In the rapidly evolving US economy, businesses with strong fundamentals will survive and prosper. At Hermes, we look for companies that have enduring competitive advantages. Here, we highlight a financial opportunity that we believe will thrive in the coming months and years.
Many market observers are anticipating a prosperous year for the US economy. Falling unemployment, rising wages and gradual growth have all laid the foundation for companies to outperform their developed market peers. Meanwhile, the new political government, under President Trump, is expected to introduce several favourable policies, including tax cuts, regulatory changes and repatriation of overseas profits.
These changes look particularly likely to benefit US small and mid-cap stocks. These companies derive the majority of their revenues from the domestic economy - around 70%-80 compared to 50% for large-cap stocks. Also likely to benefit are those industries most aided by Trump’s policies, such as financial services, which can expect supportive regulatory changes under the new administration.
Signature Bank: Misplaced sentiment provides a mispricing opportunity
During the third quarter of 2016, banks became more attractive in an environment of improving business sentiment and with the prospect of an uptick in net interest margins in a rising rate environment. Anticipation of a regulatory roll-back under Trump, amid a strengthening economy, also improved the outlook for lenders.
One bank we hold in the Hermes US SMID Equity Fund is New York-based Signature Bank. It is one of about 250 companies on our long-term watch list of stocks that meet our investment criteria. The bank focuses on winning and keeping mid-market commercial clients through excellent service and tailored deposit accounts, resulting in sticky revenues. This is a sustainable competitive advantage, one of the key characteristics we seek in our holdings, which should allow the business to maintain funding throughout the cycle. Its management team has done a good job of attracting and developing sales teams that have been able to grow the bank’s loan book and deposits.
Signature Bank is exposed to taxi medallions, city-issued licences to operate cabs, the value of which has fallen due to the popularity of Uber and other taxi-alternative apps. The challenge this presented impacted the stock’s valuation and piqued our interest in the stock, provided we could be comfortable that it was a transitory and manageable issue. In an in-depth meeting, Signature Bank’s management explained that they had provisioned conservatively for the medallion portfolio, mitigating potential future losses. This reassured us that the likelihood of further provisioning was minimal and that the business’ core growth drivers remained intact.
Given our confidence in the bank’s growth strategy, we took the opportunity in the last quarter of 2016 to increase our position at an attractive price. With a government supportive of financial regulation reform, a high-quality loan book and good growth prospects, Signature Bank looks well positioned for 2017.