• The firm will likely benefit from a hike in interest rates
• In the 2021 calendar year, pre-tax losses narrowed from £311m to £245m
• It sold its residential mortgage segment to NatWest in February 2021 for around £3bn 

Metro Bank (LSE:MTRO) has seen a volatile share price in the past year. The high street retail and commercial bank, which was founded in 2010, saw its price falling 36% over the past year. And it’s down 20% in the past month. It currently trades at 80p. With this recent price movement, I want to know if I should be buying shares in the company to add to my long-term portfolio. Let’s take a closer look.

Interest rates and other factors

Given that interest rates are important for Metro Bank’s revenue, because it’s a lender, it makes sense to briefly look at their impact. For the last 15 years, interest rates have never exceeded 6%. In fact, they fell to just 0.1% when the Covid-19 pandemic hit the economy. 

The Bank of England recently raised rates to 0.5% and this may increase further in the near future, even though they remain well below that 6% figure. More interest rate hikes would tend to positively impact the Metro Bank share price. In addition, RBC analysts recently said they expect the firm to break even by 2023 at the earliest.

Metro Bank was the centre of an accounting scandal in 2019. This has been a grey cloud over the share price in recent years but finally concluded in December 2021. It was forced to pay a fine of £5.38m to the Prudential Regulation Authority, the UK financial services regulatory body. With this issue now resolved, I would feel more comfortable buying shares.

Recent results and the Metro Bank share price

The company’s historical revenue progression is rather solid. Between the 2017 and 2021 calendar years, revenue grew from £293m to £418m. Furthermore, in the annual results for the 2021 calendar year, underlying revenue increased 17% from 2020. 

In addition, pre-tax losses narrowed from £311m to £245m. This has all been a result of cost-cutting efforts by management. That includes closing some of its 78 branches. It also sold its residential mortgage segment to NatWest in February 2021 for just over £3bn. This is all aimed at creating a platform for further growth in higher-yield lending operations. It’s worth noting, however, that any further Covid-19 lockdown could dent these growth plans.

Furthermore, the cash balance at the 2021 year end was £3.5bn. As a potential investor, it’s heartening to see an increase from £3bn the previous year.

The historical Metro Bank share price makes it easy to see the difficulties the company has faced in recent years. As it builds back its credibility after the accounting scandal, results also appear to be improving. While I won’t be buying today, I won’t rule out a purchase in the future if results continue on the current trajectory. 

Shares in Lloyds have produced a 2% return excluding dividends over the past year.

Even after the recent market volatility, shares in many financial institutions have outperformed over the past 12 months as interest rates have started to move higher. Higher interest rates will allow these companies to charge more to borrowers, boosting their bottom lines.

After more than a decade of ultra-low interest rates, this could bring some much-needed interest rate relief to the sector. 

Unfortunately, it looks as if the Metro Bank share price has missed out on most of this performance. The question is, why? 

Metro Bank share price challenges 

Ever since the company’s accounting scandal several years ago, the bank has struggled to regain investor confidence. In 2019 the group announced that it had misreported the value of its commercial loan portfolio. The corporation lost a number of senior managers as a result of this error and had to raise additional cash. The lender’s reputation also took a significant hit. 

Soon after this accounting error was announced, the coronavirus crisis began. The crisis had a significant impact on the company’s growth plans. 

And it looks as if the crisis has left scars on the group. 

According to the company’s 2021 financial update, while revenue increased by 17% in the year, overall operating costs only declined by 1%. As a result, the enterprise reported a statutory loss before tax of £245m. It is also expecting further fines from regulators over its accounting error. 

Metro Bank’s growth has also taken a hit after the business disposed of its mortgage arm. This was part of its plan to recover from the accounting error. By shifting away from mortgages, the company would be able to target higher-margin personal loans. That was the theory anyway. 

This means the company missed out on last year’s housing market boom, and it has its work cut out to restore lending margins and profits. 

Missing out

Considering all of the above, it is clear to me why the Metro Bank share price has underperformed over the past 12 months. The company has made a series of strategic missteps. It is going to be some time before it regains the market’s confidence. 

Still, rising interest rates could act as a significant tailwind for the business. If management is able to navigate the current economic turbulence and capitalise on higher rates, the company’s sales and profits could recover. This is something I will be keeping an eye on over the next few years. 

However, for the time being, considering the company’s troubles, I am not going to add the stock to my portfolio anytime soon. I would like to see further progress on the turnaround before buying in. 

That said, these investments can turn sour very quickly, so I have to keep a close eye on their operations. With that in mind, here are three penny stocks I would buy today for their growth potential. 

Cheap penny stocks 

The first company on my list is the hospitality operator Marston’s (LSE: MARS). After the challenges of the pandemic, it looks as if the business is bouncing back.

According to its latest trading update, sales during the 16 weeks to 22 January were down just 3.6% compared to 2019 levels. However, before the Omicron variant emerged, like-for-like sales in the eight weeks to 27 November were 1.3% above 2019 levels. 

The company is having to deal with some challenges that could hold back this growth recovery. Inflationary pressures could increase costs for the group and customers, hurting sales. 

These numbers appear to show that without restrictions, Marston’s has the potential to return to pre-pandemic levels of sales and profits.

Still, despite this potential, the stock is selling around 30% around pre-pandemic levels. I think this presents an opportunity for long-term investors. That is why I would buy the shares for my portfolio of penny stocks today. 

Building the recovery 

Specialist building products supplier SIG (LSE: SIG) has struggled to earn a profit since 2015. The group has lost more than £400m since 2016. 

Thanks to the booming European construction market, analysts believe this will change over the next two years. The City has pencilled in a group net profit of around £10m for the 2021 financial year and £18m for 2022. 

Yet it looks as if the market doubts the company’s potential. And I will admit I think there is a strong chance it will miss the projections. After five years of disappointment, the company needs to pull out all of the stops to convince the market it is back in business. Inflationary pressures and the supply chain crisis will not help matters. 

Despite these challenges, I would acquire this business for my portfolio of penny stocks as a speculative recovery play. If it can return to the black over the next two years, investors could return to the shares and drive a re-rating of the stock. 

Rising interest rates

Metro Bank (LSE: MTRO) only recently entered the realm of penny stocks. The company was once one of the most sought after businesses on the London market. But after a string of scandals and disasters, the shares have plunged. 

Nevertheless, I believe the outlook for the banking sector as a whole is improving as interest rates start to rise. Higher interest rates will enable lenders to charge borrowers more, boosting their profit margins. 

Metro’s main challenge now is to reduce costs far enough for rising rates to have a material impact on group profit. If costs begin rising faster than interest income, the lender could struggle to return to growth. 

Despite this headwind, I think the combination of the economic recovery and rising interest rates provides a very favourable environment to support the business’s comeback in the next few years. 

The fall has erased most but not all of the 25% rise in the Metro Bank stock price after the approach from Carlyle was made public on 4 November 2021. 

The Metro bank takeover is off

The timing of the announcement from Carlyle is perhaps a little odd. The consensus opinion was that Carlyle was interested in Metro Bank because the Bank of England might raise interest rates soon. Metro Bank has been struggling to generate profits owing in part to low-interest rates. Yesterday saw the publication of inflation numbers for the UK. Inflation has risen over 4%, well above the Bank of England’s target. Higher than expected inflation combined with the robust labour market numbers reported this week make a rate hike more likely.

Yet, Carlyle has walked away, and the Metro Bank share price has crashed. Since neither party has given any reasons for the talks ending, I can only speculate. Perhaps the Metro Bank board increased the price at which they were willing to consider selling the business on the back of the inflation report, forcing Carlyle to walk away. Maybe the Metro Bank board did the walking after deciding that a private equity firm would be a poor steward of the company.

Challenger banks

This is not the first deal to fall through that involves a challenger bank. In October, J Sainsbury decided against selling its banking business after interest from private equity firm Centerbridge Partners. Sainsbury’s said that the approaches did not “offer better value for shareholders than would be realised through retaining Sainbury’s Bank“.

Two rejections of takeover offers might suggest that the private equity firms are offering less than the challenger banks think they are worth. Again, this is speculation, but where could an idea like this come from? Well, if I look at challenger bank Revolut, I see it has a market cap north of £25bn on annual revenues of around £220m. Metro Bank has a market cap of £228m on revenues of £460m. Of course, Revolut is not a public company, so comparisons are tricky, but the difference is pretty stark.

But Metro Bank has a lot of branches (so does Sainbury’s, but it can add them onto existing stores). Revolut is entirely online and app-based. Metro bank has been growing revenues at 30% per year on average over the last five years, whereas Revolut has managed 226%.

Metro Bank share price crash

I may never know what caused the takeover talks to end. All I do know for sure is that the Metro Bank share price rose when they were announced and crashed when they finished. That suggests investors would have been happy being bought out. Perhaps, that is not surprising given the poor share price performance over the last couple of years.

This has thrown up some exciting opportunities, which may not be suitable for all investors. Indeed, the companies I’ve outlined are turnaround opportunities. Unfortunately, more often than not, turnarounds fail to turn around. 

Still, despite the risks involved, I’d buy the three UK shares outlined below for my portfolio today as recovery plays. 

UK shares to buy now

The first stock is the manufacturer and supplier of plastic and foam packaging products, Essentra (LSE: ESNT). Shares in this company crumbled at the beginning of 2020 after it reported a near-80% decline in earnings for 2019. 

It’s now trying to put this lousy performance behind it. For the six months ended 30 June, revenues increased 7.5% on a like-for-like basis. Adjusted profit jumped 34%, and adjusted basic earnings per share rose nearly 40%. 

These figures tell me Essentra’s heading in the right direction. Nonetheless, the company has its work cut out to restore investor confidence. It’s also built up a considerable level of debt during the past 24 months, which could hold back recovery. 

Despite these headwinds, I’d buy the stock for my portfolio as Essentra moves forward and builds on its recent growth. 

Property regeneration

Another company I’d buy for my portfolio of UK shares is U and I (LSE: UAI). It’s clear the UK’s facing a structural property shortage, and one way to alleviate this could be to convert old properties. This is U and I’s specialism.

The company partners with local authorities and long-term capital providers to help regenerate city centre locations. 

Recently, the company has undertaken a review of its operations. Management has set out goals to reduce costs and increase output as well as reducing debt. I think these changes will put the business on a solid footing to capitalise on the growing demand for real estate development in the UK. 

That said, there’s no guarantee U and I’s restructuring will lead to profits for the group. Property development can be time-consuming and costly if the project isn’t managed correctly. If projects overrun significantly, the developer may encounter financial problems. 

However, I’d buy this company for my portfolio of UK shares, considering its recovery potential. 

Financial services

The final stock I’d acquire for a recovery portfolio is Metro Bank (LSE: MTRO). This company’s quite risky. In recent years, it’s struggled to earn a profit. And regulators have reprimanded it for failing to account for risk on its balance sheet correctly.

These challenges have really hurt its reputation among investors. However, from a customer point of view, Metro offers something most banks don’t. Its branch network and focus on customers over profit really stand out.

In a world where its competitors are slashing costs and removing branches from town centres, I think Metro has the edge. As such, I think if the business can get past the challenges outlined above, I think it could make a solid recovery play in my portfolio of UK shares. 

A sad tale

For Metro Bank, the issues started before the pandemic even began. In early 2019, it was revealed that there was an accounting issue regarding different types of loans. In short, the bank classified millions of pounds worth of loans wrongly. This meant that they had a lower risk rating than they should have. With tight regulations on the level of risky loans to bank capital, investors were worried new funds would need to be raised to give more of a capital buffer.

This issue caused the Metro Bank share price to fall from 39% in a day. Since then, the trend has been downwards. From trading at levels around 2,200p at the start of 2019, it opened 2020 at 200p. Then came the pandemic!

Although it recorded 11% growth in deposits last year, overall results were poor. Like most banks, it recorded a loss, in this case of £271.8m. The estimated hit from Covid-19 was £124m, with around £100m of this being expected credit losses. This shows to me that even without the pandemic, the bank would have likely been loss-making anyway.

With this being the case, the share price continued moving lower last year, reaching 58p in October.

Could the Metro Bank share price reach historical levels?

When I look back to the share price levels of 2,000p+ in 2019, it’s incredible to think about the level of the fall in a fairly short period. The shares currently trade around 94p. So this could be a great long-term value play.

One reason this could be the case is because of the tide turning. H1 2021 results were released last week. Adjusted underlying revenue was up 14% versus the previous half-year and up 47% year-on-year. The disposal costs of the mortgage portfolio did see the company record another loss for H1, but I think this is a step in the right direction. Since the issue back in 2019, reducing exposure to this area, I think, is a positive.

On the flipside, the Metro Bank share price could be a value trap. Competition in the banking space is high, particularly in retail and corporate banking, which are the two main areas Metro operates in. Add into the mix new competitors including Starling Bank and Wise, and this space is only going to get harder. As Metro Bank is starting on the back foot anyway, it might find it hard to tackle such competition.

On balance, I do see value in the Metro Bank share price sub 100p, but I think it could still head lower before bouncing. Therefore, I’m not going to buy the shares now, but am putting it on my watch list.

So is this a buying opportunity? I don’t think it is for me. I reckon the Metro Bank share price could be set for a further decline. Here are my reasons.

Turnaround

Daniel Frumkin was appointed as the bank’s new CEO in February 2020. After completing a review of the business, he set a plan to turnaround the bank and return it to sustainable profitability.

This consisted of five strategic priorities that he believed would deliver shareholder value. In short, these include: cost and revenue initiatives, improving infrastructure, balance sheet optimisation, as well as clear internal and external communications.

Well, it’s one thing saying something and it’s another actually delivering the goods. Not only did Frumkin have the pressure of carrying through his goals for the bank, but a few weeks after he had to contend with the challenges of Covid-19. So I think it’s safe to say that he had his hands full.

The strategic drivers and the transformation plan are still intact. But let’s just say that the pandemic got in the way and the bank has had to adapt just like any other business.

Loss-making

As I said, the Metro Bank share price has fallen since the start of the year. But I’m not really surprised as it has been unprofitable for some time. It made a loss of £311m in 2020. And in 2019 the bank also made a loss of £131m.

In fact, the loss last year was lessened by the sale of its £3.1bn residential mortgage portfolio to NatWest. This disposal was in line with its strategic priorities as it’s looking to move towards higher yielding assets.

But let me be frank, two years of losses doesn’t help boost investor sentiment. And this has placed pressure on the shares. Even though it has a turnaround plan, the firm continues to face headwinds and has to endure the costs that come with transforming the business.

I’m fully aware that this change isn’t going to happen overnight. And it could overhang the stock. I reckon the Metro Bank share price may deteriorate even further.

The plan

But it’s not all doom and gloom. As I mentioned, there’s a plan and it’s sticking to its five strategic priorities. The bank is focusing on higher yielding assets and differentiating itself from its competitors.

It shifting its lending towards specialist mortgages as well as small business and retail unsecured loans. Metro Bank also acquired RateSetter as part of its goal to grow its unsecured lending business. This offers the bank a scalable solution to reach new customers as well as improve its brand awareness.

My view

I don’t think the challenges are over just yet but the company is taking the right steps. It still has a tough road ahead and I think this could place pressure on the Metro Bank share price going forward.

In my opinion, it really hasn’t demonstrated that the turnaround plan is working yet. Until I see this evidence, I’m steering clear of the shares.

As such, the returns are flattered by the positive market performance since then. If we go back to the beginning of 2020, before the pandemic spread around the world, the stock was trading for around 200p. This implies shares in the bank have declined just over 50% since the beginning of 2020. 

So, what’s going on with the Metro Bank share price? 

The Metro Bank share price stands out

Something that stands out about the company’s recent performance is that, compared to other lenders, the group has substantially underperformed.

Over the past 12 months, shares in Lloyds have returned 55%, and shares in NatWest have returned 69%, excluding dividends. Metro has underperformed its larger peers by 63.9% and 77.9% respectively. 

These returns suggest the company is struggling from issues specific to itself rather than the broader economic performance. 

Looking through the company’s figures, it seems clear to me why the business has failed to win over the support of investors. Last year, the group lost £311m. That followed a loss of £131m in 2019. Higher loan impairment charges and a lower net interest margin (the difference between the rate of interest the bank charges to borrowers and pays lenders) both hurt profitability last year. 

Unfortunately, it doesn’t look as if the group is going to return to profit anytime soon. City analysts have pencilled in losses for at least the next two years. While these are only projections at this stage, I think they show the scale of the business’s challenges right now. 

Furthermore, as the bank continues to lose money, it’s technically shrinking. It seems to me this is the primary reason why the Metro Bank share price has been falling. And it could continue to do so if the business continues to lose money. 

Growth plans 

Still, management is being proactive in looking for new growth avenues. Last year, it agreed to acquire RateSetter, as part of its strategy to reach new customers and increase loan volumes. Management is also trying to reduce costs, recently closing its central London office. 

It’s also well-liked by consumers. Last year, the bank was awarded ‘Moneynet Banking Brand of the Year 2021’ and ‘MoneyAge Bank of the Year 2020’. Its large peers can only dream of winning such awards. 

As such, Metro Bank has its strengths, but the company continues to lose money. This is probably the biggest challenge the enterprise faces right now. Getting out of its loss-making cycle will take time.

Until then, I reckon it’s likely the Metro Bank share price will continue to decline. With this being the case, I wouldn’t buy shares in the enterprise right now.

Despite this poor performance, some encouraging trends did emerge. And even with this recent decline, the Metro share price is still up around 40% compared to a year ago. So, is this an opportunity to buy the stock at a discounted price? Let’s take a look.

A popular high street bank

Metro is a bank that offers services to the retail, business, commercial, and private sectors via a network of 77 locations throughout the UK. The firm, which has 2.2 million customers, sees its strong focus on customer service as part of its unique selling proposition (USP). And it has won multiple awards for doing so, including Bank of the Year at the 2020 MoneyAge Awards and Banking Brand of The Year at the 2021 Moneynet Personal Finance Awards.

The impact of Covid-19 caused some severe disruptions to Metro’s cash flow. After all, the bank makes money by charging interest on loans. But due to the lockdown restrictions, many of its customers weren’t able to keep up with payments.

Yet despite this, Metro was able to stay afloat without taking on any additional debt. Instead, it sold £3.1bn of mortgages to NatWest Group for a small profit. This surge of capital undoubtedly helped mitigate the impact of the pandemic. But it has also enabled Metro to change its strategy and focus on more profitable products in specialist mortgages and unsecured lending.

As such, CEO Daniel Frumkin is forecasting Metro will become profitable by 2024 and has recently bought £1.1m of Metro shares. While this certainly sounds promising, there are some risks to consider.

Is the Metro share price a value trap?

Banks are pretty complex businesses and are quite tricky to value. Based on the latest results, Metro has a net book value of £7.49 per share. That’s almost 85% higher than the current share price. At first glance, this looks like a fantastic opportunity for value investors.

However, trading significantly under book value is quite a common occurrence for bank stocks. And in my experience, when the discount is as high as Metro’s, it indicates that the quality of the loans being made is questionable. Given that the bank has been unprofitable for most of its recent history, the low share price could be a red flag. 

The bottom line

Metro is heading in a new direction that may lead to profitability within the next five years. While it’s too soon to draw any conclusions, the preliminary forecasts for unsecured lending and specialist mortgage income do look promising.

But it’s worth noting the firm has run into trouble in the past. In 2018, an accounting scandal broke out, causing the Metro share price to plummet 90% by the end of 2019. Metro’s aggressive lending versus customer deposits brought the bank’s total capital ratio dangerously close to the minimum regulatory requirements. And that was even after numerous rounds of fundraising.

For now, I’m waiting to see how the company performs over the next year. And so I won’t be adding Metro to my portfolio today, even at its currently reduced share price.

Despite the bank’s widely-reported problems, I think it’s fair to say Metro Bank shares were too cheap back then.

But what about today? Valuing banks is never easy, but I’ve been taking a fresh look at Metro. I reckon there could be an opportunity here but, as I’ll explain, it still looks quite risky to me.

Why I’d buy Metro Bank shares

There are several things I like about this stock. In December, it sold £3bn of mortgages to NatWest Group at a slight premium to their book value. The cash raised from this sale enabled the bank to avoid issuing any new debt, which would probably have been expensive.

The sale could also help to create a more profitable business in the future. Frumkin says the cash will be used to shift the firm’s lending into more profitable areas, such as specialist mortgages and unsecured lending.

Competing with the big banks on mainstream mortgage lending is tough for smaller banks like Metro. I think that focusing on smaller, more profitable lending markets makes sense. It could be a good way for the bank to get back to profitable growth.

Another attraction is that, even at its current share price, Metro Bank still trades at a discount of around 80% to its last-reported book value of around 780p. Buying shares at a discount to book value is a traditional value investing technique that can generate big gains. However, it’s not without risk, as I’ll explain.

Metro Bank share price: too good to be true?

Before buying, I’d ask myself why Metro Bank shares trade so far below their book value. Are they cheap for a reason?

Broadly speaking, when a bank trades at a discount to book value it’s because the market is unsure about the quality and profitability of its loan book. Metro Bank’s track record certainly doesn’t fill me with confidence. The bank has lost money in six out of the last eight years.

Although Frumkin’s turnaround plan targets a return on tangible equity of 8.5% by 2024, that’s still a long way away. As things stand, City analysts expect Metro to report a loss of £132m in 2021 and £99m in 2022.

I don’t know how things will pan out over the next couple of years. But Metro Bank’s low share price suggests to me the market expects a slow return to profitability. I share this view. I think the bank still has a lot to prove.

In uncertain times such as these, I’d rather invest in banks that are already profitable and financially secure. For this reason, I don’t plan to buy Metro Bank shares.