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Intrinsic Value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
Good morning. My name is Regina, and I will be your conference operator today. At this time, I would like to welcome everyone to the Comerica Third Quarter 2018 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. [Operator Instructions]
I would now like to turn the conference over to Darlene Persons, Director of Investor Relations. Ma'am, you may begin.
Thank you, Regina. Good morning and welcome to the Comerica’s third quarter 2018 earnings conference call. Participating on this call will be our Chairman, Ralph Babb; President, Curt Farmer; Chief Financial Officer, Muneera Carr; and Chief Credit Officer, Pete Guilfoile.
During this presentation, we will be referring to slides which provide additional detail. The presentation slides and our press release are available on SEC’s website, as well as in the Investor Relations section of our website, comerica.com.
This conference call contains forward-looking statements. And in that regard, you should be mindful of the risks and uncertainties that can cause actual results to vary materially from expectations. Forward-looking statements speak only as of the date of this presentation and undertake no obligation to update any forward-looking statements. I refer you to the Safe Harbor statement in today’s release in Slide 2, which I incorporate into this call as well as our SEC filings for factors that could cause actual results to differ. [Audio Gap] after this conference call we’ll reference non-GAAP measures and, in that regard, I direct you to the reconciliation of these measures within this presentation.
Now I’ll turn the call over to Ralph, who will begin on Slide 3.
Good morning and thank you for joining our call. Today, we reported third quarter earnings of $318 million or $1.86 per share, excluding $20 million in security losses revenue grew 2%.
Our credit metrics remain strong and expenses were well controlled. This drove an ROE of over 16% and an ROA of 1.77% for the quarter. Relative to the third quarter of last year our earnings per share increased 48% and net income is up 41%. This increase is due to our management of loan and deposit pricing, as interest rates have moved higher, improved credit quality and continued successful execution of our GEAR Up initiatives, as well as a lower tax rate.
On Slide 4, we have provided details on the adjustments related to certain items. We realized $23 million in discrete tax benefits primarily related to the 2017 tax reform law. The bulk of the proceeds were used to reposition a portion of our securities portfolio into treasuries which yield about $4 million in additional interest per quarter. The repositioning resulted in a loss in the securities sold. We also incurred restructuring charges related to our GEAR Up initiatives.
Turning to Slide 5 and an overview of our third quarter results, a seasonal decline in National Dealer Services and typical summer slowdown in middle market contributed to a $641 million decline in average loans compared to the second quarter. This was partly offset by a seasonal increase in Mortgage Banker and continued growth in Technology and Life Sciences, specifically equity fund services.
As far as deposits average balances increased $263 million. Our deposit rate increased 9 basis points as we remain focused on our relationship approach to manage deposit pricing to attract and retain customers.
Net interest income increased $9 million with the net benefit from increased interest rates contributing $13 million. Our net interest margin decreased 2 basis points to 3.60% as the benefit of rates rising was offset by lower non-accrual interest recoveries and higher excess liquidity.
We continue to have strong credit quality with a decline in problem loans and 13 basis points in net charge-offs. The charge- offs for the quarter were fully covered by our existing allowance, and as a result there was no provision for loan losses.
Non-interest income increased $6 million or over 2% excluding the $20 million in losses on securities that I previously mentioned. We have maintained our expense discipline and our efficiency ratio dropped to just under 53%.
Now that we are no longer subject to CCAR, our board is able to more efficiently and effectively take capital actions with a focus on reducing our robust capital ratios to a level that is reflective of our business strategy.
In the third quarter, we meaningfully increased our payoff to shareholders to a record level. We repurchased $500 million in shares and increased our dividend 76% to $0.60 per share. Our estimated CET1 capital ratio decreased 23 basis points to 11.66%.
And now I will turn the call over to Muneera, who will go over the quarter in more detail.
Thanks, Ralph. Good morning, everyone. Turning to Slide 6. Third quarter average loans declined $641 million compared to the second quarter primarily due to seasonality.
Our auto dealer portfolio decreased $400 million. Dealers typically reduced inventory in the third quarter in preparation for delivery of the new models.
In addition this year dealer has been impacted by M&A activity with a few of our customers taking the opportunity to sell a portion of their franchises at attractive valuations. Summer slow downs in middle markets resulted in a $225 million decline in average balances.
We had a few large loan payoffs in the second quarter in private banking as I mentioned on our last earnings call. This has resulted in a $191 million decline in the third quarter average loans.
Also we remain selective in the large corporate space maintaining our pricing and underwriting standards in a highly competitive environment. Partly offsetting these declines, Mortgage Banker grew nearly $180 million with a lower pickup in summer home sales. Our portfolio continues to benefit from the fact that it is heavily weighted to home purchases with 89% purchased versus refi compared to the industry average of 75%.
We continue to have solid growth in Technology and Life Sciences, specifically equity fund services. Total period-end loans decreased $782 million with seasonal declines in Mortgage Banker and dealer services.
Commitment to period-end were up $650 million driven by increases in most business lines led by Technology and Life Sciences and general middle market. Overall, the sentiment is positive, reflective of the strong economy, yet customers continue to be cautious given recently imposed tariff and evolving trade discussions, as well as constraints due to available labor.
On a year-over-year basis we have growth loans in many of our specialty areas such as Technology and Life Sciences, national dealer services, commercial real estate and environmental services. This has been offset by the adoptions in energy which has declined to over $300 million, as well as decreases in large corporate and private banking.
Our loan yield increased to 11 basis points. Short term rates increased at a much slower pace in the third quarter. For example average 30 day LIBOR increased 14 basis points compared to 32 basis points in the first two quarters of this year. Therefore the rate benefit of 15 basis points was muted relative to the second quarter. Also higher loan fees in the margin added 2 basis points to our yield. Finally, nonaccrual interest recoveries which were elevated in the second quarter decreased $8 million reducing the yield by 6 basis points.
As you can see on Slide 7, average deposits were up $263 million in the third quarter, with growth in nearly all business lines led by increases in interest-bearing deposits and Technology and Life Sciences and Wealth Management. We expect average deposits to increase in the fourth quarter consistent with normal seasonal patterns, but not at the same magnitude that we have seen in years past.
Period-end deposits were impacted by the timing of monthly federal benefit activity in our government prepaid card business. Of note, relative to the third quarter of 2017 average municipal deposits are down nearly $1 billion. Deposit pricing for the third quarter increased 9 basis points, as we remain focused on our relationship approach to manage deposit pricing to attract and retain customers.
Slide 8 provides details on our security portfolio. As Ralph mentioned, we repositioned $1.3 billion of treasuries at the end of the quarter. We have enhanced our future earnings as the higher yield on the purchase securities resulted an additional $4 million per quarter of net interest income.
The loss taken on the securities sold was offset by the discrete tax benefit which resulted from the new tax laws. As far as the portfolio third quarter performance, the yield on the portfolio continued to trend up and there was no significant change in the duration or the relatively small underlying loss position. Yield on recent MBS purchases have been in the 330s, 360s which was well above the average rate of 228 on the $465 million in paydowns we received in the quarter.
Turning to Slide 9. Net interest income increased $9 million, while the net interest margin declined 2 basis points. Our loan portfolio added $13 million and 8 basis points to the margin. Increased interest rates provided the largest benefit, along with one additional day in the quarter and higher loan fees. This was partly offset by an expected decline in nonaccrual interest recoveries from an unusually high level in the second quarter, as well as lower loan balances.
Deposits at the fed added $10 million reflecting the benefit from the higher fed funds rate, as well as an increase in average balances. The higher level of excess liquidity drove a negative impact of 3 basis points to the margin.
Higher yield on the securities book added $2 million and 1 basis points to the margin. On the funding side, deposit cost increased $7 million primarily due to increased pay rates. This had a 4 basis point impact. Also we issued $850 million in senior debt at the end of July, primarily to fund our share repurchase program and prefund some debt that’s maturing in the first half of next year. The higher debt balances, together with the increase in short term rates added $9 million in wholesale funding costs and 5 basis points to the margin.
In summary, the net impact increased rates contribute in $13 million or 8 basis points to the margin. Credit quality remained strong as shown on Slide 10. Our net charge-off ratio was 13 basis points. Gross charge-off remained low at $25 million. Recoveries were $10 million following an unusually high level in the second quarter.
Total precise loans declined $95 million or 5% and now represent 3.4% of total loans at quarter end. This included a decrease in non-accrual loans which comprised only 47 basis points of our total loans. Energy criticized and nonaccrual loans continued to decrease. The positive credit migration resulted in a reserve release and reserve ratio of 135%. The economy is strong and our customers are performing well. At this point they're not seeing any concerning trends.
Turning to Slide 11. Excluding the securities losses, which I previously discussed, non-interest income grew $6 million on over 2%. This included good customer activity in both interest rate and energy derivatives. Investment banking also increased with a pickup in M&A activity.
Also we have smaller increases in car and brokerage fees. This was mostly offset by decreases in syndication following the robust activity in the second quarter, as well as letter of credit fees. In addition, we had increases in bank-owned life insurance with the receipt of the annual dividend, as well as deferred comp which was offset in noninterest expenses.
You may recall that in the second quarter we incurred a charges to increase the reserve for a derivative contract related to Visa Class B shares. Expenses remain well controlled and our efficiency ratio dropped below 53% as shown on Slide 12.
Salaries and benefits increased $4 million, as the impact from higher contract labor related to technology project, deferred comp as well as one additional day in this quarter were partly offset by a reduction in our workforce. Relative to a year ago, our workforce is down nearly 2% as we have implemented our GEAR Up initiatives driving increased productivity and efficiency across our organization.
GEAR Up restructuring charges were $12 million, an increase of $1 million from the second quarter. In the third quarter, we repurchased a record $500 million or 5.1 million shares under our equity repurchase programs, as you can see on Slide 13. In addition, we increased our dividend 76% to $0.60 per share. Together with dividends, we returned $600 million to shareholders. We have a target to repurchase up to 500 million shares in the fourth quarter and expect to facilitate this through an accelerated share repurchase program.
Our estimated CET1 declined 23 basis points to 11.66%. Our goal is to reach a CET1 ratio of 9.5% to 10% by the end of 2019. Careful consideration will be given to eearnings generation, capital needs and market conditions as we determine the pace of the share buyback.
Turning to Slide 14. Our balance sheet is well positioned to benefit from increases in rates. Approximately 90% of our loans are floating rate, with the bulk tied to 30 day LIBOR. Also we have a favorable deposit mix with the majority being non-interest-bearing. Combine this with careful management of pricing, and we have been able drive a cumulative loan beta of 89% and a cumulative deposit beta of 21%.
In conjunction with the September fed rate action, we increased our standard deposit rates on select products. We believe average deposit cost will increase approximately 12 to 15 basis points in the fourth quarter.
Deposit rates are expected to continue to increase as short term rates increase. However, with some variability depending on the competitive environment among other factors, we are closely monitoring our deposits, as well as the market.
In total, we estimate $285 million in additional net interest income in 2018 resulting from the full year impact of the three rate hikes last year, plus the three rate increases so far this year. We have incorporated the slower pace of recent short term rate movement, as well as our deposit cost estimates in determining the expected net benefit of $15 million from a third quarter rate increases of which $1 million is already in the run rate.
Of course the outcome depends on a variety of factors, such as the pace at which LIBOR moves, deposit betas and balance sheet movement. It's likely that the fed could raise rates in December, as well as continue tightening next year and we stand to further benefit with our well positioned balance sheet.
We have not yet added hedges to change our asset sensitivity. Our asset liability committee continues to asses our position to determine the appropriate path given balance sheet movement and our outlook for rates.
Now, I will turn the call back to Ralph to provide an update on our outlook for the fourth quarter.
Thank you, Muneera. Certain continuation of the current economic environment, we expect loans to grow through the end of the year. We believe this rebound will result in average loans being stable relative to the third quarter.
Seasonality in the fourth quarter typically drives an increase in National Dealer Services and a decline in Mortgage Banker, supported by increased commitments, we anticipate growth in several businesses such as middle market and Technology and Life Sciences, primarily equity fund services.
Also, in large Corporate, we continue to be selective, maintaining our pricing and underwriting discipline. Regarding net interest income, as Muneera indicated, we expect to continue to see the net benefit of the recent rise in short term rates. In addition, the securities portfolio repositioning adds about $4 million.
We expect headwinds in the form of higher debt costs resulting from the full quarter impact of the late July debt issuance, as well as lower non-accrual interest recoveries and loan fees. We remain well positioned to benefit from future interest rate increases, though this outlook does not include a December rate hike.
We expect continued strong credit quality to result in a $10 million to $20 million provision. Putting aside the third quarter loss on securities, the BOLI dividend and deferred comp income, which is difficult to predict, our fee income is expected to be relatively stable. Our GEAR Up initiatives should continue to drive growth in card fees and fiduciary income. Mostly offsetting this growth is a possible reduction in derivative income and investment banking from strong third quarter levels.
Expenses are expected to increase modestly. We expect a small increase in technology project costs, as well as typical seasonal and inflationary pressures. We continue to be on track to fully realize our GEAR Up savings.
Finally, we expect our effective tax rate to be approximately 23%. Altogether, we expect our pretax pre-provision net revenue to grow while we continue to achieve positive operating leverage and drive our efficiency ratio lower.
In closing, our third quarter results were solid. We continue to focus on revenue growth, as well as maintaining favorable credit metrics and well controlled expenses. Through a significant increase in our share repurchases and dividend, we were able to meaningfully increase the capital return to our shareholders.
We expect to maintain our robust return of capital while properly managing our capital base to support growth and investment in our businesses. With a solid pipeline, as well as increased loan commitments, along with seasonal factors, we expect loan growth to trend positive into the end of the year. We remain well positioned to meaningfully benefit from rising rates as we manage loans and deposit pricing.
In addition, we have been executing our GEAR Up initiatives and delivering on the efficiency and revenue opportunities. Our return on assets, return on equity and efficiency ratios clearly demonstrate our commitment to enhancing shareholder value.
And now, we'd be happy to take your questions.
[Operator Instructions] Our first question will come from the line of Ken Zerbe with Morgan Stanley. Please go ahead.
Great, thanks.
Morning.
Just wanted to clarify one really quick thing, yeah, I think Muneera said the – the interest-bearing deposit costs are going to be up 12 to 15 basis points next quarter is that total deposit costs?
Interest-bearing deposit cost, Ken.
Got you. Okay, perfect. That helps. And then maybe a little more broadly, could you just talk about how you guys view debt or long – you know, I guess long-term debt as part of your funding mix from here because presumably if you do have further reductions in non-interest-bearing are you going to be more active in issuing sort of more net debt, like x any kind of sort of pre-fundings?
Muneera?
Okay. Thank you, Ralph. Ken, we have - first of all our deposits as you can see we talked about the profit in the fourth quarter, we’ll continue to see an increase in in line with seasonal patterns. Beyond that, as far as funding is concerned, we have a lot of attractive sources of fundings.
We can raise market index deposits fairly easily. We have FHLB funding that essentially is at about a 30 day LIBOR rate more or less. That's sort of the second source that we can go through. If necessary, clearly we can also approach the market. All of that does mean that loan growth is doing really well. So overall Comerica should benefit.
Got you. Okay. Sorry, but the day you issued in July was purely a pre-funding of debt that's maturing?
That's right. And also for the share…
Got you. Okay. And then just last question really quick. The loan yield – its called the loan yield beta calculative of 48%, was that purely due to where average LIBOR was are you guys seeing any signs at all of spread compression in the market? Thanks.
Go ahead, Curt.
Yeah. No I would say that nothing that is unusual on the lending side. It remains a highly competitive market and we remain very disciplined and very relationship focused. We have pricing model that we take into consideration client by client, overall credit risk and profitability of the client relationship.
Okay. So is this – are you saying that the loan yield beta should go back to sort of more the – call it 80%, 90% range next quarter because LIBOR goes up. Is that what you're implying?
So looking at our loan deposit, I mean loan yields and the beta – cumulative beta that we are picking up, that's an all-in calculation of how our yields are benefiting. It includes non-interest accrual interest recoveries as an example. But purely for rates you can see that, our loan yields benefited 15 basis points when LIBOR was moving on average 14 basis points. So the pull through is there and there isn't any issues on the spread front, we are maintaining our pricing discipline.
All right, perfect. That helps. All right, thank you very much.
Thank you.
Your next question comes from the line of Erika Najarian with Bank of America. Please go ahead.
Morning, Erika.
Good morning. This is Brandon on behalf of Erika. How are you.
Good morning, good.
So similar to Ken's question, just wanted to ask more about the competition within commercial lending. You know how much business would you guys estimate. You guys always think you know alternative lending and said another way, how competitive is you know structure and pricing?
Curt, do you want to take that one?
Yeah, Brandon, it is obviously a competitive environment and that competition extends not only to traditional banks but the non-banking or shadow side of things as well and we are definitely seeing some deals that are more highly leveraged and more covenant light.
Having said that, we've got a great client base. This past quarter 40% of our new originations were to new customer activities. So we're still been in a net acquiree with new customers. And so it is a competitive environment, but we felt like that we really are trying to stick to the market in line with the business we serve and we still have opportunities to grow.
Great. Thank you. And then you know my follow up question is, can you guys tell us what your exposure is to syndicated leverage lending or sponsor back transactions?
Pete?
Yes, less than 5% of the portfolio.
Great. Thank you very much.
Thank you.
Your next question comes from the line of John Pancari with Evercore. Please go ahead.
Morning, John.
Morning. A question on your interest rate sensitivity on Slide 14 and you talked about it too. You're indicating to a degree that your sensitivity is coming down a bit over time with these modifications to that sensitivity. How much of that is tied to deposit betas? And you know as you dialed that into your assumptions and if it is tied to deposit betas, is it all surprising you, because we would have assumed that you've got higher betas already assumed in your scenarios? Thanks.
Muneera?
Right. Specifically talking about our expectations for the September benefits and how we are computing that, I mean, it all depends on a variety of different factors. How is LIBOR moving and LIBOR has been slow in the way it moved in the third quarter and then building that same slow pace in the fourth quarter and certainly the other variable is deposit cost and for that I gave a range of 12 to 15. We sort of picked our most likely scenario of where the deposit cost will go - turnout and all of that is folded together [Audio Gap]
Okay. So there's no real wholesale change in your assumptions tied to your deposit betas, is that fair to say?
That is fair to say.
Okay…
From a deposit beta standpoint we have to monitor the competitive environment and make adjustments accordingly. And I talked about the fact that we made a set of pricing change early in October and that is part and parcel of those costs that I mentioned.
But I'm assuming you would have expected that you would be making that pricing change?
Exactly. Yes.
Okay. All right. And then separately on the expense front, I believe last quarter on the call you had indicated a low single digit outlook approximately for the growth rate in expenses for 2019. Is that still a fair assumption as we go into ’19? And also how would you view the efficiency ratio for the full year coming off of the 2018 level? Thanks.
Muneera, take that?
Okay. So the comprehensive update on where we are going on expenses for 2019 coming on January earnings call, but a little bit of color on what to expect, our GEAR Up program will sunset at the end of 2018. We will continue to benefit from many of its initiatives and we have the last bit of benefit of about $30 million [ph] for next year. That will be folded into our overall outlook. That includes both expenses, as well as income benefit.
Beyond that though, we won’t incur restructuring charges next year. So that will be a tailwind. Similarly, FDIC charges should be a tailwind next year as well. Offsetting this would be a typical increases that you see or merit or inflationary pressures or outside processing that typical goes up with and increase in revenue. Overall, I would say that we fully expect to generate positive operating leverage and we expect to continue to drive the efficiency ratio in the right direction.
Okay. Thank you, Muneera.
You’re welcome.
Your next question comes from the line of Scott Siefers with Sandler O'Neill & Partners. Please go ahead.
Morning, guys. I was hoping you could just spend a moment talking about overall loan growth, just I know like at the back of the beginning of the year the hope was for it to approximate kind of real GDP growth, you know, at this point it looks like this year will come in a little light than that. But just as you look at you know, say the next several quarters what would it take for loan growth to kind of reaccelerate more the number that pretty much approximates like the real GDP rate just in your guys view?
Curt, do you want to take that?
Yes, Scott. We historically had talked about loan growth more in line with GDP and I think as we’ve gone into 2018 in the current environment that we're operating in and you look at things like H2 [ph] data across the industry there seems to be less correlation to GDP. Right now a lot of that is I think due to many other factors that I have already spoken to including the competitive landscape both from a bank and non-bank or shadow banking scenario.
And so our customers are definitely I think more optimistic than they have been. We still are not seeing a lot of accelerated CapEx spending. I think some of that hesitancy as Muneera alluded to is around just you know, tax reform positive, but the customers were sitting on more cash right now and in some cases there are deleveraging. And then I think beyond that there's some hesitancy on their part around just trade issues, mid-term elections just sort of the unknowns that might be out there.
So we have obviously booked a lot of new business, but we are seeing utilization rates, its from moderate to down overall and I think that the end - I think part of that is customers are sitting on a lot of cash.
The third quarter for us is often a down quarter because the seasonality that Muneera and Ralph both alluded to earlier and we are optimistic about the fourth quarter sales and growth overall through the end of the year. Our pipelines are pretty strong and commitments are up for us about $650 million in the third quarter.
So we would expect to see growth in the market, Technology, Life Sciences, as well as the build up in dealer that we normally see in the fourth quarter and some of that would be offset by the normal seasonal decline in Mortgage Banker Finance.
Okay. All right, perfect. I appreciate that color. And then if I could switch sides on the balance sheet for just a second, just that you know as we look at the base of non-interest-bearing deposits, I mean, the growth has just been so extraordinary over the last few years. And it's you know as a percent of your total deposit base is just you know - so kind of out of bounds with where it would have been under what you would've called it today’s typical cycle in the past, you guys have - you even just sort of had a very top level as to where that ultimately ends up - ends up flushing out, in other words will it just structurally be much higher than it's been in call it decades past or does it trend back down more meaningfully?
Curt?
Yeah, you are right and we have seen a lot of growth in non-interest-bearing deposits and a lot of that has to do with the nature of our client base given the heavy commercial orientation to the base. And so as customers start to eventually to utilize some of that cash, you would expect some of that to come down. And then as we continue to see interest rates increase there will be some eventual movement of deposits potentially into interest-bearing overall.
Okay. All right. Thank you guys very much.
Thank you.
Your next question comes from the line of Ken Usdin with Jefferies. Please go ahead.
Morning, Ken.
Hi. Good morning, Ralph. Another question just on the deposit side, Muneera you mentioned that you’d put through the standard October pricing and it seems like we're kind of on like a - you know, every six months or so where you put through the standard. How are you guys monitoring the need and the speed of which you need to put through that standard right? Because you had a very fast repricing in the second quarter then it was slower in the third. Now you're saying it's faster in the fourth following the October. So can you get away with doing them every six months or so or is the dynamic of the pricing environment changing quicker now than it would have been previously?
All right. So Ken, you know, you're right and I think I've been signaling this for a few months now, but I have said, it's not going to be a linear progression, it's not going to be - this is the pay rate and that's some sort of a systematic increase over time.
A lot of this depends on what's happening with loan growth, how much funding do you need, and what's happening in your - in your markets the competition and so we look at what's happening in our own deposit base, what's happening outside the competition, where is loan growth going and all of that has been factored into doing what we think we need to do to both attract deposits and retain our customers. I would say if you look at our total deposit cost so far and how are deposit base as we access that our pricing strategy is working so far.
Yeah, I think that's fair. Thanks for that. On the other side of the balance sheet to your point about watching loan growth in terms of that pricing, obviously with loan growth being slower than initially expected, you haven't had to - you haven't seen a lot of growth in the other bucket, so the cash balances continue to build and the securities book has been pretty stable too.
So can you just talk about how you're thinking about your earning asset mix as you go forward if we get a little bit of loan growth, do you start to put some of that cash into the loan book, do you start to buy securities given that we're finally at a steeper point of the yield curve, how do you think about usage of that - that excess cash that's been building up and weighing on the NIM?
So - you know, good point that you’re making, I would say from overall cash, if we look at all balance sheet movements loan growth clearly would be our top choice in how we want to put our cash to use. Beyond that it is nice to see long-term yields moving up, which allow us the potential possibility of investing in securities, but we are happy with the size of our portfolio right now and I look at sort of the fact that we have a debt maturity coming up next year and some of the cash is going to be utilized for that, some of the cash is going to be utilized to grow loans. So we’re not really looking at the present time to change the size of our securities book.
Fair. And the last thing could you just tell us about the magnitude of that debt maturity and what it's yielding relative to the - you know the portfolio?
The debt maturity is reached 50, its going to be six months LIBOR, less, I want to say about a few basis points – about 4 basis points or so – 40ish [ph] basis points, I am sorry.
Six month, plus 40ish basis points, okay.
Yes, yes.
Thank you.
Thank you.
Your next question comes from the line of Steven Alexopoulos with JPMorgan. Please go ahead.
Morning.
Morning, everybody. Ralph, I want to start on the loan growth side and given the very strong growth you've had in commitments, which Pete called out over the past two quarters, I'm surprised the outlook for the fourth quarter isn't stronger. Or are you just being very conservative with the guidance or are you really not looking for these mid-market companies to draw on the lines they've taken out?
I think its a combination of the two. It is the companies are getting prepared for growth, but they are watching very carefully as Curt was mentioning earlier what's going on in the markets and from a tariff standpoint, as well as the other competitive parts. And as it grows they are prepared and that's the positive to compete and the commitment as you mentioned and as Pete has talked about, went up in the second quarter and third quarter nicely. And so they are prepared for that growth and on GDP has been stronger as well. So I think all of the signals are a little more positive than they have been. Pete, do you want to add anything to that?
Yeah. And Steve you know we're definitely not approving commitments that we don’t expect to be used. That's not a very profitable business for us. So it really is - utilization is lower than we normally would expect it today
Okay. That's helpful. Maybe for Muneera regarding the 12 to 15 basis point increase in deposit rates in 4Q, can you give more color on the standard increase that you're talking about here for October was that to all customers over a certain balance size or was it more widespread and are you seeing competitors do more widespread increases at this point?
It was select customers in select markets that the pricing changes were different in each. I think that this is sort of what we see others doing as well and we respond based on what we see in our different markets and how we see our customer base react depending upon what type of products they're using and what level of balances they have with us.
Okay. That's helpful. If I could ask you one more. The decline in the non-accrual interest took a couple of basis points off in this quarter. It looks like you're calling that out again as a headwind for 4Q. Can you quantify that headwind still to come? Thanks.
Yes. I would say normal we say $1 million to $2 million. So that's what we would expect to pick up every single quarter. We picked up about 4-ish this time, so I'd say a couple of million dollars, 1 to 2.
Okay. Great. Thanks for all the color.
Thank you.
You’re welcome.
Your next question comes from the line of Geoffrey Elliot with Autonomous Research. Please go ahead.
Good morning. Thanks for taking the question. Back to the – this point on non-interest-bearing deposits and a mix shift. Thanks for the comments around expecting some decline and some shift into interest bearing overtime as rates go higher.
But can you help us understand how you think about quantifying that. You know, I guess, the data points that we look at pre-crisis if that was something like 25% of deposits and it climbed to mid-50s and has started to come down.
I mean, are there reasons why it should not go back to that sort of level over time if rates increase, are there reasons why it could go lower, reasons why it should stay higher. How do you think about quantifying that when you're looking out over the next few years?
Muneera, do you want to take that?
Yes, sure. So I think it's really important for us to make sure that we are clear about what we're seeing in our deposit base. When you look at either year-over-year or quarter-over-quarter increases, our interest-bearing balances are going up because we have new money coming in. There is a little bit of mix shift thing, so I don't want to say that that's not what's happening. But at least as far as our actual deposit base and the activity that we are seeing, that we see new money coming in interest-bearing and on the non-interest-bearing side we either get customers putting their money to work, whether that’s M&A or reducing leverage you know, or in some instances we see a little bit of you know maybe a one or two customers that might have tried nothing systemic over there.
Their movement in balances it's going to happen as rates continue to increase, so I don't want to say that that's not what's transpiring. It is just very difficult to predict - just trying to give you some color of what they're actually seeing in our deposit base.
Sure…
The number of products that customer has - could also affect the amount of deposits…
And Ralph made a good point that that is well.
Understood. Thanks. And then I think you made the comments in the prepared remarks that average deposit should be seasonally higher in the fourth quarter but less of a - less of an impact than usual. Well, you know what is it about this year that means you're expecting to see a smaller impact?
If you go back and study our sort of deposit base for the last, I don't know six, five years, fourth quarter is usually a good quarter for us and people build, window dress their balance sheet. We see money coming in and the magnitude of fourth quarter deposit increases tends to be substantial. We are expecting a fairly similar seasonal pattern as we approach fourth quarter this year is about.
Great. Thank you.
Thank you.
Your next question comes from the line of Peter Winter with Wedbush Securities. Please go ahead.
Good morning.
Morning, Peter.
Just provide an update on some of the earnings benefits and strategies given that you're no longer subject to LCR?
Do you want to take that Muneera on the LCR?
Yeah, on the LCR front, I mean, the one big benefit is that you know we do have liquidity coming from our securities portfolio that we can then deploy. If loan growth picks up, its another added source of liquidity that we have, we can repurpose some of those dollars and instead of reinvesting then there move them to low and we don't - that's just - you know beyond that we still have to do our own internal liquidity stress testing and make sure that we are carrying appropriate levels of liquidity to take care of our customers.
Okay. And I guess there was a lot of opportunities then I guess as you said to pay down debt as well?
Not really because of the debt that we have - that you can look at our debt pricing it's pretty efficiently priced. So I would say not really.
Okay.
Is those views flexible…
We have the flexibility if we choose to.
Okay. And then on a separate question the capital ratios are still high at 11.66 and you've given that capital target of 9.5% to 10%. Could we assume that you're going to continue to do about 500 million share buybacks per quarter next year?
Go ahead, Muneera.
Okay. The way I think about it is for next year, clearly we have given you target. We know where want to go by the time 2019 comes to an end. We talked about the fact that you want to do a buyback at a measured pace. And we are going to look at our earnings generation. A large part of what we could give back is going to be what we generate in earnings and then beyond that it will be whatever it takes for us to get from our current capital ratios to our target. So that's how you should think about it.
Okay. Thanks.
Your next question comes from the line of Brett Rabatin with Piper Jaffray. Please go ahead.
Hey, good morning everyone. I wanted to - I guess go back to the margin and just thinking about the excess liquidity. Should we not expect at least a few basis points of improvement in the margin from a liquidity drainage in the fourth quarter, maybe Muneera can you talk about the effect of that in 4Q and what happens to that position in the current quarter?
Well in my comments I said that we are expecting to grow deposits in the fourth quarter which generally means that it's good for us in the sense that we will make more net interest income in dollars, but because the excess liquidity is going to be you know at the fed, it means that its from a yield standpoint, dilutive margin. If that helps you.
Okay. And then want to go back to deposits you know, obviously the prepaid card timing was in effect on 3Q. What else affects seasonality in the fourth quarter in terms of deposits?
Yeah. This is Curt, Brett. So just a normal build out that we see with customers building deposits at year end. So you see a build up in the fourth quarter and then in the first quarter a lot of that gets utilized as they pay taxes, distributions to employees for bonuses things of that nature. So it's just a normal sort of seasonal flow that we see, especially given our heavy core commercial orientation of the company.
Okay. But, I mean, if you excluded that from the third quarter your deposit trends would have been kind of flattish this quarter. It sounds like you're basically saying look there'll be a little bit better in the fourth quarter despite customers using excess cash. Is that a function of you growing your core customer’s deposits or new customers, how do we think about what you're doing in terms of the net flows and deposits?
Yeah, I think it's a combination of both, in the fourth quarter again we see a normal seasonal build-off that we have been a net client acquisition mode. As I alluded to earlier 40% of our new loan originations in the third quarter were to the customer. And so every new customer’s we’re relationship bank, we expect deposits and treasury management and other things to come with that.
So even though customers utilizing cash and deleveraging et cetera, are using it for M&A purposes fourth quarter is typically seasonally higher and then we continue to be - we believe in a net client acquisition mode.
Thanks for all the color.
Thank you.
Your next question comes from the line of Steve Moss with B. Riley FBR. Please go ahead.
Good morning. Just want to start on expenses or go back to expenses here. In particular on - tech spending was a little bit of a driver for incremental quarter-over-quarter expenses. Just wondering how we should think about tax spend into 2019?
Muneera, do you wan to take that.
Yes. Overall, our tech spend or our investments in technology are going to be stable and even for this year they really are stable. What you're seeing is a little bit of I’ll say push towards getting certain projects completed towards the back end of the year. It's not really because we are increasing the amount of technology budget, but we have a spend that we have. We think that it is – the overall spend is at a good level. It is - we are making the right investment and right changes that we need to make and that our customers and colleagues will find useful.
That was a big part of the GEAR Up process as well.
And Ralph is right…
For technology….
Yes, Ralph is absolutely right, that is in our E2E CRM or whether it was it was moving our applications to the cloud, it was all part and parcel of GEAR Up initiative as well.
Okay. That's helpful. And then just on the loan loss reserve here, its come down slightly, perhaps looking for a little bit more of a decline, wondering how we think about that reserve over the next 12 months or so?
Pete, do you want to take that?
Yeah. We had three reserve releases over the last three quarters that’s total about $16 million. I think the opportunity to release more reserves will probably be around energy, we’re at 16% criticized there. So to the extent that energy continues to improve, there's a little bit of opportunity there.
Charge-offs had been very low. We expect the charge-offs remain - continue to remain low, there's still more opportunity there as well. I think the rest would be – ex energy, the rest of the portfolio is pretty much at record low levels of criticize. So you know we're seeing provision in the $10 million to $20 million next quarter from a guidance standpoint and that assume that reserves remain fairly level.
All right. Thank you very much.
Thank you.
Your next question comes from the line of Gary Tenner with D.A. Davidson. Please go ahead.
Morning, Gary.
Just wanted to talk about loan growth for a second, you talked about the fourth quarter and obviously we know you've got some seasonal businesses that you know drive some fluctuations there. But wasn't much conversation around the energy portfolio other than sort of a - you know kind of trailing view of it, so I was just wondering kind of where the appetite is for that business today given the rebound in oil prices?
Curt?
Okay. I didn't quite hear you, Gary. Thank you very much. I mean, obviously energy is a big part of the Texas economy and a business that we've been in for a long time and so even that that book of business has managed down for us over time, its still a business that we want to be in and a business where we want to take care of our customers.
And we feel like it really has started to stabilize for us. It should be less of a headwind that its been in the last two years for us as we manage down that portfolio today. It's about a $1.8 billion portfolio. We would see it sort of fluctuating in a relative range around that number. We are seeing some nice new opportunities, some nice new commitments and some nice relationships that we there brought in. Energy products are certainly helping there and most of the clients that we're working with are just a lot stronger than they were as more equity and sponsor support out there. There's a lot of equity in the projects that we’re working on and there's good hedging in place. And as you know overall retail has been up in 2018.
Okay. So it’s the right way to view it then to your point that it will not serve as a headwind anymore but probably won't be additive materially to growth?
Yeah, I think it will be less of a headwind and they will have some opportunity to grow as the portfolio of the company – our loan portfolio overall our growth. But I would not expect a significant growth from here, but the more moderate growth.
Thank you.
Thank you.
Your next question comes from the line of Jon Arfstrom with RBC Capital Markets. Please go ahead.
Hey, thanks. Good morning.
Good morning, Jon.
Just a follow up maybe for you Pete, you mentioned a couple of times the 40% of your growth is from new relationships. Can you talk a little bit about the theme behind that kind of where and what?
I think that was Curt that mentioned that…
Curtis, sorry.
It's really -- we do track -- yes, Jon. We do track that across all of our business lines and we continue - really not a new thing for us. Almost every quarter we are very focused on taking care of our existing customers, but also focused on growing the franchise overall. It really is across almost every business and every market that - that we serve and even if utilization is not higher than it is right now. We are booking relationships and booking commitments of where we do feel like there will be borrowing against those facilities at some point in the future.
And what has allowed us to do is to continue to build our franchise across the board with great sort of relationship based opportunities where we can sell into the relationship, additional products and services that are value-added to the client, so treasury management, hedging product, card services, et cetera.
So we really think of it sort of the long-term view as we’re building the value of our franchise. As you know we’re in great business lines where we have a lot of depth and we’re in some really great economies throughout the United States.
Okay. So broad-based…
They are broad-based…
Okay. And then just 30,000 foot type question, you guys have done. You guys have done well the last few years with a relatively flat balance sheet. But it feels like some of the rate benefit is fading in some of the obviously GEAR Up you've done well on that and see really performed, but I think from here we all think you need to grow a little bit faster.
And I guess are you bigger picture more optimistic on the growth outlook and is this the kind of environment where Comerica can go back to putting up that mid-single digit type growth?
Curt?
Yeah, I think we are we are very optimistic. All the things that you mentioned, a lot of those are now so to speak in our rearview mirror, a lot of the things we went through with GEAR Up were meant to help position us well for a faster growing environment. So the rework of our underwriting loan origination process that we call in end to end credit redesign really is all about creating more capacity for our relationship managers to spend more time now calling all existing customers and prospects.
And then we we've added a lot of technology enablement for our relationship managers, a new CRM platform, sort of digitizing the process around loan underwriting and origination for us, like digital transformation for us in terms of treasury manager products and services, really trying to make sure our relationship managers have more mobile approach to everything they do, which we think helps create capacity longer term.
And so we've got good liquidity. Credits not an issue right now. We're very focused in our calling efforts and so as we continue to see some optimism build in the economy and as Ralph mentioned earlier GDP continues to strengthen and we are optimistic about growth possibilities.
Okay. Okay. Thanks a lot.
Thank you.
Your next question comes from the line of Brock Vandervliet with UBS. Please go ahead.
Good morning. Good morning. I think all the hot buns have been asked and answered at this point. However, just want to cover Life Sciences and equity fund services. The pricing and relative competition you're seeing in those segments?
Curt?
Yeah, I mean I think that, as we've alluded to not only on this call, but the last several quarters, most of the growth that we’ve seen in Technology and Life Sciences has been that equity fund services component where we're providing capital call and subscription lines to VC and private equity firms.
There's been a lot of strong new fund creation which you obviously have seen and that still that feels like that is continuing. We tend to work with some of the best private equity firms out there in terms of strength and ELPs that make up their roster. And so we feel like it's a relatively low risk business for us and one where we can be fairly selective. But we also feel like there's still a lot of growth opportunities.
The business that we actually only been in now for 6 to 7 years so we still feel like we've got a pretty good growth trajectory around the business longer term. And on the TLS core side there is some momentum building there, after a little bit of softness the last 24 months or so, we feel like we're getting a lot of new opportunities to look at new transactions and we've still got some very solid long-term relationships with venture capital providers and so that business has been little bit softer, but we feel good about the longer term prospects there.
With respect to the capital call lines are you seeing new entrants or is it kind of the same cast of characters?
All right. I think we work with a lot of the same banks and syndicates and bank groups that we have seen previously.
Got it. Okay. Thank you.
Thank you.
Our final question will come from the line of Michael Schiavone with Keefe Bruyette & Woods. Please go ahead.
Morning, Michael.
Hey. Good morning, guys. This is Brian Klock. I just had some technical difficulties. So how are you doing Ralph and everybody?
Good.
I just want to kind of sneak in here, I might have missed this earlier, but I think there were some questions that may be different way, I just want to try to put them together. Muneera on the sort of NII walk, when you think about for the fourth quarter, you know, if we start with third quarter NII and like you said I think there is $14 million of the benefit from the fed hike that would come this quarter, right out of the – there was $1 million already in the third quarter run rate. You pick up that $4 million from this year, the securities repurchase thing and maybe what $1 million or so would be the other piece on the non-accrual interest is that the biggest pieces that we should think about in that walk?
Yes, you’ve got it all correctly. Beyond that I mentioned the growth in deposits in the fourth quarter, which will also bring at least net interest income dollars. And then don't forget about the one extra month from the debt issuance that we had in the second quarter.
Got you. All right, great. And then one last question maybe for….
I would just clarify, the issue of the debt is in third quarter, sorry.
Third quarter, right, right. And then my last question I guess for Pete, you know – we’ve been so focused on the loan growth side of this, but it does feel like the asset quality trends continue to be as good as they've ever been and we've all expected there to be this normalization of credit costs going forward. I guess when you look out into next year and when you think about a charge-off of well, I guess what you know - you're saying $10 million to $20 million is the guidance for the fourth quarter, but that even seems conservative given the run rate and your NPLs formation keeps dropping. So maybe I guess thinking about is there anything in the portfolio or in trends that you feel like the current level of charge-offs is going to materially change in the next year or so?
Not that we can see Brian. I think we feel really good about our book of business. We – commercial real estate has been performing very well. We’ve remained disciplined in that business. Leverage lending we’ve been very disciplined in that segment as well. You know, Curt mentioned we're being highly selective in energy.
So I think overall we don't see anything out there that caused a problem. It's hard to look farther than a couple of quarters, but I would say we look - we feel pretty good about credit quality next year.
All right. So I mean, we're starting to see some of the margin benefits, as from all the other commentary, they are becoming you know the second derivative is declining when you think about NIM expansion. But if anything your risk adjusted margins continue to be pretty wide here?
Yeah…
Yes…
All right. Thanks for your time. Appreciate it.
Thanks, Brian.
I will now turn the call back over to Ralph Babb, Chairman and Chief Executive Officer for any closing remarks.
I would like to thank you all for your interest Comerica and being on the call today and I hope everybody has a great day. Thanks very much.
Ladies and gentlemen, this concludes today's conference. Thank you all for joining and you may now disconnect.