Description

Signature Bank is a high priced NYC bank trading at 23 times 2007 consensus EPS that is heavy on optimism. I believe Q1/07 EPS, to be reported this Friday, will likely be $0.29, missing the consensus $0.30 because of higher compensation expense. High priced banks that miss estimates (and many have missed on a combination of compressing margins and higher op/ex) have been getting crushed in this market (CACB and PVTB are two good examples). I think SBNY can trade back to $24, where it traded not too long ago, or down over 20%.

SBNY reported $0.30 of EPS in Q4/06 vs. $0.28 in Q3/06 and $0.25 in the year ago quarter. There were several moving parts in the quarter, however. Most importantly, they had $1.5M in excess commission gains, translating to $0.03 of EPS. Management and the sell-side all agree that this is non-recurring, although SBNY will realize gains like this from time to time. This was offset somewhat by a spike in miscellaneous “other” expenses, which were about $1.5M higher than normal. So, we can call the above two items a wash. However, compensation expenses declined suspiciously from $12.9M in Q3/06 to $12.5M. SBNY is a growth story and has been adding lots of “teams” and offices over the past few years. The company posted fantastic sequential quarter loan growth of 12.5% in Q4/06 and 51% over the past year. What makes this even more impressive is that compensation expense was up only 11.6% from Q4/05 to Q4/06, a trend I believe to be unsustainable. Because most small banks like SBNY are “relationship-driven”, they have a limited degree of operating leverage, particularly in this unfavorable operating environment of inverted yield curves and intense competition. It is my hunch that we will see SBNY playing serious “catch-up” on its compensation expense line in the quarter about to be reported. To repeat, their loan/relationship officers have grown balances by an impressive 51% year-over-year while they have seen their own compensation increase by only 1/5 of that. I bet there has been a lot of grumbling behind the scenes. Compensation expenses could easily come in at $14M or more for the quarter. Below, I have attached a model of the income statement (the far left column is my estimate for Q1/07) as well as a few key balance sheet line items and ratios. There are two additional items affecting Q1/07 EPS that are essential for understanding. SBNY is getting assessed with $0.4M of additional FDIC insurance expense, which you can see is broken out in a separate line. Management has said they plan to offset this with the establishment of a more tax efficient REIT subsidiary to house some of their loans and securities. You can see this effect in the lower tax rate. (I ask, If this REIT subsidiary is such a no-brainer money-saver, why didn’t they set it up earlier? I am suspicious.) In the model I have underlined the key numbers to focus on. Oh, and finally, it is worth noting that the quality of past earnings has been low, with the loan loss reserve ratio (LLLR) dropping from 1.00% a year ago to 0.88%. While SBNY’s credit quality is good, it isn’t pristine. Their bad loan ratio has ranged from a relatively high 0.71% to 1.0% over the past year.

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