DBRS Comments on Comerica Inc.’s 3Q11 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 rating of “A” and its R-1 (low) Short-Term Instruments rating, remain unchanged following the release of the Company’s 3Q11 financial earnings. The trend on all ratings remains Stable.

In DBRS’s view, the Company’s results continued to reflect earnings resilience, positive credit trends, and loan growth opportunities in a still challenging economy. The 3Q11 results were impacted by the Sterling Bancshares (Sterling) acquisition that was completed on July 28, 2011, and included $33 million in merger and restructuring charges. In 3Q11, Comerica reported net income of $98 million compared to $96 million in 2Q11 and $59 million in 3Q10. Total revenue was up 5% in the quarter from 2Q11 to $624 million attributable largely to the Sterling acquisition. Excluding the benefits from Sterling; however, DBRS views that legacy Comerica’s revenues were somewhat subdued due to the difficult operating environment. Average loans grew by 2.4% QoQ to $40.1 billion in 3Q11, primarily as a result of loans added from Sterling. DBRS notes that the quarter’s revenue growth was partially offset by a 12.5% sequential increase in expenses, including expenses related to the Sterling acquisition.

DBRS sees the low interest rate environment, changes in the regulatory landscape, and slow economic recovery as underscoring some of the headwinds for Comerica’s operating performance. In 3Q11, net interest income increased $32 million or 8.2% QoQ to $423 million. The improvement was primarily driven by an increase in average earning assets and from a $27 million purchase discount accretion on the acquired Sterling loan portfolio, partially offset by $8 million in accelerated premium amortization due to increases in mortgage-backed securities (MBS) prepayment activities. Average earnings assets increased $3.1 billion in the quarter due to growth of $924 million in average loans, $751 million in average investment securities available for sale, and $1.4 billion in excess liquidity. Sterling contributed $1.4 billion in average loans growth and $700 million of average investment securities available for sale.

In the quarter, net interest margin (NIM) expanded 4 basis points (bps) QoQ to 3.18% in 3Q11; nonetheless, management noted that purchase discount accretion on Sterling’s loan portfolio increased NIM by 20 bps that was partially offset by an 8 bps impact from increases in excess liquidity and a 6 bps impact from the accelerated amortization due to increased prepayments on the MBS portfolio. Management anticipates NIM to be approximately 3.15% in 4Q11 despite the benefits of a larger MBS portfolio, lower excess liquidity, and an additional month of higher yield Sterling loans. The positive variance is expected to be offset by lower purchase accounting accretion and lower MBS reinvestment rates that will be a constraining factor for NIM expansion in 4Q11.

Fee income of $201 million in the third quarter was largely unchanged from the $202 million recorded in 2Q11. The Company had an $8 million increase in net securities gains to $12 million and linked quarter increases in deposit services charges and card fees of $2 million each. This was offset by a $2 million QoQ decline in fiduciary income and a $14 million decline in other noninterest income, primarily from $7 million decrease in deferred compensation asset returns and $4 million decline in principal investing and warrants. Comerica noted that a mid-single digit decline in noninterest income is expected in 4Q11, primarily due to the regulatory impact on interchange fees and the absence of significant securities gains, partially offset by having one additional month benefit of Sterling.

Noninterest expense increased $51 million QoQ in 3Q11 to $460 million driven primarily by an increase in merger and restructuring charges of $28 million related to Sterling and $18 million in noninterest expense from the Sterling operations (such as Sterling lease terminations, system integration costs, and estimated severance and employee-related charges). For 4Q11, Comerica anticipates after-tax restructuring expense of $25 million from the Sterling acquisition and a low to mid-single digit increase in noninterest expense primarily due to one additional month of Sterling expenses. Positively, the Company anticipates merger synergies to deliver approximately $156 million (including cost saves) in profit improvements that should be realized by year-end 2012.

In 3Q11, Comerica continued to exhibit broad-based improvement in its asset quality, recording the ninth consecutive quarter of declining charge-offs. Credit quality improved for both Comerica legacy loans and the Sterling loan portfolio. Net Charge-offs (NCOs) decreased by $13 million sequentially in 3Q11 to $77 million or 0.77% of average total loans and compared favorably to 0.92% in 2Q11. Non-performing assets (NPAs) remained relatively flat, increasing $1 million QoQ to $1.04 billion and was attributable to $24 million in foreclosed property acquired from the Sterling acquisition. Credit metrics improved with NPAs at 2.53% of total loans and OREO that reflected a 13 bps sequential improvement. NPA inflows declined 13% sequentially to $130 million and overall credit metrics reflected positive migration. Moreover, watch list loans for Comerica legacy loans declined $263 million, or 5.4%, sequentially to $4.6 billion. The Sterling acquisition added $405 million of watch list loans in 3Q11.

DBRS views that positive credit trends led to a 19% sequential decline in the provision for loan losses to $38 million. Provisions were less than charge-offs for the sixth consecutive quarter in 3Q11. Despite declines in allowance for loan losses, Comerica remained sufficiently reserved at 80% of non-performing loans compared to 83% in the prior quarter. DBRS recognizes that allowance for loan losses at 1.86% of total loans declined sequentially, but continues to provide an adequate reserve cushion against unexpected losses. Allowance stood at 1.95% of total legacy Comerica loans at 3Q11. Management anticipates credit quality and migration trends to improve in the fourth quarter and NCOs are expected to be in between $65 million and $75 million accompanied by a modestly lower level in provisions.

Capitalization is solid and liquidity positions are robust, providing ample loss absorption capacity. Strong capital levels are evidenced by its estimated Tier 1 risk-based capital of 10.65%, Tier 1 common ratio of 10.57% and tangible common equity ratio of 10.43% in the quarter. As announced in prior quarters, management continued its share buyback activity and repurchased 2.1 million shares in 3Q11. The Company maintains 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: 11 October 2011

For additional information on this rating, please refer to the linking document under Related Research.