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June 28, 2023 | One of the banks that has raised the most questions with investors since the start of 2023 is Comerica Inc. (CMA), a $90 billion asset commercial lender based in Dallas, TX. CMA was originally from Detroit, but fled the city in search of growth to the south. To answer the queries from several readers, below is our profile of CMA in the style familiar to subscribers of The IRA Premium Service.
“Comerica, originally called Detroit Savings Fund Institute, opened its doors on August 17, 1849, to a city bustling with shipyards, river trade, sawmills, horse drawn carriages and dirt roads,” the company history relates. But the City of Detroit, which spawned Henry Ford, Thomas Edison and many other American entrepreneurs of the day, no longer has a real economic purpose in the 21st Century.
The first thing to say about CMA is that the bank is a solid financial performer, with most significant financial metrics lying dead center of the fairway in terms of comparisons to Peer Group 1 and market leaders like JPMorgan (JPM). Even more than the dead banks f/k/a Silicon Valley and Signature, there is nothing obviously wrong with CMA as a bank and a business. And yet since 2022, the bank has been shrinking as deposits have run off and headed out the door.
Because of the eroding funding base, CMA is one of the weaker stocks in our surveillance list, trading just above Western Alliance (WAL), KeyCorp (KEY) and PacWest (PACW). We currently own New York Community Bank (NYCB). We exited WAL in April 2023 due to a lack of conviction in the stock. While we do believe that the risk equation is shifting in 1-4 family mortgages, our only holdings in the mortgage sector are LT stakes in NYCB and Guild Mortgage (GHLD).
The IRA Bank Surveillance List
Source: Bloomberg (06/28/23)
The first thing to note about CMA is that the bank’s credit performance is strong. When you see a bank with a minus sign on net-losses, that indicates a strong credit culture. The efficiency ratio in the mid-50% range likewise indicates that CMA management is focused on delivering operating leverage.
Source: FFIEC
As you can see in the chart above, CMA’s credit performance is stellar compared with some of the regional players such as U.S. Bancorp (USB). So if CMA is getting things like credit and operating efficiency right, why is the stock under pressure? Because in the world of huge reserves of Fed Chairman Jerome Powell and massive fiscal deficits of Treasury Secretary Janet Yellen, all banks are targets.
The macro environment for banks generally is uncertain. As the chart below shows, Treasury cash balances held off-market at the Fed are rising, while bank deposits for now are stable. Yet at the current rate of runoff from the System Open Market Account, at least $750 billion in bank deposits will disappear from the US banking system over the next year.
After net losses, the next factor to examine when assessing CMA is the pricing on the bank's loans. Again, not only is CMA at Peer Group 1 levels, but the bank is actually leading our comp group higher with the notable exception of Ally Financial (ALLY). Notice that in both net losses and gross spread, ALLY is headed “to da moon” as it reprices its balance sheet, which is essentially a loan conduit for eventual asset sales to investors. All of the major banks are showing strong, even desperate increases in gross loan yields as they struggle to keep pace with funding costs.
Source: FFIEC
The big question facing CMA, however, is deposits. Looking at the chart below showing funding costs vs average assets, again CMA leads the pack. The bank’s funding costs are below all of the banks in our comp group and Peer Group 1. But that may not be a particularly good thing right about now. Core deposits have fallen 20% in the past year, leading the bank to make some painful decisions about its business that have drawn sharp criticism from informed observers.
Source: FFIEC
Michael McAuley, Principal of Garrett McAuley, among the most respected consultants in the banking and mortgage space, provided this scathing assessment of CMA’s sudden decision to abandon warehouse lending:
“In perhaps the most shocking and boneheaded move of the year in the mortgage industry, Comerica Bank senior management has decided to exit the warehouse lending business (which it's been doing since 1913!)... Credit quality wasn't the issue as the Comerica warehouse lending group has always been very smart and conservative. Size wasn't the issue as it has $1.1 billion outstanding and $400 million in deposits supporting it, which (despite senior management's and uninformed Street analyst claims) is an excellent ratio of deposits generated from a commercial lending line of business. It's not that they haven't made good money in the business as during the recent mortgage boom, warehouse lending made so much money that it was regularly addressed in the bank's earnings calls. It's not likely that the group is losing money now as warehouse lending (unlike mortgage banking) is always profitable but particularly so in a low-rate environment, and particularly during a recession when it and the mortgage banking line of business generate the large profits that fund the substantial loan losses on commercial real estate and C&I lending. No, it's probably that Comerica Bank is desperate to appear to be doing something to address its relatively high level of uninsured commercial deposits and its large underwater investment portfolio, and exiting warehouse lending is the easy way to reduce loans and those deposits quickly without taking big losses.”
What is really odd, McAuley notes, is that CMA is apparently not trying to sell the warehouse business. "They apparently think (or did poor research) that they’d have to sell the portfolio at a discount," he tells The IRA, "but warehouse lending portfolios sell at a premium of 25 bps to 37.5 bps of outstandings as of the date of closing."
We agree with the assessment of our friends at Garrett McAuley, but we note that the shrinkage in the deposit base outside of mortgage escrows goes back two years and may have forced the bank’s hand. "They could have realized some value," notes one competitor who wonders at the announcement. "It would have been better for their customers and the warehouse team to sell. Seems like they’ve acted in haste."
When you look closely at the performance metrics for CMA, what you see is a bank that actually fluctuates a good deal below the period-end assets and liabilities. While CMA is only about 50% loans to assets, in our view the shrinkage in the core deposits of the bank is behind the weak share performance and mounting volatility.
In addition to deposit runoff, the accumulated other comprehensive income (AOCI) at CMA shows a 50% impairment on capital at the end of Q1 2023. The $15 billion in MBS owned at the end of Q1 2023 is 17% of average assets or 50% higher than the 11% average for Peer Group 1. CMA illustrates in graphic terms how the Fed’s decision to “go big” by providing excessive reserves into the banking system has now essentially rendered a solid commercial lender effectively insolvent.
The last factor to consider with CMA is profitability. Again, CMA leads the comp group and Peer Group 1 in terms of asset returns, leading to the obvious question: what’s not to like? The answer, sadly, is that the bank’s outsized portfolio of mortgage backed securities may have shot a hole in the proverbial Grand Lake Canoe.
Source: FFIEC
If bank regulators and policy wonks want to understand why large depositories like Silicon Valley and Signature were caught wrong-footed by Fed interest rate tightening, it comes down to one word: duration. The long-duration position illustrated by the large MBS holdings of CMA was clearly a mistake given the accumulation of AOCI. Once investors realized that the bank’s balance sheet was misaligned given the rate environment, the deposits left the building.
At 0.9x book value, CMA is hardly in trouble today, but the real question is what is book value? If the Fed keeps interest rates at or above current levels, banks like CMA may be forced to sell MBS at a loss and reduce capital, a path that is unlikely to lead to positive results for equity investors. In the meantime, CMA is raising cash and reducing assets, hardly a recipe for stronger earnings down the road.
If the Fed is eventually forced to sell MBS from the SOMA to normalize market interest rates, then the losses on MBS will grow. The Fed has applied a tourniquet to the bank liquidity problem via the Bank Term Lending Facility (BTLF), but this latest band aid from the central bank does not deal with mounting losses on MBS in a rising rate environment. If the FOMC raises the target rate for fed funds further, then banks like CMA are likely to come under renewed selling pressure.
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