Comerica Incorporated (NYSE:CMA) made a loss of $0.46 per share in the first quarter, down from $1.85 in the fourth quarter of 2019. The loss was mostly attributable to a hike in provision expense to $411 million from $8 million in the previous quarter. The provision expense will likely decline in the remainder of the year because the economic forecasts used for determining the reserve level currently seem to be reasonable. However, exposure to hard-hit industries will keep the provision expense for the remainder of 2020 higher than the 2019 level. Furthermore, continued compression in the net interest margin will likely pressurize earnings. Additionally, a drop in non-interest income due to lower market-related fees will likely constrain the bottom line. On the other hand, continued loan growth will support the earnings. I'm expecting CMA's bottom line to return to being in the black in the second quarter. For the full year, I'm expecting CMA to post positive earnings of $2.48 per share, down 69% from 2019. The impact of COVID-19 on provision expense is uncertain; hence, there are chances that actual results will differ materially from the estimates. The December 2020 target price suggests a high upside from the current market price. Nevertheless, I'm adopting a neutral rating on CMA because of the uncertainties.
Hard-hit Industries to Keep Provision Expense Above Normal
CMA's provision expense surged to $411 million in the first quarter from $8 million in the fourth quarter of 2019. The provision expense will likely trend downwards in the coming quarters as CMA seems to have incorporated a stressful economic outlook in its allowances, as mentioned in the earnings presentation. To determine the incremental reserves needed, CMA assumed GDP contraction between 13% and 33%, which seems reasonable under the current circumstances. Moreover, CMA incorporated U and V-shaped recoveries depending on the sector, which is more or less in line with my expectations. Consequently, I believe that the worst of the provisioning is behind us.
However, I do also believe that provision expense in the remainder of the year will remain higher than normal. CMA's exposure to hard-hit industries will likely drive provision expense in the last three quarters of 2020. As mentioned in the investor presentation, the oil and gas sector made up 4% of total loans at the end of March 2020. The medium-term oil price will determine provisions in this sector as around 66% of the portfolio is backed by hedged oil and gas production for one year. CMA also has some exposure to other sectors that will drive provision expense. Around 6.9% of total loans are directly affected by social-distancing measures, around 2.4% of total loans are to the auto production industry, and around 3.9% of total loans are leveraged loans. Considering these factors, I'm expecting CMA to post provision expense of $751 million in 2020, or 138bps of net loans, versus 15bps of net loans in 2019.
Net Interest Income to Plunge Due to Rate Sensitivity
CMA's net interest margin, NIM, declined by 26bps in the first quarter of the year. I'm expecting NIM to decline further in the second quarter due to the full quarter impact of the 150bps federal funds rate cuts in March. The management expects the interest rate decline to reduce net interest income by around $55 million in the second quarter. The Paycheck Protection Program, PPP, will also squeeze margin in the second quarter because it carries a relatively low fee. Overall, I'm expecting CMA's NIM to decline by 25bps in the second quarter, and by 76bps in the full year. The following table shows my estimates for yield, cost, and NIM.
Continued loan growth in the second quarter is likely to partially offset rate headwinds. I'm expecting line utilization by cash-strapped businesses to remain high through the third quarter, which will boost loan growth. Moreover, refinance activity in the mortgage segment will likely remain high due to low rates, which will provide opportunities to attract customers from other financial institutions. Consequently, I'm expecting loans to increase by 4% quarter over quarter in the second quarter. I'm expecting partial reversal of loan growth in the fourth quarter as some of the PPP loans will likely get repaid early. For the full year, I'm expecting net loans to grow by 9% year over year, as shown below.
I'm expecting loan growth to partially offset NIM compression in the remainder of the year. For full-year 2020, I'm expecting net interest income to decline by 16% year over year.
Decline in Market-Based Fees to Hurt Earnings
CMA's non-interest income declined by 11% quarter over quarter in the first quarter, which contributed to the earnings plunge. I'm expecting non-interest income to decline further in the second quarter due to lower market-related fees. The stock market crash in March, and the resultant reduction in equities under management, will affect fees in the second quarter. Additionally, I'm expecting reduced economic activity to decrease fees from several sources, including letters of credit, foreign exchange, and servicing of deposit accounts. On the other hand, the management expects higher card fees to drive non-interest income in the second quarter. Overall, I'm expecting non-interest income to decrease by 7.8% year over year in 2020.
Expecting Earnings to Dip to $2.48 per Share
The expected increase in provision expense, dip in NIM, and reduction in non-interest income will likely drag earnings this year. On the other hand, loan growth will support the bottom line. Overall, I'm expecting CMA's earnings per share to decline by 69% year over year to $2.48 in 2020. The following table shows my estimates for the income statement.
The severity and duration of COVID-19 are unknown, which could lead to negative surprises in the year ahead. If the lockdown lasts longer than expected, or if the economy reopens too soon, thereby leading to a second lockdown, then the asset quality of the portfolio affected by social-distancing can worsen. Additionally, if oil prices remain low for longer than expected, then the asset quality of the energy portfolio can deteriorate even further. These uncertainties have increased the riskiness of the stock.
I'm expecting CMA to maintain its quarterly dividend at the current level of $0.68 per share in the remainder of 2020. I'm not expecting a dividend cut because the management mentioned in the conference call that they currently feel comfortable with the dividend. Moreover, the estimated dividend for 2020 makes a relatively small claim, of around $389 million, on capital; whereas, CMA had a common equity tier I capital of $1,757 million in excess of the minimum regulatory requirement as of March 31, 2020. My calculations to determine the excess capital are shown in the table below.
The full-year dividend estimate of $2.72 per share implies a dividend yield of 8.7%.
High-risk CMA Offering Good Potential for Capital Appreciation
I'm using the historical price-to-book multiple, P/B, to value CMA. The stock has traded at an average P/B multiple of 1.37 in the past, as shown below.
Multiplying this P/B ratio with the forecast book value per share of $49.6 gives a target price of $68 for December 2020. This target price implies an upside of 117% from CMA's May 6 closing price. The following table shows the sensitivity of the target price to the P/B multiple.
The high upside shows that CMA has good potential for capital appreciation. However, the stock carries a high level of risk because the impact of COVID-19 on earnings for the remainder of the year is uncertain. Consequently, I'm maintaining a neutral rating on CMA.
