Banking on Metro

UK retail banking is a mess; bereft of adequate customer service and lacking innovation the major banks – RBS, Lloyds Banking Group, Barclays, HSBC and Santander – are ripe to be challenged. The major banks have experienced sluggish growth and high operating costs due to a succession of acquisitions that have not yet been fully integrated. Furthermore, the retail banking market in the UK is very highly concentrated, with 88% of the market’s retail deposits taken by the top six banks. This contrasts sharply with Germany where the top seven banks have a 68% market share and the USA where the top eight banks have 35% market share.

Enter Metro Bank. Founded in 2010, it now has 15 branches, 100,000 customers and assets of £800 million. They survived tough initial scrutiny from the Financial Services Authority in 2010 in order to be allowed to establish a bank that could take retail deposits. Metro Bank’s competitive advantage is its simplicity – they have just one current account as well as a single computer system that handles all its customers’ accounts and details in order to provide staff with a holistic view of its customers. The concept of beauty in simplicity also extends to Metro Bank’s stores; they all adhere to a strict criteria of being located near transport hubs, being corner sites with around 4,000 square feet, and have ceiling-to-floor windows to create an engaging and transparent customer environment. Their 15 branches need to attract around £25 million retail deposits each in order to lend profitably, which can be obtained with just around 8% of the local retail banking market around each branch. For 2011, Metro Bank reported £33.1 million in losses, largely due to increased investment in store openings. Metro Bank will probably continue to make losses in 2012 and 2013. However, it is important with this investment to emphasize the positives and long-term potential. Since January 2012, they have increased their deposit base by 310% to £530 million and grown their lending to £150 million, a 400% growth. They also now provide around 6,000 mortgages – just three years after launching. A recent agreement signed with MasterCard to provide Debit and Credit MasterCard services with its current accounts also signals rising potential. Metro Bank have set a target of opening 200 branches in London by 2020 with calculated assets of £10.7 billion, assuming same ratios of assets to branches – this goal seems well within their grasp considering their growth story thus far. Metro Bank plan to float on the London Stock Exchange (LSE) around June 2014, which means there is ample time to assess this investment opportunity.

People are often key to a successful business – it is a oft-repeated phrase that in this case may be a considerable advantage. Metro Bank are chaired, and founded, by Vernon Hill – an entrepreneur with extensive experience founding and expanding Commerce Bancrop in 1973 from Philadelphia to throughout the eastern coast of the USA with assets of US$50 billion and 500 offices. Vernon Hill’s first foray into retail banking received many awards for its retail banking and customer service and was acquired by Toronto-Dominion Bank in 2007 for US$8.5 billion. Vernon Hill’s shrewd business judgments are not just confined to retail banking, having co-partnered with US Restaurants Inc to operate 40 profitable Burger King restaurants in downtown Philadelphia as well as developed Site Development Inc into a real estate development firm with experience developing over 1,000 shopping centers and retail sites in the USA. Furthermore, Metro Bank CEO Craig Donaldson has extensive local retail banking experience having started on Barclays’ graduate development scheme before working in management roles at HBOS, Natwest, Halifax and RBS. Additionally, key investors in Metro Bank are property magnates who value stable investments – Richard LeFrak and the Reuben brothers, as well as renowned fund manager Fidelity. In June 2012, the company also announced the end of a £126 million capital raising, which bagged funds from Moore Capital and billionaire investor Steve Cohen. It is therefore evident that the key people have the right experiences to make Metro Bank successful - and major investors also seem to think so.

love at first sight? 

I would argue that the retail and business banking industry in the UK is ripe for a new challenger, such as Metro Bank. Such a challenger also has the full support and blessings of the UK Government and financial regulatory authorities. In 1980, just 60% of the UK adult population had a bank account and now 94% do. The number of services that a bank sells to a typical customer has also risen dramatically with banks cross-selling current account customers various other products including credit cards, personal loans, mortgages, insurance and investment products. Moreover, technology has enabled retail banking to become more cost-efficient and done without need for customers to come to their local branch. Advances in information technology have driven down the cost of processing and the introduction of cash machines and internet and smartphone banking has driven down the costs per transaction. However, while the focus has been on product expansion, there has been less of a focus on the core element of retail banking – customer service and personal relationships. This is the focus that Metro Bank is banking on. In fact, contrary to other banks, they want their customers to come into their branches.

In an era of less sexy risk-taking, retail and business banking is due to play a more significant part in the universal bank’s EBITDA. The financial crisis reversed dominant trends in the UK retail banking market – trends such as reckless balance sheet growth due to fierce competition as opposed to a focus on innovation to differentiate from competitors. The financial crisis also induced low interest rates, reduced competition and a shortfall in the supply of credit. Shortage of credit in the UK is particularly sharp at 15% of GDP compared to 2.5% in the USA and 3% in the Eurozone. This is a ripe environment for new market entrants. In this environment economies of scale is no longer the primary source of domination – improved margins attached to core retail banking products is creating an opportunity for smaller entrants to differentiate by innovation. Politically, the government and opposition both want more competition in UK retail banking in order to help meet the credit needs of households and small businesses. This is backed by the EU’s demands that RBS and Lloyds Banking Group sell assets as the price for requesting state aid. Metro Bank in particular are aligning their product offering with what the customers want in the post-financial crisis era – a recent survey shows that retail depositors place high value on branches and service levels, conveniently located branches, longer service hours, and bank ethics. Metro Bank aims to attract busy London customers with late opening hours and high levels of customer service in conveniently located branches for commuters. The lack of a legacy for Metro Bank also allows them to build without constrains such as political pressures, historical mistakes, the need to integrate technology from mergers (roughly one-third of incumbent banks’ operating costs), and existing union agreements that do not allow incumbent banks to easily change banking work hours. These benefits will allow Metro Bank to enjoy a significant cost advantage once they get over their initial high cost-income ratio. They may ultimately be able to compete strongly on price and to offer services with lower charges – a major source of customer dissatisfaction. That is why I will be banking on Metro.