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Intrinsic Value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
Ladies and gentlemen, thank you for standing by and welcome to the Comerica First Quarter 2020 Earnings Conference Call. At this time, all participants lines are in a listen-only mode. After the speakers' presentation, there will be a question-and-answer session. [Operator Instructions].
I would now like to hand the conference over to Darlene Persons, Director of Investor Relations. Please go ahead.
Thank you, Carmen. Good morning and welcome to Comerica's first quarter 2020 earnings conference call. Participating on this call will be our Chairman, President and CEO, Curt Farmer; Chief Financial Officer, Jim Herzog; Chief Credit Officer, Pete Guilfoile; Executive Director of our Business Bank, Peter Sefzik.
During this presentation, we will be referring to slides which provide additional detail. The presentation slides and our press release are available on the SEC's website as well as on 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 our 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 on slide 2, which I incorporate into this call, as well as our SEC filings for factors that can cause actual results to differ.
Also, this conference call will reference non-GAAP measures. And in that regard, I direct you to the reconciliation of these measures within the presentation.
Now, I'll turn the call over to Curt, who will begin on slide 3.
Good morning, everyone. Thank you for joining our call. I hope you and your families are healthy and managing as best as possible during this unprecedented time.
The first priority for me, along with our leadership team and Comerica as a whole, is the wellbeing of our customers, employees and communities. Comerica has quickly adapted to the COVID-19 crisis. I'm extremely proud of the work our team has done to ensure we continue to deliver the same high level of service
We currently have over 65% of the Comerica team working from home. This transition happened quickly and without any significant issues. For those that cannot work remotely, such as operations and banking center colleagues, we are taking precautions to minimize health risk and increase compensation to show our deep appreciation for their dedication to continue to provide essential services. To further support our employees, we have made monetary assistance available for dependent care and telehealth services at low cost.
Also, we've been working closely with our customers to provide financial assistance, such as providing additional liquidity, as well as payment deferrals and fee waivers.
As an SBA preferred lender, we have been assisting customers in accessing the government's SBA Paycheck Protection Program, under which we have thus far provided $1.8 billion in loans.
Finally, serving our communities is more important than ever at this time. Therefore, Comerica, together with Comerica Charitable Foundation, have pledged $4 million to nonprofit organizations that care for and provide critical services to our communities. These funds will be deployed to support strategic programs designed to meet the needs of small and micro businesses, as well as community service organizations that serve youth, seniors and other vulnerable populations, particularly those organizations addressing food insecurity and access to health care.
Helping our customers and communities navigate this challenging environment by providing our expertise, products and services is at the heart of Comerica's relationship banking strategy.
Turning to slide 4 and a summary of our first quarter results. Due to a large increase in our credit reserves, we recorded a loss of $0.46 per share. With the forecasted impact of the COVID-19 pandemic, including the economic impact of social distancing and continued stress in the energy portfolio, we prudently increased our credit reserves to over $900 million, or 1.71% of total loan. Our reserves reflects our adoption of CECL, which incorporates the life of loan methodology.
While there is a great deal of uncertainty about the duration and severity of the impacts related to COVID-19, we are closely monitoring our portfolio and proactively reaching out to customers. We believe that our reserves are appropriate and we are currently well positioned.
Average loans in our mortgage banker business, which serves mortgage companies, decreased with seasonally lower home purchase activity and a decline in refinance volumes for the quarter.
Also, National Dealer continued to decline due to lower inventory levels. However, total period-end loans increased over $3 billion to a record high as customers grew on their credit lines beginning in mid-March to meet cash needs and to build liquidity buffers. Also, period-end Mortgage Banker increased their record level as refi activity picked up as rates declined.
Following strong seasonal deposit growth in the fourth quarter, average deposit levels remained relatively stable. After the typical decline in January, deposits increased throughout the quarter. Relative to the first quarter last year, average deposits were up $2.8 billion or 5%.
Net interest income declined with the Fed's action to reduce interest rates. Concurrently, we are taking action to appropriately adjust deposit pricing.
Non-interest income declined with a decrease in non-customer related activity, including a reduction in deferred compensation returns, which is offset in expenses, as well as the gain on the sale of a business in the fourth quarter which was not repeated. In addition, following robust volume in the fourth quarter, syndication activities slowed as economic uncertainty increased.
Expenses decreased $26 million as we maintained our discipline, including a $15 million decrease in salaries and benefits. This resulted in an efficiency ratio below 57%, well below the peer average of 58.4% in the fourth quarter.
Capital remains strong. We suspended our share repurchase program last month as we focused on deploying our capital to meet our customers growing financial requirements.
The tone of recent conversations I've had with customers across our markets reflect the challenges with the current environment. It is important to note that, in general, over the past several years, our customers have remained cautious, prudently managing expenses and reducing leverage in anticipation of the eventual economic downturn. And while the environment has turned abruptly, we all remain hopeful that COVID-19 will be contained soon. And with the economic stimulus that has been provided globally, business will return to normal quickly.
And now, I will turn the call over to Jim to review the quarter in more detail.
Thanks, Curt. And good morning, everyone. Turn to slide 5. Average loans decreased approximately $900 million in the first quarter. As Curt mentioned, Mortgage Banker decreased following very strong refi activity in the fourth quarter and typical slow home sales in the first quarter.
This is a line of data reported by the Mortgage Bankers Association. Also, loans decreased in National Dealer with lower inventory levels, particularly in January and February.
Energy declined of decreasing CapEx and slightly better capital market activity early in the quarter. These declines were partly offset by continued growth in commercial real estate, driven by multifamily projects where we work with proven developers who provide substantial equity upfront.
Loan activity picked up significantly in the back half of March with the rapid change in economic conditions. The increase in period-end loans to a record $53.5 billion was due to a combination of customers drawing on lines to meet higher operating needs, as well as holding cash reserves in a time of uncertainty.
Mortgage Banker loans peaked at quarter-end with rising refi volumes. Also, as widely reported, companies – particularly larger customers – drew down on lines to ensure they had excess cash as a buffer. As a result, our lines utilization increased to nearly 57%. In and of itself, we do not see this as a sign of credit issues.
Mortgage Banker, General Middle Market and National Dealer customers typically have a borrowing base and/or financial covenants that govern the amount that can be drawn and, therefore, curtail risk. Further detail is provided on slide 20 in the appendix.
Since quarter-end, line usage has leveled out. It is of the utmost importance that we support our customers' liquidity needs at this challenging time. We are proactively reaching out to customers to determine their needs and provide our expertise. We are granting amendments on addressing loan pricing as appropriate.
Loan yields were 4.19% increase, an increase of 24 basis points from the fourth quarter. This was a result of lower interest rates, primarily one-month LIBOR.
Slide 6 provides details on deposits. Average balances were relatively stable and included a $300 million reduction in average non-customer broker deposits. Typically, deposits decline in the first quarter. In fact, first quarter deposits in each of the last four years have declined $1.5 billion or more.
This year has been different. In line with my comments regarding line draws, we believe customers are conserving cash and holding on to excess liquidity in this time of uncertainty.
Interest-bearing deposit costs decreased 16 basis points as a result of the full quarter benefit of actions taken in the fourth quarter, as well as recent rate adjustments made in conjunction with the Fed action in March.
Total funding costs remain low at 60 basis points primarily due to the large portion of non-interest bearing deposits, as well as the floating rate nature of our wholesale funding.
As you can see on slide 7, our MBS portfolio is stable and the yield on the portfolio held steady. We opportunistically pre-purchased a portion of second quarter expected payments at relatively attractive yields. This resulted in the period-end portfolio balance being a little higher than our target around $12 billion.
We had a modest decrease in prepays in the first quarter, but we expect they will pick up in the second quarter. We don't expect this to have a significant impact on our duration or the unamortized premium, which remains relatively small.
Turning to slide 8, net interest income declined $31 million to $513 billion and the net interest margin was 3.06%, a decline of 14 basis points relative to the fourth quarter. The negative net impact of lower rates was $15 million and 8 basis points.
Interest income on loans declined $47 million and reduced the margin 21 basis points. The major factor was lower interest rates, which had a $27 million impact and 16 basis points on the margin. Also contributing to the decrease were lower balances, one less day in the quarter and lower loan fees.
Lower non-accrual interest activity and other portfolio dynamics, such as a big shift in the portfolio, including an increase in higher quality/lower yielding loans, provided another headwind.
A slightly lower yield on the securities portfolio reduced net interest income by $1 million. Interest on deposits at the Fed had a $2 million negative impact or 4 basis points on the margin. The lower Fed funds interest rate had an impact of $4 million or 2 basis points and higher balances at the Fed added $2 million that resulted in a 2 basis point drag on the margin.
Deposit costs declined by $14 million and added 8 basis points to the margin, primarily a result of our prudent management of deposit pricing as interest rates declined, as I previously discussed. Finally, with lower rates, wholesale funding costs declined by $5 million, adding 3 basis points to the margin.
In summary, given the nature of our portfolio, our loans reprice very quickly. Also, we continue to closely monitor the competitive environment and our need for liquidity as we manage deposit pricing.
Slide 9 provides an overview of credit. We increased our allowance for credit losses by $279 million to $916 billion, or 1.71% of total loans. This reflected our expectations for the impact of COVID-19 and social distancing, as well as the continued pressure in energy.
We adopted CECL in the first quarter. For modeling purposes, we use economic forecasts through March 31 to inform us as we determine the allowance. There is a high degree of uncertainty regarding the ultimate economic impact of the pandemic, as well as the effectiveness of the government stimulus packages and payment deferrals.
Therefore, we also considered qualitative adjustments based on more severe or benign forecasts for certain sectors. We considered more severe assumptions for areas where we have the most concern, such as those more at risk due to social distancing, as well as auto production, leverage lending and energy.
This forecast includes GDP declining anywhere from 13% to 33% in the second quarter.
It is important to note that we're starting to cycle with very low levels of criticized and non-accrual loans. As you can see in the table, putting energy aside, net charge-offs were only $17 million or 13 basis points.
In addition, total non-performing loans were a mere 45 basis points and criticized loans remain low at only 4.6% of total loans as of quarter-end.
Energy loans, which were outlined on slide 10, were about $2 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 a riskier segment, was only $55 million.
Volatile oil and gas prices have resulted in more stress in the energy portfolio, evidenced by increases in criticized and non-accrual loans, as well as charge-offs. Therefore, we increased our reserve allocation to more than 10% of energy loans.
Spring redeterminations were approximately 8% complete as of March 31. And as of yesterday, 16% complete. So, we are still very early in the process.
With the decline in energy prices, we expect to see a relatively significant decrease in borrowing basis as well as collateral deficiencies. As we've done in previous cycles, we aim to work with customers to cure deficiencies through repayment over time.
Our energy customers are acting prudently, cutting costs and reducing CapEx in order to preserve liquidity. The ultimate outcome will depend on the duration of the cycle. With more than 40 years of serving this industry, we have deep expertise and remain focused on supporting our energy customers. Overall, our customers are well positioned and have weathered many cycles.
Slide 11 provides detail on segments we believe pose higher risk in the current environment. We're closely monitoring and working with customers in areas where social distancing is having a serious impact, such as hotels, retail and recreation-related businesses.
Our exposure to any one of these industries is not significant. And there are many areas where we have no exposure, such as franchise restaurants or consumer credit cards.
I've already covered energy. In regard to auto production, we have a long history of working through economic cycles, and two-thirds of the loans are to middle market companies. At quarter-end, there were only $9 million of non-accrual loans in the sector.
We're always closely monitoring our leveraged loans, which tend to be with middle market, relationship-based customers, sponsors, management teams and industries we know well. Also, our sweet spot would be in the lower end of the levered spectrum.
We've increased our allowance allocation for loans in these areas. As Curt mentioned, we maintain a well-diversified portfolio, which is a fundamental part of our credit strategy to help minimize losses during times of stress.
Turning to slide 12 and non-interest income, which was impacted by non-customer activity. This included deferred comp asset returns of negative $3 million, a $7 million decline from last quarter. Recall this is offset in non-interest expenses.
Also during the fourth quarter, we benefited from the sale of our HSA business for a gain of $6 million.
Customer derivative income was $9 million, a decline of $4 million as record derivative sales of $22 million were offset by a $13 million negative credit valuation adjustment due to the decline in interest rates.
Commercial lending fees decreased $8 million, following near record-high syndication activity in the fourth quarter and fewer deals in the first quarter due to economic uncertainty. There was a $3 million decrease in card fees, partly due to lower transaction volume.
Fiduciary income increased $2 million with strong sales. Note that market-related fees are billed on a one-month lag. Therefore, the recent decline in equities and money market rates is expected to be reflected in the second quarter.
Expenses declined $26 million, as shown on slide 13. Salaries and benefits decreased $15 million due to a number of factors. Deferred comp was lower, as I mentioned on the previous slide. Incentive compensation, including annual executive stock grants, was lower as it is tied to our performance.
In addition, we had a reduction in contingent workers and seasonally lower staff insurance as most employees have not yet met their healthcare deductibles. Seasonally higher payroll taxes partly offset these reductions.
In addition, outside processing fees decreased $13 million as the new accounting standard resulted in a $7 million reclassification of software expense. And recall, in the fourth quarter, we paid a $4 million vendor transition fee. Seasonality drove a $4 million decrease in occupancy expense and a $3 million decrease in marketing expense.
We continue to carefully manage costs as evidenced by our efficiency ratio, which remained solid at 57% – under 57%.
In light of the current environment, Comerica's conservative approach to capital and liquidity management positions us well to meet our customers' needs.
Slide 14 provides an overview of our strong liquidity position and funding base. We have ample access to multiple funding sources, with 75% of our funding coming from relationship-oriented deposits, of which nearly half are non-interest bearing deposits.
At quarter-end, we had approximately $4 billion on deposit at the Fed. Through the Federal Home Loan Bank, we have almost $10 billion available to draw at very attractive rates.
At quarter-end, we held $7 billion of unencumbered liquid securities in the form of treasuries and mortgage-backed securities, which had an accumulated unrealized pretax gain of over $400 million.
Finally, we have ready access to grow in deposits as well as the discount window at the Fed if necessary. Our capital levels remain strong, with an estimated CET1 of 9.51%, as shown on the slide 15.
In the first quarter, we returned a total $283 million to shareholders, including an increase in the dividend to $0.68 per share and the repurchase of $3.2 million shares. Last month, we suspended repurchases as we focused on deploying capital to meet customers' financial requirements and providing an attractive dividend. Note that we have elected to defer a portion of the transitional impact of adopting CECL, which provided a benefit of 10 basis points to the estimated CET1 ratio.
As we navigate the current environment, we expect our capital levels to remain strong. While our first quarter CET1 ratio, it is below our 10% target, we expect to return to this level when the economy improves.
Slide 16 provides our outlook for the second quarter relative to the first quarter. We are assuming recessionary conditions, including a significant decline in GDP and increases in unemployment.
Given the high degree of uncertainty pertaining to the economic impacts of COVID-19, as well as the government stimulus, we do not feel comfortable providing a full-year outlook at this time.
We expect average loans to grow, with increases in Mortgage Banker due to spring home sales and continued strong refi volumes. Also, we expect elevated line usage to continue as we support customers' liquidity needs, including loan advances under the government's Paycheck Protection Plan lending program.
Partially offsetting this, we anticipate businesses to have lower financing needs as a result of reduced working capital and CapEx requirements.
We expect average deposit growth in conjunction with customers conserving cash and receiving distributions under the stimulus program. We believe this will mostly be offset by business customers using funds to meet high operating needs.
The net impact from rates alone on net interest income is expected to be $55 million in the second quarter relative to the first quarter based on our economist's LIBOR forecasts. This expectation includes the full quarter effect of the March Fed cuts, combined with the actions we've taken to lower deposit rates. Of course, actual results will vary depending on a variety of factors, such as movements in LIBOR, which remain somewhat elevated relative to the Fed funds through quarter-end. Loan growth is expected to provide a partial offset to this rate headwind.
Credit quality is expected to reflect the economic environment, which is highly uncertain, and therefore, makes it impossible to provide clear guidance at this time. Of course, the largest variable is the duration and severity of COVID-19 and the resulting effects.
The current Federal Reserve was based on recessionary scenarios. However, we are in unchartered waters. In addition, CECL may cause greater volatility in our provision.
We expect non-interest income to benefit from an increase in card fees with higher transaction volume as customers receive the government stimulus funds, partly offset by lower merchant and commercial card activity.
On the other hand, a reduction in economic activity and lower market-related fees is expected to have an impact on derivatives, investment banking, fiduciary and brokerage activity.
Deferred comp, which was a negative $3 million in the first quarter, and is offset in expenses, is hard to predict and is not assumed to repeat.
We remain focused on controlling expenses and are closely managing discretionary spending. However, we expect to see a rise in outside processing tied to growth in cared fees.
Also, we expect COVID-19 related expenses to rise with increased compensation for employees who are not able to work remotely, as well as measures we've taken to protect employees, such as providing masks and intense cleaning of facilities.
In addition, we expect seasonal increases in annual merit, staff insurance and marketing.
As far as capital, I mentioned on the previous slide, we've suspended the share repurchase program and are focused on meeting customers' financing needs as well as maintaining an attractive dividend.
Now, I'll turn the call back to Curt.
Thank you, Jim. Over our 170-year history, we have managed through many economic cycles. We have demonstrated our resiliency and our ability to work cohesively and leverage our ingenuity and entrepreneurial spirit in order to persevere through the Great Depression, two World Wars and the great financial crisis.
We have a long-tenured experienced team which is able to adapt to the rapidly changing environment, as well as support our customers as they navigate these challenging times.
It is at times like these that you build and solidify loyal customer relationships. Our geographic footprint is diverse, and we lack reliance on any one industry.
As discussed, we significantly increased our credit reserve in the first quarter. Of course, it is impossible to gauge the ultimate impact of the pandemic. But we believe our conservative underwriting standards, prudent customer selection and history of superior credit performance through the last recession demonstrates our ability to weather the current cycle.
We're also focused on maintaining our expense discipline. We look forward to returning the business as normal and we are taking steps to ensure we are prepared to serve our country when the economy rebounds.
With strong liquidity and capital levels, we are able to meet our customers' growing financial needs as appropriate and are focused on maintaining an attractive dividend for our shareholders.
In summary, during times of stress, we believe our conservative approach to banking serves us well.
And now, we would be happy to take your questions.
[Operator Instructions]. Your first question will come on the line of John Pancari with Evercore ISI. Please go ahead with your question.
Good morning.
Good morning, John.
As you look at the loan loss reserve and as you decided on the magnitude of the addition, just want to get some color on how you thought about through-cycle losses, particularly how that would break out for the overall loan book, but also for energy? How would you think about that that could play out this time around? Thanks.
Pete?
G, John. Yeah, CECL is not a stress test. It's not about calculating your through-the-cycle losses. It's really an accounting exercise. And so, we did our best to build our reserves appropriately, given what CECL calls for. I think we feel really good about the number we came up with. We use the most recent economic scenarios that were available. We even kept our books open a couple of days to make sure we got that. And I think that 1.71 coverage ratio is a really solid number and we feel good about where we ended up.
Okay, thank you. And then, when it comes to the dividend, I just heard your comment about your focus on maintaining an attractive dividend. So, I guess, just give us your thoughts around your ability to maintain it as the credit pressures weigh here and then considering the hit to your common equity that we saw this quarter. I'm also curious, where do you see your common equity ratio playing out in a stress scenario? Thanks,
John, I'm going to start answering your question and ask Jim to fill in a few details. First, let me just reiterate what I think many of you already know. And that's that we've done a very good job of returning capital to our shareholders the last few years, both in terms of our buyback, as well as raising our dividend. And so, we remain focused on leveraging capital really, first, to meet loan growth, but we also want to provide really a healthy and competitive dividend to our shareholders. And, obviously, right now, there are a lot of unknowns, a lot of uncertainty. We're uncertain around sort of the duration and depth of the economic cycle and how long the COVID-19 situation will last.
But today, based on what we know, we feel comfortable in our capital position and our dividend, and I'll turn to Jim for some more color.
I would just supplement that with – we do stress tests for dividend. That's an ongoing exercise we do at least once a year. We have very strong levels of parent company cash, which is very important when you want to maintain the dividend. We took very healthy reserves this quarter, and we still have strong capital. So, we feel good about that. And then, when I look at the earnings projections as things start to normalize with credit, we certainly believe the dividend can be managed within the context of those earnings even in a low rate environment. So, [indiscernible] how the future might play out with COVID over the next several quarters, what we're seeing in the near and medium term, we feel good about dividend and believe it can be maintained.
Got it. Thanks. Just one more. Can you remind us what your internal target is for your common equity tier one ratio?
Our CET1 target is 10%. And that's already publicly disclosed.
Okay, great. All right. Thank you.
Thank you, John.
Your next question is from the line of Ken Zerbe with Morgan Stanley. Please go ahead.
Ken, good morning.
Good morning. Thanks for taking my question. I guess maybe starting off, just in terms of the energy portfolio, I obviously saw you guys increased your reserve to over 10%. Can you just help us understand? From our perspective, you have a very large reserve on the energy portfolio; another bank, for example, might have a much lower reserve on their energy portfolio. How do we from the outside know whether the reserve is because you're being much more conservative than other banks perhaps or because the credit quality of your portfolio might not be the same as theirs? Thanks.
Ken, as you know, with CECL, the main driver, particularly this quarter, may be more than any other quarters, is the economic forecast. And so, the economic forecast had a lot to do with the reserves that we decided to build for energy. And so, we made some assumptions about where oil prices were going to be over a reasonable and supportable period.
The other point that we just did as kind of a gut check was we felt this felt worse than what we went through a few years ago. And we decided that we wanted to make sure that that number was above where our reserves were in the last down time. So, that 10.5% exceeds the reserves that we had last time and we didn't need all those reserves last time. But we felt the severity here was worse.
And do you feel the portfolio quality is worse this time around?
Yeah. No, I feel the opposite for a couple reasons. One is, I think our E&P borrowers are, for the most part, less leveraged. We have a lot less energy services than we had in the last downturn. Energy services contributed 45% of our credit losses in the last downturn, with only 15% of the portfolio. Today, we're out of that business.
And then, I think the most important factor really is our portfolio is smaller. It's about $1.2 billion smaller than what we had going into the last downturn. And I think that is probably the biggest factor of all.
Got it, okay. That helps out. And then, just one last question. In terms of the NIM impact, I noticed, obviously, your guidance is based on LIBOR 78 basis points. It looks like it's down about 12 basis points already this quarter. Can you just remind us, like, what the sensitivity is to, say, I don't know, 25 basis point reduction in one month LIBOR on the NII? Thanks.
Jim?
Yeah. I would probably offer you a very crude rule of thumb, just in fairness, because I know you guys are trying to get the models right. Obviously, LIBOR has been jumping around quite a bit, and it got lower, then it went back over 100, now it's back down again. So, depending on how COVID plays out will ultimately dictate the stress on the economy and where LIBOR ends up at.
But you probably apply to that about $700,000 a quarter [indiscernible] LIBOR. And I would warn you that's a very crude rule of thumb. It depends on when during the month LIBOR might go up or down and when resets occur. But just to be transparent, that hopefully gives you a little bit more information.
Got it. It does. All right, thank you very much.
Thank you, Ken.
Your next question is from the line of Steven Alexopoulos with JPMorgan. Please go ahead.
Good morning, everybody.
Good morning, Steven.
First, just to follow-up on your commentary around the energy reserve, how much of that is specific reserves and how much is qualitative of the 10%?
Pete?
Yeah, by specific, you mean cited, right?
Your specific credits rather than – because you're implying that a lot of the build versus peers may have come from just your model assumptions. So, I'm trying to delineate between what's model, what's specific to the individual credits.
Yeah, I understand. It's a little bit more complicated than that because we also increase our loss given default in the process, and so that did make it really apples to apples on what portion was just driven by the standard versus the qualitative. But very little of it was cited reserves because our criticized at the end of the quarter was still reasonably low.
Okay, got you. And then, I may have missed this, but did you give the portion of loan deferrals, the balances of loans that were deferred in the quarter?
Yeah. So far, we have deferred payments on 1,000 loans, totaling $1.6 billion to 600 borrowers, and the average deferral period is 90 days.
Okay, got you. And then finally, given that you did report a loss in the first quarter, do you guys need to secure special regulatory approval to pay the dividend? And is that done already?
So, we are always in communication with our regulators and they're aware of our actions and how we're proceeding. So, we don't disclose details there, but I'll just say we're always in ongoing contact with them.
Okay, fair enough. Thanks for taking my questions.
Thank you, Steven.
Your next question is from the line of Jennifer Demba with SunTrust. Please go ahead with your question.
Hi. Follow-up on the deferral question. If you looked at your slide deck with the listing of the kind of greater at-risk portfolios, what percentage of those borrowers have asked for deferrals?
Jennifer, I don't have the breakdown. My sense of it is that a fair number of them would have come from those carve-out portfolios, but I would say also many were really borrowers that really didn't need deferrals. They looked at asking for the deferral as just really an insurance policy for their liquidity. And so, I wouldn't necessarily jump to the conclusion that all of the deferrals that we granted were to trouble borrowers at all.
Okay. Thank you so much.
Your next question is from the line of Mike Mayo with Wells Fargo. Please go ahead with your question.
Morning, Mike.
Hi. Hey. We didn't plan for an oil environment like this. I can't imagine. I know there is some flukes with these negative oil prices. But it seems like the oil prices, as you look out ahead, would be below the level where the Fed stress test takes place. And it might be below the level where you have your own stress test. So, can you talk about the impact of the oil price, like where it is today and what that could mean for losses and how that differs from the past?
Sure, Mike. Sure. As you know, it's not so much – it's not so important where oil is today or next week or even a month from now. It's where it's going to settle in over the longer period of time. And that's because two-thirds of our borrowers can generate positive free cash flow before CapEx with oil really in the 20s. Only about 10% of our oil portfolio needs oil to be in the mid-30s or higher to generate positive free cash flow before CapEx.
The more, I would call it, intermediate concern is going to be liquidity. We're using much lower price decks, and given where prices have gone over the last month, to determine what our borrowers' borrowing bases are. And so, as those borrowing bases come down, some of our borrowers are going to get squeezed from a liquidity standpoint.
In this environment, more than ever, we need to work with them. We need to bridge them to a point where prices stabilize, demand stabilizes, supply stabilizes, so that we can get them to a point where they can just function in a more normal environment. So, that's the way we kind of see this playing out. I'm not so focused on where prices are right now today, but try to bridge to a point where prices stabilize.
That's a good clarification. In working with our energy analysts, he had a couple of questions that might help us bank analysts. So, I can go back in the queue if I need to. But what is the level of utilization for your energy borrowers, public versus private?
That's a good question. I don't think we have it broken down that way. That's something we could get, but I don't have that, Mike.
That's fine. And what's the process for covenants if they are breached?
No. Well, again, we're going to be triaging the portfolio and there's not one blanket answer. But the bottom line here is not just Comerica, but all the banks, we're going to be working with our borrowers to just get through it. And the ones that continue to be supportive, we're going to be very supportive of them.
Okay. Last two. Reports that banks are creating shell companies to own the assets. Is Comerica considering doing anything like that? Are you allowed to?
Yes to own, but not to operate. We're not big enough energy player that we would consider operating energy assets. But if we need to have an equity position in them, we're prepared to do that.
And then lastly, limits that you can place on E&Ps on outspending cash by leaning on revolvers?
I'm sorry, Mike. Can you say that one more time?
What are the limits that Comerica can place on E&Ps on outspending cash by leaning on revolvers, if any? What kind of control do you have over the borrowers what they do with the money?
Are you talking about the energy portfolio?
Yeah.
Yeah. So, there are not a lot of restrictions in that regard. But if they are using the money for distributions or something that's not going to be accretive to their borrowing bases, they know that wouldn't sit very well with the banks. And I can't imagine any of our borrowers doing that. In fact, I would say I've been really pretty pleased with the way our borrowers are handling this so far. They're really cutting back on expenses. They're cutting back on CapEx. They are using whatever little free cash flow they have to pay down debt. And we've not seen very many defensive draws at all.
So, one last thought. Again, this is the issue in the stock market. Today, at the moment, oil price is tanking. You're exposed to oil. Your kind of one thought you really want us to have as those who own or analyze Comerica would be what?
I would say we're going to get through this. We have a very long 170-plus-year history of getting through a lot of the different downturns. We'll get through this one as well. We have a diversified portfolio. Energy is only a very small piece of our portfolio. In fact, ex energy, our portfolio is really in great shape. Our charge-offs are pretty nominal this quarter again. So, we go into this downturn with a really – I think a position of strength from a credit quality standpoint. We've got one issue, in particular energy. We've got our eye on the social distancing portfolios. But as we work through this with our customers, I think we'll get through it fine.
All right, thank you.
Your next question is from the line of Erika Najarian with Bank of America. Please go ahead.
Good morning, Erika.
Good morning. My first question is a follow-up to John and Steve's question on the dividend. My understanding is that automatic restrictions on the dividend don't kick in until you breach that 7% CET1 level and then the restriction is a 60% payout on trailing eligible net income. I'm wondering if the same rules apply on Tier 1 capital if you fell below 8.5%. And as we go forward, what are the RWA considerations that you have on hand in order to prevent further erosion in capital?
Good morning, Erika. Yes, the same restrictions do apply to all levels of capital. So, it would be 8.5% for Tier 1. And as you know, I think you've asked this previous calls, Tier 1 is a binding constraint. We don't anticipate getting down 8.5%. Obviously, we're getting very strong and over 100 bps above that level. We estimate at 9.51%. Again, unknown where COVID is going to take the industry, but we do not anticipate going down to that level.
But you do righty point out that risk-weighted assets is probably the biggest variable. It's got the potential to move the capital ratios even more than provision or net income. And we're watching that. This is a very different type of crisis. We know that in the last Great Recession, we had some initial line draws, but ultimately, companies de-levered and risk-weighted assets shrank and that really drove up capital ratios. It's unclear if that's going to occur in this crisis. It's more of a demand destruction crisis. It's not clear that customers will de-lever. Some of them, obviously, have drawn up. It just remains to be seen where that goes. So, risk-weighted assets will drive a lot of this.
We are appropriately right-sizing Comerica. With customer commitments, we're there for them. But where there is larger commitments than perhaps need to be, we are talking to customers about just make sure those are right-sized to meet their needs, and we'll just have to monitor the risk-weighted assets. We'll do the right things for the customers and we'll see where demand for those goes over the next year.
Jim, I might just add and maybe Peter to add a little color just around what we're seeing in terms of draw activity with customers. But our first focus is always on taking care of our customers. That's why we're here. We're a relationship bank. And we're going to make sure that our customers are taken care of. And those that are operating well and guys that are working through difficult situations, as Pete alluded to earlier. But, Peter?
I would just add to what Jim said earlier in the call that we saw utilization go up into the first quarter and a little bit into April, but since then, it's really kind of tapered off. And I think our customers are well positioned going into Q2 and the rest of the year. So, I think that we haven't seen a whole lot more active defensive draws or drawing down lines than we did sort of that first end of the quarter into April.
Thank you. And my second question is, everybody is grappling with what cumulative losses can look like in the industry. And Comerica has clearly had a very strong history on C&I. So, if I'm looking at the regulatory data correctly, cumulative losses of 2.25 in 2009 and 2010 in C&I. And in 2002, 2003, cumulative losses of 3%. And I'm wondering, if we carve out your energy portfolio, which is clearly uniquely stressed, if those are good starting points for two-year cumulative losses as we look forward in terms of the type of recession that we're going to have and the impact on your C&I portfolio?
So, Erika, let me give you a couple of data points, and hopefully, this would help. So, first of all, just comparing ourselves to the Great Recession, this recession, every recession, of course, is going to be different and, of course, we've got the social distancing segment of the portfolio, which is different this time around that we didn't have to be concerned about in 2008, 2009.
But if you just compared our book today to 2008, we have made a very concerted effort over the last 7 to 10 years to make it more recession resilient. And so, if you look at the lines of business that were, what we call, recession susceptible, going into 2008, they totaled 31% of the portfolio. Today, we've reduced that by 20%. So, now those businesses that we consider most susceptible to recession are only 25% of the portfolio today, and that includes energy. Energy is in that 25%.
If you take a look at our reserves today, our peak reserves are right about – from a dollar standpoint right where they are today. Now, the coverage ratio was higher in 2010 when the coverage ratio peaked, but that's because – primarily due to the downturn, our loans ran off a bit. But from a reserve standpoint, the $1 billion that we have in reserves right now is very comparable to what we had in the downturn.
And then then, lastly, some stress test numbers. Our last DFAST was 2017. That was $2.2 billion. We have had two stress tests with our model since then, one in 2017 which was $1.9 billion, and then one in 2019 at $1.4 billion. So, our reserve levels today as a percentage of the stress test losses are 48%, 67%, respectively.
So, I think the takeaway there is, I think our portfolio is better positioned than we were going into the last downturn and I think we're better reserved as well.
Got it. And just one last question. Just a little help in understanding PPNR as clearly that's the first line of defense in terms of absorbing provisions. Does your net interest income outlook for 2Q include the impact of PPP loans? And also, as we think about your card fees, clearly, there's going to be lower transaction volumes. But can't the Direct Express business benefit from the stimulus packages? And could that be an offset from the pain that we're seeing or remodeling in terms of the exit rate and transaction volume?
Yeah, Erika. Number one, the PPP impact, we made an attempt to factor that into the overall outlook, but it's really an unknown in terms of how it's going to affect income because a huge variable with PPP is how long loans are outstanding, when they pay off, how many are forgiven. So, we took a stab at it, but I think there's a lot of uncertainty with all banks in terms of how it's ultimately going to impact the financials. Of course, we're primarily focused on just making sure we're taking care of customers' period.
Regarding Direct Express, in my remarks, you might recall that I mentioned that we expect card fees actually to be up in the second quarter. So, stimulus payments being processed is a component of that. So, we have factored that in.
Thank you.
Thank you, Erika.
Your next question is from the line of Ken Usdin with Jefferies. Please go ahead with your question.
Hey, thanks. Good morning, everyone. Good morning. Just in terms of thinking about your diversity, you guys also happen to also have a lot of specific industry expertise in areas that might be pretty severely impacted. So, I'm wondering if you could kind of walk through how mortgage banker, auto floor plan, the equity lines, business, tech and life sciences, can you just talk about what you're seeing and hearing in those businesses and to the extent that you expect volumes to change just underneath the line draws in each of those areas? Thanks.
Yeah. So, I'm taking it from a credit standpoint, maybe Peter can take it from more of a revenue standpoint. The mortgage banker and equity fund services businesses are fairly low risk businesses. Our mortgage banker portfolio, as you know, is all conventional mortgages. Our source repayment on those is the secondary market. They could get disrupted for a short period of time. That's okay. We've seen that before. We work through that with our borrowers. And eventually, when the markets stabilize again, they're able to reduce their warehouse lines.
Equity fund services, very clean portfolio. The LPs are institutional. Very strong type of borrowers we would not expect to see credit issues at all develop in that portfolio.
Technology and life sciences tends to be up and down, not just in cycles like this, but it can be up and down when cycles are strong. And so, for instance, when the economy is strong, multiples are high, and sometimes our venture capital firms are buying companies at very high multiples. That results in charge-offs for us. So, in a kind of a more difficult market for equities, it sometimes translates into better results from a credit quality standpoint in that portfolio.
Automotive would be certainly one we have our eye on. Those companies are very volume dependent. They have high fixed costs. And so, when auto volumes drop off, we tend to see some migration there. I would say, though, that we've got a lot of confidence in our people in Michigan that manage the risk in those portfolios. They've been through a lot of downturns and they're really good from a customer selection standpoint and knowing how to work with the borrowers.
I can't remember if there was another one that you had mentioned, but…
Those were them. Thanks.
Yeah. The only thing from an activity level, it's the same order that Pete went. Mortgage is clearly still very, very active. You've got less activity, obviously, in TLS and EFS and then in the auto space. There's not cars really being made right now. So, clearly, you're seeing a slowdown in the activity [indiscernible]. The same order that Pete described is also what we're seeing on activity.
Got it. And one follow-up on the CRE side of things. Not a big book for you guys. But I remember we talked about this in 2015 and 2016 with regard to the secondary impacts around energy and CRE. Can you just talk about just your views of just how that might play through this time in terms of secondary effects and the impact on the commercial real estate book? Thanks.
Sure. The commercial real estate book is dominated by a Class A infill multifamily construction. It's a really good product in downturn. So, it tends to hold up really well. And that's why we like it. The areas that we avoid are office, which is obviously something that's going to get – is getting hit very hard right now. We've got a little bit of retail, about $500 million of that, but for the most part, very strong developers, low loan-to-valued.
The last time, at least going into the downturn, I think our occupancy rates were in the mid-90s or something like that. So, it's a pretty strong, but small portfolio. We do have multifamily in Houston. Houston, obviously, is going to be ground zero with what's going on in energy. We do have some history there. In the last downturn, we did not have a single loss in our multifamily portfolio. We were able to work through that with our borrowers.
And most of these developers, they are national developers. They have equity partners with deep pockets. We have 30% to 40% equity in each of the projects. And they're not going to walk away from these projects, given their investment, and the fact that we've got a long history with them of knowing how they handle things in downturn. So, we feel pretty confident about the commercial real estate portfolio as a whole.
Thank you.
Thank you, Ken.
Your next question is from the line of Gary Tenner with D.A. Davidson. Please go ahead with your question.
Good morning, Gary.
Thank you. Good morning. So, you gave the [indiscernible] portfolio reserve being over 10%. I was wondering if there's any of the other at-risk industries that you'd be willing to disclose where you've got the reserve levels at?
Yeah, Gary, we didn't go into that much detail. I think the number that we feel really good about, and I think it's the most important number, is the 1.71 coverage. And I think it's going to stand pretty tall relative to our peers, especially when you consider that banks that have larger consumer books than us should have larger reserves because of CECL. Our consumer book is very small. So, when you compare apples to apples, commercial reserves to commercial reserves, I think our reserves are going to be amongst the highest in the industry.
Okay. And then, just to follow-up on your – you made the comment on the companies that are coming to you to request deferrals. I forget the percentage, but high percentage seemed to be those that didn't necessarily need them, but were looking at them as insurance. Just to clarify, are you providing deferrals in those scenarios?
We have. If they were to come back to us again, we would have to reevaluate them in 90 days to see if they really need them. But, yeah, we've been very accommodative this quarter with just the amount of turmoil that's out there. We just felt it was the right thing to do. And we were happy to accommodate our customers.
And, Gary, I just would say – this is Curt – that I would apply that same lens across all of our customers. So, whether they're a retail consumer customer or even a private banking/wealth management customer or a commercial customer, any of our commercial channel, we have really tried to be accommodative on the front end because of the great deal of uncertainty. And then, hopefully, customers behave well, which we think they will through this cycle and address the situations where maybe they are not, but we wanted to be as flexible and accommodative because we think it's the right thing to do for the country.
Okay. Thank you.
Your next question is from the line of Jonathan Arfstrom with RBC Capital Markets. Please go ahead.
Good morning, Jon.
Thanks. Good morning. Hey, good morning. Just a real quick one, kind of following up on Ken's questions. You were talking about economic activity. I'm wondering if you – and really by line of business, can you talk about it by market? I know that sounds like Texas is preparing to open back up. Michigan's a bit more restrictive. And California might be somewhere in the middle. But talk about whether or not you think you've seen activity trough in some of your markets and what kind of expectations you have in a place like Texas when it opens back up.
Jon, first of all, obviously, this impact is broad and it's really across all markets and almost all industries. So, not just those that are dealing with social distancing sort of disruption. So, there is sort of broad impact. Broad impact on GDP, broad impact on unemployment from a sort of consumer level. And so, all that has to play out.
We do believe – our sort of economic view is that the economy should start to stabilize as we get into the third quarter, assuming that we see some of the trends and the COVID abatement that we're anticipating. And then, if we kind of go through the year and start to see some more normalization and certainly a much stronger sort of pace to GDP heading into 2021, a lot of that's supported by what is just unprecedented massive physical and sort of monetary stimulus.
Kind of going back to each of the markets, I'll make a couple of comments on all three of them. Texas is a little bit unique, and that is facing the dual challenge not only of the COVID situation, but of the oversupply of crude oil that Pete has been talking about. But having said all that, it does seem like Texas got ahead of things early and, at some point, there seems to be a movement from the governor for some more normalization and some selective reopening. So, we'll see how that plays out.
I'd also say, just to Texas, while there's certainly the energy issue, it definitely is a more diverse economy than it was last 10 years ago during the Great Recession. And as you know, we've seen just very significant new job creation and net population inflow. So, Texas will take a blow here from energy and COVID, but I do think, for the longer term, it's better positioned than it was during the last Great Recession.
California seems to have gotten a little bit ahead of the quarantine early, although there is some recent news out that maybe the numbers for LA were higher than originally reported. And what I would say that in California, we also are seeing some opportunities. There is always opportunity that get created on the IT side as people are doing more automation and technology. And then lastly, I just would say, as I've said previously, California is a very resilient economy, very diverse economy, sixth largest economy in the world. And so, I think longer-term, we'll be okay.
Michigan had more concentration of issues and took a more restrictive quarantine early on to deal with that, to deal with the COVID impact. I think the state is dealing some of the impacts of extended plant closures, certainly in the manufacturing sector. We talked about the decline in auto sales as well. And we would expect auto sales to probably fall again in April, but then it may start to stabilize in the summer as, hopefully, we start to come out of and people start to move around.
But I'd say the same thing about Michigan. You look at where the state is today versus where they were 10 years ago, it's definitely moving to a more diverse economy. We've had a tremendous resurgence in the core of Detroit and we've seen some population inflow, especially amongst millennials into the state. And so, every state's a little bit different situation. Certainly, the reopening will be governed by the governors, and so we'll have to work with each state related to that and we've been working now for a few weeks on our own reopening plans.
But the good news is whether we go back to full throttle reopening or maybe a phased reopening, it has not stopped us from doing business and we have been able to operate well in a more remote environment with some of our colleagues, about 65% of our colleagues working remotely, and then certainly some who are – banking centers, et cetera, that are still in more direct face-to-face contact with customers.
Okay, all right. Thanks a lot.
Thank you, Jon.
There are no more questions at this time. I will now turn the call back over to Curt Farmer, Chairman, President and CEO, for any closing remarks.
Well, thank you as always for your interest in Comerica. We continue to wish all of you and your family good health and safety in the days ahead. Thank you, again, for joining us.
Thank you for joining today's Comerica conference call. You may now disconnect.