Metro Bank’s failed bond sale last week was launched to help it meet the new MREL (Minimum Requirement for Own Funds and Eligible Liabilities), brought in to prevent a repeat of the 2008 government bailouts. The 2008 crisis that led to the term, “Too big to fail” as RBS, Lloyds and others were bailed out by tax payers. What’s the story?
About Metro Bank
Metro Bank plc is a retail bank operating in the United Kingdom, founded by Anthony Thomson and Vernon Hill in 2010. At its launch it was the first new high street bank to launch in the United Kingdom in over 150 years. Its first branch opened on 29 July 2010 in Holborn, London.
It is listed on the LSE. ticker MTRO with a market cap as of Friday of £332 million.
What are SRB, MREL and BRRD ?
The Single Resolution Board (SRB) is the European Banking Union's resolution authority. It is a key element of the Banking Union and its Single Resolution Mechanism. Its mission is to ensure the orderly resolution of failing banks, with as little impact as possible on the real economy and public finances of the participating EU countries and others.
The SRB was set up in January 2015, based in Brussels to ensure the orderly resolution of failing banks. It is chaired by Elke König and its key partners are the European parliament, European Commission, European Central Bank (ECB), National Resolution Authorities (NRAs), European Banking Authority (EBA)
Its main tasks are to:
establish standard rules & procedures for the resolution of entities
take decisions on resolution within the Banking Union according to a standard process - this helps maintain market confidence
establish credible & feasible arrangements for resolution
remove obstacles to resolution, to make the banking system in Europe safer
minimise resolution costs & avoid destruction of value unless necessary to achieve the resolution objectives
provide key benefits for taxpayers, banks & deposit-holders
promote EU-wide financial & economic stability.
In 2017, the SRB developed its Minimum Requirement for own funds and Eligible Liabilities (MREL) policy and adopted its first binding decisions for major banking groups.
The Bank Recovery and Resolution Directive (BRRD) establishes a common approach within the European Union (EU) to the recovery and resolution of banks and investment firms. The BRRD represents an important step forward in ensuring that the EU effectively addresses the risks posed by the banking system.
The UK’s special resolution regime (SRR) provides the Bank of England, the Prudential Regulation Authority (PRA), the Financial Conduct Authority (FCA) and the Treasury with tools to protect financial stability by managing the failure of financial sector firms.
The BRRD, which has been transposed in all participating Member States, requires banks to meet MREL targets so as to be able to absorb losses and restore their capital position, allowing banks to continuously perform their critical economic functions during and after a crisis. MREL represents one of the key tools in enhancing banks’ resolvability.
In 2017, the SRB developed its MREL policy and adopted its first binding decisions for major banking groups, which was split into two waves.
The first wave started in January 2018 to allow for the banks that did not have binding targets, for instance those without presence outside the Banking Union, to be addressed first based on a MREL policy largely following the 2017 approach and published on 20 November 2018.
For the second wave of resolution plans, covering the most complex banks, MREL will be based on an enhanced MREL policy published on 16 January 2019. This second part of the 2018 MREL policy introduces a series of new features to strengthen the MREL approach and banks’ resolvability within the Banking Union. The SRB published an update to its policy on MREL in light of the publication of the Banking Package in the Official Journal of the EU on 7 June 2019.
Capital requirements and ringfencing
The eurozone requires banks to raise expensive loss-absorbing debt with assets over €100 billion and in the US, the threshold is $250 billion. In the UK, by contrast, the requirement starts at just £15 billion, causing a high burden for small lenders.
For any bank in the UK with more than £25 billion in customer deposits, ringfencing has to be adopted. For example, Santander had to legally transfer €25 billion of assets from its UK bank to a UK branch of its Spanish parent and duplicate certain functions between the two units as certain types of service for large corporate customers cannot be carried out in the ringfenced UK bank.
Even Larger lenders like HSBC, have been required to have many billions of pounds in excess customer deposits that can be used only in the UK. HSBC has been forced to put cash into the mortgage market, driving down prices and hitting profit margins at rivals.
Individual banks and trade groups such as UK Finance have also been lobbying for regulatory changes to make rules such as MREL more proportionate for smaller banks, but any changes are unlikely in the short term. The Bank of England said its primary objective was to ensure banks “are run in a safe and sound manner”, but said was listening to industry concerns and it has said “It’s natural that our work is now moving on to barriers to growth, given the amount we’ve done on barriers to entry.”
Implications for Metro Bank
Last Friday, Metro Bank (MTRO) shares rallied from all time lows around 150p (compared with a 52 week high of £30) as rumours swirled the markets. The shares were hammered again earlier in the week as it pulled it proposed £250 million bond offer, on weak demand which was needed to meet the MREL deadline in January 2020.
Despite a 7.5 per cent yield on the Metro bonk offer, orders had only reached £165 million by 1pm on Monday, September 23. The bank plans to try again to raise debt before the end of the year, when it can give more evidence that its performance has stabilised. The company said “Given the current market conditions though Metro have elected to not proceed with a transaction at this time.” Almost sounds like Sirius Minerals (which couldn’t get its bond offer away at a 13% yield).
In January 2019, Metro Bank admitted classifying a portfolio of commercial loans for capital purposes incorrectly, thereby failing to hold sufficient capital to meet regulatory requirements. The error applied to around 10% of its loan book. The miscalculation was identified through a review by the Prudential Regulation Authority (PRA), but Metro Bank erroneously gave the impression that the bank had identified the incorrect classification itself. To correct the error in the capital classification. A regulatory investigation was started by the FCA and PRA causing a share price collapse and they have fallen almost 90 per cent since the start of 2019 to an all time low last week.
By March 2019, the BBC reported that Metro Bank shares were the second most shorted shares on the UK stock market and larger depositors, worried about the bad publicity caused by the commercial loan classification error, began withdrawing funds. Metro Bank revealed that there had been a 4% drop in its deposits in the first quarter of 2019 because of “adverse sentiment”. Recently the bank has been forced to issue reassurances to worried depositors that it wasn’t going bust. But as Northern Rock found in 2007, sentiment and confidence are everything.
Critics have questioned its longer-term strategy of building an expensive network of large physical branches at a time when most larger rivals are looking to close theirs in favour of online options.
Alasdair McKinnon, manager the Scottish Investment Trust, a FTSE 250 investment trust that owns stakes in RBS and several foreign banks, said falling share prices could create some opportunities for investors but, with the sector out of favour and Brexit still to unfold, it would be imprudent to opt for “the riskier and riskier options”. “You want to be in the ones that will definitely survive the cycle and participate in the upside.”
The Sunday Times had a story yesterday that US raider Elliott Advisors is one of a group of investors circling Metro and that investors are interested in an equity stake or issuing new debt in a premium priced private placement. Other investors are looking at purchasing of Metro’s deposit book as a way to access cheap funding.
Barclays analyst Aman Rakkar said last week that the failed issuance meant there was “an increasing likelihood – and need – for Metro to dispose of ‘non-core’ assets”. He said asset sales could reduce the size of bonds that Metro Bank needs to issue and could “potentially sizably boost capital at the expense of earnings”.
What next for MTRO shares?
The MTRO share price was completely bombed out earlier last week as the bond issue was pulled on weak demand. Unsurprisingly investors like Elliott Advisors were interested in an investment. After Friday’s 16% share price rally, there is probably more upside to come on the Sunday Times story. But it is worrying that despite a 7.5 per cent bond yield, the bank failed to get the offer away, illustrating the stuctural issues facing these challenger banks. An expensive high street banking presence in the age of the internet appears questionable. The BRRD and MREL are certainly factors which have hampered Metro and made the bond offer necessary. The Bank of England, hasn’t helped with its inflexible approach in order that it has comfort that there is no repeat of the 2008 banking crisis, where Northern Rock and others failed.
This is a high risk punt for sure, but for those buying last week, some upside to come. It looks like Metro will pull off a funding deal in the short term, even though the terms won’t be advantageous. Not a buy and hold for sure, trade it to take advantage of this bounce from the share price lows. Longer term, I have plenty of questions about the business model of this bank.