There are few true growth stories in American banking today, but one mid-sized New York City-based commercial bank surely fits the description. Tuesday, Signature Bank (SBNY) reported 4Q10 operating EPS of $0.70 (GAAP EPS was $0.72), handily beating the $0.64 consensus estimate. Earnings accelerated again. In 2010, this $2.2 billion market cap company earned $2.30 per share on an operating basis, up +43.3% from $1.61 in 2009, when operating EPS grew 20.6%. In financial panic year of 2008, operating EPS grew a mere 9.5%.
As always, the more interesting story is how Signature produces such exceptional earnings. The company is much more than today’s typical credit recovery or net interest margin expansion banking story. This company has a niche and a talent; specifically, it caters to the New York metro region’s plethora of small business customers, who in recent years fled their money center banks and rewarded Signature with their deposits and other banking and investment business. Among the most important results: a golden combination of fast-growing, low cost liabilities to fuel rapid and sustainable revenue growth.
On what evidence? Average core deposits grew a remarkable +5% in 4Q10 and +29% in 2010, funding average earning asset growth of 26% in 2010. In 4Q10, non-interest and core deposits averaged 22% and 91% of total liabilities, respectively. The cost of interest bearing liabilities was +1.47%; adjusted for non-interest deposits, its all-in funding cost was just 1.14%, better than Bank of America’s (BAC) 1.21%. And loans, which increased +21.1% last year, were just 58% of average 2010 deposits. In a higher rate environment, its deposits will be even more valuable. div
Rapid balance sheet growth yields rapid net interest income growth, and in 2010, Signature’s net interest income rose 31%, consistent with growth of 34% and 33% in the prior two years. Margins held steady in 2010, with net interest margin of 3.45%, compared to 3.41% in 2009.
It's held costs in check, with positive operating leverage and an astounding 4Q10 operating efficiency of 39%. Return on assets was 1.08% last quarter, and return on common equity topped 12%.
With regard to risks, Signature was profitable through the financial panic. Non-performing assets peaked at +0.61% of total assets in 2Q09 and have subsequently fallen to 0.29% at year-end 2010. Despite its rapid growth, capital levels are strong, with a Tier 1 Ratio of 14.2%.
Given its success, Signature trades at premium multiples, 2.35x 4Q10 tangible book value of $22.84 and 18.5x consensus 2011 EPS of $2.91. But as I run the numbers, I expect that Signature can earn $3.49 and $4.61, in 2011 and 2012, respectively. I assume average earning assets of $15.9 billion in 4Q12 (up from $10.9 billion in 4Q10), gradual net interest margin expansion to 3.69%, and continued additions to the allowance for loan losses averaging $7.4 million per quarter over the next two years. A 15x earnings multiple would price the stock at $69 per share, compared to yesterday's $53.55 close.
As a sell-side analyst, I covered Signature Bank from its 2004 initial public offering. Now, as a portfolio manager, my partners have benefited greatly from our investment in Signature’s common stock and warrants.
The company’s founders are former Republic Bank small business commercial bankers, who built Signature’s model on Republic’s customer service and convenience model. I respect that it’s hued closely to its model. The greatest risk is that management might forget what brought the company this far, that they buy some backward retail bank and all its associated problems, or that some investment banker convinces them to buy some outsized finance company in California.
Absent those unhappy possibilities, I see substantial upside opportunities in this, NYC banking's growth story.
Disclosure: I am long SBNY, BAC.