Comerica Inc (CMA) 2020 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by, and welcome to the Comerica Second Quarter 2020 Earnings Conference Call.

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

Please go ahead, ma'am.

Thank you, Regina.

Good morning, and welcome to Comerica's Second Quarter 2020 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 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 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 release and Slide 2, which I incorporate into this call as well as our SEC filings 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.

I hope you and your families are healthy and coping well during this unprecedented time.

Today, we reported earnings of $0.80 per share.

The highlight of the quarter was very strong loan and deposit growth, which drove balances to record highs and partly offset the impact of lower interest rates on net interest income.

Overall, credit quality remained solid.

However, with the unprecedented, rapid decline in the economy and high level of uncertainty, we again prudently increased our credit reserves.

Capital levels continue to be strong, and our book value per share grew to over $53.

We have quickly adapted to the COVID-19 pandemic and are continuing to make adjustments as the crisis evolves.

With over 65% of our colleagues working from home, the health and safety of our employees and customers remain our top priority.

For those who cannot work from home in our operations areas and banking center locations, we have taken precautions to minimize health risk and have provided enhanced COVID-19-related benefits.

Across the bank, our colleagues continue to ensure that our customers are well taken care of, consistent with our long-standing relationship banking focus.

Our team has worked diligently to support our customers, providing sound financial advice, credit expertise and payment flexibility where needed.

I am proud of tremendous dedication our colleagues have displayed in supporting the Paycheck Protection Program.

I'm extremely thankful for the unwavering commitment of our Comerica team, and I'm honored to serve as CEO during these challenging times.

Helping our customers and communities endure stressful situations and achieve long-term success is at the heart of Comerica's relationship banking strategy.

As we previously announced, we have significantly increased our financial commitment to serve our communities.

Comerica, together with Comerica Charitable Foundation, have pledged $8 million to nonprofit organizations that care for and provide critical services to our communities.

This includes more than $3 million to community development financial institutions and other business development nonprofits as well as our recent $1 million commitment to the National Business league to assist Black-owned small businesses.

Our loan growth in the second quarter further demonstrates the support we have provided our customers.

Average loans increased $3.9 billion, with growth in the majority of our businesses, including $2.6 billion in PPP loans, which provided needed liquidity to Middle Market and small business customers.

The strength of our customer relationships was also evidenced with broad-based growth in average deposits of $7.5 billion.

Noninterest-bearing deposits grew $5.9 billion.

Government stimulus programs have resulted in tremendous liquidity.

In addition, as we have seen in other times of economic uncertainty, both retail and commercial customers are conserving cash in the safety of their Comerica accounts.

As expected, the decline in interest rates had an impact on net interest income.

In this ultra-low rate environment, we continue to carefully manage loan and deposit pricing to attract and maintain customer relationships.

Comerica has a long history of prudent credit underwriting, which has allowed us to manage through many economic cycles.

Despite the current period of unprecedented disruption, our portfolio has performed well.

And while we have not -- while we have seen some negative migration, it has thus far been manageable.

Nevertheless, there remains a great deal of uncertainty about the duration and severity of the impacts related to COVID-19.

After taking a large provision in the first quarter, we further increased our credit reserves to over $1 billion or 2.15%, excluding the SBA guaranteed PPP loans.

We are staying close to our customers and are working to address their needs.

At this point, we believe our reserves are appropriate and that we are well positioned.

In regard to noninterest income, we saw growth of 4% quarter-over-quarter with our strong card franchise being a major contributor.

Overall, we have continued to maintain our expense discipline.

However, COVID-19-related expenses as well as external card processing costs, resulted in an increase in expenses for the quarter.

Capital remains strong, and we further bolstered our Tier 1 ratio by issuing $400 million in preferred stock.

We remain focused on maintaining our attractive dividend and deploying our capital to support growth.

Recent conversations I've had with employees and customers reflect the challenges of the current environment, especially as we have seen an uptick in COVID-19 cases.

However, while it's very difficult to predict the path forward, I sense longer-term optimism based on the country's overall economic resiliency.

I continue to be inspired by the spirit of determination demonstrated by my Comerica colleagues, our customers and the many communities we serve.

And now I'll turn the call over to Jim to review the quarter in more detail.

Thanks, Curt, and good morning, everyone.

Turning to Slide 4. Average loans increased $3.9 billion or 8% in the second quarter.

Average loans in our mortgage banker business, which serves mortgage companies were at an all-time high, increasing $1.2 billion due to very strong refi activity and seasonal spring home sales.

As far as corporate banking, you may recall that large companies began to draw down lines late in the first quarter to build liquidity buffers at a time of great uncertainty.

Those advances have begun to decline for the full quarter effect contributed to a $767 million increase to corporate banking average balances.

General Middle Market increased $737 million, and business banking increased $567 million, aided by PPP loan fundings.

Also, commercial real estate loan growth continued driven by multifamily projects where we work with proven developers who provide substantial equity upfront.

Providing a partial offset to the strong growth, loans decreased the national dealer with lower inventory levels as expected.

Period-end loans were stable and very close to the record $53.5 billion reported at March 31.

Increases in loans to small business and a peak in mortgage banker loans at quarter end were offset by lower national dealer balances and customers reducing working capital needs and leverage in the uncertain environment.

Line utilization decreased to just over 49% and mainly due to the drop in National Dealer usage.

Commitments decreased about $300 million with increases in Corporate Banking and general Middle Market, more than offset by declines in Energy, Equity Fund Services and Mortgage Banker.

Loan yields were 3.26%, a decrease of 93 basis points from the first quarter.

This was mostly a result of lower interest rates.

1-month LIBOR, the rate we are most sensitive to, declined 105 basis points.

In addition, lower-yielding PPP loans weighed on our total loan yield.

This was partly offset by pricing actions we are taking particularly adding LIBOR floors when possible as loans renew.

Deposits increased 13% or $7.5 billion, as shown on Slide 5, with growth in nearly every business line.

As Curt mentioned, customers are prudently conserving and maintaining excess cash balances.

Period-end deposits increased $10.4 billion, led by general Middle Market, Business Banking, Corporate Banking and Retail.

Deposit growth outpaced loan growth, resulting in a decline to our loan-to-deposit ratio to 79% and helped increase balances held at the Fed to over $12 billion at quarter end.

The average cost of interest-bearing deposits was 26 basis points, a decrease of 50 basis points from the first quarter.

Our prudent management of relationship pricing in a lower rate environment, our large proportion of noninterest-bearing deposits as well as the floating rate nature of our wholesale funding, drove our total funding cost to only 22 basis points for the quarter.

As you can see on Slide 6, the yield on the MBS portfolio declined just a couple of basis points, helped by the fact that in the first quarter as rates began to fall, we opportunistically prepurchased a portion of second quarter expected payments.

Yields on recent purchases have been around 130 basis points.

We had a moderate increase in prepays in the second quarter, however, this did not have a significant impact on the portfolio's duration or the unamortized premium, which remains relatively small.

We expect payments to range in the $900 million to $950 million per quarter range for the near term.

We are considering opportunistically putting some of our excess liquidity to work by increasing the portfolio as market conditions allow.

Turning to Slide 7. Net interest income declined $42 million to $471 million, and the net interest margin was 2.50%, a decline of 56 basis points relative to the first quarter.

The major drivers were the negative net impact of lower rates, which totaled $67 million or 37 basis points in the margin as well as an increase in excess liquidity, which reduced the margin by 17 basis points.

Interest income on loans declined $83 million and reduced the margin 60 basis points.

Lower interest rates on loans alone had an impact of $105 million and 57 basis points in the margin.

There was a $2 million or 1 basis point impact from lower nonaccrual interest activity.

Higher balances added $15 million and fees in the margin added $7 million.

Over half of the combined increase in volume and fees, which related to PPP loans, which had a net negative impact of 3 basis points on the margin.

Other portfolio dynamics contributed $2 million or 1 basis point which mainly reflected our success in adding LIBOR floors to loans.

Interest on deposits of the Fed had a $15 million negative impact or 26 basis points on the margin.

The lower Fed funds interest rate reduced net interest income by $16 million or 9 basis points in the margin.

Higher balances of the Fed added $1 million, but resulted in a 17 basis point drag in the margin.

Deposit costs declined by $36 million and added 19 basis points to the margin, primarily a result of our prudent management of deposit pricing as interest rates decline, as I previously discussed.

Finally, with lower rates and to a lesser extent, lower balances, wholesale funding costs declined by $20 million, adding 11 basis points to the margin.

In the third quarter, we will receive the full quarter benefit of the June maturity of $675 million of senior debt and May repayment of $500 million in FHLB advances as well as a further planned reduction of $1 billion in FHLB advances.

As a reminder, given the nature of our portfolio, our loans reprice very quickly.

Also, we continue to closely monitor the competitive environment and our liquidity position as we manage deposit pricing.

Overall credit quality was solid, as shown on Slide 8. Net charge-offs were $50 million or 37 basis points and only $5 million or 4 basis points, excluding energy loans.

We continue to work closely with our customers carefully reviewing their current and projected financial performance and adjusting risk ratings as appropriate.

This is reflected in the $922 million increase in criticized loans.

General Middle Market criticized loans increased $519 million, primarily related to the migration of leveraged, auto and social distancing loans as expected.

Energy criticized loans increased $348 million.

The total criticized portion of the portfolio remains low at 6% of loans.

Nonperforming loans also remained low at 51 basis points, a modest increase over the first quarter.

Excluding energy, nonperforming loans decreased.

In summary, we started the cycle from a position of strength with very low nonperforming and criticized loans, and migration so far has been manageable.

Turning to Slide 9. As far as the allowance, the economy improved through the quarter.

However, it does remain weak, and the outlook continues to be uncertain with the unprecedented impacts of the COVID-19 pandemic, particularly related to social distancing, our CECL modeling included the significant recession we have been experiencing, followed by a slow recovery.

More severe assumptions were used in the qualitative adjustments made for certain segments.

This resulted in an increase in our allowance for credit losses to $1.1 billion.

Our credit reserve ratio was 2.15%, excluding PPP loans, which were guaranteed by the SBA, so carry very little risk and the majority are expected to be forgiven over the next 6 months.

Our credit reserve coverage for NPLs was strong at 3.9x.

Again, we are well positioned with a relatively high credit reserve and lower nonperforming assets as illustrated.

We believe our disciplined underwriting, diverse portfolio and deep expertise will assist us in management through this pandemic recession.

Energy loans, which are outlined on Slide 10, were $2.1 billion at quarter end and represent 4% of our total loans.

E&P loans make up about 80% of the energy portfolio and energy services, which is considered the riskiest segment, was only $50 million.

The allocation of loan reserves to Energy loans remained above 10% as fluctuating oil and gas prices have resulted in increases in criticized and nonaccrual loans.

However, charge-offs decreased quarter-over-quarter.

Spring redeterminations are 90% complete, and on average, borrowing bases have declined 20%.

As we have done through previous cycles, we aim to work with our customers to cure deficiencies through repayment over time.

In general, our E&P customers have less leverage than the last energy downturn, are hedged to varying degrees, and are acting prudently, cutting costs and reducing CapEx in order to preserve liquidity.

With more than 40 years of serving this industry, we have deep expertise and remain focused on working with our Energy customers as they navigate the cycle.

Slide 11 provides detail in segments that we believe pose higher risk in the current environment.

We've seen only limited negative migration in the social distancing segment, and we applied a more severe economic forecasts.

Therefore, we believe we are well reserved for these loans.

Also note that this segment is relatively granular, and our exposure to any one of these industries is not significant.

Our automotive production exposure primarily consists of loans to Tier 1 and Tier 2 suppliers.

Many of these customers experienced disruptions in manufacturing.

However, production has begun to ramp up.

We have deep expertise and a long history of working in this cyclical sector.

While nonaccrual loans are only $1 million, criticized loans have increased, and as a result, we increased the reserve allocation.

Ultimately, we believe losses will be manageable.

Leveraged loans are where you often see the first indication of stress.

While balances were stable, criticized loans increased as expected.

Our leveraged loans tend to be with Middle Market, relationship-based customers with sponsors, management teams and industries we know well.

Also, our sweet spot would be on the lower end of the leverage spectrum.

And we avoid the highly leveraged covenant lite deals that have been more prevalent in the industry in recent years.

As for payment deferrals and forbearance, we have granted deferral requests for more than 2,000 customers, totaling $4.5 billion of loans, with substantially all considered performing at the time of deferral.

Over the past month, new request, including a request for a second deferral, have been nominal.

Noninterest income increased $10 million, as outlined on Slide 12.

This included deferred comp asset returns of $2 million, a $5 million increase from last quarter, which is offset in noninterest expenses.

Card fees were very strong and increased $9 million due to higher transaction volume related to stimulus programs and changes in customer behavior.

Securities trading income increased $8 million, reflecting fair market adjustments for investments we hold related to our technology and life sciences business.

There were also increases in securities gains as well as customer derivative income, which included a lower credit valuation adjustment.

On the other hand, poor economic conditions weighed on several fee categories.

Deposit service charges declined $7 million, with reduced cash management activity.

Lower money market rates weighed on brokerage and fiduciary income and foreign exchange activity decreased with the decline in economic activity.

Turning to expenses on Slide 13.

Salaries and benefits increased $7 million with annual merit and additional compensation paid to colleagues who are not able to work remotely or worked overtime on PPP loans.

Deferred comp increased $5 million, as I mentioned on the previous slide.

This was partially offset by a seasonal decrease in payroll taxes.

Outside processing increased $5 million, primarily related to higher card transaction volume and PPP loan initiation.

We continue to invest for the future and prepare for the return to normalcy, while maintaining our expense discipline.

Comerica's conservative approach to capital and liquidity has positioned us well to navigate the current environment.

Our capital levels remain strong with an estimated CET1 of 9.97%, as shown on Slide 14.

In the second quarter, we issued $400 million in preferreds.

This was the next logical step in optimizing our capital base, adding approximately 60 basis points to our Tier 1 ratio, which is our binding constraint.

We, opportunistically, took advantage of market conditions and received a very strong response, reflected in the favorable pricing of $5 and 5/8ths.

Earlier this year, our Board increased our dividend of $0.68 per share and declared that level for the July first dividend payment.

As the dividend is determined, careful consideration is given to expected earnings power and capital needs to support loan growth and investment in our businesses.

The current dividend yield is very attractive and is supported by a strong holding company cash position.

We also conduct robust capital stress test to help ensure our dividend can withstand cyclical pressures like we are experiencing now while we maintain strong capital levels with a CET1 target of 10%.

Slide 15 provides our outlook for the third quarter relative to the second quarter.

We are assuming recessionary conditions remain with continued slow improvement in GDP and unemployment.

However, a high degree of uncertainty remains regarding the economic impacts of COVID-19.

Loans to small businesses are expected to reflect the full quarter benefit of the PPP advances as it ramped up early in the second quarter, and we anticipate only modest loan forgiveness in the third quarter.

More than offsetting this, we expect loan growth to be challenging in a few business lines.

Mortgage Banker is expected to reflect lower refi volumes from record second quarter levels as well as seasonality in home sales.

Also, we expect continued reduction of liquidity draws by large corporates and lower National Dealer balances as auto inventory levels declined further.

We expect average deposits to be stable as some customers utilize their economic stimulus payments while others work to conserve cash.

The net impact from rates alone on net interest income is estimated to be $10 million to $15 million in the third quarter relative to the second quarter.

This includes the full quarter effect of lower interest rates, partly offset by our actions to decreased deposit rates, which we expect to average 20 basis points in the third quarter.

Reduced loan volume is expected to roughly offset a reduction of wholesale borrowings and an additional day in the quarter.

Credit quality is expected to reflect the economic environment, with our solid credit metrics and our credit reserve at about 2% of loans for the second quarter, we believe we are well positioned.

However, the path of the economy is uncertain.

We expect noninterest income to decline primarily due to the unusually high second quarter levels for securities trading income, derivative income, card and deferred comp, which were not expected to repeat.

Also, we believe lower market-related activity should have an impact on investment banking and fiduciary fees.

Partly offsetting this as the economy improves, we expect an increase in areas such as deposit service charges as commercial activity picks up.

We expect a rise in technology and occupancy expenses as we catch up on initiatives that have been delayed due to COVID-19.

We are committed to investing in our future so that we are well positioned coming out of the pandemic.

In addition, we expect an increase in charitable giving and seasonal increases in staff insurance and marketing.

These costs will be mostly offset by our continued focus on controlling expenses as we are closely managing discretionary spending and expect COVID-related costs to decline.

As far as capital, I mentioned in the previous slide, we expect to declare our first dividend on the preferred stock of about $8 million, which includes a stub period from the second quarter.

Our capital levels are healthy, and we remain focused on managing our capital with the goal of providing an attractive return to our shareholders.

Now I'll turn the call back to Curt.

Thank you, Jim.

As I shared in my opening remarks, I'm extremely proud of the Comerica team.

Over our 170 year history, Comerica has successfully managed through many challenging times.

We continue to demonstrate our resiliency and unwavering dedication to provide a high level of customer service as we navigate the COVID-19 pandemic.

We believe our disciplined underwriting approach and prudent customer selection resulted in superior credit performance through the last recession, and is assisting us in weathering the current environment as evidenced by our solid credit metrics this quarter.

Our diverse geographic footprint and relationship banking strategy continues to serve us well.

We are committed to maintaining our strong expense focus while investing for the future.

In uncertain times like these, our ability to serve our customers, using our experience and deep expertise, builds and solidifies loyal relationships.

With strong liquidity and capital levels, we are able to meet our customers' financing needs, and we remain focused on delivering the attractive return for our shareholders.

Now we will be happy to take your questions.

(Operator Instructions) Your first question will come from the line of Ken Zerbe with Morgan Stanley.

I wanted to -- maybe just we can clarify, if you can -- on Slide 15, the guidance for net interest income.

I just want to make sure I really understand what you're saying there.

Because obviously, the rates is a negative, totally got it.

There's a negative sign there.

There's also a negative sign again -- ahead of the lower loan balances, which are offset by the lower debt, et cetera.

So net-net, it sounds like NII is going down from here.

But can you just help us understand the -- like can you quantify maybe what the lower loan balance part might be?

I'm just trying to get a sense, like are we talking -- because you do say it's offset, but are we talking like down $1 million or down $20 million?

Yes.

Thanks for the question.

We -- that's going to be somewhat dependent on PPP loan volume and when those prepays.

So there is a range of outcomes there.

But just to give you a general feel for where it could end up, we're looking at probably $10 million to $12 million in terms of reduced volume impact, and that should be roughly offset, as we mentioned by the one additional day in the lower wholesale debt.

And there's probably kind of a plus or minus $3 million or $4 million to that, depending on where PPP volume goes.

But hopefully, that boxes the range in for you.

Got it.

Okay.

That actually does help quite a bit.

I guess maybe just a second question, in terms of operating expenses, your expenses have been fairly stable, I would say, over the last few quarters.

Several of the other banks that I cover, seen sharp declines in expenses, whether it's lower travel or marketing or even incentive compensation.

Can you just remind us, is there anything different in terms of how you're approaching the expenses for the business where you might not be seeing that same level of benefit?

Because I'm assuming you're not traveling anymore or very little travel.

Whereas other banks might be seeing a bit more of that benefit.

Yes, Ken, we are seeing some pockets of lower expenses, just like, I think, some of our peer banks are.

I would point out to a couple of key differences between us and perhaps some of our peers.

Of course, it's a discount to $5 million of deferred comp expense, which is offset in noninterest income.

Another key differentiator would be the outside processing costs that associate with our improved card fees for the quarter.

So we did have some very good performance in card noninterest income, which you saw in the previous slide, but that does come with some processing expense.

So that would be a layer of expense that I would suspect our peers would not have had.

Beyond that, we did have some buildup in our SBA program from PPP loans.

It's possible that some of our peers had an infrastructure already, and we're not a real big SBA lender.

So there was some investment that went into that.

So I would probably point to those 3 things as key differentiators.

But we are seeing the pockets of reduced expenses, and we are managing them very prudently.

So overall, we feel pretty good about the way expenses are flowing.

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

Back to your PPP comment there.

I just wanted to see if you can give us a little bit more color around your expectation for how much of the $3.8 billion in PPP production could remain on balance sheet.

Or conversely, how much of it do you expect to be forgiven?

It continues to play out in terms of how these are viewed by the treasury, but we do think that the vast majority will be forgiven.

Right now, our assumption is in the 85% to 90% range, but that could have a plus or a minus.

We do think that most of them will be forgiven that over the next 6 months, but we don't see a substantial amount of that in the third quarter.

To the extent, it does happen in the third quarter, it will be at the very end of the third quarter.

So I don't see it affecting average balances to a material degree.

But that's something that I think we and everyone else in industry is keeping a close eye on in terms of just how quickly these are forgiven.

That should be more clear over the next few months.

Okay.

That's helpful.

And then separately, I appreciate the color you typically give around the seasonality items impacting National Dealer and Mortgage.

Can you just talk to us when it comes to the core commercial loan book outside of those portfolios, what are you seeing in terms of underlying demand?

Are you seeing anything at this point, showing signs of improving demand?

Or where do you -- where can you give us some color on that?

Peter, do you want to take that?

Yes.

John, I would say in the general book, the demand is still pretty muted.

There is activity in various markets in certain industries, and we're being selective and smart about the choices that we make.

But I can't say that you've seen a real pickup in demand across really any of the major markets.

But I think the company has continue to be really, really responsible managing their debt, managing liquidity.

And so that would be my answer to that right now.

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

Just hoping you could offer a little bit more color and thoughts around the dividend.

I know you mentioned that in your prep remarks, but I feel like there are just a bunch of countervailing issues.

The return to profitability.

Certainly, relieves some pressure capital is back in your range and then the preferred helps some support, still a relatively high payout though.

I just want to be curious to hear any updated thoughts you have.

Yes.

Thanks, Scott.

Your question is related to the dividend.

Is that correct?

Yes.

That's it, exactly.

You were cutting off over there.

First of all, we just say that as Jim remarked and I did as well in my comments, we are coming at this from a very strong capital position.

Preferred issuance helped to strengthen that further on the Tier 1 side.

And always, for us, from a capital perspective, we sort of think of it in 2 areas.

One is how do we support our customers and continue to grow in the organization.

And then secondly, how do we provide what we would consider a healthy and competitive dividend to our shareholders.

Obviously, there's a lot of unknowns out there around the depth and duration of the current economic health crisis.

But at the moment, we continue to feel very comfortable both from our capital position and our dividend.

Okay.

Perfect.

And then just out of curiosity, have you guys received any indication from the regulators that non CCAR banks would be subject to that same newer earnings efficiency test that the CCAR banks are subject to now?

No.

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

Steve.

Maybe to follow-up on Scott's question.

It seems like you guys are in the same bucket as many regional banks where you may not be forced to cut your dividend.

But just because rates are, you may end up having a very high payout ratio.

As you think about recommending to the Board, right, the dividend where it is right now, how sustainable do you view that over the intermediate term?

Yes, Steven, it's Jim.

We do very long-range forecasting very sorts from various scenarios, and we actually feel pretty good about our PPNR in the foreseeable future.

We really have the range of credit outcomes.

And if you layer in just the number of, what I'll call, normal credit run rates, it appears the dividend is very sustainable from a payout ratio, and there is some capital left over to grow assets and serve our customers.

So I think the key factor there is how long this credit cycle continues, but assuming we return to some level of credit normalcy in the not-too-distant future, which we do expect it to normalize.

We feel good about the ongoing PPNR and normalized credit costs that are expected to maintain the dividend and grow assets to support our customers.

So we feel pretty good about it.

Jim, you might comment about liquidity of the parent company as well.

Yes.

That's certainly not an issue.

We have more than enough liquidity of the parent company, especially with the preferred issuance we did of $400 million in May.

So we have -- we were somewhat of awash in liquidity at the parent company and it really does come down as you probably point out to the payout ratio.

That is the key.

We do have a strong capital levels to sustain any type of over 100% ratio, should that occur again like we had in the first quarter.

But again, the key thing is the ongoing long-term PPNR stream and normalize credit costs.

And in our modeling, that is capable of sustaining the dividend.

Okay.

That's helpful.

And then if we look at where you saw most of the increase in the criticized loans in the auto production and leveraged loans, what is the reserve that you're now carrying on each of those buckets?

Melinda?

Yes.

This is Melinda.

We do not disclose individual reserve levels for each of those individual carve-out portfolios.

What I would say is we feel very good about our $1.1 billion in reserves in our 2.15 coverage ratio.

The entire reserve is available for credit losses, really, in any of our portfolios.

And the only that we have disclosed, obviously, is Energy.

We feel really good about that plus 10%.

Okay.

And then I think you said the covenant light of the leveraged loans was small.

Can you call out exactly what portion is covenant light?

I don't know what that number would be, but I will tell you that we generally just don't play in that space.

Again, our leveraged loan book is really -- it's a wraparound for a Middle Market relationship banking strategy.

And our percentage of loans in the large corporate space in leverage is very, very small.

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

This is Brandon King on for Jennifer.

So I wanted to hear more color on the Energy portfolio.

I believe in your prepared remarks, you stated that charge-offs were actually lower sequentially for that book.

And I wanted to just know your thoughts currently where you stand now as to where you see charge-offs trending going forward?

So that's where charge-offs and the energy going forward.

Yes.

Yes.

Let me talk a little bit about how we're -- how we view energy.

Obviously, this is the segment that we are most concerned about and have been for quite some time.

This industry was under stress prior to COVID and then obviously, with the demand shock that took place because of COVID and stay at home, that escalated some of the concerns that we have.

All that being said, we do feel a little bit better about where we are at the end of Q2 than we were at the end of Q1 compared to where we were this time last quarter, prices have stabilized, around $40 a barrel.

We have a very heavy oil-weighted business.

The capital markets, however, are still nonexistent, and that's what's really leading to our charge-offs.

It would be really difficult and impossible for me to predict exactly what we're going to see in terms of timing of charge-offs.

But just given the elevated level of nonaccruals for this portfolio specifically, we would expect to continue to see charge-offs in the coming quarters.

This is a portfolio of very large sophisticated borrowers, as Jim mentioned, they have lower leverage than what we saw in the last downturn.

And quite frankly, are operating as appropriately as they could in this really difficult environment in terms of shutting in wells, controlling CapEx and expenses and working with us where there are any deficiencies in borrowing bases to put repayment plans in place.

Okay.

And just a quick follow-up.

Were there any thoughts around selling some of those energy loans like another bank has?

Or was that not even a consideration?

No.

We are very committed to the business and have no plans on selling the portfolio.

Your next question comes from the line of Erika Najarian with Bank of America.

I just wanted to follow-up on Scott and Steve's question on the dividend.

So Jim, looking forward, as I look at consensus estimates, there's definitely plenty of room in terms of dividend coverage for the $0.68 common dividend.

And I'm just wondering, the Fed test is backward looking.

And so if we use dividend coverage according to the Fed, according to consensus by the first quarter, you won't be covering your dividend, if you look back in terms of your average net income before preferred because of that lost quarter in the first quarter.

And I guess the question really here is, if you haven't gotten any color from your regulators about dividend coverage for non-DFAST banks.

The look back in terms of dividend coverage, in terms of how the Fed calculates it just doesn't matter to you in terms of how we should think about dividend sustainability as it relates just to coverage.

That is correct.

We have very strong capital levels.

And if you look at the Basel 3 rules, it's really not until a bank dips into the conservation buffer that the 4-quarter net income test should really be applicable.

So it seems to be able the Fed has done with CCAR banks as they've essentially used that buffer above the conservation buffer and say -- and essentially said, it doesn't matter we're going to apply the 4-quarter net income test regardless.

Now that's a special CCAR view that the regulators have.

Does not apply to us, as Curt had mentioned, and we feel really good about the capital levels of how far above we are of the conservation buffer.

We're about 200 bps above it.

So we just don't have any concerns about dipping into that, and we should be good to go just from an overall check the box, what are the key things we're concerned about payout ratio, current company cash, capital levels.

The concerns there.

Got it.

And my second question is, there's been a lot of discussions now among investors in terms of valuing bank on normalized returns post pandemic recession, particularly for stocks that are trading below tangible book.

And as we think about the net interest income run rate, post all the PPP noise, post forgiveness, we're calculating something like your net interest income would have been $457 million without PPP.

And as we think about the back half of 2021, is that a good jumping off point in terms of how we should think about your core net interest income power?

And what are the puts and takes that would take you above or below that run rate?

Yes.

There are a number of factors that are floating out there that I think would be beneficial to the run rate.

Of course, we're not done with deposit pricing.

So there's a little bit to go there.

And we have managed that pretty prudently up to this point.

The other big X factor is going to be loan pricing, which obviously makes up the vast majority of our earning assets.

Our loan portfolio rolls over a little more quickly than the typical timing.

It's a little bit shorter.

And we are seeing expanded pricing in the industry and more floors, LIBOR floors are becoming more predominant.

And so I think that's a big enough X factor that there's the potential to well exceed the numbers that you're quoting there during 2021.

But there's just a number of unknowns.

The deposit pricing, the loan pricing, I mentioned that we are going to opportunistically invest some of our excess liquidity and securities, which should give us a small bump.

So there are some things that we can do to head off this interest rate impact.

But it just remains to be seen how much of it we can offset.

Also just how LIBOR tracks, given how it's tracked thus far, if there's some recovery in the economy even if the Fed doesn't take action.

Given that we're in a lot more per day of or below 25 basis points.

That's right.

It does seem to have bottomed out.

And we're preparing for the fact that it may not go up, but that would certainly be a big benefit extent it did.

Your next question will come from the line of Mike Mayo with Wells Fargo.

Just to clarify, if you were a CCAR bank, you'd probably be forced to cut the dividend.

But since you're not a CCAR bank, you don't need to because you have such strong capital ratios, that can help you weather the storm and maybe that's the benefit of being a smaller, more simple company.

Is that correct?

Yes.

Okay.

Look, there's not an easy answer to this, but the COVID cases have been on the rise in 2 of your 3 markets, Texas, California.

And so you mentioned as the economy improves, and it does seem to be improving in some ways.

On the other hand, there's the risk that COVID cases lead to death, that lead to shutting down like you're seeing in California and some other parts.

So what's your best guess on the course of COVID in specifically some of your markets?

That's the thousand dollar question, Mike, it's really hard for us to predict.

And as you pointed out, we are seeing a rise in several of our markets.

Also remember that we have operations in Arizona and Florida as well, and they're seeing a rise there.

The Michigan market did a really good job of addressing the shutdown early on and it's not seeing quite the same resurgence.

In Texas and California what I would say, just overall is that you're talking about 2 very strong economies that came into this situation from a position of strength.

California remains the sixth largest economy in the world, extremely diverse.

Texas has had tremendous inflow of population and that job creation, and strengthen real estate values, et cetera.

So there's a lot of positives that both of those economies bring into this situation.

And the question that you're weathering the storm by now, I think you're located in California.

So you're experiencing it firsthand.

I do think the governors in both states and local municipalities are doing the right things and trying to step back and create some social distancing and trying to reinforce some of the guidelines around masks, et cetera.

And so I think there's some short-term retrenchments that will occur, but we feel good about sort of the longer-term perspective on both of those markets.

Again, a lot of that tied to just the overall strength of those 2 economies.

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

You mentioned loan deferrals have stabilized and only a modest number as for a second deferral.

My question is at what point do you make the decision to move the loan to nonperforming status and maybe taking some charges?

Melinda

This is Melinda.

Thanks for the questions.

So I'll start my comments really with the commercial portfolio, and we have about 1,400 borrowers that ingrate the payment deferrals for a relatively small percentage of the total book.

Probably most importantly, many of those requests came at the very beginning of the pandemic, and they were really insurance policies for our customers.

They did not know what to expect going into shelter in place.

They also did not know that the PPP program would be launched.

So they asked for them and where they did, we granted them.

Of 60% of those commercial borrowers resumed paying after about 60 days into the pandemic, and the majority of these payment deferrals for the commercial book will roll off in July and August.

We do not expect to see any credit losses from these particular actions.

And again, I think as Jim mentioned, the level of request for a second deferral has been extremely low.

From a consumer book, again, this is not a big space for us, but we did have about 600 customers ask for payment deferrals, it's only about $250 million in principal balances.

The vast majority of those will be rolling off between the months of August and October, again, second requests there have been modest.

Great.

And just a follow-up on the securities portfolio, what are the reinvestment rates on those cash flows, securities?

And kind of what are you looking for in terms of the environment to use all that excess liquidity and put it into securities?

Yes.

Obviously, it's a bit of a challenging rate environment.

So we're going to consider a mix of securities.

Obviously, we want to keep any excess liquidity tied up in vehicles that are very liquid.

So we would see the majority of it went into treasuries, which are in the 20 to 25 bp range right now.

Which doesn't sound like a lot, but it's better than the 10 bps of the Fed.

And again, it is very likely we don't really see long-term rates over the next 1 to 2 years, taking any kind of significant move.

I will blend it in with that some mortgage-backed securities, which are also somewhat liquid and are yielding, as I mentioned in my opening script, well over 1%.

So we think we can get a weighted average that would be meaningful to helping us just a little bit in terms of the run rate and utilizing some of this excess liquidity.

And really, if you look at the prepayment rates on both -- or the prepayment maturities coming up, both for our treasury portfolio, we have about $1.5 billion coming up over the next 1.5 years, 2 years.

And of course, the MDA prepays are significant right now for the whole industry, as I mentioned.

You can almost view these as just a pre-investment for maturities coming up in the near term.

So we feel pretty good.

And we think it's an elegant way to just prepurchase and also get a few extra dollars into the PPNR run rate.

Your next question comes from line of Gary Tenner with D.A. Davidson.

Just a quick question.

On your CECL methodology slide, I think Slide 9, you highlight your unemployment and GDP assumptions.

Can you just remind us where those assumptions stood when we had this call in April?

Yes.

This is Melinda.

I'd like to remind everybody that in Q1, we used the most severe economic scenarios that we could.

In fact, we kept our books open a couple of extra days to make sure -- I mean, as you recall, there were so many things unfolding right at the time we were working on our CECL reserve process.

So we had very severe unemployment in GDP and oil; oil, in particular, in the 20s.

And for an extended period of time, it would have been in 30.

So for our current forecast, again, we consider a range of third-party generated forecast.

As Jim mentioned, all of those were recessionary with varying degrees of severity and length.

Again, we took our biggest hit in the first quarter, which is why our reserve build and provision was higher than many of our peers.

For the current forecast period, we have unemployment at 10%, oil at about 30% and stabilizing at 50% by the end of 2022.

And peak GDP, which was fourth quarter of 2019, being recaptured by 2021.

Our next question comes from the line of Brian Foran with Autonomous Research.

I wonder on PPP.

And this is as much an industry question as a Comerica question, but I was curious for your views.

There's one school of thought out there among investors that's definitely strip out PPP net interest income, underlying trajectory is not great.

2021 has a problem for earnings.

But there's another school of thought that's kind of like, look, these grants -- the kinda grants, they lowered the probability of default for a lot of borrowers, maybe some deposits stick around, maybe some new clients were acquired and maybe even some of these businesses borrow more as they survive and recover.

So for people having that debate around how should we think about PPP.

Is it one-time that gets stripped out?

Or is there maybe more ongoing business benefit than people realize?

What are some of the puts and takes you've had to?

Let me -- Brian make a couple of comments on the front end and then I want to turn to Jim for a little bit more detail there.

First of all, we were honored to participate in the program.

And we think it was the right thing for our country, and it was the right thing for so many of our customers, especially the smaller businesses that just really would not have had an alternative.

And our team worked extremely hard to make sure all of our customers were taken care of.

And we do believe that there will be some additional stimulus.

We don't know what it looks like.

It could be a second round on PPP.

We're prepared to respond, if that's the case.

It could be stimulus checks, it could be something else that may be forthcoming.

We are prepared.

We are participating in the Main Street lending program.

We do not expect demand there to be very high, but we will be using that and be accommodative wherever it makes sense for our customers.

And then, Jim, if you want to add on to that.

I'm just going to add, and it kind of harkens back to Erika's question in terms of what could be lost from new and PPP goes away.

And I would say there's a time and a purpose for every type of lending.

And for right now, our customers want to make sure they can manage the prices.

And that's really the purpose of the PPP loans.

And as Curt said, we're honored to be able to do that for our customers.

And really for the country as a whole.

There'll come a time where those loans are forgiven, and our customers are ready to start investing again.

And at that point in time, we'll start hopefully investing in CapEx and borrowing, increasing their working capital levels.

So I think you'll see one type of lending just transition into another eventually.

I don't think it's necessarily a hole that's going to be created.

And maybe in a similar spirit, it's interesting on your slide on credit the divergence we're seeing in criticized assets versus charge-offs and NPLs.

And again, this is something not unique to you.

A lot of peers are showing that as well.

I mean you talked to some of the good experience so far in deferrals.

You mentioned just now maybe more government support coming.

Do you think all of this has just delayed the normal relationship between criticized and loss?

Or do you think it's fundamentally altered and lowered it, i.e.

the criticized are not going to flow through to NPL and charge-offs in the magnitude they would in a normal recession?

Or I guess, this isn't a normal recession, but given the economic numbers we're seeing.

Yes.

This is Melinda.

Thanks for the question.

I think I'd start off by saying that Comerica's long history of kind of conservative and disciplined approach to underwriting, certainly, plays well for us when we do have economic cycles.

We're not the most aggressive in the good times, but we are very, very disciplined, and that gives us the flexibility to continue to support our customers through these types of situations.

Overall, again, ex-charge-offs -- or ex-energy charge-offs were only 4 basis points.

We started into this cycle from a position of strength, as Curt mentioned, I mean, the portfolio was about as good and clean other than energy, as we've seen.

Our borrowers reacted to the pandemic better than I think we all would have expected.

They've demonstrated resiliency.

The PPP program was really, really impactful to our customer because I don't think we can underestimate that.

This $3.8 billion went into -- majority of that went into our Middle Market and business banking portfolios, which is where a lot of our small business customers reside.

And if you look at the percentage of PPP money versus what those customers have in terms of lending relationships with us, it's a very, very meaningful number.

You can almost think of it as quasi equity coming in once those loans are forgiven.

Where we are seeing stress and deterioration, we are adjusting our risk ratings appropriately.

Most of the stress that we've seen so far has been -- really been centered in our leverage book, automotive, and to a lesser degree, that social distancing portfolio.

We're monitoring their performance very closely.

We look at liquidity.

We have great visibility into each of these borrowers.

And we would expect any losses that we do experience to be manageable.

And again, we've got $1.1 billion in reserves and a 2.15 coverage ratio to really handle pretty much anything that comes at us.

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

I just wanted to ask, given that the mortgage banker and dealer floor plan are among the most volatile of the loan lines.

And given that those 2 businesses are going through some unique cyclical things, positives and negatives.

Can you just kind of walk us through what's happening with each of those businesses?

And what you're expecting in terms of normal seasonality and the outlook for each banks?

Yes.

Sure.

Ken, this is Peter.

I'll talk to mortgage first.

What we're seeing there is a bit different, I think, than maybe better than the past, where in the third quarter, we're projecting it to come down a little bit along with the projections for the industry and refi, particularly maybe up a little bit in purchase.

And so we've seen amazing activity in that business in the second quarter across the industry.

And we're not necessarily thinking that, that will continue in the third quarter, where in the past, maybe it has, but -- so that will be a little bit of a divergence.

And then on dealer, you just continue to see less -- I mean, if you've been to a car lot lately, there's not a lot of cars out there.

Floor plan continues to be coming down.

I do think that there's the possibility of that picking back up as we start making cars again in Michigan.

And so to the extent that there's more funding for consumers and ability to buy cars, then you'll start to see turnover at the lots, but I don't know that, that necessarily means to more increases in floor plan lending in that space either.

So the normal trends are a little bit off maybe from what we've seen in prior years.

Probably be next year before we get to kind of a regular seasonal pattern in those businesses.

Got it.

And one follow-up on the capital front.

As you mentioned, you raised the $400 million of preferreds.

As did much of the industry this quarter when spreads tightened, given that preferreds are still a very small part of ROA, and you've always had CET1 be a major part of your capital stack.

Is this the beginning of trying to get that into a better balance over time?

Or was this episodic and kind of a one-time given where market was?

Yes, this is Jim.

We're going to leave our options open there.

We have no immediate plans to fill in the rest of the stack for Tier 1 of the preferred.

But is something I could see -- we could see happening over time, but I don't see it in the near term, but we'll continue to monitor the market and our own RWA growth and capital levels and make the appropriate assessment in the future.

Your next question comes from the line of Terry McEvoy with Stephens.

Just a question or 2 on the other social distancing loans.

It's a little over $1 billion.

Just looking at the footnotes, it looks like wineries and breweries were removed.

I was wondering, were there any changes in the second quarter at all?

And any portfolios within that other category that experienced an elevated increase in criticized loans?

The short answer to that is, no.

Again, it's a very granular portfolio and the migration really in that whole social distancing category has been relatively modest.

And then just a quick follow-up for Jim.

I was wondering if you could quantify that the COVID-19 and PPP-related expenses last quarter, they were called out a couple of times on the call today and in the presentation.

Yes.

There -- question gets a little bit squishy in terms of what you include and exclude because there were expenses realized, some were very obvious, some not.

And of course, there are some savings that would offset that.

I heard some of those mentioned earlier.

But roughly speaking, I would characterize it as we had about $10 million of COVID and PPP expenses that were more extraordinary in the second quarter.

We actually see the majority of those continue, but it will come down.

But we will see a little over half of those continue, some of it in the form of contributions, which we consider a part of the overall COVID and PPP environment.

But it was meaningful in the second quarter, and we will see those come down gradually over time this year.

I might just add, Jim, that we are going to do whatever is necessary to continue to support our employees through this crisis.

And to the degree that there are things that we need to do from a benefits perspective to support our employees, we will do that.

And we are very, very proud of the efforts we're making around giving back to the community.

And I think that's an important necessary thing right now, especially related to small businesses and some of the efforts that we've made to help in a number of our -- number of the communities that we serve.

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

You got some good disclosure in on energy.

I was -- just wanted to return to that.

Just roughly speaking, where would you say your borrower base is really making -- able to cash flow these loans?

Is it as low as $40 a barrel?

Or is it realistically $45.50?

This is Melinda.

In general, we have -- it's really important to remember that a good portion of our portfolio is very well hedged.

In fact, we actually saw hedging go up in the second quarter as prices kind of rebounded into that $40 a barrel.

We do have a portion of our portfolio that can cash flow absent any CapEx at $20 oil and $30 oil.

But it's really unique and specific to each company's balance sheet and their hedging strategy.

So I couldn't really give you an exact percentage on that.

Okay.

And as you touched on this in -- earlier in the call in terms of the conservatism of your underwriting, historically.

As you look at this at the energy sector now, does it continue to kind of meet your criteria?

Or do you see the entire sector under real secular pressure that may make this something you'd want to kind of extract yourself from over time?

Well, I'll just start by saying that, again, we are committed to the energy business.

And although this has obviously been a challenging time.

We've been in this business for decades.

We've been through many cycles.

And although this one has the added benefit of a pandemic, a worldwide pandemic.

We feel really good about our participation in this industry and plan on continuing that.

So no change in the strategy.

And Peter, is there anything else you'd add to that?

I would just iterate that, again, we've been in this business for years.

And I think through that, there's probably 3 or 4 cycles that we've been through.

So we're committed to it and intend to stay in the business.

I will now turn the call back over to Curt Farmer, Chairman and CEO, for any further remarks.

Well, thank you always for your interest in Comerica.

We continue to wish all of you and your families, good health and safety in the days ahead.

Thank you.

Ladies and gentlemen, that will conclude today's call.

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