Comedy (NYSE: CMA) has made real progress since my last update on the company, with credit quality in particular improving significantly faster than I (or the street) expected. Low leverage in short-term spreads remains a real challenge, but Comerica is one of the most asset-sensitive banks that I follow, so when rates start to move there is a significant source of earnings momentum waiting in the wings. I was also encouraged by the signs of loan growth during the quarter, and with dealer floor plan loan balances as low as they are, this too could be a real source of growth during of the next two years.
With stocks up around 20% since my post, beating regional banks by around 7% and outperforming peers like Cullen/Frost (CFR) and Prosperity (PB), but not American bank (USB) or Wells Fargo (WFC), I can’t say the improvements went unnoticed or unrewarded. I believe Comerica is in better shape today, however, and while the potential return is not as strong here as it may be for other banks, a stronger economy than that drives growth Stronger-than-expected lending and sooner-than-expected rate hikes would unlock a lot of upside earnings at Comerica.
A quarter dominated by credit, but with some other positive points
Like the vast majority of banks, Comerica got most of its second-quarter rise from lower provisioning charges related to reserve releases (better-than-expected credit quality, allowing the bank to write off reserves held for loan losses). Even so, there was an underlying outperformance here.
Revenue was up 5% YoY and 5% QoQ, although quarterly earnings were closer to 3% on a baseline basis; that was good for a $0.14 to $0.15/share beat from Street’s average estimate. Net interest income fell 1% yoy and rose 5% qoq (up 1% qoq), beating around $0.02/share. The net interest margin was again weaker than expected (2.29%, around 3 bps lower than expected).
Commission income has been a source of strength for many regional and super-regional banks, as well as Comerica. Non-interest revenue rose 16% year-on-year and 5% quarter-on-quarter to $284 million, outperforming about $0.13/share. Card fees were up 24% year-on-year and 18% year-on-year to $84 million on improved spending activity, and fiduciary fees were also strong, up 15 % YoY and 13% YoY to $60 million.
Expenses were up 7% yoy and 4% qoq, more than expected, and it took $0.08/share off earnings, but those expenses were in part to support higher revenue and the efficiency ratio for the quarter was about 30 bps higher than expected, so Comerica came out ahead. Pre-provision earnings rose 1% year-on-year and 8% quarter-on-quarter, beating expectations by around $0.06/share.
The remainder of the $0.74/share ($0.68/share) basis beat came from these lower provision costs. Tangible book value per share rose 1% QoQ to $51.43, not one of the best performers.
Some signs of momentum in lending development
Very few banks posted particularly good loan growth this quarter, and Comerica was no exception, but there were still some bright spots.
When taking into account PPP loans, Comerica actually recorded loan growth of more than 1% at the end of the period. The comparison was not as positive on an average balance basis, but activity picked up in the second half of the quarter. Although C&I loans are still under pressure, Comerica saw growth in middle market loans (up $671 million), environmental services (up $207 million) and CRE (up $193 million). millions of dollars). Consumer credit was not as strong, with mortgages up less than 1% qoq and consumption down slightly.
Commercial line utilization is still below normal, although at 47% it is still quite high compared to many other banks. Comerica also reported that floor plan loans from dealerships were about $1.2 billion in the quarter, well below the $4 billion-plus in normal times as auto dealerships struggle. understandable to get products off the showroom floor. Management also noted that the lending pipeline continues to improve and has returned to pre-pandemic levels.
Here is an interesting underlying phenomenon. Management said it was seeing business customers simultaneously draw on loans while maintaining excess deposits. It would appear that companies want to have plenty of cash on hand to weather the uncertainties of this recovery and hedge the risk that the resurgence of COVID-19 infection rates (or other issues) will hit the recovery and access credit disappears. While this is understandable and perhaps a good indicator of elevated uncertainty, it leads me to believe that deposit balances could fall sharply once business confidence picks up, sending deposit betas higher. than bank CEOs anticipate.
Perspectives
Comerica’s credit situation looks much better now, with crunch loans falling from 6% in Q4’20 to 5% in Q1’21 to 4% in Q2’21, and energy loans are down as a percentage of loans criticized from 37% to 17%%. Clearly higher oil prices are helping, but Comerica has also been proactive in working with customers.
The real key for Comerica is higher rates. A shock move of 100 basis points would result in a 10% rise in net interest income, making Comerica one of the most rate sensitive banks. While investors have cooled some of their near-term rate expectations, making Comerica more dependent on loan growth, it is still an important “coil spring” for earnings growth.
Long term, I still have my worries about Comerica. I like the basic deposit base (one of the least expensive in its peer group), but the commercial lending operation has a lot of competition, including ANCof (PNC) in Texas, as well as increased competition from Sions (IF WE). With a Net Promoter Score below its peers (30 against 39), customer service still needs to be improved, as it is a source of potential vulnerability.
I raised my longer-term earnings forecast for Comerica, and advanced more earnings in 2021 thanks to higher reserve releases. I expect core earnings to grow in high single digits for a few years (annualized) after 2021 and mid single digits of nearly 6% thereafter, and if rates exceed my model (and/or Comerica earns more loan share than I expected), there could be significant increases in future earnings.
Comerica has also significantly increased its capital returns, including an accelerated redemption of $400 million, and I expect above-average capital returns for some time as management seeks to bring its CET1 ratio back higher. almost 10%.
The essential
While I see a path to much higher earnings expectations, the current outlook does not claim that Comerica is significantly cheap. Unless you want to argue that Comerica’s asset sensitivity deserves a bigger premium, I think a 12x multiple on base earnings of 22 is fair enough (peer group is trading around 11x) , and that only gets me to the mid-$60s. Long-term discounted basic earnings and ROTCE-based P/TBV argue for a bit more upside, but not much beyond the near-term $70.
I don’t like Comerica, but it looks like a high leverage bet on the US recovery, commercial loan growth and higher rates. I’m okay with the idea of going long on this band but beyond the low $70s they really start to become story critical and I think there are other bank stocks that offer more benefits without as much that looks good in the macro setting.
