Can you ride the Metro to the Challenger Bank future?


Metro Bank does not fit any obvious category. It is not a stodgy old bank. Nor is it a mobile only disrupter created by and for Millennials. It is based in the UK but founded and led by an American.

We aim for actionable insights on Daily Fintech. If you believe that challenger banks can beat the incumbents and you don’t want to start a challenger bank (it is very hard work) or invest in a startup challenger bank (you may be a bit late to that party), you might take a look at Metro Bank. It is a publicly traded business, so you can get detailed financials and buy and sell without anybody’s permission.

The public stock market is the original permissionless innovation and tool for the democratization of capital markets. The public stock market may have lost its way recently with all the focus on High Frequency Trading (HFT), but the fundamentals are still sound. Choosing a stock to buy or short only needs smarts. You don’t need permission from anybody.

That is why Daily Fintech likes looking at public companies and the Daily Fintech Index.

The question is, if you believe that challenger banks will own the future, can you ride the Metro Bank to that future? In simple terms, should you buy Metro Bank stock? Or do you think that a challenger bank with physical branches does not make sense in the digital age and that means that Metro Bank is over-valued and that you should short it.

That is the question we shine a light on in this post. Our focus is the strategic tailwinds and headwinds more than current financials. I Am Not A Financial Adviser (IANAFA). Do your own research. If it does not work out, don’t blame me. If my research helps your research I am happy. I have not yet bought Metro Bank stock but I might.

Metro Bank Background

Metro Bank was founded in 2010. This was the Cambrian Explosion era of Fintech when other great ventures such as Lending Club were born. Metro Bank was celebrated as Britain’s first new high street bank in over 150 years.

The founder is an American entrepreneur called Vernon Hill, who had earlier created Commerce Bancorp in America (which was acquired by TD Bank in 2007). This gained the nickname of “McBank”, because Hill used his knowledge of the fast-food chain business to the bank.

Metro Bank looks like Vernon Hill’s second act.

Metro Bank is a contrarian play in the digital age. They invest in physical branches – or “stores”. These branches are open seven days a week, and have longer working hours and work hard for better customer service (often through simple human touches such as being dog friendly). Speed is a key selling point. Customers applying for a current account in store can start using it the same day and get their bank card and cheque-book printed while they wait.

They are better branches, but they are still physical branches.

In the digital age is it too late for a strategy that emphasises physical branches?

The tipping point for UK Challenger Banks

A few weeks ago we did a landscape review of UK Challenger Banks, where we posed the question Can Challenger Banks break the massive bank concentration in the UK?

In short, I believe the answer is yes. This is about the tipping point when it becomes normal to switch from the Big 4. After that tipping point, word of mouth marketing will take over and the Customer Acquisition Cost will come tumbling down.

Tipping point is the Malcom Gladwell term and there is empirical observation behind it. Before the tipping point, the idea of change seems ridiculous. After the tipping point, everybody agrees that change was inevitable.

In that landscape report we said that “Metro Bank is the one to watch”. In this post we dig deeper into that thesis.

Before digging deeper into Metro Bank, we need to look at a different tipping point.

When do people stop using branches?

Back in October 2015 we wrote that Branch closures will soon pass the Wile E Coyote moment. This is a different tipping point, when people see so many branches closing (or semi-closing by reducing branch staff to such a minimum that their only job is to teach customers how to use the automated tools) that the customer’s takeaway is “it is pointless to go into a branch”.

At the time I was focused on incumbents. It did not occur to me that a new bank would actually aggressively open new branches. I had seen Metro Bank branches, but assumed this experiment would soon end. As we enter 2017, it is clear that the experiment is still going strong. That is why we are re-evaluating and digging deeper into Metro Bank. It is about behavioural economics. If all you see is branches closing, your behaviour changes one way. If you see new branches opening, your behaviour changes the other way.

Does their technology stack make them agile?

Metro Bank’s co-founder Anthony Thomson left in 2012 to set up rival Atom Bank.

There can be two stories behind this:

  • Either – Metro Bank’s technology is a boat anchor constraining innovation
  • Or – Metro Bank is a talent incubator and great companies are defined by their alumni

Challenger Banks either buy/license from established vendors or build their own from scratch. Metro Bank opted for the former strategy and has licensed technology from the following vendors:

  • Temenos’ T24 core banking
  • Backbase Omnichannel Banking Platform for front-end.
  • FIS/SunGard’s Ambit for Asset Liability Management
  • BancTec for mortgage processing
  • Glory Global Solutions’ Vertera 6G teller cash recyclers (TCRs)

The question is, in the mobile age, how good is their mobile app? How do they compare to the big incumbents and the pure digital upstarts? For this we turn to the Great British Mobile Banking Review 2016 which as of April 2016 did not even give Metro Bank a mention.

You can see their app here.

The tech stack matters. User Experience is more than putting fresh paint on an old car. There is no reason why Metro Bank cannot compete with their mobile app, as they have a reasonably modern tech stack. However, they are clearly late to this party. Metro Bank is due to launch a new mobile app soon. It does not have to blow away the competition, because the physical branch is the differentiator, but it does have to be good enough. It also has to show 1+1= more than 2. It has to show how the combo of branches + mobile is a winner. We await that eagerly.

Apple store comparison

Another contrarian play was Steve Jobs opening Apple stores when most consumer electronics stores were hurting. Good visual design and customer service does wonders. But the comparison soon breaks down. Consumer electronics are physical. You want to touch them, look at them before buying. That is not true for financial services. Both are complex but you can learn about financial services online, by phone or by somebody visiting your office (what Civilised Bank do).

We have to look elsewhere for a potentially winning reason for opening physical branches in the digital age.

The first bank built for Market Place Lending?

Banks bundle two functions – they borrow from you (and call it a Deposit Account) and lend to you (and call it a Loan Account). The latter is hard to do well. That is where Market Place Lending is the first fundamental innovation in banking for hundreds of years (by creating the Lending Account). If you get lots of Deposits, you don’t need to lend the hard way, you can outsource that to Market Place Lending platforms. Metro Bank is going down this route as evidenced by their deal with Zopa.

Metro Bank is happy to lend direct if the collateral is a house aka mortgage lending and are aggressive on the rate they offer for residential mortgages.

If Metro Bank can get a low cost of capital via Deposit growth by using physical branches they will be onto a winner. As an investor that is the one metric worth tracking.

UK Economy Post Brexit?

Two features offered by Metro Bank indicate an entrepreneur who understands that the UK works in a global economy:

  • You can withdraw cash or pay by card anywhere in Europe without being charged a fee.
  • Metro Bank is the only bank that uses MasterCard’s market conversion rate. This is the rate that banks themselves trade at, so there is no need to use a broker.

The FTSE 100 goal

Vernon Hill does not lack for ambition. He has declared a target of getting into the FTSE 100 as per this report.  This is not just about bragging rights. FTSE 100 status brings in new investors. He states the bull case clearly:

“We are very close to one million accounts in a country where people say no one switches bank accounts. If we only get 5 per cent of the British deposits market, that is £100 billion. If you value the bank at about 20 per cent of that, you are looking at a £20 billion company.”

You have to take a man seriously who built Commerce Bancorp from scratch and sold it for $8.5 billion – netting him $400 million.

Neither Growth nor Value play

Many investors position as either a Growth investor or a Value investor. Metro Bank is neither fish nor fowl. That may make Metro Bank a good long term bet – they could be growth at a reasonable price. That may make it a good long term bet, but will constrain short term price momentum as it lacks an obvious story.

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