Comerica Incorporated (CMA) Earnings Call Transcript & Summary

All right. Good morning, everyone. I'd like to welcome you to the RBC Capital Markets 25th Annual Financial Institutions Conference. It's many, many years we've been doing this. And just 12 months ago, we were pulling the plug and running this virtually. And here we are, 365 days later, doing the same thing virtually. And we're just pleased that Comerica is here to kick off the U.S. Banks with us today. We have Jim Herzog and Darlene Persons. Jim is going to run through some slides, and then we'll get into some Q&A, but Jim is a long time finance executive at Comerica, been around for all the changes. He has been there through all of it. Been the CFO just a little over 1.5 years and was Treasurer before that. So if you think back to a year ago, I just -- we'll get into this, but I wonder what Jim was thinking when the 10-year broke 1%. I'm sure that was notable for him. However, a year later, the stock is up, and the stock is also up from January 1, '20. So the company has done okay. So Jim will go into the prep comments, and we'll get into the Q&A. So take it away, Jim.

Well, great. Yes, thank you so much, Jon, and good morning, everyone. It is a pleasure to be here. 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 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 date of this presentation, and we undertake no obligation to update any forward-looking statement. Slide 3 provides a brief overview of Comerica's key streams, which have driven our success and enhanced shareholder value over time. Our long-tenured employees have a deep understanding of the businesses they serve. Our geographic footprint is diverse and includes 5 of the 10 fastest-growing metropolitan areas in the U.S. Also, we maintain a balance among a wide variety of industries and customer segments. We deliver high-quality financial products and have a culture of continuous improvement. Our conservative underwriting standards and strong capital base have assisted us in navigating the current environment. On Slide 4, we provide our typical mid-quarter update on loans and deposits, which is based on preliminary results through the end of February. Starting with Loans, there are a number of moving parts. Mortgage Banker has declined from its record high with seasonally lower purchase and refi volumes. However, it is notable that it's still double its first quarter average of the previous 5 years. Energy decreased as higher oil prices are driving improved cash flow and capital markets activity. Middle market and small business loan demand continues to lag and is impacted by PPP loan forgiveness. On the other hand, activity has increased in equity fund services. We continue to believe that loan growth should pick up in the back half of the year, in line with improving economic conditions. Quarter-to-date average deposits increased over $500 million. Overall, customers continue to perform well with strong cash flow, and many have received the benefit of government stimulus programs. In summary, we expect average loans and deposits for the first quarter to remain at the current level. Slide 5 provides an update on PPP loans. Since launching last spring, Comerica has helped over 17,000 customers gain a PPP loan. The second round has commenced, and we expect to fund nearly $1 billion in loans by the end of the quarter. Also, we are assisting customers in the forgiveness process. Through the end of February, $750 million in repayments have been received. We do expect minimal repayments in March as the forgiveness portal has been closed, while process updates were made in concurrence with the second stimulus bill. Our mission is to help customers keep their businesses open and their workforces intact. Turning to Slide 6 and net interest income. Actions we have taken have helped to offset some of the rate headwinds. By prudently managing deposit costs, first quarter average rate is expected to decline to approximately 9 basis points from 11 basis points in the fourth quarter. Also, while this is becoming more challenging, there has been a benefit for maintaining and adding rate forwards on LIBOR loans. Finally, we deployed some excess liquidity by repaying $2.8 billion of FHLB advances this quarter, which has provided a modest flip. Aside from these actions, there is a benefit from PPP loan repayments, which results in accelerated fee amortization. More than offsetting these actions in the first quarter are several factors, such as 2 fewer days in the quarter, and 30-day LIBOR, the rate we are most sensitive to, has averaged 12 basis points so far this quarter, a decrease from 15 basis points in the fourth quarter. Also, reinvestment rates in MBS repayments have been lower. The average yield on purchases so far in the first quarter was 148 basis points compared to securities rolling off at 250 basis points. Finally, loan volume does weigh on net interest income in the first quarter. Over time, we see opportunities to offset some of the headwinds derived from expiring interest rate hedges and security maturities. First and foremost, we are focused on driving loan growth. In addition, we expect the bulk of the PPP loans to be repaid this year, resulting in the continuation of accelerated amortized fees. Finally, given recent market conditions, we are again considering opportunistically putting some of our excess liquidity to work by increasing the securities portfolio. In summary, the pressure from the decline in rates has been mostly absorbed and the recent steepening of the yield curve is a positive sign for the future. Our balance sheet is very sensitive to rate movements and our models at year-end estimated a 9% increase in annual net interest income in the first year, but rates rise 100 basis points point-to-point, as outlined in the slide, and of course, year 2 would be yet higher. Turning to Slide 7. We strive to develop long-lasting relationships by providing the financial 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. Our card platform is a great example of our success. We are the fourth largest prepaid card issuer in the U.S. as we serve 57 state and local programs as well as the U.S. Treasury Direct Express program. Also, card is a key component of our integrated treasury management product suite, providing customers with increased efficiency. Card provided 27% of our fee income and generated growth of 5% year-over-year in 2020. These products have helped to position us for the recent and likely ongoing changes in customer transaction behavior. Fiduciary fees comprised 20% of noninterest income. With strong collaboration, our Wealth Management Business brings private banking, investor management and fiduciary solutions to our commercial and retail bank customers. Also, we continue to build our unique Trust Alliance business where we partner with third-party broker-dealers and investment advisers to provide trust services for their clients. Last month, we increased the breadth and the scale of this business through the acquisition of a small Trust Alliance group. Deposit service charges are also a significant contributor to fee income and are primarily derived from commercial customers. As a leading bank for business, we continuously invest to provide a wide array of high-caliber products. Our expertise, along with the relentless attention to customer service, results in deep product penetration and long-tenured relationships. As we progress through the year, we believe customer-driven fee categories, in general, should grow with improving economic conditions. We are maintaining our strong expense discipline, as shown on Slide 8. Comerica has a culture that drives continuous efficiency improvement. We have managed costs by reducing our workforce and footprint over the past several years. By leveraging technology, we have increased productivity and our ratio of loans and deposits per employee is one of the highest amongst our peers. Also, we have one of the highest ratios of deposits per banking center of our peers, 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 invest for the future. Slide 9 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. We have been rapidly adopting cloud computing to become more scalable, resilient and agile in the development and deployment of solutions. Also, we are very efficiently leveraging third parties to keep pace with evolving and emerging technologies. Altogether, this should help moderate the rising cost for technology projects. In addition, we are excited about some leadership we've added in the technology area over the past year. We have a new Chief of Technology and Operations in Megan Crespi, who joined us from Ally last year, as well as a new Chief Information Officer, a new Head of Technology for the Commercial Bank, and finally, joining just a few weeks ago, a new Chief Information Security Officer. These key management hires have positioned us well for the ever-changing technology landscape. And our technology investments are enhancing the customer and colleague experience, helping to attract and retain customers, which drives revenue growth as well as control expenses by improving colleague efficiency. Slide 10 highlights credit. Our conservative credit culture, diverse portfolio as well as deep expertise have produced superior results. Through the cycles, our net charge-offs have typically been at or below our peer group average, including during this pandemic. Certain segments that pose higher risk in the current environment such as those impacted by social distancing have performed better than expected. Overall, we had one of the lowest NPA ratios amongst our peers in the fourth quarter. This, combined with our healthy reserve, resulted in us having one of the highest NPA coverage ratios. The pace of the economic recovery is uncertain. However, we believe we are well positioned with a relatively high credit reserve and overall improving credit quality. Turning to Slide 11. Our capital levels are strong. Our CET1 ratio increased to 10.34% in the fourth quarter, above our target of 10%. As always, our priority is to use our capital first to support our customers and drive growth while providing an attractive return to our shareholders. In this regard, we have maintained a very competitive dividend yield, which is a very predictable and dependable way of returning capital to shareholders. As far as share repurchases, we have a long track record of actively managing our capital and returning excess capital generated to shareholders. As the economy continues to regain its footing, we are feeling more optimistic. In closing, Slide 12 reiterates Comerica's key strengths. We continue to demonstrate our resiliency and unwavering dedication to provide a high level of customer service as we navigate the COVID pandemic. We are committed to maintaining our strong expense discipline while investing for the future to ensure we can provide high-caliber products. Our disciplined credit culture and strong capital base continue to serve us well. Deep expertise and experience help us build and solidify long-term relationships, particularly in uncertain times like these. These key strengths provide the foundation for long-term shareholder value. Thank you for your time, and now we are happy to take questions.

All right. Thanks, Jim. Well done. And I just want to remind those of you on the webcast. If you have questions, there is a box on the screen where you can send questions in and we'll get through as many as we possibly can. Jim, maybe let's start with something that I think a lot of people have questions on just economic activity in Texas. You obviously had some weather-related issues there. And also, I guess, to some people are terrified, other people are ready for the masks to come off, but touch a little bit on what you're seeing in Texas and contrast that to maybe what you're seeing in California and Michigan?

Yes, great. Yes, we're really excited about what's happening in all of our markets. Certainly, the winter stress that you just mentioned caused probably a slight slowdown in the first quarter for a week or 2, lost momentum in Texas. We actually think through the remainder of the quarter as well as throughout the year, it's actually going to be a plus as the rebuilding occurs, not on totally dissimilar to hurricane activity where people have to rebuild or repair houses and infrastructure when these things occur. So we are very encouraged there. I'll start with the national view in terms of GDP. We are quite bullish in terms of where the country is going for the remainder of the year. The good news is that in our 3 main states, Michigan, Texas, California, we expect that state GDP to exceed the national average this year. So we feel like we're very well positioned in terms of where we're at. Texas GDP should probably be the strongest amongst our 3 states, closely followed by Michigan and then California, which is going to be just a step behind given some of the COVID shutdowns and some of the challenges they've had there. And then as I look at our own customer base and the activity of the pipelines, it follows very similarly. Michigan actually seems to have the relatively strongest pipeline right now, then followed by Texas, and again, California just being a step behind. But overall, we see some great strength in our 3 main markets, and we really couldn't be happier with where we're at. So we really do that as competitive advantage over the next 1 to 2 years.

You still wear a mask outside of the office, Jim?

When we walk around outside, you don't see a lot of masks in Texas. But when you're inside, I don't see any change in behavior. Most people are doing the prudent thing that I can see at least, and wearing their masks when they're inside. So I think people are using good common sense. And overall, the environment is pretty healthy here in Texas. COVID is not really a topic minute to minute like it might be in some other states. Whether that's because we're more spaced here, I don't know. But people are using good common sense, and you do still see the mask when you're inside.

Okay. Good. 2 loan categories. I guess, one would be the mortgage banking, Mortgage Banker finance business. And then also middle markets, there's kind of this view -- there is this view that the second half is going to be much more robust from a commercial lending point of view. And I think that, that probably leads to more middle market and small business growth. On the flip side, you have the mortgage banking segment that you talked about was maybe still somewhat elevated. Can you just mix it all together and talk about what you're thinking for longer-term growth potential?

Yes, we actually see a lot of good signs out there. Starting with Mortgage Banker. It is down in the first quarter from the fourth quarter, seasonally so. But again, much higher than it has been in previous first quarters. And much of that is due to market share that we've taken over the last few years. I'm not surprised that we continue to run very strong. What makes me particularly encouraged about mortgage banking is that the majority of our activity is purchase as opposed to repayment. We, of course, had record repayment activity in 2020. But I'm quite bullish in terms of where purchases may go as 2021 progresses. Just as we've had some supply chain disruptions in our dealer national business, likewise, there have been some supply chain disruptions in homebuilding. So I actually think there's going to be a bit of pent-up demand to buy houses as we move through 2021, whether it's people relocating to states based on jobs they may have taken in previous months or just people that want a new house and supply wasn't there for them to buy a new house. I think our strong purchase component of mortgage banking is going to play to our advantage. So even though it is going to be down in 2021 compared to 2020, I think there's reason to feel very good about that business. Small business and middle market is lagging a little bit. We're encouraged by the pipeline that we're seeing. The pipeline seems to be approaching where we were pre-COVID. Now the quality of the pipeline remains to be seen. It's not always for the core traditional CapEx that we've seen in the past; there are some one-off reasons why some customers are borrowing. But nonetheless, it's encouraging to see the pipeline is getting very close to pre-COVID levels, really within the range of pre-COVID levels. Now once you have that pipeline, you need customers to ultimately sign on the bottom line. And then once they have that line, they need to start drawing on it. So it remains to be seen just where small business and middle market growth goes. But we see the encouraging signs to give us reason to think that the second half could be very strong. We do have customers that will probably, in some cases, have to burn through a little bit of liquidity first. But I also think, as I saw following the great recession, that a number of customers like to keep safety nets when they leave a time of great stress. So I think we'll have some customers that maybe aren't the same customers with all this liquidity they need to borrow. I think there will be some customers that have some liquidity, but want a safety net, and they will still borrow. And then, of course, you will have some customers where the borrowing may be a little bit muted. But overall, as I look at the economic backdrop and some of the very strong GDP we're forecasting in our 3 main markets in 2021, there is certainly reason for some optimism and to see that scenario where loan demand grows quite strong in the second half of the year. Having said that, we are in uncharted territory, there's no guarantees. And we're certainly watching the HA data like everyone else, and there remains to be seen how it plays out exactly. But we are prepared to step up and certainly ready and able to win.

Yes, I'd add a little footnote there, too, that, that commentary really excludes the PPP, which we're still advancing for the t week or so. And I see that it looks like it's been extended. But then we expect most of those loans to be gone by the end of the year, and those are small business and middle-market loans for the most part. So that -- we'll see how that plays through on the loan growth side. But we do see a strong GDP in the back half of the year. I think most of the economists, including our own, continue to up their estimates as we look at the back half of the year. And we're seeing more stress on the supply chain side of things, whether it's manufacturing or services that could really boost inflation. So we'll have to see what kind of working capital needs these companies are going to have as we approach year-end.

Okay. Good. Fair. We'll have to get to margin, I guess, next because that's maybe the important topic. And Jim, there are a few things we could unpack here, but you talked about the securities portfolio, potentially doing some things different there. So maybe first touch on that and what you're thinking? And then also maybe go into some of the hedging strategies and what you're thinking for your overall goals for margin and net interest income for the year?

Yes, a lot going on there. Traditionally, we've been very asset sensitive. Number one, I will say, from a strategy standpoint, it absolutely is our intention to be less asset sensitive going forward. So we don't experience some of these highs and lows and things stay a little bit more even-keeled. Obviously, we're somewhat limited in what we can do right now from a repositioning standpoint in this low rate environment, but it doesn't necessarily mean we do nothing either. So for instance, as a first step, we do want to increase our asset duration gradually over time. You don't want to necessarily pick your spots. You want to be somewhat methodical and systematic about it. So we're actually taking some steps now in the sense that some of the securities we bought recently have been a little bit longer in duration. We've also increased the size of our securities portfolio. We had our $2.25 billion worth of purchases in the second half of 2020. And we are considering growing that portfolio even a little bit more as we move into the late part of the first quarter and the second quarter, given where the long end of the yield curve has gone. Now we want to be very careful and methodical about how we do this, because we don't know where rates are going to end up. But again, we don't necessarily want to stand pat also. And so we are going to move very slowly, but again, methodically and increase the duration of the balance sheet and once we get to the good part of the second quarter, we may actually see ourselves with a little bit larger yet securities portfolio. In terms of some of the headwinds, we feel like the yields on our core customer loans are largely reflected, almost entirely reflected in our yields today. Now that assumes LIBOR is steady, and we have seen LIBOR drop a little over 3 bps since the fourth quarter. But assuming LIBOR is steady, we do think that the current rate environment is reflected in the customer yields. We do have, over time, some bonds insuring, not just our mortgage-backed securities, but some lumpy treasuries that we put on Slide 6 of this presentation, as well as some hedges over time that will mature. And so depending on what the rate environment is when those longer-dated assets roll over, that will have the potential to create some drag on net interest income. Now the levers we have, of course, growing the securities book will provide some offset. Loan volume certainly is expected to be an offset to a large degree. And of course, continuing to price loans and deposits appropriately, something that we're very focused on, and that certainly paid dividends over the last few months. So overall, we have a number of strategies and tactics that we think we can use to offset some of the longer-term drag from some of these maturities that will occur over the next 2 to 3 years. But the good news is for core customer yields, the rate environment is very largely deflected.

Okay. Is it -- not to put words in your mouth, Jim, but is it fair to say you're feeling like you're more balanced just from a margin and net interest income point of view?

More balanced in terms of?

The pressure is essentially over in terms of some of the rate headwinds?

Again, I would say largely over. We will have some small rate impacts, again, from normal security maturities, again, as well as over time, some lumpy maturities. So I would say it's largely over, but we will have some small rate pressure from quarter-to-quarter, which we intend to offset as much of as possible with loan volume and the appropriate pricing that I mentioned.

Okay. Okay. I did have 1 quick question come in, I think it can be handled quickly. But is the Comerica guidepost still kind of GDP plus potentially or are there any elements of your business that you think could take that above GDP? Or we just kind of in line with the industry? Is that your expectation for growth?

Yes. In terms of loan growth, GDP is always a good marker to start with. We do have a number of businesses that are more specific to certain industries. So we're not always going to track GDP exactly. And of course, a lot of it depends on commercial ownership confidence and their willingness to borrow. But it's a good general guidepost, but we're always going to be a plus or minus from there depending on what's going on in certain industries.

Okay. Good. A couple more topics I want to touch on, given the time, but let's touch on credit. Obviously, you have a lot of reserves, credit has trended better than I think a lot of people had expected. Is it possible for you to go back to day 1 CECL? Does that feel like maybe the right level of reserves for the company longer term? If so, what kind of time frame would you think about for that?

Jon, there are so many variables involved there. First off, I always like to think of it in terms of reserve loan coverage as opposed to dollar amount, given that over the next few quarters, we could see a change in overall balance sheet size. So it's more about the reserve coverage as opposed to releasing a certain dollar amount of reserves. But putting that aside, the reserve calculation for CECL really takes into account our credit metrics, various economic forecasts, our business mix and certainly the uncertainty factor is something that we're always looking at. And on that topic of uncertainty, we always look at various economic forecasts that consider more benign and more severe scenarios, just to test the very sensitivities given all of that uncertainty. And so given the COVID impact on all of these factors, it's not likely that we see us return to day 1 all at once when that does occur. It's likely to be over time as the uncertainty fades. And one of the guideposts that I like to look at is where are the absolute dollars of GDP in the economy. And most of the economic forecasts used for CECL on 12/31 at least, for most banks, I suspect, including Comerica, didn't have us moving back to the fourth quarter of '19 GDP dollar levels on an absolute basis until sometime in 2022. It's that [ policy ] that until we have that full recovery, there's going to be some degree of uncertainty. And we sensitize that uncertainty as we do our CECL calculation. So I think what's going to happen is you'll just see a gradual return towards day 1, at least, over time, as that uncertainty is removed from the environment.

But generally feels better, right? It feels better each month?

There's no doubt. There's no doubt. Credits were progressing better than we might have thought. The economic forecast, including GDP and unemployment, continue to be better than what we may have thought previously. So yes, there's certainly reason to be optimistic and assume that things are going in the right direction here.

Okay. Good. It's amazing what a few trillion will do in the economy.

Yes.

Exactly.

Yes. Again, another one of the variables of unchartered territory, but you have to assume that we have a nice positive impact.

Right. Okay. A couple of minutes left, and we need to touch on the buyback and capital allocation. You made your case for the yield. But probably ties into credit, but what do you need to see to start the repurchase plan again? And in general, how do you think of aggressiveness and size of a buyback program? Just kind of touch on those for us.

Absolutely. Number one, as I mentioned during the opening remarks, we are feeling more optimistic about the share buyback. Things are certainly looking even better than they did during the earnings call in January, when we touched on this topic. And I would say going into the share buyback and the pace of the share buyback will be somewhat proportional to our line of sight, as we look at what's going on with the pandemic and the economic recovery. And we'll certainly calibrate to what we see and the uncertainty factor that we see over the next few quarters as we make those decisions. But the other thing we want to consider is not just the risk to the downside, but also the potential enterprises to the upside. Once we start the share buyback, though we will be appropriately assertive in terms of buyback, we don't want to throw that needle too tightly initially, because we don't know where loan growth might go in the back half of '21, where it might grow in 2022. So if you draw that needle, again, a little too tightly, you could be surprised in terms of where your capital ratios go. So we'll certainly start with share buyback at the appropriate time and start moving towards our targeted CET1 levels. But again, we want to make sure we do so in a cautious manner to make sure that we're not in a position to not cover our customers when they go to borrow, and we see the economy start to take off in the second half of the year, hopefully.

Okay. Good. Well, we're up against the time limit. And I'd just want to say thanks for covering everything. We've learned a lot, and we appreciate you being here. And hopefully, next year is live.

Yes we sure hope so, Jon. Thank you, and thank you, everyone.

Bye.

Bye.