Signature Bank (SBNY), which is based in New York City, is doing really well. The stock trades around $250 per share and the company is valued at 243% to tangible book value (equity minus intangible assets and goodwill).The bank also recently reported a strong first quarter of earnings to start the year, generating a profit of $190.5 million, which was equivalent to a 0.97% return on assets (ROA) and a roughly 13% return on equity (ROE). While things are certainly rosy at the bank right now, I think they are about to get a whole lot better. Here's why.
So much liquidity
Signature Bank was founded in 2001 and has grown extremely fast. It started with just $50 million in assets and is now up to $85 billion in assets, growing to this level without making a single acquisition. In recent years, the bank, which used to be a heavy multi-family lender, has really transitioned into more of a tech player.
In early 2019, the bank launched its Signet payments platform, which leverages blockchain technology to create a real-time digital payments platform that clears and settles payments 24 hours a day, seven days a week, and 365 days a year. This allows two commercial clients on the network to move funds between one another at any day or time for free, although clients are encouraged to maintain balances of $250,000 or more in their accounts. This system is particularly useful for traders of digital assets such as Bitcoin (BTC -3.54%) because cryptocurrencies trade around the clock.
Image source: Getty Images.
Signet has been essential to the bank's success because it brings in large sums of non-interest-bearing deposits. That, coupled with all of the excess liquidity in the banking system, has led to a massive influx of deposits at Signature over the last year. The bank grew deposits from roughly $41 billion at the end of the first quarter of 2020 to more than $68 billion in deposits at the end of the first quarter of this year.
This is such a large amount that despite seeing better loan growth than most of the industry, Signature Bank still doesn't have anywhere to deploy its excess liquidity. As a result, more than $19.5 billion of Signature's deposits are sitting at the Federal Reserve earning practically zero interest. This in effect has dragged down Signature's return metrics.
Signature's Executive Vice President Eric Howell said on the bank's recent earnings call that the excess cash dragged down the bank's net interest margin (NIM) by a whopping 58 basis points (0.58 percentage points). The NIM is the difference between what banks pay out on interest-bearing liabilities such as deposits and what they make on interest-earning assets such as loans. With more than $19.5 billion making almost no yield, that hurts the interest-earning asset part of the equation. It's also a huge drag on ROA and ROE because you've got assets making basically no return, and that could make much more profit if deployed. Just imagine if the Fed raised its federal funds rate from practically zero to 1% or 2%. At 2%, that $19.5 billion of cash sitting at the Fed would generate an extra $390 million of interest income.
Deposit costs should continue to decline
Although all of this excess cash dragged down profitability, the good news is that it should enable Signature Bank to keep pushing down its funding costs. At the end of the first quarter, the bank paid interest of 0.47% on its total deposits and borrowings, and 0.34% on its total deposits. One thing to understand is that as a former multi-family lender, Signature likely didn't have the best deposit franchise because most multi-family lending relationships don't typically attract good deposits.
But now, with so much excess liquidity and non-interest-bearing deposits, funding costs should be able to come down more because the bank in theory can keep replacing higher-cost deposits and borrowings with non-interest-bearing and lower-cost deposits. Howell said he doesn't expect deposit growth to slow any time soon. Signature at the end of the first quarter had nearly $1.7 billion in time deposits with an average yield of 1.10%, which is a high rate to pay in this low-rate environment. The majority of these time deposits will mature within the next year, so I expect the bank can allow most, if not all of those, to run off.
Signature also has another nearly $3 billion of borrowings with an average yield of 2.41%. Most of these will mature within the next three years, so I expect the bulk of them will be paid off as well. But in the meantime, Signature's funding costs should keep moving down as more non-interest-bearing and core deposits keep coming in. Cheaper funding costs will help the bank expand its NIM and increase profitability.
Lots of revenue opportunities
Signature Bank should be able to deploy at least some of its excess liquidity this year because there are plenty of revenue opportunities at the bank. Loans grew $2.12 billion in the first quarter of the year and Howell said the bank expects $1 billion to $2 billion of loan growth per quarter, along with $1 billion to $2 billion in securities purchases each quarter as well. Securities don't carry as high of returns as loans, but will be better than having cash sit at the Fed.
Around the time Signature launched Signet in 2019, the bank also launched its fund and venture banking division, which provides special lines of credit and other loans specifically for the private equity and venture capital communities. This segment has performed remarkably well, growing from about $5.9 billion in total loan volume at the end of the first quarter of 2020 to more than $12 billion in volume at the end of the first quarter of this year.
Additionally, the bank is planning to launch new business lines, including loans administered with the U.S. Small Business Administration and mortgage warehouse lending. These new lending verticals, which are not expected to be up and running until later this year, are not included in the $1 billion to $2 billion loan growth projections, so there could start to be even higher loan growth toward the end of this year.
Lastly, I would be remiss to not touch on revenue opportunities from Signet. Signet not only brings in all of these great deposits, but it will likely start to generate revenue through fee income at some point, as well as through lending to clients on the platform. CEO Joseph DePaolo said on the bank's earnings call that Signature plans to start doing some lending in the crypto space. He didn't exactly specify what that means, but if it's anything like the competition, I suspect it will involve making loans in U.S. dollars that are collateralized by a cryptocurrency like Bitcoin -- these loans can carry a higher yield than other commercial loans. Signet had grown to 740 clients at the end of the first quarter.
Ready to run
Signature Bank is really firing on all cylinders when you look at its performance, stock price, and valuation. But there's a lot more to come, once the bank is able to better deploy its excess liquidity. This will happen as Signature keeps growing its fund and venture banking business, and as it launches other new business lines. It will also happen as Signet continues to onboard new clients and begins to grow loans and fee income on its own.
Analysts on average are already projecting that the bank can grow earnings by more than $2 per share between 2021 and 2022. That's why I would hold on to this stock or even think about buying in, because the bank is going to generate some pretty exceptional returns.
