Britain's Metro Bank PLC is reshaping its loan portfolio to steer away from corporate lending and toward residential mortgages as it attempts to boost profitability.
The company has changed direction after it made an error in classifying large sums of commercial property and professional buy-to-let operators' loans.
It had a total of £4.1 billion in commercial and buy-to-let loans at the end of 2018, and revealed in January that it had deemed a considerable proportion of them as less risky than they actually were. Correcting that error resulted in a £900 million addition to its risk-weighted assets, and meant it had to raise £375 million in equity to boost its capital buffers.
The Bank of England's Prudential Regulation Authority and the Financial Conduct Authority are each investigating the bank following the mistake.
The firm boosted its retail loans — mostly mortgages — to nearly 71% of its total loan portfolio in the first quarter, up from just over 69% at the end of 2018, data compiled by S&P Global Market Intelligence shows. Corporate loans, in contrast, fell to just over 29% from nearly 31% over the same period.
From 2023, Metro is aiming for 70% to 75% in mortgages, and 20% to 25% in corporate loans, with 3% to 7% in consumer unsecured loans.
Metro CEO Craig Donaldson said at the time of the bank's full-year results in February that the bank wanted to make commercial real estate loans a smaller part of its lending portfolio because of a lower return on equity compared with its mortgage business. The bank regards the latter as much more efficient than its staff-intensive CRE operation.
Returns from retail mortgages are also likely to grow when Metro wins permission from regulators to switch to an internal ratings-based model for calculating risk-weighted assets, from the standardized model it is currently obliged to use. The IRB model allows for more flexibility when determining the riskiness of loans.
But following the mistakes Metro made with loan classification, the switch to an IRB model is likely to be some way off. The bank does not expect approval to be granted before 2021.
Donaldson said commercial real estate is "very important" but that Metro wants to lower it as a proportion of its overall book, "because it is much higher on capital allocations, and therefore it's lower on the return on equity."
The CEO has since noted that the bank has slowed its growth in "high-risk-density commercial real estate" as it concentrated on boosting its mortgage business, which it accepts is a highly competitive market.
Metro was an unexpected big winner from the £775 million scheme designed to boost competition in the banking sector for small businesses when it was awarded £120 million. It has said it wants to become the U.K.'s leading bank for small businesses.
Analysts at Goodbody Stockbrokers have expressed skepticism over its plans, noting that the average yield on residential mortgages was 2.36% in the first quarter of 2019, compared with 2.44% in 2018. This, said Goodbody, was "hardly conducive to a double-digit return on tangible equity for a bank lacking in scale that carries a very high operating expenditure base."
Donaldson has suggested that the bank might sell or securitize more than £1 billion of its commercial property and professional buy-to-let loans.
Goodbody suggests this might be worth doing since it believes the bank is likely to have to raise more capital in addition to the £375 million it raised recently.
It also noted that it believes the assets are sound and should command a price at or near book value. It would, however, indicate a step-change in the bank's strategy, Goodbody said.