Metropolitan Bank Holding Corp. Q2 FY2024 Earnings Call

Welcome to Metropolitan Commercial Bank's Second Quarter 2024 Earnings Call. Hosting the call today from Metropolitan Commercial Bank are Mark DeFazio, President and Chief Executive Officer; and Dan Dougherty, 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. The operator provided instructions to participants. During today's presentation, references 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 and investor presentation. It is now my pleasure to turn the floor over to Mark DeFazio, President and Chief Executive Officer. You may begin.

Thank you. Good morning and thank you all for joining our second quarter earnings call. MCB’s solid second quarter financial performance was indicative of the strength of our core commercial banking franchise. During the quarter we thoughtfully grew the balance sheet while maintaining our price discipline, credit standards, and with a continued sharp focus on liquidity and interest rate risk management. I am pleased to report we saw four basis points of NIM expansion in the second quarter. This marks our third consecutive quarter of NIM expansion. Our two major strategic initiatives, the wind down of the GPG business and the digital transformation project, are proceeding on time and on budget. We remain keenly focused on the successful completion of these important initiatives. Also, MCB remains focused on the continuation and expansion of our profitable and intentional commercial bank growth strategy. In the second quarter, we reported earnings per share of $1.50, including a $0.34 net impact of the GPG wind down, regulatory remediation and digital transformation expenses. Profitability was supported by strong growth in net interest income and continued excellent credit performance. As the asset quality remains strong, we have not identified any broad-based negative trends in any loan product segment, geography, or sector that is impacting our portfolio. We believe that our healthy credit metrics are a direct result of MCB's pricing discipline, conservative underwriting, and portfolio diversity. Our performance is also supported by our exclusive focus on relationship-based commercial banking, with high-quality commercial clients and sponsors in industry segments that we know exceptionally well. As I mentioned on the first quarter earnings call, we have two loans totaling approximately $21 million that were characterized as non-performing at the March 31 reporting date and are now current and have funded interest reserves. I will now turn the call over to our CFO, Dan Dougherty.

Good morning, everyone and again, thanks for joining our earnings call. As Mark mentioned, the net interest margin increased by four basis points to 3.44% in the second quarter, adding to the four basis point increase that we saw in the first quarter, as well as a nine basis point increase that we saw in the fourth quarter of 2023. Our loan repricing, loan pricing and repricing discipline are the main drivers of our ability to expand. We expect to see some additional modest uplift in the margin throughout the remainder of the year. In our updated forecast model, we have assumed a 25 basis point rate cut in September. In that scenario, we expect to see approximately three to five basis points of additional uplift. In other words, we forecast a fourth quarter NIM in the range of 3.47% to 3.50%. Focusing on lending, we grew the loan book by approximately $120 million in the same quarter. It is noteworthy that our quarterly loan growth was net more than $240 million in payoffs and paydowns in the quarter. Loan growth in the quarter was led by an increase of $48 million in C&I and an increase of $105 million in CRE, offset somewhat by $28 million in multi-family loans. Our continued focus on economic loan pricing resulted in a weighted average coupon of 8.81% on second quarter new loan originations and draws. That coupon does not include deferred fees, which are typically 15 to 25 basis points per year. The coupon on loan curtailments in the quarter was approximately 7.88%. The weighted average coupon on upcoming loan maturities for the balance of 2024 is closer to 7.5%. In the quarter, deposits declined by approximately $68 million primarily as a result of a wind down related decline of $60 million in GPG deposits. As well, there was a temporary $80 million decline in borrowed deposits, partially offset by an increase of $70 million in property manager deposits. Year-to-date we are up about $320 million net of GPG flows. Importantly, we intend to maintain our discipline in what continues to be an extremely competitive deposit gathering environment. Accordingly, we are adopting guidance on new loan growth for the full year 2024, which is somewhat lower than our previous guidance. The current forecast for loan growth is approximately $500 million to $600 million for the year. We believe this more conservative approach will further enhance our ability to maintain our discipline on lending and, importantly, will also provide some relief on the funding side of the equation. As Mark mentioned, asset quality remained strong with no identifiable negative trends within the portfolio. The provision in the second quarter was generally in line with the increase in loan flows. Non-interest income included an uptick in deposit fees from the first quarter, which as previously mentioned was expected to be sustainable. These increases were more than offset by declines in letter of credit fees and GPG revenue. For the full year 2024, we currently forecast BaaS revenue to total $9 million to $11 million. Our total non-interest income expectation for 2024 is slightly higher than our previous guidance. We now expect it to be $20 million to $22 million for the year. Non-interest expense totaled $42.3 million in the second quarter. Expenses related to the digital transformation project totaled $1.7 million, and an additional $3.8 million reflected regulatory remediation work and costs associated with the GPG wind down. Q2 regulatory remediation costs came in approximately $2 million higher than expected. We have made arrangements with the GPG clients to recoup that $2 million in the third quarter and further to pass a significant portion of any future remediation expenses back to them rather than absorbing it as previously anticipated. For the full year 2024, our guidance remains total non-interest expense of $161 million to $163 million. Further, I expect the go-forward run rate for non-interest expense will be around $140 million to $152 million. Of course, please keep in mind that this estimate is certainly subject to adjustment as we move through the 2025 planning season. Our $12 million to $13 million digital transformation budget remains unchanged. We continue to expect to complete the project in 2025. Approximately $8 million to $9 million of the project will be expensed in 2024, inclusive of the $3.5 million that has been reported through June. To date, we have executed the vast majority of the underlying major contracts. The effective tax rate for the quarter was approximately 30%. Going forward we expect the effective tax rate to be in the range of 31% to 32% excluding discrete items. Please refer to the updated investor deck which can be accessed at our website for the walk-down from reported earnings to non-GAAP core earnings. Year-to-date the one-time charges related to our digital project, regulatory remediation and other items totaled $10.4 million, or $7.1 million after tax. I will now turn the call back to our operator for Q&A.

The operator provided instructions to participants. Our first question will come from Alex Lau with J.P. Morgan. Please go ahead.

Hey, good morning. Starting on deposits, what are your expectations in terms of timing and magnitude of the exit of the $900 million in GPG deposits through year end?

Good morning Alex.

At the end of June, we had about $800 million remaining in GPG deposits, with approximately $350 million expected to run off in this quarter and $450 million to run off in the fourth quarter.

Got it. And as these deposits leave the balance sheet, what are the key sources of funding that you plan to use to replace these deposits in the near term and what are the costs associated with these funding?

We're going to rely on our existing verticals clearly. We've actually had a meeting yesterday strategizing on that. We see a lot of opportunity in our lending customers, ED5 and HOA as well. I expect that the replacement funding should come with approximately a similar cost to our current funding, but again, it's very dependent on how that mix comes down.

Got it. And do you expect much wholesale borrowing in the near term in anticipation of the outflow of deposits?

We're planning to replace all of the outflow with deposits, but we are fully prepared to use wholesale funding if necessary.

Thank you. And then just to touch on the loan growth, is the slower start to loan growth for the year a factor of less demand from your customers at all, or is it largely from the paydowns that you mentioned?

Well, it is really how this is marketed. It's more as a result of pricing. We believe in capital preservation, especially this year; that is critical across the industry. And we are just not seeing the risk-reward out there. So we prefer to do a bit less. We're seeing a lot of opportunities. I believe the last thing I've heard from the head of my Commercial Real Estate Group is we've turned down some $400 million of deals so far, specifically because of pricing, or perhaps a little bit outside the range of asset quality that we were looking for. So we're a bit more cautious today. I wouldn't call it conservative, but it's really about asset quality and pricing.

Thank you. And just one last one from me, what is the latest update on your progress on the regulatory remediation process?

We're making a lot of progress. We are very much aligned with our regulators. We have a good working relationship with them. We're anticipating material enhancements and improvements, and the meaningful costs that we have been expecting in 2023 and 2024 will likely come to an end or materially come to an end by the end of this year.

Great. Thanks for taking my questions.

Thank you Alex.

Our next question will come from Christopher O'Connell with KBW. Please go ahead.

Alright. I'm following up on the GPG runoff of the $800 million or so that's remaining. Can you just remind us what the breakdown is, either just on the blended cost or how much of that is within the non-interest bearing deposits?

The blended cost on the remaining balances is around 1.5%.

Got it. And so as far as the NIM guide up, 3 to 5 basis points into the end of the year here, I'm assuming that that assumes that the deposits with the 4% handle are replacing the entirety of the GPG deposits, is that correct?

That is correct.

Got it. So, depending on if you have to dip into short-term borrowings temporarily for a quarter or so here, that probably results in either a flatter NIM trajectory or kind of just a modest uptick in the year-end depending on how much Fed funds cut through yet?

Yeah, that's exactly right. To the extent we can work a better blend under the deposit growth that produces upside; to the extent that our timing variance forces us into the wholesale market, that creates a little bit of a headwind. But the plan for now is to replace those deposits with core deposits, and we're pretty comfortable with that plan.

And Chris, just to point out, we have been de-emphasizing GPG for the last two years now. So we have a history of replacing those deposits. More particularly, given the instability over the last two years while we have truly decreased $800 million, this is a lower point compared to where we were two years ago with the entire GPG deposit base. So this is not a heavy lift. We may use wholesale funding for a short period of time, but the timing and instability are very much in line with our expectations.

Great. And I think you guys said on the last quarter, but it still holds true that each Fed funds cut that we get here is about a 5 to 10 basis point loss in the margin?

Each 25 basis point cut results in about 4 to 8 basis points of impact on the margin.

Got it. So, you guys only have one cut in the mid-guidance, correct? There could be some good upside there?

That is correct, without a doubt.

And it looks like you guys had a good chunk of the multi-family portfolio come due this past quarter and that some of it may have been refinanced. Can you just talk about how you handled that, what you guys are seeing, and any additional color as to how those loans were performing when they came due and whether you guys either refinanced them yourselves or whether they went elsewhere?

No, they went elsewhere. As we have mentioned in the past, we really haven’t played in the multi-family space in any meaningful way. So these are stabilized multi-family properties in and around New York and other markets, and are very refinanceable for banks that are interested in taking on more concentration in that asset class. So we don't see any pressure with the remaining book in its ability to either be refinanced elsewhere or be refinanced by us if that made sense.

Great. The 0% non-performers on the office certainly remains impressive. Any outlook or conversations with your customers that you've been having on the $115 million that set to come due in the second half of the year?

I'm sure our real estate group is engaged with those clients and managing expectations as far as either payoffs or refinances. But I can tell you as of now there is no stress in any of those conversations. It's a normal conversation as to whether or not those loans will be repaid, meet their next milestone, or whether we would consider refinancing them. So that's all in flight, and it is just normal communication between our lenders and our sponsors.

Great. And then the clean expense run rate of $149 million to $152 million, is that basically where you think you'd be shaking out going into 2025 on an annual basis prior to normal merit increases?

Yeah, once we're behind the three major projects that's the clean run rate that we expect. Again, the 2025 planning season is just around the corner. We could refine those numbers obviously, but that's the expectation once we've got the three major projects in place.

Okay. But is that number inclusive of annual merit increases and normal growth?

No, that's inclusive, Chris. Absolutely.

Okay. Got it. That's helpful. Great. Thanks for taking my questions.

Our next question will come from Mark Fitzgibbon with Piper Sandler. Please go ahead.

Hey, guys. Good morning. Happy Friday.

Yeah. Thank you. We woke up to an interesting Friday. Thank you very much.

Sure. Well, let me start by following up with that question on expenses. Just to clarify the $161 million to $163 million of expenses you're assuming for this year, does that incorporate all of the charges that you're expecting to take on the various projects?

Yes, it does, Mark.

Okay. And then I'm curious where you think the balance sheet size ends up at the end of this year with the runoff and the organic growth that you're going to have? What do you think the total balance sheet footings are — are they sort of flattish or maybe up a little bit from where they are today?

Oh, I think they'll be up a little bit. As you know we kind of closed the quarter at about $7.2 billion and I really think that we'll see some additional growth into year end. So maybe another $200 to $300 million.

Okay. Great. And then was curious on that one multifamily loan that cured during the quarter, went back on accrual status. What changed — was it simply having a conversation with the company and causing them to come in with additional cash or interest reserves or something else?

All of the above. The root cause of that problem was a dispute between partners. The dispute got reconciled with a little help from us. In addition, they stepped up with a plan to execute to get us paid off and decide how to liquidate these properties. As a result, they brought additional interest and also had to put up meaningful additional reserves for the rest of the year and into 2025. So there is a real action plan right now for these properties to get sold. This was unfortunate, but it did happen and the actions taken resolved it.

Okay. And then lastly, and I hate to ask this, but it is relevant this morning. Just curious, any impact on your systems today associated with the CrowdStrike situation?

Yeah. We had a bit of a service outage for our core provider, and we were in touch with our key stakeholders here since 6 A.M. this morning. There was a bit of impact in ACH postings and, unfortunately, payroll. So it's being rectified as we speak. I haven't heard of any other material issues since I've been in this room now on the earnings call. We reported to the regulators first thing this morning about where we stand. I think we're going through the same process as many other companies across the country and the world.

Thank you.

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

The only thing that I'd like to say is I'm very much looking forward to the second half of the year and closing out 2024 for a lot of different reasons. We are turning the corner on some very strategic initiatives and I am very much looking forward to it. We have a very clear line of sight into 2025 and we're excited about getting back to historical performance standards here at MCB that we've experienced over the last two decades. We just celebrated 25 years of operating performance in June, and we're very much looking forward to getting through 2024. Thank you all very much for your support and taking the time out this morning to listen in and participate. Have a nice day.

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 lines at this time and have a wonderful day.