November 17, 2021

Breakingviews: Carlyle bank buyout would need hard work and hope

by Breakingviews.

Carlyle’s mini bank buyout may require a lot of heavy lifting. The U.S. private equity group is eyeing Metro Bank, a beleaguered British lender that is now only worth 20% of its book value. Getting a respectable return would still require turbocharged lending and deep cost cuts.

Founded by American businessman Vernon Hill, Metro once hoped to shake up British banking. Launched in 2010 when public confidence in financial services had been battered by the financial crisis, it championed dog-friendly branches that were open seven days a week. But poor controls and insufficient capital led to an emergency rights issue in 2019. In the past five years its value has collapsed from almost 3.5 billion pounds to just 177 million pounds.

A buyout wouldn’t be quite that cheap. Besides paying a premium of perhaps 30% for the bank’s equity, a buyer would also need to inject capital to absorb 144 million pounds of losses over the next two years, which Metro is racking up thanks to its branch-heavy cost base. That could bring the total outlay to at least 380 million pounds, according to Breakingviews calculations based on Refinitiv forecasts. For Carlyle to make a private equity-style 25% annual return, Metro would need to be worth 1.2 billion pounds after five years.

Such a valuation would require a big earnings boost. Assume a 10 times price earnings multiple, and Metro would need to generate around 120 million pounds of net income in 2026. That’s possible if it can sustain annual revenue growth of 10% a year, and bring costs down to below 70% of income from over 130% this year, according to a Breakingviews calculation which assumes annual provisions of 30 million pounds a year. Yet cutting costs could be an uphill battle for a bank with large branches in city centres on expensive leases. And a rapid expansion in higher-yielding corporate loans could lead to high losses.

One way to make Metro more profitable would be to merge it with another lender, enabling lower expenses and cheaper funding costs. Other so-called challenger banks like TSB or Sainsbury’s Bank are candidates. Yet mergers can carry integration risks, and rivals may be wary of merging with Metro given its history. A Metro buyout, if it happens, will need hard work and a bit of luck.

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