Comerica Incorporated (NYSE:CMA) Q4 2023 Earnings Call Transcript

Comerica Incorporated (NYSE:CMA) Q4 2023 Earnings Call Transcript January 19, 2024

Comerica Incorporated beats earnings expectations. Reported EPS is $1.46, expectations were $1.38. Comerica Incorporated isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Hello, and welcome to the Comerica Fourth Quarter 2023 Earnings Conference Call and Webcast. [Operator Instructions] As a reminder, this conference is being recorded. It’s now my pleasure to turn the call over to Kelly Gage, Director of Investor Relations. Please, go ahead, Kelly.

Kelly Gage: Thanks, Kevin. Good morning, and welcome to Comerica’s fourth 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 Banking Officer, Peter Sefzik. During this presentation, we will be referring to slides which will provide additional details. The presentation slides and our press release are available on the SEC’s website as well as 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 in today’s earnings presentation on Slide 2, which is incorporated into this call as well as the 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 direct you to the reconciliation of these measures in the earnings materials that are available on our website. With that, I’ll turn the call to Curt.

Curt Farmer: Thank you, Kelly, and good morning, everyone. Thank you for joining our call. Although 2023 was challenging for our industry, we felt it was a year of achievement. Following industry disruption, we protected relationships, stabilized deposits, maintained strong credit quality, enhanced our capital, and took steps to position our business for future success. In fact, we delivered record average loans and record net interest income. Despite the marketplace instability, we advanced key strategic initiatives and received impressive recognition for our results. Small business is the highlight, as we initiated a national expansion effort, delivered award-winning products, and achieved our three-year lending goal ahead of schedule.

Non-interest income remained a priority as we launched targeted initiatives aimed at enhancing our products and increasing our mix of capital-efficient income. Although the economic environment remains uncertain, we observed a cautiously more optimistic trend in customer sentiment at year-end as we believe many expect less rate pressure in 2024. We remain committed to supporting our customers and feel we are positioned to grow alongside them as the economy strengthens. Full-year financial highlights are on Slide 4. With 7% growth, we produced our highest level of average annual loans, despite the impact of deliberate optimization efforts in the second half of the year. Deposits remained a targeted focus and we were pleased to see stabilization following the industry events and ongoing quantitative tightening.

We delivered record net interest income aided by higher rates and loan balances. Credit quality remained strong with net charge-offs well below historical averages. In all, it was a strong quarter for the company, and we ended with a good fourth quarter. Since there are a number of notable items in this quarter’s results, I’m going to hand the call to Jim to discuss those upfront and provide context for the remainder of the presentation. Jim?

Jim Herzog: Thanks, Curt, and good morning, everyone. Slide 5 details the notable items Curt referenced, most of which were furnished in an 8-K earlier this month. As previously announced, we recorded $109 million of non-interest expenses related to the one-time special FDIC assessment. This was unchanged from indications provided in our December update. Next was the accounting impact from the pending cessation of BSBY since approximately $7 billion of our swap portfolio was designated to BSBY loans. The announcement impacted our ability to maintain hedge accounting for that portion of the portfolio and resulted in a net non-cash loss of $88 million. The key message is that cessation does not result in an economic impact, only a change in the time recognition of earnings.

These recognized losses will creep back and the normal course pay received cash settlements and earnings recognition on the swaps remain uninterrupted. While the realization of losses flowed through to our regulatory capital ratios, they did not further impact tangible common equity or tangible book value. Also note, operationally, and from a customer perspective, we feel well-prepared for a seamless transition. Third on the list were $25 million in severance charges, which elevated fourth quarter non-interest expenses and were intended to enhance future earnings power and create capacity for investment. We’ve previously signaled such efforts were being considered and we will discuss them in more detail later in the presentation. The last item does not impact bottom-line results but created line item geography changes within our income statement.

The finalization of our agreement with Ameriprise to serve as our new investment platform provider caused a decline in non-interest income, offsetting a decline in non-interest expenses. While relatively small impact in late 2023, we noted here because we expect a larger impact in 2024. Slide 6 summarizes our fourth quarter results. Overall, the quarter performed in-line with expectations, excluding notable items. Considering the impact of those items, I’m going to move to the individual line item slides to discuss the quarterly results in more detail. Turning to Slide 7, our intentional balance sheet management reduced average loans and commitments in the fourth quarter. The exit of mortgage banker finance contributed to almost half of the reduction in average balances.

At year-end, approximately $250 million in loans remained in that business. Muted customer demand due to elevated rates impacted general middle-market balances, while increased selectivity, prioritizing full relationships and higher returns reduced loans and equity fund services and corporate banking. Ongoing funding of multi-family and industrial construction projects continued to drive higher commercial real estate utilization, while commitments declined for the second consecutive quarter as we strategically managed pipeline and originations. The floating rate nature of our commercial loan portfolio benefited from higher rates as loan yields continued declined to 6.38% in the fourth quarter. Slide 8 highlights the stability of our deposit base.

Average deposit balances remained relatively flat to the third quarter at $66 billion even with declines of $564 million in brokered time deposits and $176 million related to the exit of mortgage banker finance. Growth in general middle market and corporate banking reflects seasonal patterns, while retail benefited modestly from promotional campaigns. Declines in national dealer services deposits were attributed to operations consistent with inventory and utilization trends observed in that business. Noninterest-bearing balances performed in-line with expectations and the pace of decline continued to flatten. Ongoing success in growing interest-bearing deposits drove a 42% noninterest-bearing deposit mix, which we continue to view as a competitive advantage.

Industry competition, the rate environment, and successful promotional campaigns drove deposit costs higher to 312 basis points, resulting in a cumulative beta of 58% in the fourth quarter. Our deposit profile has historically been a strength and with our favorable mix, operating nature of our accounts, and uninsured trends, we feel it is even more compelling. As shown on Slide 9, we continue to normalize our liquidity position, using excess cash to repay wholesale funding while retaining significant capacity. We absorbed $1.2 billion in maturing FHLB advances and allowed over $500 million in brokered time deposits to mature in the quarter. We expect decisions on future wholesale funding maturities to follow the normal course monitoring of balance sheet dynamics and funding needs.

At 78%, our loan-to-deposit ratio remain favorable and positions us to prioritize high-return loan growth going forward. Period-end balances in our securities portfolio, on Slide 10, increased approximately $550 million as paydowns and maturities were more than offset by a $975 million positive mark-to-market adjustment from rate movements late in the quarter. Treasury maturities and anticipated securities repayments are projected to benefit net interest income and AOCI and we anticipate a 25% improvement in unrealized securities losses over the next two years. Turning to Slide 11, net interest income decreased $17 million to $584 million, driven by higher rates and deposit mix as volume changes related to loans, deposits, and wholesale funding were largely offset by lower balances at the Fed.

Successful execution of our balance sheet optimization strategy has allowed us to reduce wholesale funding and enhanced margin. As shown on Slide 12, successful execution of our interest rate strategy and the composition of our balance sheet positions us favorably for a gradual 100 basis points — or 50 basis points on average decline in interest rates. Of note, BSBY cessation did not impact the ongoing cash flow associated with swaps listed on the slide. While we took a loss in the fourth quarter, we will accrete that loss back with the majority coming back into net interest income in 2025 and 2026. We expect the impact in 2024 to be relatively muted, although there may be some mark-to-market volatility until we fully redesignate remaining impacted swaps to SOFR.

By strategically managing our swap and securities portfolio, while considering balance sheet dynamics, we intend to maintain our insulated position over time. Credit quality remains strong, as highlighted on Slide 13. Modest net charge-offs of 15 basis points remained below our normal range. And a few we had were more concentrated on relatively higher-risk portfolios. We observed some normalization in general middle market and corporate banking as rates pressured customer profitability. These normalization trends drove a slight increase in the allowance for credit losses to 1.40% of total loans. Non-performing assets increased, but still remain historically low. Overall, our portfolio continued to perform as expected, and we believe migration will remain manageable.

On Slide 14, fourth quarter non-interest income of $198 million included $93 million of notable items. Excluding the impact of these items and an increase in deferred compensation, which is offset in expenses, non-interest income performed in-line with guidance. While we continue to expect non-customer income in 2024 to come down from elevated 2023 levels, we remain committed to investments to drive capital-efficient fee growth over time. Expenses, on Slide 15, included $132 million in notable items. Beyond those items, increases in salaries and benefits reflected the impact of higher deferred compensation offset within non-interest income. Increased consulting expenses are attributed to advancing strategic and risk management initiatives and a smaller gain on the sale of real estate in the fourth quarter had the net impact of increasing expenses.

Moving to Slide 16. We previously communicated an intention to address growing expense pressures and the structural impact to industry profitability from 2023 events. In addition to our normal efficiency efforts, this slide details incremental actions to recalibrate expenses in support of investments and enhanced earnings. Through this process, we are prioritizing customers and positioning the business for future success. Complementing efforts already underway to rationalize real estate, we initiated a plan to further reduce our physical footprint, including the closure of 26 banking centers where we assess nominal customer impact. In order to enhance colleague efficiency and key decision makers close to our customers, we are streamlining our management structure and eliminating select roles.

When combined with the impact of banking center closures, these actions eliminated approximately 250 positions. Further, we are optimizing our product offering to enhance capital efficiency and returns and select contracts are being reviewed for renegotiation. In total, these actions have the effect of reducing expected 2024 expenses by $45 million, growing to an estimated benefit of $55 million in 2025. These decisions are challenging and we do not take them lightly, but we feel they are necessary to support the sustainable growth of our business. Slide 17 highlights our solid capital position. Even with the impact of notable items, our estimated CET1 grew to 11.09%. Rate movement, coupled with continuous paydowns and maturities in our securities portfolio, reduced losses within AOCI and increased tangible common equity to 6.3%.

Based on the December 31 forward curve, we expect our unrealized losses to reduce by one-third by the end of 2025. Although the proposed capital changes do not apply to us based on our asset size, we favor a conservative approach to capital management and plan to monitor ongoing AOCI volatility and regulations as they evolve. Our outlook for 2024 is on Slide 18. We project full-year average loans to decline 1% to 2%, impacted by optimization trends late in 2023. While we expect some impact of selectivity to continue into the first quarter, we anticipate 5% loan growth from December to December with contributions from almost all businesses. Full-year average deposits are expected to be down 1% to 2% from 2023, but we project relative stability point to point.

Following a seasonal decline in the first quarter, we expect customer deposits to stabilize and rebound in the second half of the year. Based on a 12/31 forward curve, we expect full-year net interest income to decline 11% from 2023, driven largely by year-over-year deposit mix. We expect deposit seasonality, and to a lesser extent, less income from BSBY redesignation, slightly higher deposit betas, and lower loan balances to impact first quarter net interest income. From there, we expect a small uptick in the second quarter and more pronounced growth in the second half of the year. As it relates to BSBY hedge accounting, interest rates and timing of redesignation could create volatility, but we expect to eliminate most or all of that potential volatility from transition of indexes by the end of the first quarter.

Credit quality remained strong and we expect continued migration to be manageable. We forecast full-year net charge-offs to move into the lower half of our normal 20 basis point to 40-basis point range. We expect non-interest income to grow 6% on a reported basis, which should be relatively flat year-to-year when adjusting for notable items. As we signaled last quarter, we expect FHLB dividends, price alignment income from hedges and BOLI to decline from elevated levels. Customer income is expected to increase modestly, with growth in fiduciary and capital markets and deposit service charges, partially offset by pressures in card, commercial lending fees, and the assumption that favorable mark-to-market derivative adjustments do not repeat.

Full-year non-interest expenses are expected to decline 4% on a reported basis, but grow of 3% after adjusting for notable items. Through successful execution of our expense re-calibration efforts, we believe we have created capacity to prioritize investments designed to further enhance our funding base, revenue mix, and capital efficiency as well as risk management framework. Even with 5% projected point to point loan growth, we expect to maintain capital well in excess of our 10% target. We will continue to monitor AOCI volatility and the evolving regulatory environment as we evaluate the right time to resume share repurchases. In all, we are proud of our year and we feel we’ve taken the right actions to support the future of our business.

Now, I’ll turn the call back to Curt.

Curt Farmer: Thank you, Jim. Despite the industry volatility in 2023, we think it is important to take a step back and reinforce that our core business remained unchanged as shown on Slide 19. As a leading bank for business with strong wealth management and retail capabilities, our tenured colleagues deliver value-added expertise to our impressive customer base. Our highly regarded approach to credit continues to perform well and has historically outperformed our peers. Tailored products are designed to meet the needs of our customers, enhancing revenue and retention. Our deposit profile has long been a strength, and investments in products and small business are expected to make this core funding towards even more compelling.

Actions to recalibrate our expense base are designed to benefit our future. And at well over 10% strategic capital target, we believe we have a strong foundation. In August, we will celebrate our 175th anniversary. You do not achieve that kind of longevity without proving time and time again that you can successfully navigate disruptions. In 2023, our model proved resilient. Our colleagues rallied to support our customers to an uncertain time, and we delivered record results. As we look forward into this milestone anniversary year for our company, I’m confident in our ability to deliver for our customers, colleagues, and shareholders. We appreciate your time this morning, and we’d be happy to take some questions.

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Q&A Session

Operator: Thank you. We’ll now be conducting a question-and-answer session. [Operator Instructions] Our first question is coming from Peter Winter from D.A. Davidson. Your line is now live.

Curt Farmer: Good morning, Peter.

Peter Winter: Good morning. So, there’s been a lot of focus this earning season on kind of a normalized margin range. I’m just wondering what you’ve — as some of these swaps mature, what the margin could get back to? Do you think it can get back to those pre-COVID levels in that 3.50% range?

Jim Herzog: Yeah. Good morning, Peter. As you may know and recall, I don’t like to get real specific on margin. I think this quarter is a great example of that, where we actually had a decrease in net interest income, but we had an increase in NIM. So, a bank with our business model where we have some lumpiness, you can get those correlations don’t match up. But I do see NIM trending in a very good direction. We ticked up this quarter. We will have a little bit of a tick-down next quarter as the first quarter guidance would imply based on the percentage growth that we put in the outlook. But then we see a steady climb from there. I do see us by the end of 2024 actually getting above where this past fourth quarter was and then we continue to project up from there throughout 2025 as we have swaps and securities roll off and we get into a more normalized environment.

So, I do see a lot of momentum building for us in the second half of this year and I see that momentum actually accelerating as we move through 2025. And of course, that’s exclusive of the BSBY hedge accounting impact. We’re actually going to have significant income added to 2025 on top of the factors that I just talked about.

Peter Winter: Got it. Thanks, Jim. And then just a follow-up. You had really nice growth in the CET1 ratio. And even adjusted for AOCI, you’re above the minimum 7% threshold. I’m just wondering, you mentioned in the prepared remarks, looking at AOCI, but what are some of the parameters you’re looking for to resume share buybacks? And then, how much capital do you accrete on a quarterly basis?

Jim Herzog: Yeah. Peter, number one, I do think we’re on a very good track to comply with Basel III endgame rules should they end up applying to us. But with that said, we do have a little bit of flexibility based on the fact that we are in pretty good shape there. The number one thing that I continue to keep an eye on is AOCI. It did come down significantly this quarter. Let’s keep in mind, it came down after a number of quarters being more elevated. And then since then, rates have ticked back up again. So, I don’t want to declare a victory yet on the AOCI front for us or the whole industry. I mean, it looks like things are going in the good direction and we’re certainly going to being very solid shape to comply with any capital rules.

But before we start the share repurchase up again, I will put AOCI at the top of the list that we want to keep our eye on to make sure that doesn’t tick the other direction again, a little more line of sight into what the overall economic environment is from an interest rate standpoint and just overall uncertainty standpoint. But it does appear we are going to be in shape at some point to start the share repurchase, but we want to be cautious and we will be cautious this year. Certainly in the first half of the year, we won’t be active in share repurchase. We’ll keep our options open in the second half of the year, but I’ll say that even there, we will likely be cautious unless we get a better line of sight in terms of interest rates and overall economic stability.

Peter Winter: And how much capital do you accrete roughly on a quarterly basis?

Jim Herzog: Well, it’s going to depend on the quarter and the year and what’s going on in the economy. I can tell you that in 2024, we will likely not accrete a lot of capital, maybe a tad bit above where we ended the year, but with 5% point to point growth. Even though we’re going to have, I think, strong earnings next year, I don’t think you’re going to see a significantly above where we ended the fourth quarter. But I think as you move into 2025, you’re going to start seeing some nice accretion from that point on.

Peter Winter: Got it. Thanks, Jim.

Curt Farmer: Thanks, Peter.

Jim Herzog: Thank you, Peter.

Operator: Thank you. Our next question today is coming from Manan Gosalia from Morgan Stanley. Your line is now live.

Curt Farmer: Good morning, Manan.

Manan Gosalia: Hi, good morning. I wanted to ask on your loan-to-deposit ratio, it ticked down again in the quarter to about 78%. I get that you’re looking for 5% loan growth point to point next year and you might be bringing in deposits ahead of that. But I guess, if the loan growth is contingent on rates coming down, why pay up for deposits now? Why not bring in the deposits later as loan growth comes in? And what is the right loan-to-deposit ratio to consider as we look out into the end of 2024?

Curt Farmer: Manan, I might — this is Curt, I might start and then ask Jim repeat or to add in. But on the deposit front, maybe just to keep the perspective here, is that we consider deposits as part of full relationships with clients. And we have clients for whom we have lending relationships and clients for whom we have deposit relationships and clients for whom we have both. But in the case of growing deposits, we’re going to grow deposits sort of in-line of taking care of our customers. And having lived through what the whole industry lived through last spring, I don’t believe this is an environment where we’re going to look any deposits — turn any deposits away for lack of a better definition. We do believe that, that loan-to-deposit ratio will go up some, but we should be able to comfortably stay within our target we believe kind of in the mid-80%s, even with the point to point growth that we’re expecting in 2024.