By Iain Withers and Simon Jessop
LONDON (Reuters) - Metro Bank shares surged on Friday after it raised 375 million pounds to repair its balance sheet, giving the British bank breathing space ahead of a potentially fractious annual meeting next Tuesday.
The nine-year-old challenger bank's market value fell more than 1.5 billion pounds after disclosing in January it had under-reported the risk of its loan book by nearly 1 billion pounds, hitting its capital levels.
Shares in the bank jumped more than 25% on Friday following the successful fundraising. They are still below their value in January of more than 20 pounds.
The Bank of England welcomed the capital increase, saying the bank was "profitable and continues to have adequate capital and liquidity to serve its current customer base".
But Metro Bank's management remains under pressure and chairman Vernon Hill and some of his board are facing growing calls to resign ahead of the bank's annual shareholder meeting on Tuesday. CEO Craig Donaldson has previously offered to resign, but this was rejected by the bank's board.
Legal & General Investment Management, one of Metro's biggest institutional investors, said it would vote against Hill and others at the annual meeting.
Royal London Asset Management, said it would vote against the re-election of eight directors, including Donaldson and Hill.
Shareholder adviser Glass Lewis has also recommended investors oppose Hill's re-election, while another investor advisory service ISS advised them to withhold support from Hill and other directors, including Donaldson.
Earlier this month, a filing showed Fidelity Management & Research, once Metro Bank's second-biggest investor, had cut its stake by nearly a third.
In the fundraising prospectus published on Friday, there were signs the bank is starting to react to some of the investor criticism.
The bank disclosed Metro would stop using the services of InterArch, an interior design company owned by Hill's wife Shirley Hill, by the end of 2020.
Since it was founded Metro has paid InterArch more than 20 million pounds for work on the design of its branches, despite investors raising concerns about the arrangement.
Analysts said hedge funds scrambling to unwind short bets on Metro - one of the most shorted stocks in London before Friday's trading - was helping to power the rally in the shares.
Short bets involve paying to borrow the shares before selling them on to another investor, hoping to buy them back at a lower price before returning the stock to the original owner.
Data from Astec Analytics showed the cost to engage in this trade on Metro shares was the highest for at least 15 months on Thursday, with 9 out of every 10 shares available to be borrowed out on loan.
That helped to drive the rally on Friday as some funds rushed to buy back the shares in the market and return them, a so-called "short squeeze".
Nine funds had short positions equating to more than 0.5 percent of Metro stock at the end of Thursday, the level at which the British markets regulator demands disclosure.
Odey Asset Management's was the largest position, at 3.83 percent.
"Given a large short base, we could see some pricing support tomorrow (Friday), though we remain cautious on the longer-term outlook," Morgan Stanley analysts said late on Thursday.
Metro hopes the fundraising and Bank of England support will help to rebuild confidence with customers and investors, and allow it to proceed with plans to expand its branch network and increase its share of Britain's retail banking market.
But some customers have pulled their money out of the bank after media speculation about the company's financial health. On Thursday, Metro said the position was "stabilising".
British customer deposits are guaranteed up to 85,000 pounds if a bank gets into financial difficulties and post-financial crisis rules mean deposits can be moved to another bank more easily to ensure continuity of service.
Regulators have given no details on their investigations into the error or possible penalties or sanctions.
Goodbody analyst John Cronin said Metro still faced challenges.
"We don't know what the quantum of deposit outflows has been, we don't have any certainty regarding management longevity, and I believe the 2023 double digit RoE (return on equity) target is unachievable," he said.
(Reporting by Simon Jessop and Iain Withers; Editing by Rachel Armstrong, Jane Merriman and Mark Potter)