Signature Bank's Deliberate Shrinkage: Walking Away From Growth to Save the Franchise

By the fall of 2022, Signature Bank looked like a machine operating at peak efficiency. Net income for the third quarter hit $358 million, a 48 percent jump from the same period a year earlier. Pretax pre-provision earnings reached a record $492 million. Through just nine months, the bank had already crossed $1 billion in net income. The fourth quarter would push full-year earnings to $1.3 billion, a record, with a return on common equity of 16.4 percent that put Signature in the top tier of American regional banks.

The paradox was hard to miss. Signature was reporting its best financial results in 22 years of existence, and its CEO was describing the operating environment as the worst he had ever seen. The tension between those two statements defined the moment. The bank's floating-rate loan book, roughly half of total loans, had benefited enormously from the Federal Reserve's rapid rate hiking cycle. Net interest income surged 19 percent year over year in the fourth quarter. But the same rate environment that inflated earnings was simultaneously shredding the deposit franchise.

What made the situation unusual was management's response. Most banks in a rising rate environment scramble to retain deposits at any cost. Signature chose the opposite path. It announced that it would deliberately reduce the size of its digital asset banking relationships, accepting the deposit outflows that would follow. The decision, made public on December 6, 2022, at an industry conference, was a strategic choice to trade growth for stability. It was also an admission that the bank's most dynamic deposit source had become its most vulnerable.

Signature Bank was founded in 2000 with a model that looked nothing like traditional branch banking. Rather than building a network of retail branches and competing for consumer deposits, the bank recruited experienced private client banking teams from larger institutions. Each team brought its own book of commercial relationships. The bank provided the balance sheet, the credit infrastructure, and the operational support. The teams provided the clients.

Co-founder Joseph DePaolo has led the bank since inception. He took it public in 2004 on the NASDAQ, and over the next two decades built a commercial lender that specialized in industries other banks found too specialized or too small. The bank became a dominant lender to New York City's multifamily real estate market. It built a franchise in fund banking, serving private equity and venture capital firms. It expanded into healthcare banking in 2022 with a dedicated team. And it moved west, hiring private client banking teams in California, Nevada, and the Pacific Northwest.

The team-based model gave Signature a cost structure that traditional banks envied. Without a large branch network to maintain, the bank kept its efficiency ratio low and its lending spreads wide. But the model also created a dependency on recruitment. When the bank wanted to grow, it hired a team and let the relationships follow. When a team left, it could take clients with it. The model rewarded growth but demanded constant renewal.

In 2022 alone, Signature hired 12 private client banking teams. Five were added in New York, seven on the West Coast. The expansion reflected management's confidence that the bank's model could work beyond its home market. But the West Coast push also introduced new risks. California real estate markets behaved differently than New York's. Competition for deposits was fiercer. The teams had to prove themselves in a rate environment that none of them had experienced before.

Digital asset banking was Signature's most high-profile and most controversial business line. The bank had become one of the few major lenders willing to serve cryptocurrency exchanges, stablecoin issuers, and blockchain-related firms. At its peak, digital asset deposits represented a substantial portion of Signature's total deposit base, providing low-cost funding that helped the bank expand its net interest margin.

The collapse of FTX in November 2022 changed the calculus. Even before the exchange's fraud was fully exposed, Signature's management had been watching the digital asset space with growing unease. The bank had never taken large credit exposure to crypto firms. Its lending to digital asset companies was modest relative to its total loan book. But the deposit side was a different story. Digital asset deposits were large, concentrated, and potentially volatile. If a major crypto firm failed, the ripple effects could hit Signature's deposit base hard.

The announcement had immediate consequences. Digital asset deposits fell by $7.4 billion in the fourth quarter alone. That decline accounted for more than half of the bank's total deposit shrinkage of $14.2 billion, which brought total deposits to $89 billion by year-end. The numbers were stark. Total deposits had dropped 14 percent in a single quarter, a pace of outflows that would alarm investors in any bank, let alone one that had just reported record earnings.

Management was direct about the trade-off. A more granular deposit base, spread across more clients and fewer concentrated exposures, would be more stable in a crisis. But getting there meant accepting that reported deposit totals would look worse than peers who continued to count digital asset deposits at face value. The question was whether investors would reward the discipline or punish the shrinkage.

The digital asset reduction was Signature's self-inflicted wound. The broader deposit environment was a war that no bank could control. The Federal Reserve raised interest rates seven times in 2022, for a total of 425 basis points. It was the fastest tightening cycle in four decades, and it transformed the deposit landscape almost overnight.

The pressure came from two directions. First, customers who had been content to earn near-zero interest on their deposits suddenly had alternatives. Money market funds, Treasury bills, and high-yield savings accounts from online banks all offered yields that commercial bank checking accounts could not match. Second, corporate depositors, particularly those with large cash balances, began demanding higher rates or moving their money to institutions that offered them.

Signature's response was to hold the line on pricing. The bank chose not to match the highest rates offered by competitors, a decision that cost it $2.3 billion in high-rate deposit outflows. Those customers who were shopping for the best yield were not the core relationships Signature wanted to keep anyway, management argued. But the arithmetic was unforgiving. Replacing cheap digital deposits with more expensive borrowings pushed the bank's cost of funds higher and compressed its net interest margin from 2.38 percent in the third quarter to 2.31 percent in the fourth. Net interest income fell 5 percent sequentially, even as it remained up sharply year over year.

The margin compression was manageable at the scale of Signature's balance sheet. But the trend line pointed in the wrong direction. If deposit costs continued to rise faster than loan yields, net interest income would keep shrinking, and the record earnings of 2022 would look like a peak rather than a platform.

One measure held steady through the turbulence: credit quality. Nonaccrual loans, meaning loans on which the bank had stopped recording interest income because payment was in doubt, stood at $184 million at the end of 2022, or 25 basis points of total loans. That was down from $218 million, or 31 basis points, at the end of 2021. In a year of deposit chaos, margin pressure, and strategic upheaval, the bank's loan portfolio continued to perform.

The credit quality story was rooted in Signature's lending discipline. The bank's multifamily loan portfolio, its largest single category, was concentrated in New York City rent-stabilized buildings, a market that had historically shown low loss rates even through recessions. Its fund banking loans were secured by capital call lines and other low-risk structures. Commercial and industrial lending was diversified across industries. None of this guaranteed that credit would hold up if the economy entered a severe downturn, but it explained why nonaccruals remained low even as the macro environment deteriorated.

Loan growth itself was slowing. For the full year 2022, Signature grew its loan book by $9.4 billion, or 15 percent. But almost all of that growth happened in the first three quarters. Fourth quarter loan growth was just $452 million, or 1 percent, as the bank pulled back in the face of deposit outflows and economic uncertainty. A bank cannot lend what it does not have in deposits, and with deposits shrinking, loan growth had to moderate.

Management's view of the future was cautious but not pessimistic. The floating-rate loan book meant that the bank would continue to benefit if rates stayed elevated. The deposit base, stripped of its most volatile digital asset component, was more stable and more diversified. The team-based hiring model continued to attract experienced lenders from larger banks. And the core commercial relationships that had driven the bank's growth for two decades remained intact.

The strategic discipline that led Signature to cut its digital asset deposits was costly in practice. The bank had chosen stability over growth at exactly the moment when growth was hardest to come by. Whether that trade-off would prove wise depended on factors that no one could control: the path of interest rates, the behavior of depositors, and the stability of the financial system. What was clear was that Signature's management had made a bet on its own identity. The bank was built on relationships, not transactions. It was betting that in a crisis, relationships would hold.