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Morningstar | Excellent Second-Quarter Results Place Comerica Ahead of Our Medium-Term Expectations. See Updated Analyst Note from 17 Jul 2018

Narrow-moat-rated Comerica reported excellent second-quarter results. The bank’s net interest income and overall profitability measures have come in ahead of our expectations, and we are increasing our fair value estimate from $81 to $90 per share. The bank has really come a long way, generally having earnings per share (EPS) of less than $3.00 prior to 2017, and now, after reporting diluted EPS of $1.87 for the current quarter, the bank is on course to easily exceed $6.00 this year. As we expect to be the case with all regional banks this year, earnings will begin exceeding decade-long record levels. Comerica's adjusted return on equity was 16.7% for the quarter, exceeding where we thought the bank would get this year.

Comerica remains our most rate-sensitive bank, and this quarter was no exception. Net interest margins expanded to 3.62% from 3.41% just last quarter and from 3.03% one year ago. The average rate paid on interest-bearing deposits is up just 27 basis points year over year, while the rate on average earning assets is up 77 basis points. While deposit betas are increasing for the bank, and there has been some shift in the mix of non-interest bearing to interest bearing deposits, we still expect sizable NIM expansion for the bank over the short to medium term. The key risk with this is, of course, that the bank remains the most sensitive to any change in the rate path, i.e. if the Fed is forced to lower rates in a worsening economic environment. However, it appears we are far from that at the moment.

Balance sheet growth was limited, with average loans up only 1% year over year and total average assets and deposits down year over year. While growth was picking up quarter over quarter, management did admit that it still isn't seeing as much of the traditional capital expenditure spending that we might have expected following tax reform and a healthy economy, but rather most borrowing has been due to M&A and/or standard working capital purposes. Noninterest income growth was also again a bit stagnant, being roughly flat year over year after adjusting for accounting changes. However, expenses remained well controlled, and we would expect positive operating leverage both this year and next.

Comerica was recently released from being subject to the annual stress testing cycle and the capital return restrictions that result. Management stated that it plans to “meaningfully increase capital returns” given these developments. The decision will take place on July 24. Given the bank’s high profitability and newfound freedom, we would expect sizable increases here. We wouldn’t be surprised to see the dividend increased yet again (after being increased just last quarter) to something closer to $0.40 or higher, potentially even as high as $0.50, from the current quarterly dividend of $0.34. A quarterly dividend of $0.50 would still be below the 30% payout ratio we see at many other banks. Eventually, we are sure the bank would like to break the $0.66 mark it achieved at pre-crisis, as this would be a significant symbolic event. We also wouldn’t be surprised to see share buybacks increase as well, with last quarter’s run rate of $169 million potentially increasing to $200 million or more.

For a more in-depth take on capital returns in the banking industry and the effects of changing stress-test regulations, please see our special report, "New Regulatory Proposals Will Change Stress Test Landscape," published on July 8.