DBRS Comments on Comerica Inc.’s 2Q11 Earnings; Senior Debt at “A” Unchanged; Trend Stable

DBRS Inc. (DBRS) has today commented that its ratings for Comerica Inc. (Comerica or the Company), including its Issuer and Senior Debt ratings of “A” and its R-1 (low) Short-Term Instruments rating, remain unchanged following the release of the Company’s 2Q11 financial earnings. The trend on all ratings remains Stable.

In DBRS’s view, the Company’s results continued to reflect earnings resilience and well-controlled expenses in a difficult but slowly recovering economy. Comerica reported 2Q11 net income of $96 million compared to $103 million in 1Q11 and $70 million in 2Q10. Revenue of $593 million was 1.5% lower than the prior quarter, reflecting the impact of a modest decline in average loans and narrowing loan yields. On an adjusted basis, income before provisions and taxes (IBPT) was up $10 million, or 5.4%, quarter-over-quarter (QoQ) to $195 million. DBRS notes that the quarter’s decline in revenue was partially offset by a 1.4% reduction in expenses in the quarter. In 2Q11, the Company recorded $5 million in costs related to the Sterling Bancshares (Sterling) acquisition and $19 million in charges related to a settlement agreement with the Internal Revenue Service (IRS) involving a foreign structured investment, which were partially offset by a $9 million reversal of tax reserves.

DBRS views positively the nascent indicators of loan growth that, combined with the Sterling acquisition, should generate asset growth for Comerica in 2H11. Although average loans declined by $377 million, or 1%, over 1Q11, total period end loans increased modestly in 2Q11, attributable to commercial loan growth (excluding dealer floor plan loans) of $1.1 billion, or 6%, over the prior quarter. The loan pipeline remained strong with commitments and utilization up in a majority of its business lines and markets. Average CRE loan balances declined and are expected to continue to contract, albeit at a slower pace. National Dealer Services average loans were down $194 million in the quarter as a result of the Japanese natural disaster, but management anticipates rebuilding of inventory and stabilization in 2H11. Moreover, average loans are expected to grow in the mid-single digit range in 2H11 driven by the Sterling acquisition and the anticipated commercial loan growth.

Comerica continued to exhibit broad-based improvement in its asset quality in the quarter, recording an eighth consecutive quarter of declining charge-offs. Net Charge-offs (NCOs) decreased by $11 million sequentially in 2Q11 to $90 million, or 0.92% of average total loans, and compared favorably to 1.03% in 1Q11. Non-performing assets (NPAs) declined $60 million QoQ to $1.04 billion, or 2.66% of total loans and OREO. All credit metrics improved with loans past due 90 days or more and still accruing declining $8 million, or 11%, QoQ to $64 million. NPA inflows improved, although remained relatively flat to the prior quarter, to $163 million and foreclosed properties were down a modest $4 million from 1Q11 to $70 million. Moreover, watch list loans declined $339 million, or 6.6%, sequentially to $4.8 billion.

DBRS notes that positive credit trends led to a 4% sequential decrease in the provision for loan losses to $47 million. Provisions were less than charge offs for the fifth consecutive quarter and despite declines in allowance for loan losses, reserves to non-performing loans improved sequentially from 82% to 83%. Moreover, the allowance for loan losses, at 2.06% of total loans, provides an adequate reserve cushion against unexpected losses. Management anticipates credit quality to improve in 2H11, including migration trends, with management forecasting NCOs between $165 million and $185 million accompanied by provisions of $65 million to $85 million in 2H11.

In 2Q11, net interest income declined $4 million QoQ to $391 million driven by a decrease in average loans, changes in excess liquidity, and maturities of swaps at positive spreads in 1Q11. Average earnings assets increased $789 million, or 1.6%, primarily due to significant growth in Comerica’s excess liquidity of $1.1 billion in the quarter. Core deposits grew $881 million to $41.1 billion, of which 37% were noninterest bearing deposits. Growth in excess liquidity invested in lower yielding, shorter duration assets, coupled with loan pricing based on the decrease in LIBOR resulted in NIM compression of 11 bps to 3.14% at 2Q11. Management anticipates average earnings assets to grow in the mid single-digits and expects NIM expansion in the range of 3.35% and 3.40% for the remainder of 2011 (assuming that the Federal Funds rate and LIBOR remain consistent to 2Q11 levels), driven by purchase accounting discount accretion on the acquired Sterling loan portfolio and from reduction in excess liquidity.

Fee income declined modestly by 2.4%, or $5 million, to $202 million as a result of declining deferred compensation asset returns. Management expects a mid single-digit decline in 2H11 compared to 1H11 attributable to the impact of regulatory changes partially offset by the inclusion of Sterling.

Noninterest expense improved $6 million in the quarter to $409 million due primarily to improved salary, FDIC insurance and software expense. For 2H11, Comerica anticipates after-tax restructuring expense of $80 million from the Sterling acquisition with $25 million recognized in each of 3Q11 and 4Q11 and the $30 million remainder in 2012.

Capitalization is solid and liquidity positions are robust, providing ample loss absorption capacity. The Company is entirely core funded with core deposits covering 105% of net loans. Composition of capital is strong with Tier 1 risk-based capital consisting entirely of common equity at 2Q11. Capital levels are robust, as evidenced by its Tier 1 common ratio at 10.53% and tangible common equity ratio of 10.90% in the quarter. With its strong capitalization, management expects to resume its share repurchase program in 3Q11 with an annual earnings payout ratio target, including dividends and share repurchases, of up to 50% of 2011 earnings. Although many uncertainties surround the adoption of the Basel III framework and implications for Comerica, DBRS views the Company’s robust and prudent capital management as ample for the anticipated Basel III regulatory requirements.

Notes:
All figures are in U.S. dollars unless otherwise noted.

The principal applicable methodology is the Global Methodology for Rating Banks and Banking Organizations. Other methodologies used include the Enhanced Methodology for Bank Ratings – Intrinsic and Support Assessments, Rating Bank Subordinated Debt and Hybrid Instruments with Discretionary Payments and Rating Bank Preferred Shares and Equivalent Hybrids, all of which can be found on the DBRS website under Methodologies.

The sources of information used for this rating include the company documents, the Federal Deposit Insurance Corporation and SNL Financial. DBRS considers the information available to it for the purposes of providing this rating was of satisfactory quality.

Lead Analyst: William Schwartz
Approver: Roger Lister
Initial Rating Date: 24 April 2001
Most Recent Rating Update: 19 January 2011

For additional information on this rating, please refer to the linking document below.