Comerica Inc (CMA) 2021 Q2 法說會逐字稿

Good day, and thank you for standing by. Welcome to the Comerica Quarterly Earnings Call. (Operator Instructions)

I would now like to hand the conference over to Darlene Persons, Director of Investor Relations. Please go ahead.

Thanks, Regina. Good morning, and welcome to Comerica's Second Quarter 2021 Earnings Conference Call. Participating on this call will be our President, Chairman and CEO, Curt Farmer; Chief Financial Officer, Jim Herzog; Chief Credit Officer, Melinda Chausse; and Executive Director of our Commercial Bank, Peter Sefzik.

During this presentation, we will be referring to slides, which provide additional details. 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 can cause actual results to materially vary from expectations. Forward-looking statements speak only as of the date of this presentation, and we undertake no obligation to update any forward-looking statements.

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

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

Good morning, everyone, and thank you for joining our call. Our second quarter results showed continuation of several favorable trends, including strong deposit growth, robust fee income and excellent credit quality. Revenue increased quarter-over-quarter and year-over-year despite the low rate environment. We remain focused on expense control while supporting our revenue-generating activities. Also, we repurchased nearly 6 million shares, reducing our share count by over 4%. We generated earnings of $2.32 per share and an ROE of over 17% and an ROA of 1.50%, remain above our historical norm. We continue to demonstrate our unwavering dedication to providing a high level of service and support for our customers, communities and each other.

During the quarter, we committed $5 billion to small business lending over a 3-year period. Also, we appointed a National Asian-American Business Development Manager, who joins our Hispanic and African-American development managers to support and strengthen relationships in our communities. In conjunction with this announcement, we made a deposit into an Asian-American Minority Depository Institution.

In regard to sustainability, our ESG Council recently defined the most significant ESG issues for our company, specifically those that are most impactful for our customers and colleagues and in which we feel we can make a meaningful difference. We call this our ESG Commitment as outlined on the slide. I look forward to sharing with you our continued progress in these critically important areas.

Turning to our second quarter financial performance on Slide 4. We saw a solid loan growth in several business lines, led by General Middle Market. This was more than offset by a large decline in auto dealer floorplan due to supply constraints as well as Mortgage Banker due to lower refi volumes. Our pipeline again increased as companies ramped up with the economy re-opening. Deposit growth continued to be very strong. Average balances increased 6% or over $4 billion to another all-time high. The full quarter benefit of federal stimulus payments, along with seasonality, contributed to a $1.7 billion increase in consumer deposits. Commercial deposit growth mostly reflects our customers' solid profitability and capital markets activity.

Net interest income increased $22 million. You may recall that the first quarter was impacted by a $17 million in lease residual adjustments. We continue to carefully manage loan and deposit pricing as well as the securities portfolio in this ultra-low rate environment. Credit improved from already strong levels. We had net recoveries of $11 million, the highest level of net recoveries in at least 20 years. Criticized and nonaccrual loans declined, a true reflection of our disciplined credit culture, diverse portfolio and expertise in the industries we serve. Our credit reserve continued to decrease and resulted in a negative provision of $135 million as the portfolio continues to perform better than expected going into the pandemic. The reserve ratio remains healthy at 1.44%, excluding PPP loans. Fee generating activity was again robust. Noninterest income grew 5% with increases in card, commercial lending and fiduciary income. Also, expenses were well controlled and our efficiency ratio improved.

As I previously mentioned, we repurchased nearly 6 million shares during the second quarter. We expect to continue to make strides towards our 10% CET1 target, keeping a close eye on the loan growth trends and capital generation. Using our capital to support our customers and drive growth remains our top priority while providing an attractive return to our shareholders. Our customers and colleagues across our markets remain optimistic about the future. We expect economic metrics to remain strong in the back half of the year despite labor and supply chain constraints. We believe that these issues will fade with sustained economic momentum.

And now I'll turn the call over to Jim.

Thanks, Curt, and good morning, everyone. Turning to Slide 5. Average loans decreased $761 million. As Curt mentioned, the biggest driver was an $870 million decrease in National Dealer Services as auto inventory levels are very low due to supply chain challenges. Looking back 2 years, floorplan loans are down over $3 billion. We believe that we are close to the bottom and over the next few months, inventory should start to slowly rebuild and return to normal levels sometime next year.

Mortgage Banker declined approximately $300 million coming off of the record levels reached at the end of last year. Seasonally higher purchase volume was more than offset by lower refi volume, which is expected to continue. Of note, our purchase-related volume was 67% in the quarter compared to the industry at 44%. On the other hand, activity in several other businesses has begun to pick up, including General Middle Market, Environmental Services, Commercial Real Estate, Entertainment, Equity Fund Services and Corporate Banking.

As far as PPP, average loans decreased a little over $100 million during the quarter. However, on a period-end basis, PPP loans declined nearly $1 billion as the forgiveness process accelerated at the end of the quarter. Excluding the decline in PPP loans, period-end loans were up $613 million due to increases in General Middle Market, Environmental Services and Commercial Real Estate, partly offset by a decrease in Dealer. Total line commitments increased $1.5 billion with growth in most business lines led by General Middle Market. Usage also grew, resulting in line utilization holding steady at 47%. Our pipeline increased despite the strong level of commitments closed during the quarter and the portion in the last stage of the pipeline, again, grew significantly. This bodes well for future loan growth.

Loan yields increased 16 basis points, including the 14 basis points impact from the lease residual adjustment in the first quarter and 2 basis points from fees, including accelerated fees on PPP loan forgiveness. All other factors offset each other.

Average deposits increased $4.1 billion, climbing to a new record, as shown on Slide 6. Noninterest bearing deposits accounted for almost 75% of the growth. The full quarter benefit of recent fiscal stimulus, along with strong cash generation, drove the increase. With strong deposit growth, our loan-to-deposit ratio decreased to 66%. The average cost of interest-bearing deposits reached an all-time low of 6 basis points, a decrease of 2 basis points from the first quarter, and our total funding costs fell to only 7 basis points.

Slide 7 provides details on our securities portfolio. During the quarter, we purchased approximately $2 billion of MBS to replace about $1 billion in MBS repayments and $750 million in Treasuries maturities as well as continued to deploy some of our excess liquidity. The net result was about a $250 million increase in the portfolio at period end and a slightly higher proportion of MBS. By increasing the size of the MBS portfolio by over $1.5 billion since year-end, we have been able to mitigate the rate headwind and maintain approximately the same level of securities income.

MBS purchases in the second quarter had average durations of 6 to 7 years and yields of about 185 basis points. This compared to securities rolling off at 230 to 250 basis points, which resulted in a decline in the portfolio yield to 1.82%. Our goal is to continue offsetting the pressure from lower reinvestment yields by gradually and opportunistically increasing the portfolio size.

Turning to Slide 8. Net interest income increased $22 million, including the $17 million in lease residual adjustments recorded in the first quarter. The net interest margin was stable as the impact from the lease residual adjustments was offset by the large increase in excess liquidity.

As far as the details, interest income on loans increased $18 million and added 8 basis points to the net interest margin. This was primarily due to the lease residual adjustments. One additional day in the quarter added $4 million and fees, primarily PPP related, added $2 million and 1 basis point to the margin. Lower loan balances had a $3 million impact and lower LIBOR and nonaccrual interest recovery each had a $1 million impact. The benefit from a modestly larger securities portfolio was mostly offset by the lower securities yields.

Average balances at the Fed increased over $3 billion, which added $1 million and had an 8 basis point negative impact on the margin. Fed deposits remain extraordinarily high at nearly $16 billion and weigh heavily on the margin with a gross impact of approximately 50 basis points. Continued prudent management of deposit pricing added $2 million and 1 basis point to the margin.

Credit quality was very strong, as shown on Slide 9. Net recoveries of $11 million were comprised of a decrease in gross charge-offs to only $8 million combined with a relatively high level of recoveries of $19 million. Nonperforming assets decreased slightly and remain low at 64 basis points of loans. Also criticized loans declined in nearly every business line and are now close to pre-pandemic levels. Strong credit metrics combined with our growing confidence in sustainable economic growth resulted in a decrease in our allowance for credit losses. Of note, the social distancing-related segments continued to perform better than we expected.

Also, with help from an increase in oil prices, the Energy portfolio had significant decreases in nonaccrual and criticized loans as well as net recoveries of $12 million. However, we continue to apply a more severe economic forecast to both of these areas. Our total reserve ratio is very healthy at 1.36% or 1.44%, excluding PPP loans.

Noninterest income increased $14 million or 5% as outlined on Slide 10, continuing the positive trend we've seen over the past 5 quarters. Card fees increased $13 million and are 23% higher than a year ago, primarily due to Government Card and to a lesser extent, also merchant, consumer and commercial card activity. These have all been spurred by economic stimulus, changes in customer behavior as well as new and expanded customer relationships.

Commercial lending fees increased $9 million to the highest level we've seen in over 5 years, primarily driven by an increase in syndication fees. Fiduciary income set a record with a $7 million increase, mainly due to annual tax service fees, a full quarter benefit of the Trust Advisory business we acquired in March as well as equity market performance.

Deferred comp asset returns were $6 million, a $3 million increase over the first quarter and are offset in noninterest expenses. Partly offsetting these increases, derivative income decreased $8 million as there was a $1 million benefit from a change in the credit valuation adjustment compared to a $10 million benefit in the first quarter. Aside from this change, underlying derivative activity remained robust. Following strong performance in the first quarter, warrant income decreased $4 million and BOLI declined $2 million. In summary, we are pleased with another strong quarter for fee income.

As shown on Slide 11, expenses were up $16 million in the quarter. The primary drivers were a $7 million increase in outside processing in line with higher revenue and elevated litigation costs related to pending resolution of certain legal matters. Also, we had a seasonal increase in advertising and higher operational losses, which returned to a more normal level. Salaries and benefits decreased $5 million, mainly due to annual stock compensation and payroll taxes re-setting in the first quarter. Providing a partial offset was an increase in performance-based incentives, annual merit, tech-related labor as well as deferred comp. We continue to demonstrate that we are committed to maintaining our strong expense discipline as we invest for the future.

Slide 12 provides details on capital management. With our CET1 sitting well above our target, we entered into an Accelerated Share Repurchase program for $400 million at the end of April. We also repurchased an additional $50 million of shares in June. Our CET1 ratio decreased to an estimated 10.39%, and our goal is to continue to make strides towards our CET1 target of 10% while carefully watching loan growth trends and capital generation. In addition, we have maintained a very competitive dividend yield, which is currently yielding about 4%.

Slide 13 provides our outlook for the expected trends for the second half of the year relative to the second quarter. Excluding PPP loans, we expect loan growth in most businesses, led by Middle Market as a result of increasing working capital and CapEx needs. This is supported by our robust pipeline and expectations that the economy will continue to grow. Of note, we believe Mortgage Banker will decline modestly due to lower refi volumes and seasonality. In addition, we believe National Dealer is close to a bottom as auto inventory levels are expected to start to rebound as we get closer to year-end.

As far as PPP loans, it is difficult to predict, however, we expect loan forgiveness will continue to pick up and the bulk should be repaid by year-end. We expect average deposits to remain strong. Customers continue to maintain excess balances, however, at some point, we believe they will start to put the cash to work. We expect net interest income to benefit from loan growth, excluding PPP and additional days. However, we believe this will be more than offset by the anticipated decrease in PPP loans.

Credit quality is expected to remain strong. Assuming the economy remains on the current path, we believe the allowance should continue to move towards pre-pandemic levels. We expect customer-driven fee categories to continue to benefit from strong economic conditions along with our focus on attracting and enhancing customer relationships. However, card fees are expected to decrease as the benefit from growing merchant and corporate volumes could be more than offset by lower government card activity as direct stimulus payments wane.

In addition, in the second quarter, there were categories that were also somewhat elevated such as fiduciary due to the second quarter tax preparation fees and deferred comp, which is difficult to predict. On a year-over-year basis, we expect to see solid growth in the second half. We expect expenses to decrease. Certain line items should be seasonally higher, such as occupancy, advertising and travel and entertainment. In addition, as we continue to invest for the future, technology investments are expected to rise modestly as they typically do in the second half of the year. However, more than offsetting these factors, we expect second quarter levels of litigation-related expense and deferred comp will not repeat. Finally, as I indicated on the previous slide, we plan to continue share repurchases.

Now I'll turn the call back to Curt.

Thank you, Jim. As I mentioned at the beginning of the call, we are seeing many favorable trends, including some loan growth momentum in certain business lines, including General Middle Market. With strong ISM Services and Manufacturing Indices and a record number of job openings, business and consumer confidence remains positive and is supportive of continued growth in the back half of the year.

As we continue to navigate this ultra-low interest rate environment, we are focused on delivering a more diversified and balanced revenue base with an emphasis on fee generation. And our progress is demonstrated in the consistent increase in noninterest income over the past 5 quarters. We are investing for the future to ensure we can provide high-caliber products, such as our treasury management services. In the second quarter, Comerica became one of the first banks to offer commercial banking customers the ability to send real-time payments. In addition, Business Deposit Capture now includes the ability to scan images of checks for deposit with a mobile device.

Finally, utilizing intelligent automation, we improved our Integrated Receivables offering. Our expertise and experience continues to help us build and solidify long-term relationships, particularly in extraordinary times like these. We are uniquely positioned with our nimble asset size, large customer deposit funding base and commercial bank weighting complemented by robust retail and wealth management capabilities.

Finally, we are committed to maintaining our conservative credit culture, strong capital base and expense discipline. These key strengths provide the foundation for creating long-term shareholder value.

Thank you for your time, and now we'd be happy to take your questions.

(Operator Instructions) Our first question will come from the line of Gary Tenner with D.A. Davidson.

I wanted just to ask about the loan outlook for the back half of the year. I know talking about generally more positive and close to a bottom on Dealer floorplan. Wondering about the Energy segment, in particular, looks like E&P balances kind of stabilized this quarter after a decline last quarter. How are you thinking about that segment now, given the increase in commodity prices?

Gary, it's Peter. And I appreciate the question. Yes, we are still an Energy bank. And over the years, you've seen our portfolio, we migrated away from the services business, still in midstream, still in E&P. We are seeing opportunities, but we're being very selective about what we do. The underwriting is probably more conservative than it was in years past. I don't know that I would tell you that what commodity prices have done lately has necessarily made us dive into it more. We've seen improvement in the credit portfolio, which is really good. And so I think we're going to continue to have opportunities there. I do feel like the headwind we've seen over the last few years of balances dropping is slowing. So we're encouraged by that and feel like it's a space we're going to continue to be able to be successful at.

Okay. I appreciate that. And then just a follow-up, if I could, on kind of expectations for liquidity deployment back half of the year. Obviously, the influx of deposits continues quite a bit and the net increase in the securities portfolio was fairly modest for the quarter. So even with your commentary about expectations that customers start to use those deposits at some point, it seems like you've got plenty of excess liquidity that you could put to work and just thinking about how you're viewing that going forward.

Gary, it's Jim. Thanks for the question. First, starting with second quarter. You're right, it may look on the surface like a modest increase in our securities portfolio, but there was a lot of wood to chop in the second quarter. We did have $750 million of what I'll call lumpy treasury maturities up and beyond the almost $1.1 billion of MBS. So we feel we are very busy on the securities front even in the second quarter, going after good quality securities just to get the average up to $250 million where the purchase is up. So we feel like we had some good momentum in the second quarter.

Our plan for the second half of the year is, of course, to replace the MBS maturities as we always do. We do have $400 million of treasury maturities in the third quarter and another dose in the fourth quarter, and we outlined these on Slide 18 in the appendix. And so we plan on replacing not only the MBS maturities but also those lumpy treasury maturities. And then we plan on also find some modest additional amount above that to offset the rate pressures in the securities portfolio.

So having said that, we certainly have a lot of excess liquidity to deploy, and we are deploying some of it as we did in the second quarter. At the same time, if you look at what the market is doing right now, we're not sure we want to rush into that and dramatically increase the size of the portfolio given all the maturities and given the MBSs we're putting on to replace them. So we will continue to make steady progress in deploying the excess liquidity, making sure that we're going forward on the overall securities balance as well as offsetting any rate pressures. But I wouldn't look for the excess liquidity to take a massive dive in the next quarter or 2. We want to be very measured about how we increase the securities portfolio.

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

Maybe just starting off in terms of fee income, obviously, a very strong quarter, but it does seem that from your guidance that some of that is sort of unusual in nature. I think you mentioned like the tax prep in fiduciary and something in card as well. Can you just quantify how much was, let's just say, unusual in this quarter that needs to reverse going into 3Q or the back half?

Yes. Ken, it's Jim. Yes, I'll be happy to answer that. We have been very strong in noninterest income, not just in this quarter, but if you look at the slides on Page 10, the numbers and the trend, we have gradually been increasing every quarter for the last 5 quarters. And I'll remind everyone that our run rate for noninterest income prior to the pandemic was about $1 billion a year, which we hit in the third quarter of '20 as we came back in the recovery of the pandemic. Since then, we continue to elevate. And you see some of the unusual items for the current quarter over on the right side of the slide.

I don't think we're going to slide back to the old $1 billion a year that we used to run at, but we are not going to stay at these current levels either. That would be a very dramatic increase in a short period of time. So card fees will certainly take a step back from where we're at today. Now I don't think they will go back to pre-pandemic levels because we've had a change in customer behavior. There's a lot more electronic use of cards and other channels beyond some of the cash usage we used to see. And so card fees will probably end up somewhere in between where they started during the pandemic and where they're at now.

Commercial lending fees, obviously, high this quarter, one of the highest quarters we've ever seen. Fiduciary income, we will maintain half of that increase you see in this quarter. We have added customers, and we did make a small acquisition for a trust advisory business. So you will see a portion of that continue. Deferred comp of $3 million, that's the increase, but the absolute number of deferred comp was $6 million, and we always assume that's 0 each quarter. And so you do some extraordinary levels of noninterest income currently occurring. We will take a small step back, but we will not return to the old pre-pandemic levels either. So overall, we think going forward, we're going to show some nice percentage growth on our year-to-year noninterest income, if you go back to the base year of 2019.

Got it. Okay. All right. That is very helpful. I guess just in terms of the second question, you mentioned the Dealer could be close to a bottom. I was just hoping you could talk a little bit more about that. It's -- I know you mentioned the re-bounce as you get the new inventory coming in, in the fall. But can you just layer in the supply chain issues and if that's still an issue and if that's still affecting your dealers and how that might affect growth in the back half?

Ken, it's Peter. I think the answer to your question is it is still affecting -- the supply chain is still affecting things. You've obviously seen some plant closures in Michigan. But in talking to our customers, we're encouraged that we're getting to the bottom. I don't know that I can tell you exactly when that's going to be or when the uptick, what month that would occur in. But we do feel like the headwind, again, is going to get slower going into the back half of the year. We're encouraged at what we think would occur, particularly in Q4 going into next year.

I do think, though, we're talking 2022 before we really start to see some improvement in floor plan balances. And I think it's probably even a little further out. I've been asked in the past about getting back to the numbers that you see on Slide 23, for example, in prior years. I think that's probably at least 1.5 years or 2 out. But we do feel like we're reaching the "bottom," if you will, of where the supply chain constraint is for the dealer business. And again, our dealers continue to perform really, really well. We are adding customers. We feel like we bank the best of the best in the space. We had great deposit growth in Dealer. So it's a business that we really, really -- we love. We feel like we're a leader in, and we're committed to figuring out a way to support our customers through this.

Your next question will come from the line of Jon Arfstrom with RBC Capital Markets.

Kind of a follow-up on that. Can you touch a little bit more on the General Middle Market growth and how you think things may have changed relative to a quarter ago? It feels like we're seeing a commercial bank recovery in front of our eyes here, but just curious what your thoughts are on it. And then, also, can you touch on -- you mentioned the pipeline of loans in the last stages, can you talk a little bit about that as well?

Jon, it's Peter again. So let me -- maybe I'll talk about the pipeline part first. So what we've continued to say is that our pipeline is above pre-pandemic levels. And I would say, candidly, well above pre-pandemic levels of what we're seeing of late. And when we mentioned the later stages, it feels very good about what we feel like the closings are going to look like in the next 90 to 180 days. So when we talk about that, we're pretty positive that those are going to lead to new commitments, new outstandings. We had a great commitment quarter in Q2 increases. And so we're encouraged that, that would occur when we tell you guys that the later stages of our pipeline are feeling very, very good.

As far as Middle Market, I would tell you, and I think, Jon, to affirm what you said, it does feel across the board really, really encouraging. And in just about all of our geographies, many of our verticals, we are seeing the pipeline growth. We're seeing activity pick up. Michigan had a fantastic quarter, followed by Texas and then kind of California. And I think that's just a little bit indicative of the size of the books in those markets and the number of customers and opportunities. But as things start to open up across the country, I think you're going to see it unfold pretty quickly, and we are seeing it in that middle market space. Again, we had a very good Q2. Historically, Q3 has been a challenged quarter for us in Middle Market, but we are encouraged this time just based on what we're kind of seeing as of the recent quarter end.

Okay. Good. And then maybe one for Jim, just on the net interest income guidance. It feels like things are positive and maybe the margin is bottoming here, but does this phrase more than offset by the decrease in PPP loans, how material is that and really what needs to happen for your net interest income guide to potentially flatten out?

Good. Thanks, Jon. Happy to take that question. I'll try to boil this down to really the big drivers. Our net interest income is really going to be driven by loan volume over the coming quarters. If you look at deposit pay rates, securities for which we're going to try to offset any rate pressures with volume, purchase funds, they're all going to be likely very stable from an income standpoint going forward. So that takes you right back to loans as the big driver. So let's talk about loans and their impact on the net interest income line item.

As Peter was saying, ex PPP, we do think we're going to get some good loan growth in the second half of the year in our core businesses. And so you can do the math on that, and that will be a nice pickup in net interest income. However, the major headwind will be the PPP volume and the pay downs that occur there. That will certainly more than overpower any core growth we get on the other end. And just to kind of throw out the numbers here, as we disclosed in the package, I think, on Page 19, our quarterly average in the second quarter for PPP was $3.5 billion. And as we disclosed, the ending balance at the end of the quarter was $2.8 billion. So when you look at the third quarter average and what we're headed for versus relative to what we're seeing, we're probably going to end up with a third quarter average that's probably half, it could be a little bit less than half, of what we saw in the second quarter.

So that's approaching a $2 billion drop in PPP balances. Keep in mind, those are earning about 2%. So that's a pretty significant headwind. And then as we move to the fourth quarter, you'll probably see that PPP balance going half yet again. Now putting aside the normal yield, which includes amortized fees, we think our accelerated fees in the third quarter will likely be around the same $15 million that we saw in the second quarter, but it's probably going to be about half of that in the fourth quarter. And so when you look at those factors just from PPP more than overshadowing what's going on in the core portfolio, that will create a headwind.

Now just some smaller items to consider. We do have some smaller headwinds from swap maturities that we itemize on Page 18, that includes a second maturity -- second quarter maturity in June that will have a small impact on Q3. And then I'll just say, LIBOR, success of floors, loan mix, competitive pressures, all of those things can move it up or down slightly. We'll see where those go. But again, I'll just summarize it as it's really going to be a function of loan volume for the most part and to what extent we can offset the PPP average rundown. So hopefully that helps.

Your next question comes from the line of Ebrahim Poonawala with Bank of America.

I guess just first question on that Slide 18. Jim, if you could talk about from an ALCO standpoint, you talked about the duration of the new securities that you bought. How are you thinking about and no one knows when we get to a rate hike from the Fed, but talk to us as we approach a Fed rate hike cycle, how you're thinking about maintaining asset sensitivity and how we should think about the duration of the securities book leading into that?

All right, Ebrahim. Thank you for the question, and by the way, welcome to the coverage. When we look at our decisioning around securities portfolio and how we grow it and the type of securities we add to it, there are a lot of considerations, but we think we're in a very advantageous position to take advantage of what good rates might be out there for certain types of securities. When I look at Comerica, our asset sensitivity is high and it actually has grown since the end of the year since we added all these securities. It's mostly a function of deposit growth, but there are some other factors also. And so we feel like with all the asset sensitivity we have, certainly adding securities, fixed rate securities is something we can afford to do and we can afford to spend some of that asset sensitivity.

We did add securities with longer duration over the last couple of quarters. But again, if you look at our average duration, it's pretty reasonable, and we think it's pretty manageable, especially when you consider the rest of the complexion of our balance sheet and some of our long-term deposits. We consider the fact that we have excess liquidity. That's certainly not an issue. We can probably afford to do more. And then just when you look at the kind of the sweet spot out there in terms of what's available, swaps really aren't a good value right now. Treasuries, not a good value. We think given the capacity we have to add some longer duration securities to the balance sheet and the yield that offers is really the right way to go for us, and we feel like we can continue to go this direction.

Having said that, no one knows where rates are going. There's no free lunch out there. There could be regret either direction. But we think given the complexion of our balance sheet and our business model, this duration is something that we can afford to add to the balance sheet.

Jim, I might add that as we see rising rates occur, which would be a good thing, obviously, for the banking industry. Some combination of leveraging our securities portfolio and synthetic hedges would really be our focus at that point. And we made good progress on hedging before the pandemic and then obviously, rates fell so dramatically that we really were not able to fully hedge the portfolio, but we're always going to be an asset-sensitive bank. But in a rising rate environment, we'd like to mute some of that asset sensitivity. And then secondly, I would say, just our focus on fee income continues to be a way that we're trying to diversify the overall asset sensitivity of the revenue base.

Got it. That's helpful. And just on a separate -- based on your response to one of the earlier questions, it doesn't sound like you're seeing a big divergence geographically in terms of loan demand, Midwest versus California versus Texas. Give us a sense of -- there has been a lot of headlines around this move from California to Texas, are you actually seeing that in any discernible way when you look at sort of client movement and just demand from your customers?

Ebrahim, yes -- it's Peter. So yes, I do feel like our growth that we've seen has been sort of across the country, so to answer that question. And then second, we feel like with our geographic footprint, we're in a great spot to support customers moving from California to Texas or Texas to Michigan or sort of either way. I mean I think you're seeing anything else that we're seeing on population movement. We continue to feel really good about the California economy and the opportunities that are there. And so I think the answer to your question is, yes, we are able to support our customers through that, but both markets are really opportunities for us to continue to grow our customer base and our portfolio. And we're seeing that occur.

Peter, I might just add that -- maybe just add a comment on California because we do get that question periodically. And as Peter said, we're still very bullish on that market. I mean it's still the sixth largest economy in the world. It's still a very diverse economy. We're seeing some positive trends in import-export activity, travel and leisure. There are a number of things sort of positive to point to, despite some of the challenges that have been very public for the California market.

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

Just have a question on -- back to the loan growth front. On line utilization, I know you indicated that it remains steady at around 47%. I guess based upon the activity that you're seeing and then you're encouraged by, is it fair to assume that you do expect an increase there in drawdowns? And can you also help us frame out what's your longer-term utilization level that you think is fair to assume and the timing that you believe you can get back to that level?

John, it's Peter. I think we're seeing utilization, as we mentioned, sort of level out. I think that we'll probably see it -- I hope we'll see it sort of bounce along there to slightly up as we go forward. I don't know that you're going to see a tremendous increase in utilization. I mean, obviously, the big question in the industry is when does this liquidity deposits get used up first versus borrowings occurring second and when is all of that going to occur. I think that as you get into the back half of the year, you'll see a little bit of utilization increase. But I think customers are going to do a little of both is what I've said. I think they're going to maintain higher cash balances. I think they'll start to use a little more credit. I don't think they're going to swing heavily one way or another just because despite the encouraging outlook across the country, all of our customers are more cautious about the future than they have been as we all are.

So I think that the timing of those 2 things occurring are going to be interesting to unfold, but we're encouraged by the utilization we saw in Q2. We think that it's going to hang in there, start to increase a little bit. And I think it will probably be into next year or maybe even further before we get back to "normal utilization levels" that you might have seen in years past or pre-pandemic.

Okay. All right. That's helpful. And then separately on the capital front, CET1 ratio of 10.4%. I know your internal target though was around -- you reiterated at around 10%. We are seeing some regional peers begin to nudge down their internal targets. Is that -- can you just talk about that potential if there is any likelihood of being able to move that target lower over time?

Great. John, it's Jim. Happy to take that question. For now, we are comfortable with that 10% target. We're always observing the environment and just taking note of what's going on, both on the regulatory front and just the overall economy. But right now, we are comfortable with the 10%. We're always in tune with some of our key constituents such as regulators and rating agencies to make sure that we're properly positioning our capital. Having said that, we will continue to observe what's going on. And certainly, one of our internal goals is to -- as rates go up to take pretty significant steps to smooth out our earnings stream with respect to asset sensitivity. We know that we have a very good credit risk profile. We would like to improve our earnings stability profile from an asset sensitivity standpoint. And I can tell you that once we do that, I will feel better about potentially considering and I think our Board would too, considering going below 10%, that may accompany a little bit of a shift in the capital stack. We may issue some preferred at that time. But for now, I'll say, we are comfortable with the 10% target.

Your next question will come from the line of Scott Siefers with Piper Sandler.

Just wanted to ask on the reserve and sort of what you guys consider kind of the steady state once we sort of complete the reserve drawdowns. Is the plan to sort of level it out at the pre-pandemic kind of CECL Day 1 reserve or just given the improving macroeconomic backdrop, is there an opportunity to take it down below that level in your guys' eyes?

Yes. Scott, this is Melinda. Thanks for the question. Obviously, first and foremost, CECL is really a complex accounting exercise that we go through every single quarter based on what the economic forecast is at that time as well as how our portfolio is performing. As Jim mentioned in his comments, we do expect, based on the performance, the strong performance of the credit portfolio and what we believe to be the economic forecast at this time that we're going to continue to see reserve levels moderating down to a pre-pandemic levels of Day 1 CECL. Day 1 CECL was about 1 23. We're at about 1 44 right now. So it's reasonable to assume that we'll continue to trend downward over the course of the next couple of quarters.

Given the fact that CECL is new, I don't know that anybody really knows where the "bottom" of CECL is, but I do think it's possible that we could see reserve levels fall slightly below that Day 1 CECL number.

Okay. Perfect. That's excellent color. And then I wanted to revisit the Floorplan business for just a second and see if you guys have any updated thoughts on what you would consider sort of a normal level for that business. I think historically, you've bounced around sort of the $6 billion to $7 billion level. But just given sort of how dealers have adopted to a low inventory world -- or adapted to a low inventory world, do any of your customers sort of tell you that there's some middle ground where there's like a net benefit to having lower inventory levels than they've carried in the past?

Scott, it's Peter. Yes, I think the dealers would tell you that they're having as much profitability as they've ever had in these lower inventory levels for them and actually work pretty well for the dealership. The question really is about the industry in general and what do the OEMs do at the end of the day. And our belief is that when we get to the other side of this, it would be back to normal; 100% back to normal? I don't know. I think that's probably debatable amongst the -- in the industry.

As you see on Slide 23, I mean, you're right, our balances have been in the 6 to 7 range for a long, long time. And in particular, floor plan has been $3 billion higher than what it's running today. We think we'll get back to that. I don't know if we'll get all the way back to it, but we definitely think in the coming years that we'll get pretty close to it. And again, I think that comes back to when does normalization hit the space. And we believe, based on the conversations that we're having that, that will happen. It's just a question of timing. And so that's why we feel that way.

Your next question comes from the line of Steven Alexopoulos with JPMorgan.

I wanted to start. So if we look at the $671 million of General Middle Market loan growth that you saw in the quarter, did you see those companies draw down their deposit balances prior to drawing on credit lines or are they drawing on lines concurrent with deposit balances being highly elevated?

Steven, it's Peter. I'd say it's a little more of the latter that you said. I think that they are borrowing in conjunction with still having the deposit balances. So I believe middle market loans in general still grew. So back to what I was kind of saying a little bit earlier, I think that some of this is a timing issue. I think you've got an optimistic, encouraged economic environment, but cautious leadership of middle market companies that want to make sure that they've got liquidity for whatever comes. So they're comfortable borrowing some more money, but they still want to have cash in the bank. And candidly, that's why our credit quality looks so good. So I think that as we sit today, I would answer you that it feels like they're borrowing more money but still maintaining cash balances. And back to -- I would tell you, utilization a little bit back to this question, even though it was flat for the company, it was up a little bit in Middle Market.

Got you. Okay. And where you are seeing new loan opportunities, right, every bank is in the same boat, you guys are with a low loan-to-deposit ratio. Is the competitive environment, I imagine it's significantly more intense, is it primarily a rate or you're starting to see structure enter in terms of companies trying to win away from you guys?

Yes. Steven, I continue to feel like it's primarily rate. I think the banks, for the most part, continue to be really, really responsible on credit structures. So the most competitive piece of it right now does seem to be rate.

Okay. That's helpful. And then if I could squeeze one more in, just final. On the Environmental Services business, you actually saw a nice growth this quarter, right? That's been flat for most of the past year. Is this a one-time bump or should we be expecting this to be a more significant contributor to loan growth each quarter?

I know I'm expecting it to be a more significant contributor to loan growth, Steven. So we think this is a great business for us. We feel like we are a leader in this. We've talked about dealer, mortgage, energy, the TLS. There's a number of businesses that we stand out and ESD is another one where we are really encouraged by the opportunities we're seeing. We're adding talent to this space. We're exploring lots of different avenues that we can do in ESD, including renewables, solar opportunities. So we're encouraged. It's why we have a slide in here this quarter. And so we believe it's an opportunity for us to continue to grow this business.

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

Just a follow-up on the capital return question. You used a good 70 basis points of CET1 with the combination of the risk-weighted asset inflation and the big buyback. I'm just wondering, as you go forward and expect better loan growth, which would imply continued, if not faster RWA growth, how does the buyback foot against that in terms of the magnitude? It would seem that you could get to your 10% pretty close without even doing much buyback. So just wondering how the balancing act between the 2.

Ken, it's Jim. Yes, you're exactly right. We expect earnings continue to be strong. The dividend, of course, is already strong. But we are expecting, as we saw at the end of the second quarter, we are expecting continued good core loan growth. And so that will make us far less reliant on share repurchases in the third and fourth quarter. And I would certainly expect our share repurchase dollar amount to be far less than what we saw pace wise in the second quarter. So yes, that will be -- we will be winding down probably the absolute amounts of that tool as loan growth starts to step in and become essentially a very productive use of our capital.

Okay. Got it. And then just on -- you made the point earlier about balancing out your asset sensitivity. And I'm just wondering if you can elaborate on that a little bit more vis-à-vis like does it make you think about changing the orientation of the swaps book, adding, terminating just kind of -- we have that great layout on 18, but just any -- Page 18, but just any updated thoughts on how you would anticipate doing that as we get closer to the rate cycle?

Yes. Ken, we are very asset sensitive currently, even with all the securities we've added. So -- and we are always going to be asset sensitive to some extent, but we do want to reduce that asset sensitivity gradually and probably pick up the pace of reducing it as rates go up over time. And so right now, we do have the excess liquidity. We do have the room in the balance sheet. The best value right now, we feel, is adding securities. I think what you'll see is, as rates go up, you'll see us start to transition from on balance sheet tools to more synthetic tools and adding off-balance sheet hedges. And off-balance sheet hedges will become probably the primary way we do it once we start seeing rates go up. But for right now, we think we do have the room in the balance sheet to use cash instruments, and you'll just see us gradually transition as rates go up over time. And we will ultimately reduce a very large amount of the asset sensitivity, but now it's not the time to do that. But at the same time, we're not going to sit and do nothing either right now. So it will be measured over time is how I would describe it.

Okay. And so you haven't done anything in terms of changing the look and feel of the off-balance sheet book as it stands right now? It looks pretty consistent versus where it's been?

That's right. That's not a tool we're going to utilize at this point. And we do have some swaps maturing over the next year. You could see the overall swap number actually decrease. We may be able to offset that with cash instruments. But for now, we just don't see the value with swap rates being where they're at right now. But certainly, it will be our primary tool over time as rates start to go up.

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

It sounds from your earlier comments that there is an appetite among your dealer partners for keeping floor plan levels lower versus history, even after the supply chain issues have been resolved. From Comerica's perspective, what are your thoughts on the idea that lower floor plan balances wouldn't necessarily be a negative since dealer floor plan loans are 100% risk weighted and they're relatively low yielding such that you may actually find that it's actually accretive to your ROEs if we did see dealers with lower inventory levels in the future? Can you speak to that thought process?

Bill, it's Peter. I don't know if Jim wants to add in here. But our approach is to make sure we're supporting our customers. I mean that's the #1 focus for us. So I -- your question you're asking is a really big picture one on what does the business look like going forward. We're going to support them, whether they've got low inventory levels. And right now, they've got huge deposits. We're supporting them with wealth management opportunities, finding other ways to take care of our customers in this environment. The day will probably come that they will need the floor plan availability because it may candidly be something that gets pushed on them. It may not be something that they can necessarily decline. And so we'll be there to support them through that. And we've been in this business over 50 years. And it's been good for the bank, the whole time. We continue to believe it will be going forward and are very encouraged about what that could look like into the future.

Peter, I might add that, that's a business where we also have other opportunities. You mentioned, Wealth Management, but we do a lot of real estate lending for new add points for dealers, and then there's a fair amount of M&A activity that we support on the lending side as well. So there are other ways that we support the dealerships beyond just the floor plan.

That's super helpful. If I may just follow up on the point that it may get pushed on them, it may not just be their decision. So if the dealer does want to run with less inventory and customers remain willing to, as I think we've seen during the pandemic, either take whatever inventory is on hand or wait a few months, if they want something more specific, that willingness is there. I guess, what are some of the other variables that would lead to sort of that being pushed on them? Just maybe if you could give a little color on what you...

Yes. It's just the manufacturing of cars. I mean the industry historically has been -- cars are manufactured and they're sold at the point that they arrive on the dealership. So in the past, that's the sort of model that you've had. I don't know that we're moving to a completely just-in-time type environment. Maybe we are. I'm not attempting to try to predict what that does or doesn't look like. But one way or another, our job is to support our customers and whatever unfolds there, we're going to be there to do it. Don't forget, we're a huge auto lender in Michigan as well. So we're very comfortable with the auto industry space, whether that's on the car manufacturing side, the dealer side, whatever happens with autonomous driving, whatever happens with electric vehicles. We feel like we're a bank that's able to be a leader in the auto space as it unfolds in the next couple of decades. And there's going to be a lot of macro things that happen, but we are well positioned to be in the front of that.

Your next question comes from the line of Chris McGratty with KBW.

I want to follow up on Ken's interest rate sensitivity question. Just ask a little bit differently. We've seen some of your peers talk about taking down rate sensitivity as rates go down -- rates go up. And some of them are doing it through purchasing of resi mortgages to add duration and they're saying it's a better risk-adjusted yield than just buying MBS. I'm wondering if that's at all on the table as you kind of consider broader ALCO strategies?

Yes. Chris, welcome to the coverage. Being a commercial bank, we're actually quite comfortable with our current approach of buying the MBS securities. They carry far less capital that you have to hold on them. We feel we have the expertise to manage it. And so that's where we choose to put that liquidity on the mortgage-backed security side. And then from a pure business standpoint, we're comfortable with our current business mix.

Great. And then as a follow-up, just interested, maybe I missed it in your prepared remarks, normalized cash levels. Obviously, they're pretty high right now. And I guess to the degree and timing you expect to hit normalized?

Chris, that will be a function of what happens in the economy. Right now, we have incredible fiscal stimulus. We have very accommodative monetary policy. And that is driving a large amount of excess liquidity. The Fed will start tapering at some point, but taper doesn't mean stop. It just means taper. And in the meanwhile, I just see this fiscal stimulus continuing to occur. The economy is running at a very high rate right now and will for some time, and that creates a bit of a velocity factor or multiplier, which creates deposits in the system. And I do see these deposits, they'll move around the banking system, but I don't see them leaving it to any large extent.

And so I do see deposits waning a little bit for Comerica. We do have some businesses that are specific to some of the stimulus that's occurred and some of those businesses will lose some of the deposits over time. But I think we're going to be very flush with deposits for some time to come. We will see loan growth start to eat into that, but I don't see us getting back in the foreseeable future to the more minimal levels of cash that we are holding prior to the pandemic. So it just feels like this environment is here to stay for some time.

Your next question will come from the line of Steve Moss with B. Riley Securities.

Just on commitments here. You guys mentioned another really strong increase for the quarter here. I think it was up about 5% in the first quarter. Just kind of curious as to how strong it was? And also just are these from existing customers or new customers?

Steve, it's Peter. Yes. So the commitments were up on Slide 5, $1.5 billion in the quarter, which was a really, really good quarter compared to the last 5. There's a little mix of both. We've got -- we typically run on average historically about half and half, half new to new, half new to existing. And I'd say right now, it's a little more new to existing. But it was a little bit of both. And again, a very, very good quarter for commitment increases.

Okay. That's helpful. And then in terms of just loan pricing, maybe go drilling down a little further on that. Just kind of curious as to where loan spreads are now versus maybe prior quarters -- the last couple of quarters or pre-pandemic levels?

Yes. Steve, I'm kind of reluctant to say anything about where loan spreads are. I would just tell you that, again, pricing is more aggressive than it has been historically. It's definitely the more challenged part on winning business versus credit exposure. So I think you can infer from that, that loan spreads in general are lower than they historically have been. But we don't usually comment about what sort of spreads we're seeing.

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

I think everything has probably been asked, but I just wanted to ask you about what you're seeing in terms of competition for talent and wage pressure right now?

Jennifer, I think each of us has a perspective around the table here. It's somewhat of a recent phenomenon. But in general, I think it's fair to say that it has gotten more competitive and more challenging. The society has really gone through a transformation here, it feels like, and there are a lot of people, not just like Comerica, but friends, family, people are making life changes and life choices about how they move forward from the pandemic, and that's created a little bit of churn. Beyond that, you just have -- what we see is a little bit of wage inflation that might be coming not just our way but in the whole industry, and you're seeing this across the whole economy.

And for us, it's anecdotal. A lot of that's not in the run rate at this point in time, but just as we stay in touch with the market, it does feel like there's a bit of a challenge there just as other manufacturers and service industries we're seeing in terms of getting the talent in for the same price that we used to. So it does feel like we're going through a little bit of a transition as an economy, and that's something we're going to have to adjust to.

Jen, I might just add, this is Curt, that we feel like we did a really good job of being sensitive to our employees' needs throughout the pandemic and being accommodative and supportive financially and otherwise of our employee base. And we, as a company, sort of pride ourselves on having longer tenured employees and deep relationships with not only customers, but employees over time. And certainly, there is some pressure out there, and we're trying to stay in front of it in terms of the right benefits, in terms of retention where it's needed and just in terms of being proactive and communicating and connecting with our employees.

What is the post-pandemic work environment look like for your employees. I mean, how many are going to be -- will be back in the office full time versus flexible versus totally remote?

Jennifer, we are about -- this is Curt, again. We are about halfway -- maybe more than halfway through our return-to-office planning. We -- our execution will have -- be completing that in sort of the August, September time frame, unless something significantly changes. We all are dealing with this sort of this COVID resurgence and variants, et cetera. But assuming that, that is manageable, that is our plan right now. And what we are focused on or what we've been saying is that the majority of our employees will be in the office the majority of the time. That does not mean that everyone will be here 5 days a week.

We will certainly have employees who are here 5 days a week, but we will have employees where we're providing more flexibility really depending upon the job and the employees' needs as well. So we'll have some that are working 3 days in the office, 2 days at home or 4 days in the office, 1 day at home, those types of things. We will have very few employees that are working completely remotely. And I think that's important just from the standpoint of maintaining our culture, our environment, apprenticeship, development of employees, the collaboration amongst our employees, et cetera.

I'll now turn the call back over to Curt Farmer, President and CEO, for any concluding remarks.

Okay. Well, thank you. As always, we appreciate your continued interest in Comerica, and we hope you have a great day. Thank you.

Ladies and gentlemen, that does conclude today's call. Thank you all for joining. You may now disconnect.