Signature Bank Falls With Crypto Mayhem: Time To Buy
For context, we originally wrote this in November 2020 here, recommending investors buy this high-quality growth bank at a value multiple. We wrote that it could be a double, and to date it’s grown almost 100% since then. We I still like it and added shares last week.
Collapse of TerraUSD
We spoke to Signature Bank (NASDAQ: SBNY) in the wake of this week’s collapse of the “stablecoin” TerraUSD (UST-USD). Designed to be pegged to the dollar, TerraUSD kind of hit the mark. This crypto is an algorithm-driven stablecoin, whereby the creators of TerraUSD mint or withdraw tokens from the market in order to maintain a 1:1 price/dollar ratio. It is important to note that TerraUSD does not have actual US dollars to back its value.
With the backers of TerraUSD holding Bitcoin (BTC-USD) as only a partial reserve against TerraUSD, now they are seen as Bitcoin sellers. This has created fear and a wave of many cryptos over the past few weeks. TerraUSD is now believed to be worthless (trading below 1c). Bitcoin fell to $29,000, down more than 50% from its highs.
In the background, Signature Bank has a banking service called Signet. Signet offers institutions the ability to make crypto deposits to these accounts. He uses Ethereum (ETH-USD) based on blockchain technology and can therefore process payments (free of charge) in real time, 24/7. According to Signature Bank, Signet would not offer services to a low credit customer like Terra (although they have legally stated that they cannot release the names of their depositors).
We therefore believe that the fear of SBNY holding TerraUSD deposits is highly unlikely based on the company’s comments.
In total, Signature Bank has $29 billion in cryptocurrency deposits in various Signet accounts. These include miners, funds that want to invest in cryptos, and exchanges, among others. $7 billion of that is tied to stablecoins, and the fear is of course that that $7 billion is tied to TerraUSD. Again, this seems highly unlikely, and the company told us that it can disclose that it is banking TrueUSD and USD Coin stablecoins. Both of these are backed by real US dollars.
Both of these cryptocurrencies continue to trade at $1 to this day.
Run on the bank?
The next level of worry surrounding their Signet business is simply worry about a run on the bank. We walked through a scenario where Signature Bank’s crypto customers decide to withdraw their money from the bank and go elsewhere.
It seems pretty unlikely, but in a year, let’s just assume that 100% of Signature’s crypto deposits are leaking. Mind you, this is a bit of an extreme assumption, as the cryptos keep pouring in – selling here and buying there, even lower prices mean they still exist.
Coinbase (COIN) has $6 billion in cash and, as an exchange, is much more risky than its bank. For example, let’s say a large institution sells Bitcoins on Coinbase. Coinbase needs to fund this seller with US dollars (which they may need to withdraw from their bank account at Signature Bank). But then the buyer uses dollars to pay for the coins sold on Coinbase. So COIN gets dollars from the other side of the trade, and those dollars would go straight back to the bank.
But again, taking this example to the extreme, COIN decides to move to another bank, along with all the other miners and institutions that have deposits at Signature Bank. (They have no retail crypto repositories).
This would imply $29 billion in lost deposits out of their $109 billion total. SBNY confirmed that they still only have one $100 million cryptocurrency-backed loan (out of a total of $66.4 billion in loans). It’s 0.15%, literally nothing.
This means that we don’t have to worry about the asset side of the balance sheet.
SBNY suggests that they really don’t charge any fees on these deposits and they mostly have this money on their balance sheet. There would therefore be no impact on commission income.
At the end of the quarter, the company had $26.3 billion in cash on its books. They think they should probably keep at least $10 billion in cash for regulatory purposes. This means that if SBNY lost $29 billion in crypto deposits, it would have to sell some investments on the balance sheet or fund them with corporate borrowing.
Here is the calculation:
The Q1 revenue report details cash returns and the 1.6% they earn on agencies today. This is the active side of the balance sheet.
We’ve highlighted the relevant assets: available-for-sale or held-to-maturity securities total $26 billion, plus another $26 billion in cash and cash equivalents.
The company suggests it would like to keep $10 billion in cash on the balance sheet at all times (but admits it could go as low as $7.5 billion).
Here are their liabilities, with minimal debt and plenty of non-interest-bearing, non-crypto deposits.
According to our calculations, by removing their crypto business, its repositories, in its entirety involves about a $3.27 BPA hit at current yields/spreads (1.8%). The company confirmed our methodology here and said it would be “a few dollars”.
EPS assuming this happened in this year could imply $23.73 in 2023, down from Street’s current estimate of $27. But at the current share price, $200, Signature Bank is trading at about 9 times its earnings. Historically, this is about the lowest ever traded. And guess their crypto business goes away completely.
We also think the company would likely borrow a little from the bond market to fund the cash it needed (based on what it said it was likely to do). Currently, financing would cost them around 2.5% and would allow Signature Bank to keep its agency portfolio intact.
Would the growth rate be affected by the loss of Signet? At 9 times earnings, the stock appears to be priced for a lot of risk and zero growth anyway. It usually trades between 10-15x, so the market already seems to be involving $12-19 in EPS, a very big hit.
We estimate the fair value to be 12 to 16 times, especially given its growth history and superior business model. Loan balances increased 3% in the first quarter (excluding PPP loans), with an annualized growth rate of 12%. It’s impressive. From 2015 to 2021, earnings doubled across the business from $7.37 to $15.03, a CAGR of 15%.
Indeed, it should be worth at least 15x. We recommend reading our previous articles here illustrating Signature Bank’s superior ROE and efficiency ratio.
We encouraged management to issue an 8-K to provide an update to investors. They are presenting a Wells Fargo conference on Wednesday and said they might post something before (I guess that morning or the day before).
They ruled out the need for a stock offering. Yellen also said that there are no real risks to the financial system from cryptos today.
Ultimately, even without any crypto deposits, SBNY holds $80 billion in dollar deposits and $64 billion in loans. The record is really excellent here.
SBNY stock is much more correlated to cryptocurrency prices than it should be. They own no crypto assets on the balance, and essentially no loans. We sense the opportunity and recommend adding actions. It certainly “seems” risky, and it may make sense not to catch the falling knife. But the purchases we make that are the most uncomfortable are often the best. I can tell you that buying favorite Crestwood stocks was a scary trade in March 2020 (especially since it fell to $4 after buying stocks at $6 and $5).
As we have confirmed, there is no credit risk for cryptos On the side of Signature Bank, simply deposits that could leak. This cost, assuming a 100% exit from Signet, has a 15% impact on profits. With a roughly 50% drop from its January highs and a 31% drop in one month, we argue that SBNY is significantly oversold.
With the carnage and panic of late, perhaps expect some additional volatility. But in a year or two, we’re struggling to see that capital worth less than $300 a share. Long term, we continue to aim for $400-500. This is a volatile but excellent buy and hold security.