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Comerica Inc (CMA) Earnings Report: Q1 2016 Conference Call Transcript

first-quarter 2016 earnings conference call. (Operator Instructions) I would now like to turn the conference over to Darlene Persons, Director of Investor Relations. Ma'am, you may begin. Darlene Persons (Director, IR): Thank you, Operator. Good morning. Welcome to Comerica's first-quarter 2016 earnings conference call. Participating on this call will be our Chairman, Ralph Babb; President, Curt Farmer; Vice Chairman and Chief Financial Officer, Karen Parkhill; Chief Credit Officer, Pete Guilfoile; and Executive Vice President of the Business Bank, Pat Faubion. A copy of our press release and presentation slides are available on the SEC's website, as well as in the investor relations section of our website, As we review our first-quarter results, we will be referring to the slides, which provide additional details on our earnings. Before we get started, I would like to remind you that 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. I refer you to the Safe Harbor statement contained in the release issued today, as well as slide 2 of this presentation, which I incorporate into this call, as well as the filings with the SEC for factors that could cause actual results to differ. Also, this conference call will reference non-GAAP measures and in that regard, I would direct you to the reconciliation of these measures within this presentation. Now I will turn the call over to Ralph. Ralph Babb (Chairman and CEO): Good morning. Before getting into our quarterly results, I'd like to directly address the recent discussions of our fundamental performance. I've talked to many of our shareholders over the past several months and have listened closely to their feedback and suggestions. I want to make sure everyone recognizes that I, along with the rest of the Comerica


Our growth opportunities align with our commercial bank model where client relationships are stickier.

Our business bank is national class and we are a trusted advisor with long tenured employees who have deep expertise in the businesses they serve. Many of our high-caliber clients have banked with us for generations and beyond serving their business needs, we have integrated our strong retail and wealth management capabilities to further cement these relationships. We also have a strong treasury management platform with an improved merchant offering and are one of the top commercial card issuers. And through the cycle, we posted superior credit metrics. At the same time, as you know, we have been managing for years in an extremely low rate environment, along with a slow-growing economy, a host of increasing regulatory and technology demands and more recently the energy cycle headwinds. In light of the mounting challenges we have faced, we took actions to reduce costs, including judiciously renegotiating vendor contracts, reducing real estate and rationalizing some operations. In addition, last year, our key senior leaders did not receive the normal merit increase, as well as our three-year incentive payment. Our pay for performance comp structure reflects our strong alignment with shareholders. As a result of these efforts, our 2015 expense to earning assets ratio was better than all but one of our peers. However, we, along with nearly half of our peers, have not achieved double-digit return on equity. As a result, we have been undertaking a more intense review of our expense and revenue base. To help us in these efforts, we've engaged Boston Consulting Group, a globally-recognized management consulting firm that is very familiar with the range of challenges the US banking industry is facing. While this process is in its early days, we fully expect to identify meaningful opportunities to operate more efficiently and lower expenses, as well as drive increased revenue even in the current environment. We are taking an expeditious yet comprehensive and thoughtful approach to executing this type of program with the goal of building a stronger, more competitive and more profitable organization. Given the breadth of the review, we plan to provide more information around the opportunities identified by the next quarterly earnings call and we intend to deliver to our shareholders as soon as practical a broad, enterprise-wide plan designed to help reach tangible targets. We are going to pursue this cost and revenue initiative with the urgency it deserves and continue to utilize our strengths and competitive position to improve our results. And if other strategic alternatives present themselves that are realistic, achievable and will maximize shareholder value, we will not hesitate to consider them. That said, it's important to realize that when considering any strategic alternative, timing, economic developments and industry condition, like what's occurring in the energy space, must all be taken into account. Over the last five quarters, we have been impacted by the current oil and gas cycle. We have been appropriately increasing our reserve application for energy loans over that time and we have significantly increased them in the first quarter to nearly 8% of total energy loans. A year ago, our total energy commitments were $6.9 billion. Today, they are $5.6 billion, a decline of $1.3 billion. Outstandings have declined also during that time by $500 million to $3.1 billion. Overall, our borrowers are aggressively reducing costs, cutting back on capital expenditures and preserving liquidity. In addition, they are paying down bank debt through the sale of assets, which are generally sold at prices significantly higher than reflected in the borrowing base. Utilization has increased slightly to 54% driven by the decline in total commitments. While you are all very understandably following reserve to loan ratios across multiple energy portfolios in the banking system, it is important to understand the risk differences. Our energy portfolio consists of 70% E&P, 16% midstream and 14% services. Within E&P, the well or field diversity of our customer base is spread broadly across the major producing basins in the country. We have very little deepwater exposure and only two second lien loans totaling $18 million. Typically, we do not make high-yield unsecured or second lien loans and less than half our E&P relationships have high-yield debt behind our senior position. Our risk ratings and current reserve allocation for energy reflects our rigorous review of every relationship. We have been prudently downgrading loans taking into consideration our customers' expected operating cash flows in a continuing depressed price environment and the resulting total leverage. We believe we are being realistic in our assessment of the probability of default given our expectation that prices may remain lower for longer.


The provision increase in the first quarter reflected the high end of the range in our 2016 guidance for the incremental impact of energy loans adjusted upward for revised regulatory guidance and includes the results of the Shared National Credit Exam. However, it is important to note that our fundamental view on the energy sector has not changed significantly.

While the current oil and gas cycle presents a challenge, we believe we are adequately reserved. Keep in mind those reserves may not turn into ultimate losses. We also look beyond direct energy risks and we remain comfortable with our Texas commercial real estate exposure. We have not seen any noteworthy deterioration in our Texas portfolio outside of our energy book. I believe that we have a framework for delivering enhanced shareholder value and are moving with urgency to execute against our strategic priority to drive meaningful improved returns for our shareholders. Now I will move on to our first-quarter results turning to slide 4. Absent the impact of energy, our overall results were solid. In particular, we saw a significant benefit from the December rate increase. Average loans were stable at $48.4 billion. Increases in commercial real estate and national dealer services were offset by decreases in general middle market, as well as a cyclical decline in energy and seasonality in mortgage banker finance. Average total deposits decreased $3 billion to $56.7 billion, reflecting our relationship banking strategy, as well as purposeful pricing and strategic actions taken in light of the LCR rules. Typical seasonality was also a factor as deposits declined in January and February followed by growth in March. The majority of the deposit decline on a period-end basis was relative to our -- to an elevated deposit level associated with our government card product at year-end. Net interest income increased $14 million, or 3% quarter-over-quarter. The Fed's December rate hike is expected to add about $90 million for the year as the bulk of our loan portfolio is floating rate. The benefit of the rate rise in the first quarter was partially offset by lower non-accrual interest, fewer days in the quarter and several other smaller items. Aside from the provision for energy loans that I already discussed, overall credit quality continued to be solid. Total net credit-related charge-offs were $58 million, or 49 basis points of average loans. Excluding energy, net charge-offs for the remainder of the portfolio remained low at $16 million or 15 basis points. Non-interest income declined $22 million following strong commercial lending fees in the fourth quarter, particularly for syndication fees. Non-interest expenses decreased $24 million or 5% primarily reflecting a $14 million decrease in salary and benefits, as well as decreases in many other categories such as consulting fees, advertising and occupancy expenses. Our capital position is solid. In light of the earnings impact from the deterioration of the energy book, we remained disciplined and repurchased 1.2 million shares under our equity repurchase program. We continue to return excess capital to our shareholders in a meaningful way as we have for many years. Now I will turn the call over to Karen who will go over the quarter in more detail. Karen Parkhill (Vice Chairman and CFO): Thank you, Ralph. Good morning, everyone. Turning to slide 5, first-quarter average loans were basically stable at $48.4 billion compared to the fourth quarter. We had good loan growth in our commercial real estate business driven primarily from construction draws on attractive projects with proven developers and continued conservative credit parameters such as high equity content. Also, our national dealer business was seasonally higher. This growth was offset by a decline in general middle market as we remain disciplined in this highly competitive environment, as well as seasonal decreases in mortgage banker loans and the continued cyclical decline in energy. Importantly, positive growth trends through February and March resulted in period-end loans $1 billion above the average for the quarter and our stronger pipeline increased further. Total loan commitments declined led by energy resulting in utilization increasing to 51%. Our first-quarter loan yield increased 14 basis points reflecting the increase in short-term interest rates in December, continuing loan price discipline and wider spreads on energy loans., partially offset by lower fees in the margin and a decline in interest collected on nonaccrual loans following an extraordinarily high fourth quarter. Turning to deposits on slide 6, our deposit costs remained low and stable at 14 basis points as we continue to prudently manage pricing. We have not instituted any standard pricing adjustments in response to the December increase in short-term rates.

We are closely monitoring our deposit base, as well as the market and we believe we are well-positioned with predominantly operational relationship-oriented deposits. Of note, our loan-to-deposit ratio remains low at 87%.

Turning to slide 7, as you know, during the fourth quarter, we deployed a portion of our excess reserves into securities given the likelihood of rate increases occurring in small increments over a longer period of time. As you can see in the diamonds on the slide, our portfolio yield declined modestly resulting from the mix impact of adding lower yielding treasury securities, along with continued depressed yields on replacement securities. Going forward, assuming no change in the rate environment, we expect continued minor pressure on the average securities yield, primarily due to reinvestment of prepaids at slightly lower rates. As of quarter-end, our estimated LCR ratio continues to meet the fully phased-in 2017 requirement plus a buffer. Turning to slide 8, the December rise in short-term rates positively impacted us in the quarter. As Ralph mentioned, net interest income grew $14 million or 3% and the net interest margin expanded by 23 basis points. The largest factor was a benefit from higher LIBOR and prime base rates on our loan portfolio, which added $20 million, as well as slightly wider loan spreads. This was partially offset by lower interest received on nonaccrual loans and lower fees. Other loan impacts included one fewer day and slightly lower balances. A larger securities portfolio added $6 million. The higher interest rate earned on Federal Reserve deposits was more than offset by lower balances, resulting in a $2 million negative impact. Higher interest rates also resulted in a modest increase in our floating rate wholesale funding costs. In total, higher rates contributed about $22 million to the increase in net interest income. As we've indicated, we expect that if deposit rates hold at their current level, the upside from the first rate hike will be about $90 million for the full year over the 2015 level. Turning to slide 9, as you can see in the bottom right table, aside from energy, our overall credit picture remains strong. Criticized loans were $3.9 billion at quarter-end with close to half attributed to energy loans. While the level of criticized energy loans continues to increase as we prudently downgrade, we are not seeing any meaningful negative migration in the remainder of the portfolio where less than 5% of the loans are considered criticized. Close to two-thirds of our non-accruals are energy loans and the quarter-over-quarter increase is almost entirely from energy. Net credit-related charge-offs were 49 basis points or $58 million, also derived mainly from energy. Our other business lines had low charge-offs and strong recoveries. The $148 million provision for our total portfolio reflected an increase in our energy reserves as a result of the negative migration, along with charge-offs and the preservation of a qualitative reserve. Overall, our allowance for credit losses increased $91 million to total $770 million and our allowance to loan ratio increased to 1.47%. Slide 10 provides further detail on our energy portfolio, which at quarter-end totaled $3.1 billion outstanding, equivalent to 6% of our total loans. E&P loans comprised 70% of our energy portfolio and we are 26% through the spring redetermination process. So far, borrowing bases have come down about 22% on average as a result of lower energy prices. We had a handful of customers draw down lines as they prepare to restructure their...