It’s been a torrid year for investors in Metro Bank (LSE: MTRO). Those that bought into the company at the beginning of the year are nursing losses of up to 90%, with performance blighted by a deluge of issues that culminated in the resignation of the challenger bank’s founder.
It was forced to go cap in hand to investors for additional equity in each of the last three years to shore up its capital levels. This has effectively diluted existing investors’ share of company profits. More worrying though is the fact that aren’t any profits to dilute anyway.
The bank reported a £5m loss for the third quarter after rising costs and a deteriorating net interest margin. And this comes after customers pulled out £2bn in deposits (13% of the total) in the first half of the year.
As well as an equity raise earlier this year, Metro Bank more recently raised debt in the form of high-yielding bonds with a coupon rate of 9.5%. While this will help to meet its capital requirements, it means that interest costs will eat into future operating profits at a time when the company is already struggling with profitability.
Taking all of this into account, I expect the bank to report a loss for the full year and struggle to see how it will return to profitability in 2020. Metro Bank has some serious underlying profitability issues that need to be addressed, and if I was a shareholder, I reckon I’d sell out and put my money to better use.
A better option
Sticking with challenger banks, I think One Savings Bank (LSE: OSB) is a much better company to invest in.
In the last month, it has completed a combination with Charter Court Financial Services Group, that brings together two specialist mortgage providers, with growing loan books and lean cost structures.
As standalone banks, financial performance was impressive. Revenues at One Savings have more than doubled from £125m in 2014, to £287m last year, with after-tax profits rising from £51m to £140m over the same period. Over at Charter Court, after-tax profits have more than tripled in just two years, from £37m in 2016, to £120m in 2018.
This financial performance is underpinned by strong banking metrics. Both boast industry-leading net interest margins and cost-to-income ratios of under 30%, while return on equity is over 20% at both.
Post-combination, the company should be even stronger. Management believes that there will be additional operating and cost synergies as a result of the merger, which has the potential to improve operating models that are already very good. Cost savings from the merger are expected to be in the region of £22m a year, for the first few years. The combination should also make it easier to raise finance, as well as reduce the cost of debt.
With the combined group’s shares priced at just over six times last year’s earnings, I think they look remarkably cheap, considering growth prospects and profitability. A dividend payout of 25% of after-tax profits and a yield of over 4% is the icing on the cake for me.