Participants

Kelly Gage; Director, Investor Relations; Comerica Inc

Curtis Farmer; Chairman of the Board, President, Chief Executive Officer; Comerica Inc

James Herzog; Chief Financial Officer, Senior Executive Vice President; Comerica Inc

Peter Sefzik; Senior Executive Vice President, Chief Banking Officer; Comerica Inc

Manan Gosalia; Analyst; Morgan Stanley

John Pancari; Analyst; Evercore ISI

Jon Arfstrom; Analyst; RBC Capital Markets

Bernard Von Gizycki; Analyst; Deutsche Bank AG

Ben Gerlinger; Analyst; Citi

Chris McGratty; Analyst; Keefe, Bruyette & Woods, Inc.

Samuel Varga; Analyst; UBS

Michael Rose; Analyst; Raymond James Financial, Inc.

Anthony Elian; Analyst; JPMorgan Chase & Co.

Presentation

Operator

Greetings and welcome to the Comerica Bank third quarter 2024 earnings call. (Operator Instructions) As a reminder, this conference is being recorded. I would now turn the conference over to your host, Kelly Gage, Director of Investor Relations. Thank you. You may begin.

Kelly Gage

Thanks Melissa. Good morning and welcome to Comerica's third quarter 2024 earnings conference call. Participating on this call will be our President, Chairman, and CEO, Curt Farmer; Chief Financial Officer, Jim Herzog; Chief Credit Officer, Melinda Chausse; and Chief Banking Officer, Peter Sefzik.
During this presentation, we will be referring to slides which provide additional details. The presentation slides in our press release are available on the SEC's website as well as in the Investor Relations section of our website comerica.com.
The presentation in this conference call contain forward-looking statements. 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 we undertake no obligation to update any forward-looking statements.
Please refer to the Safe Harbor statement in today's earnings presentation on slide 2. Also, the presentation in this conference call will reference non-GAAP measures. In that regard. I direct you to the reconciliation of these measures in the earnings materials that are available on our website, comerica.com. Now I'll turn the call over to Kurt who will begin on slide 3.

Curtis Farmer

Well, thank you, Kelly, and good morning everyone. Today we reported third quarter earnings of $184 million or $1.33 per share, exceeding expectations across most line items. Strong customer activity drove higher average deposits which offset the impact of lower loans and help net interest income outperform guidance for the quarter.
The downward shift in the rate curve resulted in a meaningful improvement in AOCI [opt out], contributing to 23% growth in tangible book value. Credit quality remains solid, reflecting our proven underwriting discipline as net charge offs remain historically low.
While customer sentiment remains cautiously optimistic, the initial decline in rates was well-received as select businesses showed early signs of an uptick in activity nearing quarter in. However, to see a more significant shift in behavior and reinvestment, we believe customers are looking for further rate reductions confirmation of a soft landing and getting past the impending election.
Before we get into more detail on our strong quarter, I wanted to take a moment to touch on the historical milestone we celebrated on August 17, Comerica's 175th anniversary. My leadership team and I spent a lot of time this past quarter, visiting our markets, meeting with customers, colleagues, and community leaders. We have a great story and a value proposition that resonates with our target market. Our customers trust us with their business and we take that responsibility seriously.
As a bank, we have successfully navigated industry changes, global conflicts, and economic cycles over many years. We feel this impressive history underscores the strength of our unique model. And we believe our consistent execution along with our strategic investments position us to successfully support our customers now and into the future.
Moving back to results, third quarter financial highlights are on slide 4. High inflation and elevated rates continue to pressure loan demand. But we saw positive momentum in deposits as average balances grew in most of our businesses.
Excluding the impact of BSBY cessation, net interest income increased 1.3% over the second quarter trough. Charge off of the 8 basis points remain below historical averages and even declined slightly from last quarter's already strong results. Lower noncustomer income offset favorable trends and customer related fees and non-interest expenses were well-managed.
We continue to favor a conservative approach to capital with our estimated CET1 increasing further to 11.97%, well above our 10% strategic target. Jim will discuss our capital management strategy later in this presentation. In all, it was a great quarter with positive momentum moving into the end of the year. I will now turn the call over to Jim to review our third quarter financial results in more detail.

James Herzog

Thanks, Curt, and good morning everyone. Turning to loans on slide 5, we saw some reversal of the growth signals from the second quarter with loans coming down in August. But we're encouraged to see balances relatively flat in September.
Most of the decline in average loans was in national dealer services and corporate banking. Dealers saw elevated balances in the second quarter related to the cyberattack that impacted the industry. As we look at dealer trends month to month, balances were most pressured early in the quarter and September saw more positive activity.
Corporate banking specifically US banking saw more relative pressure than other businesses as we focus on maintaining our pricing discipline and return targets. Additionally, soft loan demand across the industry caused some bank group consolidation. US banking saw an improvement late in the quarter and period-end loans were relatively flat to June 30.
Moving the businesses that grew. Commercial real estate utilization increased which is a continuation of the trend we've seen in this elevated rate environment. However, as rates come down, we expect to see an uptick in the pace of payoffs as projects sell or refinance into the permanent market as intended.
Growth in environmental services was attributed to our renewables focus. In 2022 we formed a new renewables team and we have seen strong results. Environmental services overall is a great business for us and we feel our distinguished talent and unique expertise have allowed us to carve out a leading position in this niche industry. Touching briefly on loan yields lower [non-accrual] interest was the main driver of the 8 bps decline. And we saw only a minor drag from lower short term rates in the quarter.
On slide 6, we were encouraged by customer deposit activity. Average deposits increased 1.3% with growth across most business lines. Average third quarter brokered time deposits were higher due to activity late in the second quarter. However, favorable customer deposit trends allowed us to repay almost $900 million in brokered CDs by the end of the third quarter.
Despite that deliberate reduction in brokered CDs, we grew total period-end deposits by over $600 million. As we win new and expand existing relationships, we continue to see the elevated rate environment drive customers to bring those deposits into interest bearing accounts.
Despite continued modest cyclical pressure on non-interest bearing balances, they performed in line with their expectations and remained favorable with 38% of total deposits. We took steps to adjust pricing as the Fed began to cut rates. We plan to continue monitoring the competitive environment as we manage ongoing deposit pricing alongside additional rate cuts in the future.
With our strong relationship model, we feel well-positioned to strike the right balance between our customers' objectives with our own funding needs and profitability. Our securities portfolio on slide 7 benefited from the shift in the rate curve as we saw a 24% improvement in our valuation adjustment in the quarter. This favorable mark to market impact more than offset repayments and maturities and drove a net $130 million increase in the portfolio.
We continue to believe the expected repayments and maturities of this portfolio will enhance earnings in the coming quarters even if we resume investment at some point in 2025.
Turning to slide 8, net interest income increased $1 million to $534 million. Excluding the impact of the BSBY cessation, net interest income would have grown $7 million quarter over quarter. The shift in the rate curve allowed us to reallocate cash collateral from the CME to the Fed, benefiting net interest income.
That coupled with strong customer deposits, which allowed us to pay down wholesale funding and the benefit of ensuring swaps and securities offset pressures from BSBY cessation, lower loans, and non-interest bearing deposit balances.
As shown on slide 9, successful execution of our interest rate strategy and the composition of our balance sheet has made us slightly liability sensitive and allows us to better protect our profitability from a declining rate environment. By strategically managing our swap and securities portfolio, while considering balance sheet dynamics, we intend to maintain our insulated position over time.
We feel credit quality remains a competitive strength as our overall trends in the third quarter remain solid and relatively unchanged from the second quarter, as shown in slide 10. Net charge offs remained low at 8 bps. Criticized loans were essentially flat and nonperforming assets remained well below historical averages. The overall economic outlook was also relatively unchanged, but lower average loans especially in lower risk portfolios drove an increase in the allowance for credit losses to 1.43% of total loans.
Even though our portfolio remains strong, we have potential for even further improvement if lower rates materialize and inflationary pressures abate. Regardless, we feel our proven conservative credit discipline continues to position us well to outperform peers through the cycle.
On slide 11 third quarter, non-interest income of $277 million decreased $14 million from the second quarter, primarily due to non-customer related income. Changes in the value related to our BSBY derivative drove a negative $11 million variance as we recognized a $5 million loss in the third quarter compared to a $6 million gain in the second quarter.
Risk management hedging income declined $10 million as the lower rate curve reduced the amount of required collateral held at the CME. While this resulted in a decline in non-interest income, part of this benefited net interest income.
We saw encouraging trends in several customer related categories with increased syndication fees, derivative income, commercial lending fees, and a small increase in commercial service charges. Fiduciary income was down, but excluding the $3 million seasonal tax related benefit in the second quarter, it would have been up consistent with improved market performance. We continue to be encouraged by the progress and targeted initiatives designed to further enhance non-interest income.
Expenses on side 12, increased $7 million over the prior quarter. Salaries and benefits were up $12 million, which included a $4 million increase in deferred compensation, which was mostly offset with a non-interest income and various other smaller increases.
FDIC expenses declined by $8 million partially due to a $4 million favorable accrual adjustment in the third quarter compared to a $3 million expense in the second quarter, both related to the special assessment. In all, we feel expenses were well-controlled and we continue to prioritize opportunities to drive positive operating leverage and improved efficiency.
As shown on slide 13, our already strong capital position improved further in the third quarter. Solid profitability, lower loans, and conservative capital management, drove our estimated CET1 to 11.97%. Adjusting for the AOCI opt out, our estimated CET1 would have been 9.12% which is well above required regulatory minimums and buffers.
Movement in the forward curve coupled with ongoing repayments and maturities in our securities portfolio resulted in a 32% improvement in AOCI, increasing our tangible common equity ratio by over 150 basis points.
Considering our compelling estimated CET1 well in excess of our strategic target and the favorable movement in the rate curve, we plan to utilize a portion of our excess capital to repurchase $100 million of our common stock shares starting in the fourth quarter.
Allocating capital to support our customers' loan needs always remains our first priority. So we intend to be measured in our approach and calibrate the size and frequency of future repurchases with expected loan trends. We will also continue to closely watch the forward curve, our profitability, the broader economic environment, and any regulatory updates as they may also influence our strategy.
Moving to slide 14, we do not yet have any meaningful update regarding the timing or specifics of the transition of the Direct Express Program. As a reminder, our current contract allows fiscal service to utilize up to a three year extension under our current terms. Fiscal Service would need to notify us of their intention to extend no later than early December, so we expect to hear more before the end of the year.
However, our expectation of the timing of deposit transition has not changed. Based on the size, complexity, and critical nature of this program, our experience leads us to believe this transition may be longer rather than shorter. We do not anticipate an impact to 2024 deposit balances, non-interest income or expenses. In fact, it is possible we may not see a significant impact to average deposit balances in 2025, although we need more information on the proposed transition plan to confirm.
In the meantime, we plan to continue prioritizing targeted deposit strategies aligned with our core relationship operating model to further enhance our funding position and prepare for an eventual transition.
Our outlook for 2024 is on slide 15. We project 2024 average loans to be 5% lower than 2023. Muted demand which we feel has been consistent across the industry and our deliberate optimization efforts in the latter half of 2023 are the major drivers for this decline. With some customer optimism following the third quarter rate cuts and normal seasonal patterns, we anticipate modest broad-based growth in the fourth quarter.
One of the bigger variables will be our commercial real estate business as we believe loan balances in this business may have peaked. Depending on the pace and size of further rate cuts, we could see a more rapid reduction in balances than projected in that business. Full year average deposits are projected to be down 3% to 4% from 2023.
This slight reduction relative to last quarter's guidance is driven by the expectation of an approximate $1 billion decline in year-over-year brokered time deposits, not customer related trends. Further reductions in brokered time deposits are also driving the projected 2% decline in average deposits in the fourth quarter as fourth quarter customer deposits are projected to remain relatively flat.
Although we are projecting some level of modest fourth quarter seasonality, third quarter averages were elevated by large temporary customer deposits which were distributed by quarter end as expected. Based on the high interest rate environment, we project deposit growth to continue to be concentrated in interest bearing accounts, but we still expect to maintain a favorable deposit mix in the upper 30% range.
We expect full year 2024 net interest income to decline 13% to 14% compared to 2023. This slight improvement relative to prior guidance is a result of our strong third quarter results. Fourth quarter net interest income is expected to grow 6% over the third quarter or 1% to 2% adjusting for the impact of BSBY cessation.
We expect no sparing deposit pressures to be more than offset by benefits from swaps, securities, and the forward curve. However, we continue to watch non-interest bearing balances and overall pricing dynamics as they could impact results.
Credit quality remains strong as we produce another quarter of low net charge offs. Interest rates remain elevated and as customers continue to navigate high borrowing costs and inflationary pressures, we believe modest, manageable migration will continue.
However, given our strong results to date, we forecast full year net charge offs to remain well below our normal 20 basis point to 40 basis point range. We expect non-interest income to be flat year over year or down 2% to 3% when adjusting for BSBY and the impact of the Ameriprise transition. This reflects a modest reduction in prior guidance due to trends in risk management hedging income.
Although the lower forward curve benefited AOCI and net interest income, it does pressure this line item. Fourth quarter non-interest income is projected to decline 1% to 2% relative to the third quarter, also driven by lower risk management hedging income.
Despite this and other non-customer related pressures, we continue to be encouraged by customer related fee income trends. Full year non-interest expenses are expected to decline 2% to 3% on a reported basis and grow 4% after adjusting for special FDIC assessments, expense recalibration, modernization, and the impact from the Ameriprise transition.
Fourth quarter expenses are projected to increase 3% over our strong third quarter results or 4% on an adjusted basis, as detailed on the slide. Expense discipline remains a priority as we work towards our objective of positive operating leverage. Even with modest projected loan growth in the fourth quarter and the resumption of share purchases, we expect our CET1 ratio to remain well above our 10% strategic target through year end. In all, we expect a solid fourth quarter, which will set us up nicely for a strong start to 2025. Now I'll turn the call back to Curt.

Curtis Farmer

Thank you, Jim. This was an important quarter. As an industry, we saw the Fed take their first steps away from a higher for longer rate environment. For Comerica, the actions we took to deliberately minimize our natural asset sensitivity position allow us to better protect our net interest income from lower rates.
Additionally, rate decline should be a net positive for credit quality and loans as customer profitability improves and they resume investing in their businesses. Coupling those tailwinds with our disciplined approach to credit and expenses, along with the resumption of share repurchases creates what we believe to be positive momentum for generating compelling returns over time. We appreciate your time this morning and now we'd be happy to take your questions.

Question and Answer Session

Operator

(Operator Instructions) Manan Gosalia, Morgan Stanley.

Manan Gosalia

So I wanted to dig in on deposits. The average deposit rates went up a little bit this quarter. I think in the prepared marks you noted that there was some brokered time deposits that were higher earlier in the quarter that you paid down. So maybe if you can expand on what drove those overall average interest bearing deposit rates higher. And if you have it, what the spot deposit costs are as of September 30 or October 15, whatever you have.

James Herzog

Good morning, Manan, it's Jim. Thanks for the question. You know, we were really encouraged by the success we had in interest bearing deposits in the third quarter. On average, they were up $1.5 billion and notably on an ending basis, they were up $2.2 billion. Now we know $300 million of that was brokered, but overall just really great success in gathering interest bearing deposits.
So I will say in the higher for longer environment that we experienced through mid to late September, I mean, increasing pay rates has been somewhat of a common trend in the industry, including Comerica. You couple on to that the fact that we had such great success in bringing in these deposits, which by the way, were very intentional. We've been really successful in paying down wholesale funding in the last few quarters.
That trend continues with brokered deposits being reduced, both this quarter and next quarter. And we're very happy to have those core interest bearing deposits even if we have to pay up just a little bit. So I feel like the 8 bps increase we had on a quarter-to-quarter basis was really in line, not just with the industry but well, in line with our intentions and our goal of just raising strong core customer deposits. So it's something we just felt really good about and think it's a great value proposition.

Peter Sefzik

Got it and any indication on how deposit costs have [Fed] rejected since the Fed rate cut.

James Herzog

Yeah, we are really projecting very closely to what we've been planning all along. I will say the spot rate at the end of the quarter was maybe slightly lower than the month before as we started to see success with our pricing strategy.
Overall, rates trended up a little bit as the quarter went on, I'm always hesitant to give a very spot rate on a given day because it does move around a little bit. But I will say that we are having success with our repricing.
A lot of work went into this, a lot of strategy. I'm really proud of our product managers for what they've put together, not just in terms of what we're repricing, but just some of the product designs they've done to make sure that we have mix shifts that are mutually beneficial to both us and our customers.
But there will be a lot of moving parts and maybe just looking forward to the fourth quarter because I know that's really what you're interested in, the success we had in repricing deposits, I think really approached on a product basis, something approaching or a cumulative beta just north of 60%, so really happy about that.
But of course, a number of other things are going on, we are bringing in core deposits and being very successful in that. And that puts a little pressure on the overall beta as we looked from third quarter to fourth quarter.
We do have a little bit of mix shift going on. We do continue to survey both our customer reaction as well as the competition and what they're doing. And as I mentioned, just a little higher, jumping off point maybe at the end of the quarter than perhaps on average prior to that FOMC cut.
So if you put all that together and there's a lot going on there and a lot of variables, I do think when we get to the fourth quarter, you're going to see an overall beta relative to average FOMC rate changes probably hovering somewhere between our standard beta of 47% and that cumulative beta that we had just north of 60%.
So that's something we're really pleased about, but I will say a lot of moving parts, a lot of mix shift again by design on our part as well as our customers. So it's something we're just going to have to continue to monitor, but so far a pretty successful outcome.

Manan Gosalia

Got it. And do you think betas from there as we think, as we look out into 2025, what's your best guess on whether deposit betas accelerate from there? Because we get through more rate cuts or do they roughly stay the same? Because I guess, loan growth could be improving next year, maybe help us with how you're thinking through that. Thanks.

James Herzog

Well, first of all, I would say the rate or cuts always depends on what kind of landing we have. I've been very consistent in saying that and it does look like we're going to have a soft landing, which I think puts a little pressure on the pace of betas because it's always easier to change rates when there's perhaps a little more fear in the economy, which typically does accompany a rate reduction.
But the way I look at it is we're starting from a strong position. You know, there are probably some mid-tier rates that were hesitant to move down to this point. So I think the betas will pick up a little pace as we start to move through mid-2025, late 2025.
I think they will accelerate a little bit and then they'll probably back off as some of those rates start to approach a floor and you have to pull back a little bit. So it'll be a little bit of a U-shaped curve I suspect for the industry. But again, a lot of it's going to depend on just what happens in the overall economy and what type of landing the economy has.

Operator

John Pancari, Evercore ISI.

John Pancari

On management's prepared comments, good to see the upside guide despite the lower deposit growth expectation and your loan growth expectation. And I know you mentioned a lot of that is partly given the third quarter performance and your fourth quarter expectation on NII, the 6% or the 1% to 2% up ex-BSBY is noted, given that curious, its loan demand remains relatively modest and you still see some continued competitive pressures around deposit pricing.
How do you see NII trajecting beyond the fourth quarter? I know, looking out there, it looks like expectations could be in the mid to high single digit growth for net interest income as we look into 2025. Do you think that is reasonable if you've got a slower rebound in loan growth as we move into next year.

James Herzog

Good morning John. It's Jim. I'm happy to take that question. Overall we're pretty bullish about net interest income in 2025. It does look like we hit an inflection point in the second quarter of this year and that's even with a little bit of BSBY drag in the third quarter, so really pleased with how that's trending,
I would say and as I've been saying, I think the overall trend quarter to quarter to quarter beyond where we're at now is going to be up. There could always be some anomalous quarter, whether it has to do with the timing of FOMC reductions or day count or whatever, you could always have a quarter where maybe it starts to plateau a little bit.
But I think the general trend is going to be just continuously increasing net interest income as we move beyond 2024. So that's something we're really looking forward to. We do expect loan growth on a somewhat continuous basis in 2025. So that will be helpful also.
I will say we're not ready to give guidance for 2025. So I'm hesitant to quote any specific loan growth numbers or net interest income numbers. But I would say overall it's a pretty nice picture in terms of just ever increasing net interest income as we move through the next not just few quarters, but few years.

John Pancari

And then separately on if I could skip over to capital, your CET1 that's just shy of 12% versus your 10% target is certainly noted and I know you expect a resumption of buybacks of about $100 million in the fourth quarter. Maybe could you give us at least a trajectory on how you feel about the possible acceleration of buybacks as you go through 2025, just given that type of margin where you're running right now above your target?

James Herzog

I don't think we're prepared yet to talk about 2025. We do acknowledge that we're carrying very strong levels of capital. Now, we do want to stay maturely above our 10% target CET1. And frankly, I think we want to stay above probably an 11% well above an 11% CET1 target because we want to make sure we're ready for Basel III end game as it approaches, even though those rules are not quite final yet.
But that still does give us a little bit of flexibility. We expect earnings to continue to be very strong going forward. But we do have to as always continue to make sure we prioritize capital for loan growth and our customers.
We have to keep an eye on rates in the overall economic environment. Longer term rates and the curve shift up a little bit since the end of the quarter. And again, we are sensitive to what's going on with the AOCI and making sure that we don't get a surprise there, continue to monitor this profitability in the regulatory environment.
So it's just something we're going to have to monitor on a quarter-by-quarter basis as we move through 2025. But we do feel very comfortable with our capital position and really proud of the fact that we're starting to share repurchase this quarter.

Operator

Jon Arfstrom, RBC Capital Markets.

Jon Arfstrom

Jim, maybe just bigger picture for you, can you just talk a little bit about your philosophy on hedging right now and your approach to rate management? It feels like there's a better outcome on NII and the margin if rates fall further, but just talk a little bit about what you're trying to accomplish and how we should think about NII trajectory and margin trajectory if the Fed continues cutting.

James Herzog

Good morning, John. As you see on our sensitivity slide in the deck, we are just very slightly liability sensitive, actually a little less liability sensitive than last quarter, but still slightly liability sensitive. I've been saying that I really think of it as largely interest neutral.
There's always a somewhat of a fixed component of that sensitivity equation that ties back to balances and the assumption that non-interest bearing balances will grow if rates continue to go down. And we may not get the full effect of that until we see a few more rate cuts. And we have some type of inflection point in terms of how customers manage their money.
And so I don't necessarily expect to get the full benefit of that balance until we get a few more cuts down the road. So as a result from a pure rate standpoint, I really think of us as being closer to interest neutral. And eventually, we'll get the balanced benefit of that liability sensitivity also.
And so I don't see the rate picture really changing things materially for us on a quarter-to-quarter basis because we are so close to neutral. And I think the real wild card really for us is going to be deposit pay rates, how competition and the customers react.
I think that's probably got a wider range of outcome than what you might argue in terms of asset and liability sensitivity assumption, so much closer to interest neutral. The good news is I feel like we are insulated from any drop in rates and should be protected from that

Jon Arfstrom

Okay. And it feels like you're starting to get the early signs of maybe a little bit of customer acceptance to lower deposit rates. Is that a fair assessment?

James Herzog

Yeah, I think so. We feel so and Peter may want to comment too, but I've been really pleased with how it's received and our relationship managers are doing a great job shepherding these through and explaining to the customers and I'll give credit to our customers. They understand it. And when they ask for rate increases as rates were going up and I think they understand that when rates go down, we have to be a little bit symmetrical there. And so overall, I feel like it's going really well,

Peter Sefzik

Jon, it's Peter. I would echo that we feel like it's going really well and we're being very selective across each of our businesses. I mean, some of them, we can achieve more success than others. But I think our continuous message is about our relationship strategy and being able to have these conversations before customers make moves is proven to be very successful. So I would echo what Jim's comments are there.

John Pancari

Okay. And then just one kind of a follow up on John's question on loan growth, but you talked, you guys flagged a couple of times CRE payoffs and maybe an uptick in CRE payoffs, but on the flip side, maybe some better potential lending growth if rates do fall. How do you kind of square that, how material do you think the CRE payoffs might be? And this kind of gets to the '25 loan growth question, but is that just a real impediment to 2025 growth?

Peter Sefzik

Yeah, Jon, it's Peter. It's certainly something we're watching. I think it's yet to be determined of how much of a headwind it is or isn't. I would say we feel like CRE loans have peaked in the third quarter here. And so it probably is sort of a downward slope as we get into next year.
Now that said, I think we feel like the rest of the portfolio will perform in the opposite direction and hopefully be able to offset that headwind. So and we'll talk more about '25 outlook when we talk about our next call. But at least as we sit today, I think CRE is probably a downward slope from here on and our expectation is with rates coming down further, sort of where we feel like the rest of the portfolio maybe has bottomed a little bit, that will hopefully offset the headwind on CRE.

Operator

Bernard Von Gizycki, Deutsche Bank.

Bernard Von Gizycki

So just a quick question, a modeling question on the risk management hedge income, given the geography change. So is there a rule of thumb on how much risk management income would decline and [net I] increase on a 25 basis points rate cut?

James Herzog

Good morning, Bernard. I don't necessarily have a rule of thumb for you, but you can probably look at how three to five year treasuries move this quarter and draw a little bit of a conclusion relative to the previous quarter because it is tied to our swaps and our swaps do have a much shorter duration than our bond portfolio.
But we did see a shift of income as we mentioned in the script from non-interest income to net interest income, you see that on the non-interest income slide, risk management hedge income was down $10 million. Net interest income probably benefited from $8 million of that in the third quarter and net interest income will continue to benefit from that in the fourth quarter.
So we do have some positive inflows in the net interest income. And I think on the strength of those, we did improve our outlook reflecting in part the great third quarter success. And I do think as I look to that down 13% to 14% guide, I do think we have a really good shot at being closer to the 13% than the 14%. So we continue to look at really strong in [net interest income]. And I think that explains some of the weakness in the non-customer portion on the non-interest income side.

Bernard Von Gizycki

Got it. And then just separately, I appreciate that the forward curve has changed. It feels like it's ebbed and flowed, just even day by day. But on slide 7 of the deck, you estimate the securities, AOCI, unrealized losses were declined by, I think it's about 16% by [1C '26]. The footnote, I believe it's the forward curve at 9/30, you know, given changes in the forward curve since then, there's like two less rate cuts priced in. Just wondering any idea of the impact from, from just higher forward curve versus the 9/30 that I believe is assumed in that assessment?

James Herzog

You know, it's been moving around quite a bit since 9/30 trending up somewhat. So I don't really have a number for you as to where it sits today. We do have some sensitivities on the capital slide that point to overall AOCI and a large portion of that, a vast majority of that relates to bonds. So that's a little bit of a harbinger that you can look at there. But overall, we'll just have to wait and see, where rates end up in the fourth quarter.

Operator

Ben Gerlinger, Citi.

Ben Gerlinger

Just kind of high level, a little more philosophical than anything. So you guys, you stuck your neck out a little bit this year in terms of loan growth expectations and please by no means feel like I'm picking on you because everyone seemed to and then everyone seemed to walk it back a bit just because you have a little bit more of a national and commercial footprint than most of my coverage, I'd say on average. When you think about kind of the impediments, why loan demand really wasn't there?
And is there anything that stood out, is it other than just lack of rate cuts? And then kind of as we go into next year, I mean, does political uncertainty actually fix anything or is there kind of inflection points on rates where you might see demand? Just kind of thoughts on what you're hearing from boots on the ground level,

Peter Sefzik

Ben. It's Peter. It's a really good question. I don't know that my story is any more compelling than maybe some of the other things that you're hearing. But I think I would probably say that we all felt like some interest rate relief would really drive loan demand. And I think that's kind of proven to be not necessarily the case.
So the feedback we're getting from our portfolio was that 50 basis points was nice, but not inspiring necessarily. And that really, I think what most of the economy is going to need to see is another 50 basis points to 100 basis points to really see some stimulation there.
So we certainly were feeling earlier in the year that the second half of 2024 we would start to see loan demand pick up and that really hasn't occurred. So what does that mean for going into the future? I think that probably it does become a little more of even a second half of '25 conversation about what does loan demand look like in the economy?
And certainly getting to the other side of the election, I think will be helpful because I do believe that business owners wait to make decisions until they understand what the tax outlook might look like for them. I think to Jim's point continuing to see the economy kind of level out here.
But I don't know that there's anything more compelling other than to tell you that what we are hearing is that interest rates are going to need to come down, probably another 50 basis points to 100 basis points to really start to inspire business owners to make more decisions here on investing capital.

Ben Gerlinger

I mean, some clarity on the political front, whether team red or team blue would definitely help. But I get what you're saying, it's kind of more of this lack of animal spirits across the board. But if you do kind of have to rank order in certain areas, that kind of might be chomping at a bit. Like economically speaking, that seem to probably want to take loans a little bit faster or anything that comes to mind that might be kind of first out of the gate to increase loan demand.

Peter Sefzik

Ben, when you look at our portfolio, I would say our national and specialty businesses have probably started to see a little bit more pick up across the board. Our pipeline feel like it actually has grown a little bit more in those businesses in the last quarter.
I think it's really more general middle market C&I, where you're just going to have to have that reduction in interest rates to get the stimulant of borrowing and to your comment about animal spirits. I think your average middle market business in the country right now is just waiting for that interest rate relief. So they're not in a situation where they have to do anything. If anything they're building a little bit of cash, they're making good money.
You know, why take any chances when they believe that the outlook on interest rates is really going to be in their favor next year. On the other hand, our national specialty businesses, I think, they're going to kind of run their businesses. I don't want to say, despite interest rates, but we are seeing some pick up there. And so that's where I think you put all that together between sort of muted middle market growth, CRE coming down, and some of our other specialty businesses picking up. That's where you're hearing us talk about sort of modest to flat loan growth going into the fourth quarter and possibly next year.

Operator

Chris McGratty, KBW.

Chris McGratty

Just wanted to get a better understanding of the guide for Q4 for NII. The plus 6% or the plus 1% to 2%, the gap was [534] in the third quarter. Is the math 6% off of that? I'm just trying to make sure I get the right NII for the fourth quarter.

James Herzog

It is. Yeah, it's the printed number 6% above that BSBY, obviously has about a $25 million swing. If you look at the BSBY schedule that we have from the third quarter to the fourth quarter and again, that schedules in the deck. But yeah, it is 6% on the printed number.

Chris McGratty

Okay. So that would to get to that closer to 13% down, you'd be north of [560] kind of ballpark for Q4.

James Herzog

Yeah, pretty closer to [mid-560s to 570].

Chris McGratty

Okay, awesome. And then second on ECRs is a commercial bank. You know, it's kind of a hidden deposit beta. Can you maybe opine about what lever that might be in the expense line over the next few quarters?

James Herzog

I think there is a little bit of opportunity with ECRs as rates continue to come down. Our ECR is actually had a much lower beta than our deposits did. So I do expect service charges to benefit over time as rates continue to come down. And I think it'll be noticeable, but I don't think it'll be huge. It'll be really just a fraction of what you're going to get on the pure deposit pay rate side.

Operator

Samuel Varga, UBS.

Samuel Varga

I just wanted to ask if you can put maybe a finer point on the margin in 4Q. I understand that you're looking to pay back some of the broker deposits, but I just wanted to get a sense for, I guess a finer point on how you're managing that extra liquidity and what your level of willingness is to move cash lower, move brokered lower, and sort of protect the margin a bit more.

James Herzog

Hey, good morning Samuel, we do expect the balance sheet to become a little bit more efficient as we move into the fourth quarter. On a quarter-to-quarter basis, we will see a little bit lower wholesale funding on average brokered deposits where you're going to see the biggest change as we pay down quite a few almost $900 million at the end of the third quarter in a somewhat similar amount as we move through the fourth quarter.
So we did inflate the balance sheet a little bit with excess cash supported by those higher level of broker deposits because frankly, the loan growth that we might have expected at one-time when we took those broker deposits out didn't fully materialize.
And so, I will say that we expect improvement in the NIM as we move into the fourth quarter. I think many of, you know, on the call that I really hate talking about NIM. And I think yet again, we have another example where net interest income increased even with the BSBY drag, yet the NIM went down because of dynamics of the balance sheet. So never really like to talk a lot about NIM percentage.
Having said that, it is going to move up, you know, materially just because of a more efficient balance sheet and probably end up somewhere near 3 handle, 3% as we move through the fourth quarter. But a lot of that will just depend on just the various levers within the balance sheet and how they move.

Samuel Varga

And then the other question I had is just around the environmental services teams that you have and obviously you're pretty bullish on the opportunity set here. So can you talk a little bit more about the business in terms of the growth ramp with the teams that you have and what your expectations might be over the next couple of years in terms of where that business can go?

Peter Sefzik

Yeah, Sam, this is Peter. So it is a business that we're very proud of. We've been, we've been at this business for a long time now, a couple of years ago, we started a renewables group as well that shows up in that line item. And quite candidly, our environmental services business has been a quarterly positive performer for several years now and I think that outlook will continue.
We've got a great team. I think we're the best in the business. We continue to try to give resources to those folks. So I'd be surprised to see anything other than the pace that you've seen the last few years continue in that space. It's a fantastic, it's really a great middle market business. It's a specialty business, but the size of the loans, the fee income that it generates, it's just a fantastic business for us.
And so it's one that we're going to continue to lean into. And I would expect that on a go-forward basis, the growth rates would be similar to what you've seen in the last few years. So that's how I would think about it that way if I were you.

Operator

Michael Rose, Raymond James.

Michael Rose

I think both the NIM and the loan growth questions have been asked. So maybe I'll ask on just the pace of future investments, specifically as it relates to the loan hires. I think we're hearing more commentary. You know, across other banks that, you know, hiring efforts are going to be a little bit more robust as we enter next year. Wanted to get your thoughts there and maybe drive some incremental loan growth and then, you know, maybe any sort of updates you have just in terms of costs related to eventually crossing the $100 billion in assets.

Peter Sefzik

Michael, it's Peter. I might take the first one and then I'll probably let Jim take the second one. I think the thing that, you're exactly right, the competition for talent is tremendous right now. I think whether you're no matter which market we're in, no matter what kind of line of business you look at, there's a lot of competition for talent.
I continue to believe that something that makes us very special is we have a fantastic training program where a lot of our relationship manager growth over the next few years is because of talent that we have hired and trained and developed and they go to market with that sort of culture and expectation. And I think a better knowledge of credit than our peers.
And so that program is one that we are leaning heavily into, of trying to get folks into that program and out of it as well-trained and ready to be successful as we possibly can. I think hiring from other banks can be successful, but I also think it's expensive and I don't think it's necessarily the best way to grow your culture or your brand.
So I think that distinguishes us when you look at Comerica from others as to why we've got a really good outlook there. And so we're intending to grow that population, especially in our middle market and business banking businesses where we've got opportunities in Texas and California.
And we will certainly add talent from other banks. We do that all the time, but I think that you put those two things together. It's a very compelling story as to why you would look at Comerica compared to others. And so Jim, I might flip to you on the $100 billion number

James Herzog

Yeah, specific to the $100 billion efforts, I always remind people that we're one of two existing banks that have been in that regime in the past. So we've been there, we know how to do it. We kept some of the practices that we had in place at that point in time. Of course, the bar has gone up since then.
But we feel like we have really strong capital planning and stress testing practices, liquidity and stress testing practices. When I look at what it takes to get ready for $100 billion, beyond just having that general good risk framework, which we're making great progress on, the task that probably takes the most effort is just the data and all the reporting that's required.
And that is probably the longest tail on it. And we've been working on that really for the last year, year-and-a-half, we're making great progress. We plan on being done well ahead of hitting the $100 billion. And so our goal overall is to do this in layers so that any one year, there's not a huge step up in expenses, we will ultimately have a higher run rate, you know, a modestly higher run rate because of $100 billion in Category 4 readiness. But we're also working to offset those costs.
And my goal is to put it in context of you'll never actually notice a big step up specifically due to a Category 4 readiness effort because we are layering them in as time goes on and feel like we're on a really good track to be ready well ahead of hitting $100 billion.

Michael Rose

Very helpful. And then maybe the natural follow-up question is that relates to next year and I'm not trying to pin you down here, but I think we're hearing other banks at least plan for positive operating leverage next year. I heard your comments on NII trajectory. You know, balance that with, you know, maybe some, some expense growth related to what you just talked about, but it is at least the initial plan or expectation that you can generate positive operating leverage next year. Thanks,

James Herzog

It's always our goal to have positive operating leverage and obviously '23 with the regional bank crisis and its trailing effects on '24 made that very challenging, but positive operating leverage is always our goal and I would say 2025 is no exception to that. That's our own expectation and that's what we are shooting for. And that will be through a combination of both revenue efforts as well as making sure that we calibrate expenses appropriately.

Operator

Anthony Elian, JPMorgan Chase.

Anthony Elian

I appreciate the comments you provide on loan growth and customer sentiment towards quarter-end. Just asking the question around loan growth expectations a different way. Once borrowers get past hurdles of the election and we see more rate cuts, do you see a loan growth at the company at a level comparable to the rest of the industry or do you think you can grow faster than the industry, just given your footprint and other segments you've mentioned?

Peter Sefzik

Yeah, Anthony, it's Peter. I'd answer that a couple of ways. We had a lot of years where we were growing at the rate of the industry, if not even slightly below for a while. But if you kind of went back 2019, 2022, so call it the non-COVID, the non-2023 years, we were growing at a rate equal to or above the industry.
So I think on a go forward basis, particularly when we get to the other side of, as I talked earlier about CRE kind of downward slope from here, I think we should be able to grow at the industry growth rate or better when we get into '25 and '26 that would be the expectation.
And I certainly think when you look at our portfolio, all of our specialty businesses being highly exposed in Texas and in California, we would expect of ourselves to be growing better than the overall industry. And we've proven that we could do that the last couple of years absent sort of these major events. So the only part of that I would just, you know, caution again is the CRE headwind that we have. But the rest of the book on a go-forward basis, we would expect to be able to grow better than the industry.

Curtis Farmer

I might just add to that when you look at -- this is Curt, that the markets we operate in really all of our geographies have grown this year and expected to grow next year above GDP. So we feel really good about sort of the markets we operate in the national, especially businesses that Peter referenced earlier. Part of our capital management strategy is to reserve capital for long growth.
So we are anticipating long growth on a forward basis where we feel really good about our funding position and credit continues to be very well-behaved. So we're ready, willing, and able, and we got a great team on the field. And back to the question earlier about relationship managers, we've got plenty of capacity right now for growth. But again, we are building in additions of capacity through our training programs and selectively in some of our businesses' external hires.

Anthony Elian

Thank you. And then my follow-up, you saw good growth in equity fund services deposits during the quarter. Can you talk about what specifically you saw in that segment that drove the growth and the expectations from your end? Thank you.

Curtis Farmer

Yeah, Anthony. So I mean, equity fund services has been a really good business for us and in 2023 it was one that we did optimize quite a bit, I think through last year. We are seeing good success in that business. It's a little bit of a different environment there, there's not maybe as much fund formation as there was for a while.
There's not as much activity in the private equity space as you know, but on a loan outlook standpoint, I feel like it's sort of up from here. We did sort of expect to see a little more growth in Q3. It worked a little bit against us in August.
But I think that's starting to flatten out. And on the deposit side, I mean, I just think we're continuing to add sort of more what I would call bilateral relationships where we're the only bank which leads to more deposits, which leads to more treasury and fee income. We're trying to do less participations per se in that business and more bilateral deals.
And so I think we're just capturing relationship. And I think as events occur in the book that our customers have, we've proven as a really good bank for them to place their deposits with and as we talked about earlier, that's at appropriate rates across our portfolio.

Operator

Thank you. Ladies and gentlemen, that concludes our question-and-answer session and I'll now turn the call back to Mr. Curt Farmer, President, Chairman, and Chief Executive Officer, for final comments.

Curtis Farmer

Well, thank you all of you for joining us again today as always. Thank you for your ongoing interest in Comerica and we hope you have a good day.

Operator

Thank you. This concludes today's conference call. You may disconnect your lines at this time. Thank you for your participation.