Comerica Incorporated (CMA) Earnings Call Transcript & Summary

Good morning, everyone. We're continuing on with our financial institution conference in 2022 and pleased to have Jim Herzog here today from Comerica. Jim is the Chief Financial Officer for the past 2 years, and it's been an interesting ride. But things are going very well for the company. And I guess we'll pass it over to Jim, let him introduce himself and talk a little bit about some of the trends you're seeing.

Great. Thank you, Jon, and good morning, everyone. Before we get started, I'd like to remind you that today's presentation may contain forward-looking statements. 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. And with that, we will start the formal part of the presentation. We have provided a brief overview of Comerica on Slide 3. For those who don't know us, we are a leading bank for business with over 90% of our loans to commercial entities, complemented, though, by very strong retail bank and wealth management capabilities. Our long-tenured employees have deep expertise in industries they serve. As you can see on the right, our unique geographic footprint provides significant growth opportunities with locations in 7 of the top 10 fastest-growing metropolitan areas. Our strengths enable us to deliver shareholder value by maintaining a sustainable competitive advantage and have driven our success for over 170 years. On Slide 4 is our mid-quarter update on loans, which is based on preliminary results through the end of February. We have had broad-based growth led once again by general Middle Market, which is up 4% on average relative to the fourth quarter. As expected, mortgage banker and PPP loans have continued to decline. Quarter-to-date loan performance is slightly better than the outlook we provided in January. This is due in part to better-than-expected performance from Middle Market and dealer. We believe that average balances for the quarter will likely be stable at the current level, and the positive trends should continue as we progress through the year. Slide 5 provides further detail on the loan performance, starting with our largest business segments. We continue to see growth in general Middle Market and Corporate Banking. Higher commodity prices and rebuilding of inventory levels are resulting in increasing working capital needs. However, supply chain disruptions and, in some cases, excess liquidity, which can temper borrowing, do provide some headwinds. But overall, our customers remain optimistic, and that is reflected in our strong pipeline and growing loan commitment levels. We continue to have great success in our equity fund services business where we provide capital call and subscription lines, debenture capital and private equity firms. The pipeline is strong, and activity remains high. And we are planning on adding more resources. Our Environmental Services and Entertainment divisions have had strong growth also over the past year with abundant opportunities. We continue to attract new relationships resulting in record loans and strong syndication activity. On the other side, our loan performance has been hampered by some unique headwinds that we believe are abating. PPP loan forgiveness picked up significantly in the middle of last year, and we expect the remaining balances to be essentially paid off in the next few months. National Dealer Services floor plan loans are extraordinarily low due to supply constraints. After a modest increase in the fourth quarter, average dealer loans have been relatively stable but slightly higher than we expected. Prior to COVID, dealer loans were running about $7.5 billion. We expect inventory levels will slowly rebuild over the next 1 to 2 years as supply issues are resolved and pent-up demand is satisfied. Finally, mortgage banker volumes have been impacted by the wind down of the refi boom, low inventory levels, higher home prices as well as seasonality. We believe we should fare better than others in this space as housing supply increases given our larger mix of purchase relative to refi volumes. In summary, we continue to have good momentum in many business lines, and we are starting to see PPP National Dealer headwinds side. The diversity of our business mix, combined with our geographic footprint, should help us achieve consistent sustainable growth. Turning to deposits on Slide 6. We achieved record average deposits in the fourth quarter and the highest quarter-over-quarter growth rate amongst our peers. As expected, through the first 2 months of this quarter, average deposits have declined due to seasonality. We believe deposits will remain relatively elevated until such time the Fed begins to significantly increase interest rates and shrink its balance sheet. The average cost of interest-bearing deposits has remained at an all-time low of 5 basis points so far this quarter. With the loan-to-deposit ratio for us and our peers at very low levels, we do not expect deposit rates to adjust very quickly as rates rise. The strong deposit growth has led to excess liquidity, which for us and our peers is well above historical averages. You can see this on Slide 7. We have been deploying some of our excess liquidity by gradually growing the securities book, which is enhancing revenue. This also helps us achieve our goal of prudently reducing our asset sensitivity over time. This quarter, we have purchased about $2.5 billion in mortgage-backed securities with an average duration of 5.5 years and yields of about 225 basis points. On average, new purchase yields have been above the level of those rolling off. Slide 8 reviews a couple of factors that are central to our asset sensitivity and results in us being more asset sensitive than our peers. Due to the commercial nature of our business, over 3/4 of our loans are floating rate and reprice quickly. As far as deposits, the majority are noninterest-bearing. The benefit of our balance sheet structure was demonstrated in the last rising rate cycle when we had the highest loan yield beta in one of the lowest deposit rate betas. Of course, every cycle is different, so history may not repeat exactly. Our models have forecast the upside of higher rates are on Slide 9. The standard model assumes a nonparallel rise in rates with a dynamic balance sheet as outlined. As I mentioned, our goal is to gradually reduce our asset sensitivity over time as market conditions allow. Recently, we opportunistically added $1.75 billion in swaps at an average rate of 1.84% at an average duration of 5.5 years. These additional swaps and the larger securities portfolio essentially pulled forward some of the rate benefit. Combine this with a decrease in deposits since quarter end and the result is a moderate reduction in our asset sensitivity relative to the year-end balance sheet, which is modeled here. Deposit performance is a major driver of our asset sensitivity, and our standard model assumes a moderate decline in the range of 2% to 4%. First quarter net interest income is expected to be slightly lower than the fourth quarter due to the decline in PPP revenue and 2 fewer days in the quarter. However, putting these 2 factors aside, we expect higher loan and securities volumes, improve rates, including the net impact of loan swaps and floors, should all be positives for the quarter. For the remainder of the year, the major driver is expected to be loan dynamics, specifically movements in short-term rates as well as the pace of growth. We are optimistic on both fronts. Our success in achieving record fee income in 2021 is outlined on Slide 10, with strong performance in nearly every category. We have been focused on growing noninterest income in order to deepen customer relationships and provide a more balanced and diverse revenue base. As we indicated on our earnings call, we expect it will be challenging to repeat this high level in 2022, particularly in light of the accommodative environment experienced in 2021. So far this quarter, we are seeing some headwinds from market performance as well as slower economic activity early on due to Omicron. We do not expect these should have an impact beyond the first quarter. However, we believe our robust product offering and talented team will assist us in achieving sustainable fee income growth over time. Our expense discipline is well ingrained in our culture. We have increased our productivity and effectiveness over time, as illustrated by the metrics on Slide 11. Our performance also compares well to our peers. As we look forward, we expect performance-based compensation to normalize in 2022. However, staffing levels are expected to return over the course of the year to prepandemic levels, and inflationary pressures could impact a number of line items, including salaries. Also, we are focused on product and market development as well as driving efficiency through continued investment in technology. By carefully managing our resources, we have the wherewithal to invest in our future and attract strong talent, which is key to developing deep loyal customer relationships. Our technology evolution is centered in 3 priority areas, as outlined on Slide 12. We are building a scalable cloud-first platform that will allow us to deliver services to our customers and colleagues with greater speed and agility. We have migrated more than 60% of our business applications to a public cloud or SaaS model. Also, we are modernizing our core platforms to drive greater operational excellence and empower our colleagues to serve our customers better. We are currently investing across our businesses, including migrating our financial systems to an industry-leading cloud-based solution. Finally, we are evolving our digital capabilities to deliver more convenient customer experiences and faster customer outcomes. For example, we recently developed a new Direct Express app in our digital factory. For those not familiar with the Direct Express program, since 2008, Comerica has been the exclusive financial intermediary for the federal government's debit card program, helping millions receive their federal benefit payments. Reviews of the app have been great, receiving 4.6 stars in the Apple App Store. Overall, our technology investments are enhancing the customer and colleague experience, helping to attract and retain customers and improving call efficiency. Slide 13 covers capital management. We are focused on our 10% CET1 target, and we have continued our share repurchase program as we closely monitor loan trends. As always, our top priority is to use our capital to support our customers and drive growth while providing an attractive return to our shareholders. In closing, Slide 14 outlines Comerica's key strengths. Our expertise and experience help us build and solidify long-term relationships. We are committed to maintaining our strong expense discipline while investing to provide high-caliber customer and colleague experience. Finally, our unique geographic footprint provides us significant growth opportunities. Thank you, and I'm now happy to take questions.

All right. Thanks, Jim, for that update. I have to say last night, I was sitting here in New York looking at the screen, and everything was red on my screen. And when I saw your 8-K hit, I was pleasantly surprised, particularly with the loan growth. And just a question for you. I know a lot of the kind of global conflict has been relatively recent, but you had a good fourth quarter in growth. It feels like that's pulling through. Have you seen any subtle changes in customer sentiment or getting any feedback from the field in terms of any recent changes given the volatility in the macro environment?

I really haven't, Jon, even though it is early. First, I'll say we are, as you heard from the script, very pleased with the loan growth in the first 2 months. Some of that is, as you indicated, a carryover of the strong year-end that we had, but much of what I'm seeing is really new originations since January 1. So truly a very broad-based good story through the first 2 months of the year. Regarding very recent events over the last 2 weeks, we have not seen anything specific yet in terms of customer pullback, deals canceled, deals slowed up. Having said that, it's early on, but we're not seeing any signs at this point in time. Having said that, we think the real story here is going to be how customers perceive the outcome of all this in terms of just what it does to the medium-term and longer-term economy. That's really what we're focused on. And we think our customers are, too. So still early on. There could be some short-term ramifications that are still yet to come, but we have not seen them yet.

Okay. Okay. Good to hear. And then just related to that, Jim, the -- just the surge in energy prices. You guys have been around the block on this given your location and some of your exposure, but how do you want investors to think about high energy prices and the impact potentially on demand portfolio health, your appetite and energy? How does that -- how do you think through that?

Well, on the loan demand side, it's great to see higher energy prices to some extent. Of course, you don't want to see frothiness built in. And so there's a limit to how high you want to see them go because ultimately, it has a spillover in other parts of the portfolio on the credit side. So we'll wait and see where that goes. We're very specific to energy loan demand. Well, our customers that we talk to are still talking the discipline story. They're hesitant to start doing a lot of additional investment just because of this current environment that we're in. I think a lot of hard lessons were learned over the last decade plus. And so at this point in time, while we've always said we're in the energy space, and we do expect our energy loans to grow with the balance sheet, we are not expecting any kind of outsized growth as a result of these recent events. And we don't think our customers are going to demand a lot of capital to do additional drilling. We do think there'll be some of the margin, and we'll see where world events goes over the short and medium term. But at this point in time, we're seeing a lot of discipline on the part of our customers, and we're fairly committed to see energy stay within proportion on our balance sheet.

Okay. Great. And one comment you made that I picked up on when you were discussing equity fund services, you talked about adding resources there. Can you expand on that or just let us understand what you're trying to say there.

We're talking about adding people. And I wouldn't say it's a large scale event, but we do see opportunity there. It's a very healthy market. It's been a great business for us. We want to make sure that we're not missing any opportunities there. And so we will, in a very measured way, add resources as we think we can take advantage of them. So I wouldn't call it a large-scale change, but we want to make sure we're taking advantage of the opportunities in that business. And we do see a lot of opportunities. It looks like it has a very bright future to us.

Okay. Great. So pretty good message on loan growth from you, it seems.

Yes. No real concerns, and I should reinforce that the pipeline seems to be refilling, too, as we make loans. So it was very broad-based. Whether you define that by market, by customer type or the type of lending itself, it just seems quite broad, and it looks very healthy to us. And it looks like customers are continuing to be responsible. They're not getting over-leverage. They are using their deposits in some cases. So it's a mixed bag depending on which customer base you're talking about. But overall, it just feels a super healthy story. And just as importantly, the pipeline looks very good. So putting aside recent world of -- like it's an optimistic picture.

Okay. I want to touch on swaps in the securities portfolio a bit. I know you've heard it all from all sides on this, but philosophically, talk about your overall goal and then talk about -- let's talk about first your approach on the securities portfolio, how far you want to take that, and then we can get into some of the swaps as well.

Yes. I mean, certainly, the end game is to reduce ultimately a vast amount of our asset sensitivity. With the business model we have, we will probably not eliminate all of it. So we're always going to benefit to rising rates to some extent, but we would like to remove the vast majority of it. We think that's really important for the earnings stability. We'd like to ultimately reduce our capital levels, which is probably one of your future questions, I'm guessing. But we think precursor to that is to smooth out the earnings, and we can't have this volatility in our net interest income. We think it's really important that, that gets smoothed out. And so certainly, the ungained objective is to remove the vast majority of it. In terms of how fast we do it, I've been very consistent, I think, in saying that we want to do it in a very measured way. We don't want to put all of our bets in one place because the future is very unpredictable, as we've learned recently. And so we were making some pretty steady progress really starting in the fourth quarter of last year. Even before then, we were adding securities, but deposits were finding way to outpace it. But we did put on a significant amount of swaps in the fourth quarter. We actually added a significant amount of, as you can see, securities and swaps in the first 2 months of this year. Obviously, all of that was done before some of these recent events over the last few weeks took place. We feel like we've been somewhat validated in doing that because, again, you never know what the future holds. And I think what we've seen overseas is just an example of the type of black swan events that can jump up. So we are making steady progress through the first quarter. We're obviously sitting on the sidelines right now, but we would expect to pick that up again assuming we get through this period of volatility. We would expect to pick that up early in the second quarter. Hopefully, the market conditions allow that. And again, we won't do it all at one time, but we're not going to let the stretch out for 2 or 3 years also. We think it's important we get in front of it because while short-term rates may go up over the next couple of years, long-term rates are very forward-looking. And there's no guarantee that those swaps will be available 2 and 3 years from now. So we want to move at a somewhat decent pace but not do it all at once either.

Okay. So inside of a couple of years, you'd like to have it done.

That's right.

Okay. Well, it's good to have a former Treasurer and the CFO, sure, Jim, given everything that's happening. You touched a bit on the NII expectations and just help us clarify the message. I think you're saying that maybe some headwinds in Q1, but you're more optimistic as the year progresses. Is that fair?

Yes. Regarding the noninterest income?

Net interest income, sorry.

Net interest income. Yes. I made some comments, too, about Omicron early on in the year for noninterest income. Net interest income, we -- the picture has improved a little bit from the guidance we gave in the January earnings call. We clearly expect that you put PPP aside to be higher than the fourth quarter. The 2 days, of course, counts for something, too. But going forward, we think that a lot of these swaps that we bought in the first quarter, many of them were forward dated to April 1. We think we're going to have some income -- some nice income really moving into the net interest income for the last 3 quarters of the year. And even the first quarter, again, putting aside PPP, we expect that to be a favorable story. And many of the actions we've taken in, fruits of the loan growth that we got in the first quarter, you'll see the full quarter effect, and from then on, in the remaining quarters of the year as we move through the year. So the loan growth will be a dominant story in terms of generating net interest income, and the rates will be a huge part of that also, both in terms of short-term rates going up, but also in terms of adding to our received fixed income assets, whether that be securities or whether that be swaps.

Okay. Okay. And I didn't mean to made the witness here, but touch on fees as well in terms of what you mean by a little bit of the first quarter being a bit slower and then picking up.

Just very early in the quarter, we saw a little bit of slowdown. And this is not surprising. Economic data that I saw showed that we did have a bit of a slow up in the first few weeks of the year economically just because of Omicron and a little bit of slope in business activity. So those activities, those service chart or those fee incomes that are related to economic activity which is being processed like deposit service charges. They were a little slower than we would have liked in January. But we do see it picking up. And then I reference market-related fees, things like warrants and securities trading. Ultimately, if this market correction doesn't turn around, I think you'll see banks get a little bit of pressure on fiduciary fees just due to lower market levels. So that's really what I was referring to. But we think most of those are hopefully pass through events and -- but anything that would stick with us throughout the year. So overall, we're still bullish on noninterest income. Keep in mind, a lot of noninterest income is tied to not just unit pricing, but also bps of asset values. And I do see nominal asset values continuing to increase as we go through the year. We've seen that to some extent over the last few quarters. So we feel good about noninterest income, but a little bit of a slowdown just early in the first quarter, but we see that turning around as time moves on here.

Okay. Good. And then on expenses, Jim, you guys have really challenged expenses, I would say, at the company over the last 5 years, but it feels like the environment from a revenue point of view isn't improving, and it's going to be a little bit stronger. I mean you have the wind at your back in a couple areas in terms of volumes and rate. Where do you want to spend money? Do you feel like you're keeping up from a technology point of view? And if revenues come in a little bit higher than you're expecting, what do you plan to do with that excess revenue?

Well, we do think we're making the proper investments over the last few quarters. We've really seen a turnaround in terms of investing in more build the bank as opposed to just run the bank, and that's great to see in terms of product development and improving customer experiences. And I gave a couple of examples of those in the script. So we feel like we're doing the right thing. Those places where we want to be best of breed, we are building. And those places that we don't need to be best of breed, we think at our size, it pays to these third-party providers and partners. And I think that's a very cost-effective way as well as a great way to keep up on the technology trends as time moves on. So we think we're making the right investments. In terms of the quantity of investment, we -- I do like to look and the bank likes to look at expenses being managed, to some extent, somewhat separately from what's going on in the environment in the sense that we don't want to starve investment, if things aren't going well. But at the same time, we don't want to spend away any kind of windfall that comes with the change in rates and so on. And so to some extent, we are managing expenses in a vacuum. Having said that, when things like rates go up, it's usually because other good things are happening in the economy. And when those other good things are happening in the economy, you want to make sure that you're there to serve the customer. So whether that's being in the right markets, whether that's retaining the right people, whether that's just making the right product investment where you see perhaps a gap that you have to keep up on, those things tend to accompany a higher rate environment. So it wouldn't be surprising a little bit more spend as rates go up just because it means the economy is healthy, and there's a lot of opportunities. But at the same time, we want to be good expense discipline managers in terms of just making sure we're doing the right thing regardless of the environment. So we do look at it from a couple of different peoples there.

Okay. And how are you thinking about some of the inflationary pressures as you look forward?

They are there. And I don't think we've seen all of them at this point in time. I mentioned in previous calls, I thought that it would add probably 1% to our expense base in 2022. I think every bit of that is going to come to fruition. It seems like it's got the potential to keep building from there, even though we're not seeing direct evidence of that yet. But these things tend to be a bit of inflation. Spiral, we see what's going on with energy. We see price raises by some vendors or parts of the economy, and that dominoes into other parts of the economy. And so the skill side it could go on for a while. We are seeing some wage inflation. But fortunately, we do have long-tenured employees at Comerica with a lot of Comerica DNA to them. It doesn't feel like the turnover or some of the wage inflation has hit us as hard as perhaps other companies, but it is hitting us, and we are aware of it. Being a Middle Market-oriented institution with a heavy emphasis on commercial banking, the people side is just as important to us as the technology investment. We have to keep the right people around. These are the ones that have the relationships with the customers that go many years back. And so we are going to do what it takes to retain the right employee base. But my sense is it's not hitting us any harder than some companies. In some ways, it might be less. But nonetheless, the pressures are there, and we expect to continue for some time.

Okay. Got a few minutes left. I want to touch on a couple more topics. But help us -- you alluded to this earlier. Help us understand the relationship between hedging, having some more stability in the NII line and then the ability to take down capital levels potentially below your current targets. How is that all interrelated?

Yes. We think the #1 obstacle to us taking down our capital levels to a lower level of CET1 is smoothing out with the interest income stream. And we want to make sure that when rates are at some moderate level and then go back down, we want to make sure that we're able to sustain our common dividend, obviously, our preferred dividend. We want to make sure that from a rating agency standpoint that we're still seeing it's a very solid institution, and we do have very good credit ratings to date. It's one of our strategic advantages, I think. But we want to make sure that no matter what environment we're in that we have that good credit rating, that the dividend is solid, that we're there to support customers in terms of loan growth. And so net interest income stability seems to be the biggest check box that's left before we can take that step of lowering capital levels. And it is something we're very committed to. And as long as the markets cooperate, we expect to get there over the next 1 to 2 years.

Okay. Okay. Good. On M&A, it's obviously a big topic in the industry. What's the latest thinking from Comerica on M&A? Do you need to do anything? Do you need to partner up? Or do you feel like you're capable of going it alone?

Well, first and foremost, we are always focused on the organic growth story, and that is our first option. We think we have a great business model that's paid off for a number of years. We've actually recently exported that model, as you know, to North Carolina, and we do have a Southeast expansion strategy there. And so we think that it's a best -- better known quantity to go with the model that we know, that we know we can execute as opposed to the risks that are fraught in acquisition where you don't always know what you're getting where you tend to have to pay a pretty good premium to get it. Having said that, we have done acquisitions in the past, but it needs to be almost a perfect storm of opportunity and culture fit. And it's not something we're out looking for. It would be an opportunity that really just pops up and just fits like a glove. And it's not something that we're focused on right now, and it's not our first choice. We are very focused on organic growth and that's where you're going to see our resources likely go into.

Okay. Good. I had one question come in just on deposit stability. It sounds like you're -- look, what you're saying is your deposits down in the first quarter was really seasonal more than anything. And how do you feel about your ability to retain deposits to maintain that asset sensitivity?

Well, our deposits, it is a seasonality story through the first 2 months of the year. That's really 90% of what we've seen happen here. I think that will continue through the month of March. The slope is flattening, but I think the seasonality story will play out throughout the whole first quarter. We think things will level out from there, all things equal. But very likely not all things will be equal once we move through the last 3 quarters of the year. Certainly, to the extent the Fed raises rates, that's going to move some balances off balance sheet to other opportunities the customers have. Probably won't happen in the first hike or 2, but it will happen eventually if they get to the fourth hike, the fifth hike, the sixth hike. And then, of course, when the Fed decides to unwind its balance sheet, that's likely to push all bank deposits down in the system. So I think a lot of this is going to depend on Fed actions, but I think we will be past at least the seasonality part of this once we get done with the first quarter.

Okay. Good. Just 30 seconds left, you and Curt, both assumed your jobs right before the pandemic. It's been a wild 2 years. It feels like things are moving forward for you despite some of this recent volatility. But just quickly, what's the message internally to the troops? I'm guessing it's forward-looking, but what are you telling your people and your producers internally to do these right now?

A couple of things. One, we remind them of the period that we've been through and just what a great job everybody did getting us through such a challenging period. And in some ways, I think we did come through it stronger than ever, both in terms of a culture and in terms of our balance sheet. So we feel like we're very well positioned for the future. And I think there's a role that's really core that we've always had here at Comerica but perhaps set a new level under Curt's leadership. And so we feel really good about the future. We recently did a colleague survey in terms of just colleague engagement and morale and so on. And we've done this a couple of times now, and it just continues to improve. We feel really good about the spirit of the troops here, and I think everyone feels very excited about the future. So we think we're positioned well financially. Culturally, we think we're very well positioned. And the future just, frankly, looks very bright to us. So we're very excited about it.

Okay. Well, great. We're out of time, Jim. But thank you, Jim. Thank you, Darlene. And great story, and good luck with all the meetings today.

Thank you, Jon. Thank you, everyone.