Earnings Call Transcript - MCB Q3 2025

Operator, Operator

Welcome to Metropolitan Commercial Bank's Third Quarter 2025 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. 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 and investor presentation. It is now my pleasure to turn the floor over to Mark DeFazio, President and Chief Executive Officer.

Mark DeFazio, CEO

Thank you. Good morning, and thank you all for joining our third quarter earnings call. In aggregate, MCB's results this quarter reflect how our strategic position fuels our performance, highlighted by strong balance sheet growth funded by core deposits. Importantly, our continued growth strategy is underpinned by our unwavering commitment to risk management in all of its forms. In the third quarter, loan growth was approximately $170 million or 2.6%. Year-to-date, we have grown the loan book by approximately $750 million or more than 12%. Total loan originations year-to-date were $1.4 billion. As well, core deposits were up approximately $280 million or 4.1% in the quarter. Year-to-date, we have grown deposits by over $1 billion or 18%, and that's without the acquisition of any teams. Our strategic funding initiatives include the maintenance and development of existing deposit verticals as well as the identification and pursuit of new verticals. In addition, we are moving forward with new branch openings in strategic markets well known to MCB in Lakewood, New Jersey, Miami, and West Palm Beach, Florida. The third quarter marked our eighth consecutive quarter of margin expansion. The net interest margin increased 5 basis points to 3.88%, up from 3.83% in the prior quarter. Our financial highlights of the third quarter include a Board-approved $50 million share repurchase program and the payment of our first common stock dividend. These actions reflect our unwavering commitment to provide our shareholders with a meaningful return on their investment. We will utilize these capital management tools with a level of discipline that is appropriate and necessary for a growth company such as us. We continue to move forward with our new franchise-wide technology stack. We anticipate full integration to be completed by the end of the first quarter. We are confident that these new technologies will support and scale with MCB's diversified and growing commercial bank for years to come. I am equally excited about the launch of MCB's AI strategy. The hiring of MCB's first AI Director last quarter was a great start. We will approach AI reasonably and align ourselves with regulatory expectations and will identify and prioritize use cases that advance MCB's franchise value overall. Our asset quality remains very strong with no broad-based negative trends identified in any loan segment, geography, or sector impacting our portfolio. We actively engage with our customers to gather insights on current and expected market stress. The feedback to date has not indicated any specific areas of concern. Importantly, our thorough analysis of the Medicaid and Medicare features of the recently passed 'One Big Beautiful Bill' indicates that the proposed cutbacks will not affect our borrowers in any material way. Our third quarter provision expense was $23.9 million, $18.7 million of which is related to three out-of-state multifamily loans extended to a single borrower group in 2021 and '22. The specific reserve is a clear outlier considering that over our 26-year operating history, we have experienced minimal actual credit losses. I will discuss the ongoing workout during the Q&A. The balance of the provision of $5.2 million was driven by adverse movements in the forecasted macroeconomic factors underpinning our CECL model and, of course, the loan growth. As we look to the future, despite recent market volatility, favorable tailwinds for the banking industry are building, and we are well positioned to benefit from them. Loan growth remains solid, and we are diligently managing the expansion of our deposit funding opportunities. We remain committed to managing asset quality and optimizing profitability while further solidifying our presence in New York and complementary markets. Our focus for 2025 and beyond is to capture additional market share through traditional channels and strategically position ourselves to seize opportunities that enhance shareholder value. At this time, I would like to extend my gratitude to all of our employees and the Board of Directors for their dedication and hard work, which drives our continued success. Lastly, I want to thank our clients for their engagement, loyalty, and continued support. I will now turn over the call to our CFO, Dan Dougherty.

Dan Dougherty, CFO

Thanks, Mark. Good morning, everyone. MCB's strong performance in 2025 continued in the third quarter. I'll begin with a few comments on the balance sheet. As Mark said, we grew the loan book by approximately $170 million or 2.6% in the quarter. Year-to-date, we're up more than 12%. Importantly, our underwriting standards and loan pricing parameters have not been altered to achieve our growth results and goals. Total originations and draws were approximately $583 million, with a ready weighted average coupon net of fees of 7.27% in the quarter. The new volume origination mix was about 70% fixed and 30% floating, which is in line with our current modeling assumptions. While the coupon delta between new volume originations and back book maturities has narrowed, it is noteworthy that we still have more than $1 billion of upcoming loan maturities with a weighted average cost of capital of about 4.65%, including $365 million that will roll off by the end of 2026. Our loan pipelines remain strong. We project between $100 million and $200 million of additional loan growth for the remainder of the year, and our first quarter '26 pipeline is shaping up to deliver continued robust growth. Recent headlines have raised concerns about non-depository financial institution lending. Our NBFI book totals about $350 million or about 5% of the loan portfolio. Our channel checks on this portfolio have not identified any credit issues or stress in the portfolio. All credits within that portfolio are currently rated pass. In the third quarter, we grew deposits by about $280 million or approximately 4%. Clearly, the depth and diversity of our deposit funding model is the strength of MCB. Quarter-over-quarter, the cost of interest-bearing deposits declined by 9 basis points. As you all know, late in the third quarter, the FOMC did reduce the target Fed funds rate by 25 basis points from 4.5% to 4.25%. As our balance sheet remains modestly liability sensitive, and about one-third of our indexed deposits reprice on the first business day of the month following a rate change, the benefits of the mid-September reduction in short-term rates will become much more apparent in the fourth quarter. We have $1 billion of hedged indexed deposits, which display positive carry down to a Fed funds effective rate of approximately 3.5%. In our forecast model, we're using a generic funding rate of the Fed funds target rate minus 50 to 75 basis points. We repriced approximately 80% of our unhedged interest-bearing deposits by a full 25 basis points after the Fed rate move. As Mark mentioned, our net interest margin in the quarter was 3.88%, up 5 basis points from the prior quarter. For the fourth quarter, we expect modest further expansion of the net interest margin due to a decline in the cost of funds supported by expected further monetary policy easing and continued repricing of the loan book. As well, supported by our continued deposit growth, the average balance of relatively expensive wholesale funding declined by about $275 million in the third quarter. Based on current trends, I expect that the fourth quarter net interest margin will be between 3.90% and 3.95%, and that our annual net interest margin this year will be north of 3.80%. That forecast includes only a 25 basis point cut in the fourth quarter in December. As a reminder, each 25 basis point cut in the Fed funds target rate will, all else being equal, drive about 5 basis points of net interest margin expansion annually. Now let's move on to some high-level comments on our income statement. I'd like to start by emphasizing the continued earnings strength and momentum of the franchise. For the third quarter, net interest income was $77.3 million, up 5% on a linked-quarter basis and up more than 18% versus the same quarter last year. Diluted EPS for the third quarter was reported at $0.67. On a normalized basis, adjusting primarily for the Q3 specific provisioning, I estimate diluted EPS would have been approximately $1.95. And that estimate does not include the reversal of $675,000, or about $0.04 per share of interest income related to the new nonperforming loans. Our linked quarter noninterest income was $2.5 million, essentially unchanged from the prior period. Noninterest expense was approximately $45.8 million, up $2.7 million versus the prior quarter. The major movements in operating expenses quarter-over-quarter were as follows: an increase of about $1.4 million in compensation and benefits, primarily related to growth in headcount; a $1.6 million increase in technology costs, the primary driver of this increase was a $900,000 increase related to the digital transformation project. In aggregate, for the third quarter, digital project costs were about $2.5 million. Another operating expense item was an $890,000 increase in licensing, primarily due to increases in a deposit vertical that leverages third-party software. And then finally, we had a $1 million decline in the FDIC assessment. On a go-forward basis, the quarterly run rate for the FDIC assessment should begin at about $1.5 million per quarter. And of course, this expense will scale with risk-weighted asset growth over time. Fourth quarter operating expenses are expected to be approximately $46 million, inclusive of $3 million in one-time digital project costs. Finally, the effective tax rate for the quarter was approximately 30%, and as a housekeeping note, detailed guidance for next year will be provided after we report fourth quarter earnings in January. I'll now turn the call back to the operator for Q&A.

Operator, Operator

Our first question comes from Gregory Zingone with Piper Sandler.

Gregory Zingone, Analyst

I'm stepping in from Mark this morning. Could we start with additional details on that one CRE multi-family relationship? Metrics like debt service coverage, LTV, size, and geography would be appreciated.

Mark DeFazio, CEO

The geographies are Champaign, Illinois and a city in Ohio. These are basically vacant buildings that were going to be renovated and then stabilized. It's a complicated story around the situation of why the renovations didn't get done and why the properties didn't get stabilized. But we're at a point now where we are working through a restructuring with the client and cautiously optimistic that a material part of this specific reserve will be reversed in either the fourth quarter or the first quarter of next year.

Gregory Zingone, Analyst

Awesome. Thanks. If there's any more detail you could provide on the $5.2 million provisioning. I know you said it was forecasting-related to the CECL model. But is there any more detail you could share with us?

Dan Dougherty, CFO

That's really just a feature of the CECL process, Greg. We rely on a third-party vendor to provide the reasonable and supportable forecast for macroeconomic variables, Moody's, who we use. And as it turns out, Mark Zandi's forecast was a little negative on the CRE price index, and our model is highly levered to that index. And so it's not aligned generally with our specific concerns, but those macroeconomic variables as forecasted by Moody's drive the result. So $5.2 million, probably $3.5 million of that is related to the macroeconomic variable forecast deterioration, and then the other part is growth.

Gregory Zingone, Analyst

And one more question for me. What's the bank's policy on insider selling prior to earnings releases?

Mark DeFazio, CEO

Well, obviously, when you're in a blackout period, it goes without saying you can't sell, and the comment that you guys made last night in your flash note, you would have noticed that the insider trading from officers are under a 10b5-1 agreement. So they've been in place for some time. So nobody does insider trading here, and nobody would violate a blackout period.

Dan Dougherty, CFO

Let me further that. You may have noticed that we shifted our reporting date by a week, so the 10b5-1 plans are set up to trade on the 20th. We shifted our reporting date for a couple of reasons. One was the Columbus Day holiday, but the bigger reason was that my financial reporting team is very much involved in the ongoing digital project and our loan servicing system dress rehearsal was last weekend. So they've been putting in a tremendous amount of work to support that process. And as such, we thought it was reasonable to shift our reporting date by a week. And that's why the trade date was before the earnings release. But again, all insiders that are selling stock are subject to 10b5-1 plans or blackout periods as required by the SEC.

Operator, Operator

Our next question comes from Feddie Strickland with Hovde.

Feddie Strickland, Analyst

It's great to hear when I see a recovery on that new NTA. I was just wondering if you could provide a little more color on how many other CRE loans or what percentage of the book is out of market today?

Dan Dougherty, CFO

We're going to have to dig for that one, Feddie...

Mark DeFazio, CEO

Hold on a second, Feddie. In our investor deck...

Dan Dougherty, CFO

I can confirm that we have no additional concerns related to CRE beyond what was shared in the third quarter. Currently, we are focused on obtaining that information.

Feddie Strickland, Analyst

Actually, I think I found it.

Mark DeFazio, CEO

Yes. Feddie, Page 14 of the investor deck, you'll see a whole slide there. So 19% is in Manhattan. So if you look at a couple of the other borrowers, a good percentage of the portfolio is outside of the New York City area. If you go to Page 14 of the investor deck.

Feddie Strickland, Analyst

Are those relationships the same borrowers you know and work with in New York, but now they are undertaking projects in other parts of the country?

Mark DeFazio, CEO

Generally, that is always the case. We have seen emerging markets over the last couple of decades, and we have tracked New York owners and operators of not only commercial real estate but also commercial businesses and healthcare as they expand their franchises beyond the New York area. You will not find MCB trying to compete in areas like Main and Main. We typically follow strong sponsors who can grow outside of their original markets.

Feddie Strickland, Analyst

Got it. Appreciate that. And just switching gears to deposits. It looks like you had pretty strong growth across pretty much all the verticals aside from retail. As we look forward there, can you talk about where you see the most opportunity? Is it still that kind of EB-5 title and escrow bucket? Or is it elsewhere?

Mark DeFazio, CEO

I think it's spread fairly evenly. That's how we approach it. And that's one of the value propositions of continuing to be a core-funded institution. We have so many different deposit verticals. We don't have to rely on any one of them to drive 10%, 15%, or even 20% balance sheet growth. So we're very fortunate to be able to spread that challenge out throughout all of these categories. And we're working on a number of other opportunities that we'll talk more about in early '26. So we expect all of them to continue to contribute.

Feddie Strickland, Analyst

Got it. And then just on the digital transformation side, I appreciate the color and what your expectations are there. Given that you expect it to wrap up in the first quarter of '26, should we expect a little bit of a ramp in digital transformation expenses in the first quarter, just given I think you still have about $11 million or so left in the budget. And I think you said there's about $3 million coming next quarter.

Dan Dougherty, CFO

Yes, you are correct, approximately $3 million in the fourth quarter. There will be a slight impact in the first quarter, but we are currently managing that figure and will provide more details when we release the fourth quarter results. To summarize, it's going to be less than $2 million, likely significantly below that amount.

Operator, Operator

Our next question comes from David Konrad with KBW.

David Konrad, Analyst

Just a follow-up question on the credit here. Maybe I missed this, but what was the size of the credit? I know CRE NPAs went up around $41 million quarter-over-quarter. Is that a good proxy for what this is?

Mark DeFazio, CEO

There were three loans in particular. One was around $8 million, one was around $17 million, and I believe the total was around $34 million.

Dan Dougherty, CFO

$34 million...

David Konrad, Analyst

Okay. So then, I mean, the allocated reserve is about 55% of that exposure, so pretty healthy provision.

Mark DeFazio, CEO

Very conservative.

David Konrad, Analyst

Can you provide more details on the trends regarding criticized and classified assets or past dues, particularly outside of this relationship related to asset quality?

Dan Dougherty, CFO

Yes. If you look at this specific credit migration regarding out-of-state multifamily, there are no other significant movements in credit within our portfolio. It remains very stable from one quarter to the next.

David Konrad, Analyst

So, it seems that my final question is whether this credit will impact any of your short-term growth strategies or anything like that?

Mark DeFazio, CEO

No. This is an outlier that we'll work through, but we just felt it was prudent to take this specific reserve. Remember, it's not a charge-off; this is a specific reserve this quarter, right?

Dan Dougherty, CFO

There is no impact on our future lending. As I mentioned, the fourth quarter is looking promising. We are set to continue our growth through the year-end. We conducted checks in the pipeline, and the first quarter of next year is also looking very strong.

Operator, Operator

And we do have a follow-up from Feddie Strickland with Hovde.

Feddie Strickland, Analyst

Just one more follow-up as we consider the year-end margin guidance. I appreciate the information on your interest rate sensitivity and the possibility of multiple cuts next year. Is it realistic to expect the margin to approach 4% in 2026 if we see several cuts? Do you think that's a possibility?

Dan Dougherty, CFO

Very much so, Feddie. Very much so. Yes. We continue to be liability sensitive slightly, modestly. My forecasting, yes, we here is 4% when I look at that. And I'm a bit less aggressive than the market in the outlook for cuts. But when we model in one this quarter and three next year, yes, indeed, we can get very close or above 4%.

Mark DeFazio, CEO

And Feddie, that's the base case. We're working hard here to replace GPG. As you know, we exited that business last year. And we're working on other deposit opportunities that will drive lower cost of funds, which we're trying to control margin expansion and not relying on the Fed exclusively. So we're expecting to see some expansion by our own efforts, not just through the Fed.

Operator, Operator

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, CEO

Just like to say thank you for taking the time out this morning and your continued support of MCB. Thank you. Have a nice day.

Operator, Operator

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.