Welcome to Metropolitan Commercial Bank’s Second Quarter 2023 Earnings Call. Hosting the call today from Metropolitan Commercial Bank are Mark Defazio, President and Chief Executive Officer, and Greg Sigrist, Executive Vice President and Chief Financial Officer. Today’s call is being recorded. At this time, all participants have been placed in a listen-only mode, and the floor will be open for your remarks following the prepared remarks. [Operator instructions] During today’s presentation, reference will be made to the company’s earnings release and investor presentation, copies of which are available at mcbankny.com. Today’s presentation may include forward-looking statements that are subject to risks and uncertainties that may cause actual results to differ materially. Please refer to the company’s notices regarding forward-looking statements and non-GAAP measures that appear in the earnings release. It is now my pleasure to turn the floor over to Mark Defazio, President and Chief Executive Officer. You may begin.

Thank you. Good morning and thank you for joining our second quarter earnings call. The first six months of this year was a very interesting but disruptive time. Bank management teams were challenged to prove how prepared they were to manage their business and balance sheet in a sustained high-rate environment. It's clear there is no quick fix to this problem if you came into the year unprepared. Thin and growing opportunities will continue to secure more organic market share, driving material shareholder value. I believe that identifying these well-prepared banks will be easier than in the past, and the focus will be on true fundamentals and a strategy to produce sustainable shareholder value. I am pleased with MCB's second quarter as well as year-to-date results. We continue to achieve critical objectives, including but not limited to, demonstrating margin stability, driving lower-cost funding, reducing the reliance on higher-cost borrowings [technical difficulty]. What has been evident in MCB's fundamentals is that we have absorbed a portion of this compression by managing a diversified earning assets balance sheet that allowed us to maintain lending spreads as well as various deposit verticals that continue to drive lower-cost core funding. It is important to recognize that MCB caused more margin compression than we would have experienced to date by deciding to offload 100% of crypto deposits. In 2022, MCB moved off balance sheet a total of $754 million in zero-cost deposits from their peak at June 30, and year-to-date, June 30, 2023, we moved off an additional $436 million of crypto-related deposits as well as having the ability to absorb the temporary margin compression that came with replacing these deposits. Looking forward with the addition of lower-cost deposits that are coming in from the new verticals we have announced in the second quarter, along with the many diversified core deposit verticals we already have embedded into the franchise, we are very close to at an inflection point where NIM compression from replacing crypto deposits with borrowings will transition to expanding net interest margin as we efficiently replace those borrowed funds with lower-cost deposits and maintain our discipline on low pricing. I am confident about the future of MCB, and I believe executable opportunities for MCB will continue to emerge from the disruption the industry will continue to experience. I will now turn the call over to Greg, who will share some specific results with you.

Thank you, Mark, and good morning, everyone. While the second quarter was a turbulent one for the industry, MCB had a very strong quarter for deposit and loan compression verticals; thanks to the dedication and hard work of the MCB team in what was a very challenging time for the industry. Net inflows were particularly strong for retail deposits, including those with loan customers, which collectively were up nearly 13% in the quarter, reflecting growth from both existing and new customers. Crypto deposits were substantially reduced by $220 million in the quarter. What remained at quarter end was $58 million of corporate and reserve deposits with crypto-related companies, which we expect to be fully transitioned away from MCB within the next few weeks. While borrowings were utilized to manage those expected outflows, growth of our deposit verticals has allowed us to reduce borrowings from an average balance of $597 million or 6% on $425 million of loan production. Notably, loan pay-down and pay-off activity occurred largely early in the second quarter, while loan closings generally occurred late in the quarter. Combined, this had an obvious muting effect on net interest income in the quarter. New loan production came in at an average yield of 8.19% versus a portfolio rate for the first quarter of 6.34%, as we have stayed focused on our pricing discipline. While we did see 42 basis points of net interest margin compression in the quarter, replacing non-interest bearing crypto deposits with borrowing did drive half of that compression. The remainder of the compression came from the impact of rising short-term market rates on deposit costs and balance sheet, thanks to the success of our historical funding strategies and strong capital levels, which demonstrates the strength and stability of the franchise. Asset quality remained strong. Loan growth drove the majority of the second quarter credit provision, with the remainder being driven by macroeconomic factors in our CECL model. Our global payments business also performed quite well in the quarter, with revenues from non-bank financial service companies up 21% from the first quarter of 2023, as our partners continue to hit their stride. Within that growth, we are particularly pleased to see corporate disbursement client revenues up 27% in the quarter. Overall, non-interest expenses remained very well managed, but I do want to give color on a few items. The decline in compensation of benefits largely reflects the first quarter seasonality in employer taxes. Looking ahead, we do expect to continue our investment in human capital and technology. We do expect professional fees to revert back to historical levels. While legal fees were elevated, outside counsel engagement on open matters wounded down in the second quarter. We've also been making investments in several corporate initiatives including strategic planning and technology consultants, which will being winding down in the third quarter. Collectively, we would expect approximately $2 million to drop out of the run rate or professional fees in the third quarter of 2023. Lastly, there was a discrete item in the quarter that increased income tax expense by $1.7 million. We will see a discrete tax benefit of $1.7 million in the third quarter on the conversion of stock awards that have already occurred. Going forward, we would expect the effective tax rate to be in the range of 31% to 32%, excluding discrete items. And I will now turn the call back to Shelby for Q&A.

[Operator instructions] We will take our first question from Alex Lau with JPMorgan.

Hi, good morning.

Good morning, Alex.

Greg, last quarter you mentioned you thought the NIM could get back to the 1-2 level, call it 380 to 390 range. Is it fair to assume that with NIM expanding for the next two quarters, we could see that move back to that level or has that exit rate changed? Thanks.

I think it's possible, Alex. Obviously, the balance sheet is still slightly liability sensitive. So that rates would be a bit of a headwind going forward. If we have 25 bps next week, that's one conversation. But to me, it's really the uplift is going to come from a combination of asset yields. Obviously, we've had a lot of success maintaining loan yields in the quarter. We expect that to continue. We are taking $20 million to $25 million a quarter of investment securities, which are rolling off at a very low rate, putting those into loans at a higher rate. I think getting back to that level is going to be dependent upon what we think is very possible, which is continuing to bring in low-cost deposits, particularly from our new verticals, which will come in at a much lower rate. So I think we can get back to that level, if not in the fourth quarter, then very early next year, first quarter. I think, to Mark's point, though, on his prepared remarks, we are at that inflection point. I really think if we haven't hit that floor, we'll hit that floor early in the third quarter and with the build in the low cost deposits I think we get back up to that the prior rate pretty quickly, but this is the marathon right now to sprint for us and we are looking to do it over a couple of quarters.

I wanted to move on to deposits. So non-interest-bearing deposits were down $400 million, half of that coming from crypto-related. On the other half of the $400 million, where did that come from in terms of deposit verticals? And has this shown any signs of moderating?

Frankly, it was just normal flows in the quarter. Some of that was coming from retail clients, especially commercial lending clients, as they've deployed liquidity. So it kind of came across a number of different verticals, Alex. And it wasn't repricing -- wholesale repricing of DDAs into interest-bearing. So it was really more of a timing issue. I think some of that will come back in normal course as DDAs again, but whereas I kind of part through it, I didn’t really see any red flags or any story lines to pull forward for you.

Thanks. And you mentioned you had good quarters on the retail and loan customer segments. Can you give some colors in terms of the rates that you're paying on those balances that you brought on board?

As you know, we don't publish our money market rates or rates on individual customers. I would say we brought it in well inside of what our borrowing costs would be. So if we were out with our borrowings, that fund's effective, plus a spread, we'd be well inside of that. I think as part of that, you would see just naturally, and not just the growth in the quarter, but we certainly had rates up in the first quarter and second quarter. You'll start to see -- continue to see a little bit of just pull-through in the cost of funds or cost of deposits into the third quarter, but again, I think it's going to be offset very well by what we're able to do on the loan pricing side.

Thanks. And you mentioned in the last few months you've added a couple of deposit gathering teams, the EB-5 teams, title and escrow and charter schools. Can you give some colors on these deposit opportunities with these teams? And when should these deposit gathering pick up and contribute and if you could also touch on briefly about the type of costs are associated with these deposits. Thanks.

Hi, Alex. It's Mark Defazio. Each and every one of them have now started to contribute to that increase in deposits in the third quarter. We've been working on these new channels for quite a while. So as we've reported in the past, we get a return on investment pretty quickly at this stage of our operating efficiency. So we're very optimistic. The one item you didn't mention was our 1031 entitled Escrow as well is really hitting their stride, and we're doing a fair amount of technology integration. So we have the human capital in place. We're doing the legal framework around these structures, which are fairly complex as well. And we are doing a technology integration which is required as well to be very competitive. So I think, we're not sure if we're going to report specifically on these outlined items in the third and fourth quarter and beyond, but we do believe they are going to be meaningful and can assist us with going back to our traditional funding strategy, which is very, very core and relies very little at a minimum level to borrowed funds. As I said, in the first quarter, we would expect by yearend to be back at the original levels of borrowed funds than we were when we came into 2023. So we're optimistic. And all in on the cost, and, Greg, keep me honest here, I think they'll be well on the inside of our total deposit costs tonight.

Yeah, I agree with that.

Thanks for all that color there. And then just one on loan growth; you're close to 100% loan to deposit ratio now. How do you think about loan growth for the rest of the year considering you are at this 100% mark? Are you comfortable running above 100%? Thanks.

I am comfortable at running above 100%, but as we have been talking, this six months was a disruptive six months, and we relied more on borrowed funds than we have in two decades. So I think, as I just mentioned, we will go back to normal trends. So I would expect you will see that number stay south of 100% in the future.

Yeah, and, again, I think we've said in this conversation before, if we thought that if we didn't have the ability to grow our deposit verticals and to bring in the new verticals, which will contribute significantly over the balance of the year, Alex, I think that might be one conversation that might lead us down the path of slowing down loan growth. But the reality is we see the runway not only to fund loan growth, but to also significantly reduce the borrowing balances over the next quarter or two. So we're comfortable at a short term, in a moment in time, being closer to 100% on that loan to deposit ratio because I think over the next several quarters, whether it's two to four quarters, I think, to Mark's point, that will come down to a more historic level.

Thanks. And then just on the GPG Group, the fee income was up nicely in the quarter. Is there anything one time in nature in that increase, or was that mostly a transaction volume related?

It was mostly last transaction related volumes. There is always quarter-on-quarter, you might have a little bit of just contractual revenues peak into it. There might have been a little bit of that. But, frankly, on balance, it was really just transaction revenues, Alex.

Thank you. And then this last one from me. On the GPG deposits, it's been holding in that $700 million range in deposits. Is this still a deposit growth vertical for you in the near term, or is that expected to be in that similar range moving forward?

Well, I think it is still a deposit growth vertical for us. And this goes back and ties into your question on non-interest bearing deposits. It's the one vertical where it's very active flows. We see a fair amount of them announced in that vertical. Average balances for the quarter, I got to tell you, we're definitely above the spot at the end of the quarter. And again those are non-interest bearing flows that kind of came out as well near the end of the quarter. So, it's absolutely a growth vertical, as we think, longer term.

Thanks for taking my questions.

You're welcome, Alex.

And we'll take our next question from Chris O’Connell with KBW. Chris O’Connell: Hi. So just wanted to circle back on the GPG fee question; I think in the second quarter, about $1.5 million was identified as being crypto related within the $5.7 million GPG fees. Does that fully fall out next quarter, or does some of that stick around? How should we be thinking about kind of the new baseline level starting in 3Q?

Yeah, having that business wound down by June 30th, Chris, you'd expect that to go zero for the third quarter. Chris O’Connell: Okay, great. And then, I appreciate the color on the loan deposit ratio and the overall growth. Obviously you guys have had, strong growth this quarter, and now are getting the deposits to be able to effectively fund that going forward. How are you thinking about the level of balance sheet growth overall on the loan and deposit side into the second half of the year? Are the pipelines winding down a little bit or slowing, given the broader economic environment or just how are you thinking about the overall balance sheet growth as a whole?

Yeah, so the pipeline is still fairly robust. Times like this are very opportunistic also, notwithstanding some of the obvious headwinds in various different industries or real estate asset classes. Our clients are very active across the franchise. They are very opportunistic. So I think we're finding the right deals to involve ourselves in. So I think historical, I think our balance sheet growth will be in line with what we have said in the beginning of the year, closer to historical trends. I think the second half of the year they will be even more cost-funded than they were for this quarter. And as I said, as far as the funding, ultimately we expect our borrowings to be at or even less than where we were when we came into the year in January. So we're really optimistic. Again, we're not growing for the sake of growing. If we're not getting the net interest margin and the operating efficiencies by leveraging our capital, we just won't do it, but we clearly are demonstrating that stability. Chris O’Connell: Okay. Got it. And you mentioned, obviously the securities yield is still really low. It should migrate pretty substantially upward over time. I was just trying to think about the timeline of how that occurs. If you can give any color around kind of end of the monthly or quarterly portfolio cash flow and how quickly that can kind of turn over that way?

Yeah quarterly, we're seeing somewhere between $20 million and $25 million of principal cash flow coming off the portfolio, Chris. So it's still a fairly -- these interest rates are still a fairly long-duration book. At points in time, we've looked at maybe doing some restructuring around it. I don't see that being imminent. We might be opportunistic down the road as rates start to come back down in terms of rebalancing the portfolio, but frankly I don't see that in the near term. So in the meantime, that cash flow coming off the portfolio is just going back into the pool to be deployed into lending at a much more attractive rate. Chris O’Connell: Okay. Yes. Makes sense. And, I think you said in 3Q the professional fees should benefit about $2 million downward, but, they're showing the overall expense growth. On a net basis, do you have an idea as to whether, you think overall expenses will be up or down in the third quarter? Just how you're thinking about kind of expense growth going forward, recognizing that, you guys have hired a bunch of teams at different points throughout the past quarter. So I'm just trying to see what the new starting point might be there.

Yeah, no, once you've normalized for that professional fee, the $2 million run rate, when you think about the rest of the lines, I think profit and benefits is the one where you're absolutely going to continue to see the investments coming through from what we're doing with human capital, Chris. I think if you look at that and you kind of look at our trends over the last, historically last, call it six to eight quarters before this, that will give you a pretty good idea how we're going to look there. I think the teams that have come on are going to take some time to ramp up, but I think that will get reflected in that run rate as well. As you always hear us talk too, we don't focus on the efficiency ratio. We're much more focused on driving RoTCE and the expense base it takes to get there is just part of the sausage making, but I would tell you in the quarter, the efficiency ratio was obviously elevated just given both the little bit of compression that happened on the net interest side, combined with the elevated professional fees. The first six months of the year, we're still right around 50% on the efficiency ratio. We do a very good job managing expenses. So I think the other lens you should look at is -- look through is, over the next several quarters, we're going to continue to push that efficiency ratio back down toward the historic levels, which are more, in that mid-40s, so call it 45% to 47%. That's what my goal would be. Chris O’Connell: Okay, really helpful. And then as far as the human capital you mentioned, and, you guys have obviously hired a bunch of teams and deposit-related. How are you thinking about opportunities going forward? I know that you're always looking, but is there any, specific types of teams that you are seeing opportunities with or having discussions with? Have those opportunities kind of increased or decelerated over the past few weeks, given the immediate opportunities that were present after the M&A disruption last quarter?

Yeah. We're not out there seeing any new teams. Obviously, we're open to new opportunities, but I think, our plate is fairly full right now, and we want to get the real value out of the new partners we've brought on and really give them the attention and time and resources to get into the market. These are not simple business lines. They are very much aligned alongside of our core competency, and that's something else that everyone should keep in mind with we're not the type of franchise to bolt on just teams for the sake of adding people or products. We try to leverage off of our core competency. So what we announced in the first quarter is standing up quite well. I think you're going to see material contributions going forward, but our focus right now is to assist those teams in being as successful as they possibly can. So we're not interested in any other distractions, but obviously we're open to an opportunity if it falls in front of us. Chris O’Connell: Okay. Yes. And on the credit side, everything was very clean this quarter, not much movement around at all, and obviously net charge-off super low. I mean, how are you guys, what are you guys seeing within your portfolio? Is there any signs of stress anywhere that you're keeping a close eye on? As far as loan demand or, desire to put on loans, is there any particular areas that you're seeing that are still attractive versus shying away from? And anything that you're seeing, from others in your local markets that are, I guess, concerning on the credit side?

Yes, Chris, it's not an all or nothing. MCB has always been in the market, and career-wise, I could probably speak to most of our more senior stakeholders on the lending side. We're always in the market. The question is finding the right spot and with the right sponsor around what deal in real estate or what industry we want to support. So we're just very careful. We're just more careful than we are conservative. And are we paying more attention today as it relates to certain asset classes in real estate as opposed to an industry in the C&I side? Yeah, of course. But we've noticed that a long time ago. We've noticed some of those tealeaves or what you can call weaknesses and concerns. So it doesn't mean we exited those industries or those asset classes. It just means that we have to look at them a bit differently to lean on the side of being more careful. And clients understand that as well. There's a lot. There's scarcity value today to liquidity that's out there for a lot of different reasons. So we're filling that void as well. So the pipeline is full. We're very careful. I'm very happy with our independent risk management process around managing the portfolio, stress testing the portfolio. I'm very pleased with that. It's fairly robust, as you know. And we continue to throw a lot of resources behind the risk management side of the business. So I'm opportunistic that, we can continue to manage the portfolio and manage the new business we bring on well. Chris O’Connell: Great. Thanks for taking my questions.

This concludes the allotted time for questions. I would like to turn the call over to Mark DeFazio for any additional or closing remarks.

Thank you. I'd just like to take a moment to thank everyone. I would like to thank all of our investors who have hung in there with us during this challenging time. And for those, who have increased their positions for their continued confidence in MCB. For the new shareholders that came in at a very attractive entry point, welcome to MCB. I would also like to thank our entire MCB team and our directors, who continue to step up and recognize the challenges our industry face and what it takes to keep MCB a top performing and relevant financial institution. Thank you again. And I look forward to our next call.

This does conclude today's conference call and webcast. A webcast archive of this call can be found at www.mcbankny.com. Please disconnect your line at this time and have a wonderful day.