Description

Signature Bank (SBNY)

$137.30 (5/27/16) - SHORT

Signature is a rapidly growing but overvalued bank trading at 2.2x stated book and ~3x our base case estimate of normalized book. The bank currently earns an ROE of ~14%, which is above a through-the-cycle average. SBNY’s loan book is concentrated in multi-family and commercial real estate in New York City, which show signs of having peaked. Book value could be overstated by ~15%-35%+ given our position in the real estate and economic cycles, near record low loan loss allowances, and a troubled taxi medallion loan book. SBNY should also be negatively affected by rising short term interest rates, while growth should slow. Shorting shares represents an attractive risk/reward.

Signature operates a business banking model focused on multi-family and commercial real estate (CRE) in New York. CRE loans are typically low risk / low reward, especially in New York. While current spreads are only ~200bps above treasuries, charge offs have averaged below ~30bps. For the 65% of New York apartments that are rent-stabilized, rents and occupancy rarely go down – a loan underwritten based on cash flows should default very rarely. CRE loans are also cheap to originate and service. SBNY also makes specialty finance and C&I loans (including taxi medallion loans). Because of its focus on CRE loans, and because it doesn’t gather retail deposits, SBNY has an exceptionally low expense ratio that is half the average for banks of its size (32% vs. ~60%).

The downside to Signature’s model is low asset yields and less-sticky/higher cost rate-sensitive business deposits. While the cost of having rate-sensitive deposits has been minor in a zero-rate environment, it will be more apparent when rates rise. Despite having deposits and short-term borrowings which should reprice quickly, SBNY makes mostly fixed-rate 5 year loans, and invests in long-term securities with average maturities of ~10 years. Signature’s model relies on the term spread: a flattening of the curve would jeopardize the model, while a gradual parallel increase in the yield curve would be a drag on earnings for several years.

Despite the liability-sensitivity in Signature’s model, the bank has found a successful niche which should earn above average returns through the cycle (with above average duration risk compensated by below average credit risk). We think the bank can average 10%-12% ROEs through the cycle. Current ROE is overstated by at least 2% because the company is under provisioning compared to long-term averages.

The bank has grown deposits and loans at a rapid pace by hiring experienced bankers away from other banks, and offering them higher pay and a “low bureaucracy” culture.  Signature’s marquee hire was George Klett, who was recruited in November 2007 from North Fork Bank, which had been acquired by Capital One. Klett’s multi-family and commercial book represents ~70% of the loans at Signature and 75% of the growth since he was hired.  Growth in NY CRE was facilitated by the great timing of ramping up post credit crisis. Signature could lend in a hard market with a clean balance sheet while CMBS conduits and banks were retreating. More recently, growth has been driven by high refinancing and transaction volumes enabled by rising valuations. SBNY has high market share of the long-term family holders of rent-controlled buildings; these owners tend to extract cash from their buildings by refinancing whenever the buildings appreciate.

New York City real estate prices have passed prior highs and construction is booming. Recent market data suggests that building values and rents may have peaked. While the current pause could be temporary, the market is likely closer to a top than to a bottom, especially considering the exceptionally low cap rates that are a result of depressed interest rates. If NYC real estate plateau’s or declines, growth should slow down meaningfully since owners will no longer have an incentive to re-finance early. A sizable market correction would produce elevated loan losses.

About 3.5% of SBNY’s loans are backed by taxi medallions in NYC and Chicago. While medallion values are plummeting due to the rise of Uber and Lyft, SBNY has yet to write down the loans meaningfully. Losses on medallion loans could eventually total 20%-50% or more.

About 15% of Signature’s loans are C&I and Specialty Finance loans which should experience higher charge-offs in the event of a recession.

SBNY has grown loans at a 35% CAGR over the last 5 years. While underwriting at the bank appears to be reasonable, rapid growth at any bank is concerning. Note that regulators have recently renewed their focus on rapidly growing banks like SBNY which are heavily concentrated in CRE and deemed to be higher risk. While the risk of loan losses appears elevated, loan loss allowances are near-historic lows.

One of the biggest risks to the short is equity issuance. Issuing overvalued equity creates value. While management has grown the share count at a ~4% CAGR over the last five years, they don’t seem to recognize the opportunity afforded to them by their high valuation, and aim to minimize dilution rather than maximize share issuance. They recently issued subordinated notes rather than issuing equity.

Signature Bank is overvalued and heavily concentrated in NYC real estate, which may have peaked.  Book value could be overstated by 15%-35%+, given our position in the real estate and economic cycles, near record low loan loss allowances, and a troubled taxi medallion loan book. Rising short term interest rates will likely be a drag on earnings. Shorting the stock is an excellent risk/reward. 

Catalyst

• Price and rent declines in New York real estate
• Slowdown in loan growth
• Continued declines in taxi medallion values
• NIM compression from rising short-term rates
• George Klett could retire or leave