Comerica Incorporated (CMA) Earnings Call Transcript & Summary

Good morning, everyone. I'm Jon Arfstrom from RBC, and we're pleased to host the Comerica team today for our virtual fireside chat. We have Curt Farmer, the CEO; Jim Herzog, the CFO; Pete Guilfoile, the Chief Credit Officer; Peter Sefzik, the Head of the Business Bank; and Darlene Persons, the Head of IR. Curt has some prepared comments that will walk us through their latest update, and then we'll get into questions. And just a reminder to investors listening to the webcast, they can submit questions through the webcast. We'll get to as many as possible. So I guess with that, live from Dallas, live from New York, take it away, Curt.

Thank you, Jon, and good morning, everyone. Before we get started, I'd like to remind you that today's presentation may contain forward-looking statements. And in that regard, you should be mindful of the risks and uncertainties that can cause actual results to vary materially from expectations. I'll refer you to Slide 2 for our safe harbor statement, which I incorporated in this presentation as well as our filings with the SEC for factors that could cause actual results to differ materially from expectations. Forward-looking statements speak only as the date of this presentation, and we undertake no obligation to update any forward-looking statement. Turning to Slide 3, and an overview of Comerica's key strengths, which have driven our success for 170 years through many economic and interest rate cycles. We believe these strengths will help us navigate the coronavirus outbreak as well as related reduction in interest rates and the associated economic slowdown. Of course, there is a lot of uncertainty. So it's impossible to gauge the ultimate impact as the picture is changing by the day. However, we would like to share some insights on what we are seeing so far this quarter. Customer sentiment has been relatively positive, but we are perceiving some signs of concern. We continue to see good opportunities, and we remain selective. Our loan pipeline remains solid and has been increasing through the quarter. Also, deposits are running slightly ahead of our forecast. As far as lower interest rates, I will address the net impact later in the presentation. Energy remains challenging as we see increased stress on select credits. Credit quality for rest of the portfolio is strong. Our consistent approach to underwriting has produced superior credit result, with net charge-offs in nonperforming loans consistently below our peer group average. As far as expenses, we have demonstrated our ability to carefully control costs, and we have heightened our focus on expense management during this period of uncertainty. We are always looking for opportunities to further increase our efficiency while balancing investments we support and drive growth. Finally, we maintain a strong capital base liquidity profile, which has served us well in many downturns. And in certain times like these, our ability to serve our customers using our experience and deep expertise, builds and solidifies loyal relationships. Slide 4 provides highlights of our 2019 results which were strong with a 9% increase in our earnings per share to a record $7.87. Average loans increased 4%, including broad-based growth across all markets. With the contribution from higher fee income, revenue reached an all-time high. This increase in revenue, coupled with careful expense control, resulted in an efficiency ratio of under 52%, the best in our peer group. Finally, we meaningfully reduced excess capital to a record-setting repurchase of 18.6 million shares during the year. Together with a 46% increase in our dividend, we returned a total of $1.8 billion to shareholders and grew our book to value per share by 7%. Turning to Slide 5, and an update on loans based on preliminary results through the end of February. As you can see at the right of the slide, mortgage banker average loans have decreased nearly $800 million compared to the fourth quarter. However, they are up to close to $600 million relative to the first quarter of last year. This is in line with the mortgage origination volumes reported by the Mortgage Bankers Association. Due to seasonality, Mortgage Banker usually hits a low in February with slower winter home sales and then begins to rebound as we enter the spring selling season. While refi activity is robust, it slowed in the first half of the quarter but is expected to pick up with the recent drop in mortgage rates. As far as National Dealer Services, average loans have declined $665 million, partly due to lower inventory levels, which is reflected in recent industry data. Partly offsetting these headwinds, commercial real estate has continued to grow. Overall, we have seen positive trends recently, and therefore, we believe average loans will exceed $49 billion for the first quarter. As of the end of February, commitments have held relatively steady, and the utilization rate has increased modestly. We are closely monitoring the environment in light of elevated economic uncertainty. Our portfolio is diverse by industry and geography, which helped support more consistent growth and credit performance. On Slide 6, we have a preliminary update on deposits. Quarter-to-date, average deposits have decreased $900 million, including a $300 million reduction in average noncustomer broker deposits. Due to our strong liquidity position, we have been able to reduce the higher cost noncustomer broker deposits to 0. Average deposits for February increased $800 million over January, which is a result of strong noninterest-bearing growth. The seasonal upswing has come much earlier than we typically see, demonstrating that our deposit-gathering strategy is working. As a result, we believe that average deposits for the quarter will come in slightly higher than the quarter-to-date average. Again, we are closely monitoring the environment and have not seen any noteworthy change in customer behavior. We have a very favorable deposit mix, with the largest component of noninterest-bearing deposit amongst our peers, which contributes to us to having a low total funding cost. Our interest-bearing deposit costs of 92 basis points in the fourth quarter was in line with the peer group average. With the recent Fed action, we are making pricing adjustments. We continue to carefully manage our deposit rates in order to attract and retain relationships. Turning to Slide 7. Our strategy is built on relationship banking, and we strive to develop deep, long-lasting relationships by providing the finance of products and services our customers' desire. Furthermore, we are aiming to deliver a more diversified and balanced revenue base with an emphasis on fee generation. As an example of our success, card provides a significant portion of our fee income and has generated growth of 5% year-over-year. Commercial card and Comerica's merchant services are key components of our integrated treasury management products and provide customers with increased efficiency. We are focused on being a premier bank for treasury management services. One of the ways we develop formal relationships is through collaboration across business lines. During 2019, we had nearly 4,000 referrals between business lines, of which over 1,300 resulted in new business, specifically $1.4 billion in new loans, deposits and assets under management. For example, our Business Owner Advisory program provides the owners and executives of our business bank customers with a warm introduction to our wealth management advisory team. Our wealth advisers have been to work to understand our customers' needs and establish a personal financial strategy, including succession and retirement plans, life insurance and investment advice. With a strong business relationship already in place, we are uniquely qualified to help our customers with their personal banking needs. Slide 8 highlights some of our technology investments. These include projects recently completed and those that are in process beyond the normal care of our infrastructure. Increasingly, our technology spend is focused on customer and colleague enablement as we work to maintain our competitive position. For example, on the commercial side, we automated and streamlined our loan origination process, leading to greater marketing capacity for our relationship managers. Also, we've made upgrades to our commercial payments platform, and we are developing a road map to help ensure we continue to deliver leading-edge treasury management solutions. On the consumer side, we've replaced our teller system, and we are working on an upgrade through our onboarding capabilities to make it easier to open accounts online. For both segments, we've been rapidly adopting cloud computing to become more scalable, resilient and agile in the development and deployment of solutions. Our emerging technology strategy, which we call, Digital 2025, puts us on a path to become fully digitally enabled and data-driven, enabling reengineering our entire processes. Finally, we have been investing in data analytics to help us do a better job of identifying products and services that might best meet our customer needs. We believe our technology investments are helping drive customer and revenue growth, reduce costs and streamline processes, which will reduce risk and increase efficiency. Turning to Slide 9, in the rate environment. We estimate the net impact from rate on net interest income in the first quarter will be approximately $20 million. This takes into consideration the full quarter net impact from rate movements in the fourth quarter combined with spot rates as of March 6 and assumes no further decline in rates. The impact from rates in the second quarter is expected to be an additional $50 million to $55 million. As far as the last few quarters of 2020, assuming LIBOR holds steady, we expect rates for loan should have a relatively smaller residual effect as longer-dated assets and liabilities reprice. Of course, actual results will vary depending on a variety of factors, most notably, further LIBOR movement. On the right side of the slide, we provided 3 rate scenarios with the estimated impact on net interest income. You can see that the impact is pretty linear and provides authoritative framework for analysis. We are utilizing our standard asset liability model. However, we have adjusted the deposit beta to 30%. As you can see in the bottom left, we have steadily increased our swap portfolio over the past year. Our goal is to significantly mute our asset sensitivity by executing a hedging program, which should help us maintain a more consistent net interest margin through the cycles. We are closely monitoring the markets and plan to take advantage of opportunities as they arise. Slide 10 highlights our conservative credit culture. We also have provided some details on areas that may be relatively more impacted by the economic slowdown, specifically related to the coronavirus outbreak. Our loans to Energy and Automotive comprised 4.5% and 2.5% of our portfolio, respectively. We have nominal exposure to other industries that may come under more duress such as hotels, airlines, cruise lines and restaurants. We are known for our consistent underwriting, which produced superior credit quality relative to our peers throughout the last recession, with net charge-offs and nonperforming loans well below our peer group average. Further information on our Energy portfolio is provided on Slide 11. Over the past several years, we've significantly reduced our Energy loans. The Services component, which was the major driver of losses during the last downturn totaled only $48 million at year-end. In general, our E&P customers are well capitalized, have less leverage than they did during the last energy downturn and are hedged to varying degrees. As we work through the spring redeterminations, we expect to see some borrowing base deficiencies, if prices remain at these extremely low levels. Our customers are acting prudently, cutting costs and reducing CapEx in order to preserve liquidity. The ultimate outcome will depend on the duration of the cycle. With more than 40 years of serving this industry, we have deep expertise and remain committed to supporting our energy customers. Overall, our customers are well positioned and have weathered many cycles. As I mentioned, we've been actively managing our capital, which you can see on Slide 12, with the goal of maintaining a CET1 target of approximately 10%. During 2019, we reduced our average share count by 11% and increased our dividend 46%. In January, we increased the dividend again. The current yield is very attractive and is supported by a strong holding company cash position. We have completed our share repurchase for this quarter. We have repurchased 3.2 million shares, a 50% increase of our total shares repurchased in the fourth quarter. Each quarter, we determine the pace of our share buyback, we gear careful consideration to our expected earnings generation as well as capital needs to fund future loan growth, with an aim to maintain our CET1 target. We continue to focus on managing our capital with the goal of providing an attractive return to our shareholders. In closing, Slide 13 reiterates Comerica's key strengths, which produced the best ROA, ROE and efficiency ratio in our peer group in 2019. Over our 170-year history, we have managed through both prosperous and challenging times. With our conservative, consistent approach to banking, we believe we can successfully navigate the coronavirus and the associated economic slowdown. Our geographic footprint, combined with our relationship banking strategy, is expected to result in growth of loans, deposits and fee income over time. We are focused on maintaining our proven expense discipline as well as leveraging our strengths to drive profitable growth and continuing to enhance long-term shareholder value. Now we'd be happy to take your questions.

All right. Thank you, Curt. Thank you for going through that. And as I mentioned before, we do have the availability for listeners to ask questions. But we'll start with this one, Pete Guilfoile. Maybe Energy is maybe the best place to start, and I know this is sudden and rapid and -- in terms of the decline, but maybe a good place to start would be, can we go back to '15 and '16, it was an extended period of low energy prices. Can you go through and remind us of your peak losses and cumulative losses in Energy during that period and talk a little bit about -- a little bit more about the hedging programs and the hedging requirements that Curt referenced?

Sure, Jon. First, let me just remind folks how our portfolio might be a little bit different than where it was back in 2015. I think first and most significantly, it's much smaller. Our loans outstanding in Energy are about $1.3 billion lower than they were in 2015. So we would expect the results from Energy to be less impactful on our overall results going forward. Secondly, we have much less Energy Services exposure. Going into 2015, Energy Services was about 15% of our portfolio, but it contributed to 45% of the credit losses. Today, Energy Services is only 2% of the portfolio. And we believe Energy Services could, again, be one of the most impacted segments as -- if prices remain low for a period of time. And then in general, I think Curt mentioned this in his comments, we believe our E&P borrowers in general are stronger than they were back in 2015, stronger balance sheets, less leverage and overall lower cash costs. Having said that, if you go back to that -- the worse 3 years of the downturn, 2015 to 2017, we averaged 150 basis points of losses in the Energy book per year that -- over that 3-year time frame. But if you subtract out Energy Services from that, and again, we're effectively out of the Energy Services business, our losses were only 90 basis points. And that's based on loan balances going into the downturn. We think that's the better measurement than average balances because we took our balances down pretty quickly right at the very beginning. As far as hedging goes, Jon, our borrowers are reasonably well-hedged right now. These numbers go back to the fall redeterminations, but I think they're pretty much the same today as they were back then. About 65% of our borrowers have hedged 50% or more of their PDP production out 12 months or more. So 50% of revenues out 12 months or more. And then 37% are -- have hedged 50% of their PDP production out 2 years or more.

Good. That's very helpful. I also want to get to margins and capital. But Curt, one of the comments you made is you're seeing some early signs of concern from borrowers. But then again, your pipelines aren't increasing. So could, maybe, you touch on both of those. When you say early signs of concerns, what do you mean by that? And then also, where are you seeing the pipelines increasing?

I will let Peter respond to that.

Yes. As far as the early signs of concerns, I think it's more just the similar concerns that all of us have about what the outlook is for the economy. I mean our customers have been managing through this, just like the rest of us and being prudent. Now that said, our general middle market, business banking space, the pipeline, particularly in markets like Texas and California, has continued to feel pretty good, matter of fact, up until here recently that the overall pipeline for the business bank has been increasing through the year. Now what that looks like in the next 60 days is yet to be determined, but we had felt pretty good about the outlook of the field here recently. So I think the concerns are more just around what's happened really in the last couple of weeks around, are we on the verge of recession, what sort of headwinds does the overall economy have? And again, the concerns that all of us have in this environment, our customers are paying attention to.

Okay, good. And then any recent changes in pricing or spreads in your commercial lending business?

No, no immediate -- no recent changes there as far as our strategy or really what we're seeing.

Okay. Good. Maybe start with a question on margins, just so we all understand it. That Slide 9, you talk about the 50 basis point shock. And I guess, what you're trying to say is if we get another 50 basis points from the Fed in the relatively near term, it's safe to say that we just take another $40 million a quarter out of net interest income as soon as that happens. Is that the right way to look at it in terms of how you're modeling it?

Yes. That's right, Jon. We have that modeled on the right side of the page. 50 bps shock you would see with about $165 million impact. Depending on the timing of that, it's hard to say what quarter would come in, it depends what part of the quarter it occurs. And -- but typically, you can start to see a lot of that in about a one-month delay.

Okay. And it's challenging to ask questions about the margin, given what's happened to the tenure. And I know that you're more focused on the shorter end of the curve. But the CFO, Treasurer role, talk a little bit about the most challenging part of this environment for you. I'm assuming you have a balanced approach, but kind of the risks of reacting too soon or being too patient. And how you go through the decision-making process on things like securities purchases or sales and further hedging and things like that?

Yes. We're trying to keep a very systematic approach here. As you know, we've been hedging at a pretty consistent rate since last spring. We're trying to avoid making any one big bet at a point in time. At the same time, we don't want to set up sidelines for too long. So you've seen a bit of consistencies from us over the last year. And I wouldn't expect any rash movements at this point in time. We're managing through the environment as best we can. And obviously, we're in a very volatile period right now, and we'll see where this goes in the short term.

Okay. And then, Curt, you talked about some ability to make some pricing adjustments on deposits. Can you maybe talk about what you're seeing there and some of the magnitude of that repricing?

Yes. I'm actually going to let Jim speak to that.

Yes, you do see that we've modeled a 30% beta on Slide 9. That's very purposeful with the most recent 50 bp cut. We did take pricing actions that should yield about a 30% beta. We have room to move for future cuts also. In fact, I would expect to see that beta increase over time, if the Fed should execute further rate cuts. We have those customers identified. We have a good feel what product set sales would be. And we have a number of deposits that are well below 1%, that will start to fall into that net if further rate cuts occur.

Okay. I guess another topic here is expenses. I know you've been -- you guys have all been pushed a little bit on expenses post GEAR Up, but obviously, the revenue environment may have changed a little bit more. What's your latest thinking on expenses? And are there areas where you can maybe slow spending and you stop projects or do things to offset this challenging environment? Is that really not in your thought process at this time?

Yes. I'll just start by saying, Jon, since you mentioned GEAR Up, we have historically had a very good focus and leadership around expense management. GEAR Up certainly provided a boost to us in terms of our efficiency ratio. And we ended the year, as I said in my prepared remarks, with below 52% efficiency ratio, the best in our peer group. So we believe that even as things change here and the revenue component changes on the efficiency ratio that we still can perform relatively well versus our peer group. Having said that, we are looking at the current environment, and a lot has changed since we set our financial plan at the beginning of the year. We want to strike the right balance between investing in the company for the long term and doing the things that we need to do to grow the company, position the company, be relevant from a technology and competitive -- from a technology perspective longer term. We are looking at a number of things in the immediate future, those would include: how we manage human capital and headcount, how we handle our project portfolio or the things that we can slow down -- technology initiatives that we can slow down and not hurt for the longer-term strategy. We're certainly looking at more discretionary items like travel, spending on entertainment, marketing, some of those types of things. So no change to the forecast as of right now that we would share with you, but just know that we are very, very focused on the expense side of the equation. And as this thing becomes a prolonged situation, then we will continue to work on levers to make more prorated expense reductions.

Okay. Good. Just 3 more things I want to handle. We have about 4 minutes left, but maybe a quick one for you, Jim or Pete. Anything to note on provisioning in the CECL with some of this elevated near-term uncertainty? I know you guys are very short in terms of your loan book and CECL impact, but anything you want to point out or call out?

Yes, Jon, it's so difficult for us to give guidance on provision in a post-CECL world. As you point out, the provision is really driven by several factors, 3 in particular, your credit quality, the duration of your portfolio and your economic forecast. We have a really short duration, so the impact to us is all things being equal less. We don't expect to see any major changes in our credit quality this quarter. So the driving factor is just the economic forecast. And given the rapid developing events that have been occurring over the last few days and few weeks, we would want to select our economic scenario as late as possible in the quarter. I think it's safe to say that, that economic scenario will be not as attractive as the economic scenario we picked in the first quarter, where we were operating in a relatively benign environment. But that's about all we can really say on provision.

Okay, good. And then buyback appetite. You're obviously very active this quarter. I'm surprised, yesterday, you were at 80% of tangible book value. Any capital structure opportunities or any willingness and ability to be more aggressive on the buyback?

Well, of course, our buyback always can be calibrated to our earnings generation, what we need to support the dividend. And of course, capital needed to support capital growth. With that said, we are pretty comfortable with our 10% CET1 level. We think it serves us well, especially in these volatile times. And I would also remind everyone that even though we're relatively high in the CET1, we're relatively low in Tier 1. And I'd like to remind people that currently some of our peers are below 10%, they usually have a multiple of that issued and preferred. So we think we have a relatively efficient capital stack right now. Having said that, we're all always observing the environment and where we have some of the coupons out there and trading both tangible book, and that's something we think nobody doesn't really observe. But I would certainly say, for now, we're comfortable with the 10% CET1 level.

Okay, good. I would encourage that, by the way. And then end with Curt, I wish we had a little bit more time for this, but I wanted to talk about some of your leadership changes. But maybe just bigger picture, you're a relatively new CEO, you kind of get this trial by fire of rates and oil. What's the message, what's the Curt Farmer message to the troops internally in terms of how to deal with this type of environment, as I'm sure you're getting questions about the stock price and rates and oil? Just give us your -- the Curt Farmer internal message.

Yes. I mean we're doing all the things that I think all other financial institutions are doing and all companies more broadly in terms of being prepared for the coronavirus and trying to make sure that we're instituting appropriate safety for our employees, for our customers and for the institution at large. And so we're going through all that preparedness exercises and will be accommodating the customers as needed if there are -- if this thing becomes an elongated situation. What I said in my prepared remarks, I'd reemphasize is that, we've got a strong culture at the company and very relationship-focused as an institution, and that extends both through our colleagues and to our customers. We are very focused on doing the right things for both the customers and our employees. And in many cases, these are very, very long-standing relationships that we have. And again, we've been a bank for 170 years and have managed through lots of the different cycles. And I think, as Pete alluded to, oftentimes, we've outperformed very well under difficult circumstances. So this is a period of time where we've got to be careful. We don't want to stretch inappropriately. We do want to take care of our customers. However, we're going to watch the expense side of the equation and do the things we need to do to manage our capital liquidity, et cetera, well. The good news is that we are approaching this from a position of strength. Credit quality is relatively strong, a little bit of issues in the Energy book, but those we already knew about, and we'll have to watch them on a go-forward basis as we've got strong capital, very strong liquidity position, and we continue to operate in great markets, greater lines of business with a great customer base.

All right. With that, we'll end it, but thanks for hanging in there with us, and thanks for the presentation today.

Thank you, Jon.

Thank you.