Comerica Incorporated (CMA) Earnings Call Transcript & Summary

I'm Jason Goldberg with Barclays. And continuing with our financial services conference this morning, very pleased to have Comerica up next. Before I turn over to the management team, let me just remind you some housekeeping items. On the left-hand side of your screen, there's some audience response questions. Please take the time to answer them. After you answer a question, you just scroll back up to the top. You can hit the Next button and go to the next question. And then time permitting, we'll review them towards the end. Also on the upper left-hand side, you could hit Questions and submit a question to me and my team. And again, time permitting, we'll ask those of management as well. And if you click back to the About, it'll take you back to the audience response Q&A portion of the presentation. From Comerica today, very pleased to have Curt Farmer, Chairman and CEO; we have Jim Herzog, Chief Financial Officer; we have Melinda, our Chief Credit Officer; Peter, who runs the Commercial Bank; and, of course, Darlene Persons is on the line from Investor Relations. And with that, let me turn over to Curt, who will take us through some slides before we open it up to Q&A.

Well, thank you, Jason, and good morning, everyone. I hope you and your families are healthy and coping well during this unprecedented time. 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 are incorporated 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 day 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 over 170 years. Our geographic footprint is diverse and focused in major metropolitan areas. Also, we maintain balance among a wide variety of industries and customer segments. Our conservative underwriting standards and strong capital base are assisting us in navigating the current environment. In the second quarter, we had very strong loan-to-deposit growth, which drove balances to record highs, and credit quality remained solid. Our performance demonstrated our resiliency and our ability to leverage our ingenuity and entrepreneurial spirit as the landscape rapidly changed. We have a long-tenured, experienced team which quickly adapted. Across the bank, we have been working diligently to support our customers, providing sound financial advice, credit expertise and digital banking solutions where needed. In fact, a recent Greenwich survey of middle market companies recognized Comerica as a standout in our COVID-19 response to their banking needs. It is times like these that you build and solidify loyal relationships. Turning to Slide 4 and an update on loans based on preliminary results through the end of August. So far, the quarter is playing out as we anticipated and is in line with industry trends, as shown in H8 data. Average loans in National Dealer have stabilized after decreasing through the second quarter due to significant decline in inventory levels. This is due to supply backlogs following the manufacturing shutdown, combined with a rebound in sales activity. We expect it could take a few quarters for inventory levels to build back up. As far as Corporate Banking, you may recall that large companies drew on lines earlier this year to build liquidity buffers. This resulted in an increase of nearly $800 million in second quarter average balances. These draws are being repaid with balances, down $420 million on average so far this quarter. Balances in General Middle Market have declined as customers have prudently reduced working capital and CapEx in this uncertain environment, more than offsetting the full quarter benefit of PPP advances. Mortgage Banker loans have increased $250 million to an all-time high, with continued strong activity in both refi and home sales. We expect volumes to come down from this accelerated pace in the months ahead. We've been seeing improvement in the customer sentiment as economy has reopened. This is reflected in our loan pipeline, which began to pick up in early July from relatively low levels. As of the end of August, total commitments have held relatively steady. However, the utilization rate decreased. Overall, we believe the modest downward trend will continue and average loans for the third quarter will approximate $52 billion. On Slide 5, we have a preliminary update on deposits, which continue to show strong growth. Quarter-to-date average deposits have increased over $4 billion to another record, exceeding our expectations. The largest driver continues to be noninterest-bearing deposits. And growth has been really broad-based, with increases in essentially every business line. Government stimulus programs have provided tremendous liquidity. In addition, as we have seen at other times of economic uncertainty, both retail and commercial customers have remained cautious, conserving cash in the safety of their Comerica accounts. As a result, we believe the average deposits for the quarter will be around $69 billion based on current trajectory. We have a very favorable deposit mix with the largest component of noninterest-bearing deposits among our peers. This contributes to our total funding costs falling well below the peer average. Also, our interest-bearing deposit cost was lower than the peer average in the second quarter, and we expect it to decline about 18 basis points in the third quarter -- to decline to about 18 basis points in the third quarter. Looking back to 2014 to 2016 when rates were near 0, our interest-bearing deposit costs were in the range of 14 to 15 basis points as we carefully managed our deposit rates in the prolonged low rate environment. A key part of our strategy is to maintain diversity across our business lines, as illustrated on Slide 6. This affords important counterbalances as cyclical and seasonal factors can impact growth and credit quality. For example, in previous cycles, as energy was challenged with lower oil and gas prices, many areas benefited, such as automotive manufacturing. In addition, we have a high percentage of businesses that we consider more recession-resilient, such as National Dealer, Corporate Banking, Equity Fund Services, Private Banking and Mortgage Banking. Looking at our deposit base, 35% is generated by our Retail Bank. Consumer-based deposits are typically stickier and less rate-sensitive. General Middle Market provides 28% of our deposits, with nearly all tied to treasury management products. Our relationship-focused deposit base is diverse by industry and geography, which helps support more consistent performance over time. Turning to Slide 7, net interest income. As we -- net interest income. As we indicated on our earnings call, we estimate that the net impact from rates alone in the third quarter will be about $10 million to $15 million. This reflects the full quarter effect of lower interest rates, partly offset by our actions to decrease deposit cost. Going forward, assuming LIBOR holds steady, we expect rates to have a relatively small residual effect as longer-dated assets and liabilities reprice. Also, third quarter net interest income is expected to reflect the decline in loan volume, roughly offset by the reduction in wholesale borrowings in the second quarter, better loan pricing and an additional day in the quarter. We expect that most PPP loans will be forgiven in the fourth and first quarters. Note that deposit growth has been very robust so far for the quarter, resulting in excess liquidity, which could weigh on our margin but adds to net interest income. Over time, we see opportunities to offset some of the rate headwind. We expect loan pricing to remain competitive. However, additional spread due to credit migration and the increasing prevalence of rate floors to the market could provide some lift. We expect deposit pricing could move modestly lower. Finally, as mentioned, we expect to benefit from actions we have taken to reduce wholesale funding and increase the size of our securities portfolio, which is outlined in the bottom right of this slide. Slide 8 highlights investments we are making to drive revenue. Our relationship banking strategy is built on deep, enduring relationships by providing financial products our customers desire. The COVID pandemic has further driven our customers' need to conduct business through digital channels. The bar chart shows that the number of active Retail Banking mobile users has been accelerating. In addition, we are aiming to deliver a more diversified and balanced revenue base with an emphasis on fee generation. As a result, we have been making, and will continue to make, significant investments in our online and mobile applications. On the Retail side, recent investments include capabilities to make it easier to open and fund accounts as well as originate loans in a digital manner. Our new online account channel was launched earlier this summer with a robust marketing campaign. We are pleased with our progress, having opened nearly 5,000 accounts thus far. As far as the Commercial platform, customer utilization of our treasury management solutions is very strong. We have a technology road map to help ensure we continue to deliver leading-edge products, including investing over $55 million over the past couple of years. A few examples of recent and upcoming product innovations include various upgrades to our reporting capabilities and the ability to send and receive real-time payments. It is evident that our technology investments are helping us attract and retain customers and help drive revenue growth. As we continue to invest, we're maintaining our strong expense discipline, as shown on Slide 9. Comerica has a culture that drives continuous efficiency improvement. We have provided a few examples of our ability to manage costs by reducing our workforce, banking centers and energy usage over the past several years. Our leveraging technology, we have increased productivity, and our ratio of loans and deposits per employee is one of the highest amongst our peers. In addition, regular evaluation of our real estate footprint helps us ensure we have optimal locations and has reduced our banking center network. We have one of the highest deposits per banking center ratios in our peer group, which demonstrates the efficiency of our network. Our expense discipline is well ingrained in our company and is assisting us in navigating this low rate environment as we also invest for the future. Slide 10 highlights our conservative credit culture, which has produced superior credit results, with net charge-offs typically below our peer group average. We started this cycle from a position of strength with very low nonperforming and criticized loans. We continue to work closely with our customers, carefully reviewing their current and projected financial performance and adjusting risk ratings as appropriate. Nonperforming assets have remained low and were below the peer average in the second quarter. During this period of unprecedented disruption, our portfolio has performed well. And since quarter end, further, a negative migration has been minimal. There is a great deal of uncertainty about the path of the recovery. Therefore, in the second quarter, our allowance for commercial loans increased to 1.91%. And excluding PPP loans, the ratio was 2.07%. Our reserve coverage for NPAs was over 3x, the highest among our peers. In the current environment, there has been some focus on commercial real estate. Our portfolio is outlined on Slide 11. Nearly half of the portfolio is multifamily, which demographics favor, and the bulk is in the Class A infill construction projects. 20% of the portfolio is industrial warehouse, primarily in Texas and California, which is also considered low risk. Credit quality remains excellent and criticized loans of just 1%, including only $4 million in nonaccrual. We have adjusted the diversification by property type since the last recession, and today, we feel comfortable with both the size and composition of the portfolio. Energy loans, outlined on Slide 12, have decreased 40% since 2014 and now represent 4% of our portfolio. The services component, which was the main driver of losses during the last downturn, is only $50 million. Our E&P customers have been acting prudently, cutting costs and reducing CapEx. Energy prices have increased sharply from the lows in early April, and it appears that supply and demand are becoming more balanced. Our allocation of reserves energy loans is above 10%, reflecting an increase in criticized and nonaccrual loans as we completed the spring borrowing base determinations. However, charge-offs actually decreased in the second quarter. With more than 40 years 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. Slide 13 provides detail on segments that we believe pose higher risk in the current environment. Note, we continue to review the portfolio, refining our assessment. As a result, we have removed casinos and sports franchises from this group as we no longer see elevated risk. Overall, criticized loans in the social distancing segment increased in the second quarter as we prudently adjusted risk ratings. However, nonaccruals are very low. We believe we are well reserved as we apply the more severe economic forecast. Also, note this segment is relatively granular, and our exposure to any one of these industries is not significant. We have deep expertise and a long history working in the cyclical automotive sector. Production has ramped back up, and we increased the reserve allocation in the second quarter. Ultimately, we believe losses will be manageable. Our leveraged loans tend to be with middle-market, relationship-based customers with sponsors, management teams and industries we know well. Also, we avoid the highly leveraged, covenant-light deals that have been more prevalent in the industry in recent years. Payment deferrals serve the purpose of providing a cushion as customers became acclimated to the challenging environment. Now that they have adjusted, the deferrals are expiring. And new requests, including a request for a second deferral, have been nominal. Total deferrals at June 30 were 8% of the portfolio and declined to 1% at August 31. Our capital levels remain strong with an estimated CET1 of 10%, as shown on Slide 14. Earlier this year, our Board increased our dividend to $0.68 per share and declared that label -- level for the October payment. As the dividend is determined, careful consideration is given to earnings and our capital needs to support growth. The dividend yield is very attractive and is supported by over $1 billion in cash at the holding company. We also conduct robust capital stress tests to help ensure our dividend can withstand cyclical pressures or we may probably maintain strong capital levels and a CET 1 target of 10%. In closing, Slide 15 reiterates Comerica's key strengths, which produced an ROA and an ROE well above our peer group average in the second quarter. Over our 170-year history, Comerica has successfully managed through many challenging times. We continue to demonstrate our resiliency and unwavering dedication to provide a high level of customer service as we navigate the COVID-19 pandemic and as business returns to normal. We believe our disciplined underwriting approach and prudent customer selection is assisting us in weathering the current environment as evidenced by our solid credit metrics in the second quarter. Our diverse geographic footprint and relationship banking strategy continues to serve us well, and we are committed to maintaining our strong expense focus while investing for the future. In uncertain times like these, our ability to serve our customers using our experience and deep expertise build and solidifies loyal relationships. With strong liquidity, capital and capital levels, we are well positioned to drive profitable growth and enhanced long-term shareholder value. So thank you for your time. And Jason, now we'll be happy to take some questions.

Great. I appreciate that informative presentation. Maybe some follow-ups, and I'll try to maybe run through it in kind of the order you spoke. But first, you highlighted that I think commercial loan pipelines improved in July and held stable in August, although utilization rates decreased. Maybe just talk to what do you think the lending outlook is from here. Obviously, industry data implies near-term loan growth on the commercial side under pressure. But kind of when do you think that bottoms? And when do you think that could start growing again?

Great. Jason, I'm going to turn that question to Peter Sefzik, who runs our Commercial Bank.

Yes, Jason. So we are encouraged as of late, but I don't know that I would say we feel like things are anywhere near back to normal. The last 30 days have been more active than the last 90. You did hear Curt talk a little bit about we feel like commitment levels have kind of stayed even, utilization is down, pipeline up a little bit. But those are -- the pipeline's up from what was really low. So I think going into the fall, we're -- we continue to feel like it's a very flat environment, more encouraged going into Q1, hopefully. I think, to me, it's really a question of do we get past this second wave of what potentially might happen across our country with COVID. And if we can get through that positively, and we're starting to see a little bit more normal activity, if you will, just in our environments that, hopefully, that will be a good sign for what Q1 looks like.

And you alluded or talked to -- or showed very strong deposit growth really continuing quarter to date. And then you talked about kind of reinvesting some of that into securities. Maybe talk to kind of how you assess the deposit durability in terms of how do we know this is kind of balancing between what's kind of excess deposits that's sticky and what's kind of transitory in this heightened liquidity environment and just how you go about kind of assessing the overall balance sheet and kind of make those kind of risk return trade-offs.

Yes. I'm happy to take that, Jason. Thanks. I would split the growth into a couple of sections. There is a piece of it that's a little bit transitory, and that would be the PPP loans, which translated to deposits on the balance sheet. And I would say the majority of those are still sticking around. And then secondly, the line draws that we saw when COVID first started. And even though those have largely come down, there's still some out there, and those are also sitting on the balance sheet in the form of deposits. So I would say there's a piece of it that's still going to run off, and we'll see that step down probably sometime over the next couple of quarters. But I would say the vast majority of the increase that we've seen is a combination of the stimulus in the economy, which is, of course, growing the Fed's balance sheet that found its way to our balance sheet as well as just customers being conservative right now. We saw those latter 2 factors. We saw evidence of that even in the last recession, and it's a little bit more so even in this recession. So I would expect most of these deposits to stay on the balance sheet. With that said, we want to make sure we optimize the balance sheet in a responsible way. We did take about $1 billion of purchase funds over the last quarter down. And we also moved, as you saw, about $2.25 billion of liquidity into the securities portfolio. So we'll continue to assess that. We still have a little bit further to go. Even though we've taken the low-hanging fruit on the funding side, the funding we have locked is very efficient. But it may be we have a little bit of opportunity left there as time goes on. And also, we will also consider reinvesting more liquidity into the securities portfolio over time. But we just didn't want to jump into that with full speed at once. We want to assess the environment quarter-by-quarter, given all the uncertainties and kind of leg into it in a very responsible manner.

No. Makes sense. And I think maybe somewhat of a follow-up, but Curt mentioned seeing 14 to, I think, 15 basis points of deposit costs last cycle. Is that a level we'd expect to return to at some point this cycle?

I see it heading that way. And if the Fed produces more stimulus into the economy, it's possible. Over time, it can even be a bp or 2 lower, I think. We're certainly treading in new territory here with this recession. But I would expect in the foreseeable future to have a good shot at getting pretty close to 15 bps.

Helpful. And then maybe shifting gears to credit quality. Curt mentioned, I think, further kind of -- further negative migration had been minimal. You showed that your social distancing kind of portfolio concern is now a bit smaller. You showed a very strong kind of relative reserve position, both overall and on the commercial side vis-à-vis your peers. After kind of significant allowance build in the first half of the year, how do you think we should think about in the back half of the year?

Yes. Thanks, Jason. Let me just talk a little bit about the portfolio performance overall. Obviously, the portfolio has held up better than, I think, what we expected. The general portfolio and some of those more recession-resilient industries that Curt mentioned are actually performing really, really well and, again, as we would expect than how they performed the last time around. The portfolios that have the most stress, energy, obviously, has been under a great deal of stress really for about 12 months now. The good news on energy is that, obviously, with prices stabilizing a little bit closer to the $40 a barrel and gas up materially, that portfolio is not showing material additional migration. So it is still the portfolio that has the most criticized. Clearly, charge-offs have been elevated in this area, and it does make up the preponderance of our nonaccruals, even though our total levels of nonaccruals have really not -- have not started to escalate yet. The other portfolios that we're watching that have the most concern for us would be our leverage portfolio and our automotive portfolio. Automotive, we feel really good about that book. Overall, we have an incredibly experienced team in Michigan that has been through multiple down cycles and have managed through that. Our customer base is also very long tenured, and they have learned from previous cycles so they have responded appropriately. And our credit teams that support all of that are also very, very tenured and, in most cases, have decades of experience. Our leverage portfolio, obviously, leverage is generally the portfolio that starts to show a little bit more stress. They're obviously more leveraged. Cash flow is a little bit tighter. But again, this is a real relationship strategy for us. It really wraps around our relationship banking, predominantly for middle market and environmental services. And we're dealing with sponsors that we've dealt with, in many cases, for decades with really strong management teams. And although criticized is elevated close to 20% in this book, and we'll probably see a little more credit migration in that book, we haven't seen migration into nonaccruals or charge-offs. The social distancing portfolio has actually been a bit of a pleasant surprise. We all took a stab at what social distancing portfolio, what needed to be lumped into that bucket. And those were the industries that were most impacted immediately at the beginning of the pandemic, and we felt would have the most long-term impact. And a lot of those really relate to kind of the hospitality and closer to the consumer. And the good news is we just don't have a concentration in any one of those segments. The portfolio, as a whole, is only about $3 billion. The migration into criticized has been moderate and has held there as of yet, and we haven't really seen much migration in the way to nonaccruals, which would ultimately potentially lead to charge-offs. So overall, we're feeling cautiously optimistic about the performance of the credit portfolio. As Peter mentioned, there is a big unknown, however, and that relates to what happens in the fall with the resurgence. Whether or not we need to build additional reserves really depends on the length of the recession, the severity and depth of the recession and then how all that modeling really correlates to how our portfolio performs. So the economic picture today is a little bit better than where we were at the end of the second quarter. And the portfolio statistics certainly have held up. So that would all lead you to believe that we shouldn't need to add materially to the reserves in the coming quarter.

Helpful, and I guess, not adding materially to reserves in the coming quarter. And I guess, when we think about -- I think charge-offs for you guys were sub-40 basis points in the most recent quarter. It feels like 3Q won't be dramatically different. How do you think about kind of the loss emergence curve this cycle? And are we kind of -- things are a bit better expected now, are we kind of pushing losses out, or you think actually lowering the level of losses we'd expect to see over the next year or so?

Yes. I think we fully expect that we'll start to see some charge-offs escalate from very low levels that they are today in the fourth quarter and then losses really peaking sometime in the first half of the year. I mean it's really difficult to predict exactly when that happens. I mean, obviously, if there is a resurgence and any additional pullback in the economic factors, it could be a little bit more elevated. If the economy continues to perform, and we don't have as much of a resurgence in the fall and the economic picture looks a little better, I mean it is possible that we could have better performance than what's expected. I mean the CECL reserves are an indication of what we think losses over the life cycle of the portfolio are going to be.

Got it. And then in the slides, you saw some stats on the spring redetermination period on the energy book. I guess now we're approaching -- or the fall redetermination period, I know kind of oil has rebounded somewhat off the lows. Could you just maybe talk to maybe your expectations around that process?

Yes. It seems like we just finished spring and it's time to start fall again. So obviously, we take a look at our price deck on a pretty regular basis. Historically, we've adjusted our price deck about once a quarter. Certainly, the first half of 2020, we were adjusting it almost on a monthly basis to try to keep up with the extreme shock that was going on. The price decks that we used for all of our spring redeterminations is materially lower than where the strip is today. So we will be adjusting our price deck along with the rest of the industry, and we generally try to stay in line with the big agent banks. And generally, we're slightly lower than what their price decks are. So we shouldn't see any material deterioration in the borrowing basis or the collateral values that are a result of that process.

Helpful. And maybe -- this is probably a question best for Jim. But I guess we got some updates around net interest income on the quarter and loan growth, deposit growth. I guess, any updated thoughts on fee income or expense expectations given only a couple of weeks to go in the quarter?

I'm sorry, is that with regard to net interest income, Jason?