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Metro's potential RateSetter deal raises questions even at knockdown price

Metro Bank PLC's possible acquisition of peer-to-peer lender RateSetter could boost the loss-making bank's income if the deal is priced right, yet analysts remain unconvinced about its benefits for the lender.

Metro's shares jumped on the news that the bank — under new CEO Dan Frumkin, a restructuring specialist — was in exclusive talks with the peer-to-peer lender, though it stressed that the discussions were at an early stage with no guarantee of a result.

The benefit of a deal to Retail Money Market Ltd., which does business as RateSetter, was obvious, but the benefit to Metro was far from clear, according to an analyst who wished to remain anonymous due to the sensitivity of the matter.

"RateSetter is in a tough place. It is near the point where it needs to be rescued. It's making lower payments to investors — a classic sign of a business in trouble. But if I were an investor in Metro I would not be terribly happy if it were to buy a business like that — even if they do get it at a knockdown, distressed price," he said.

The timing of the deal is questionable, the analyst said, since the business supplies unsecured personal loans and as a result of the pandemic there is likely to be a huge expansion of bad debt.

Consumer lending

An acquisition could allow Metro, which declined to comment further, to increase its consumer lending business by funding it with the deposits in its interest-free current accounts, perhaps adding up £35 million of annual interest income, Goodbody analyst John Cronin said. This, he warned, is contingent on the deal being struck at the right price.

"For Metro it would provide a way of boosting its consumer loans business with higher-yielding loan assets, and RateSetter is a tech platform on which you can grow that business," he said.

But the acquisition would not be enough for Cronin to change his "sell" recommendation on Metro's stock.

Metro appears to have sufficient surplus capital to make the acquisition, as its common equity Tier 1 ratio stood at 15.6% at 2019-end.

Although Metro's market capitalization has fallen drastically since February, its current valuation implies the market is expecting loan impairments to be relatively low at 1.3%, compared with 3.5% at Virgin Money UK PLC, for instance, Barclays' equity analysts said in a note.

Lockdown woes

Peer-to-peer lenders launched in the wake of the global financial crisis and rely on providing a better deal for borrowers by connecting them to retail investors, who earn interest on funding loans.

RateSetter, which declined to comment, has struggled amid the coronavirus lockdown. It appointed Lazard to carry out a strategic review in April. On May 4 it said it would halve interest payments for the rest of the year in the face of worsening economic forecasts for the business. It said it would use the money it saves to top up its "provision fund" that absorbs the losses from bad debt.

"The effect of the increase in expected credit losses is that the interest coverage ratio has gone below 100%. This means that while everyone's capital remains fully protected, the capital coverage ratio is 166%, not all future interest is," the company said.

Metro, too, was created after the financial crisis as a challenger bank by Vernon Hill, who had successfully founded Commerce Bancorp in the U.S. Unlike the tech-focused RateSetter, Metro has rolled out bricks-and-mortar branches — it calls them stores — aimed at winning consumers from long-established rivals through a combination of seven-day opening and customer service.

Metro's troubles

Last year, the lender admitted to wrongly classifying the risk of a number of mainly commercial buy-to-let loans, initially claiming it had spotted the mistake itself before admitting it had been alerted to the error by the Bank of England. Metro had to raise £375 million in funding and is still being investigated by both the Bank of England and the Financial Conduct Authority. Hill subsequently quit, along with the bank's CEO.

The lender posted a net loss of £182.6 million in 2019, down from a profit of £27.1 million a year earlier.

Frumkin, who was appointed in February, said then that the bank would scale back expansion plans and consider selling some of its loan book. He has previously worked at other troubled banks in the U.S. and Europe, including Royal Bank of Scotland Group PLC.

His aim is to develop Metro into a full-service community bank, selling customers more products, from credit cards to personal loans. He said credit cards are currently held by less than 3% of customers and said taking out a personal loan at Metro was currently an overly bureaucratic process that took more than three hours to complete.

Frumkin has scaled back the branch-opening program but said the bank had no plans to close any existing branches as they are expensive to shut because of long leases.