Signature Bank Preferred Shares: A Rates Play

Thesis

Signature Bank (SBNY) is a full-service commercial bank that was established in 2001 in New York City. The financial institution specializes in serving privately owned businesses and high-net-worth individuals, offering a wide range of banking and financial services. As of late Signature has been associated with the crypto space, which has resulted in increased volatility in its share price and a negative share price move in the past year. SBNY stock is down over 60% on a 1-year lookback, while large banks such as Citi (C) or Bank of America (BAC) are down only 10%.

This is exactly where the issues lie with Signature - it has allowed itself to be pulled in the same bracket with the likes of unregulated crypto exchanges such as FTX and Binance, when in fact it has very little to do with the exchanges from a regulatory standpoint.

SBNY is regulated by various federal and state regulatory agencies in the United States. As a commercial bank, Signature Bank is subject to regulatory oversight by the Federal Reserve System, the Federal Deposit Insurance Corporation (FDIC), and the Office of the Comptroller of the Currency. These agencies are responsible for ensuring that the bank operates in compliance with applicable laws and regulations, maintains adequate capital and liquidity, and manages its risks appropriately.

SBNY has itself started to proactively address market concerns around its involvement in crypto:

NEW YORK--(BUSINESS WIRE)-- Signature Bank (Nasdaq: SBNY), a New York-based, full-service commercial bank, addressed an article today that appeared in the Monday, January 23, 2023 edition of the Wall Street Journal titled “U.S. Home-Loan Banks Help Crypto Lenders Stem Outflows.” The article includes inaccurate statements that the Bank would like to clarify.

The headline falsely refers to Signature Bank as a “crypto lender.” Signature Bank does not lend in the crypto space, nor does it have loans that are backed by crypto assets. Additionally, the Bank does not invest, does not hold, and does not custody crypto assets. Signature Bank’s relationships with clients in the crypto space are limited to U.S. dollar-denominated deposits only.

The article also incorrectly states that Signature Bank is “rushing to stem a flood of customer withdrawals.” In the fourth quarter of 2022, the Bank announced a plan to purposely decrease deposits in the digital asset banking space by reducing the size of relationships; thus, these deposits are declining as the Bank is intentionally managing them to a lower level.

Basically SBNY is telling us they are acting like a bank in keeping dollar deposits, and do not engage in any 'crypto exchange' type of operations, such as holding crypto assets, lending against crypto assets or any type of staking. As a banking institution, it has merely targeted dollar deposits from a growing market niche, namely crypto.

Capital Structure

The bank has mainly issued debt and preferred equity as funding mechanisms. Let us have a look at its traded debentures to get a sense of where the market is pricing credit risk in respect to SBNY:

This six year bond traded in the past week with a price of $93.43 and an equivalent yield of 5.4%. That is only roughly 100 bps over 5-year treasuries, which is a middle of the road investment grade spread. The market is telling us they see no issues whatsoever with the credit quality of this bank.

The above analysis is a market based snapshot of the credit worthiness of the bank. The market trades daily, and it gives us a sense of the thought process of the participants - if the market thought SBNY was in trouble we would see its yields blow up through the roof.

From a fundamental standpoint we see the same theme of stability:

Company Release - 01/31/2023

Signature Bank announced today it has received affirmation of credit ratings at current levels from three of the financial industry’s premier credit rating agencies: Fitch Ratings, Kroll Bond Rating Agency (KBRA) and Moody’s Investors Services. All ratings on the Bank’s outstanding subordinated debt and noncumulative preferred stock issuances have also been affirmed. The Bank has no long-term senior unsecured debt outstanding. All rating information can be found on the Signature Bank Investor Relations site, and are summarized as follows:

Prior to each rating affirmation, Signature Bank underwent a review of its financial stability as well as its business and risk management practices by each credit rating agency. All three annual reviews were conducted between November 2022 and January 2023.

With its ratings re-affirmed and its bonds trading in the middle of the range for investment grade credit companies, all flags are green.

Preferred Shares Sensitivities

Signature Bank 5.00% Non-cumulative Perpetual Series A Preferred Stock (NASDAQ:SBNYP) is a preferred stock issuance from Signature. The shares are non-cumulative and are junior in the capital structure:

This security was rated as Ba1 by Moody’s and Not Rated by S&P at the date of its IPO. In regard to the payment of dividends and upon liquidation, the preferred shares rank junior to the company's senior debt, equally with other preferreds of the company, and senior to the common shares of the company.

Given the lack of credit stress in the bank's debt, the main risk factor affecting SBNYP are rates. The preferred equity is trading with a 7.3% yield and is down over 25% in the past year:

As rates rise the preferred equity will be negatively impacted, but will also see a swift recovery as it approaches its call date in 2025.

Make no mistake - preferred shares do tend to go to zero when there are fundamental issues with an entity. Look no further than Silvergate (SI.PA):

Silvergate Capital has a very different business model to SBNY, and the market is telling us they are in deep deep trouble, very much heading towards a restructuring event.

We do not think SBNY will take any impairments from its crypto business, it is just a matter of losing deposits. The market agrees with the bonds trading in line with other IG names. The preferred shares are a rates play at the moment and offer attractive valuation entry points.

Conclusion

Signature Bank is a full-service commercial bank that has been associated with crypto as of late. SBNY has merely taken deposits from the crypto space, and has shied away from holding crypto assets, lending against crypto assets or any type of staking. As a commercial bank, Signature Bank is subject to regulatory oversight by the Federal Reserve System, the Federal Deposit Insurance Corporation, and the Office of the Comptroller of the Currency, with its capital ratios monitored closely. Fundamentally the bank just got re-affirmed from a ratings perspective by Fitch, Kroll and Moody's while from a market perspective its bonds are trading within the IG cohort spread band. Currently its Series A preferred shares are a nice rates play that offer a 7.3% yield and significant upside as we approach the 2025 first call date.

Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.