Comerica Incorporated (CMA) Earnings Call Transcript & Summary

All right. Good morning, everybody. I'm Ken Zerbe, the Midcap Banks analyst here at Morgan Stanley, and I want to welcome you to our 2021 financials conference. Now before we begin, I do have to read important disclosures. For important disclosures, please see Morgan Stanley research disclosure website at www.morganstanley.com/researchdisclosures. If you have any questions, please reach out to your Morgan Stanley sales representative. All right. So this morning, we have Peter Sefzik and Jim Herzog from Comerica. I'm very excited to have you guys. Peter and Jim are going to run over some slides first, and then we're going to go into Q&A a little bit later. Now some of you may not have had the chance to meet Peter. Peter joined Comerica over 20 years ago as a banking analyst and the bank's commercial credit training program and has experience in private banking and energy and served as the Texas market President. He's also been the Head of the Commercial Bank since 2018. Now Jim has been with Comerica for over 35 years and a long-time finance executive and has been CFO for almost 2 years and was Treasurer before that. So Peter, Jim, why don't I turn it over to you to go through the slides.

Thank you, Ken, and good morning, everyone. It is a pleasure to be here. Now 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 statement. For those of you who do not know us well, Slide 3 provides a brief overview. Comerica has a long history of successfully navigating through many economic cycles. Our size enables us to be nimble and efficient. We are a leading bank for business, complemented by strong Retail Bank and Wealth Management capabilities. We have a unique geographic footprint with significant growth opportunities. Slide 4 gives a summary of the Commercial Bank, which provides 85% of Comerica's loans, 58% of our deposits and over 3/4 of our revenue. We have the highest concentration of business loans among our peers and one of the highest in the industry. In addition to general Middle Market and Business Banking, we serve many specialty industries. We are well known for our long tenure teams who have an excellent understanding and strong reputation in the businesses they serve, enabling them to develop loyal relationships. Our well-diversified portfolio helps drive growth and reduce risk. We provide a wide array of financial products and services. And through collaboration with our Wealth Management and Retail colleagues, we can develop deep relationships. For example, our Business Owner Advisory program provides the owners and executives of our Commercial Bank customers with a warm introduction to our wealth advisors to establish a personal financial strategy, including succession and retirement plans, life insurance and investment advice. Turning to Slide 5 and our unique footprint. We primarily cover the major metropolitan areas in Texas, California and Michigan, which afford abundant opportunities. As you can see in the table, our footprint places us in 7 of the 15 largest cities in the United States, in 5 of the 10 fastest growing cities. Our Chief Economist forecasts Texas, California and Michigan will grow faster than the national average in 2021 and 2022. Our loan and deposit mix is well balanced, with loans in California comprising 1/3 of our portfolio, followed by Michigan with 23% and Texas at 20%. The national or other component includes the portion of businesses that we pursue on a national scale that fall outside of these primary markets such as U.S. banking, mortgage banker, environmental and auto dealer services. They have customers throughout the Continental United States. In addition, we have a strategy to make investments in select faster-growing markets where our customers want more coverage and there is a concentration of industries we serve such as Boston and New York for Technology and Life Sciences or Denver for Dealer and Energy. The diversity of our business mix, combined with our geographic footprint, should help us achieve consistent, sustainable growth over time. On Slide 6, you can see our major business leaders have an average of 30 years with Comerica. Behind them is our deep bench of talented, long-tenured colleagues. These well-experienced bankers deliver Comerica's relationship-driven, trusted advisor approach. Furthermore, the longevity of our colleagues demonstrates the strong appeal of Comerica's culture and the quality of the products and services we deliver. Our trading programs aid in attracting and retaining high-quality relationship managers. Our commercial banking development program includes robust credit and sales courses. Another factor that drives our success is our multifaceted approach to relationship management, which is supplemented by well-rounded measurement of performance and accountability. In summary, the experience and knowledge of our team is a clear differentiator for our customers. Turning to Slide 7. Middle Market and Small Businesses are at the heart of Comerica and the communities we serve. These business lines represent about 1/3 of our loans and deposits. To demonstrate our commitment, we recently made a pledge to lend $5 billion to small businesses over the next 3 years. For us and the industry, deposit growth has been very strong over the past year, while loan growth has been challenging and line utilization is at historic lows. Overall, customers have been able to shrink their balance sheets and achieve good profitability, which has resulted in excess liquidity. In addition, PPP was a lifeline for many of our customers, and we have been there to navigate them through the process. Many are now working through the forgiveness process, and we expect most loans will be repaid by year-end. Some of the keys to our success was the Middle Market and Small Businesses were highlighted in a recent customer survey. They included our trusted advisor approach, willingness to extend credit, creative and flexible solutions and the depth of contact with the bank. I spend a great deal of my time reaching out to companies and referral sources as does my leadership team. Having access to our executive team is highly appreciated by customers and prospects. On Slide 8, we have a couple of specialty businesses that have seen extraordinary conditions over the past year. We have been in the auto dealer business for over 75 years and have customers that have been with us for generations. We focus on top-tier, multi-franchise dealers. We have a good mix of sales and service revenue. Dealer inventory levels have been very low due to strong demand combined with supply constraints. This has resulted in quarter-to-date average loans declining about $1.5 billion relative to the second quarter last year and almost $3.5 billion from the second quarter of 2019. We remain confident that inventory levels will rebuild to normal levels, but it will take some time, likely into next year. On the other hand, mortgage banker finance activity has been robust and reached record levels last year, but slowed with modestly higher mortgage rates dampening the refi boom. Our customers are more purchase-oriented, and purchase volume has remained pretty strong. Quarter-to-date, loans are down about $400 million relative to a year ago, but $900 million higher than 2 years ago. The latest MBA forecast was revised upward and shows 2021 volumes dropping 11% year-over-year with 27% decrease in refi volume, but a 16% increase in purchase obligations. We are a committed leader in both the Dealer and Mortgage Banker segments. We expect to offset some of the decline driven by lower industry activity with new customer acquisition. Supporting customers during these tumultuous times has further enhanced our reputation and resulted in a solid pipeline. Slide 9 provides our typical mid-quarter update on loans and deposits, which is based on preliminary results through the end of May. As I just mentioned, loans have been impacted by headwinds in Mortgage Banker and Dealer. In addition, Energy continues to decrease as higher oil prices are driving improved cash flow and capital markets activity. General Middle Market loans have begun to pick up, but are partly offset by PPP loan forgiveness. which is expected to accelerate. We've also had increases in Commercial Real Estate and, to a lesser degree, several more areas such as Environmental Services and Corporate Banking. We continue to believe that overall loan growth, excluding PPP, will resume in the back half of the year. This is supported by our strong pipeline, which sits above pre-pandemic levels and increasing total commitments. As far as loan yields, recall that the first quarter was impacted by $17 million in lease residual value adjustments. Excluding the 14 basis points impact from this adjustment, loan yields increased 3 basis points in the first quarter, with the benefit of accelerated fees from PPP forgiveness. So far in the second quarter, PPP fees and mix shift in the portfolio have more than offset the slight decline in LIBOR. Quarter-to-date, average deposits have increased $3.8 billion, including a $1.8 billion increase in consumer deposits, primarily due to seasonality and the latest government stimulus. With strong deposit growth, our loan-to-deposit ratio decreased to 66%, another record low. The average cost of interest-bearing deposits fell to an all-time low of 6 basis points. In summary, we expect average deposits and loans, excluding PPP, for the second quarter to remain at the current level. Turning to Slide 10 and fee income. The Commercial Bank contributes over 50% of the bank's noninterest income, complemented by a suite of Retail and Wealth Management products. Strong understanding of the unique banking needs of the industries we serve, along with a relentless attention to customer service, results in deep product penetration. Furthermore, we are aiming to deliver a more diversified and balanced revenue base with an emphasis on fee generation. Our success is evident in the increase in fees we have seen over the past year. Our card platform is a great example. We are the fourth largest prepaid card issuer in the United States as we serve 57 state and local programs as well as the U.S. Treasury direct expense program. Also, card is a key component of our integrated treasury management products, providing customers with increased efficiency. Card provides about 1/4 of the bank's fee income and generated growth of over 20% year-over-year in the first quarter. Deposit service charges are also a significant contributor to fee income. As a leading bank for business, we are focused on providing a wide array of high-caliber treasury management products. We continue to enhance our offerings. For instance, we are currently investing to enhance the cash management tools for Small Businesses and Technology and Life Sciences, both of which have unique cash management needs to continue to evolve. Also, we intend to expand our corporate finance capabilities, allocating resources and expertise. As outlined on Slide 11, our expense discipline is well ingrained and is assisting us in navigating this low rate environment as we invest for the future. By carefully optimizing our resources, we have increased productivity and effectiveness as demonstrated by our ratio of loans and deposits per relationship manager. We believe the efficiency of our bankers is one of the highest among our peers. Some of our recent technology investments are listed on the slide. Increasingly, our technology spend is focused on enhancing the customer and colleague experience, helping attract and retain customers, which drives revenue growth as well as control expenses by improving colleague efficiency. Also, we often leverage third parties to keep pace with evolving and emerging technologies. Before I turn it over to Jim, I will reiterate Comerica's relationship banking model is centered on the expertise and experience of our bankers who provide valuable advice to our customers to aid in their success. This is complemented by strong Retail Bank and Wealth Management capabilities and our unique geographic footprint. All together, we believe we can drive consistent, sustainable growth over time. And now I will hand the presentation over to Jim.

Thanks, Peter, and good morning, everyone. Starting on Slide 12, I'm going to quickly touch on our asset sensitivity and capital position. As you probably know, our balance sheet is very sensitive to rate movements. Our models at the end of the first quarter estimated a 9% increase in annual net interest income over 12 months when rates rise 100 basis points, with additional lift in the second year. This is primarily due to the fact that the bulk of our loans are floating rate, and we have a large proportion of our noninterest-bearing deposits. This fact also means that the impact of the current low rate environment has been mostly absorbed. However, some challenges remain. So far this quarter, 30-day LIBOR, the rate we are most sensitive to, has averaged about 10 basis points, a 2 basis point decrease relative to the first quarter. However, recently, it has been closer to 7 basis points. Also, reinvestment rates on our MBS repurchases so far this quarter have an average duration of 6 to 7 years and yields of about 185 basis points compared to securities rolling off at an average of 240 basis points. We have swaps expiring and treasures maturing, as you can see in the charts. Finally, lower loan volume does weigh on net interest income. We have taken action to mute these impacts such as prudently managing deposit costs lower. Also, while this is becoming more challenging, there has been a benefit for maintaining and adding rate floors on LIBOR loans. Finally, we are looking at deploying some of the excess liquidity by gradually growing the size of our securities portfolio. Aside from these actions, there is a benefit from PPP loan repayments, which results in accelerated fee amortization. In summary, as we move to the second half of the year, we expect pressure from securities yields and swap maturities to be roughly offset by loan growth. In addition, PPP loan volume and accelerated fees are expected to be a headwind. Moving to Slide 13 to capital management. As always, our priority is to use our capital to support our customers and drive growth while providing an attractive return to shareholders. With our CET1 sitting well above our target at the end of the first quarter, we entered into an accelerated share repurchase program for $400 million at the end of April. This is now complete, and it yielded 5.2 million shares, reducing our share count by over 3.5%. In addition, we expect to repurchase an additional $50 million of shares by quarter-end. Our goal is to continue to make strides towards our CET1 target of 10%, keeping a close eye on loan growth trends and capital generation. In addition, we have maintained a very competitive dividend yield, which is currently yielding about 3.5%. In closing, Slide 14 reiterates Comerica's key strengths, We continue to demonstrate our resiliency and unwavering dedication to provide a high level of customer service. Our expertise and experience help us build and solidify long-term relationships, particularly in extraordinary times like these. 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. Finally, we are uniquely positioned with our nimble asset size, Commercial Bank orientation and very strong deposit base. These key strengths provide the foundation for long-term shareholder value. Thank you for your time. We are now happy to take questions.

All right. Thank you very much. Appreciate those comments. I will say, if anyone does have a question on the webcast, please just fill it in, and I'll get it on my computer here.

With that, why don't we go ahead and start off. Now, Peter, you mentioned that you do expect loan growth to pick up in the back half of the year. I guess -- and you mentioned pipelines for this. But really, what gives you the confidence that loan growth will accelerate, especially given all of the excess liquidity in the system?

Yes. Ken, the excess liquidity in the system is clearly something that is a headwind to loan growth. We think that as the year moves on and we start to see those deposits hopefully drift down a little bit, maybe we see some utilization pick up, I think just the overall improvement in the economy that we're seeing, particularly the nice bump that we started to see in kind of our general Middle Market and Business Banking businesses is probably the most encouraging part of that. So that's where our confidence comes from. We did talk about pipeline being above pre-pandemic levels. We've seen that now for several months, and it's encouraging as we're kind of moving into the latter half of the year. I do think there's still a number of sort of factors out there in the macro economy that companies are concerned about those. So we're optimistic. We believe that the second half of the year will continue to see a pickup across most of our businesses. And I really think that, that liquidity is a headwind that we'll start to see dwindle down as we go into the second half of the year.

Got it. And can you just talk a little bit about the sentiment among your commercial customers?

Yes. Ken, I would say the sentiment is really pretty good right now. They feel, I think, and are seeing a lot of the things that all of us are. Return to office is encouraging, people coming back to work, going out into the communities more. And so things are picking up. But there's concerns they have. The supply disruption that we're all experiencing as every day they're also experiencing. And so that's a challenge for them. It's encouraging on one hand because of the amount of activity, but on the other, it's certainly slowing down revenue in some form. But I would say in general, they're very encouraged by what we're seeing, and the optimism is creeping up every day. Now all that said, I still think many companies are sort of preparing for the -- what could happen scenario, whoever prepared for COVID. And so just like many of us as consumers are doing, I think you're seeing some companies just wanting to make sure that in case things take a turn, they are prepared for that. So that -- but all in all, I would say, Ken, customer sentiment is really pretty encouraging.

All right. No, not to put you on the spot, but Comerica's loan growth over the last 5 years has been about 1.2%. So that's -- which is probably not as strong as the rest of the industry. And that includes PPP. Now honestly, we do expect the economy to pick up and rebound over the next several years. It's just everything reopens. If that were to happen, how should we think about Comerica's more normalized loan growth overall?

Yes. Ken, that's a fair question. And I think that what I would say is that we feel like we continue to be in the right geographies, in the right lines of business. We've certainly, over the last several years, seen some pretty heavy headwinds in our Energy business that has particularly declined quite a bit during that period. We've also seen some headwinds in our Technology and Life Sciences business that have brought those balances down over the last several years. But I think where we sit today, and the outlook going forward, we feel really good about our ability to grow consistent with those economies that I mentioned where we feel like the growth in the markets that we're in is going to exceed national averages and going to put us at a better loan growth than maybe you had seen in the past. And so I think once we get past some of these maybe bigger businesses over the last few years that have held us back and really continue to focus on our Middle Market and Business Banking businesses in those geographies, we'll be able to exceed those expectations.

All right. Now Jim, question for you. Once we get around or get past like all this noise on PPP and the excess or elevated cash balances, how do you see the core net interest income trending, let's just say, up until the point where we actually get the first rate hikes? Because I obviously know you're very asset-sensitive. So just in the next, let's call it, 2 years?

Okay. Ken, yes, we do look forward to those rate hikes at some point. But in the meanwhile, I will say that given our high level of LIBOR loans, as I mentioned earlier, we have absorbed the vast bulk of the rate decrease at this point in time. So going forward, assuming LIBOR does stabilize, it's been -- had some recent drops. We're assuming it stabilizes. I do think the key to net interest income growth will be loan volume. Now we do have some headwinds, as I mentioned, in the form of treasury maturities and slot maturities. And that will certainly put a little pressure on net interest income. We do think we can offset that with investing some of our excess liquidity. Now you saw some of that in the very end of the first quarter and, to some extent, we would expect to continue that. We feel really good about the loan pricing that we've implemented in recent quarters, and we continue to see loans priced off very well. You see us managing the deposit pricing quite well also. So that's actually providing a nice offset to some of the recent drops in LIBOR and even helping offset some of the maturities that I mentioned. Having said that, I think investment in excess liquidity will largely offset some of these maturities on the swap side and securities side. And so when you net out all those puts and takes, you really come back to the big X factor of loan volume. Loan volume is what is ultimately going to move the needle on net interest income. And so that's something we're focused on. You heard Peter's comments just a few minutes ago. And we do expect loan volume, assuming it does materialize, to roughly offset these other pressures that I mentioned earlier.

Got it. Okay. Great. And then maybe just a follow-up, though. With the average deposit balances were up a ton like $4 billion this quarter, can you just talk about how you're thinking about investing those? Like what types of securities, what types of duration? Just a little more detail would be great.

Yes, Ken. Number one, some of the increase that you saw this quarter is transient in the sense that a stimulus likely benefited deposits at Comerica more than at a typical bank, given some of our card programs. And we see a lot of stimulus flowing into both our commercial customers accounts as well as some of the government programs that we have. So we do expect some of that deposit volume to dissipate over the next couple of quarters. In addition, we do think that customers will make use of some of their liquidity. So we do think this liquidity will ultimately come down to some extent as we approach it into the year. Having said that, I do expect this to be in an excess liquidity position for some time to come. And so we will, at some very manageable and steady pace, investor excess liquidity, taking into consideration where we think we may end up over the next few quarters from a liquidity position. And also, we want to be careful not to make any big bets by investing too much at one time, given that there is some uncertainty in terms of where the rate environment may go. So I think what you'll see us do is make some very slow, steady investments in excess liquidity while continuing to assess where the rate environment is going, where loan demand is going and where we see the fed potentially going and the ultimate impact on liquidity in the system. So small steady steps on investing excess liquidity is probably how I would summarize it.

All right. Maybe turning to capital. How quickly do you think it's going to take for you to get down to that 10% CE Tier 1 target, assuming no change to the economic outlook or loan growth outlook.

Well, as you know, Ken, we have been pretty active capital managers over the years. And we were in a very high level of CET1, just over 11% at the end of the first quarter. Having said that, we did take a pretty assertive step in terms of soaking up some of that excess capital with our $400 million accelerated share repurchase program, and we didn't stop there. We expect to repurchase another $50 million worth of shares by the end of the quarter. And so that should take a pretty good chunk out of that excess capital position that we have into the first quarter. Having said that, we don't know where earnings generation will go over the next 2 or 3 quarters. We do expect it to be good. And so that will certainly provide some degree of increase in capital, all things equal. We do expect to have some loan growth, which should offset increasing offset some of that capital accretion. And so we want to be a little careful until we have a full view of where loan growth is going over the next 2 and 3 quarters and not pull all the way down to 10%. Having said that, we do expect to make steady steps. We will see some very significant strides, I think, when you see our capital ratios over the next couple of quarters. And then as we get towards the end of the year, first quarter of next year, we should have a pretty good feel at that point as to whether or not we can actually get down to the 10% and just reassess where we go from there. But for now, we are being somewhat cautious, but we are also dedicated to taking capital levels down at a pretty steady rate each quarter. And so we do expect to make consistent progress over the next 2 or 3 quarters.

All right. Well, maintaining just a slightly longer-term view, given your high reserve ratio that you have, given an improving economy, does it ever make sense or would it ever make sense to bring your CE Tier 1 below that 10% target?

Yes. That is something that we are always evaluating in terms of what the appropriate levels of capital are for us. For now, we are comfortable with the 10% CET1 target, given our overall complexion and given the needs of some of our external constituents. Having said that and over time, we will reassess where the regulatory environment is, where the overall industry is. And also, we do expect to change our risk profile over time. As rates someday go up, we do expect to be in a better hedge position. We do expect to have less volatility in terms of net interest income over time. And we also expect to have a better revenue mix in terms of net interest income versus noninterest income. And so as we reduce the risk profile of Comerica over time, I do see the potential to take our CET1 below 10%, possibly with the reshifting of our capital stack. But for now, we are comfortable with the 10% of CET1 target.

All right. Great. Now in terms of credit, you're still holding a fairly sizable reserve, as I mentioned and especially given your low level of charge-offs. And you mentioned in the past that I think you're planning a more adverse economic scenario to your CECL modeling, especially given, I guess, around energy and the social distancing portfolios. But just given price of oil has been going up, [indiscernible] is coming off, the economy does seem to be opening up, shouldn't this all lead to a pretty sizable release in reserves over the next couple of quarters?

Yes. Ken, we are comfortable with our credit position as it stands. And when you look at CECL, certainly 2 of the big drivers were energy and social distancing over recent quarters. Looking at energy, we did see some significant improvement during the first quarter with our energy metrics. And of course, if you look at the second quarter, we've seen oil prices only move higher. We've seen capital markets open up for energy customers. And we've seen the overall cash positions of our customers improve. And so we feel really good about where energy is headed. With regard to social distancing, that's certainly a segment that many in the industry had concerns about. We actually did see those credit metrics for social business staying pretty stable in the first quarter. And we're not seeing anything overly concerning at this point in time. And so from a credit metric standpoint and how that impacts CECL, we certainly see things moving in the right direction. With regard to the economic forecast, which is the other half of CECL, we certainly expected the economy to improve with the economic forecast that we had on 3/31. Nothing has really changed materially from that. We still expect the economy to perform very well. And so when you look at the continued strong economic forecast, when you look at where the credit environment is overall, we do feel pretty good about that reserve coming down over the next few quarters, and we do think it's moving in the right direction.

Got it. And then just to clarify, I think you mentioned -- you talked about energy and social distancing in first quarter. Are those positive trends still occurring in second quarter?

No. We haven't revealed any specifics with regard to that. But for energy, again, I'll just point to the overall environment. Oil prices have done nothing, but go up. Capital markets, again, have opened up. So I think you can infer from that, for the overall industry, energy is going to be a good news story. And Comerica has certainly been a good steward of credit in that regard. And then certainly, in terms of social distancing, we're not seeing anything overly concerning on that front either. So overall, I would say, without getting too specific, we're pretty comfortable with where those metrics are. Having said that, CECL is a complex exercise. There are a lot of variables that go into it. We have not finalized the economic forecast for CECL that we'll use June 30. So there's still a bit of a wildcard out there. But overall, I think we feel pretty comfortable with the way things are trending.

Okay. And then maybe a little bit of a debate that I seem to be having with the Street from time to time. It's -- we're building in reserve release -- sorry, not reserve release, but reserve is getting back to CECL day 1, call it, very early 2022, maybe early to mid-2022. I think we're a little bit on more aggressive side. The Street consensus tends to be a little more less optimistic about reserve release. I know you really can't comment specifically about your portfolio, but is early 2022 on a realistic goal to get back to CECL day 1? Or am I just thinking about that wrong?

Well, I don't think you're real off base there. But having said that, the economic forecast for such a heavy weight in the overall CECL equation, I think all banks, including Comerica are hesitant pint it to a specific quarter, But having said that we are seeing credit metrics continue to move in the right direction. Again, we had been projecting a strong economy with our CECL economic forecast, and there's no reason to think that will change in the near future. And so we do think that the CECL reserves are moving in the right direction, and we do expect to see some pretty steady increases over the next few quarters. But again, pinning it down to a specific quarter would be very challenging.

Of course. So I thought I'd ask. Maybe in the interest of time, we can probably have one last question. In terms of bank M&A, there's obviously been a big increase in bank M&A across the industry. Is there any products or capabilities that you would like to improve upon at Comerica and geographies as well?

Well, certainly, in terms of broader M&A, we feel really good with our current model. Being a relationship bank, we feel less pressure to build scale compared to what other banks might feel. We feel really good about the markets we're in. We're in some of the highest MSAs in the nation. And so I don't expect to see Comerica to take any steps in terms of larger M&A activity. Having said that, we are open to smaller fill-ins or tuck-ins if we do see a product gap. Some of these are the types of acquisitions that may or may not even warrant the press release. So doing kind of smaller tuck-ins, where we do see an opportunity to add to the product set, you may take advantage of. But overall, I wouldn't expect any large M&A announcements out of Comerica. We're very comfortable with our model. We don't feel the pressure to do so. And it would really take a perfect storm of events to see us move on the M&A front, which we don't see is likely at this point.

All right. Good to hear. All right. Well, we're out of time. Peter, Jim, I want to thank you very much for being with us today. And thank you, everyone, for watching.

Thank you very much.

Have a good day.