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Make no mistake, this market is in bad shape with sentiment being so low. The Federal Reserve just did another 75 basis point hike in rates, while inflation has yet to subside. It is no surprise that investors are nervous, and the market has been moving lower and lower, with traders hoping for bear market rallies. Each time we have had some green on the screen, it has been met with selling. But all of this Fed-induced market pain is creating ample opportunity to generate alpha in the medium term in this market. That said, we are of the opinion that it is time to take advantage of this decline for long-term positioning. You will never catch the full bottom but look for stocks with some yield going on sale. You can do that with banks. We do believe that the next couple quarters will be tough for America, but the high rates are going to feed net interest income for years to come. The market has and continues to price in uncertainty, but when you look more broadly beyond the averages, some stocks and sectors have just been flat-out liquidated. The economy, which remains still strong despite the stock market, will slow, but this is a temporary phenomenon.
Position yourself ahead of a rally which we see as happening as soon as the Fed slows rate hikes and/or real disinflation begins. One stock that has been absolutely crushed is Signature Bank (NASDAQ:SBNY). Frankly, we think it is overdone, especially if you consider the earnings power potential several to many quarters from now. The market is pricing in the performance in the next few months, but beyond this, there is opportunity for some major wealth building. In this column, we discuss the recent performance of the name which shows the rate hikes already having an impact before we got to the fall. Recent performance was strong and the valuation is now much more reasonable. Bank stocks have suffered, but Signature has taken it on the chin with crypto exposure. Still, legacy banking operations will drive success.
Headline performance strong in Q2
It had been a rough go for Signature Bank for some time. COVID-19 really hurt the bank as it was a New York-based commercial bank with exposure to deals all throughout the metropolitan New York area. It also has exposure elsewhere like California. It was a bad time for commercial real estate, but things started to improve in 2021, and the company had dabbled into crypto. Fast forward to today, and crypto prices have fallen dramatically, and interest rates are making new mortgage deals a bit more difficult. Still, demand is robust. We are awaiting commentary in a month when Q3 is reported to see if this has changed, but the recent volatility in rates led to better numbers in Q2.
The bank reported revenues of $687 million, which was a strong 43% increase in this critical metric year-over-year. Further, this was a very slight beat again consensus analyst estimates of $0.145 million. This increase in revenues along with stronger margin power led to a record net income quarter. Signature Bank reported net income of $339.2 million, or $5.26 per share, which was a huge increase from the $3.57 per share brought in last year.
One concern that we noted in other banks is the provision for loan losses. Banks are stepping up their loan loss provisions to offset possible losses in the coming quarters due to concerns over a worsening economy and the possibility of loans going into default. They increased their provision for credit losses for the second quarter to $4.2 million, compared with $2.7 million for the sequential Q1 2022. We expect the next few quarters to also show year-over-year gains in revenue and earnings. Rates are doing better. Net interest margin was 2.23% versus 2.02% reported a year ago, and up nicely from the 1.99% in the sequential quarter. The company has managed expenses well, but what we are concerned with is if loan loss provision jumps higher, and there is lower non-interest income from lower originations. These are the risks.
Valuation so much more reasonable than a year ago
A year ago, this stock traded well over 2X book value. Folks, the valuation is so much more reasonable here, especially when you factor in the growth. We like to buy bank stocks as close to book value (or even under) as we can. The book value per share at June 30, 2022 was $116.38. Now, it is not uncommon for banks to trade at premiums, and this is more than acceptable if the book value continues to grow. Honestly, at $154 per share, this is the best bargain you may see in some time. The market could go lower if inflation data is bad, and investors panic. But, a 30% premium-to-book is the cheapest this stock has been since the pandemic crash. What is more, book value is up from last year’s $106.24. This comes as the share count is up too. Book value has been improving with growing loans and deposits.
You have to love the growth in loans, but deposits on hand dipped
There continue to be strong improvements in loans that have been issued, however, deposits dipped. The primary reason deposits fell was in digital assets. The deposits fell $5.04 billion to $104.12 billion, while average deposits increased $816.8 Million. Digital asset banking fell $2.4 billion. While this seems poor and is sequentially, total deposits for the last 12 months were up 21%, or $18.5 billion. Pretty key trend. The pain in crypto, however, may subside if the overall market stabilizes.
As for loans, they increased $5.6 billion, or 8.4% to $72 billion total. From last year, they are up a massive 32%. The increase in loans was once again primarily driven by growth in commercial and industrial loans.
The quality of assets remains strong. Non-accrual loans were 0.23% of all loans, down from 0.25% last year. That is strong, and shows the rate hikes earlier this year have not weighed much. We will be monitoring this issue. The company also saw improving efficiency, as it gets a strong return for every dollar spent. In fact, the bank has one of the best efficiency ratios we have seen, improving to 30.6% in the quarter, from 35.8% a year ago. Both the return on average assets and return on equity continue to be strong at 1.14% and 17.9%, respectively.
We think you start buying
We believe that banks offer the most potential upside off of the bottom whenever that is made. We suspect the bottom in the market is later this fall. While recession is more likely than not, the market will start rebounding well before the economy does. Just like the market fell in anticipation of pain, it will rebound ahead of real improvement. We think you should consider buying here, and adding in equal amounts every 5 points lower. We would do this until about $120 and then hold, while collecting a dividend that will be well over 2% at that point.
Take home
This is a contrarian buy, going against the grain, but it is quite clear that margins are set to improve markedly. Sure, loan demand may slow some with this ‘rate shock’, but we see the market as having this more than priced in here. This is what we do. We find beaten-down opportunities and profit from the reversal. The stock is the closest to book value since the crash in 2020. Efficiency is improving. Loans are growing. Crypto assets have weighed, but should start to stabilize. We like this one.
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