Jeff Davis, CFA, is a veteranbank analyst. The views and opinions expressed in this piece are those of the authorand do not necessarily represent the views of S&P Global Market Intelligenceor Mercer Capital, where he is the managing director of the financial institutionsgroup.
One ofthe basic tenets of deal making is this: when a board needs an acquirer to stepforward to pay an irrational price — or perhaps just make an offer — such a buyeris usually confined to a banker's PowerPoint presentation. Dick Fuld as CEO of LehmanBrothers when it failed in 2008 knows the capital raising equivalent: when a companyabsolutely has to raise funds to roll maturing debt to survive, it is tough to raiseit at any price. The corollary to both of these is the opposite: when a companydoes not have to have a buyer or raise capital, the pricing can be attractive andsometimes irrationally so.
's management and boardare in what probably is an uncomfortable spot. Earlier this year disclosed itssoft-velvet approach to pushthe company to sell. Its executive advisers include bankers Bill Harrison (), RichardKovacevich (Wells Fargo & Co.)and Howard Milstein (New York PrivateBank & Trust Corp.). Comerica was featured a couple of times inApril in The Wall Street Journal, includingan April 22 story about CLSA bank analyst Mike Mayo's effort or perhaps voice onbehalf of some institutional shareholders to explore a sale. It is not the kindof publicity any management would want.
For WallStreet the math that matters is share performance. Does a stock deliver alpha orbiological bricks to a portfolio? During the five-year period ended April 30 thetotal return was 28%, which was about half the median return for U.S. banks withassets greater than $10 billion. Only in the year-to-date period have the bank'sshares outperformed the broader index, but that is largely attributable to the acquisitionspeculation.
Amonglong-time followers of the company I do not think there was much surprise when aBloomberg story reported that Comerica determined it's a bad time to pursue a sale.As a small SIFI with $69 billion in assets, there are only a few logical buyers,and they are hamstrung. Richard Davis of U.S.Bancorp noted the company is precludedfrom acquiring whole banks until its regulatory consent agreement is resolved. CEO Kelly King deals for the time beingduring the company's first-quarter conference call. Given its size it is not clear(to me) that Wells Fargo could get a merger application through the Fed, and Comericais not a have-to-have proposition for Wells unless the price is a steal. parent apparently has regulatory hurdles to clear with the Fed before acting on its statedintention to buy U.S. regional banks.
In short,it's a bad time to sell.
The underperformanceof the shares and pressure from some investors and analysts can be traced to thecompany's returns. Comerica's ROCE and ROTCE for the last 12 months are just mediocreat 5.8% and 6.4%, respectively. During the non-boom years of 2012 to 2014 when creditcosts were low its ROCE was between 7% and 8%, and ROTCE was between 8% and 9%.My back-of-the-envelope cost of capital calculation with the 10-year around 2% is9% to 10%. Obviously GAAP ROCE and the cost of capital are not exactly the samething given differences in charge-offs and provision expense, but there seems tobe broad agreement that Comerica and many (or most) banks are not earning theircost of capital even though credit costs are low.
Comerica'spredicament is both cyclical and, I think, secular. The impact of elevated energycosts is cyclical; the issue will eventually run its course — maybe this year ifenergy prices continue to trend higher. The secular issue is zero interest-ratepolicy, which the Fed and other central banks may find impossible to end. ZIRP hascrushed Comerica's net interest margin as a predominantly LIBOR-based commerciallender with large amounts of noninterest deposit funding. The LTM NIM was 2.65%,while the first-quarter NIM was higher at 2.81%, but still lousy. ROE cannot begreat absent support from non-spread-based business units or upping leverage.
EnterBoston Consulting Group. Comerica CEO Ralph Babb informed investors April 19 withthe release of first-quarter results that BCG has been hired to analyze the bank's cost structure and revenue drivers.I am sure BCG will have many options to present to management. The theme presumablywill be shrinkage, which is ironic given the pressure on the largest banks to getsmaller.
One ofBCG's recommendations could be a radical downsizing of the branch network ratherthan a more modest effort that probably would be more in-line with management'sDNA. Branch networks are costly, ZIRP has devalued core deposits, and the futureis mobile banking. What would be a radical downsizing? Perhaps 25% or more of the470+ branches the company had as of June 30. Would that be enough? Would regulatorsapprove a massive consolidation effort that left branch coverage thin in some markets?I do not know.
Asidefrom cutting expenses and maybe changing processes to add a few revenue dollars,I assume BCG will review the balance sheet to ask whether the asset base can beshrunk sufficiently to shed the costs that go with being larger than $50 billionin assets. That seems unlikely, but the board should ask the question of someoneother than management.
BCG hasan interesting assignment, though not an easy one if the objective is to get ROEabove 10%. Few have cut their way to prosperity. Perhaps Star Banc of Cincinnatiand its transformationin the 1990s is an example. Aside from the issue of branch networks being rapidlydisplaced by technology, Comerica and the industry have a revenue issue due to ZIRP.The response may require something that is radical such as a massive branch consolidationeffort. The benefits of the savings expressed in present value dollars will haveto exceed the initial charge to implement the strategy by a meaningful amount. Evenif the math is compelling in a PowerPoint slide, Wall Street may not like pain todayfor tomorrow's return.