Metropolitan Bank Holding Corp.

to Metropolitan Commercial Bank's Third Quarter 2023 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. If you would like to ask a question at that time, please press star one on your telephone keypad. If at any point your question has been answered, you may remove yourself from the queue by pressing star two. We ask that you please pick up your handset to allow optimal sound quality. Lastly, if you should require operator assistance, please press star zero. During today's presentation, reference will be made to the company's earnings release and investor presentation, copies of which are available at mcbankny.com. Today's presentation may include forward-looking statements that are subject to risk and uncertainties that may cause actual results to differ materially. Please refer to the company's notices regarding forward-looking statements and non-GAP 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, Shelby, and good morning. And thank you all for joining our third quarter earnings call. I will be brief today, because I'd like to leave more time for Q&A. To get started, I am pleased with MCB's third quarter and -to-date results. To say the last nine months have been challenging is an understatement. However, as you can see, MCB has been able to navigate through these challenging times, primarily because we were as prepared as we can be for them. Along with our ability to grow alongside of these challenges, -to-date, we have experienced reasonable balance sheet growth, funded by new core deposits, while maintaining our underwriting and pricing disciplines. All deposit verticals contributed to our growth in liquidity, as well as early contributions from our latest initiatives in 1031, Title and EB-5 lines. Excess liquidity this quarter also allowed us to pay down our federal home loan bank borrowings, which were used specifically to off-ramp our previous on-balance sheet crypto deposits. We are confident we will see further reductions of these borrowings over the coming quarters. We are also confident that each of our deposit verticals will continue to set us aside from others, and maintain MCB as a core funded institution. We are working on a number of other deposit and fee income initiatives, which we will start discussing in the coming months, and are confident they will all add to our liquidity arsenal, which will not only stave off margin compression, but will start to expand it. Finally, as many of you may have seen online last night, we issued a press release related to the settlement with the Federal Reserve and the New York State Department of Financial Services pertaining to a matter from March, 2020. The amount of the fine has been fully reserved for, and enhancements to our processes and procedures have been well on the way for some time. I will now turn the call over to Greg for more detail.

Thank you, Mark, and good morning, everyone. We are pleased to report strong third quarter net income of $22.1 million and fully diluted EPS of $1.97. Despite a challenging operating environment for banks, net interest income remains steady at $53.6 million. Significant expansion in total interest income was driven both by strong loan growth through the first nine months of the year, as well as the impact of two rate increases since May of 2023. While funding costs have largely offset this increase in the quarter, we were able to substantially pay down borrowings late in the quarter and remain confident in our ability to drive lower cost deposits through 2024 and beyond. MCB saw deposit growth across all verticals as Mark had mentioned, with total deposit verticals increasing $291 million for nearly 6%, despite the challenges of an evolving rate environment and its influence on customers. Net inflows were particularly strong for retail deposits, including those with loan customers, which collectively were up $188 million, reflecting growth from both existing and new customers. We did see outflows of $58 million representing the return of remaining corporate and reserve deposits with former crypto clients. For additional caller, net of those outflows, non-interest bearing deposits increased in the quarter by $75 million, or just over 4%. We had a very strong quarter for lending with net loan growth of $205 million, or 4%, on $333 million of loan production. Bigger picture, -to-date net loan growth of $514 million has been fully funded by $738 million of net inflows from our deposit verticals. The excess liquidity in the quarter has been used to reduce borrowings. New loan production came in at an average yield of .7% versus a second quarter portfolio yield of 6.54%, which showcases MCB's pricing discipline and the resilience of the lending franchise. There was 17 basis points of net interest margin compression in the quarter, primarily as a result of liability's pricing repricing more quickly than assets in the short run. There are several factors that give comfort that we are at or very near the inflection point for them, assuming of course a stable rate environment. Loan pricing discipline has been maintained, which is evident in our new production yields. We do expect to see the continued repricing of the loan book, which is a relatively short duration book. Borrowings have been substantially paid down, and while that is apparent in the spot balance sheets, the average balance sheet for the third quarter shows we have incurred interest expense on a much higher average balance for borrowed funds. We do expect to see the benefit of those reduced borrowings to benefit NIMM and more importantly P&L as we move forward. We entered the year with $250 million in borrowings, and as we've said for the past few quarters, we do expect to reduce borrowings close to this level by year end. We did see an opportunity late in the third quarter to lock in funding cost on $300 million of FHLB borrowings using a pay fixed swap at an average rate of approximately 5%, versus the third quarter average borrowing rate of 5.66%. That benefit will start to come into NIMM and P&L in the fourth quarter. The goal would be to exit 2023 with only the $300 million of hedged FHLB borrowings remaining on the balance sheet. And as Mark has already mentioned, we expect MCB's newest deposit verticals to provide a funding advantage well into the future. Touching briefly on credit, asset quality remains strong. Strong loan growth drove credit provisioning in the quarter, which was partially offset by improvement in the economic forecast underlying our CSO model. Total non-interest income was down approximately $1.3 million from the prior linked quarter, due largely to the exit from crypto. We were particularly pleased, however, to see corporate disbursement client revenues continue to scale, with revenues up 22% from the prior linked quarter, and up 104% from the prior year quarter. Non-interest expense in the quarter did benefit from the settlement reserve related release of $3 million. Legal fees came down substantially from the prior quarter, but remained elevated by roughly $600,000, which we would expect to drop out of the run rate prospectively. Lastly, the increase in competent benefits reflects our continued investment in human capital. This includes the increase in FTEs during 2023, many of whom were onboarded in the second and third quarters and is in line with increased profitability. There was a discrete tax benefit of approximately $1.8 million in the quarter from the conversion of stock awards. Going forward, we would expect the effective tax rate to be in the range of 31 to 32% excluding discrete items. And I will now turn the call back to Shelby for Q&A.

Thank you. The floor is now open for questions. At this time, if you have a question or a comment, please press star one on your telephone keypad. If at any point your question has been answered, you may remove yourself from the queue by pressing star two. Again, we do ask that while you pose your question that you pick up your handset to provide optimal sound quality. We'll take our first question from Nick Couture with Hosa Group. Your line is open.

Good morning, everyone. Morning, Nick. I wanted to start on the expense front. Nice to see a material reduction in the professional fees this quarter. Given the resolution of the regulatory issues, is it your expectation that this line continues to normalize? I heard that 600,000 you expect to drop out in the fourth quarter, but is there more to come in the near term there?

I wouldn't expect any upward movement on the professional fee line, Nick, in the next couple of quarters, particularly from a core perspective. I think legal expense will settle out largely in the fourth quarter, but maybe into the first quarter, just given some timing. Given the announcement yesterday, I think you'd still expect to see some in the quarter. Longer term though, we've talked for many quarters and many years now about investments we make in the business. And that's not just human capital, which I mentioned in my preparatory remarks, but also investments in technology and our digital strategies. So we did announce the Fensley partnership earlier this week. So I think these people have seen that. There's over the last several quarters been some spend in that line related to our digital initiatives. I think you're going to continue to see that. And as we get through the budget process and Mark and team have a chance to finalize the plans around, I think you'll get more guidance in the first quarter, in January, I should say, around what that looks like. And again, that's non-core to me. But, and I think where you're kind of probably going with this is what should you expect from a core run rate perspective on expenses? And I think we've been pretty consistent as we've talked over the last couple of years, we can really drive core efficiency ratio in the 40s. Right now, if you did look at it on a core basis and stripped out legal fees in particular, and some of the technology spend, I think you'd see it's in the high 40s. And I think the expectation would be to continue driving that lower as we go through time. And the investments we're making in this quarter, particularly in people, it helps to do that. There's client facing people in those numbers and the team's working hard. And as we've seen over the last couple of years, we typically see a pretty quick return on those types of investments. Probably more than you asked for in the question, Nick, but I thought I'd give it to you all at once.

No, that's great color. I appreciate it. I know we're in the early innings and you touched on it briefly in your opening remarks, but could you update us on your newest deposit verticals, 1031, TIDAL, EB5, et cetera?

They're well on their way. The infrastructure setting those two, specifically with 1031, we can start with that. There are two or three actually technologies that we have to integrate in order to be very competitive in that space and we're well on our way. We have our IT team working with our 1031 team in implementing these new technologies. So we would expect, we didn't expect much out of 1031 or EB5 in 2023. These were 2024 big initiatives for us. So we'll be fully prepared and fully in the market for 1031 and TIDAL in 24 early January. And EB5 also, there's a lot that goes behind it. It's a complicated business from a documentation perspective, policies, procedures and getting out into the marketplace. So they're fully stood up. And so we expect it to have a good run rate in 2024 and beyond.

Fantastic and then loan growth was strong again this quarter. Are pipelines at similar levels relative to the previous quarter?

Yeah, I would say so, yes. Yeah, pipeline remains robust.

Fantastic, thank you for taking my questions.

Nick, thank you and thanks for joining.

And we'll take our next question from Chris O'Connell with KBW. Your line is open.

Hey, yeah, good morning. Morning,

Chris.

So wanted to follow up on that last question there regarding loan growth and overall balance sheet growth. It sounds like pipelines on the deposit side and the loan side remain full. Do you expect going forward on the deposit side that there's any kind of remaining core -interest-sparing deposit mix shift remaining or that the growth from these new deposit verticals can offset any kind of related mix shift on a go-forward basis?

Well, in the quarter, Chris, we're really pleased to see in the quarter the existing verticals all contributed. That was largely with a lot of existing clients. It was also new clients, strictly in retail and with our lending clients. Importantly though, we're really focused on the mix. The mix I'm thinking I'm focused on the most is that DDA versus interest-sparing mix. And with the 75 million of DDA growth in the quarter, that's a direct reflection of how hard the teams are working. They get it and they're really focused on working with our clients and bringing in the operating accounts. So I think looking ahead, I really think that the mix is gonna be pretty consistent. I would expect to see all deposit verticals continuing to contribute. The teams are working really hard. I'd like to see that DDA mix of existing verticals continue to scale as well. And then the new verticals, EB5 and Tile and Escrow 1031, that to me, that's a long runway for those just to continue to scale and scope. And I mean, they contributed this quarter, they've contributed for the last two quarters actually, they're gonna continue to contribute for quarter and beyond, but you're really gonna see those verticals scale in the latter half of next year. And that to me is just the real exciting part here in terms of what you're gonna see from a mix shift perspective that's gonna impact that cost of funds over time.

Yeah, and for the new verticals and the deposit production coming on there, any sense you've in general terms, what the blended costs of the new deposit pipelines are coming on that?

Yeah, I mean, as you know, we're not gonna talk about pricing and specific protocols, except I would say for EB5 in particular, it's certainly on a blended basis inside of our current total cost of deposits. So that's gonna give you some comfort that as we continue to put on new production yield loans, which frankly right now are over 9%, what we see in the pipeline, you're gonna see healthy loan yields coming on, the asset side repricing, but you're gonna see those newer deposits starting to come in inside of our current funding base and that's a good place to be.

Yeah, I guess said another way, I mean, it's just bearing deposit costs are at, now at 410, how much higher do you think that those will go over the next two or three quarters?

My crystal ball is broken, Chris. I mean, I think you're still gonna see, I think you've already largely seen the pull through effect of rate impacts to this point. You might see a little bit more impact in the third, in the fourth quarter in October potentially, but I would actually expect to see that number starting to hold steady, particularly if you think we're through the rate hike cycle, right? We are liability sensitive, state that as it is, but over the next two quarters, assuming that rate hikes kind of settle out, I think we're pretty close to the high end of that number.

Got it. And just given that outlook and some of the borrowing dynamics that you discussed in the prepared remarks, how do you see the NIM progressing near term into the fourth quarter and over the next several quarters, if the rate environment kind of remains steady?

Yeah, I really truly feel we might have seen the inflection point in the third quarter on NIM, Chris. I think that's gonna go back to kind of your embedded last question, which is, is there any upward pressure on the existing interest bearing deposit side? I'm not seeing it right now. I would expect us frankly, to start that inflection point, if not already then into the fourth quarter, you might see some modest uplift in the fourth quarter in NIM, but by the time we get into the first quarter next year, again, combination of a more stable rate environment and the connotation that would have on our funding costs combined with just the ability to continue to reprice the asset side, you'll start to see that uplift, certainly by the first quarter at the latest.

Got it. And on the GPG pipeline, I know you guys announced that partnership and have some things that you'll have to update us on as we get into 2024, but how do you see the GPG fees trending into the fourth quarter? Should we expect those to be up on a -by-quarter basis?

I would still expect to see GPG revenues trending as they have historically, Chris. If you call that 15%, 20%, whatever range you're looking at historically, I'm not seeing anything that would say otherwise. I mean, we're obviously still continuing to focus on the quality clients we want to have in the portfolio there. And I think, as you know though, anybody we onboard now, it's really, you're not gonna see any substantial revenue generation, fee generation for at least 12 to 18 months. It takes some time to get them to the portfolio. And I think that's a good place to start. I mean, we're still in the process and ramped up, but just with the existing portfolio clients we've got, you're starting to see, I call that on my prepared remarks, the corporate disbursement clients, you're starting to see some of those partners really hit their stride and as they're building out their client base, it's filtering through. But I would say, continue to look at the historic run rate. I think that's a good place to start.

Got it. And then just lastly, on the consent order and the impact going forward, now obviously the actual monetary penalty came in below expectations. Do you have any color detail as to how much of the kind of internal investments related to that are needed on a go-forward basis?

I don't think there's any more additional internal investments we have been working on in proving the policies and procedures, as I mentioned in my prepared remarks. So there will be no incremental increase in cost associated with addressing the concerns of the regulators. We may have some outside validation done through some consulting work to validate what we have done, but we're in a pretty good shape to address the concerns of the regulators.

Great. That's all, thank you for taking my questions.

Thank you, Chris.

We'll take our last question from Alex Lau with JP Morgan. Your line is open.

Hi, good morning, everyone. Morning. Just to follow up on the previous topic, can you walk through the two consent orders and how you expect to respond to these if this changes how you approach the GPG business at all? Thanks.

Well, the consent orders are pretty straightforward. They're specific to different areas of compliance oversight, specifically for the consumer-facing part of GPG. And we have been addressing, as you know, this is a 2020 matter. So we have been addressing and working alongside very productively with our regulators. We have a very good relationship with the regulators. Open communication, good transparency. They've had some very good ideas and some suggestions on how to address these type of business relationships. You saw recently there was joint agency guidance that came out on third-party oversight for these types of relationships. So that's been very helpful. And we'll address them one by one. It's no different than findings in any report of exam. We'll address them, we'll evaluate them, we'll have discussions with the regulators, and then we will make the changes necessary. We will likely get some of the changes looked at by outside companies to validate. And then we'll present them to the regulators for their review and consideration. But we don't find it to be a heavy lift. We've addressed many of these already because this wasn't a very acute challenge in March of 2020 specifically because of the global pandemic and the circumstances around that. But no, we're in a good place and we have good dialogue with the regulators on this.

Yeah, and the only thing I would add, Alex, is I mean, we, from an investment perspective in human capital, we've almost doubled the number of folks in that, you know, the control function since that time, since early 2020. And I think that speaks to Mark's point in terms of, you know, the level of focus on this internally since that time.

Thanks, guys. And just to follow up to that, does this impact the near-term growth potential of the GPG business with regards to gathering deposits and feeding income at that historical growth pace?

I don't think so. As I sort of signaled many times over the last several quarters, we're repositioning and looking primarily at more B2B business in GPG as relates to the payment space and not really looking to expand the consumer side of the business. So no, we don't expect any interruption of business at all.

Thank you. And my last question was on the non-performing loans. There's a tick up in the quarter. Can you share some color on what that loan was and also maybe just refresh us on the health of the existing non-performer?

Working backwards, we are still going through the foreclosure process on that one loan that's in Mission, Kansas. And we're still fairly optimistic on a positive outcome, likely to be a 2024 event. As it relates to the tick up, it was two small loans actually with the same principle, I think roughly three and a half million each. We have no concerns at all on at least half of it, one loan at three and a half million. The other loan we are highly confident will get paid 100 cents on a dollar. So no concerns at all. And overall, the health of the book is very good.

Yeah, and stating the obvious, the non-performing, the ratio there is still incredibly low even with that modest uptick of those two small loans.

Appreciate it. Thanks for taking my questions.

Yeah, and poor Mark doesn't need closing remarks. I just wanna thank Mark for the time I've spent here at MCB. It's a remarkable franchise. It's an incredible team. So Mark, thank you to you. Thank you to the board. I really enjoyed working here and working with everybody.

Yeah, and we feel the same, Craig. And we wish you all the best in your new initiatives and hopefully we'll keep in touch and work together again as well. Without a

doubt. And Chris and Alex, it's been a pleasure working with you guys the last couple of years. And Nick, sorry for the timing on it. It's been really good getting to know you as you've gotten up the curve here. But as you know, it's a remarkable franchise. So good luck.

And this concludes the allotted time for questions. I would like to turn the call over to Mark DeFazio for any additional or closing remarks.

I have nothing other than thank you again for your support and interest in MCB. And as I've said many times, we are here and we're available to anybody, any investor or analyst who would like to chat with us offline. Have a nice day.

This does conclude today's conference call and webcast. A webcast archive of this call can be found at .mcbankny.com. Please disconnect your line at this time and have a wonderful day.