2023-11-30 21:21:26 ET
Summary
- Comerica has seen deposit growth in its deposit base in Q3'23 and the regional bank has good asset quality.
- The bank is facing net interest income headwinds, however, as the Fed is poised to cut interest rates next year. Comerica's NII declined for three quarters straight.
- Comerica's shares are now trading at a material premium to book value which makes CMA a sell for me.
- Long term investors may find value in the 6.6% yield, growing dividend and low payout ratio, however.
Comerica ( CMA ) is a well-run regional banking franchise with has seen growth in its deposit base in the third-quarter and which boasts good underlying loan quality, but the bank is facing net interest income headwinds as the Fed appears poised to lower interest rates next year. Considering that interest rates are set for a drop-off in FY 2024 and Comerica has seen a sharp upward revaluation since I bought in May, I have sold my shares of Comerica. A reason to keep holding shares of Comerica is that the bank is growing its dividend and delivers a very decent 6.6% yield to dividend investors!
Previous rating
I recommend shares of Comerica initially in May of 2023 after Silicon Valley Bank’s failure caused a massive crash in the regional banking market and forced an intervention of the Federal Reserve. Shares of Comerica were trading at a 25% discount to book value at the time, compared to a 25% premium today: Get A 9% Dividend Yield At A 25% Discount .
Since I see NII headwinds on the horizon, I have decided to sell my shares at a decent profit, but believe long term investors can still find value in the community bank’s 6.6% dividend yield. My new rating on CMA is hold.
Growing deposit base
Comerica has seen consistent pressure on its deposit base in the last year as the Federal Reserve raised interest rates to offset soaring inflation. This change in the investment landscape has led to a reshuffling of cash in the banking sector, with depositors withdrawing bank deposits and investing them into higher yielding money market funds.
The collapse of Silicon Valley Bank caused a confidence crisis in the community banking market earlier this year. The crisis made already existing deposit pressures worse for regional banks like Comerica because depositors move funds from the regional banking sector to the biggest banks in the country, like JPMorgan Chase ( JPM ) or Bank of America ( BAC ).
However, deposit flows have stabilized since the second-quarter in the regional banking market. At the end of the September quarter, Comerica reported average deposits of $65.9B, showing an increase of $1.6B over the Q2’23 deposit balance. However, deposits were down $8.1B compared to the year-earlier period due to higher interest rates.
But there are headwinds…
Although deposits have returned to the bank in the third-quarter, on an average basis, there are headwinds for Comerica and these headwinds chiefly relate to interest rates. Inflation rates have come down a lot lately, implying that the Federal Reserve is no longer adamant about raising the federal funds rate. Inflation is running at 3%+ which is significantly below last year's levels of around 7%.
I believe the drop-off in inflation is good for consumers and the economy as a whole, but will set back the earnings prospects of the banking sector. A bank’s net interest income depends to a large extent on its ability to charge consumers higher rates for loan products, and declining interest rates would force banks like Comerica to charge its customers less. Comerica’s net interest income has already declined for three straight quarters and was reported at $601M in Q3’23... which was about 20% less than at its peak in Q4’23 (before the financial crisis in the first-quarter).
Comerica's loan quality is not yet a problem
As far as loan quality is concerned, the trend still looks healthy and I don’t see any major issues. The amount of non-performing assets held on Comerica’s balance sheet dropped consistently in the last year, indicating high average loan quality, and the non-performing asset to loan ratio hit a low of 0.29% in the September quarter.
Comerica is no longer a bargain
Comerica’s shares have not only managed to narrow the gap between stock price and book value that existed after the failure of Silicon Valley Bank, but they are now trading at a material premium to book value. Comerica's shares are now trading at a P/B ratio of 1.25X, which is approximately 7% below the average P/B ratio in the last year. A lot of regional banks like U.S. Bancorp ( USB ), Fifth Third Bancorp ( FITB ) and KeyCorp ( KEY ) are now also trading at premiums to book value, with the first two trading at similar P/B ratios than Comerica. Given that rival banks are also selling at premiums to similar-sized premiums to book value, I believe CMA is about fairly valued right now, given the headwinds to net interest income growth.
The dividend would be one reason to stay invested in CMA
Besides a high discount to book value, I recommended shares of Comerica in May because Comerica raised its dividend just before the community banking crisis to $0.71 per-share. The dividend yield, currently, is 6.6% based off of a $2.84 annual payout and the bank is likely to raise its dividend again in Q1'24.
The dividend is covered by Comerica’s earnings and the bank had a payout ratio of about 32% in the last twelve months, which was slightly below the 36% payout ratio in the sector.
Risks with Comerica
The risk with Comerica is obvious: declining interest rates are set to pressure Comerica’s net interest income, which could result in investors being unwilling to pay such a high book value multiplier going forward. While I don't see any issues with Comerica's dividend coverage, deposit base or loan quality at the moment, there is a risk of a lower multiplier factor for regional banks in a lower-rate world.
Final thoughts
Comerica is a well-run regional bank and it reported a 2.4% increase in deposits Q/Q in the third-quarter. The bank’s asset quality, measured as a percentage of non-performing assets relative to total loans, was and is still good. However, the decline in inflation and three straight quarters of net interest income declines strongly imply that the bank has seen the peak of its NII potential in a high-rate world. While I like the dividend and the payout ratio, I believe a 25% premium to book value makes Comerica a sell here for me personally. However, for long term investors that don’t care about cyclical changes to a bank’s net interest income potential, the 6.6% dividend yield is a very good reason to stay invested!
For further details see:
Comerica: Solid Yield, But No Longer A Bargain