Comerica Incorporated (NYSE:CMA) Q1 2023 Earnings Call Transcript April 20, 2023
Comerica Incorporated beats earnings expectations. Reported EPS is $2.39, expectations were $2.29.
Operator Hello, and thank you for standing by. Welcome to the Comerica First Quarter 2023 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers’ remarks, there will be a question-and-answer session. [Operator Instructions]. I would now like to turn the conference over to Kelly Gage, Director of Investor Relations. Please go ahead.Kelly Gage Thanks, Leah. Good morning, and welcome to Comerica’s First Quarter 2023 Earnings Conference Call. Participating on this call will be our President, Chairman and CEO, Curt Farmer; Chief Financial Officer, Jim Herzog; Chief Credit Officer, Melinda Chausse; and Chief Director of Banking, Peter Sefzik.During this presentation, we’ll be referring to slides, which provide additional details.
The presentation slides and our press release are available on the SEC’s website as well as in the Investor Relations section of our website, comerica.com.This conference call contains forward-looking statements. And in that regard, you should be mindful of the risks and uncertainties that can cause actual results to vary 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. Please refer to the safe harbor statement on today’s earnings release on Slide 2, which is incorporated into this call, as well as our SEC filings for factors that can cause actual results to differ.Also, this conference call will reference non-GAAP measures.
And in that regard, I will direct you to the reconciliation of these measures in the earnings materials that are available on our website, comerica.com.Now I’ll turn the call over to Curt, who will begin on Slide 3.Curtis Farmer Good morning, everyone, and thank you for joining our call. Today, we reported first quarter earnings per share of $2.39, driven by continued loan growth, a favorable rate environment, and effective management of balance sheet, credit, and capital.Despite the recent industry disruption, we affirm the strength of our core deposit base by successfully retaining our relationships. While we saw some deposit pressure, it was predominantly localized and very manageable. Our prudent risk management had us well prepared. Our effective liquidity strategy allowed us to remain laser-focused on seamlessly supporting customers as we open a significant number of new accounts.We remain focused on business as usual, winning new opportunities, attracting talent, underwriting credit, and expanding relationships.
We believe our strong deposit franchise is now even more attractive and stable with a lower percentage of uninsured excess deposits and less concentration with price-sensitive customers. Moving to a summary of our results on Slide 4. Broad-based loan growth and increased noninterest income exceeds expectations. Credit remained a key strength for the quarter. And although we saw modest migration, we were starting from very low levels. Despite some pressures related to funding costs and expenses, we maintained a solid efficiency ratio and produced a robust ROE and Tier 1 capital ratio.Complementing our compelling financial results, we achieved significant milestones, including our new partnership with Ameriprise, aimed at further elevating our wealth management customer experience, digital tools, and capabilities.
The launch of our new investment banking group and the national expansion of our small business banking platform strengthened our solutions for customers throughout their life cycle. Further, these initiatives advance the priority of increasing our mix of noncapital consuming fee income. Turning to Slide 5. We generated earnings of $324 million or $2.39 per share in the first quarter. Average loans grew almost $1.1 billion. Average deposits decreased $3.5 billion due primarily to normal first quarter seasonality and customer utilization of funds related to monetary actions.Credit quality outperformed with net recoveries in our criticized loan percentages remained well below our historical average. Expenses were elevated due to pension and several larger notable items, but we maintained a solid efficiency ratio.At all, we retained our strong capital position with an estimated CET1 ratio of 10.09%.
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It was a remarkable quarter for Comerica, and I’m excited about our future and our ability to support our customers while delivering compelling results for our shareholders.And now I’ll turn the call over to Jim, who will review the quarter in more detail.Jim Herzog Thanks, Curt, and good morning, everyone. Turning to Slide 6. Broad-based loan growth exceeded expectations as average balances increased 2%. Commitments grew across most business lines, up 2% from the fourth quarter of 2022. Utilization increased modestly to 46%, but remained below historical averages.Growth in our commercial real estate business of over $640 million continue to be driven largely by construction of multifamily and industrial projects originated over the last two years in addition to the slower pace of payoffs.
Our commercial real estate strategy remains highly selective with a focus on Class A projects, and our office exposure is limited.National Dealer Services loans grew over $360 million as a result of new relationships and continued customer M&A. Both management and middle market also contributed to our strong loan growth. Elevated interest rates, lack of housing inventory, and normal seasonality continue to pressure mortgage banker as average loans declined $184 million for the quarter.The MBA forecast expects higher volumes in the second and third quarters, consistent with the normal spring and summer buying season. Slide 7 provides an overview of our deposit activity. Quarter-to-date deposits through the first week of March trended in line with guidance as customers continue to deploy funds into their business and we experienced expected seasonality.
Following the March industry events, excess balance diversification efforts by our customers further impacted deposits. We saw our peak impact in the days immediately following, concentrated in certain customers with balances well in excess of their operational needs.Outflows moderated. And in the last two weeks of March, we saw a return to a more normal pattern, and that trend has continued. The greatest outflows were localized in select portfolios with a muted impact across the rest of our businesses. Despite on-boarding new customers in TLS, balances decline as this disruptive sector diversified deposits. Portfolios with larger-than-average deposit relationships, such as corporate banking and select customers in Middle Market California, also saw diversification within a portion of their excess balances.
These three business lines saw disproportionately high deposit growth through quantitative easing and much of the decline offset that increase. Utilization of an FDIC reciprocal deposit product was an effective strategy. And through quarter end, our customers placed $2 billion in balances in that solution.Deposit diversification efforts were concentrated in more price-sensitive customers, and the increase in deposit pricing to 152 basis points was driven by the cumulative impact of previous pricing changes. Our strategic relationship focus was proven successful as we retained and in fact, grew our total number of core deposit relationships. Slide 8 highlights the strength of our core deposit franchise. It is important to note how elevated deposit levels have been since 2020.
With that context, our current position is much stronger than prior to the pandemic as we have higher overall deposits, a better loan-to-deposit ratio, and a lower percentage of uninsured deposits. Some look to uninsured deposits as the primary metric to detect risk of elevated outflows. However, we believe a more comprehensive view is appropriate.As a commercial bank, it is natural to have a higher relative percentage of uninsured deposits, the majority of which are noninterest-bearing, which we view as a key strength and a proxy for operating accounts. With 95% of our commercial noninterest-bearing deposits utilizing treasury management services and an average of more than seven treasury management products for a middle market customer, we are integrated with our customers’ daily operations.
We feel our market and business diversification, favorable deposit mix, commercial orientation, and connectivity into our customers’ operations combined to create greater relative stability in our deposit base.We see opportunities to even further improve the resiliency of our deposits, including strategic investments underway to enhance payments, digital customer transformation, and wealth management, in addition to our national small business banking strategy, which should drive granular deposit growth over time.Ultimately, our deposit base has always been and continues to be a differentiating strength, and we expect even more stability with a more favorable level of uninsured and a high percentage of operating deposits. Successful execution of our liquidity strategy proved effective, as shown on Slide 9.Following the industry events in March, we conservatively increased our cash position, and our abundant liquidity allowed uninterrupted support of our customers and business as usual operations.
Our quarter-end loan-to-deposit ratio was 85%, remaining below our 15-year average. And very light unsecured funding maturities create flexibility to manage funding needs and cash levels over time.Period-end balances in our securities portfolio on Slide 10 declined over $700 million as paid down some maturities offset the positive mark-to-market adjustment of $309 million. The total unrealized loss after tax of $2.1 billion affects our book value but not our regulatory capital ratios.Our security strategy remains unchanged as we stopped reinvesting in the third quarter of 2022. From that peak through the end of 2024, we expect natural portfolio attrition of approximately $4 billion and a 42% improvement in unrealized securities losses. We maintain our entire portfolio as available for sale, providing full transparency and management flexibility.As our portfolio is pledged to enhance our liquidity position, we do not foresee any need to sell our portfolio and therefore, unrealized losses should not impact income.Turning to Slide 11.
Net interest income decreased $34 million to $708 million, as the benefit of higher rates and loan volume were offset by the impact of lower deposit balances, deposit pricing, and fewer days. We still saw a net positive impact due to rising rates and net interest income remained incredibly strong relative to our historical results.Slide 12 demonstrates our desirable interest rate sensitivity profile. Successful execution of our strategy and the current composition of our balance sheet favorably position us with minimal negative exposure to a gradual 100 basis points or 50 basis points on average decline in interest rates.As intended, our strong net interest income stream is now more insulated from rate reductions. Credit quality continues to be a strength of our franchise and remained excellent, as outlined on Slide 13 with $2 million in net recoveries.
Nonaccrual loans declined and inflows to nonaccruals remained low at $9 million.Loan growth and the weakening economic outlook drove the $30 million provision and the allowance for credit losses to increase modestly to 1.26%. Criticized loans increased but remained well below historical levels, as we saw expected credit normalization and portfolios prone to pressure from the elevated rate environment.Office is not part of our primary strategy, only making up 7% of our total commercial real estate line of business. Of this limited office exposure, a majority of suburban with strong contractual financial support from sponsors. Within the overall commercial real estate portfolio, pressure from the elevated rate environment contributed to a modest increase in criticized loans, and we expect continued manageable migration in the coming quarters.Robust fee generation increased noninterest income by $4 million relative to a seasonally high fourth quarter 2022, as shown on Slide 14.
Capital markets income grew $5 million and is now distinguished in our reporting to reflect the investment and opportunity in that business. Derivative income and investment banking offset the seasonal lighter quarter for syndication fees.Brokerage benefited from the rate environment, and strategic private wealth investments contributed to growth in fiduciary income. Continued expansion of our noncapital consuming fee income remains a priority. And with growth in nearly every customer category, we are excited to see the results from this emphasis.Turning to expenses on Slide 15. We had a number of notable expenses in the quarter, including $16 million related to modernization initiatives, $9 million of which were attributable to the Ameriprise transition.
While litigation-related expenses and operating losses were elevated, the largest drivers related to isolated events. Quarter-over-quarter, non-salary pension expense increased $17 million, as expected.Salaries and benefits increased $8 million, driven by higher stock-based compensation with first quarter grants, inflationary pressures, and attracting talent. FDIC insurance increased $6 million, driven by the higher statutory assessment rate and the impact of funding late in the quarter.Occupancy came down $12 million with a reduction in lease termination fees, lower rental expense, and a seasonal change in property tax rates. Both consulting and advertising declined in the seasonally high fourth quarter. With a track record of proven discipline, we are committed to carefully managing expenses, balancing necessary investments for the future, and overall earnings power in order to maintain a solid efficiency ratio over time.Slide 16 provides details on capital management.
Strong profitability continued to generate significant capital to support loan growth. Our CET1 is estimated at 10.09%, above our target, and we were excited to announce a 4% increase in our quarterly dividend for common stock paid April 1.Our conservative excess cash position impacted our tangible common equity ratio, adjusting for our cash increase — we’ve increased over the fourth quarter in AOCI. Our first quarter TCE ratio would have increased to 9.47%.Expected loan growth, profitability, and any potential regulatory changes will continue to be carefully considered as we manage our capital strategy. Our outlook for 2023 is on Slide 17 and assumes no significant changes in the economic environment. We expect momentum, especially in our commercial real estate and national dealer services business, to drive average 2023 loan growth of 8% to 9%.We continue to expect growth in most businesses but plan to be appropriately selective supporting opportunities most aligned with our target credit, pricing, and relationship strategy.
Our estimated average year-over-year deposit decline of 12% to 14% assumes continued stabilization and reflects the impact from Fed monetary actions that began last year in addition to the first quarter industry events.Despite the impact of funding, we still project net interest income to be at an all-time high, growing 6% to 7% over a record 2022 performance. Through effective execution of our balance sheet strategy and based on our current composition, we delivered on our objective to limit rate exposure and protect a high level of net interest income.Credit quality has been excellent, and we expect it to remain strong. We continue to forecast net charge-offs at the lower end of our normal 20 to 40 basis points range and expect a gradual normalization and credit metrics.
We expect strong noninterest income performance to drive 6% to 7% growth over 2022. Customer-related income is projected to increase, particularly in card due to our payment strategy and fiduciary income, which benefits from rates and investments in wealth management.Risk management income related to our internal hedging position is forecasted to increase relative to 2022, but will vary over time as rates move. FHLB dividends created a new tailwind in this quarter. Since we do not expect to repeat the elevated derivative volumes from 2022, we expect the year-over-year derivative delta to offset positive momentum in other capital market categories.A reduction in our deposit service charges is expected due to an increase in commercial account ECA rates and adjustments to our retail NSF fees, more than offsetting growth in core treasury management income.
With robust overall noninterest income performance in the first quarter exceeding seasonally high fourth quarter results, we feel very good about our momentum.Despite elevated expense pressures in the first quarter, we maintained our 7% guidance for 2023 expense growth, considering expected adjustments to select discretionary expenses. Even after including the expenses related to the Ameriprise transition, we still expect modernization to be lower in 2023 compared to 2022.We acknowledge the dynamic nature of the current environment and plan to assess the longer-term implications of the March disruption. With a culture of prudent management, we expect to manage expenses as appropriate based on the new environment.In summary, we expect strong overall financial performance and forecast record net interest income for 2023.
Now I’ll turn the call back to Curt.Curtis Farmer Thank you, Jim. Slide 18 highlights our compelling story. Risk management decisions made over the last several years prepared us to emerge from the recent disruption in a strong position. We were resilient. We built liquidity. We protected relationships, and we grew our customer base. It was a great quarter for our company.Broad-based loan growth and robust noninterest income exceeded expectations, and credit quality remained excellent. We produced an ROE of over 24% and an ROA of 1.52%, and we feel very good about our outlook.Comerica has long had one of the most enviable deposit franchises. And now it’s even better with lower uninsured deposits, improved granularity, and less price sensitivity.
In addition, we have a loyal blue-chip customer base, robust fee income, balanced interest rate exposure, strong capital, and an impactable reputation for credit.We are diversified in great markets to support our strategy. And I’d be remiss if I didn’t mention our tenured and tenacious colleagues who partnered extraordinarily well with our customers.Banking is based on trust, trust we have in our customers, and trust our customers have in us. I feel this period has proven the strength of our relationship model and reaffirmed Comerica’s stable foundation as a trusted banking partner into the future. Thank you for your time, and now we’d be happy to take your questions.
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Question-and-Answer Session Operator [Operator Instructions].
And we will first go to the line of Steven Alexopoulos with JPMorgan.
Please go ahead.Steven Alexopoulos Good morning, everyone. So, no surprise, I want to start on the deposit side. First, the color you provided on the slide is really helpful. I’m curious, when we look at the decline in the deposits from March 9 through the end of the quarter, I’m surprised that TLS specifically wasn’t a beneficiary of the SBB situation. And even when I look at the decline in corporate mid-market, I’m again surprised because I would have thought the company would have been somewhat of a port to start, right? I mean, you’ve been in markets for decades. You’ve been with customers for decades. Could you take us behind the scenes? What did you hear from your customers during this time in each of those? And why were they moving balances away from the company?Peter Sefzik Steve, this is Peter.
So, I would tell you that in the very beginning, for sure, we actually took on a lot of accounts. And Curt mentioned in his remarks that we opened a number of accounts from customers that were wanting to come to Comerica from the other banks that had failed.So, during that time, we definitely took on new customers. I think the average balance probably is just not intact. But on the whole, we saw some departures. Some of that is because we’ve got a lot of late-stage also which a lot of late-stage TLS customers are going to have more deposits, but not as much credit. And so that’s where you did see some diversification wanting to occur at that level.But net-net, if you look at our TLS slide in the back, we have seen deposits coming down in that space going back to second quarter of last year, really.
So, what’s occurred, I think, in the space in general has been burning through cash. So, we saw that. But we didn’t necessarily think that we would be taking on excess deposits fleeing from SCB coming to us out of this deal. We did take on more accounts. and we definitely saw that. We also saw during the period, as I mentioned already, late-stage fleeing, but we saw some accounts sort of spreading across not just to us, but other banks as well out of TLS, so.Steven Alexopoulos What about corporate and mid-market?Peter Sefzik Yes. Same thing there, Steve. I think on the corporate side, on our corporate business, that’s our sort of national business of banking large corporates. We saw diversification there as well. And then in middle market, it was mostly in California.
So again, we haven’t lost in just about all of the cases [ph], we have not lost customers. We have just seen diversification of excess balances that they had.So, we believe that there’s opportunities for those to return in the future. We’re not relying on that. But we still have relationships with these customers. We mostly have just seen diversification. So that’s really what we’ve seen in the businesses that we’ve got outlined on the slide.Steven Alexopoulos Okay. That’s helpful. And then on the noninterest bearing, so you saw a pretty sharp drop in the quarter. We just anticipated somewhat, right, because of seasonal factors. But given everything that just unfolded, where do you see that mix now bottoming? Where is the timeframe for that?Jim Herzog Good morning, Steve, it’s Jim.
I’ll take that question. We still think that we are likely to end up very close to 50%. We did see most of the drop occurred in the DDA space over the course of the quarter. That was not a surprise to us at all. As rates continue to go up with new customers, we continue to be more rate sensitive. We knew that a lot of research balances that we have are still more in DDA than interest-bearing.We knew a lot of the seasonal outflows relative to what came in, in the second half of ’22 were likely buried in the DDA. In fact, that’s where they were. And then we did have some customers that switched over to using some FDIC products that have been in DDA, but for safety reasons, they were attracted to the FDIC products, which pay a nice rate of interest.
So, all those things moved us closer to the 50% number. We still think we’re going to end up right around there.We moved a lot closer to it during the course of the quarter. And so, we still expect to have really one of the strongest ratios of noninterest-bearing deposits to total deposits among all our peers, if not well above our closest peers. So, we still feel really good about noninterest-bearing.Steven Alexopoulos Okay. Great. Jim, if I could ask you one last question, which is somewhat theoretical. But so interest-bearing deposit costs are 1.5%. If we — if the Fed does start cutting rates in the second half of this year, but the rates you’re paying are still well below market rates, how do you model this impacting your deposit cost, right?
I mean do market rates need to move below or close to what you’re paying before you could start lowering deposit rates yourself? Because I don’t recall other periods where the banks were this far out of the money with what they’re paying and the Fed could potentially sort of lowering market rates. What do your models show you in terms of how this would flow through to your interest-bearing deposit cost? Thanks.Jim Herzog Yes. Well, of course, we do expect rates to continue to go up. But relative to what might happen when rates go down, it’s important to remember that we have a pretty wide distribution of rates paid to a variety of customers. So, I don’t really view that average is a typical customer.We have a lot that are well below that range, a lot that are well above that rate.
So, each one of those is going to respond differently. But we do think that there is some degree of some tree in the betas that we pay on the way up and the way down. The key is that there likely is a couple of months laying, two to three months laying when rates start to come down before we can really respond to that drop. There’s just the same leg that we saw on the way up. But ultimately, we do think we’ll be able to start cutting pay rates if, in fact, the Fed makes some material moves.Curtis Farmer Yes, we would always be sensitive to, obviously, the competitive landscape and what other institutions are doing as well, and making sure that we’re taking care of our customers appropriately.Steven Alexopoulos Got it. Thanks for taking my questions.Operator Next, we go to Ebrahim Poonawala.
