Comerica Q2 2022 Earnings Call Transcript

Quartr
Provided by Quartr
July 20, 2022

There are 13 speakers on the call.

Operator

Hello, and thank you for standing by. Welcome to the Comerica Second Quarter 2022 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 I would now like to turn the conference over to Darlene Persons, Director of Investor Relations. Please go ahead.

Speaker 1

Thanks, Tani. Good morning, everyone, and welcome to Comerica's Q2 2022 earnings conference call. Participating on this call will be President, Chairman and CEO, Curt Farmer Chief Financial Officer, Jim Herzog Chief Credit Officer, Melinda Chasse and Executive Director of our Commercial Bank, Peter Sevcik. During this presentation, we will 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.

Speaker 1

This conference call contains forward looking statements. 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 release on Slide 2, which is incorporated into this call as well as our SEC filings for factors Now I'll turn the call over to Kurt, who will begin on Slide 3.

Speaker 2

Thank you, Darlene, and good morning, everyone, and thank you for joining our call. Today, we reported 1st quarter earnings of $261,000,000 or $1.92 per share, An increase of 40% over the Q1. Pretax pre provision net revenue was up 53% And our ROE increased to 17%. These results reflect the rising rate environment, including prudent actions we have taken to lock in higher rates. In addition, we produced strong loan growth and generated a solid increase in fee income.

Speaker 2

While the overall economic environment is uncertain, overall our customers are generally optimistic about the future. And while they may be seeing some pressure on their margins, They remain in good shape. As I discussed on our last earnings call, we kicked off several initiatives related to modernization as we should also reflect this change. Therefore, we recently unveiled a refreshed corporate logo that represents our commitment to both our 173 year legacy and our vision for the future. Also last month, we announced actions taken as part of our retail bank transformation, Which included adding small business bankers in strategic locations, updating our web and mobile banking platforms and expanding our completed by the end of the Q3.

Speaker 2

We have continued to work on other initiatives around optimizing our facilities. The goal is to better accommodate flexible work arrangements and reduce our footprint, while maximizing locations that best serve our customers. In addition, as we progress on our cloud journey and decommissioned data centers, our technology facilities are being consolidated. We are excited about the progress we have made and the path we are laying for our future. As far as our progress from the ESG area, encourage you to review our 14th Annual Corporate Responsibility Related Report, which was recently published.

Speaker 2

In the Q2, our green loans and commitments honors from the National Diversity Council as one of the 50 most community minded companies in the U. S. Also, we appointed a National Hispanic Business Development Manager to further support our commitment to strengthening relationships with Hispanic business leaders, entrepreneurs and communities. And finally, we've established Renewable Energy Solutions Group. Turning now to highlights of our 2nd quarter results outlined on Slide 4.

Speaker 2

2nd quarter loan growth was one of the highest in our history with increases in nearly every business line. The biggest drivers were general middle market, Large corporate, equity fund services as well as modest growth in national dealer services. In general, customers are rebuilding inventory levels, which has resulted in increasing working capital needs, while CapEx spending remains relatively slow. We are strategically managing deposits and customers are putting their excess liquidity to work, which resulted in a decline. Net interest income benefited from higher rates as well as growth of our loan and hedging portfolios.

Speaker 2

Credit quality remained excellent And fee income increased 10% led by syndication, derivative and warrant activities. Expenses were driven by investments we are making to support growth and our efficiency ratio to 58%. Overall, a strong quarter, and we feel positive about the path we are on as we move through the remainder of the year.

Speaker 3

And now,

Speaker 2

I will turn the call over to Jim, who will review the quarter in more detail. Thanks, Kurt, and good morning, everyone. Turning to Slide 5. As Curt just mentioned, loan growth was very robust, increasing $1,800,000,000

Speaker 4

Driven by favorable environmental factors as well as our relationship focused approach. As of quarter end, loan commitments were up $2,000,000,000 or 4% The line utilization rate held steady at about 46%. National Dealer Services loans increased over $400,000,000 This included a $200,000,000 increase in floorplan loans to $840,000,000 However, these balances remain well below our typical run rate of about $4,000,000,000 We expect it will take some time for inventory levels to rebuild as supply issues are resolved and pent up demand is satisfied. General middle market average loans were up over 3% and large corporate grew 7%. Borrowing needs are Driven by higher material prices and inventory levels as well as M and A into a lesser extent CapEx.

Speaker 4

We continue to have great success in our Equity Fund Services business where we provide capital call and subscription lines to venture capital and private equity firms. Of note, mortgage banker increased about $125,000,000 While home sales were seasonally higher, volumes remain depressed due to higher rates, Lack of housing inventory and shorter dwell times. We expect 3rd quarter mortgage banker loans to be stable. Commercial real estate loans decreased. However, production remains strong and loan commitments were up.

Speaker 4

We expect moderate loan growth in commercial real estate as projects As shown on Slide 6, on a year over year basis, average deposits were up $2,100,000,000 Relative to the Q1 deposits declined as customers continue to put their excess liquidity to work and we prudently manage pricing as it relates to non relationship based deposits and highly rate sensitive segments. Approximately half of the decrease occurred in our municipalities and financial institutions businesses, which fall under general middle market. Notably, retail and wealth management deposits increased. The average cost of our interest bearing deposits remained at an all time low of 5 basis points. We continue to monetize our asset sensitivity as rates increased by growing our securities portfolio.

Speaker 4

Average balances increased $1,700,000,000 as shown on Slide 7. During the second quarter, we repurchased 3 point $1,000,000,000 in MBS with average yields of 3.50 basis points and we had repayments of 650,000,000 As we continue to execute our balance sheet hedging strategy, we will likely pivot towards swaps given the relative size of our securities book and the desire to maintain adequate cash to fund loan growth. The larger portfolio along with the favorable new purchase yields 3rd quarter securities revenue would increase about $16,000,000 The rise in rates resulted in a mark to market impact in our securities portfolio of 8 While we maintain the portfolio as available for sale mostly for liquidity purposes, we typically hold these securities to maturity The net interest margin increased 55 basis points. The benefit from higher rates lifted loan income $52,000,000 and added 26 basis points to the margin. Loan growth added $15,000,000 and 3 basis points.

Speaker 4

One additional day in the quarter provided $4,000,000 As I mentioned, the increase in the size of our securities portfolio at higher yields added $23,000,000 Higher rates on deposits at the Fed Higher rates on our floating rate wholesale debt had a $3,000,000 impact. Altogether, the 9, including no net charge offs. Criticized loans decreased to a record low level and non accrual loans declined as well. Overall, our customers have continued to perform well and they maintain strong balance sheets despite supply chain issues, labor constraints and inflationary challenges. Strong credit metrics, loan growth and a somewhat weaker economic forecast resulted in a relatively stable allowance for credit losses At 1.18 percent of loans and a provision of only $10,000,000 As always, we are closely monitoring the portfolio for signs of stress.

Speaker 4

Nevertheless, with our consistent disciplined approach to credit as well as our relationship based diverse portfolio, We believe we are well positioned to manage through a recessionary environment. Non interest income increased $24,000,000 or 10% as outlined on Slide 10, syndication activity was strong and increased from a seasonally low first quarter resulting in an $8,000,000 increase in commercial lending fees. Warrant related income also increased 8,000,000 Derivative income increased $7,000,000 including $5,000,000 of favorable credit valuation adjustments along with increased interest rate derivative activity. Fiduciary income increased $4,000,000 mainly due to annual tax related fees. Deposit service charges increased with a pickup in activity relative to Slow first quarter.

Speaker 4

Finally deferred comp which is offset in expenses decreased $7,000,000 to a total negative return $14,000,000 for the quarter. Of note relative to the Q2 last year deferred comp decreased $20,000,000 And card fees declined $15,000,000 due to last year's stimulus related activity. Turning to expenses on Slide 11. Our efficiency ratio improved 9 percentage points to 58% as we continue to maintain our expense discipline As revenue generation accelerates and we position for future growth. Salaries and benefits increased $5,000,000 with a number of moving pieces.

Speaker 4

Performance based incentives tied to our strong financial results increased $17,000,000 Annual merit, higher staff insurance technology related contract labor each added $4,000,000 This was partly offset by the resetting of annual stock comp and payroll taxes, Which impacted the Q1. Finally, as I mentioned on the previous slide, deferred comp asset returns decreased 7,000,000 Of note, our staff levels were stable as we are successfully retaining and attracting talent in a very competitive market. Certain technology related costs such as software equipment and consulting increased $8,000,000 Litigation related legal costs were higher and the increase in occupancy includes our branch consolidation activity. Operational losses decreased from The elevated first quarter level and we received a $4,000,000 state tax refund. We are experiencing some inflationary pressure, particularly in salaries, travel and entertainment and insurance.

Speaker 4

By leveraging technology investments to increase productivity, We have been working hard to offset this headwind. As Kurt described, we continue to make progress on certain modernization initiatives, which totaled 7,000,000 This is a journey which includes transformation of our retail banking delivery model, alignment of corporate facilities and technology optimization. The cost savings generated are expected to be reinvested as we continue to evolve. Slide 12 provides details on capital management. Loans and securities portfolio growth resulted in a decrease in our CET1 ratio to an estimated 9.72%.

Speaker 4

We continue to closely monitor loan trends and we expect to move closer to the targeted CET1 ratio Over the near term through capital generated from strong earnings retention. As always, our priority is to use our capital to support our customers and drive growth while providing an attractive return to shareholders. Our common equity declined in the 2nd quarter as a result of the impact of OCI losses from Securities and swap portfolios. Excluding the OCI losses, our common equity per share increased to 1.35 Slide 13 provides an update on our interest rate sensitivity. The bulk of our loans are floating rate and the majority of our deposits are non interest bearing.

Speaker 4

Therefore, as demonstrated in the Q2, our balance sheet reacts very quickly to changes in interest rates. In order to provide a more sustainable earnings stream through the rate We have been adding hedges to lock in market expectations for future short term rates, while importantly reducing the as of June 30 as well as expectations for loan and deposit activity for the remainder of the year. A slightly steeper curve and added hedges have provided We now expect 2022 net interest income to increase by approximately 31% Relative to 2021, an increase about 21% in the 3rd quarter relative to the 2nd quarter. Of course, there are many dynamics that may cause results to differ, specifically the pace of changes in short term rates, deposit betas and loan activity. Our outlook for 2022 is on Slide 14 and assumes a continuation of the current economic environment.

Speaker 4

Given the robust broad based loan growth we've generated so far this year, we are increasing our expectation for average loans to grow 6% to 7% year over year excluding PPP loans. Relative to the 2nd quarter, we expect average loans to grow 1% to 2% per quarter. In the first half of the year in certain areas like middle market for example, We saw increased utilization as customers work to rebuild their inventory. In the second half of the year, we expect that trend to stabilize. Consistent with customers' increased borrowing needs, we expect they will continue to draw down deposits.

Speaker 4

Also the impact of the Fed's tightening is expected to be partly offset by our typical 4th quarter seasonality. As far as rates, we are closely monitoring the environment and staying close to our customers. We expect to increase deposit rates in the second half of the year and start moving towards our historical beta as interest rates continue to increase. Net interest income expectations were reviewed on the previous slide. Credit quality is expected to remain strong.

Speaker 4

Assuming that the macroeconomic challenges continue to remain manageable, We expect criticize and non accrual loans to remain low and that charge offs could begin to trend to the lower end of our normal range of 20 basis points to 40 basis points. We believe our reserves are appropriate for the current and expected environment. Non interest income is expected to 6% to 7% on a year over year basis. Recall that 2021 was the highest on record and included elevated levels of warrants, derivatives, stimulus card fees and deferred compensation. We expect 3rd and 4th quarter levels to be consistent with the 2nd quarter.

Speaker 4

Following strong activity in the Q2, we expect some pressure on commercial lending fees, derivatives and fiduciary. This may be offset by deferred comp which is difficult to predict therefore we assume will not repeat. Expect expenses to increase 4% to 5% year over year excluding any notable expenses related to our modernization program. This year over year increase is primarily due to higher performance based compensation, annual merit, technology investments and inflationary pressures. Relative to the first half of the year, the second half is expected to increase 5% to 6% excluding modernization related expenses.

Speaker 4

The increase is driven by annual merit, higher staff insurance, advertising, business investment and outside processing expense, partly offset by lower performance based comp and deferred comp. Excluding the $21,000,000 benefit from deferred comp in the first half, which is not expected to repeat, Expenses are expected to be up 3% to 4% in the second half of the year.

Speaker 3

We expect

Speaker 4

the tax rate to be 22% to 23% Discrete items and finally as I indicated on the previous slide, we are focused in our CET1 target of 10% as we monitor loan growth trends. In summary, our outlook for the full year has improved with the benefit of higher rates, including the execution of our hedging strategy, More robust loan and fee income generation, partly offset by higher expenses in conjunction with growing revenue and our strong financial performance. Now I'll turn the call back to Curt.

Speaker 2

Thank you, Jim. Many business lines continue to show good momentum With very strong loan growth and increases in commitments in our pipeline. Our unique expertise in many areas as well as our geographic expense discipline was evident as we continue to invest to provide a high caliber customer and colleague experience. Our balance sheet quickly produced benefits from rising rates and we expect to continue to appropriately add hedges with the goal of providing a more consistent earnings performance through the cycles. It was a strong quarter.

Speaker 2

I'm very grateful for the dedication of my colleagues who work hard every day to ensure Comerica's success. We believe we are well positioned to continue to produce strong results as we move through the remainder of the year. Thank you for your time and now we'd be happy to take your

Operator

Our first question will come from the line of Scott Siefers with Piper Sandler. Please go ahead.

Speaker 2

Good morning, everyone.

Speaker 3

Hey, thank you for your question. Just wanted to discuss the NII trajectory a bit. So I think the guide sort of parsing between the Full year and Q3 would imply you'd reach a 4th quarter 2022 NII of about $720,000,000 or So is that a sustainable level? And I guess more broadly the question is can you just sort of describe in layman's terms How your NII will react once it reaches its peak? And what exactly happens to the margin this time around when rates either

Speaker 4

Yes, your math is correct. It would imply assuming the June 30 forward curve holds a 4th quarter net interest income of $720,000,000 I think that's a pretty good jumping off point for 2023. Of course, we're not offering 2023 guidance at this time, but There are some puts and takes there. We do not realize the full impact of the December November hikes in the Q4. On the other hand, deposit betas do lag and you could see some upward pressure there once we get beyond the Q4.

Speaker 4

So with that said, I think it's a pretty good jumping off point in the Q4. Of course, we'll have loan volume increases and other balance sheet movement, but it does position us very well For 2023, in terms of how we react to interest rate changes, our goal all along has been to reduce The asset sensitivity to the point where we can produce a very high level of net interest income. And I will note that $720,000,000 if the forward curve is realized It is by far and away the highest net interest income we've ever earned for a quarter. So I think we will have achieved our goal We left enough asset sensitivity to achieve record levels, yet at the same time we're protecting that net interest income. And to answer your question more directly, Our goal once we enter 2023 is to have our asset sensitivity to the downside at a low single digit percentage.

Speaker 4

So That would imply that our short term rates do drop. We should be largely protected. Now over time, you will have swap securities roll off and rolling back on. So there'll be a little bit of up or down depending on what happens to the long end of the curve. But we think we're very well positioned for 2023.

Speaker 3

All right. That's perfect. Thank you. And then just wanted to ask on deposit costs. So the 5 basis points of That deposit cost is just terrific.

Speaker 3

You noted betas will start to ramp up in the second half here. Just curious Broadly, how you balance pressures on costs with a desire to ultimately hold certain balances?

Speaker 4

Yes. Scott, we are paying very close attention to deposit costs. We're staying extremely close to our customers. Those conversations are going on daily. We will clearly see those costs rise in the second half of the year.

Speaker 4

There is a little bit of a lag typically between when those discussions happen and when they're fully realized. So I've heard in some other earnings calls in terms of when The real pivot point is and frankly I don't think you can ever point to any one hike when these hikes are so close to each other. But we will certainly start seeing a move towards not just our standard betas in the Q3, but by the end of the year, Probably be approaching our standard beta for the accumulated standard beta that we publish also. But those conversations will go on and I'll just stress that it's a very relationship based model here. So it's based on the full relationship with the customer, it's based on those conversations And we feel like we're in very good communication with the customers and feel good about our positioning there.

Speaker 4

Perfect. All right.

Speaker 5

Thank you guys very much. Thank you.

Operator

Thank you. Our next question comes from the line of Jon Arfstrom with RBC Capital. Please go ahead.

Speaker 2

Thanks. Good morning. Good morning, John. Good morning, John.

Speaker 6

Can you help us understand what you're seeing and hearing from In terms of the economic outlook, we're all on recession watch. And I guess I'd love to hear your views. And maybe for you, Melinda, can you just on what kind of an economic outlook your 1.18 reserve level reflects?

Speaker 7

John, this is Peter. I'll go first on customers And then Melinda, you can talk about the economic outlook. But I think recession watch that you use there, that's not Unique to you or all of us, our customers are probably in the same boat. That said, I think that they are Doing really well. Our pipeline is strong.

Speaker 7

Our activity levels are good. So it's hard to see sort of immediate concerns. I think lot of the concerns that we hear are a lot are further out. They don't feel like 'twenty two concerns, Obviously, inflation, interest rates, all the things that we're dealing with. But the outlook, we said generally optimistic.

Speaker 7

We still feel that way. We're encouraged about what we're seeing. It does depend a little bit on geography and it does depend a little bit on line of business. But overall, we feel like our sentiment of our customers is still pretty good at this time. Melinda, do you want to comment on that?

Speaker 8

Yes. John, thanks for the question. So, as you know, we use a variety of third party forecasts. And the Q2 economic forecast, although it was still positive, Did show some deterioration from the Q1 with weaker growth, higher likelihood of recession and a higher much higher degree of uncertainty. So our baseline forecast, I would say, was slightly worse than our Q1 forecast.

Speaker 8

We also use a severe recessionary scenario to stress Certain parts of our portfolio and this is really used to inform the qualitative component, and those qualitative levels at this point, we believe that they are appropriately conservative for the economic environment, including kind of the near term uncertainty.

Speaker 6

Okay. So general message on provision would be growth plus charge offs and that's Generally adequate in your view at this point?

Speaker 8

Yes. Yes. Assuming the economic forecast remains sort of stable and the portfolio metrics don't change to the downside, the reserve Builds will tend to tie pretty closely to loan growth. And then obviously, if the economic forecast worsens, then we'll see reserve builds. But as you know, this is a complex process We go through each quarter, and it would be pretty impossible to guesstimate what that would actually be.

Speaker 6

Yes. Okay. All right. Thank you. It's very helpful.

Speaker 6

Welcome. Thanks, Sean.

Operator

Thank you. Our next question comes from the line of Steve Alexopoulos with JPMorgan. Please go ahead.

Speaker 9

Hey, good morning everyone. So first to drill down on deposits. Historically speaking, companies drawing On deposits to fund business and investment was a good thing, but we also have companies now drawing down to earn a higher yield. I'm curious, when you guys look at the $42,000,000,000 of non interest bearing, How much of that do you see that could be a risk of outflows?

Speaker 4

Hey, Steve, good morning. If you look at where we were pre pandemic, our mix of non interest bearing deposits was just under 50%. I think it's 48% to 49%. You see that we're closer to 55% this quarter. I think that might be a good proxy for where we could end up if rates go up to where the forward curve is predicting right now.

Speaker 4

So it's going to be a little bit dependent on ECA rates and other levers we pull to either keep

Speaker 7

That are going to be rate driven that are going to be in our bigger businesses, you might say. So call it U. S. Banking, Our business deposit services businesses where they're moving higher deposits, but we have relationships, but it's not We don't have like all the treasury management. We don't have all the relationships.

Speaker 7

So there are deposits that are going to move for rate, but we can negotiate that if we need to. We can Appreciate that if we need to, we can be more aggressive if we need to. But I mean we feel like we can have conversations and handle that appropriately.

Speaker 9

Okay. Actually to follow-up on that. So if we think through this, right, the Fed actions are going to have an outsized impact on deposit markets. How you see that playing out into the business? And do you think that you might continue to see deposit runoff in 2023, Great.

Speaker 9

Could this just continue through next year?

Speaker 4

I think we will see the bulk of it likely in that Q4 of 2022 to Q1 of 2023 range, at least that's our forecast right now. Predicting deposits is always a little bit challenging. Not just pricing can lag a little bit, but sometimes customer action can lag a little bit too. Having said that, these outsized changes by the Fed do put the antenna up on some customers, so maybe we won't see quite the Like we've seen in the past, but I do think it's kind of in that crossover range of Q4 The Q1, but having said that, you'll recall earlier from my opening comments, we usually get seasonality in the 4th quarter. It may not be apparent when you see the 4th quarter results, it would probably manifest more in the Q1.

Speaker 4

But I would expect most of that to shake out by the Q1 of 2023.

Speaker 9

Okay. That's helpful. If I could squeeze one more in, going back to John's Question on customer sentiment. When I look at line utilization not line utilization, but commitments increasing, It could be a sign that customers are more optimistic or it could be an assign that they're more cautious on recession coming. Are you guys really Vince, that what you're seeing is because of optimism in their business and not just companies historically want to get more credit before a recession comes?

Speaker 9

Thanks.

Speaker 7

Steve, again, it's Peter. Yes, I would say that that is true. We don't really see this as Defensive asks or recession concerns, certainly nothing like what we saw when the pandemic started and we saw tremendous asks for Recession, lines of credit insurance. That's not what we're seeing right now. We're seeing business reason asks For all those things that Jim and Kurt outlined of working capital needs, everything costs more money, there's good M and for some of these companies.

Speaker 7

So, no, it's all pretty legitimate business needs. And at this time, it doesn't appear to be or We're not seeing indications of it being recession preparation sort of ask.

Speaker 9

Okay. Thanks for all the color.

Speaker 6

I appreciate it.

Operator

Thank you. Our next question comes from the line of Ebrahim Poonawala with Bank of America. Please go ahead.

Speaker 2

Good morning, Abraham.

Speaker 10

I guess just one, Jim, to follow-up on Scott's initial question around NII. And just want to make sure we Understand your comments correctly. In a world where the Fed stops hiking by the end of the year, potentially gets to cutting interest rates at some point in 2023, Do you expect NII in that backdrop to stabilize compared to I'm looking back to 2019 when NII peak the same quarter when the Fed stopped hiking. I'm just trying to make sure the impact of your swaps essentially implies that $7.20 plus kind of NII will still hold for the foreseeable future until some of the swaps roll off, which is in the out years?

Speaker 4

Yes, Abraham. We feel we are much, much better positioned if rates were to drop in 2023 than we were in 2019. We were some Exposed there and had not finished the hedging program. We feel much better about holding on to the higher levels of net interest income this time around. And As I mentioned, the goal by the end of the year is to get down to the single digit percent of net interest income at risk for a gradual 100 bp hike or 50 bps on average.

Speaker 4

So we should hold on to most of that income as we move into 2023.

Speaker 2

Jim, I just met with some puts and takes around where deposit betas Might go in what loan growth does in 2023.

Speaker 4

That's right. Yes, certainly some ins and outs there. As I mentioned, the Full impact of November December hikes isn't factored into that Q4 guidance. Loan volume is not factored in, But deposit betas may lag into the year. So definitely some moving parts going different directions.

Speaker 4

But I mean the whole goal along, Abraham, as you know and you've To say is to protect ourselves, better protect ourselves from a drop in rates. So that's what we've been working on and we're Largely successful up to this point and we plan on being done with the overall program by the end of the year.

Speaker 10

Sure. And I'm sure if I missed this. Did you mention Jim What's the deposit beta you're assuming by the end of the year?

Speaker 4

Well, we typically think about a 30% standard beta. I do think that we will through the Q3 be approaching that with hikes and probably go a little Hi, X5 into the year. I don't know that the accumulated standard beta will be fully reflected in the 4th quarter results just because of the lag and The full quarter effect, I mean it could be, but at this point I think it's more likely to be early Q1 of 2023. But we'll see how market forces react and respond and how we work with our customers.

Speaker 10

Got it. And if I could one on the lending side. I think you mentioned dealer finance close to $840,000,000 versus $4,000,000,000 pre pandemic. I mean, one, I'm assuming inventory build For cars will help that, but do you think that business may have structurally changed where we never get to that $4,000,000,000 Would love to hear your thoughts in terms of What you're hearing from your clients? And second, I think the other thing that you mentioned, I think Kurt was you're not seeing a high degree of CapEx spend driving demand.

Speaker 10

Give us a sense of what's holding back customers around CapEx. We've heard some of your peers talk about actually CapEx contributing to growth. So would you have any perspective on both those?

Speaker 7

Ebrahim, it's Peter. So on dealer, the question you asked was about whether or not we'll ever get back to the $1,000,000,000 levels. And that's a question the industry in general is dealing with. What do days inventory look like on the other side Of this cycle that we're in. And I don't know that there's a clear answer to it.

Speaker 7

As of right now, we still see Really low inventory levels on dealer lots. Our floor plan usage is still really, really low compared to historical levels and Whether it gets back to the $4,000,000,000 is to be determined. We believe and I think when you talk to a lot of customers that it's probably somewhere in the middle. I don't think you're going to see 90 days of inventory, but I don't think you're going to see 10 days either. It's probably 50 to 60.

Speaker 7

So but at the same time, Different OEMs are communicating different things to the dealers and so we'll just kind of see what that looks like on a go forward basis. As far as the CapEx, I don't want to suggest to you that there's no CapEx going on. I think that most of our customer base though is being As we have said, recession watch, making sure that they don't do something that stretches themselves too much. So we are seeing a little bit of CapEx, but it's not probably the main driver of the borrowings that we have mentioned. So you do see some of it.

Speaker 7

I think that it's all They're wanting to make and understand those and so far we're seeing really good decisions.

Speaker 10

Got it. Thanks Peter and thanks for taking my questions. Yes.

Operator

Thank you. Our next question comes from the line of Ken Usdin with Jefferies. Please go ahead.

Speaker 2

Hey, good morning, Ken.

Speaker 5

Hey, thanks. Good morning, guys. Just on the cost side, I know you're recalibrating in the second half versus the first and that deferred comp is a part of Just wondering with the inflationary environment, just can you talk through the types of pressures you're seeing there built And then how you think about that translates as you look further ahead relative to all the points that have been made about the NII strength in terms of Operating leverage and how much of that incremental NII falls to the bottom line as we look further out?

Speaker 4

Hey, good morning, Ken. Thanks for the question. Yes, we are seeing some inflationary pressures. We're seeing it certainly on the salary side in terms of attraction and retention of talent. We think we're doing a really good job of calibrating that and hitting the right balance.

Speaker 4

We're seeing a little bit As contracts renew, there's a bit of a lag effect there. So I think that will probably stick with us over the next year since contracts obviously don't renew On a frequent basis, T and E, we're seeing it as I mentioned. I think anyone that's even personally traveled has seen that. Insurance, the insurance market has been hit a little bit hard. That's probably for factors in addition to inflation.

Speaker 4

But it is going to put some pressure. I mentioned earlier this year that I thought overall on a full year basis it would perhaps add 1% to the overall expense base. And I think we're probably looking at least probably about 1% for the second half of the year alone in terms of pressure. And we'll probably see that continue a little bit next year. In terms of operating leverage, that's always our goal to achieve positive operating leverage.

Speaker 4

We obviously Did it this quarter? The goal is to do it going forward now that we're stabilizing net interest income. Having said that, we're not prepared to offer Yes, but that

Speaker 2

is always the goal to generate positive operating leverage. Jim, I might just add from a bigger To make sure that we're appropriately balancing expenses versus revenue growth and trying to find ways To be relevant from a revenue perspective on a go forward basis, so we've had 8 consecutive quarters of double digit ROE, 17% This quarter, we're 58 percent efficiency ratio. And so continuing to invest in technology and digital will be relevant There to our customers and to our colleagues, we've made some geographic expansions into the Southeast and as well as into the Denver For the Mountain Central region, we've been adding some capacity in terms of REMs and advisors in our commercial and wealth management business. We talked about the Renewable Energy Group. So there's some things we're doing to continue to add capacity as we sort of go forward and sort of take advantage of This higher rate environment, but we've done a good job historically of managing expenses.

Speaker 2

Certainly, if the environment changes, we know how to manage expenses appropriately. But sort of balancing the 2 is really important for us taking the longer term view.

Speaker 5

Got it. Appreciate that. And just one follow-up question on the loan side. Almost all of the specialty This showed good direction and I think that might have been a little surprising, especially been what's going on in dealer mortgage equity fund services. Can you just kind of flush out As you expect the loan growth to continue, how do you expect some of those to act out of your are you seeing just better underlying trends in some of the

Speaker 7

Yes, Ken, it was a great quarter with all of our businesses kind of moving in the right direction. The only one that we Didn't really see it was commercial real estate. But as we mentioned, we booked a ton of business and we expect that to continue. So the Look for all of them continues to be pretty positive. As I think we've said, maybe not in the second half of the year what we've seen in the first half, but It does feel positive.

Speaker 7

I think mortgage bankers probably going to be flat to maybe down into the Q4. We're just we haven't seen the type of activity everybody knows, with interest rates, housing inventory, affordability, I think that business will probably stay a little flat. But the rest of the businesses have got really good pipelines, really good outlooks, and we feel good about it. So it was nice for it to all be moving in the same direction This quarter and we're encouraged that we would see that again this next quarter.

Speaker 2

Thank you, Ken.

Operator

Thank you. Our next question will come from the line of Christopher McGratty with KBW. Please go ahead.

Speaker 2

Hello, Chris. Great. Good morning.

Speaker 11

I want to start with just the earning asset Back to the equation, a lot of discussion on deposits. Can you help us with kind of targeted or minimum cash levels Given the liquidity that's being removed from the system and also I think you touched upon in your prepared remarks, backing off the securities purchases, I was trying to see Trying to gauge what the earning asset levels will be for the next

Speaker 4

quarter? Hey, Chris, good morning. Historically, we have always maintained probably a little larger cash buffer than perhaps other regional banks just because of our commercial banking model. So typically, we like to hold at least $2,000,000,000 to $3,000,000,000 in cash and we have a little more than that. It doesn't necessarily bother us.

Speaker 4

Obviously, we're starting to approach those levels. We certainly have very strong and efficient borrowing channels, Whether it be broker deposits or FHLB lines. So to the extent we start getting down to those minimum cash levels and need to borrow, That's not necessarily worrisome for us whatsoever. It's been contemplated and it's really what we've been preparing for. So We feel really good about how we're managing that.

Speaker 4

We're earning assets go overall. That's obviously going to be dependent on loan growth and Where deposits go, so there's a lot of ins and outs there. We're not necessarily forecasting earning asset levels themselves, but We feel really comfortable with what we're mapping out over the next couple of years in terms of managing cash and being able to fund loan growth.

Speaker 11

Great. And then if I could, as a follow-up to Steve's question about the DDA reversion, I guess, mean reversion. If I'm looking at the mix of deposits, you said a couple of years ago, it was mid low high 40s, now it's mid-50s. If you look at the dollar difference, it's pretty meaningful. So I'm just a little more interested in how do you get to your target, Call it 50% mix.

Speaker 11

Is it growing others and shrinking? Or is it purely shrinking DDA by multiples

Speaker 4

of billions? Thanks. It's going to be a combination. We will see overall deposits of course go down and you'll see some of that from both DDA And interest bearing, but at the same time you will see even for balances that stay on the balance sheet, you will see for rate sensitive customers and where we're price competitive, you will Some of those DDAs moved interest bearing. So I feel like it's a little bit of a fifty-fifty mix in terms of how that mix changes.

Speaker 4

It will be a combination of Both overall DDA leaving the balance sheet, but also DDA moving into interest bearing.

Speaker 3

Great. Thank you.

Speaker 5

Thank you.

Operator

Thank you. Our next question comes from the line of John Pancari with Evercore. Please go ahead.

Speaker 2

Good morning, John. Good morning.

Speaker 12

Just want to follow-up on the loan growth front. I think it was a Follow-up to Ken's question. I know you gave your expectation on the components specifically around The mortgage warehouse indicated stable to down. Can you maybe give us your thoughts on the other buckets specifically? I believe you said modest Growth you expect in commercial real estate, but want to confirm that and then maybe if you can talk about equity fund service outlook, corporate banking and middle market.

Speaker 12

Thanks.

Speaker 7

Yes, sure, John. It's Peter. So I guess I'll try to take those one at a time. The Equity Fund Services outlook is still Pretty good. There's been a lot about private equity funding, fund formation and so forth.

Speaker 7

Our utilization was Actually down in EFS this quarter, but our commitments grew, our outstandings grew, despite that. And so we're encouraged by what We feel like we're a leader in that business and feel really good about The opportunities knowing that there is some challenges in the fundraising space, but overall we've got a really good pipeline there. Our corporate business, so U. S. Banking, has had really good success.

Speaker 7

That is probably on our customer sentiment. I think larger companies with More geographic or international, national exposure, that's where our sentiment probably did drop a little bit more than the rest of our portfolio. That said, we did have a really good quarter and our activity level there continues to be really good. Within U. S.

Speaker 7

Banking, we've got some great specialty businesses around our gaming business, around our sports franchise lending business. And so The activity level there continues to be really, really solid. And then middle market in general you asked about It's really encouraging. In all of our geographies, we've got a great activity level in Texas. Michigan continues to be really strong.

Speaker 7

California has come back from kind of where it was last year, a little bit behind, although We did see a little bit of drop in sentiment in California versus the other two markets, but our activity level is still really, really strong. And then we're starting to see really good About the opportunities that we're starting to see there. And then on commercial real estate, John, what I said there is we didn't see maybe as much outstanding loan growth In the Q2, but we did see a tremendous amount of commitment production. We bank A lot of really great developers where most of the business we're doing there is with existing customers. It's not like we're reaching with new customers and the opportunities for those customers have been really, really good.

Speaker 7

And so we expect to see outstandings Increase from here with commercial real estate just with the amount of activity that we have closed so far. So I hope that gives you a little bit more, John, on each of the businesses that you were asking about.

Speaker 12

No, that does. That's helpful. Thank you. And then My follow-up is just around loan growth overall. I know you're Looking at 6% to 7% growth ex PPP for 2022, which is pretty solid.

Speaker 12

And I know you're Not formally out there with 2023 expectations, but wanted to see if you can maybe help us think about the trajectory of that growth rate as you look at 2023, Particularly with the expectation of potential economic slowing, is it fair to assume a growth rate somewhere below that level? Or could you see it hold in that Mid to high single digit range.

Speaker 7

John, it's Peter. I'll comment first and I don't know what Jim wants to add. But we're going to continue to everything we can to keep that growth rate as we have said above GDP. We're striving to do that in all of our markets. And If you look at the outlook for Texas and California and Michigan, those GDP outlooks are better than national averages.

Speaker 7

So we're going to continue to We do believe that our company can perform at a level better than what you might see on national GDP levels is how I would answer your question.

Speaker 4

Yes. Yes, I think that's good. I think we would be It does stick, but a lot of it's going to depend on the economy and how we move through 2023.

Speaker 12

Got it. Very helpful. Thank you.

Operator

Thank you. Our next question comes from the line of Jennifer Demba with Truist Securities. Please go ahead.

Speaker 2

Good morning, Jennifer.

Speaker 1

Good morning. With the deposit growth slowed down significantly for the industry, just Wondering what Comerica is doing in terms of tweaking its strategy there, whether incentives related to deposit gathering or adding some more small business bankers. Can you just give us some details on how you're thinking about that?

Speaker 2

I might make a Jennifer, this is Kurt. I might make a couple of comments and then turn. First of all, I mean perspective is really Here, we're at a 68% loan to deposit ratio and we do not chase sort of transactional hot deposits. Everything we do is from relationship based focus, and so whether it's in our commercial bank, in our retail bank, in our wealth management organization, We've got the ability to flex up on pricing if we need to do that. So we're sort of watching, we're going to do the right things from our customer perspective.

Speaker 2

And then we've got access To plenty of other funding sources, leveraging our securities portfolio, FHLB, etcetera. And On the list of things that I'm concerned about as a CEO, this is way down that list. And you look at sort of we were post pandemic, we were in the 90% plus range on a loan to deposit perspective. And so we still got Plenty of funding to take care of our customers and appropriately grow the balance sheet. And so we're just trying to Sure.

Speaker 2

We're staying focused on the relationship side of this, leveraging treasury management services and some AP, you want to

Speaker 7

talk about that? Yes, Jennifer. This is Peter. I was just going to add to Kurt's comments that we are investing a lot in looking at our digital experience on the commercial side And making sure that we're a leader in that space and making it as easy as we possibly can for our customers to interact with us Digitally and providing all those products and services. So that's where we're leaning in on this issue When it comes to gathering deposits into the future, particularly as you mentioned, I think you'll see more talk from us about the small business space, which is a great Deposit business, but we're focused on that investment as it relates to products and services.

Speaker 7

I think the digital customer experience For commercial customers is one that we can lean into heavily and that we can lead in. Yes. And I

Speaker 4

would just say along with digital deposits, I love the emphasis we're putting on treasury management investment. And I love treasury management. We love treasury management not just for the non interest income, but the deposits that come with it. So I would certainly lean on that as part of the mix also.

Speaker 10

Thanks so much.

Speaker 4

Yes. Good. Thanks, Jennifer.

Operator

Thank you. Our next question comes from the line of Gary Tenner with D. A. Davidson. Please go ahead.

Speaker 5

Gary, thanks. Good morning. Hey, my questions were largely answered. So I just thought I'd ask in terms of capital, I don't believe you were active in the buyback this Quarter with your CET1 under 10%. As you think about kind of building that back Up over 10% late this year or say early in 2023, if that comes to pass.

Speaker 5

Given the kind of uncertainty In terms of the economy and growth, would you anticipate maybe being more constrained On the buyback, even in that scenario where you're back over 10% over the next several quarters, let's say?

Speaker 4

Yes. Thanks, Gary. We do think we We will at least in our baseline forecast likely get back to 10% by the end of the year. I think we can accrete capital at 10 to 15 bps per Quarter, maybe closer to 15. I think once we get there, we'll do an assessment of where we stand, where the economy is.

Speaker 4

On one hand, I am really excited about the fact that we will stabilize net interest income, stabilize a lot of earnings that makes it A little easier to activate things like the share buyback. On the other hand, we are very aware of the volatility of CECL, What that can do to capital ratios and we would certainly give that a fair amount of consideration as we start Reaching 10% going above, we would look at the credit environment and that would certainly weigh on how quickly we weigh back into a share repurchase program.

Speaker 2

Certainly coupled with loan demand.

Speaker 4

Yes, loan demand and all the other variables of course also.

Speaker 5

Sure. Thank you. Thank you.

Operator

Thank you. Our next question comes from the line of Steve Moss with B. Riley Securities. Please go ahead.

Speaker 7

Good morning, Steve.

Speaker 5

Good morning. Just following up on your asset Tivity here. You guys talked about next year wanting to be in the, I guess, single digit range for downside to NII in the event of break cuts. I just want to confirm, I see on the deck that it looks like no more swaps are needed for the loan book or maybe How much more do you guys need to add to get to that level?

Speaker 4

Yes. Thanks, Steve. Yes, I think we have on the slide that we We'll likely need up to $10,000,000,000 of hedges to get to the low single digit percent. That is likely It'd be more of a swap strategy as opposed to a security strategy at this point given our cash levels. But I will emphasize up to.

Speaker 4

It is going to be dependent upon how the balance sheet shifts. Deposit levels will probably be the most important variable there. So it could end up being far less than 10, but I would just say up to 10,000,000,000 depending on how the balance sheet shapes up.

Speaker 5

Okay, great. Thank you very much. Thank you.

Operator

Thank you. That was our last question in the queue. I will now turn the call back over to President, Chairman and Chief Executive Officer, Curt Farmer, for Closing remarks.

Speaker 2

I just want to say again, it was a very good quarter. Thank you to all my colleagues for all that they do every day to take care of our customers And help us grow the company. Thank you as always for your interest in Comerica, and I hope you have a very good day.

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Earnings Conference Call
Comerica Q2 2022
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