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Metro Bank: challenger’s business case now looks licked

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Metro Bank’s first London branch opened with an unlikely combination of polished marble, chrome and free lollipops in 2010. Investors have since been left with a sour taste for its shares, down 98 per cent since the 2016 listing.

The bank has built out a 76 branch retail network to gain access to relatively cheap deposit funding to redeploy into a loan book. But its business case has failed. Metro this week said it wants to raise £600mn in capital.

Metro requires more scale to get overheads down. An expensive branch network brings a high cost-to-income ratio of 90 per cent for a UK retail bank. By comparison, the ratio for Lloyds Bank is 51 per cent. Moreover, about 92 per cent of its deposits reside in current accounts and demand deposits which can disappear quickly.

It also faces difficulties deploying its funds. Most of Metro’s assets sit at the Bank of England or in high-quality bonds. Insufficient capital buffers have capped its loan growth. As of June its common equity tier one ratio was 10.4 per cent, some 3 percentage points below the UK peer average. That explains why Metro talks about raising capital and selling part of its mortgage book to reduce capital requirements. That runs counter to their need for growth, Gary Greenwood at Shore Capital points out.

Why has no bank bought Metro? It trades at a tenth of its book value. Even paying a pound for all of it would trigger fair valuation accounting under IFRS 3, says Autonomous, revealing a need for more capital. An overvalued property estate, on very long leases, plus negative revaluations to its mortgage and securities portfolios could force a buyer to stump up £1.3bn to cover valuation losses.

Metro is now seeking to shore up its balance sheet. But investors recapitalising the company risk throwing good money after bad. The business model underpinning its attempt to turn lollipops into lots of lolly is deeply flawed.

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