Wednesday, June 17, 2015
Absent Higher Rates, Comerica Has Probably Gone Far Enough
Another Familiar Pattern In Second Quarter Earnings
Add Comerica to the list of banks reporting okay net interest income and beating quarterly estimates on the basis of fee income and lower credit costs. Commerce Bancshares (Nasdaq:CBSH) actually reported the opposite, but other banks like Bank of the Ozarks (Nasdaq:OZRK), Wells Fargo (NYSE:WFC) and Citigroup (NYSE:C) have been following this basic pattern for the second quarter.
SEE: Citigroup Continues The Theme Of Decent Big Bank Earnings
Operating revenue declined 2% from the year-ago level, but rose about 1% sequentially. Net interest income declined slightly on a sequential basis as the net interest margin ticked lower (down 5bp) on lower purchase accretion. Again, that slim sequential decline was consistent with Wells Fargo and Citigroup's experiences. Fee income rose 5% sequentially and expenses were flat, leading to a 4% sequential improvement in adjusted pre-provision earnings.
Growth Is Still Lacking
Comerica saw just 1% sequential loan growth, better than Wells Fargo and Citigroup, but weaker than Commerce (which also focuses on commercial lending and is looking to grow its loan book in Texas). Commercial lending was up about 2% over all, though commercial real estate lending was softer. Deposits declined 2% (on an end-of-period basis), marking the second straight sequential decline. With Comercia's capital position on the weaker side of "okay" (at least relative to peers), I'm starting to wonder if this softness in deposits will constrain lending capacity at some point or force the company to turn to more expensive wholesale/borrowed sources of funds.
Quality Improving, But Capital May Be A Little Thin
Comerica reported some solid improvements in multiple credit metrics. Non-performing loans declined 38% from the year-ago level and 9% from the first quarter, and the non-performing asset ratio declined again (from 1.78%/1.18% in the prior year/quarter to 1.05%) - far below the level of Citi and Wells, but more than double the rate of Commerce. The net charge-off ratio dropped again (from 0.42%/0.22% to 0.15%) and is very low.
The reserves are interesting, though. While the decline in non-performing loans has lifted the reserve/NPL percentage to almost 137% (from 93% a year ago), the reserves-to-loans ratio of 1.35% looks a little thin to me, particularly as the the Tier 1 common ratio of 10.4% isn't exactly a peer-leading number. That said, Comerica did fine in the Fed's stress test earlier this year and has the all-clear to return capital to shareholders, which is a meaningful detail in a growth-poor banking industry.
SEE: Foreclosure Activity Tumbles In 1H
The Bottom Line
With close to 10% of Comerica's loan book going to car dealers, Comerica should be taking advantage of a pretty healthy car market in the U.S. Likewise, the company's position in the energy sector ought to be a positive assuming the North American energy market has indeed seen its trough. And as I mentioned earlier, this is a lender with above-average leverage to higher rates, as about 80% of the portfolio is variable rate (with about 70% indexed to 30-day LIBOR).
There aren't too many cheap bank stocks left, though, and Comerica isn't one of them. A 10% estimate for long-term ROE suggests a fair value today in the low-to-mid $30s, and you have to go up to about 13% to get a target ahead of today's price. While Comerica's geographically concentrated business may give it an above-average chance of returning to the higher ROEs of yesteryear, I still think that's a pretty bold assumption to use today. On the other hand, the company's return on tangible assets suggests a fair price/tangible book value multiple of around 1.4x, which implies a fair value of about $47. So not unlike Citi, there seems to be a dichotomy in how the market is viewing/valuing the long-term prospects for some of these banks.
While I think Comerica is a relatively good way to play higher rates, I think at least some of that expectation is already built into the stock price today. With mediocre loan growth and still above-average expenses, I'll continue to be on the sidelines with this stock.