Description

SBNY is an extremely high quality bank that historically has traded at a premium valuation due to its high growth and strong credit quality.  It is now trading at a deeply discounted valuation because it is being hurt by the flat yield curve and because it has recently struggled with taxi medallion loan losses.  The medallion losses are now behind it, and the yield curve issues are temporary. The pitch is now is a compelling time to buy into a high quality multi-year growth story at a temporarily discounted valuation. It is hard to see losing much from here because the current P/TBV is already approaching 2009 financial crisis level lows (a remarkable statement!).  I think the stock is a double over 3-5 years. Meanwhile, SBNY has just started an expansion on the West Coast which should replicate the tremendous success it has enjoyed in the NY market.

Overview

• Based in New York, NY, Signature Bank has grown organically to $45B of assets through 31 offices since its founding in 2001.  SBNY holds 2.0% share of the NYC MSA (#9). It is run by the same well regarded management team since its founding.

• It operates a differentiated team-based, client-focused approach driving better than average growth, core deposits and efficiency metrics.

• SBNY hires teams from large banks that focus on business owner customers. It pays the teams a lot more through a partnership/eat-what-you-kill model and offers no bureaucracy.  It has hired 100 teams in its history with almost no turnover.

• It does not have retail branches. Instead it has 31 private banking offices in office buildings, all in metro NYC.  As a result, it has a low cost model with an efficiency ratio of 35% vs most banks at 55%.

• New client teams mostly bring over deposits, so SBNY is a deposit gathering focused bank and its deposit quality is excellent with 34% non interest bearing deposits and <5% CDs.  On the loan side, it mostly invests in low risk commercial real estate (CRE) loans. The majority of CRE loans are multi family. These are considered low risk loans and its credit history is fantastic.

• The model has proven to be very effective because it has grown assets at 20-30% for many years and its credit quality was very good during the financial crisis. Now it is growing more like 10% because it is bigger, but it is still a lot faster than most banks.

• 97% of revenue comes from spread income.  Fee income is only 3%.

• Loan mix: 44% multi-family, 27% commercial property, 19% commercial and industrial.

Bull Case

• Expansion into CA extends the growth runway:

• SBNY has just started to hire teams in CA which is a ripe market for them to replicate the success they have had in NYC.  It has hired 3 teams in CA this year. (SBNY has also hired 5 teams in NYC this year. In a typical year, it adds 3-5 teams, so 2018 is a strong year.)

• SBNY is very optimistic because there are lots of banking teams looking to leave tainted banks like Wells Fargo and a couple of other banks that have issues (e.g. City National was acquired by RBC 4 yrs ago).  The West Coast is very ripe for SBNY’s unique model, and management sees a similar opportunity to what they had in NYC when they started. Also, deposit costs are much lower in CA than NY.

• Great core deposit franchise

• 34% non-interest bearing deposits (vs northeast average of 20%) and a #9 market position.  Most impressively, SBNY has been able to grow deposits at a consistently high rate for many years without sacrificing deposit quality. For example, CDs are <5% of deposits.

• SBNY does pay up a little for interest bearing deposits which is a result of the fact that it services commercial customers who are more rate sensitive. So, its all-in deposit cost is inline with the median for northeast banks.  But, as mentioned, its efficiency ratio is much lower, so all in its ROE is a very healthy 15%.

• Credit quality has been very strong excluding recent taxi medallion losses.

• SNBY has had among the lowest through the cycle charge-offs.

• If you apply the peak 74 bps loss rate from 2010 to 2019, it is a 26% hit to EPS, but the ROE is still 10%.  The caveat is that SBNY is 8x larger than it was in 2010, but I also don’t expect a repeat of financial crisis loan losses in the next cycle.

• The removal of the $50bn SIFI threshold removes some expense pressure.

• SBNY is not regulated by the Fed so is not subject to the CCAR, but it relieves expenses for tests from the FDIC which is its primary regulator.

• Valuation is cheap:

• The stock is close to its 52 week low and has significantly underperformed other banks.

• It trades at 1.60x TBV which compares to the trough valuation during the financial crisis of 1.4x.  The 5-yr average is P/TBV is 2.2x. As book value grows, the P/TBV compresses to 1.5x at the end of 2018, 1.4x at the end of 2019, and 1.25x at the end of 2020. It is hard to see the stock staying at current levels through next year because the P/TBV will be ridiculously cheap.

• P/E is 10.5x 2019 vs peers at 13.5x despite being a much higher quality franchise.  Historically SBNY has traded at a premium.

• Fast forward 3-5 years and I think SBNY will be earning over $15 per share and trading at 15x EPS, resulting in a double from current prices.

Issues

• Liability sensitive

• SBNY is one of the few banks that is liability sensitive, meaning its NIM goes down when rates go up.

• To illustrate: 97% of revenue is spread income. 76% of loans are NYC CRE and multi-family loans which are 5-10 year fixed rate paper.  66% of deposits are subject to repricing. As such, when short term interest raise as they have been and long rates stay flat, SBNY feels a modest squeeze.

• SNBY just lowered its NIM guidance from 1-3bps of decline per quarter to 3-6 bps for the rest of 2018, and has guided to 1-3bps per quarter of NIM compression in 2019.  The result is that net interest income is growing 4% per year even though loans and deposits are growing ~10%.

• In my opinion, the NIM pressures are temporary and will abate once the Fed stops raising at the end of 2019.  At that point, net interest income will resume growing in line with loans and deposits. The much more important driver of value is the fact that SBNY will be growing low cost core deposits for years to come.  In fact, I think SBNY will be able to double in size within the next 10 years.

• CRE concentration

• In 2015 regulators started to focus on CRE concentrations with a soft threshold of 300% CRE-to-total risk based capital and SBNY is at 523%.  But, SBNY has credibility with regulators given its long history in the space, and it has not been asked to slow loan growth even as other banks with lower CRE exposure have been.

• Trump/Kushner/Cohen Headline Risk

• The NYTimes recently had an article talking about SBNY’s lending to the Trump family, the Kushners and to Michael Cohen.  SBNY had a very strong rebuttal on its website, and the net is there is no substance.

• Taxi Medallions losses:

• Taxi medallion loans were 3% of loans in 2015, or $800mm. SBNY has endured ~$550mm of losses, causing a higher charge off rate in 2017 than it experienced in the financial crisis.

• I view this as an extremely anomalous event due to the advent of ride sharing that is now behind them. Medallion loans are now 0.4% of total and have likely been sufficiently written down.  They are marked at $170K per medallion vs they are worth $200K+ today.

This posting is solely for the evaluation of club members and is not a recommendation to buy or sell this stock.  The views expressed are those of the author individually and should not be attributed to any affiliated investment firm, which may or may not hold positions consistent with the views expressed herein and may buy or sell shares at any time.  

Catalyst

End of Fed rate increases.  Book value growth. CA expansion.