Once the darling of investors in U.K. midsize banks, Metro Bank PLC's latest results have piqued short-seller interest and sparked warnings of a potential hostile takeover, although a loyal group of investors and analysts continue to keep faith in the company's branch-driven strategy.

Growing short positions in the stock, high exposure to U.K. residential housing — an asset class widely seen as flatlining — and decreasing interest margins, are among the top factors behind a long-winded and continuing share price decline which in turn may spark a takeover attempt, said one analyst.

John Cronin, from Goodbody in Dublin, said that although "one could not be definitive about these things" he foresaw the risk of a hostile takeover of Metro Bank if its shares dropped to around £17-£18 apiece. At market close Nov. 20, a Metro bank share stood at £19.98, down from a 2018 high of £40.40.

"The bank is not yet a takeover target but it could become one if the price keeps falling," he told S&P Global Market Intelligence, pointing to its cheap deposit-gathering strategy as something of which other midsize banks were envious.

"Investors have had to swallow a lot of losses already," he added. In a recent note, Cronin said the bank would also need to raise around £350 million from equity investors in 2019, and more in 2020, to finance its expansion, therefore diluting the control of existing backers. The need for capital was compounded by the recent earnings, which "came in below expectations."

Lower margin, capital pressure

Metro's net income for the third quarter of 2018 was £10 million, up from £4.7 million in the same period of 2017, according to data compiled by S&P Global Market Intelligence, while the CET1 ratio stood at 15.7%, following a £303 million equity call in July. Its net interest margin fell to 1.77% from the 1.94% reported for the third quarter of 2017. The bank also attracted criticism for paying millions to its founder's wife for interior design work at its branches.

Meanwhile, Metro is at a competitive disadvantage compared to certain, mostly larger rivals due to it having to use the so-called standardized approach to calculating common equity Tier 1 capital, a regulator-issued formula which, as a safety measure, considerably increases capital demands on startup banks. Metro Bank is in discussions with regulators to have its internal, or IRB, model approved, which will allow it to set aside less funding against loans, but the final decision may not come earlier than 2021, Cronin said.

"It would be fortunate if it got its IRB approval in 2020," he added. However, it is "too optimistic to expect it to take it as little time as CYBG," he said, in reference to the Bank of England's 18-month process for approving rival lender's Clydesdale and Yorkshire Bank's internal model for capital requirements.

A merger would potentially speed up the capital model approval process, said Cronin, who has a sell rating on Metro's stock.

Loyal base

Three other analysts thought a forced takeover was far-fetched, though two agreed the bank was struggling.

"I'm not sure anyone would like to buy it out," said Shailesh Raikundlia, a banks analyst at Panmure Gordon in London. Metro's "unique" physical branch-led model is a "concept that is not widely appreciated in the banking community," he added.

Raikundlia believes there is a "high likelihood" the lender's IRB model will be approved in 2020, and that would be the same year in which the bank will tap markets for new capital. "Its largest shareholders are all fans," he said, adding it is unlikely they will give up on the company.

Joe Dickerson, an analyst with investment bank Jefferies, also said that the odds the bank would become a takeover target were low. "It's very premature to talk about a takeover," he said.

"The bank is expanding phenomenally and the pricing pressure will be removed by base rate hikes," he said, pointing to concerns over declining interest margin, generated by low mortgage rates in the highly competitive British market.

Dickerson estimated the IRB approval would arrive in the first half of 2019, adding that "the current share price does not reflect the strength of the bank."

Investec bank analyst Ian Gordon said he, too, could not imagine a takeover, adding: "[Metro's] is a unique high-growth model which wouldn't obviously fit within another bank's proposition." Gordon, who labelled Metro stock a buy, said in a note that the bank's deposits would reach £50 billion in 2023, after hitting just over £14.8 billion in 2018, in direct proportion with growth in the number of branches.

Short interest

Some of the largest asset managers in the U.K. have positioned themselves against Metro Bank by shorting significant amounts of its stock. Public disclosures to the financial regulator reveal that BlackRock Investment Management is shorting 0.67% of Metro Bank's shares, while Marshall Wace, Odey Asset Management and JP Morgan Asset Management are shorting 1.4%, 1.83% and 0.63%, respectively.

A total of 7.06% of Metro's shares were being sold short as of Nov. 16, implying widespread belief among investors that the stock will continue to cheapen. By comparison, only 3.25% of rival CYBG's share were being sold short as of Nov. 20.

A Metro Bank spokeswoman told S&P Global Market Intelligence the company does not comment "on rumor or speculation."

See the financial highlights for any bank: Search the company in the top search box and go to the "Financial Highlights" section, housed under the Templated Financials on the left-hand panel. Here is an example for Metro Bank PLC. Enjoyed this analysis? Click here to set up real-time alerts for data-driven articles on any region of interest.