A ‘crisis of confidence’ at Vernon Hill’s U.K. bank

Vernon Hill is in hot water again.

Hill, long known as an innovative retail banker, famously clashed with U.S. regulators more than a decade ago before being forced to resign as head of Commerce Bank in Cherry Hill, N.J.

His next gig took him across the Atlantic and had all the makings of a big comeback story.

And though Hill unquestionably has shaken up the United Kingdom’s banking landscape since founding Metro Bank in London nine years ago, he is now under fire for a recent series of missteps that some say could lead to his ouster as the bank’s chairman.

The bank is being investigated by British regulatory agencies for mistakes it made in risk-weighting commercial mortgages at the same time it has fallen out of favor with investors for its overreliance on residential mortgage lending and its decision to continue investing heavily in new branches.

Meanwhile, investors are frustrated that Hill continues to do business with his wife’s architectural firm — a dozen years after that relationship got him in trouble with U.S. regulators when he ran Commerce. (Commerce was sold to TD Bank in 2008.)

With Metro’s shares down by roughly one-third over the last six weeks — and by more than 80% since this time last year — calls for Hill’s removal as chairman are getting louder.

One proxy advisory firm is urging shareholders to oust Hill at Metro Bank’s annual meeting next week, and another is recommending that shareholders abstain from voting. Investors are also telling investment analysts that they believe Hill’s days are numbered.

“I don’t want to add my voice to the choir of those calling for his ouster, but he’s going to find it very difficult to survive through this,” said John Cronin, an analyst at Goodbody Stockbrokers in Dublin.

Charlie Armitstead, a Metro Bank spokesman, declined to comment. Hill was not available for comment.

None of Metro Bank’s large U.S.-based investors have publicly indicated that they plan to vote against Hill’s re-election as chairman. The bank’s investors include the hedge fund managers Steve Cohen and Glenn Greenberg; a fund that manages the personal assets of former New York Mayor Michael Bloomberg; and Bruce and Robert Toll, the founders of the luxury homebuilder Toll Brothers.

“I’ve known him for years, and I’ve complete faith in him — that’s all I can say,” Bruce Toll told Bloomberg News in March.

However, Fidelity Investments recently cut its stake in Metro Bank from 7.6% to 5.4% and this week the New York hedge fund Hound Partners reduced its stake from 5% to 4.9%, according to regulatory filings.

The annual meeting and shareholder vote is scheduled for May 21 in London.

Hill founded Metro Bank in 2010 and found immediate success by replicating the same strategy as Commerce Bank — blanketing its area with retail branches, keeping those branches open long hours and on weekends, paying high rates on deposits, and providing white-glove customer service.

Metro Bank’s strategy contrasted with the widespread branch closings by Britain’s large banks. Consumers embraced Metro Bank’s business model, helping it grow to £22 billion (U.S. $28.3 billion) of assets in less than a decade.

“There’s no doubt about it, he captured the popular imagination,” said Robert Sage, an analyst at Macquarie Group in London. “To a point, he has been extremely successful.”

The run of success has slowed, however, as a result of several contributing factors, Sage said. For one, Hill tried to grow Metro Bank too rapidly, he said. Metro Bank has 65 branches and plans to open 30 more in northern England by 2025, including locations in Liverpool and Manchester.

“He’s been growing at a rate that people don’t believe he should be growing,” Sage said. “He didn’t place the controls around that growth that he should have, and the issues are coming home to roost in a very big way.”

Total operating expenses rose 24% in the first quarter from a year earlier, and those costs will remain elevated as the bank keeps opening new branches, David Arden, the chief financial officer, said during a May 1 conference call with analysts.

“Clearly, as we're growing business, you will expect cost to continue to grow over time as we increase the scale in terms of stores and customers,” Arden said.

The hefty investment in new branches has also forced the bank to repeatedly raise fresh capital, suppressing its returns on equity, Sage said.

Even the bank’s focus on deposit gathering, a cornerstone of Commerce Bank’s success in the U.S., is showing signs of stress, Sage said. Metro Bank gets a larger share of deposits from commercial customers than competitors. Commercial depositors are savvier than retail customers and will quickly pull deposits if their bank isn’t paying the highest rates, or if they sense the bank is having financial problems — and both things are happening at Metro Bank, he said.

Retail consumers may have picked up on the trouble, too. Last weekend, photos were posted on social media of long lines of customers forming at a Metro Bank branch to access their safe deposit boxes. But the bank issued a statement saying that customers’ money was safe.

In the May 1 conference call, Hill defended his strategy of rapidly adding branches throughout England despite the heavy cost, and said Metro Bank would soon return to strong profit growth.

“During the first quarter … we had some tough events to deal with,” Hill said. “I want to make it clear to everyone on the call that I have complete faith in the Metro Bank model, and of course we have to adapt and adjust the model as things change.”

Metro Bank has also been hurt by its heavy reliance on residential mortgages, which make up about two-thirds of its loan portfolio.

In January, British regulators required stricter ringfencing of commercial and investment bank assets. As a result, large banks were stuck with excess liquidity on the commercial bank side and they poured those funds into the residential mortgage market, which led to a price war, Sage said.

“The business model is just not commensurate with delivering the necessary rate of return” with mortgage rates so low, Cronin said. “The large U.K. banks can throw massive scale at this and scale and volume is the name of the game. Metro Bank doesn’t have that scale.”

CEO Craig Donaldson said in January that profit margins on mortgages have been reduced. Metro Bank’s overall net interest margin narrowed 17 basis points to 1.64% from the fourth quarter to the first quarter.

Another cause for alarm among investors has been Metro Bank’s repeated capital raises after management had earlier said that each capital raise would be its last, Sage said. Most recently, Metro Bank said in March 2018 that it didn’t need another capital raise, but only three months later it raised £250 million through a debt sale.

“Investors thought that was too close to the bone,” Sage said.

Metro Bank has another one lined up, with plans in place to raise £350 million by the end of the second quarter, according to a news release.

But that share sale will further dilute investors who have already seen their holdings diluted several times over, Cronin said.

Finally, Metro Bank in January announced that it had wrongly placed a lower risk weighting on some commercial mortgages. The Financial Conduct Authority and the Prudential Regulatory Authority are both investigating the incident.

Metro Bank admitted its error, as Donaldson said “it was a misinterpretation of the rules” and that it did not affect the company’s earnings.

As a result of all these issues, the proxy advisory firm Glass Lewis recommended voting against Hill’s re-election as chairman and ISS recommended shareholders abstain from voting.

Metro Bank’s shares have reflected the problems, as its stock dropped to a record low on Monday on the London Stock Exchange before rebounding somewhat Tuesday and Wednesday. Metro Bank’s shares are the most-shorted in the U.K., according to Financial Conduct Authority data.

Sage said investors would also like for Hill to end his longstanding business relationship with his wife’s architectural design firm. Last year, Royal London Asset Management threatened to vote against Hill’s re-election as chairman unless he canceled the arrangement with his wife’s firm, The Guardian reported. Hill easily defeated the challenge, winning 96.3% of the vote, according to The Philadelphia Inquirer.

Richard Harris, an individual shareholder in Metro Bank, said during the May 1 conference call that Metro Bank’s board “should look again at Mrs. Hill’s company’s payments. Up to now, I think it’s been justified in some way because it’s been very, very obvious and spectacular. But it’s a question of reputation … and we need to clarify and clear up anything that looks as though it’s holding the bank back in any way.”

Hill responded: “We are working on those issues. Reputation is very important.”

Glass Lewis cited the arrangement with Hill’s wife as one reason for voting against his re-election as chairman.

“This long-standing arrangement, and the potential over-reliance on one individual it may occasion, may not be in shareholders' long-term interests,” Glass Lewis said in an April 27 proxy advisory report.

Hill is also the chairman at the $2.8 billion-asset Republic First Bancorp in Philadelphia. Both Metro and Republic Bank in the U.S. pay Shirley Hill’s architectural firm, InterArch, for design work on their branches. The results are noticeable, as Metro and Republic share the same red-and-blue color scheme and operate branches with very similar designs.

While at Commerce Bank, Hill was forced to resign as chairman due in large part to his business dealings with his wife’s firm.

At least in the U.S., the relationship between Hill’s wife’s company and Republic Bank does not appear to be a major concern, said Frank Schiraldi, an analyst at Sandler O’Neill. Republic plans to send a request for bids for the design work this year.

“It would seem that the regulators have signed off on him using his wife’s company,” Schiraldi said. “They now have a process in place that they will consider other vendors and they have made certain that’s all very transparent to the regulators.”

For now, Republic First’s investors do not appear concerned that Metro Bank’s troubles could spill over to America, Schiraldi said. The two companies are separately managed and operated.

“It doesn’t seem to me that any of the issues with Metro would be something that Republic would have to deal with,” Schiraldi said.

As for Hill’s future at Metro Bank, Cronin said that Hill’s best chance to remain chairman is to find a group of investors who support his business plan and insists that he stays put.

Otherwise, he expects a new chairman to be named in the not-too-distant future.

“There’s a crisis of confidence, and things are getting worse by the day,” he said.