Metropolitan Bank Holding Corp.

Welcome to the Metropolitan Commercial Bank's third quarter 2022 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 touchtone phone. 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 need 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 risks and uncertainties that may cause actual results to differ materially. Please refer to the company's notices regarding forward-looking statements and non-GAAP measures that appear in the earnings release. It is now my pleasure to turn the floor over to Mark DeFazio, President and Chief Executive Officer. You may begin.

Thank you, Katie. And good morning and welcome to MCB's third quarter earnings call. I am pleased with MCB's strong and sustained performance as evidenced by a 17.1% return on average tangible common equity in this quarter, powered by the strength of our sustained loan growth and min expansion. Amid a backdrop of raising interest rates and increasing economic uncertainty, the MCB team has remained engaged with our clients, and that commitment shows in our financial performance. We set out over 23 years ago to build a branch-like commercial bank. In doing so, managing the funding side of our balance sheet by adding optionality has been a cornerstone of successful net interest margin management. Fast forward, MCB remains focused on the management and the development of a diversified, lower cost funding base while looking out two years or more to expand our funding strategies to support the balance sheet growth we have seen over the past 20 years the third quarter was no exception we saw total deposit growth apart from expected crypto related deposit outflows as we were able to source lower cost deposits that will more than offset outflows from depositors seeking treasury rates or looking to substantially reprice existing arrangements. This highlights the pricing discipline that underpins our margin management. Margin management is reflected in our ability to drive top line growth in net interest income with high quality loan growth funded by lower cost and scalable deposit verticals. We have had success moving our new loan production yields up during this unprecedented rate environment, along with raising floor rates that will provide net interest margin and net interest income protection when rates reverse. I would like to spend a moment on our global payments business. As a reminder, we provide basic retail banking services to our digital currency clients. which we often refer to as being crypto-related businesses. For sake of absolute clarity, the services we provide do not include custody or lending against any digital assets, nor are we involved in any stablecoin issuances. Further, as many of you have heard me say, we have not onboarded a new digital currency client since 2019. Revenues from this sector currently represents roughly 2% of NCB's total revenues or 13% of our total deposits. We remain strategically focused on spending our banking as a service offerings to fintechs who are well positioned to continue taking retail market share from banks of all sizes. I am pleased to report that banking as a service revenues of 2.5 million in the third quarter are up 21% over the prior year quarter. Our ability to scale banking as a service related deposits over time is clearly a differentiator for us as well. Now turning to a few third quarter highlights as compared to the prior year. Total loans were up $1 billion or 28%. Total deposits were up $274 million or 5%, including DDAs, which were up $254 million or 9%. Net interest income of $63.3 million was up 55%. Return on average assets was 1.51% as compared to 109 a year ago. As mentioned, return on average tangible common equity was 17.1% in the quarter, and our efficiency ratio improved to 45.1% from 47.1%. I will now turn it over to Greg for more comments. Thank you, Mark, and good morning, everyone. We reported strong third quarter net income of $25 million, or $2.23 of fully diluted earnings per share. Loan growth and NIM expansion led net interest income higher in the third quarter, with NII increasing 15% to $63.3 million as compared to the prior quarter. Let me take you through a few of the key drivers this quarter. Commercial bank performance remained strong, with net loan growth of $242.1 million, or 5.5%, bringing year-to-date net loan growth of 23.7%. Though down from a record second quarter, loan originations remained strong at $424 million, bringing total originations for the first nine months of 2022 to $1.4 billion. Credit quality remains pristine, with no charge-offs to date and non-performing loans effectively at zero. The provision in the quarter was in line with loan growth. As expected, crypto-related deposits were down $486 million, led by the effort to promptly return funds to Voyager customers once approved by the bankruptcy court. This was our second consecutive quarter of measurable inflows of retail deposits, including those with loan customers, with an increase of $151 million in the third quarter. Credit goes to our retail and commercial lending teams for the sustained client engagement. We also saw strong inflows of $162 million related to our FinTech Banking of the Service clients. The inflows I mentioned more than offset the expected outflows from deposit categories seeking higher yields, which is consistent with our disciplined approach to deposit pricing and margin management. Non-interest-bearing deposits remained robust at 53% of total deposits. Net interest margin was up 58 basis points in the quarter to 3.85%. Asset yields benefited from rising rates as well as deployment of liquidity into loans, with interest-earning asset yields increasing 76 basis points to 4.26%. Importantly, the total cost of funds increased a modest 20 basis points while remaining low at 45 basis points given our patience and ability to hold deposit betas low to this point in the cycle. We do expect to see NIM expansion into next year on the strength of our pricing discipline on both sides of the balance sheet and given the funding options available to us. While being mindful of the current interest rate forecast, we are looking further down the field to position for an eventual decline in rates. We have increased asset duration gradually over the past several quarters. For securities, duration has naturally extended with rising rates. For loans, we have taken on a bit more duration, which is evidenced by a modest decline in the floating rate portion of the portfolio to 41% at September 30th as compared to 44% to begin the quarter. This also shows in our net interest income sensitivity modeling, which has come in a bit this quarter, particularly in the rates down scenarios highlighted in our IR deck. We've had continued success in moving floors up on new origination floating rate loans, where the majority of loans are subject to floors. These structural benefits are important elements of our margin management, which provides stability as rates continue to move up and will provide a significant level of NIM protection when the rates inevitably begin to move back down. GPG revenues were down 1.1 million quarter-over-quarter, given the expected decline in crypto-related GPR card volumes. Partially offsetting this decline were fintech banking-as-a-service revenues, which were up 312,000, or 14%, in the quarter, on an 11% increase in related transaction volumes. Overall, expenses continue to be well managed as we are building for scale with a focus on generating near-term returns on the investments we make. This has been clearly evident in human capital, where compensation and benefits has continued to scale along with MCV's growth and profitability, reflecting the continued investments being made, particularly in control and infrastructure functions. Apart from our core run rate, professional fees did increase in the quarter. The primary driver was legal fees, which were elevated by approximately $4 million, with outside counsel engagement focused on Voyager's bankruptcy proceedings as well as other matters. We do expect legal fees to moderate back to historic levels as we move through the fourth quarter with our expected first quarter run rate for legal fees in line with historic trends. 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 discrete items recognized in the first quarter. Our capital levels remain strong, with all capital ratios significantly above well-capitalized levels. And I will now turn the call back to our operator for Q&A.

Thank you. The floor is now open for questions. At this time, if you would like to ask a question or comment, please press star 1 on your telephone keypad. If at any point your question has been answered, you may remove yourself from the queue by pressing star 2. Again, we do ask that while you pose your questions, that you please pick up your handset to provide optimal sound quality. We will pause for just a moment to allow questions to queue. Thank you. Our first question will come from Chris O'Connell with KBW. Your line is now open.

Good morning. Good morning, Chris. Good morning, Chris. So just wanted to start out with the legal or professional fees being elevated and see if you guys give any additional color around the issue or how you think the trajectory will be between now and 1-2-23. As Greg mentioned, this is Mark DeFazio. As Greg mentioned, we think the legal fees will start to normalize through the fourth quarter, and we hopefully will be behind it starting in the first quarter of that in 23. Voyager? as everyone knows, was a bankruptcy, so we had to represent ourselves there. And we also have one other matter that is a 2020 matter, which we're working through as well. So we expect these two matters hopefully will be behind us by the end of this year, and we'll be back to normal trends as it relates to professional fees. Okay, got it. And then... Just on the rest of the expenses, there's a disclosure around, you know, locking in some games that will help offset licensing fees going forward. Any idea, you know, given that offset, you know, where those licensing fees trend in the fourth quarter given, you know, the recent rate hikes? Yeah, there's only a portion of that line which is licensing fees that's subject to any sort of rate variability, and we've substantially hedged that rate risk out. with the interest rate cap that we disclosed, Chris. So I think what you're really going to see in the fourth quarter should largely be in line with third quarter. That rate cap, you know, the $12.7 million we referenced in the earnings release, you know, that will come in to P&L in that line over the remaining balance of the hedge period, which I think was in that 28- to 30-month period. It's probably down to closer to 25 months at this point in time. So we will see some continued protection from that as it comes into income. Okay, great. And then on the, on the loan growth side of, you know, the balance sheet, obviously, another, you know, strong quarter of growth, just any update on, you know, what you're hearing from, you know, your customers, as far as demand, and then, you know, any areas that you're, you know, more aggressive on or pulling back on at this point in the cycle? No, we're very fortunate as a commercial bank and as you see the level of diversification we have in our loan portfolio, our clients are very active in this market looking for opportunities. And, you know, we're not pulling back on any asset class at the moment, and we're just a bit more careful in certain decisions we make regarding certain asset classes. But, no, we see very little headwinds ahead of us, and looking forward to continuing to support our commercial clients. Okay, great. And any pushback on, you know, the – you know, the substantial, you know, change in, you know, origination rates over the past couple quarters given, you know, the upward move in rates and any pushback on that or the raising of the floors? I wouldn't call it pushback. I mean, obviously, there's a conversation. But one of the things I think we benefit from, again, being a commercial bank and having significant optionality or diversification on the commercial loan side. Now our clients are very high net worth individuals and we're assisting them in generating significant internal rate of returns on their investments. So they acknowledge that, you know, funding costs are going up and therefore loan yields have to rise. And, you know, someone told me once, it's not a cost of money, it's a cost of not having it. So they still see our funding as very strategic. and their ability to generate generational wealth. So, yes, there's a discussion about it, but I wouldn't suggest in any way it's a headwind. Great. And then I may have missed it, but I know in the past you guys have assumed roughly like a 70% beta in the interest rate sensitivity tables. I mean, any change as you've seen, you know, the magnitude and the pace of rate hikes and And, you know, what you guys have seen, you know, in 3Q and then, you know, conversations so far in 4Q as to, you know, when you get to that beta over the course of the cycle. And yeah, I guess like what you're seeing in the near term in terms of betas on the deposit side. Yeah, just first to confirm, for interest-bearing deposits, we do run our NII sensitivities with a 70% beta. Early in the cycle, we talked about how that might be a bit conservative. To this point, our betas have remained low. I think trying to triangulate when we hit the 70%, though, Chris, it's more to us an issue of we do have not only funding options on the table right now, but a pretty robust pipeline of deposit opportunities we're looking at. I still think we're going to stay inside of that, what I still think is a fairly conservative 70% beta. Because, again, to Mark's point, I think it's a key theme this quarter. It's just the optionality we have as we kind of think about managing the balance sheet and the margin. Got it. So, I mean, based on, you know, your commentary, I mean, it's safe to assume at least for the next couple quarters, you know, you know, fairly positive, you know, NIM trends going forward still. Yeah, and to play it back another way, I mean, even if that deposit bait on interest-bearing deposits does, you know, trend into the 50 to 60-year slightly higher range, I still think we're going to continue to see some uplift on them, just again, given our disciplines and, you know, what we're able to do on the asset side of the sheet as well, combined with just our overall deposit pricing initiatives. Great. And last one for me, just any update you can give on where you think the, you know, $1.6 million of GPG fees, you know, related to digital currency business and the 762 remaining of the digital currency related deposits, you know, trends that you've seen so far in 4Q, or kind of the outlook that you see on that in the near term? As it relates to the crypto deposits, I think we're a bit stable at this point. We're seeing a bit pick up in crypto-related transactions, but we play such a small role in that space in any event. So the transaction volumes, therefore, the revenues generated from it won't be significant either way, up or down. And on the deposit side, I think they're a bit stable. Our volatility last quarter came from Voyager, which is obviously a bankruptcy, so that speaks for itself. But GPG, excluding crypto, we continue to see expansion there. We see our banking as a service business continuing to grow. Remember, that business is a retail business. It's a retail digital bank within a commercial bank. So it's in a marathon. It takes a lot of time. Client acquisition takes a bit of time, but once you have those clients, they're here for a while. So we expect to see a continued steady increase in our banking as a service business for the foreseeable future. Great. That's all I had. Appreciate the time. Thank you.

Thank you. Our next question will come from Alex Lau with JP Morgan. Your line is now open.

Hi, good morning, Mark and Greg.

Hey, Alex. Good morning. Morning, Alex.

In the past, you've talked about growing loans in that mid-teens range. Are you feeling confident continuing in this historical loan growth range given a more challenging deposit environment?

You know, I look at it, you know, the answer is obviously yes. You know, we take, we manage our capital really efficiently here, and we take it very serious. Capital is precious to us, so we're not going to grow for the sake of growing. And if market conditions are such where it puts the kind of nim compression, that is not going to generate the kind of top line revenue that we expect to achieve, perhaps we would do less lending. We haven't seen that headwind yet. We're expecting, as I mentioned earlier, our clients are very active in this market. We are in many different markets and we have a lot of optionality on the lending side. So we will be in control of that. But we are very conscious of our capital and preserving it and making sure we get the right operating leverage for generating returns. So we'll have to see. And of course, credit discipline. And with market conditions as such, we're talking about margin. If market conditions somewhat change where it puts a bit of a concern on asset quality, of course, we'll be able to roll that back. You know, we're very opportunistic here. We don't have a talk of achieving a certain rate of growth. We're all about earnings.

That's helpful. On the deposit side, outside of the crypto-related balances, there's some good growth in the fintech deposits. Can you talk about what drove this growth in the quarter, what the cost is on these types of deposits? And in terms of just what you're seeing in the pipeline, how confident are you in growing these deposits in the near term?

We're confident. We see a direct correlation between onboarding and integrating with new fintech companies. They're executing on their business strategy in the form of the client acquisition strategy. So we're seeing the benefit of their growth. And we're sharing that. So we expect deposits to continue to grow. We expect to onboard new fintech companies at a pace that we can manage the risk because that's the cornerstone of this business is managing the operational risk. And we expect it to continue. The consumers are continuing to move more and more to a digital platform.

and the traditional banks are just not you know filling that void and fintech companies are and they need a banking as a service provider like mcb to do that thank you and on the property manager and bankruptcy trustee deposits they continue to decline another quarter can you walk through what is driving this and do you expect these balances to continue declining or have we hit a floor

It's hard to say that we've hit a floor. And again, fortunately, we have optionality. So we were able to more than outpace those outflows. In those two cases, you had, you know, we were competing with much higher yields. And I think in a couple of cases, the clients were really looking to achieve more of a treasury rate return. And we're just not going to pay up for the deposits. Unfortunately, we have the optionality to manage our margin, and we're still very engaged with these clients. We expect to do more business with those clients. But, you know, they have goals that they set out for themselves, and we have discipline around managing our cost of funds. So, fortunately, we have the optionality around our balance sheet that provides us the ability to say no.

Thank you. And then on to crypto deposits. Just to clarify on the $486 million outflow, how much of that was from Voyager and what was the rest from?

It was around 70% was Voyager, to be candid. And the rest, I would characterize as normal flows in the crypto space.

Thank you. And just a side question. At what point would you be comfortable using a portion of those crypto-related deposits to fund loans or securities groups?

You know, it's there. We have a 50% beta against those deposits already. The ones that we do have on our balance sheet are fairly stable. So to the extent that they become useful and less costly than other options, we would consider it. But right now there is volatility still in the crypto space, and we've been able to drive low-cost funds elsewhere. So it's just another arrow in our quiver to the extent – we feel comfortable enough with relying on those deposits to be around to fund longer-term earning assets. I agree with Mark. I think those deposits are getting closer and closer to being fungible along with the rest of the deposits, although there's still some hesitation. We have the optionality on the rest of the deposit verticals. We have the other strategies we're working on. And I think the other side of it is we continue to just, from an overall contingency funding plan perspective, just to increase our options there. You might have seen our FHLB capacity picked up as well. You add it all together, I think we're getting closer, you know, a little bit more comfortable. But, you know, we have options, and I think that's the important part.

Thanks. And on the deposit environment, can you just comment on what you're seeing on the deposit competition front, how much pressure you're seeing on the money market and savings deposit costs, and what are the spot rates on those deposits, I think?

Yeah, I think as we move to this rate environment, you've heard it from every other bank that's reported, Alex. I mean, I think there's definitely competition out there. I think for a lot of folks, you're starting to figure out, you know, anyone that wants to be indexed who – you know, we have the deposit pricing index is probably, there's some sensitivity, I think, in everyone's book. So we're seeing it. I think in the money market side, keep in mind, we have a lot of, you know, longer term relationships that are also tied in with lending relationships. So, you know, in a lot of the cases, we're pricing both sides of the sheet. That's why I give a credit to a lot, you know, our retail and our commercial banking teams for just the you know, the steady engagement with the clients on it. Spot rates, I know you've probably seen some of the spot rates out there around 150 or so. That's what we're kind of seeing on new money, and I think some of the competition rates. But again, we've stayed focused on the conversations with our clients and continuing to drive, you know, the margin management that we're known for.

Thanks. And then on GPG fee income, you touched on this a little bit, but just to clarify, the GPG revenue is down a million. Do you expect more crypto-related headwinds from here, or is the fintech fee income side enough to grow this overall line from here?

I think it's hard to predict what's going to happen to the GPG, I mean, to the crypto side. I mean, if... you know, crypto winner continues for a period of time, we're not going to be completely de-shackled from what happens in the broader, you know, crypto space. But to Mark's earlier comment, we're still a very small part, you know, player in that space. So you probably see some correlation to what goes on with broader trends there. I think for us, though, you know, our banking as a service, retail, fintech partners are are really starting to hit their stride. I think that's the part of that business that we continue to look to. And, you know, we're starting to see the uplift now that we knew was going to start happening. So I think, you know, we'll have completely replaced the crypto in the near term. My crystal ball is broken, but we are very excited about what we see as a continuing trend there.

Thank you. And last question from me on credit. Credit metrics were strong again this quarter. Can you just talk about where you're keeping an eye the closest in terms of asset class and markets as we head into a potential recession? Thanks.

You know, Alex, we were concerned about various asset classes even before the pandemic. Retail was under pressure. Hospitality was already under pressure. Coming through the pandemic, hospitality is recovering very nicely. We see weaknesses still in retail and some segments of retail. We're just more careful than we are conservative, and we're fairly diversified, and we understand the industries and the markets that we're in very well. I think we have the best lending teams and credit analysts anywhere in New York today. I put them up against anybody of any size bank. And, you know, after 23 years of having, you know, virtually no losses and having the kind of balance sheet growth we continue to have, I think being more careful than conservative has played well for us. And we're dealing with very sophisticated clients who are in the long game. They're not looking for quick profits. They're looking to build generational wealth. So they approach deals fairly carefully as well. Some asset classes that we do like quite a bit, obviously, is healthcare. That continues to serve us well. But across the portfolio, you know, the performance speaks for itself. So we're very fortunate, again, to have that kind of optionality.

Thank you. That's it for me.

Thank you. To ask additional comments or questions, please press star 1 at this time. Again, that is star 1 if you would like to ask a question. Seeing no further questions, this does conclude the allotted time for questions. I will now turn the call back over to Mark DeFazio for any additional or closing remarks.

I just would like to end by saying thank you again to the shareholders who are hanging in there with us. I know it's a very difficult time out there in the market, and we're working really hard for you, and we appreciate your support. Thank you very much.

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 lines at this time and have a wonderful day.