Comerica Incorporated (CMA) Earnings Call Transcript & Summary

All right. Good morning, everyone. I'm Ken Zerbe, the mid-cap banks analyst at Morgan Stanley, and I want to welcome you to our second presentation of the day at the 2020 Morgan Stanley Financials Conference. Now before I begin, I do have to tell you that for important disclosures, please see the Morgan Stanley research disclosure website at morganstanley.com/researchdisclosures. If you have any questions, please reach out to Morgan Stanley sales representative. All right. So this presentation we have Jim Herzog, Chief Financial Officer; and Melinda Chausse, Chief Credit Officer from Comerica, and I'm really excited to have both of them with us today. I do want to also remind everyone in the audience that if you have any questions for either Jim or Melinda, please submit your questions directly through the Morgan Stanley conference portal. All right. With that, let me turn it over to Jim for some prepared remarks and then we'll go to Q&A right afterwards. Jim?

All right. Thank you, Ken. Good morning, everyone. I hope everyone's doing well. Melinda and I are going to make a brief presentation, and then we will open it up to some Q&A. Before we get started, I'd like to remind you that today's presentation may contain forward-looking statements. I refer you to Slide 2 for our safe harbor statement, which I incorporate into 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 of the date of this presentation, and we undertake no obligation to update any forward-looking statements. With that, turning to Slide 3 and an overview of some of Comerica's key strengths, which have driven our success for over 170 years. We have a long-tenured experienced team, which quickly adapted to the rapid changes in the environment. Our geographic footprint is diverse, and we lack reliance on any one industry. Our conservative underwriting standards, strong capital base and liquidity profile position us well to support our customers as they navigate the challenges. It is at times like these that you build and solidify loyal relationships. Slide 4 provides pure comparison metrics for the first quarter. On the left are 2 efficiency ratios, which demonstrate our strong expense discipline. In the middle, we show our ability to grow loans and manage deposit cost better than the peer average. And finally, on the right, our credit reserve is higher than the peer average, while nonperforming assets are lower. Overall, on a relative basis, we believe we are well situated as we go through this economic cycle. Turning to Slide 5 and an update on loans based on preliminary results. Average loans increased over $4 billion in the first 2 months of the quarter to an all-time high driven by the Paycheck Protection Program, or PPP, along with growth in Mortgage Banker and Corporate Banking. Mortgage Banker increased to a new record as refi activity remained strong and spring home purchases picked up. Corporate Banking began to increase late in the first quarter as customers drew on their credit lines to build liquidity buffers, but this has since begun to recede. From the end of the first quarter through the end of May, commitments for the total portfolio held relatively steady, and utilization rate has decreased back to our historical normal range. A major driver was the drop in dealer utilization, which resulted from the interruption of auto production. Based on current trends, we believe our average loans in the second quarter will be approximately $53 billion to $54 billion. On Slide 6, we have a preliminary update on deposits. Quarter-to-date average balances have increased over $6 billion primarily due to very strong noninterest-bearing growth. Government stimulus programs, including the PPP program and consumer economic impact payments, have resulted in tremendous liquidity in the system, and we believe customers have been conserving cash in this time of uncertainty. Therefore, we expect the average deposits for the second quarter to reach a record of over $63 billion. It is important to note that we have a very favorable deposit mix, with the largest component of noninterest-bearing deposits amongst our peers, which contributes to us having low total funding costs. Turning to Slide 7. We estimate the net impact from rates of loan in the second quarter to be approximately $75 million. This assumes 1-month LIBOR remains at about 17 basis points and takes into consideration the full quarter net impact from rate movements in previous quarters. This includes the benefits from our swap portfolio, actions we have taken, and expect to continue to take to appropriately manage deposit rates and add rate force to loans. After this quarter, assuming LIBOR hold steady, we believe rate should have a smaller residual impact. Of course, actual results will vary depending on a variety of factors, most notably LIBOR movements. Other factors, such as strong and even stronger deposit growth are expected to benefit net interest income. However, that excess liquidity generated does weigh on the margin. As far as the PPP program, the revenue contribution from assisting over 14,000 customers will be determined by the timing and the magnitude of loan forgiveness. We have outlined our general assumptions on the slide. We expect the bulk of the loans to be forgiven in the back half of the year and the income to be partly offset by the cost of running the program as well as planned donations to nonprofit organizations. Our outlook for the second quarter noninterest income and expenses has not changed significantly since our earnings call. We continue to expect a decrease in several fee categories due to reduced economic activity, mostly offset by an increase in card fees with higher transaction volume as customers utilize the government stimulus funds. Expenses remain well controlled, yet we expect an impact from seasonally higher compensation and COVID-19-related expenses. We have been actively managing capital, which is summarized on Slide 8. We issued $400 million in preferred a couple of weeks ago. This was the next logical step in optimizing our capital base, adding more than 50 basis points to our Tier 1, which is refinery constrained. We opportunistically took advantage of market conditions and received a very strong response, reflected in the favorable pricing at [5 5/8].. Our Board increased the April 1 dividend to $0.68 per share and recently declared that level for the July dividend payment. As the dividend is determined, careful consideration is given to the expected earnings power and capital needs to support loan growth and investment in our businesses. Our current dividend yield is very attractive and is supported by a strong holding company cash position. We also conduct robust capital stress test to help ensure our dividend can withstand cyclical pressures, while we maintain accessible capital levels with a CET1 target of 10% over time. We will focus on continuing to manage our capital with the goal of providing an attractive return to our shareholders. Now I'll turn it over to Melinda.

Thanks, Jim, and good morning, everyone. Slide 9 highlights our conservative credit culture. Our disciplined approach to underwriting, coupled with our long tenured and experienced employees, has resulted in lower nonperforming assets than the peer average through the cycle. Coming into the current cycle, our nonperforming loans remain well below the peer average. And our reserve, which stood at 1.75% of commercial loans, is amongst the highest of our peers. In the first quarter, we prudently increased our credit reserve to over $900 million in recognition of the forecasted impact COVID-19 could have on the portfolio, our quantitative model centered on significant economic deterioration, followed by partial recovery, with more severe or benign assumptions for certain sectors. It is currently very difficult to predict the provision for the coming quarters, as there is still a great deal of uncertainty about the duration and severity of the economic impacts related to COVID-19 and even more difficult to quantify the countering benefits from the unprecedented level of government stimulus. In addition, CECL may cause more volatility in the position. However, we believe we may experience less than our peers as we have a higher proportion of commercial loans, which have relatively shorter life than consumer loans. Nonetheless, given this consistent underwriting, diverse portfolio and deep expertise that we have, we believe we are very well positioned. This expectation is supported on Slide 10. Based on the 2017 DFAST, as well as the most recent run -- company run stress tests, we have a major portion of projected losses covered with the reserve levels we have today. In addition, over time, we have adjusted the composition of our portfolio. Today, we have a higher percentage of businesses that we consider more recession resilient, such as National Dealer, Corporate Banking, Equity Fund Services, Private Banking and Mortgage Banker. With every recession -- while every recession and stress test is different, we feel our reserves are better positioned than when we entered the last downturn. Now I'm going to briefly touch on some of the areas that investors have been interested in. As far as National Dealer Services, we have had questions about the risk due to the decline in auto sales. As you can see on Slide 11, we have been in the auto dealer business for over 70 years, weathering many economic cycles. We focus on developing long-tenured relationships with top-tier, multi-franchise dealers who have a good mix of sales and service revenue. Floor plan lines adjust with inventory levels, and advanced levels are curtailed as the inventory ages. In fact, with falling inventory levels, average loans for the first 2 months of the quarter have decreased approximately $350 million. We are working with customers to assist them in managing through the COVID-related challenges and currently do not have any serious credit concerns about this portfolio. Turning to Slide 12 in Commercial Real Estate. Nearly half of the portfolio is multifamily, which demographics favor, and the bulk is in Class 8 infill in higher-growth urban and suburban markets within our footprint. Our underwriting guidelines include substantial upfront equity contributions and working with well-established, proven developers. Approximately 90% of new business comes from this existing proven customer base. About 60% of the portfolio is construction, and criticized loans represent only 1.3% as of March 31, including $3 million in nonaccrual. We have adjusted the diversification by property type since the last recession. And today, we feel very comfortable with the size of this portfolio and the composition. Information on our energy portfolio is provided on Slide 13. We have deep expertise with more than 40 years serving this industry. Over the past several years, we have significantly reduced our energy loans, and importantly, the energy services component, which was the major driver of losses during the last down cycle. We are approximately 60% of the way through the spring redetermination process and have seen borrowing bases come down in the neighborhood of 20%. In those instances where we have an efficiency, we are working with customers to share over time. Prices have firmed up in recent weeks, and we continue to update our price deck as market dynamics warrant. In general, our E&P customers have less leverage than the last energy downturn, are hedged to varying degrees and are acting prudently, cutting cost and reducing CapEx in order to preserve liquidity. Given the volatility in energy prices and uncertainty regarding the duration of the cycle, in the first quarter, we've increased our reserve allocation to more than 10% of energy loans. Slide 14 provides details on segments that we believe pose higher risk in the current environment. Our exposure to any one of these industries within what we've termed our social distancing portfolio is not significant, and there are many areas where we have no exposure, such as franchise restaurants and consumer credit cards. In the first quarter, we applied a more severe economic forecast to this portfolio, resulting in an increase in our allowance allocation for loans in these areas. As far as leveraged loans, we are always closely monitoring this, as this is where you often see the first indication of stress. So far, these loans are performing as expected. Our leveraged loans tend to be with middle-market relationship-based customers with sponsors, management teams and industries we know well. Our sweet spot would be on the lower end of the leverage spectrum, and we avoid highly leveraged, covenant-light deals that have been more prevalent in recent years. It is impossible to gauge the ultimate impact of COVID-19 as the picture is changing by the day. We continue to proactively reach out to customers to make sure that we understand what's going on in each individual business, help determine what needs they have and provide our expertise. As appropriate, we are providing relief in the form of payment deferrals, forbearance and PPP loans. Through the end of May, we have processed deferral request for more than 1,300 customers, totaling $4 billion in loans, which is about 7%, with substantially all considered performing at the time of deferral. In closing, we have a long history of managing through challenging times. We maintain a conservative -- consistent approach to banking, combined with a diverse geographic footprint and relationship banking strategy. We believe our conservative underwriting standards and prudent customer selection resulted in the superior credit performance through the last recession and is assisting us in navigating the current environment. With strong liquidity and capital levels, we are able to meet our customers' financing needs as appropriate. In uncertain times like these, our ability to serve our customers using our experience and deep expertise builds and solidifies long customer relationships. Thank you for your time. Now Jim and I, as well as my predecessor, Pete Guilfoile, who will be retiring soon, will be happy to take your questions.

All right. I guess, first question, maybe just going back to Jim. I certainly appreciate the loan update on Page 5 -- or Slide 5. If we think about, like if we strip out, I guess, the PPP program, strip out like the corporate line drawdowns, like how -- can you talk a little bit more about just customer sentiment? Like how are businesses feeling right now given the environment?

All right. Thanks, Ken. It's really going to vary a little bit by industry and geography. Maybe I'll start with using our typical middle market customer as a proxy for the overall sentiment out there. And I would say, especially very recently, I would characterize it as cautiously optimistic. They see hope out there in the distance. They see where this thing is going to wrap up and things get back to normal at some point. In the meanwhile, it's our understanding they're operating quite well and adjusting to the environment, which is good news. With that said, there are some differences by market. Texas and California, the customers are a lot more apt to be talking about when it's over, getting back to normal. And they're actually willing to meet, wanting to meet person, et cetera. So things are moving along there. Michigan is clearly further behind given some of their stay-at-home progress, a little behind the other markets, but improving each day, but it will get there eventually, too, I think. From a line of business standpoint, I commented on typical middle market, maybe a few of the other key business units. With CRE, I would characterize it as cautious customers, and we are certainly keeping an eye on the monthly payments. And there's just not a lot going on right now in terms of new build other than perhaps the new -- the Amazon-type industrial builds. But we've great customers, good balance sheets and good geographies. These are customers we've had for a long time, so we feel really good about our CRE portfolio. In terms of dealer, as I mentioned in my opening remarks, there was the auto production stopped, and so there aren't a lot of cars in the lot right now. But the customers that we think is going to be the mega dealers, they're doing fine. They have good balance sheets, and we actually think this could lead to some good consolidation. Mortgage Banker, of course, is just off the charts, not surprisingly, very busy with a lot of requests. In fact, if anything, we have to manage exposure there, but it is an opportunity to add some good select new customers. And we're getting some good pricing there, too. And in energy, which I'm sure you'll have a lot of questions for Melinda on, certainly as a tale of 2 ends of time period where things have just changed dramatically over the last 45 days, a little more positive sentiment there. We're seeing actually a lot of hedging going on in the last 2 or 3 weeks, which is kind of a good proxy for the fact that they think they can operate profitably in many areas at these levels of prices. But overall, I would say, people are seeing some hope out there, and that's actually picking up some momentum over the last few days.

Yes. Ken, this is Melinda. If I could just add one other thing that kind of gives us some indication of what's really going on in the portfolio is our senior-most loan committee. And quite frankly, when stay-at-home orders went into effect and we're kind of in the heat of the COVID crisis, I mean, all activity at loan committee basically stopped. In the last 3 to 4 weeks, we have actually seen a pretty good pickup in activity in loan committee, with request from existing customers. And quite frankly, we're starting to see some screening of some deals, which tells me that the customer optimism has definitely shifted away from just purely focused on managing through the stay-at-home orders to really positioning them for what's to come next -- in the next 6 to 12 months.

Got it. Okay. Perfect. And then I guess staying with that same slide, the line utilization looks like it's fallen quite a bit back down to year-end levels. I think some of that might be due to dealer. Can you just talk about how you're envisioning corporate line drawdowns paying off over the course of the year? I mean, do you expect them most to be done in 2Q or paid off in 2Q? Or could it last longer?

Well, as I mentioned in the opening remarks, we are seeing some those liquidity lines start to recede at this point. They're not all the way back. And of course, it's going to correlate strongly with the fear factor, which is quickly subsiding, and their perception of the openness of capital markets, so that they have access to funding when they need it, and that has certainly come back in a big way, too. So it's receding. I expect it to continue to recede throughout the summer, unless some other unknown factor pops up in the economy. And whether it's late 2Q or mid-Q3, I would say sometime this summer, we should see those pretty much get back to normal.

Okay. And then your deposit growth, again, I appreciate the update. The guidance there looks really strong in 2Q. So it's up $6 billion. Obviously, the vast majority, that's noninterest-bearing. Is there any way to know how much of that deposit growth is temporary versus what you think you might be able to retain on the balance sheet over, say, the next year or so, a little bit longer term?

Yes, there's 2 or 3 things going on there. Certainly, the PPP deposits are a contributor, and we have almost $4 billion of PPP loans that have been dispersed or made. The vast majority of that is still on the balance sheet. So as you read in the papers and so on, PPP clients are not burning through this cash real fast, hence, the recent Washington action to extend the repayment or forgiveness time line. So eventually, we'll see some of those deposits stripped away. But customers are being conservative, and they are storing some of this liquidity, too. I think a real big factor in terms of longer term is the fact that the Fed balance sheet has grown from about $4.5 trillion from that time period where we had previous record deposits back in the 2014, 2015 time frame. Balance sheet for the Fed has grown from $4.5 trillion to $7.2 trillion, and so I think that looks good. That funding is going to stay in the system for a long time, and I think you're going to see the industry -- and Comerica typically picks up more than its fair share. I think you're going to see this funding in the form of deposits stick around for quite a long time.

Got it. Okay. Now we've seen -- obviously, LIBOR has come down, right, so we know that's been a bit of a headwind to your margin. But have you seen credit spreads also start to narrow on new loans just given the perception of less risk in the market right now?

Well, I would say, there's certainly more risk than pre-COVID, but less risk than there was, say, 6 weeks ago. So we did price what I would term appropriately when COVID hit. You are correct, we have seen some bond spreads come in, in the credit markets. We have not seen that yet on our own loan portfolio. So we'll continue to price appropriately for this environment, but we're not seeing a big change as of yet.

All right. Now I guess I would expect interest-bearing deposit cost to decline pretty sharply in 2Q, which is consistent with what you guys have been saying. But is there any structural reason why those interest-bearing deposit cost might be higher or lower than where they were, like, I think it was at the mid-teens level roughly that we saw back from 2014 to 2017?

In terms of structure, and I would point back to the comments I gave in the Fed balance sheet, just a lot more liquidity in the system right now, so I would certainly expect this over time. And keep in mind, even following the Great Recession, it didn't get into the teens overnight. You need some CDs to mature and need the market to adjust. And no one wants to act too rashly given there's still a little bit of premium out there in credit spreads and so on. But we will get there eventually. I would expect to get back to the teens eventually. And with all the liquidity in the system, I would say, if anything, there's a chance, ultimately, long term, we can go even further, but that just remains to be seen.

All right. So we do hear a lot about forbearance on the consumer side. But I guess, of the commercial customers have asked for forbearance, how are you thinking about our long-term credit quality as we look out over the next few quarters?

Yes. This is Melinda. As I mentioned in my remarks, through the end of May, we've processed approximately 1,300 customer requests, which totals about $4 billion in loans. And the majority, if not all, of those payment deferrals really went to customers that had performing loans. Again, if you think about the overall credit quality of the portfolio kind of coming into the pandemic, we were at near-record levels of positive credit quality. So the majority, if not all, of those loans went to very strong performing companies. And a lot of customers requested those payment deferrals, quite frankly, as an insurance policy. They weren't sure they were going to need it, but they knew that it was probably prudent to take it. The other thing about the payment deferrals is that, that preceded really the PPP money starting to flow and customers really understanding whether or not they would qualify. So we definitely have customers that I would consider from a credit quality perspective very strong request payment deferrals, not knowing if they were going to get PPP. And in some cases, they got both. They got payment deferrals, and they got PPP. And we actually have seen a number of customers continue to make payments even though we granted them a deferral because they had the liquidity to do that. So again, it's difficult to predict credit quality for the coming quarters. There's great deal of uncertainty, but the vast majority of the companies that got PPP loans and payment deferrals, we expect to continue to perform.

Got you. Okay. And Melinda, the -- I mean, it sounds like, obviously, the vast majority, as you say, are performing. They're paying. But what about -- are you able to quantify how many of your commercial customers are not paying or that might be sort of at a bit more of an at-risk bucket because they needed the forbearance because they have the inability to pay?

I mean we certainly have metrics around and understand who's paying and not paying. And again, the credit quality of the portfolio overall has held up better than what we would have expected. I think if you would have asked us 60 days ago, and obviously, this thought process went into the building of our reserves in the third quarter and just knowing that there was a tremendous amount of uncertainty about what COVID-19 and the ensuing stay-at-home orders were going to do, we would have expected the portfolio to show a little bit more migration. And quite frankly, it just hasn't as of yet. That doesn't mean that we're not going to continue to see some migration. We have definitely seen some migration in the C&I portfolio through the beginning of the first -- the first part of the second quarter, and we would expect that to continue. And there's going to be some winners and losers. But overall, like I said, we're feeling a little bit more optimistic. The customer base has responded incredibly well by controlling expenses, cutting CapEx where they can. And really, other than the energy portfolio, we haven't seen any major credit deterioration.

Got it. Okay. Good segment to the energy portfolio. I know energy is a fairly small part of your portfolio. Looks like it was just over $2 billion or about 4% of the portfolio, certainly, a big concern when oil price was negative, I'm sure. But with economy opening up again, I think in the prepared remarks, you mentioned the customers are hedging a lot more. Like is the activities that the customers are doing, like putting on more hedges at this point, like how meaningful is that in terms of reducing Comerica's exposure or risk on those loans? I mean does activity actually have a really big impact? Or is it more of a modest impact in terms of how you think about credit quality?

Well, I think the fact that customers are kind of dipping their toe back in and willing to hedge production at about $40 a barrel is certainly in the short run, positive for the portfolio. The firming up of prices, quite frankly, impacts the collateral values and how we look at loans and how we look at loan losses. So we will be taking a very close look as we get to quarter end on all of those customers that are nonperforming, so that we make sure that we got that right. At high $30s, $40 a barrel, we are hearing that some customers that had shut in wells are willing to open those up again and get them up and running. But prices are not where they need to be to really fix the industry and get them to the point where they're willing to drill and really build value in those portfolio. So we expect to continue to see challenges in this portfolio. We expect to continue to see migration. And quite frankly, we expect that we'll continue to have some losses in this portfolio. I mean, even though prices have firmed up and things are looking a little bit better, there are definitely companies, because of the leverage and the amount of debt on the balance sheet, there's going to continue to be some PK and restructuring.

Got it. Okay. And then maybe one last question in the interest of time. One of the things that Comerica has gotten a little bit of pushback on in the past has been the commentary you guys made that you really don't have a lot of room to cut on the expense side to offset lower revenues given all the expense cutting you did in prior years, prior quarters. And I think your second quarter guidance kind of reflects that. Can you just talk about the hurdle like from here? Because the world has changed, right? People are doing much more online. I'm sure businesses are doing more online. Like is there a way for Comerica to say, "Okay. The world has changed. And therefore, we can change our business model in some way that actually could drive or create a more efficient business model given sort of the work from home and sort of the different ways that businesses and consumers are interacting?"

Yes, Ken. The world certainly has changed. In the short term, of course, we are focused on taking good care of our customers, our employees. And obviously, we've done a good job up till now with managing expenses, with an efficiency ratio in the mid-50s, second lowest amongst our peers in the first quarter. Having said that, short term, we do continue to focus on good prudent expense controls. We always have. It's kind of in our DNA. So whether it's scrutinizing, filling open positions, deferring in this time of uncertainty any kind of discretionary projects or spend, longer term, that is something that's on our mind, whether you're talking branch strategy, online banking. The world has changed a little bit. The good news is we were moving down that path already. We've been making significant investments in our online platforms, both in the retail and the commercial side. We do think that over time in terms of office space, and you want to wait for the right lease expiration and so on, but there's going to be an opportunity to adjust to the environment as those opportunities pop up. So I think you'll see that over time. But I think the longer-term trend will take time to play out. It's not something that's going to happen overnight. And again, I would say that we have some pretty good momentum going in that direction already.

All right. Great. Well, we're at the end of our time period. Jim, Melinda, I want to thank you and obviously thank Comerica for participating in the Morgan Stanley Financials Conference. We really do appreciate it. And for everyone else, thanks for attending. Thank you.

Thank you. Thanks, Ken.

Thank you.