Given how investors are prioritizing positive operating leverage with banks, you might think that Signature Bank’s (SBNY) negative operating leverage would be hurting sentiment. What’s really happening is that investors are prizing operating leverage in the absence of evidence of growth – in other words, what is spending more on opex getting its investors? In the case of Signature, the bank is following a clear strategy of building its business, including multiple growth drivers, and with two straight quarters of better than expected pre-provision profit performance, the shares are up about 17% since I last recommended them (beating its peer group by over 12%).
I don’t see quite the same undervaluation as before, but I still see upside and strong bank growth stories are rare enough as it is. Up to around $160, this is still a name I’d consider buying.
The Growth Plan Is Working
To be fair, Signature Bank isn’t posting break-out growth in absolute terms; the upside is coming from the company’s performance relative to expectations. Still, in a challenging environment for banks, I like the prospects for above-average growth and I like the ongoing beats versus rising estimates.
Revenue rose a little more than 1% yoy and a little less than 4% qoq, beating expectations by 3%. Net interest income rose 1% yoy and 3% qoq, beating by almost 3%. Outperformance was driven by both spread, with net interest margin up 4bp as reported and 1bp qoq on a core basis (beating expectations by 5bp), and balance sheet growth, with average earning assets up 8% yoy and more than 1% qoq, beating expectations by a bit. Fee income was up 27% yoy and 24% qoq and beat by 14%; while this is a trivial component of revenue today (about 2%) and will be the foreseeable future, I do see it continuing to outgrow spread revenue.
In a pretty classic example of “it takes money to make money”, Signature continues to increase its spending (opex up 16% yoy and 3% qoq) to support growth initiatives like fund and venture banking and mortgage servicing. Opex spending was a little higher than expected in absolute terms, but the efficiency ratio came in about one point better than expected due to the higher revenue base. Pre-provision profits fell 6% yoy, but rose 4% qoq, beating expectations by almost 5%. Provision expenses were higher than expected, but Signature still managed a good $0.09/sh core EPS beat.
Driving Growth In New Businesses
Between competitive hires from PacWest (PACW), SVB (SIVB), and Wells Fargo (WFC), Signature Bank is making a concerted effort to establish and grow new lending operations that are allowing the bank to diversify away from its previous reliance on New York multifamily lending.
Loans rose almost 8% yoy and more than 3% qoq on an end-of-period basis and 7% yoy and a little less than 1% qoq on an average balance basis; this is a case where I think the discrepancy between EOP and average methodologies is worth watching, as I think it signals more momentum in the lending operation. Multifamily lending was down 2.5% qoq, while CRE lending was up more than 1% and C&I lending (which includes fund and venture lending) was up a startling 15%.
Yield pressure isn’t much of an issue at Signature, with reported yields falling 4bp yoy and 2bp qoq (rising 4bp and falling 5bp on a core basis). Why is Signature doing so well when banks like Comerica (CMA) and PacWest are having such a rough time (and First Republic (FRC), too, is seeing some erosion)? It’s the mix – new-money yields for multifamily are on the order of 3.75% and CRE around 4%, but specialty finance is yielding close to 4%, C&I in the low 4%’s, and venture loans in high 5%’s.
Deposits are also growing nicely, with similar yoy and qoq growth of approximately 11% and 3.5% on a yoy and qoq basis. Non-interest deposits rose almost 4% yoy on an average balance basis – dramatically better than PacWest, though not as strong as First Republic. Interest-bearing deposit costs rose 9bp yoy but declined 20bp qoq and total deposit costs rose 10bp yoy and fell 13bp qoq. With a total deposit cost of 1.08%, Signature is still well behind First Republic and also behind PacWest, so this is an area of long-term potential improvement (and the mortgage servicing business could be one such source of improvement).
Credit is fine. The charge-off ratio remains low, and although non-performing loans increased 77% qoq, that was largely driven by a single credit (a mixed retail/office). This credit has a guarantor and I don’t think Signature Bank will take a loss on it.
A Long, But Not Necessarily Smooth, Runway For Growth
Signature Bank has shown itself to be flexible and willing to adapt to changing circumstances. Once a large lender in the tax medallion business, Signature has gotten out of that business. Now the company is deprioritizing multifamily lending in favor of increased specialty business lending, as well as new efforts in private equity (fund banking) and venture capital (venture banking).
As far as multifamily goes, management expects to keep this business more or less flat. While there’s headline risk from new rent regulations in NYC undermining property values, Signature appears to have written its loans with ample LTV coverage and conservative cash flow assumptions. Maybe there’s some risk to maintaining stable loan balances as loans pay off and the new construction market is undermined by the regulations, but I’m not too worried about it.
Venture and fund banking are already contributing noticeable deposit and loan growth, and the mortgage servicing business (providing treasury management services to residential and commercial mortgage servicers) is just getting under way. I do have some concerns about where we are in the tech cycle – even Signature management acknowledges they’ve come into the business late in the cycle. That leads me to some concern about a slowdown in loan growth and a rise in non-performing loans whenever we see that slowdown.
Signature is one of the very few banks this quarter where I came out of the earnings call feeling quite a bit better about the bank’s earnings prospects in 2020. Management expects stable-to-up net interest income in the first half of the year and strong loan growth (high single-digits to low double-digits) across the next two years, while deposit repricing in Q1 will create some opportunities to replace higher-cost funding.
My core earning assumptions for Signature work out to high single-digit long-term growth, and there could be upside if management hits the higher ends of its loan growth targets. Of course, long-term bank modeling is always challenged by the significant impact future rates will have on spreads, not to mention long-term loan demand and cost leverage.
Discounting my core earning assumptions, I think Signature can still offer a double-digit annualized return, and between discounted earnings, P/E, and ROTCE-driven P/TBV, I believe these shares could have upside toward $160. I’ll note that the ROTCE-P/TBV offers the least upside, but that methodology does not reward future growth (it’s driven by near-term profitability).
The Bottom Line
Signature Bank has worked as a stock, and I believe it can continue to work. The strong move from around $115 in late August to the mid-$140’s today leads me to wonder if it may due for a pause, but I like the underlying fundamentals and with easier comps, Signature should post mid-to-high single-digit pre-provision profit growth in a year when many banks will struggle to show any growth at all. With that, I still see some appeal here for risk-tolerant/aggressive investors.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.