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Metro Bank shares are up 30%! Here’s what I’d do now

A few months ago, it was tempting to write off upstart Metro Bank (LSE: MTRO) as a company that could face extinction.

That seems less likely today, as my colleague Alan Oscroft comments. The market seems to agree. The Metro Bank share price has risen by more than 30% from its all-time low of 155p.

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Despite this, I think investors still face considerable risks. In this piece, I’ll explain why and give my verdict on this stock.

It’s tough out there

Banking is a business that works well at a big scale. When you’re big, you can spread risk across more types of lending. When you need to borrow money, the cost is usually lower. And money spent on ever-increasing regulatory costs is spread over a larger number of customers.

Metro Bank faced a tough challenge when it decided to take on the big high street banks. The company made life much harder for itself when it made mistakes valuing some of its loans.

This shook customer confidence and caused a number of larger customers to withdraw £2bn of deposits during the first half of the year.

However, the bank battled on and has now brought forward the departure of founder and chair Vernon Hill, reassuring markets. Last week’s third-quarter results showed a return to deposit growth.

With the share price still sitting in the gutter, is MTRO stock a potential bargain?

Here’s the good news

During the three months to 30 September, customers flocked to Metro Bank, opening 106,000 new accounts. That takes the total number of accounts to 1.9m.

These new customers were keen to deposit their spare cash with the bank. Total deposits rose by £528m to £14.2bn during the three-month period.

Net loans were kept flat at £14.9bn. This is because the bank is trying to reduce its loan-to-deposit ratio to below 100%. Since the end of June, it’s fallen from 109% to 105%. I’m happy to see this. Lending more than 100% of your deposit base adds risk and most banks tend to avoid it. I think Metro is right to make this change.

Profits are under pressure

It’s clear to me that the bank’s profitability has come under pressure this year.

Metro’s net interest margin – which measures the difference between interest paid on savings and interest received on loans – was 1.58% during the first nine months of the year, compared to 1.82% during the same period last year.

This is one of the reasons why the bank’s nine-month underlying pre-tax profit has fallen from £39.2m in 2018 to £11.3m this year.

Should you buy MTRO shares?

Metro Bank appears to have stabilised its finances and is continuing to attract new customers. In my view, the bank’s financial position is improving and bad debts still seem very low.

However, the bank’s low profit margins are a concern for me. If chief executive Craig Donaldson doesn’t manage to pull back some of the bank’s lost margin, I think the shares are likely to struggle.

Although a takeover bid is a possibility, I wouldn’t invest on this hope alone. As things stand, I’d rate Metro Bank as a hold, at best. I think there are better opportunities elsewhere.

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Roland Head has no position in any of the shares mentioned. The Motley Fool UK has no 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.

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