Comerica "Gears Up" for Rising Rates

02/21/2017 9:00 am EST

Focus: STOCKS

Elliott Gue

Editor and Publisher, Energy and Income Advisor and Capitalist Times

The US economy is moving from a period of weak economic growth, contained inflation and ultralow and/or falling interest rates into a period of stronger growth, faster inflation and rising rates, asserts Elliott Gue, editor of Capitalist Times.

Two of the most important implications of this shift are an improving outlook for financial stocks. As a play on this trend, we’re adding Comerica (CMA) to the Wealth Builders Portfolio.

Headquartered in Dallas, Comerica has just under 500 banking centers in Texas, Arizona, California, Florida and Michigan.

The firm traditionally focuses on commercial loans. As of late 2016, it had the largest concentration of commercial and industrial (C&I) loans of any large regional bank in the US. In a period of ultra-low interest rates, weak business spending and low demand for loans, this concentration is a headwind for Comerica.

To help combat persistently low net interest margins and weak demand for commercial loans, Comerica announced a profitability and efficiency initiative called Gear Up in the second quarter of 2016. By consolidating branch locations, cutting headcount and shifting its pension plan, the bank sought to boost returns in a tough operating environment.

Even modest increases in interest rates this year spells significant growth in net interest income for the year. And, when you add in the positive profitability impact of the company’s Gear Up initiative, the investment case becomes more compelling.

Comerica’s exposure to the Texas market and loans to energy firms have been major concerns since the rapid decline in oil prices and industry profitability began in mid-2014.

These concerns are overblown: Comerica’s energy loans represent just 5 percent of the total loan book. And 70 percent of those loans are to exploration and production companies (E&Ps) that benefited from the decline in the cost of shale drilling and the recent recovery in crude oil prices.

Troubled loans to energy firms have declined of late, and the bank was able to reduce its reserves against loan losses in the sector last quarter.

Given the recent surge in the US oil-directed rig count, particularly in key Texas shale fields like the Permian Basin, we believe loans to the energy sector could move from a drag on Comerica’s growth to a key driver of profitability in 2017.

The company also has a history of returning capital to shareholders via a combination of dividends (the current yield is roughly 1.4 percent) and share buybacks.

In the final quarter of 2016, Comerica bought $99 million worth of stocks and paid out $40 million in dividends, returning around 85 percent of its fourth-quarter net income to shareholders.

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