Having risen by average 30% over past 12 months, small and mid-cap banking stocks (those below US$ 10 bn market cap, a total of 20 stocks I track), as a group, outperformed S&P 500 by a hefty 1,000 bps. Some investors attribute the group's outperformance to "rate trade" argument, meaning that bank stock prices have discounted expectation of higher Fed fund rate (positive for NIM) while in reality, higher Fed fund rate won't be happening probably until 2H15. In other words, this camp thinks that too much optimism has been in the price. Instead of getting caught up with rate trade argument for small and mid-cap banking stocks, I found that, from bottom-up perspective, Signature Bank (SBNY) is a stock to own. Here is a strong case to own Signature Bank.
Proven unique business model
Signature Bank is not a typical mass-market retail bank that people would see on the street. It is a bank that specifically caters to privately-owned businesses, offering the clients veteran private banking teams, with highly personalized services and single-point-of-contact relationship. In essence, Signature Bank fulfills the need of privately-owned businesses that are not getting appropriate attention from mega banks.
Meanwhile, at the same time, Signature Bank empowers its private banking teams, former employees of those mega institutions that were frustrated with bureaucracy layers, to come up with creative banking solutions. Furthermore, as a part of their P&L, these private banking teams are responsible for retaining deposit (responsible for future loan losses in case of lending teams). Hence, the teams are in a very entrepreneurial setting, and those that do well (bringing over the business and growing their books) are paid very well.
Importantly, Signature Bank's model has worked to its perfection, in my view. Its 10-yr (2003-13) and 5-yr CAGR (2008-13) of customer deposit are 27% and 25%, respectively. Loan CAGR is 42% in 2003-13 and 31% in 2008-13. These numbers (both deposit and loan CAGR) are very superior relative to the industry growth, especially taken in the context of post-crisis (5-yr CAGR). Based on the Federal Reserve - H.8 release, 5-yr CAGR in deposit and loan for outside Top 25 regional/commercial banks were only 5.8% and 0.9%, respectively.
What's more remarkable, in my view, is that amid its robust loan growth, Signature Bank has maintained a very good credit quality, which I believe is partly due to its employee compensation system having future loan losses as a major KPI in private banking teams' performance. As an illustration, Signature Bank's NCO/average loan in 2008-13 averaged 31 bps. Its NPA/total asset averaged 36 bps. This compares very favorably to peers' (20 small and mid-cap banking stocks I track) median of 66 bps in NCO/average loan and of 139 bps in NPA/total asset.
Not resting on its laurels
Signature Bank has achieved remarkable growth in the last five years in the context of a very challenging industry. However, what I like more is that Signature Bank is not resting on its laurels by staying hungry for growth. As described above, Signature Bank is a sum of the parts, which consist of private banking teams, operationally speaking. In 2013, Signature Bank added 10 new teams, bringing the total to 90. Since its inception in 2001, Signature Bank, on average, has added 6.9 teams per year. In 2009-13, Signature Bank had 39 new teams, an average of 7.8 teams per year.
What makes me more excited about the new teams is the addition of new business lines, which gives more bang in terms of growth. For example, in April 2012, Signature Bank brought in a specialty finance (equipment financing) team. With such team addition, C&I loan book (under which specialty finance is grouped) rose by 69% YoY and 36% YoY as of Dec 2012 and Dec 2013, respectively. This was after a decline of 4% in C&I loan book in 2011.
Management indicates that this specialty finance team alone had $ 4.5bn book of business at its prior institution. This should serve as a huge growth potential over the next few years, in my opinion, as overall C&I loan portfolio at Signature Bank was only $ 2.5 bn as of Dec 2013 ($1.4 bn loan book at Signature Bank from specialty finance team).
A new business line was added in Oct 2013, with the addition of the asset-based lending (ABL) team. Management commented that the ABL team had only US$ 200 mn book of loan at its prior institution, but added that the prior institution was much smaller than Signature Bank. Hence, with referral/word of mouth from other teams at Signature Bank and Signature Bank being a bigger institution, management believes that ABL lending potential would be multiples of US$ 200 mn.
What is also interesting to me from observing the team additions is that LDR has risen from 55% as of Dec 2010 to record-high 78% as of Sep 2013. Mathematically, this means that loan growth (35% CAGR) has far outpaced the deposit growth (21%) last three years. But, my point of emphasis here is that Signature Bank has evolved from a strong deposit-taking institution in its early years to a more balanced platform with a better lending monetization. This, in my view, reflects management's ability to gear up more on lending or new business lines as described above.
High growth visibility
Serving multi-family and CRE (commercial real estate) in New York metropolitan area is a big positive for Signature Bank. This is because multi-family and CRE transactions in New York metropolitan area was one of the most resilient markets during 2008-09 crisis, and the market has improved considerably past two years. Multi-family and CRE loans together have accounted for the majority of Signature Bank's loan portfolio since 2008 (the second year multi-family and CRE teams were added). As of Dec 2013, multi-family and CRE loans combined contributed 76% of total loans.
Moreover, from earnings transcripts, New York Community Bancorp's (NYCB - a direct competitor in multi-family and CRE loans in New York metropolitan area) statement is supportive of bullish outlook on this segment. NYCB claims to have a 20% market share in its niche multi-family and CRE loans, the same segment as Signature Bank operates in.
Assuming NYCB's loan growth in multi-family and CRE loans as proxy for segment growth, I can infer that the segment has been pretty resilient during 2008-09 (7% growth). The segment slowed down to 2% growth in 2010, before settling in a decent 7-9% YoY range in 2011-13.
NYCB, being a much larger competitor, managed to grow its multi-family and CRE loans by $2 bn (8% YoY) as of Dec 2013. $2 bn loan growth is equivalent to 20% of Signature Bank's multi-family and CRE loan book as of Dec 2013. Importantly, this implies plenty of room for growth, from Signature Bank's perspective (only one-third of NYCB's multi-family and CRE loan book). Therefore, assuming the segment to chug along at 7-8% growth rate in 2014-15, I believe that Signature Bank's multi-family and CRE loan portfolio can grow by 20% YoY, conservatively speaking.
Highest ROE bank in the universe
Signature Bank is the bank with highest ROE among peers. Its 14.3% ROE (my estimate) in 2014-15E is approximately 550 bps higher than peers' average (8.8-8.9% - Bloomberg consensus estimate) or a 61-63% premium, percentage-wise. Worth noting as well is that Signature Bank's ROE is the same as its ROTE (Return on Tangible Equity), as it has no goodwill or any other intangible assets. Hence, arguably, Signature Bank's ROTE is of higher quality compared to peers, given higher denominator base effect.
Valuation-wise, Signature Bank trades at 21.4x 2014 PE and 18.6x 2015 PE. This represents 21-28% premium to peers' average (Bloomberg consensus). This may look quite a premium valuation for some investors. However, I beg to differ given Signature Bank's strong earnings growth (18% EPS CAGR in 2013-17 - my estimate), higher ROTE quality, and high earnings visibility.
To arrive at a 12-month price target (mainly to reflect Signature Bank's virtue and to avoid being short-term earnings focused), I use Gordon Growth Model, using 2017 perimeters to reflect "normalized earnings". I do believe that with the Fed fund rate moving to a normal range (positive for NIM), banks' earnings would be higher and, as said, normalized. Assuming 15.1% ROE, 9% cost of equity, and 6% long-term growth, I derive fair 2017 PB multiple of 3.0x. But, to be fair, I discount future price target (since I use 2017 figures) back by three years at 9% cost of equity to get 12-month PT of $154/share (implying a more reasonable 2.3x 2017 PB multiple). This represents a handsome 24% upside potential over a 12-month period.
|Fair PB multiple on Gordon Growth Model|
|Market risk premium||4.0%|
|Fair PB multiple, x||2.98|
|FV of intrinsic value||199.71|
|12-month PT @ 9.0% CoE||154.04|
|Implied 2017 PB multiple, x||2.30|
Story of Signature Bank - Now and then
The inception of Signature Bank comes from the business ideas of Joseph DePaolo, current president and CEO, and John Tamberlane, current vice chairman and director. In 2000, DePaolo and Tamberlane sketched out a business plan that would become Signature Bank, as Republic Bank of New York was sold to HSBC Holdings in 1999. Both DePaolo and Tamberlane were working in Republic Bank.
Their idea was to cater to privately-held business, including owners and other high net-worth individuals, by providing them with a single point of contact, who could handle all of their banking needs. The bankers, subsequently, would be compensated, not just based on deposit and loan business they brought in, but also what they retained (keeping loans in good quality in case of lending).
Originally, DePaolo's and Tamberlane's idea was not to set up their own bank, but to join a bank that would embrace their concept and have them implement it. Along the way, an investment banker Scott Shay, now Signature's chairman, convinced them to start a new bank instead.
Signature Bank finally opened its doors for business in Apr 2001. As the concept was to have veteran bankers to execute the business plan on the field, Signature Bank was (still is) essentially a sum of the parts, which were private banking teams. It started out with 12 initial teams that were deposit-gathering machines, and largely lent to commercial and industrial (C&I) clients until 2006.
In 2007, it added multi-family and CRE lending teams, which have brought significant loan books/growth since. From zero percent of total loans in 2006, multi-family and CRE loans proportion rapidly rose to 29% and 54% of total loans in 2007 and 2008, respectively. A combination of serving New York metropolitan area in multi-family and CRE and of delivering passionate service by seasoned bankers proved to be very potent.
Since 2011, multi-family and CRE loans have accounted for 75-77% of total loans. As of Dec 2013, multi-family loan book was $6.6 bn (44% CAGR past couple of years), while CRE loan portfolio stood at $3.6 bn (28%). In Apr 2012, Signature Bank added a specialty finance team that served the national market. As recent as Oct 2012, an ABL team was added. Both specialty finance and ABL loans are classified under C&I, which accounted for 19% of total loans as of Dec 2013. The remaining 5-6% of total loans consists of single-family residential mortgage, home equity line, and other consumer loans.
Hence, since its inception in 2001, Signature Bank has grown to be a bank with $22 bn in total assets, $13 bn in loans, and $17 bn in customer deposits. This puts Signature Bank as the 65th largest bank in the United States. It has 27 private banking offices (not retail banks), with 90 private banking teams.
From a humble beginning in 2002, Signature Bank has become a force to be reckoned with, as it grew strongly last five years (post-financial crisis). Importantly, Signature Bank is a bank to own in the small to mid-cap universe, I believe. The fundamental/growth story has high visibility due to 1) proven business model 2) the company not resting on its laurels (i.e.: addition of specialty finance and ABL teams) and 3) robust multi-family and CRE market in New York metropolitan area. Some investors may hesitate to jump in due to its premium valuation (18.6x 2015 PE). However, in my view, given Signature Bank's strong earnings growth (18% EPS CAGR in 2013-17), higher ROTE quality, and high earnings visibility; premium valuation is warranted. Using normalized earnings perimeter in the Gordon Growth Model, I arrive at a 12-month price target of $154/share, a handsome 24% upside potential from current share price. Clearly a stock to own!