Signature Bank: One of the best performing banks in the US with a growth potential of over 60%

Why do we like Signature Bank?

Crypto-factor

In 2019, the bank launched its own blockchain-based payment solution, Signet. It connects institutional players in the cryptocurrency market into a single ecosystem and allows them to conduct transactions in real time, 24 hours a day, seven days a week. Signet has gained popularity and various crypto companies have started joining the platform: exchanges, depositories, mining firms, hedge funds and so on. Crypto-companies' assets have been placed in interest-free deposit accounts and are used by Signature in operational activities. In addition, the bank offers a loan product secured by cryptocurrency as part of Signature.

The Signet platform was a key factor in the stock's unrestrained rise in 2021, with the value momentarily hitting $366 apiece. However, it also served as a source of bearish sentiment in 2022. The stock has lost more than 60% since the start of the year and its correlation with bitcoin has reached 70%. The market fears that the declining value of cryptocurrencies will lead to a significant reduction in deposit accounts opened in the names of cryptocurrency companies.

that the business model of commercial banks, which Signature is, is based on the interest rate differential between the cost of capital raised, which is reflected in the balance sheet liability, and the return on assets - loans and borrowings issued. If the balance sheet liability sharply decreases (e.g. because customers withdraw their deposits) and the assets have low liquidity, the bank may face financial difficulties. In Signature's case, however, the impact of cryptocurrencies is severely limited.

As of 31 December 2021, the company had only one digital asset-backed loan totalling $100 million on its balance sheet, compared with a total portfolio of loans and borrowings of $73.8 billion.

At the end of the last reporting period, Signature's total deposits were $102.8 billion, of which only $23.5 billion (22.9%) came from digital deposits. Assuming all cryptocurrencies leave the bank, which is highly unlikely, deposits would total $79.3 billion, still more than loans and advances. The current loan-to-deposit ratio (Loans-to-Deposits) is 71.8%; the figure adjusted for digital deposits is 93.1%. By comparison, throughout 2019, the loan-to-deposit ratio was between 96.4% and 101.6%.

In addition, the bank is managing to offset a significant portion of the digital deposit outflow. For example, digital deposits declined by $3 billion in the last quarter, but total deposits were down only $1.3 billion, driven by an influx of new customers from other areas.

Unless bullish sentiment returns to the cryptocurrency markets, it is likely that Signature's digital deposits will eventually be displaced by more traditional sources of capital. Meanwhile, given the bank's high correlation to bitcoin, a new rally in the crypto market could see Signature stocks rise substantially. It's worth noting that Signet's customer base is steadily growing - the firm added 116 new clients in the last quarter, bringing its total to 1439. Coinbase, one of the largest crypto exchanges, announced in mid-October that it would use Signet to settle with its institutional customers.

Exemplary efficiency

Signature has seen steady and impressive growth over the years. Over the past 10 years, the bank's assets have grown by 554% and deposits by 629%. Signature has significantly expanded its geographical presence, grown its customer base and returned a solid amount of capital to its shareholders through dividend payments.

Management has been able to strike a balance between high growth and maintaining a conservative approach to lending. While crypto-market competitor Silvergate Capital has been aggressively lending against digital assets, shrinking its traditional loan portfolio, Signature has built a portfolio comprising 83% AAA-rated borrowers (AA - 11%, A - 3%, BBB - 3%). Notably, the bank's average annual net charge-off ratio since its inception in 2001 was 0.25%, compared with 0.91% for the top 50 US banks over the same period.

Comparison of the performance of Signature and the largest US banks; source: compiled by the author

Dividend yield

The bank currently pays out $0.56 per stock to shareholders on a quarterly basis, suggesting a dividend yield in the region of 1.9%. We expect the marginal payout to increase as headwinds from the digital deposit outflows are overcome, as:

• Signature has been paying dividends since the third quarter of 2018. The payout since then has been at a permanent level of $0.56 per stock per quarter (it is worth noting that the company maintained the payout even during the pandemic).
• Since then, diluted earnings per stock have risen by more than 120% and the payout ratio has consequently fallen from 24% to 11%.

Dividend yield

The company's financial results for the last 12 months can be summarised as follows

• Interest income in the last 12 months (TTM) was $2.99 billion, an increase of 36.9% year-on-year. The increase was due to a tightening of monetary policy and an increase in interest rates.
• Non-interest income rose 23.5% over the same period to $149 million.
• Profit before tax reached $1.73 billion, up 38.3% on the year. The margin on this measure was 54.82%, compared with 53.99% for the year.
• Net profit rose 43.6% to $1.31 billion. Net margin increased by 1.8 percentage points to 41.55%.

Company financial results; source: compiled by the author

Company margin dynamics; source: compiled by the author

The financial results for Q3 2022 are shown below:

• Interest income was $977 million, an increase of 75.7% over the comparable period last year.
• Non-interest income rose 39.5% year on year to $43.8 million.
• Profit before tax was $463 million, up 41.7% year-on-year. The margin on this measure was 45.4% compared to 55.7% for the year.
• Net income increased by 48.5% to $359 million. Net margin decreased from 41.12% to 35.13%. The decline is due to a reduction in net interest income margin from 85.8% to 66.1%, due to higher sensitivity of the balance sheet liability to an increase in the key rate.

Company financial results; source: compiled by the author

High margins have enabled Signature to achieve record return on assets (ROA) and return on equity (ROE). Over the past 12 months, ROA has risen from 0.95% to 1.18% and ROE has reached an impressive 17.02%.

Signature's profitability figures; source: compiled by the author

As around 50% of company loans are at floating rates, we expect interest income to continue to rise as interest rates in the economy rise. However, margins could come under pressure as the balance sheet liability is more sensitive to monetary policy tightening. However, management expects margins and ROE to remain around current levels.

At the end of Q3 2022, the company's TTM operating cash flow (Cash from Operations) amounted to $1.29 billion against $880 million for the year. Free cash flow for the same period rose from $847 million to $1.24 billion.

Company cash flow; source: compiled by the author

The Federal Deposit Insurance Corporation (FDIC) classifies Signature as a Well Capitalied bank. The Total capital to risk-weighted assets ratio is 11.99%, with a standard ratio of 10.00%. Tier 1 capital accounts for 10.90% of the minimum requirement of 8.00%. The Common stock tier 1 capital ratio is 10.11% with a requirement of 6.50%. Tier 1 leverage capital corresponds to 8.47% with a standard requirement of 5.00%.

Evaluation

Despite having one of the highest ROEs, Signature trades at a discount to the industry average: P/Cash flow is 5.80x, P/E is 5.79x, FWD P/E is 5.98x. Typically, banks with double-digit ROEs trade at a premium to book value, but Signature has a P/B multiple of 0.97x.

Comparable estimate; source: compiled by the author

The minimum price target from investment banks, set by Stephens, is $150 per stock. In turn, Wells Fargo values SBNY at $250. By consensus, the fair market value of the stock is $196, which implies a 68% upside potential.

Price targets of investment banks; source: compiled by the author

Key risks

• Throughout its history, Signature has regularly raised additional capital through stock sales. There is a possibility that the company will continue to dilute capital as additional funding is needed. It is worth noting that despite the increase in the number of stocks, return on stock and earnings per stock have shown steady growth.
• We have noted that digital deposits may be displaced by more traditional sources of capital. However, the cost of capital raised may rise because digital deposits are interest-free.
• There are certain operational, financial and regulatory risks associated with operating in the digital asset market.
• The rising cost of money, driven by higher interest rates in the economy, could lead to difficulties in continuing to increase the loan portfolio and slow down Signature's growth.