Comerica Inc (CMA) 2018 Q2 法說會逐字稿

Good morning.

My name is Regina, and I will be your conference operator today.

At this time, I would like to welcome everyone to the Comerica Second Quarter 2018 Earnings Conference Call.

(Operator Instructions) I would now like to turn the conference over to Darlene Persons, Director of Investor Relations.

Ma'am, you may begin.

Thank you, Regina.

Good morning, and welcome to Comerica's Second Quarter 2018 Earnings Conference Call.

Participating on this call will be our Chairman, Ralph Babb; President, Curt Farmer; Chief Financial Officer, Muneera Carr; Chief Credit Officer, Pete Guilfoile.

During this presentation, we will be referring to slides that -- which provide additional detail.

The presentation slides and our press release are available on the SEC's website as well as in the Investor Relations section of our website, comerica.com.

This conference call contains forward-looking statements and, in that regard, you should be mindful of the risks and uncertainties that could cause actual results to vary materially from expectations.

Forward-looking statements speak only as of the date of this presentation, and we undertake no obligation to update any forward-looking statement.

I refer you to the safe harbor statement in today's release and Slide 2, which I incorporate into this call as well as our SEC filings for factors that could cause actual results to differ.

Also, this conference call will reference non-GAAP measures and, in that regard, I direct you to the reconciliation of these measures within this presentation.

Now I'll turn the call over to Ralph, who will begin on Slide 3.

Good morning, and thank you for joining our call.

Last month, the Federal Reserve announced that bank holding companies of our size are no longer subject to supervisory stress testing, including both the Dodd-Frank Act stress tests and CCAR.

Our solid financial performance and strong capital levels position us well to meaningfully increase the capital return to our shareholders.

We will continue to properly manage our capital base while supporting growth and investments in our business.

Our board will now be able to more efficiently and effectively take capital actions quarterly.

Its next meeting is on July 24, and we expect to issue a press release announcing our planned capital actions at that time.

In addition, the Fed recently announced that we are no longer subject to certain regulations and reporting requirements, such as the liquidity coverage ratio and liquidity-related reporting and disclosures.

We are still in the process of evaluating the positive effects of these changes.

Our focus remains on achieving the most efficient use of our resources for the benefit of all of our constituencies, including our customers and the communities we serve, while managing our business prudently.

Turning to our financial results.

We reported second quarter earnings of $326 million or $1.87 per share.

Our earnings per share increased 18% over the first quarter.

Relative to the second quarter of last year, our earnings per share increased 65% and pretax income is up 39%.

This is primarily due to our management of loan and deposit pricing, as interest rates have moved higher, improved credit quality as well as continued successful execution of our GEAR Up initiatives.

On Slide 4, we are outlining adjustments related to certain items, including restructuring, impacts from the new tax law and the tax benefit related to employee stock transactions.

The adjusted return on assets was 1.89%, and adjusted return on equity was 16.7%.

Please note, in the first quarter, we adopted a new accounting standard for revenue recognition which nets certain expenses against the related fee income.

The adjusted noninterest income and expense figures for the second quarter 2017 can be found in the appendix.

Turning to Slide 5 and an overview of our second quarter results.

Average loans for the second quarter were up $804 million or 2% compared to the first quarter.

Seasonality helped drive increases in Mortgage Banker and National Dealer Services.

Technology and Life Sciences, specifically the Equity Fund Services component, grew over $300 million.

Also, we have posted growth in Middle Market as well as several of our specialty and national businesses.

As far as deposits, average balances declined, primarily due to seasonality in noninterest-bearing deposits.

Starting mid-quarter, we began seeing a rebound in deposit balances, which is consistent with trends in prior years.

Net interest income increased $41 million or 7.5%, and our net interest margin increased 21 basis points to 3.62%.

The net benefit from increased interest rates was $21 million.

With a faster rise in LIBOR, we increased deposit rates to benefit our customers.

In addition, nonaccrual interest recoveries were particularly strong.

We had a broad-based decline in problem loans as well as net recoveries with charged-off loans.

This led to a reduction in our allowance for loan losses and a negative provision of $29 million.

Noninterest income was up $4 million, with a $5 million increase in customer-driven income, including commercial lending fees and customer derivative income.

Noninterest expenses were relatively stable.

A seasonal decrease in salaries and benefits expense was offset by increases in outside processing and advertising.

Also, lower restructuring expense was offset by a business tax refund we received in the first quarter, which was not repeated.

We increased our capital return to shareholders.

Equity repurchased increased to $169 million or 1.8 million shares and our dividend was increased 13%.

And now I will turn the call over to Muneera, who will go over the quarter in more detail.

Thanks, Ralph.

Good morning, everyone.

Turning to Slide 6.

Second quarter average loans increased $804 million compared to the first quarter.

Mortgage Banker loans grew nearly $350 million, with the normal pickup in spring home sales.

Our portfolio continues to be heavily weighted to home purchases, with approximately 87% purchased versus refi compared to the industry average of 74%.

We had solid growth in Technology and Life Sciences, specifically Equity Fund Services.

And general Middle Market increased nearly $150 million, with growth in all 3 of our markets.

Our auto dealer [floorplan] portfolio also increased over $100 million due to seasonal buildup in auto inventory.

In addition, we saw growth across a number of our key specialty and national business lines, including Commercial Real Estate, Environmental Services and Entertainment.

Partly offsetting this growth was a decrease in Private Banking as a result of a few large loan payoffs.

Also, we remain selective in the large corporate space, maintaining our pricing and underwriting standards in a highly competitive environment.

As anticipated, the pace of decrease in Energy loans has slowed, but continues due to capital markets activity and asset sales, resulting from firmer commodity prices.

Total period-end loans increased $552 million, with the largest contributions from Mortgage Banker and Technology and Life Sciences.

Also, commitments were up $1.6 billion, driven by increases in nearly all business lines.

Overall, the sentiment is positive, reflective of the improving economy, yet customers continued to be cautious given uncertainty regarding evolving trade discussions.

Our loan yield increased 37 basis points.

Higher rates, including a 32 basis point increase in average 30-day LIBOR, added 27 basis points to our yield.

Nonaccrual interest recoveries, which are difficult to predict, increased $9 million, and added 8 basis points.

Finally, portfolio dynamics, such as a mix shift in the portfolio and loan fees in the margin, added 2 basis points.

Importantly, we are focused on our relationship strategy to appropriately manage loan pricing.

As you can see on Slide 7, average deposits declined $260 million in the second quarter, primarily as a result of seasonality.

Municipal deposits decreased as they typically do following tax collection in the first quarter.

Also, Middle Market was impacted by seasonality as customers are utilizing their cash in their businesses.

Midway through the quarter, we began to see positive trends.

Average deposits in June grew $749 million over May.

This included the highest growth in interest-bearing deposits for June we have seen in many years.

We expect deposit growth to continue in the back half of the year, in line with the historical pattern.

In conjunction with the faster rise in LIBOR, we increased deposit rates.

We rely on our relationship model to stay close to our customers and help ensure we are offering competitive and appropriately priced products.

Our primary objective is to retain and attract deposits, while managing our costs.

We believe we are well positioned and, at the present time, don't expect similar incremental standard pricing actions.

Our securities book remains at about $12 billion, as shown on Slide 8.

The portfolio's unrealized loss position of $328 million had a minor impact on the carrying value.

The yield on the portfolio continues to trend up.

Recent securities purchases have been in the low 340s, which was about the average rate of 2.25 on the $450 million in paydown we received in the quarter.

Turning to Slide 9.

Net interest income increased $41 million and net interest margin was up 21 basis points.

Our loan portfolio added $59 million and 29 basis points to the margin.

Increased interest rates provided the largest benefit, along with higher loan balances, an unusually high level of nonaccrual interest recoveries and 1 additional day in the quarter.

As far as our deposit at the fed, the benefit from the higher fed funds rate was mostly offset by a decrease in average balances.

This resulted in a net benefit of 3 basis points to the margin.

On the funding side, deposit costs were up $12 million, primarily due to increased pay rates, as I've previously discussed.

This had a 7 basis points impact.

Also, wholesale funding costs increased $5 million as a result of the increase in 6-month LIBOR and $2 million as a result of some FHLB funding that was added in the first quarter at attractive rates.

In summary, the net impact from increased rates contributed $21 million or 11 basis points to the margin.

Credit quality remained strong, as shown on Slide 10.

Gross charge-offs of only $20 million were more than offset by unusually high recoveries of $23 million.

Total criticized loans declined $355 million or 17% and now represents 3.5% of total loans at quarter-end.

This included a decrease in nonaccrual loans, which comprised only 51 basis points of our total loans.

Energy criticized and nonaccrual loans continued to decrease.

The positive credit migration resulted in a reserve release and a reserve ratio of 1.36%.

We remain vigilant and continue to look for signs of stress.

At this point, we are not seeing any concerning trends.

Turning to Slide 11.

Noninterest income grew $4 million.

This included a $5 million increase in commercial loan fees, primarily related to syndications as well as customer derivative income.

This was partly offset by a decline in investment banking fees.

In addition, we increased the reserve for a derivative contract related to Visa Class B shares by $2 million.

We remain on track to achieve our GEAR Up revenue target.

To highlight our progress, you can see the growth we have achieved on a year-over-year basis in card, fiduciary and brokerage.

Expenses remain well controlled and our efficiency ratio fell to 53%, as shown on Slide 12.

Salaries and benefits decreased $5 million, following annual share-based comp and higher payroll taxes in the first quarter.

This was partly offset by annual merit raises, higher incentives related to our financial performance and 1 additional day.

We continue to execute our GEAR Up initiatives, as evidenced by our total workforce reduction of 1% from the first quarter and nearly 2% over the past year.

We had increases in outside processing, which was mostly tied to revenue-generating activity as well as advertising expense, which was seasonally low in the first quarter.

You may recall that we had a business tax refund of $5 million in the first quarter and it was not repeated.

Restructuring charges were $11 million, a decrease of $5 million from the first quarter.

In the second quarter, we repurchased $169 million or 1.8 million shares under our equity repurchase program, as you can see on Slide 13.

In addition, we increased our dividends 13% to $0.34 per share.

Together with dividends, we returned $227 million to shareholders.

Employee stock activity added about 200,000 shares during the quarter.

This activity resulted in a credit to our income tax provision of $3 million or $0.02 per share.

As Ralph indicated, we expect to provide an update on our planned capital actions after our board meets next week.

Turning to Slide 14.

Our balance sheet continues to be well positioned to benefit from increases in rates.

Our asset sensitivity is illustrated by our betas so far this cycle, with a cumulative loan beta of 94%, while our cumulative deposit beta is 18%.

Our asset betas have outperformed our expectations, allowing us some flexibility to manage deposit costs, while significantly adding to our bottom line.

We expect the net benefits from 2018 from the first quarter rate increase to be $70 million and $35 million to $40 million in additional net interest income for the second quarter rate increase.

Out of our $35 million to $40 million, $6 million is already in the second quarter run rate.

In total, we estimate $270 million in additional net interest income in 2018 resulting from the full year impact of the 3 rate increases last year and the March and June hikes this year.

For the remainder of the year, we're assuming that short-term rates remain at the current level as average deposit rates increase 8 to 10 basis points from here.

We remain focused on our relationship approach to manage loan and deposit pricing to attract and retain customers.

Of course, the ultimate outcome depends on a variety of factors, such as the pace at which LIBOR moves, loan and deposit competition and balance sheet movements.

It is likely that the Fed could be raising rates 1 or 2 more times this year, and we stand to further benefit with our well-positioned balance sheet.

We have not added hedges to change our asset sensitivity.

Our Asset Liability Committee continues to assess our position to determine the appropriate path given balance sheet movement and our outlook for rates.

Now I will turn the call back to Ralph to provide an update on our outlook for the remainder of 2018.

Thank you, Muneera.

As usual, our outlook assumes a continuation of the current economic and interest rate environment.

As I mentioned at the beginning of the call, recent regulatory developments, such as elimination of CCAR and LCR, are certainly positive, but it's too early to provide guidance on the effects of these changes.

As far as loans, following a seasonally strong second quarter, we expect to drive moderate growth in the back half of the year.

This includes increases in most businesses, led by Mortgage Banker, primarily due to seasonality, as well as Technology and Life Sciences, tempered somewhat by a seasonal decline in Dealer and a slight reduction in the pace of Middle Market growth due to the typical summer slowdown.

Regarding net interest income, as Muneera indicated, we expect to continue to see the net benefit of the recent rise in short-term rates.

Also, we expect contributions from loan growth and additional days.

Recall, in the second quarter, we had nonaccrual interest recoveries of $11 million.

This elevated level is not expected to repeat, as we typically collect $1 million to $2 million per quarter.

And while not included in this outlook, we are well positioned to benefit from any further rate increases.

We expect the provision to be between $10 million and $20 million per quarter, as credit quality remains strong.

Our fee income growth trend is expected to continue with the execution of our GEAR Up initiatives, helping drive growth in card fee, treasury management and fiduciary income.

Excluding restructuring costs, expenses are expected to increase modestly from here, primarily a result of additional days in the back half of the year.

We continue to be on track to fully realize our GEAR Up savings.

We expect rising technology project costs as well as typical seasonal and inflationary pressures on occupancy and advertising.

Restructuring expenses for the second half of the year should be about $20 million to $25 million.

We expect to continue to achieve positive operating leverage and drive our efficiency ratio lower.

Finally, we are maintaining our expectation for our effective tax rate to be approximately 23%, excluding any impact from employee stock transactions, which are difficult to predict.

All together, we expect our pretax, pre-provision net revenue to continue to grow.

In closing, our second quarter results were solid, as we have continued to manage loan and deposit pricing in a rising rate environment.

Loan growth and favorable credit metrics, combined with higher fee income and well-controlled expenses, helped drive a 16% increase in our bottom line relative to the first quarter.

As I mentioned at the start of the call and as a result of recently announced changes in regulation, our board will review our capital plan next week.

We are well positioned to meaningfully increase our capital return to our shareholders.

Furthermore, we expect to benefit from additional rate increases and economic growth.

We remain focused on maintaining momentum and driving shareholder returns.

And now we will be happy to take any of your questions.

(Operator Instructions) Our first question will come from the line of Steven Alexopolous with JPMorgan.

Ralph, I wanted to start on capital.

What are your updated thoughts on how much CET1 you guys need to run the business long term?

We really haven't put a view out there as to what our point will be at this time.

That will come in the future, I think, as we look -- as we see how things develop.

Okay.

And as we think about this upcoming board meeting, Ralph, could you help us think about, what's on the table for this meeting?

I mean, could payouts move to 150%-plus where you were historically?

Like, what range of options are you now looking at?

Well, I wouldn't put ranges on it, but I would tell you that it is -- will be looked at from the standpoint of what is appropriate based on what we see with the business and what we feel comfortable with moving forward.

And I think that puts the ability to manage capital back in our hands along with the board.

And I think you will see that.

Okay.

And then on the commercial business, if we look at general Middle Market, it's still pretty flat year-over-year.

What are most of your Middle Market customers doing at this point with the benefit of lower taxes?

Curt, you want to give an update on that?

Yes.

Steven, we did see growth in all 3 of our Middle Market regions, and we've had good momentum in the first half of the year.

Having said that, as Muneera alluded to, I think Middle Market customers remain cautious.

Probably the greatest source of caution right now relates to the -- what may or may not have happened on the tariff side of the house.

Short term, the tax reform probably works against us a little bit in terms of loan growth, in terms of the fact that our customers have more cash, less expenses to plow back into their business lines.

But we are not yet seeing what I would call a lot of traditional CapEx spending occurring.

Most borrowing that we have participated in has been either M&A-type transactions or customers borrowing for traditional working capital needs.

Okay, got you.

And then just a final one on deposit strategy.

With the loan-to-deposit ratio at around 87% and you're now out of LCR, do you expect to be active trying to grow deposits?

Or going forward, do you think it's more likely you'll fund loan growth from cash and securities, not necessarily need to grow the size of the balance sheet?

This is Muneera.

Yes, sure.

I mean, our objective always is to grow both loans as well as deposits.

We will stay focused on that.

You can see that we are doing what we need to do on the deposit cost side to be able to retain and attract deposits.

But I would also -- I'll add to that, though, from a security standpoint I mean, clearly, that is an option that is available to us going forward as our securities book is a reservoir of liquidity for us.

Not being subject to LCR, it certainly frees up that source of funding.

Your next question will come from the line of Ken Usdin with Jefferies.

Muneera, can you expand a little bit on your comment about deposit costs in the second half?

So the 17 basis point increase we got in interest-bearing deposits to 42 basis points, you said 8 to 10 for the rest of the year.

So can you tell us what that means in terms of how you're thinking about the trajectory, both in the third and the fourth?

I know this is one of the hot topics out there.

So I will tell you, thus far, we've done a great job of managing our deposit costs with a cumulative beta of 18%.

We've been talking about the fact that Q2 was different.

We saw LIBOR increasing 32 basis points in the first 2 quarters.

We were in a position to make some changes to our deposit costs that we believe positioned us well competitively.

We don't expect to see another jump of 17 basis points, something in that magnitude, again.

We have signaled that, generally, deposit costs will continue to increase with every passing rate rise.

For June, you've heard my comments, I said the increase would be 8 to 10 basis points.

That translates to a beta of 30% to 40%.

And then if you're asking me about trajectory and where things will go, for now, I will refer you to our standard model, which includes a 50% beta.

It has some fairly conservative assumptions built in for deposits runoffs.

We will continue to update folks as the rate rises get closer as we can see the movement on our own balance sheet as well as what's happening in the competitive environment.

What I'll tell you is, even with a 17 basis point increase, our total deposit cost of 42 basis points will still be one of the lowest deposit costs in our peer group.

So I clearly expect that we will be able to hold on to the benefit that we've seen from lower deposit costs so far in the cycle.

I mean, I don't expect that we will give it up, but you will see some variabilities in betas going up and down, depending on what's transpiring out there.

Very good.

And as a follow-up to that.

So you mentioned that you've done that standardized increase and you don't expect to do one at least right now.

What would change your view about having to go back to the entire rate sheet and put through a broad standardized increase again?

It seems like your bias is to not do that, to your point.

Yes.

So a lot depends on what's happening in the competitive environment.

It depends on what's happening with loan-to-deposit ratios.

I would say that, so far, overall, the industry continues to be well behaved.

There's still a fair amount of liquidity in the system.

We see corporate treasurers having a bias to maintaining higher levels of liquidity.

That's what shows up in our own noninterest-bearing deposits.

And so to the extent all of that continues, I think that we won't necessarily be looking to make another broad-based price change.

But having said that, you know that the Fed is unwinding its balance sheet.

How -- where that goes and how that affects the system, all that remains to be seen.

Okay.

And then last final thing is just, the 8 to 10 basis points you said, is that expected to be each quarter from here, or is that your aggregate view of what happens in the second half?

That is our view specific to the June rate rise.

I'll tell you, beyond that, I said you look at the model, which is at 50%, and for any given single rate rise, there'll be some variability.

It will go up, it will go down.

But like I said, I expect to hold on to the benefit that we have thus far today.

Your next question will come from the line of John Pancari with Evercore.

On the expense side, specifically on comp, it came in higher than what we had expected, and overall expenses appear to be -- have come in for the quarter higher than what you've guided to.

I believe you guided to down modestly off of the first quarter core base of $430 million.

So what drove the somewhat higher level than you had expected for the quarter?

If you could give us some specific color around comp as well.

Muneera, you want to take that?

Sure.

Our view on overall expenses from the outlook that we provided earlier this year hasn't really changed.

What has changed is our outlook was based on a continuation of the economic and rate environment.

And as time has progressed, we received 2 more rate rises.

We've done a good job of managing loan and deposit pricing.

The credit situation has improved.

And if you look at the company's performance metrics, you can see that we're doing really well across the board.

All that means is that we have to look at incentive comp inside financial performance, that's one of the movers that you'd see that has [come through] salaries and benefits expense.

I mean, I pointed out workforce numbers.

We continue to watch our overall expenses, but that's the main reason for the shift.

So there's a formal change in your incentive comp structure?

No, there isn't.

The comp structure is exactly the same.

It depends solely on performance, and moves with good years and bad years.

We are having a good year and then, hence, the increase.

Okay, all right.

And then, separately, on the loan growth side.

When you look at the update that you gave us that accounted for April and May, it appears that there might have been some moderation off that pace in June.

Is that what you saw and what you cited on the mid-market side, some of that cautiousness getting dialed in?

Curt, do you want to take that?

Yes.

John, I think that's the case.

When you look at sort of a go-forward for us is the main thing, the important thing to remember for our company, given the seasonality of Mortgage Banker Finance and Dealer, second quarter tends to be a strong quarter for us, specifically around Mortgage Banker Finance, right?

Dealer tends to be a strong quarter in the fourth quarter.

So when we're using language like moderate growth for the remainder of the year, what we're taking into consideration is that remaining seasonality for the year in Mortgage Banker Finance and Dealer, and probably some seasonality as well in the third quarter that we normally see in Middle Market, with sort of the summer slowdown for many of our Middle Market clients.

But we are expecting growth in most of our other businesses.

And specifically, I might point continued growth in Technology and Life Sciences, Commercial Real Estate and a few of our other select specialty lines of business.

Your next question will come from the line of Ken Zerbe with Morgan Stanley.

I just want to, I guess, start off just in terms of the asset beta.

I was hoping you can kind of go over that a little bit more.

I think I calculated your total asset beta like 128% of fed funds.

I know you're tied off of LIBOR, which went up more than fed funds in the quarter.

But can you just talk about like the timing of resets?

Like, was there something besides LIBOR that drove it higher in terms of how the loans reset?

Just would love to get more detail.

Muneera?

I know that asset beta has been really well, 37 basis points up this quarter.

You saw the effect of nonaccrual interest recoveries, which were elevated.

But really, this is us pulling through and having normal resets that we typically do.

I would expect that, as LIBOR increases, our actual flow-through rate is about 80% to 85%.

So as LIBOR goes up, on average, 20 basis points, we see an improvement of, I don't know, about 16, 17 basis points in our yield.

That should be what you should expect going forward on the asset side.

Got you, okay.

So this quarter is just particularly unusual.

Okay, and I guess...

go ahead.

No, the only thing I was going to point out.

I mean, LIBOR did go up 32 basis points on average so -- and we are just pulling through the benefits of that.

Understood.

And I guess just to be super clear on the margin for third quarter.

If we use just, I know it's a generic example: if LIBOR goes up 20 basis points, whatever, but am I thinking about it right that your loan yields will go up, say, 16, 17 basis points in your example and then you're also saying deposit costs, your interest-bearing deposit costs go up, I think it was 8 to 10 basis points.

So -- I mean, we can run the math on noninterest-bearing, et cetera, but that's the kind of magnitude of NIM expansion we should be looking at for third quarter?

Am I thinking of that conceptually correct?

You're thinking about it conceptually correct.

I just used 20 as an example.

I don't know where average LIBOR is going to go.

So I would say, adjust accordingly.

Our next question will come from the line of Erika Najarian with Bank of America.

So as we think about some of the flexibility afforded to you by some of the regulatory change, how much do you have in HQLA currently today?

And how much of that HQLA pool can we think as flexible to potentially fund loan growth?

It's a meaningful number just in broad strokes.

But clearly, we have ample funding available today, so it's not something -- this is just something we can tap as the balance sheet changes.

Got it, okay.

Just following up, one last follow-up question at least from me on all the deposit questions that you've answered so far, and thank you so much for your answers.

As we think about the dynamics, just following up to Ken's last question, as we think of the interest rate environment continuing to normalize and, of course, you mentioned, Muneera, the Fed reducing its balance sheet, what is -- how should we think about a normal level of noninterest-bearing deposits for Comerica?

And outside of the seasonality that you saw with municipal deposits this quarter, what are you observing broadly about mix shift trends?

A couple of points on that.

When we look at the changes in our portfolio, you're right, year-over-year, municipal deposits have been a headwind for us.

But beyond that, when we look at our customer balances, when we look at Comerica's historical trends, the portfolio is behaving in line with what we've seen in times past.

So it's very typical for Comerica to have a decline in deposits in the first half of the year.

It's very typical for us to go up in the back half of the year.

This trend holds true for several years in the past.

And so that's what we based our view on as to where things are going for us.

At least in the near term, we do see some of our customers putting their money to work.

It's what we said we would be seeing.

People are -- reducing leverage, they're using their money for M&A, for working capital needs.

And so that certainly continues.

Beyond that, we will just have to wait and see how things evolve, and it's really difficult for us to predict what happens with deposit balances.

Got it.

And just one final question for me.

Just comparing the guidance slide in terms of your outlook for noninterest expenses and just looking at what you had put forth last quarter.

Last quarter, you mentioned that you're expecting a 1% increase over an adjusted 2017 number, which I think at the time implied a $1.713 billion base for '18.

And I just wanted to clarify that the different language that you put on this quarter's slide did not indicate a change in expense guidance.

Muneera?

We are indicating that expenses will be slightly higher than what we originally estimated because our original estimates were based on a continuation of the interest rate and economic environment.

And of course, as things have improved, it means that certain comp like incentive comp has to be adjusted.

And when we go get interest recoveries of $11 million, there is compensation that goes along with that.

And so that's what it reflects.

Also, I wanted to point out that our FDIC expense, we were hoping that the surcharge would go away in the back half.

And clearly, there's been some reluctance there, that just isn't quite reaching the percentage it needs to, and so that's another reason for us to make a slight change.

Got it.

But end of the day, the efficiency will continue to improve meaningfully?

Absolutely.

Yes -- thank you for reminding me.

Yes, the efficiency will increase, we expect fully to have positive operating leverage.

Your next question will come from the line of Bill Carcache with Nomura.

I had a follow-up question on capital, specifically, the pace of capital return.

So under CCAR, there had been this view that you had to take payouts up gradually over time through the process.

In light of the regulatory changes that we've seen, do you now feel like you guys have greater freedom to simply keep what you need and return the rest?

And then implicit in that question is, can you just clarify for us the degree to which you feel bound by the submission that you made that ultimately you guys didn't have to go through the process but, nevertheless, you made the submission?

If you could give a little bit of color around that, that would be great.

Well, as we discussed earlier, when you look at what we will be doing, basically, on a quarterly basis, we will be reviewing where we are from a capital standpoint and where we believe we need to be and what effects -- are the normal effects out there as to grow than the economy and so forth.

And we then have the ability to manage our capital going forward.

We haven't put out, as was asked earlier, a point of where we want to be from a capital standpoint.

We may do that in the future, but I think we want to move down the road a while first.

And our CET right now is a little over 11%, and I think we all understand that, that is pretty high.

Right.

And so in essence, there is a recognition that you are -- that the rules have changed.

And that in evaluating on a quarterly basis your capital levels, you're able to take that into consideration and, therefore, arrive potentially at a different outcome than you would have arrived at under the previous rules?

We could be more focused on what is happening today versus having to look out and consider what's happening over a [year] purposes or more.

And that makes us much more agile in managing our capital going forward.

That's great.

If I may follow up on a related M&A question.

Now that you've been released from CCAR, some investors have expressed concern with the potential that some of your excess capital could be consumed in an M&A deal that could significantly dilute tangible book value, similar to some of the recent deals that we've seen from others.

Could you speak a little bit to your appetite for M&A and whether that has or has not changed after your release from CCAR?

I would say it has not changed.

And as we've always said, when things become available, we will take a look at them.

But we feel very comfortable with our footprint today, and especially in the states where we are doing business and the growth potential there.

And adding, internally, to grow that is top of the chart at the moment where our focus is for expansion.

Your next question comes from the line of Scott Siefers with Sandler O'Neill + Partners.

Just on sort of behavioral changes post-DFAST and CCAR, not as it relates to what you'll do with the excess capital, but just practically what being released from this stuff means for how you will go through sort of measuring your own levels of risk, et cetera.

Under CCAR, for example, you spend a year, and you have a dozen -- or excuse me, dozens of people getting to the same place that you can get with a few assumptions and much more rapidly.

So presumably, there are some opportunity to flex expenses.

And even if you don't want to get into the savings, just what will you be doing differently internally now that you've got some of this flexibility or relief?

As I mentioned in the remarks earlier, what we'll be doing now is going through and looking at all of the things that we've done and put together for the previous process.

And what -- and some of those are strengths going forward in deciding exactly what we want to do going forward.

And there will be some savings there as well.

But it will be building the process we're going to use going forward, I guess, is the right way to say that.

But it will save expenses.

I was just going to highlight the same thing.

I was going to say it's going to be a lot more efficient.

Yes, okay.

And I guess that's probably an iterative process, but it's not something you've come to definitive conclusions on now, right?

You're just sort of seeing what's appropriate to continue to spend money versus get some savings out, et cetera.

Is that the best way to look at it?

That's the best way to look at it, but we want to go through it fairly quickly and make a determination of where we feel we are and where do we need to be today.

And we'll be doing that.

It'll take a little while to do it, but...

Our next question will come from the line of Geoffrey Elliott with Autonomous Research.

In terms of capital and the split between dividend and buyback, does the regulatory change shift the way you're thinking about the emphasis there?

I don't think the change causes an issue there.

We will be looking at that based on what we foresee in the future and taking the appropriate position, obviously, because we know there are ups and downs in the economy that we have to be prepared for.

And I think we've done that in the past very well and that'll be something we'll look at as we go.

And can you explain the role of the regulators now?

Are there still sort of certain guardrails, if you like, in terms of what you can and can't do on capital return?

From a regulatory perspective, what do you need to get approval to do from the regulator?

And where do you just kind of have flexibility to have the board meeting and go ahead and take your own decisions?

I think there are things that are still developing there, so I really don't have a feel for exactly how it may settle in the future, but I would say that even before CCAR and all of the tests, we routinely reviewed what our thoughts were and our planning was for the future with our local regulators to make sure that they were comfortable with it as much as we are.

Our next question will come from the line of Brett Rabatin with Piper Jaffray.

I wanted to ask, first, Ralph, is there any explicit reason why you can't be a little less opaque about the capital return process?

And you're obviously being able to manage capital more on a real-time basis.

I guess I'm just -- I want to make sure there's not something I'm missing about why you can't be a little more effusive about what you plan.

Well, I think the reason for that is that it just happened and we are getting used to it.

And I think the regulatory environment is looking at it as well, and it takes a little bit of time for that to develop.

Okay, fair enough.

And then wanted to ask.

On the deposit side, in terms of what you're expecting on deposit betas from here, what kind of assumptions does that entail from a -- just a seasonality perspective and municipal deposits?

And kind of what happens from here with some of the various categories in terms of growth, especially on a core basis?

Muneera, do you want to take that?

Yes.

Brett, as I've mentioned earlier, I do expect that there will be variability in there.

Deposit betas go from one rate rise to the next.

But overall, I would say, for now, our standard model with the 50% beta is the best thing I can point you to, and that remains to be seen on how balance sheet evolves.

I think the industry as a whole has a fair amount of liquidity and know the deposit ratios are healthy.

So at least in the near term, as best I can tell, I would expect that of the standard model assumption should hold true.

Okay.

And then just lastly, that the -- credit is obviously really good right now.

Just from a recovery perspective, is there a pool of loans, whether from Energy or otherwise, that could still result in net charge-offs being negative going forward?

Or can you give us any color around maybe that pool?

Pete, do you want to take that?

Yes.

It's been a long time since we've been in a net recovery position like this.

And it doesn't happen very often, and we wouldn't expect going forward to see those kinds of recoveries.

Your next question will come from the line of Peter Winter with Wedbush Securities.

When you guys talk about modest loan growth in the second half, can you just define modest loan growth?

And then, secondly, it sounded like customers are more cautious than they were in the first quarter.

And is that solely just related to the trade wars, or is there something else going on?

Curt, do you want to take that?

Yes.

I might start, Peter, with the second half of your question.

I don't think there's anything else going on.

I do think that tariffs and trade-related issues, especially given the markets that we're in, Michigan, California, Texas, all who have some economic reliance on trade and some of the industry verticals that we operate in, kind of given that, I would say that is probably the primary concern that we're hearing from customers right now.

So that's, I think, factored into somewhat of our more moderate view on a go-forward basis.

But I do want to emphasize that part of that moderate view as well is just the seasonality that we see especially in the third quarter in Middle Market and that seasonality in both Dealer and Mortgage Banker Finance.

And when you say modest, is that more like 1% to 3% type range?

I wouldn't quote a specific number, but just would guide you towards the language that we've used.

Okay.

And then just separately.

Now that you're no longer a SIFI bank, is there some type of informal stress test exams that you have to participate in?

No.

But there will be, and it was said in some of the announcements that there will be a development of how we'll be looked at over a longer term.

So I think they will be adjusting what they're looking at and how they're looking at it as well as we going through the process for us, too.

Your next question will come from the line of Jennifer Demba with SunTrust.

My question is for Pete.

Just wondering how the problem loan levels stand in the Energy portfolio now and when that portfolio should stabilize or grow.

Pete?

Well, we'd like to see it keep from running off.

It's been coming down quicker than we've been adding new deals.

We wanted to have new space for how we selected there, but we like it a lot.

We still have 19% criticized.

We would expect that, that 19% would continue to come down, not just through payoffs, which would reduce loan balances; but also upgrades as well.

And so we're hopeful that the Energy portfolio will stabilize from a balance standpoint from where it is today.

Your next question comes from the line of Steve Moss with B. Riley FBR.

I wanted to start off, I guess, just with -- on the credit topic and more actually CECL, just wondering what your preliminary thought could be with regard to the provision and the capital impact come 2020.

Pete?

We're not prepared to release anything with regards to CECL yet.

We're working towards a 2020 date when we'll be implementing.

The only thing about it I am comfortable saying is that if you look at our portfolio relative to our peers, the duration of our portfolio, which is a big driver of CECL, is substantially less than a lot of our peers.

And so we would expect whatever impacts there are from a level standpoint and then from a quarterly provision standpoint should impact us less because of that shorter duration.

Okay.

And then, on deposits here, your noninterest-bearing deposit mix remains really strong here, over 50%.

Just wondering -- the balances are down a bit year-over-year, just wondering where do you think that goes if we see another 50 to 100 basis points in rate hikes.

So when you look at our deposit base, and you mentioned noninterest bearing, 90% of that is commercial.

And in the past, we've mentioned that, of those commercial deposits, a vast majority of them are tied to our Treasury Management product.

We have a lot of connectivity with these depositors.

And as I mentioned earlier in my comments, there is a desire by corporate treasurers to maintain higher levels of liquidity.

So all of that plays in.

For all those reasons, at least as far as they're concerned, we expect things to be stable.

When we go along with the full relationship propositions, deposits come along with that.

So all of that kind of goes into our thinking about the fact that, generally, things should be fairly stable.

Your next question comes from the line of Dave Rochester with Deutsche Bank.

On expenses, I know 2019 is still a bit further out.

But I was just curious how you're thinking about expense growth next year as the GEAR Up efforts wind down.

Why you should still get the benefit of the roll-off of the FDIC surcharge that you were talking about?

Any preliminary thoughts there?

Muneera?

Okay.

Looking forward, I would say you're right, FDIC surcharge will go away.

We intend to continue the expense discipline that we have used in the last couple of years.

We intend to continue leveraging technology to simplify our processes and be efficient.

There will be your typical inflationary pressures.

But overall, I mean, that's sort of what I see looking out.

Are you thinking that the...

sorry, go ahead.

No, I was going to add, I do expect that the efficiency ratio will keep moving in the right directions and that we'll maintain positive operating leverage.

Are you thinking that we could perhaps see a little bit of a pickup in expense growth because of the efforts you're talking about or the fact that the tailwinds from GEAR Up are done?

Or do you think you can kind of remain in this low single-digit range of growth?

I believe we will remain in the low single-digit level of growth.

Okay, great.

And just switching to the NIM real quick.

In the absence of rate hikes, so if we don't get a rate hike in September, for example, I was just curious what your thoughts are on how the NIM would trend without the benefit of the bump up in the loan yield?

Are you thinking we could see some stability in that kind of scenario?

Or would you expect to see some kind of an upwards movement in deposit costs kind of eating into the NIM a little bit?

Just any thoughts there will be great.

Yes.

I mean, given our asset sensitivity, clearly, NIM benefits most to drive rates, but I would still expect that without rate, we would have stability in our NIM.

I don't expect that deposit costs will rise in a more stable rate environment.

Your next question comes from the line of Brock Vandervliet with UBS.

I think most of the metrics on deposit costs have been covered.

I was just curious, operationally, when you look to make the increase that was manifest in the second quarter, was that -- how has that kind of pushed down to clients?

Was that broad-brush, across-the-board increases or more of a pull-through and granting exceptions, that kind of thing?

Curt, do you want to take that?

Yes.

Brock, I think, first and foremost, for us, whether it's loan pricing or pricing on any of our fee income products for deposit pricing is to make sure that we're taking a relationship approach.

And so we really take that into consideration.

We were looking at both competitive landscape and also our customer relationships.

And so when we look at pricing increases, we really try to make sure we're passing that onto the majority of our clients as appropriate, and I think we've done that effectively thus far.

Okay.

And separately, within Equity Fund Services, I know that's been called out several times as an area of strength.

Could you quantify that at all in terms of the annualized growth we should expect there?

And secondly, has there been any change in resource allocation to that area?

Curt?

First of all, I would say that it has been an area of accelerated growth the last several years, and that's really in response to what's been happening in the private equity venture capital arena.

There's been a lot of new fund formation.

There's been a lot of both corporate or institutional and private money flowing into our private equity, for example, which has created a lot of the demand there.

In terms of resource allocation, we look across all of our businesses to make sure that we're appropriately resource allocated and that we can shift resources as needed and move relationship managers and credit support staff, analysts, et cetera, to various business lines.

Part of what we've been doing through GEAR Up, we talked about before about the E2E (end to end) credit initiative, which really for us is rethinking some of our processes around loan origination approval servicing going forward, and that is creating through automation, changing some processes, additional capacity for us, and Equity Fund Services would be one of the businesses that's benefiting from that.

Our final question will come from the line of Brian Klock with Keefe, Bruyette, & Woods.

So I just want to follow up, and I apologize if you guys answered this already.

But maybe it's a question for Pete.

On the interest recoveries, can you give us the size of the loans that paid off with that interest recovery?

Most of the unusually large interest recovery is driven by, I want to say, 2 or 3 credits.

They were good-sized credits.

It wasn't so much the size of the credit, though.

It was how long we were accumulating the interest and not running it through the P&L.

And so some of these were nonaccruals for some time, and that's why the recovery was so large.

Got you.

So I guess what I'm trying to figure out is, when you look at the criticized, that dropped so meaningfully; in the nonaccrual, that dropped.

So should we look at that drop and say that your core growth outside of those short of paydowns -- some solid growth this quarter, I can be wrong, but just thinking about it spot quarter-to-quarter, end-of-period basis, it's a lot stronger core loan growth than the 4.5%, like quarter annualized growth that you just look at from spot, so...

That's correct.

I mean, that did impact our loan growth, is the fact that we were successful in getting payoffs on some nonaccrual loans this quarter.

Got it, got it.

And just a follow-up for Muneera.

I think you mentioned something about the [FDIC] surcharge when you talked about the expense guidance for the second half of the year.

It looks like the diff is about 130, and it looks like it's on its way to getting to the 135 by the second half of the year.

So are you including any expectation of getting that $6 million to $7 million surcharge eliminated in the fourth quarter?

Or that's not in your guidance at all you had for the second half of the year?

It's not in our guidance.

I will now turn the call back over to Ralph Babb, Chairman and Chief Executive Officer, for any closing remarks.

We appreciate very much your interest in Comerica, and thanks for being on the call today, and we hope everybody has a great day.

Thanks very much.

Ladies and gentlemen, this concludes today's conference.

Thank you all for joining, and you may now disconnect.