Description

Summary

Signature Bank (“SBNY”) is a well-run, high-quality commercial bank with robust growth opportunities. The stock has appreciated materially from its lows in late 2020, but we believe it remains underappreciated. Earnings power is growing materially faster than reported earnings as asset growth significantly lags deposit growth and provision expense remains high compared to history and to other banks that are now releasing reserves. We think the stock trades for ~15.5x 2021 earnings that can compound in the high teens for the next several years. Using a 17.5x multiple on 2026E earnings, we get a ~$650 stock price, or a 23% five-year IRR (24% including the dividend) without material interest rate improvement or accounting for excess capital. For VIC aficionados, there are three other write-ups dating from as far back as 2007 if you’d like to chart the company’s history and assorted debates over the years. 

Background

• Signature is an $85B asset bank based in New York. The bank was founded in 2000 as a high-touch institution for businesses and ultra-high net worth individuals. The bank compensates relationship bankers on their book of business without mandating fee offers or other unnecessary services get hawked to clients. That controls expenses and engenders customer loyalty. Customers tend to offer very high loan quality, as exhibited by GFC-era net charge-offs <100bps – well below industry average during that time.
• Customers like Signature, as illustrated by long-term deposit growth. Banks that can sustainably grow deposits and earn attractive returns are rare franchises that tend to endure. Below we compare SBNY to a few peers: a similar business (FRC), regional banks with some similarities that we respect (EWBC, SIVB), a lower quality regional bank (CMA) and a few large banks most of you will be familiar with. As you can see, SBNY compares favorably.

Recent history obfuscates return structure

Taxi Medallions (2016-2018)

• Loan loss history is excellent, a byproduct of SBNY’s conservative lending culture. The notable exception is 2016-2018 when management wrestled with a ~$650M taxi medallion loan book that required large write-offs when ride-share companies exploded on the scene in New York and elsewhere. ROA dipped and SBNY’s multiple responded in kind, the latter impacted further by New York State legislation limiting landlord reach (which has not impacted earnings as far as we can tell). Taxi medallion exposure is no longer meaningful and despite rates swooning, returns started normalizing in 2019 (though remained depressed). 

COVID (2020-2021)

• Then COVID happened. Like the rest of the industry, SBNY took large provisions from 1Q2020-3Q2020. The reserve now sits at ~1% of gross loans, the highest level since the GFC. While most banking peers have started to release reserves through negative provisioning, SBNY is still conservatively building reserves. As of 1Q2021, COVID-related deferrals are $1.3B, down almost 90% from the 2Q2020 peak level. Deferrals are predominantly in CRE loans underwritten to a ~65% LTV on average, which comforts us. As SBNY’s empirical loan loss experience would suggest, a 65% LTV makes losses difficult to realize. 
• Management consults several NYC commercial real estate indices when considering the provision, leaning on the most conservative indices because 1) that behavior underpins any good lending culture and 2) as any banking executive will tell you, it is nice having a chunky allowance behind you. As NYC’s reopening accelerates and deferrals fall further, management’s conservatism will be difficult to sustain. We also expect further reopening will unlock pent up loan demand.

Rates

• One byproduct of COVID is the lowest interest rate environment most of us have ever experienced. That has impacted both assets and funding.  This is especially relevant for SBNY since it’s more dependent on NIM than other banks that earn a higher percentage of earnings from fee income.
• From 2019 to 1Q2021, loan and securities yields dropped 72 bps and 133 bps, respectively. But funding costs also declined significantly, with the resulting raw net interest spread compressing ~10-15 bps. SBNY’s net interest margin, which takes into account the composition of the balance sheet in addition to the raw interest rate spread, declined from 274 bps to 208 bps over this same time period.  NIM in 1Q2021 was the lowest level in the bank’s history; if this isn’t the bottom, we’re close.

Emerging growth engines

• Signature’s growth model is straightforward: it hires high-performing commercial banking teams away from its rivals. These teams bring their clients and their clients’ deposits to SBNY, where these books of business grow organically. Teams often join SBNY in the wake of disruptive M&A, but many are simply attracted to the bank’s entrepreneurial culture and “eat what you kill” approach that offers much more economic upside than traditional banks. Since 2001, SBNY has hired nearly 120 teams with minimal attrition. The model works.
• Management seeded a second growth act in 2017 when it started hiring banking teams in California. Those investments are both accelerating and starting to bear fruit. SBNY has hired over 25 California-based teams as of 1Q2021, with the state comprising ~7% of SBNY’s deposit base. Notably, NYC continues to grow, adding $1.5B in deposits last quarter. If Signature can replicate its New York success in California, deposits should grow billions per quarter for the foreseeable future.
• In 2018, SBNY hired a team with crypto expertise that accelerated the bank’s existing initiatives and made it an early provider of services that allow clients to execute banking transactions in various digital currencies.  This business has grown rapidly as cryptocurrencies have gone mainstream, with deposits growing to ~$13B as of 1Q2021 (from $1B in 1Q2020). Management is still working through how to monetize this growth, but we expect SBNY will eventually earn some fee income (potentially on FX transactions) and will deploy deposits into loans, though likely at a lower rate than non-digital deposits.

Misunderstood earnings power

Balance sheet composition

• SBNY hasn’t historically struggled to grow loans, but unprecedented deposit growth presents management with a problem it has never faced: they have too much money. Whereas other banks might rush to deploy liquidity, management has taken a conservative approach to growing loans (and even securities recently). The elevated cash balance suppresses reported earnings, even though latent earnings power is growing in tandem with deposits. Deposit growth will likely continue at a double-digit pace for the next several years, which means reported earnings growth will lag earnings power growth. 
• As asset growth ramps and/or deposit growth slows, earnings growth will eventually match how deposits have grown. Simply rearranging the balance sheet to historical asset deployment ratios while adjusting for lower digital deposit deployment gets to a loan-to-deposit ratio of ~90% (assumes digital deposits are 65% deployed to loans and other deposits are 95% deployed to loans) vs. 96% in recent history and 69% today. That adds annualized earnings power of ~$4.24 to the 1Q2021 annualized run-rate of ~$12.24 per share. As new banking teams season and NY and CA reopen, asset growth should accelerate.

Rate sensitivity

• The degree to which SBNY’s rate exposure has evolved in two years is underappreciated. C&I loans, which tend to price variably, are +160% in two years. Combined with loan maturity schedules, loans that reprice within one year aggregate to ~45% of loans. Core deposits have also improved to 95% of total and management actively prunes its highest cost funding. Rate improvement should improve spreads far more than it hurt. This is a marked change from SBNY’s past as a liability-sensitive bank – which we suspect is how many investors still think of the company.

• In the most recent 10-Q (historically charted above), management discloses that a 100bps sudden move in rates increases NII +8.6%; all else equal that is +15% to earnings. Importantly, public disclosure 1) assumes static balance sheet composition and 2) illustrates math that accounts for the average change in yield over 12 months – not where yields end up after the upward move. Practically, a meaningful step up in rates should accelerate balance sheet deployment (securities, at the very least) which adds to NII. Further, after loans reprice over 12 months, SBNY will have far greater run-rate earnings power than is implied by the simple average during that transition. 
• We aren’t making a call on rates, but reference rates should eventually reprice. Illustratively, if rates improved by +50bps vs. 1Q2021, annualized earnings would be >$3.15 higher than that reported in 1Q2021.  If we combine this with the pro forma earnings power math from above relating to balance sheet optimization, true run-rate 1Q2021 earnings power is $12.24 + $4.24 + $3.15 = $19.63. This is of course before balance sheet growth, which continues to be robust.

Good management

• It is worth noting that we like the management team and the board. 
• Over the last five years, management has 1) grown assets double digits annually, predominantly in variable rate asset categories, 2) grown book value double digits annually, and 3) improved expenses by 10bps of assets (through 2019) – despite the circumstances.
• The Company is still run by founders, who collectively own more than $180M in stock. They have built a strong track record where it matters most for a bank: low-cost deposit growth and credit quality.

Valuation

• We assume 2021 assets grow 25% before fading to 12% by 2023. That is likely conservative. We assume ROA mean reverts to 1.25%. That is also probably conservative given expense structure improvement and scale benefits.
• The above arrives at 2026E EPS ~$37/share. If SBNY grows faster than our projections, they’ll need to raise capital but our numbers would also come up. Rather than predict the price and amount of dilution, we keep it simple and chalk it up as a nice problem to have. That may be flippant, but it does not change the answer.
• SBNY’s current forward multiple is ~17.5x but 1) estimates are likely to increase and 2) near term earnings significantly understate the bank’s earnings power. SBNY’s 10-year average forward multiple is 15x but before the controversies outlined above (i.e., medallions and COVID), the average multiple was ~17.5x. SBNY is currently a ~6x discount to growth bank peers (FRC and SIVB) whereas that discount did not exist before the sequential controversies. Perhaps FRC and SIVB are overvalued, but there is a large gap to support SBNY valuation. 

• At 15x, the stock is ~$555/share (a 19% five-year IRR). At 17.5x, a multiple we feel is more appropriate for its growth profile but still a discount to FRC / SIVB (and the market), the stock is ~$650 (a 23% five-year IRR). Assigning discounted value to excess capital generated bumps the IRR to ~24%.  The stock is a 1% dividend yield, bringing the total expected return to a 25% IRR.

Catalyst

• Continued outsized deposit growth.
• Upward revision to asset growth.
• Higher rates.