Comerica: Earnings Depending On A Rising Interest-Rate Environment

Summary

• Most of CMA’s loans are based on floating rates; therefore, they will reprice soon after an interest-rate hike. Meanwhile, the deposit cost will remain sticky due to the deposit mix.
• Reversals of provisioning will likely taper off in early 2022. Nevertheless, the net provision expense will most probably remain below normal.
• After a prolonged declining trend, the loan portfolio will likely turn around this year on the back of economic strength.
• The December 2022 target price suggests a small downside from the current market price. Further, CMA is offering a modest dividend yield.

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Earnings of Comerica Incorporated (NYSE:CMA) will likely dip next year after a phenomenal year as reserve releases will taper off once allowances have declined to a comfortable level. However, a rising interest-rate environment will largely support the bottom line. Comerica's balance sheet is well-positioned to benefit from an interest-rate hike as its earning asset yield is more rate-sensitive than the deposit cost. Overall, I'm expecting the company to report earnings of $5.87 per share in 2022, down from expected earnings of $8.53 per share in 2021. The December 2022 target price is above the current market price. As a result, I’m adopting a neutral rating on Comerica Incorporated.

High Asset-Sensitivity Makes CMA a Margin Play

The Federal Reserve projects a 75-basis point interest-rate hike in 2022, which is good for Comerica. The company's balance sheet is well-positioned to benefit from a rising interest-rate environment. Firstly, fixed-rate loans made up only 23% of total loans at the end of the last quarter, as mentioned in the November presentation. As a result, a large part of the loan portfolio will reprice immediately after an interest-rate hike. Additionally, non-interest-bearing deposits made up around 53.6% of total deposits at the end of September 2021. These deposits will make the average deposit cost upwards sticky in a rising interest-rate environment. Further, the management’s interest-rate sensitivity analysis shows that a 100-basis point interest rate hike can increase the interest income by 11% over twelve months, as mentioned in the presentation.

On the other hand, the recent build-up in excess liquidity and the resultant deterioration of the asset mix will pressurize the margin. Interest-bearing deposits with banks surged to $22.5 billion at the end of September 2021 from $14.7 billion at the end of December 2020, as shown below.

Even without the anticipated rate hike, the recent improvement in the Treasury yield curve should help Comerica get a better yield on its excess liquidity. Nevertheless, the large proportion of securities and cash equivalents in total earning assets will likely keep the margin suboptimal because of the large difference between yields earned on loans and other earning assets.

Considering the factors mentioned above, I'm expecting the net interest margin to increase by six basis points in 2022.

Prolonged Loan Decline Trend Likely to Turn Around This Year

Comerica's loan portfolio has declined in the last six consecutive quarters, which sheds a bad light on the management’s abilities. Part of that loan decline was attributable to a reduction in Paycheck Protection Program (“PPP”) loans from $3.7 billion at the end of December 2020 to $1.7 billion at the end of September 2021. The remaining PPP loans outstanding made up around 3.5% of total loans at the end of September 2021; therefore, the eventual forgiveness in the next few quarters will have a sizable impact on the total loan portfolio size. Moreover, the management mentioned in the conference call that it expects mortgage refinancing to dip due to higher interest rates.

However, all is not bleak because of the ongoing economic recovery. Comerica mainly operates in three states: Michigan, California, and Texas. All three have a worse unemployment rate than the national average; however, their labor markets have improved substantially from the beginning of the pandemic. Further, the management mentioned in the conference call that it is seeing a robust pipeline. What Comerica’s management calls “robust” may not match what I generally consider to be robust because the company’s loan growth has been quite low even before the pandemic. Deciding to take the management’s guidance with a pinch of salt, I'm expecting the loan portfolio to increase by 0.4% in 2022, which is below the pre-pandemic average.

Meanwhile, I'm expecting deposits to continue to slightly outpace loan growth. Comerica will likely continue to place the excess funds in securities and cash equivalents. The following table shows my balance sheet estimates.

Reversals of Provisioning Likely to Taper-Off Soon

Comerica has released its loan loss reserves for the last four consecutive quarters. There's an opportunity to further release reserves because allowances are almost double the amount of non-performing assets. Allowances made up 1.33% of total loans, while non-performing assets made up 0.62% of total loans at the end of September 2021, as mentioned in the presentation. Further, loan growth will likely remain below normal next year, which will require lower than average provisioning.

I'm expecting allowances to decline to a comfortable level in early 2022; therefore, I'm not expecting much provision reversal next year. Considering these factors, I'm expecting net provision expense to make up around 0.13% of total loans in 2022, as compared to an average of 0.20% of total loans from 2016 to 2019. For the last quarter of 2021, I'm expecting a net provision reversal of around $20 million.

Expecting 2022 Earnings of $5.87 per Share

The anticipated margin expansion and small loan growth will likely drive earnings in 2022. On the other hand, the natural decline in loan loss reserve releases will drag earnings on a year-over-year basis. Further, the non-interest income will likely decline after a phenomenal year. The management mentioned in the conference call that certain non-interest income line items will be difficult to repeat in 2022.

Overall, I'm expecting Comerica to report earnings of $5.87 per share in 2022. For the last quarter of 2021, I'm expecting the company to report earnings of $1.67 per share, which will take full-year earnings to $8.53 per share. The following table shows my income statement estimates.

Actual earnings may differ materially from estimates because of the risks and uncertainties related to the COVID-19 pandemic, especially the Omicron Variant.

Total Expected Return Calls for a Neutral Rating

Comerica is offering a dividend yield of 3.1% at the current quarterly dividend rate of $0.68 per share. The earnings and dividend estimates suggest a payout ratio of 46% for 2022, which is easily manageable even if it is much higher than the pre-pandemic average. Therefore, I don’t think there is any threat of a dividend cut despite the prospects of an earnings decline.

I’m using the historical price-to-tangible book (“P/TB”) and price-to-earnings (“P/E”) multiples to value Comerica. The stock has traded at an average P/TB ratio of 1.41 in the past, as shown below.

Multiplying the average P/TB multiple with the forecast tangible book value per share of $59.4 gives a target price of $83.7 for the end of 2022. This price target implies a 3.8% downside from the December 31 closing price. The following table shows the sensitivity of the target price to the P/TB ratio.

The stock has traded at an average P/E ratio of around 14.0x in the past, as shown below.

Multiplying the average P/E multiple with the forecast earnings per share of $5.87 gives a target price of $82.3 for the end of 2022. This price target implies a 5.4% downside from the December 31 closing price. The following table shows the sensitivity of the target price to the P/E ratio.

Equally weighting the target prices from the two valuation methods gives a combined target price of $83.0, which implies a 4.6% downside from the current market price. Adding the forward dividend yield gives a total expected return of negative 1.5%. Hence, I’m adopting a neutral rating on Comerica Incorporated. I wouldn’t consider investing in the stock unless its market price dipped by more than 15% from the current level.

Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. 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.

Disclaimer: This article is not financial advice. Investors are expected to consider their investment objectives and constraints before investing in the stock(s) mentioned in the article.