Comerica (NYSE:CMA) hasn't always gotten its due, as analysts have in the past questioned the company's heavy exposure to Michigan, its focus on commercial lending, and how it went about gaining sizable exposure to California, and Texas. Nevertheless, Comerica sits today as one of the strongest mid-sized banks from the perspective of capital, and the company's interest-sensitive makeup could really pay if rates start to rise. Valuation makes this an interesting stock today, as the bank looks too cheap on some metrics, but fairly valued at best by others.
Good Fourth-Quarter Results, Highlighted By Strong Lending Growth
Comerica saw flat operating revenue this quarter, which isn't immediately all that impressive in comparison to U.S. Bancorp (NYSE:USB) or Wells Fargo (NYSE:WFC), both of which saw 5% year-on-year growth in the fourth quarter. Likewise, net income contraction of 4% and 1% is one of the weakest regional bank results I've seen so far. Even so, Wall Street is a relative performance sort of place and these results were basically in-line with expectation.
Net interest margin contracted again, falling about 12bp from the third quarter to 2.87%. While this was again close to expectation, it's still pretty weak in absolute terms (and well below the 3.6% of both USB and WFC). Fee income (non-interest income) rose 3% sequentially, but is only about half the size of the net interest income.
Comerica had success growing its balance sheet this quarter, as loans increased 4% sequentially and average earning assets increased 3%. Commercial lending (Comerica's bread and butter) was quite strong, up 7% sequentially, while commercial real estate was down 2% and retail lending was flat. With only a relatively small number of reports in hand so far, commercial lending seems to be holding up this quarter [JPMorgan (NYSE:JPM) was strong here as well, while U.S. Bancorp was not].
Expenses were flat relative to the prior quarter, but Comerica's efficiency ratio is still a highly inefficient 67.2% (though down from over 69% last year). All in all, pre-provision net revenue was up 1% sequentially and this was on balance a respectable quarter.
Credit Getting Better, But Spreads Aren't
Investors who follow bank stocks are going to eventually start thinking that they're hearing a broken record, as better credit and worsening spreads are likely to be very common themes.
To that end, Comerica saw non-performing loans drop 40% from last year's level and 22% from the prior quarter, with 90-day past due loans down about one-third sequentially. The company's non-performing asset ratio improved 44bp sequentially to 1.27% (a bit high relatively speaking), while the net charge-off ratio dropped another 5bp to 0.34%.
Looking at spreads, Comerica saw yields on loans drop another 6bp to 3.6%. Remember that about 80% of Comerica's loans are variable-rate, with a large majority of those indexed to 30-day LIBOR. Consequently, Comerica has likely seen the worst of the resets on its loan book.
On the deposit side, total deposits were up 4% sequentially, with non-interest deposits up 6% to about 44% of the total. That helped push the company's cost of deposits to a rock-bottom level of 0.12%, and I'm not sure investors will see a significantly lower cost of deposits this quarter.
Playing The Long-Term Game
It may well be to management's credit that it doesn't pay an excessive amount of attention to what analysts do or don't like about the business. While there were plenty of folks willing to bury Michigan not so long ago, the revival in the auto sector has helped the state and not only was Michigan the only operating area to show both sequential and annual income growth, it also had the strongest net income figure.
That said, the company's long-term growth is going to almost certainly come more from Texas, California, and Florida, and the company has built up a very solid deposit share in Texas and is coming along in California as well. The company is already a sizable lender to the automobile industry (dealer floor financing), and has been ramping up its energy lending as well. Given a highly cost-effective deposit base, I can see the company generating high single-digit to low double-digit growth on an organic basis just from further expanding its commercial lending.
Comerica is also sitting on quite a bit of capital, even after returning quite a bit to shareholders in 2012. While it's easy to be liberal with other people's money, I'm curious to see what management will do. I don't think it really needs more deals in the current core markets, though another deal or two in California, or Florida, (at the right price, of course) wouldn't hurt. I also would like to see the company consider adding more fee-based businesses in area like merchant processing and treasury services - not only does this company rely on net interest income for about two-thirds of its revenue, a lot of its fee income is tied to lending (service charges, lending fees, etc.).
On the whole, I think Comerica might need to do a little more to boost its long-term growth prospects and secure that aforementioned growth. I like the idea of commercial lending in California, Texas, and Florida, well enough, but more and more banks are turning to commercial lending as a future growth driver and that is liable to make the market a bit crowded. Yes, Comerica's experience should serve it well in terms of underwriting, but it is still likely to pressure pricing. That potential expansion into ancillary business services could be one of way of distinguishing itself in the market, and a way of not only cross-selling, but deepening client relationships, not to mention the high single-digit growth potential (and good ROE) of businesses like merchant processing in their own right.
The Bottom Line
Comerica is a frustrating stock to analyze from a value perspective. While the strong capital position is a positive, it also represents money that isn't being fully marshaled toward growth. Moreover, the company's ROE is not impressive (due in part to the high efficiency ratio and low net interest margin). As a result, long-term industry TBV/ROE regressions suggest that the stock shouldn't carry more than a 1.0x multiple to tangible book value.
Likewise, a return on capital model doesn't suggest huge value lurking here. Even if you assume a 10% long-term ROE (above the long-run average and most analysts' estimates of 8%-9%), fair value looks to be around $32.50. That said, if interest rates suddenly start moving up again, Comerica will be one of the biggest beneficiaries.
While the TBV multiple suggests a price target of about $36 and the ROE-based approach says $32.50, neither target is all that compelling relative to the current stock price. Comerica likely has little downside from here, though, and could be a very interesting stock if rates start moving up again.
Disclosure: I am long JPM. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.