Total deposits were up 890 million or 17%, including DDAs, which were up 676 million or 24%. For our Global Payments Group, revenues were up 36% from the second quarter of 2021. Second quarter 2022 transaction volumes were 29.1 million, up 29% from the second quarter of 2021, while the dollar volume of transactions was up 47% to just over 8 billion. MCB together with its partners is well positioned to build out a scalable and profitable digital retail platform within a commercial bank. Choosing the right clients to work with, along with working closely with our regulatory partners, is essential in delivering 21st-century efficient financial services available to all consumers. Lastly, I do want to touch briefly on Voyager as I know this is on many of your minds. It's unfortunate that Voyager found themselves in a situation that required them to file Chapter 11. I have been very clear for several years now that MCB has pivoted away from actively growing our crypto business with the caveat that we were well positioned to benefit from volatility without putting the bank at undue risk. The primary service MCB is providing Voyager's exchange platform is an omnibus account in which all Voyager customers' funds are held. Funds from digital asset trades settle in this account in local USD currency; the funds are segregated from the corporate funds and all for the benefit of Voyager's customers, which is why we also refer to this as an FBO account. As a result of the bankruptcy, the funds are temporarily stayed from being released in the normal course of business. On July 14, Voyager filed a motion in court asking the judge to lift the stay on these funds. I am hopeful that the judge will agree to the order, thereby allowing the funds to be released upon request to Voyager's customers seeking withdrawal from their funds. MCB held 455 million in Voyager-related deposits in the FBO account at June 30, including 356 million in the FBO account balances. The FBO balance is currently at 272 million. We have a reserve account, which holds 24 million and general corporate funds of 70 million. Voyager is optimistic that they will come out of bankruptcy and continue with their growth plan. Notwithstanding the strategy of recovery, Voyager represents less than 3% of GPG's revenue, or roughly one quarter of 1% of total MCB revenue, which is clearly de minimis to MCB. I will now turn this call over to Greg.

Thank you, Mark, and good morning, everyone. The loan growth we've seen in the first half of 2022 has certainly laid the foundation for our earnings expansion with net income of 23.2 million or $2.07 of fully diluted earnings per share and EPS up 22.5% from the first quarter. Let me take you through a few of the key drivers. The commercial banking momentum we saw to start the year certainly carried over into the second quarter with net loan growth of 253.7 million or 6.2%, bringing year-to-date net loan growth to 17.2%. Loan originations were a record 513 million in the quarter, up 5% from a strong first quarter and up 93% from a year ago. Volumes are strong across our verticals. Credit quality remains strong with no charge-offs to date in 2022 and nonperforming loans effectively at zero. The credit provision was driven by the strength of our loan production. Turning to deposits, I would like to give you some color on floors for the quarter. Retail deposits, including those with loan customers, increased 175.6 million on the strength of our client engagement during what has obviously been an interesting rate environment. The growth in this vertical speaks volumes on the strength of our customer base, especially when you consider the muted impact to this point on deposit betas. We also saw strong inflows of 64 million related to our GPG debit card programs and 143.8 million from digital currency-related customers. These inflows were partially offset by 51.2 million in outflows related to bankruptcy trustees and specialty deposits, which have generally been expected given the nature of these deposits, as well as 93.1 million in outflows from property managers as some customers diversified their longer-term cash reserves into higher-yielding treasury products. Our liquidity position remains robust with 19% of total assets in overnight deposits and total on-balance sheet liquidity at nearly 34% of total assets. When excluding 50% of crypto-related deposits discussed, total on-balance sheet liquidity remained strong at 26% of total assets. Net interest margin was up 56 basis points in the quarter to 3.27% due in large part to the deployment of liquidity into loans and securities and to a lesser extent, the benefit of higher rates. A substantial portion of loans subject to floors have lifted off their respective floors, with 408 million remaining to lift off at June 30. Of those loans, 70% will lift off by the time their reference rates increase 50 basis points, with another 20% lifting off by the time rates are up 100 basis points. So the majority of those loans will lift off with next week's expected rate increase. Transaction volumes were up modestly quarter-over-quarter in our Global Payments Business. GPG revenue was down slightly in the quarter, given a higher level of non-transactional revenues recorded in the first quarter. And as a reminder, these types of revenues include onboarding fees for new programs, FX revenues and certain expense reimbursements. Non-interest expense continues to be well managed as we are focused on driving a return on investments made previously, particularly in human capital and technology. Other expense did increase in the quarter, driven almost entirely by CRA qualifying grants and charitable contributions. We were quite pleased to be able to fund a number of initiatives in the quarter. 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 the impact of discrete items recognized in the first quarter. Our capital levels remain very strong with all capital ratios significantly above well-capitalized levels. Our Tier 1 leverage ratio was 9.2% at June 30. Overall, we've had a strong first half of the year, reflecting the sustained growth and performance across our businesses. I will now turn the call back to our operator for Q&A.

Bear with us as we may be having some technical difficulties.

The floor is now open for questions. Thank you. Our first question will come from Alex Lau with JPMorgan. Please go ahead.

Hi. Good morning.

Good morning, Alex.

Starting off with loan growth, so very strong loan growth in the quarter. This already brings you to the 17% range from year-end. So this is similar to like the prior two years. Do you think you can grow this portfolio even above that 20% or more this year given the strong growth already?

Alex, as we always said, we're very opportunistic. We're very focused more on asset quality and managing our loan yields. So to the extent the opportunity presents itself, I would expect we could see historical trends continue to pull forward. We also have a very strong pipeline as well. So we're very fortunate, but we are really leaning on a side of caution more than anything else at this point. But as I said, the pipeline is strong and we feel good about finishing out the year.

Thanks, Mark. Are there any notable paydown activities expected to offset some of that loan growth for the year?

Sure. We enjoy payoffs and amortization. So we would expect a fair amount of amortization throughout the second half of the year. And, of course, we experienced a significant amount of amortization and payoffs in the first six months as well.

Thanks. And just another one on loan growth. How much of your growth this quarter was from in your New York metro markets? And then how much was outside of the market? Thanks.

Go ahead, Mark.

Okay. I'm sorry. Alex, I may have to get back to you on that. I don't have that breakout. I could say one thing. It's not inconsistent with historical trends. We are somewhat of a national lender, but I don't recall any outlier in any particular geographic area. So I think we are clearly holding to our geographic historical patterns.

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

Thank you. Next on the line, we have Chris O’Connell with KBW. Your line is open.

Good morning, gentlemen. How are you?

Good morning, Chris.

Hi. So I was hoping just to walk through the Voyager math and just get as much color there as possible. So I think you said the total balance is 455 million with 356 million of that being the FBO account. So like under the assumption that that order is allowed, can we assume that the 356 million would fall pretty rapidly off the balance sheet in the third quarter and then that remaining 70 million or 100 million or so, is that risk of trailing off in the near future depending on how they go?

In my comments, I noted that the FBO balance has decreased to 272 million, down from 356 million as of June 30. Additionally, we have a reserve account of 24 million and general corporate funds of around 70 million. If the stay is lifted and Voyager clients decide to withdraw their funds, we could see 272 million leaving the bank over a certain period.

Okay, got it. And I'm assuming the plan is for it just to have that directly fall out of the cash balances, which is why you guys keep that in the first place?

That's correct. They're all sitting at the Fed as we said.

And then I hear your comments on the rest of the factors with the deposit base, some pluses and minuses there. Given the shift in the crypto environment and there's been kind of volatility both ways, how do you feel about the non-Voyager crypto deposits and how those are trending going into the second half of '22 as well as kind of overall GPG deposits? And I guess like to catch that into like how you guys think about overall deposit growth outside of the Voyager event for the second half of the year?

Let's break that down. Regarding crypto-related deposits, our other clients holding deposits similar to Voyager on our balance sheet are not in a leveraged position. They operate as traditional exchange and custody platforms that generate revenue through fees, which has resulted in strong balance sheets and liquidity positions. They maintain a long-term belief in the cryptocurrency asset class and are navigating their businesses effectively amidst the current interest rate environment and a decline in transaction volumes. They are well-equipped to manage through this period and observe how this asset class evolves over the next 12 to 24 months. Unless there is significant disruption affecting the industry or the value of digital assets during this time, we anticipate that the remaining deposits on our balance sheet will remain stable. I should note that this is contingent upon avoiding major corrections in the asset class or significant declines in value beyond recent trends. Regarding general GPG, it’s important to remember that building a digital retail bank within a commercial bank is a long-term endeavor. In retail banking, growth happens one client at a time, but these clients tend to be loyal and scalable. Our fintech partners are actively engaged in client acquisition through effective marketing strategies, and we expect consistent contributions from GPG month-over-month and quarter-over-quarter. However, it’s essential to evaluate performance on a year-over-year basis, especially as economic slowdowns can lead to reduced consumer spending, affecting transaction volumes and potentially deposit betas if unemployment rises. The GPG business is grounded in traditional retail banking, and like any bank with a substantial retail operation, it is not insulated from economic declines or increased unemployment rates. The additional point to mention is that we do not engage in consumer lending on our platform. For MCB's commercial deposit opportunities, as our balance sheet grows, we are pleased to work with high net worth individuals who appreciate our services. We are strengthening those relationships, as demonstrated this quarter. Our lending and cash management teams are dedicated to expanding a low-cost deposit segment for us. Therefore, we are confident in our efficiency as a branch-light franchise going forward, especially when comparing year-over-year results.

Okay, got it. That is helpful. Thank you. And then on the expense side, you guys mentioned a couple of items on CRA investments and charitable contributions this past quarter. How much was that? And is that more one-time in nature? Will that be falling off in the third quarter?

Just give me a second, Chris, to go to the right page here. The delta was close to 1 million in the quarter. I think going forward it's going to decrease, probably normalize to around 600,000 or 700,000 lower than that. Again, we had some opportunities this quarter to fund some initiatives there and we were very pleased to be able to participate in.

Got it. And can you just remind us on how you think about the overall outlook on the licensing fee line from here?

Yes. As you know, there's a component of that that is tied to rates and it's also tied to some of the deposit volume. So that really helps underlie the bankruptcy trustee deposits. I think it's one where we're going to have to look at it as we go through time just given the rate environment, but that's what I could say at this point in time.

All right. So like all else equal, is the move similar to the move that we saw this quarter a good bogie for the third quarter, given expected rate moves?

What I know right now is that I probably need to refine my analysis, and I will get back to you on it.

Okay, got it. And then as far as GPG fees outside, that was very helpful color on the Voyager component of that in the opening comments. What's the outlook or how do you see the non-Voyager-related GPG fees trending in the back half of this year?

I think they're pretty consistent. As I said, it does depend a lot on the economy. These are consumers on the other side of these retail products. So if they stop spending or deposit floors come down, you'll see a bit less revenue. But we haven't seen any real headwinds there yet with unemployment still down quite a bit. And we're seeing new client acquisition every day with our fintech partners. So I think we're in a good place to finish the year very strong based on the strategies our partners have.

Okay, great. And then lastly, I know this is going to be a tough one. But any color, any kind of near-term thoughts given the Voyager moving expected in the third quarter and cash coming down with that, but a pretty substantial mix shift throughout this quarter as to kind of what happens to the margin next quarter? Obviously up, but just any type of help in quantifying where you guys think that could end?

Yes, that's a challenging question, and there are many factors to consider. As you know, we generally do not provide forward guidance on margins. However, we are committed to managing our balance sheet efficiently and using capital effectively. You can expect to see continued growth in net interest income. It's important to consider the factors contributing to that growth, particularly from our lending activities and our success in increasing the overall balance sheet. For instance, we managed to grow despite a decrease in deposits from the first quarter, primarily through our lending efforts. Regarding margins, we anticipate an increase in loan performance and, to a lesser extent, in securities, particularly as most of these are fixed rate since we remain asset sensitive. On the deposit side, we feel fortunate about our deposit franchise. Market conditions will influence rates, and we cannot maintain deposit betas at zero indefinitely in this rising rate environment. As we've mentioned before, the interest rate sensitivity tables we provided include a 70% beta assumption. Even with this higher beta, we expect net interest income to continue expanding, reflecting our overall funding efficiency. I’ll stop here. Mark, do you have anything to add?

No, I think you covered it well, Greg. And again, we're going to get some benefit as well coming off of our floors this quarter as well coming up. So no, I'm pretty comfortable that we'll have some management to our NIM throughout the rest of the year.

Yes. I think what Mark mentioned about the floors is important as we are already preparing for what might happen in a lower interest rate environment. We don’t feel the need to significantly alter our balance sheet for rising rates. We’re quite optimistic about the advantages those floors provide, but we are also mindful of the possibility of decreasing rates as we navigate through the operating environment.

Got it. Absolutely appreciate all the color. Thank you. I'll step out.

Thank you. Next, again, we have Alex Lau with JPMorgan for a follow-up. Your line is open.

Following up on deposit costs, so interest-bearing deposit costs were stable in the quarter. Can you talk about your expectations for when that just start picking up based on what you're seeing from your customers and also competition?

Yes, please continue, Mark.

No, go ahead, Greg. I apologize.

No, it's okay. I think I just touched on that a little bit with Chris in my response. Moving forward, you will clearly see more discussions happening around rates with our high-quality client base. We have been quite successful so far by being efficient and patient. However, the market will ultimately dictate what happens next. We are not targeting a mass affluent market and don't have a large number of retail, small balance accounts. Our focus is more on high-net-worth and ultra-high-net-worth clients, as well as commercial clients, which I believe will influence the outcomes. Therefore, I think you'll start to see betas rise above zero. It's difficult to predict where they will land as we experience the upcoming rate increases. Nevertheless, I would expect to see some level of net interest margin expansion, given our asset sensitivity and the fact that over 40% of our loans will likely be floating rate loans by the time we see a rate change next week. I hope that helps.

The other thing to keep in mind, Alex, we don't expect to do anything programmatic. We deal with a rate discussion on a case-by-case basis. So we should not be shocked with any major shift going forward.

Thank you. That's helpful. And when you think about your deposit beta, do you have the prior cycle to date deposit beta from the last rising rate cycle? And where do you expect to land around this time relative to that?

I don't have that information readily available. It's quite challenging to use that as a predictor for this cycle, considering the speed and magnitude of the individual increases. Even if I had that information, I'm not sure it would be particularly useful. However, I think Mark's point is valid; we're not anticipating any significant changes across the different sectors, and our focus will remain on the long-term efficiency of funding and net interest income growth.

Got it. And just following up on the 1.2 billion in deposits from digital asset clients, that was up 13% in the quarter. Can you just explain how balances rose in the current market environment of lower prices, higher transaction volume? Thanks.

Just client acquisition. There are still a lot of investors out there that are, as they call themselves, crypto long, and putting Voyager aside, who was on a good trajectory if it wasn't for the leverage. The companies that are not leveraged, they're out there with client acquisition. And also, there is somewhat of a disruption going on right now in that industry. And to the extent that you are in exchange, this is an opportunity for you to capture new client acquisitions. So you're going to see some expansion in this business for some time. Where it ends and where it lands as an asset class is a whole another discussion. But it did not surprise me that there was a little bit of a recovery in this space because the crypto clients are really out there looking to pick up client acquisition.

Yes, I agree with that. I think it's day by day, week by week as well. What we have seen over the last couple of months, especially since the middle of May, is that some investors have moved out of digital assets, whether Bitcoin or stable coins, and into cash. They have typically rotated back in, buying different digital assets. However, we have not seen people leaving the ecosystem entirely. So, in line with Mark’s point, I believe it has been more stable than some people would have expected during this time.

Thanks. That's very good color. Staying on GPG, so just drilling in on the $5 million in GPG revenue, down $400,000 largely from the crypto GPR business. Is this the one-time revenues you mentioned? And in this line, how does lower prices in crypto impact the fee income stream? Thank you.

I'll begin, and Mark can provide additional insights on the latter part of your question. If you refer to Page 14 of the investor relations presentation, you noted that the crypto GPR experienced a slight decline this quarter. We also saw some elevated non-transactional revenues, particularly with the GTR card. Another point of interest on that page is at the very bottom, where corporate disbursements increased from 373 to 517. During the quarter, while there was a slight decrease in transaction volume for the crypto GPR cards, this was offset by increased volumes in other areas, including a rise in GPR card volumes. Additionally, corporate disbursement volumes also grew. I'll stop here, and Mark, if you have any insights regarding the pricing and stability over time, please share.

Yes. There really isn't any correlation between revenue and the value of a crypto asset. The only correlation is volume. So if investors believe the asset class is going to appreciate, they will come out of cash and purchase digital assets, therefore, increasing volumes and therefore revenue, you'll see a direct correlation with revenue but you will also see deposits going down. And in the reverse, if people are exiting the asset class, volumes will go up, transaction volumes go up, therefore, a correlation to revenue. And then when they're out of that asset class, cash balances increase if they don't leave, as Greg called it, the ecosystem permanently.

Thank you. And there was a smaller piece of GPG income, 0.5 million from crypto exchanges. Is that the same with regard to your comments about how prices are less relevant and it's more about volume? Thanks.

I can't point to that 0.5 million. I don't know what you're pointing to, but our business is all about transactions. Our revenue generators here are all about transactions and fee for retail services.

Yes, quarter-on-quarter, Alex, that crypto exchange OTC went from 133 to 135. The bottom box you're looking at again was the corporate disbursements. So we'll get that cleaned up on the IR website. We did see that this morning, just to make the legend a little easier for you.

Got it. Thank you.

You're welcome.

And then on expenses, can you speak to how you're thinking about expense growth for the year, given strong benefits from higher rates and good growth? What are some of the investments underway and maybe how should we think about expense growth for the year?

Yes, as you know, we talked about consistently we are a growth company. You did touch on benefits and the human capital side of the equation. So I think we're obviously going to have to make sure we keep pace on the investment with the employees we've got. But as a growth company, we are still continuing to invest in people and bring in people that are going to help us scale and provide stability of revenues as well. So again, I think one of the primary areas of investment on the expense side is going to be in people. You're going to see the first quarter to second quarter and kind of neutralize for some of the lumpy first quarter expenses, you definitely saw some uptick versus the second quarter in that investment. You're going to see that continue over the balance of the year, maybe accelerate a little bit. And as we've talked about technologies, the other big piece we're really focused on, we really haven't done a lot yet in terms of build for where we're headed in that space. But I think by the second half of this year, certainly by the fourth quarter, you're going to start to see us make some progress there as well. Again, it's not an outsized spend or any large investment, but it's meaningful for us, I think, in terms of the operating environment going forward and just the scalability and sustainability of the businesses. I think more broadly, again, we're not looking at it month-to-month, quarter-to-quarter. We still remain very focused on both getting a return pretty quickly on our investments in human capital and technology and having a focus on positive operating leverage. But you're not always going to see that positive operating leverage translate into a decrease in the efficiency ratio quarter-to-quarter. You've got to definitely look at that year-over-year. And you've seen the numbers. You've seen the dramatic improvement we made in the efficiency ratio versus the first half of last year, the first half of this year. So we're thinking about it more in terms of how do we drive that overall positive operating leverage and frankly net income growth? So I don't think coming out the other way, which I know you're going to look at is from the efficiency ratio, I think we're in a range right now. I think over time, you're going to see us continue to work that down. You shouldn't necessarily expect us to do that every quarter, but we're very pleased with the progress we've made over the last year on that.

Thank you for that. Thanks for taking my questions.

You got it, Alex. Thank you.

Thank you. Next, we'll go to Chris O’Connell with KBW for follow-ups. Your line is open.

I'm all set. Thank you very much.

Thank you, Chris.

Thank you, Chris.

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

I would just like to say thank you again for having the confidence in MCB and this is a marathon, and we're very pleased with where we are and what we've accomplished after 23 years and we're excited about the future as well. So thank you again for taking the time out this morning and look forward to having more face-to-face meetings with our investors in the coming months. Thank you.

Thank you. 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.