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Can the Metro Bank share price bounce back?

The so-called challenger bank has been seeing more and more news headlines of late, but unfortunately for all the wrong reasons. Monday’s trading saw its shares dropping almost 11% to new record lows at 475p, following speculation on social media over the weekend that the bank was close to collapse, and with images circulating showing large queues outside certain branches leading to fear of a possible run.

Metro Bank’s (LSE: MTRO) problems began earlier this year when it was found to have miscalculated its risk-weighted assets, and so over-reported its capital ratios – a big no-no for investors in the post-financial crisis world. Understandably, the lender has been struggling to regain investor confidence ever since, despite announcing plans for a £350m capital raising effort via the issue of new shares, and confirming it is exploring the possibility of selling the £1bn worth of loans that were at the centre of the scandal in the first place.

With prices hitting these lows, then, it seems only fair to ask the question: is the stock now worth buying?

I think there are a few key things here worth considering.

Firstly, let us think big picture. Banks need confidence, and banks need capital. Despite the growth in recent years of smaller lenders such as Metro, the fact is that compared to the larger, high-street names, they are small-fry. For the most part they have little brand recognition nationally, and tend to be regional in size (Metro is mainly focused in the South-East).

When times are good, this may not be too much of a problem; favourable rates, friendly service and niche selling points (gimmicks?) can be enough to attract and keep customers. But when things go wrong, people want to know their money is safe. For the most part, there is just no way a small, local firm can project this security as much as the big names.

The moment a bank loses confidence, it loses capital, and this could be a death blow for even the strongest of small banks. Just a few years ago Northern Rock lost the confidence of its customers, which quickly led to its permanent demise. It is worth saying at this point, however, that reports on Monday suggested the queues Metro was seeing on the weekend had dispersed.

The other major point to consider is that the bank’s capital raising efforts are going to be via the issue of new shares. Though the full terms are expected to be released in a prospectus this week, new shares mean dilution of those already in issue.

Despite the obvious pricing-in of many of the bank’s problems in its current share price, such a significant share dilution (in the region of 67%) is still going to hit very hard. What’s worse, most analysts suggest that even with this share issuance, the bank would likely need further capital injections in the near future if it wants to meet the growth targets it has set out.

With these major risk factors still in play, it seems likely that Metro’s share price still has some way to go on the downside, while the firm itself has a long way to go to regain lost confidence, if it is indeed possible.

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Neither Karl Loomes nor The Motley Fool UK hold a position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.