Comerica Looks Like A Slow-Coiling Spring

By Stephen D. Simpson, CFA | April 16, 2013 AAA

With interest rates so low, loan demand pretty sluggish, and regulations chewing into once-lucrative sources of income, most banks are stuck in a holding pattern. That's particularly true for those banks with relatively clean credit stories that don't have the tailwind of improving provision and loan loss reserve releases to pump up results.

That puts investors in a tough place with Comerica (NYSE:CMA). Certainly there isn't much near-term growth potential to get excited about here. Yet, the company remains very highly leveraged to an eventual rise in interest rates. At the same time, the company's underlying quality and footprint make it an appealing M&A candidate should the board decide it's time to look to sell. In the meantime, though, it's hard to get excited about these shares at the present valuation.

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Q1 Results Driven By Costs
Comerica's first quarter results were pretty good when compared to the average sell-side estimate. Unfortunately, core growth trends look pretty soft and tight expense control isn't likely to stoke investor excitement all that much.

Operating revenue fell 5% from the year-ago period and 2% from the December quarter, as net interest income fell 6% and 2% respectively. Net interest margin actually held up better than analysts expected, rising 1bp from the fourth quarter and falling 31bp from last year, but the company's earning asset totals were lower. Fee income was a little soft as well, coming in flat relative to last year.

Where Comerica really excelled was on the expense line. Although Comerica will likely never be as profitable as U.S. Bancorp (NYSE:USB) or Wells Fargo (NYSE:WFC) in terms of efficiency ratio (the models and revenue sources are different), progress is progress and Comerica's lower expense base could really pay dividends if (when?) interest rates start moving back up.

The net impact of all this was basically flat year-on-year pre-provision net revenue, and a slight (2%) decline relative to the fourth quarter. With that better-than-expected reduction in expenses, though, Comerica did deliver a beat relative to expectations.

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Where's The Growth?
I don't want to go overboard mixing and matching banks with different operating models and geographic footprints, but I do find Comerica's results to be surprisingly growth-poor. The end-of-quarter loan balance declined 2% sequentially, coming in about 4% shy of most analyst expectations, and both commercial real estate and commercial lending were down sequentially.

That's pretty surprising relative to the results seen at large banks like JPMorgan (NYSE:JPM) and Wells Fargo (NYSE:WFC) (up about 6% and 3%, respectively). Likewise, fellow mid-cap (and dedicated commercial lender) Commerce Bancshares (Nasdaq:CBSH) saw 2% sequential lending growth. Comerica management talked about a cautious loan market due to economic uncertainties, but I think this divergence (if it really is a divergence and not just a one-quarter hiccup) is worth watching. Along those lines, I'm now even more interested in seeing what banks like Cullen/Frost (NYSE:CFR) and Key (NYSE:KEY) report for their loan activity.

High Rate Sensitivity, Coupled With A Floor In Valuation
While I think Comerica's stock is likely overpriced today, there's a lot to like about this bank from a longer-term perspective. For starters, this is one of the most rate-sensitive banks that I follow on a regular basis. Management had mentioned earlier this year that a two-point increase interest rates would translate into an 11% increase in net interest income. With the bank's clean credit quality (including a 30% year on year drop in loan loss provision) and strong capital position, not to mention improving expense base, Comerica should do well when interest rates move up again.

At the same time, I think the bank's quality puts a floor underneath the valuation. With a strong deposit position in Texas, a good (and growing) position in California, and a quality commercial lending franchise, Comerica would have little trouble finding a buyer if the board wanted to sell. A foreign bank looking to expand into California (say a Japanese, Korean, or Chinese bank) would likely consider Comerica, and a regional bank looking to make a bold coast-to-coast move (like, say, PNC (NYSE:PNC) or even Fifth Third (Nasdaq:FITB)) could also be interested. While I really don't think a deal is in the cards today, the possibility could well keep these shares from getting too cheap absent a major negative revelation.

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The Bottom Line
Done right, commercial lending is not intrinsically inferior (nor superior) to consumer lending. My issue with Comerica at this point simply revolves around the company's current level of profitability and returns and the improvements already implied by the stock price. I'm sticking with my long-term ROE target of 10%, and that suggests a fair value around $33. If you bump that to 12%, though, the target would move to $40. Likewise, you could argue that the stock deserves a premium to its tangible book of maybe 15% or 20% if it can steadily improve its returns, but I'd argue these shares are pretty fairly priced for the company's likely performance trajectory.

At the time of writing, Stephen D. Simpson did not own any shares in any company mentioned in this article.

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