1 FORM 10-Q SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 (Mark One) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended June 30, 1998 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to Commission file number 1-10706 Comerica Incorporated (Exact name of registrant as specified in its charter) Delaware 38-1998421 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) Comerica Tower at Detroit Center Detroit, Michigan 48226 (Address of principal executive offices) (Zip Code) (313) 222-3300 (Registrant's telephone number, including area code) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. $5 par value common stock: outstanding as of July 31, 1998: 155,455,000 shares
2 PART I. FINANCIAL INFORMATION <TABLE> CONSOLIDATED BALANCE SHEETS Comerica Incorporated and Subsidiaries <CAPTION> June 30, December 31, June 30, (In thousands, except share data) 1998 1997 1997 ------------- ------------ ------------- <S> <C> <C> <C> ASSETS Cash and due from banks $ 2,222,463 $ 1,927,087 $ 1,949,851 Short-term investments 264,777 202,957 177,391 Investment securities available for sale 3,396,952 4,005,962 4,808,231 Commercial loans 16,891,406 15,805,549 14,687,352 International loans 2,389,783 2,085,090 2,022,621 Real estate construction loans 981,975 940,910 867,787 Commercial mortgage loans 3,788,052 3,633,785 3,554,351 Residential mortgage loans 1,360,363 1,565,445 1,687,900 Consumer loans 1,999,634 4,347,665 4,474,213 Lease financing 591,418 516,600 430,514 ----------- ----------- ----------- Total loans 28,002,631 28,895,044 27,724,738 Less allowance for credit losses (438,875) (424,147) (404,525) ----------- ----------- ----------- Net loans 27,563,756 28,470,897 27,320,213 Premises and equipment 361,003 380,157 388,827 Customers' liability on acceptances outstanding 26,252 18,392 30,737 Accrued income and other assets 1,214,802 1,286,946 1,179,053 ----------- ----------- ----------- TOTAL ASSETS $35,050,005 $36,292,398 $35,854,303 =========== =========== =========== LIABILITIES AND SHAREHOLDERS' EQUITY Demand deposits (noninterest- bearing) $ 6,392,257 $ 6,761,202 $ 6,858,247 Interest-bearing deposits 16,226,376 15,825,115 15,818,294 ----------- ----------- ----------- Total deposits 22,618,633 22,586,317 22,676,541 Federal funds purchased and securities sold under agreements to repurchase 1,049,308 592,860 500,011 Other borrowed funds 2,542,210 2,600,041 3,534,555 Acceptances outstanding 26,254 18,392 30,737 Accrued expenses and other liabilities 324,616 446,625 373,748 Medium- and long-term debt 5,662,180 7,286,387 6,070,543 ----------- ----------- ----------- Total liabilities 32,223,201 33,530,622 33,186,135 Nonredeemable preferred stock - $50 stated value: Authorized - 5,000,000 shares Issued - 5,000,000 shares at 6/30/98, 12/31/97 and 6/30/97 250,000 250,000 250,000 Common stock - $5 par value: Authorized - 325,000,000 shares Issued-157,187,518 shares at 6/30/98, 156,815,367 shares at 12/31/97 and 105,620,404 shares at 6/30/97 785,938 784,077 528,102 Capital surplus 14,889 - - Unrealized gains and losses on investment securities available for sale (5,206) (1,937) (13,993) Retained earnings 1,904,223 1,731,419 1,906,324 Deferred compensation (3,071) (1,783) (2,265) Less cost of common stock in treasury- 1,818,965 shares at 6/30/98 (119,969) - - ----------- ----------- ----------- Total shareholders' equity 2,826,804 2,761,776 2,668,168 ----------- ----------- ----------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $35,050,005 $36,292,398 $35,854,303 =========== =========== =========== /TABLE
3 <TABLE> CONSOLIDATED STATEMENTS OF INCOME Comerica Incorporated and Subsidiaries <CAPTION> Three Months Ended Six Months Ended June 30 June 30 -------------------- ------------------------ (In thousands, except per share data) 1998 1997 1998 1997 -------- -------- ---------- ---------- <S> <C> <C> <C> <C> INTEREST INCOME Interest and fees on loans $590,427 $578,441 $1,197,417 $1,124,013 Interest on investment securities: Taxable 56,582 79,534 118,888 156,017 Exempt from federal income tax 1,927 2,937 4,020 5,992 -------- -------- ---------- ---------- Total interest on investment securities 58,509 82,471 122,908 162,009 Interest on short-term investments 2,294 2,414 4,766 4,547 -------- -------- ---------- ---------- Total interest income 651,230 663,326 1,325,091 1,290,569 INTEREST EXPENSE Interest on deposits 160,927 169,805 328,064 329,471 Interest on short-term borrowings: Federal funds purchased and securities sold under agreements to repurchase 27,605 27,068 58,202 55,518 Other borrowed funds 17,563 29,597 30,812 56,586 Interest on medium- and long-term debt 93,879 86,501 203,707 162,182 Net interest rate swap income (13,222) (13,173) (25,780) (28,501) -------- -------- ---------- ---------- Total interest expense 286,752 299,798 595,005 575,256 -------- -------- ---------- ---------- Net interest income 364,478 363,528 730,086 715,313 Provision for credit losses 28,000 34,000 56,000 75,000 -------- -------- ---------- ---------- Net interest income after provision for credit losses 336,478 329,528 674,086 640,313 NONINTEREST INCOME Income from fiduciary activities 42,009 36,173 82,744 69,249 Service charges on deposit accounts 39,517 34,995 77,967 69,949 Securities gains/(losses) 11 (234) (139) 263 Other noninterest income 67,258 50,513 123,075 111,380 -------- -------- ---------- ---------- Total noninterest income 148,795 121,447 283,647 250,841 NONINTEREST EXPENSES Salaries and employee benefits 137,994 135,443 272,761 268,358 Net occupancy expense 21,579 22,096 44,340 45,388 Equipment expense 15,167 15,165 30,291 31,233 Telecommunications expense 6,361 6,927 12,983 14,071 Other noninterest expenses 72,198 69,628 142,797 138,946 -------- -------- ---------- ---------- Total noninterest expenses 253,299 249,259 503,172 497,996 -------- -------- ---------- ---------- Income before income taxes 231,974 201,716 454,561 393,158 Provision for income taxes 81,591 72,006 159,795 139,676 -------- -------- ---------- ---------- NET INCOME $150,383 $129,710 $ 294,766 $ 253,482 ======== ======== ========== ========== Net income applicable to common stock $146,108 $125,435 $ 286,216 $ 244,932 ======== ======== ========== ========== Basic net income per common share $0.94 $0.79 $1.83 $1.54 Diluted net income per common share $0.92 $0.78 $1.80 $1.52 Cash dividends declared on common stock $49,792 $45,341 $99,965 $91,023 Dividends per common share $0.32 $0.29 $0.64 $0.57 </TABLE>
4 <TABLE> CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY Comerica Incorporated and Subsidiaries <CAPTION> Nonredeem- able Unrealized Total Preferred Common Capital Gains/ Retained Deferred Treasury Shareholders' (in thousands) Stock Stock Surplus (Losses) Earnings Compensation Stock Equity --------- --------- --------- ---------- ---------- ------------ --------- ------------- <S> <C> <C> <C> <C> <C> <C> <C> <C> BALANCES AT JANUARY 1, 1997 $250,000 $536,487 $ - $ (22,789) $1,854,116 $ (2,245) $ - $2,615,569 Net income for 1997 - - - - 253,482 - - 253,482 Nonowner changes in equity: Unrealized holding gains/(losses) arising during the period - - - 13,795 - - - 13,795 Less: Reclassification adjustment for gains/ (losses) included in net income - - - 263 - - - 263 Nonowner changes in equity before income taxes - - - 13,532 - - - 13,532 Provision for income taxes related to nonowner changes in equity - - - 4,736 - - - 4,736 Nonowner changes in equity, net of tax - - - 8,796 - - - 8,796 Net income and nonowner changes in equity - - - - - - - 262,278 Cash dividends declared: Preferred stock - - - - (8,550) - - (8,550) Common stock - - - - (91,023) - - (91,023) Purchase and retirement of 2,235,350 shares of common stock - (11,176) (18,956) - (101,701) - - (131,833) Issuance of common stock under employee stock plans - 2,791 18,956 - - (530) - 21,217 Amortization of deferred compensation - - - - - 510 - 510 -------- -------- --------- --------- ---------- --------- --------- ---------- BALANCES AT JUNE 30, 1997 $250,000 $528,102 $ - $ (13,993) $1,906,324 $ (2,265) $ - $2,668,168 ======== ======== ========= ========= ========== ========= ========= ========== BALANCES AT JANUARY 1, 1998 $250,000 $784,077 $ - $ (1,937) $1,731,419 $ (1,783) $ - $2,761,776 Net income for 1998 - - - - 294,766 - - 294,766 Nonowner changes in equity: Unrealized holding gains/ (losses) arising during the period - - - (5,168) - - - (5,168) Less: Reclassification adjustment for gains/ (losses) included in net income - - - (139) - - - (139) Nonowner changes in equity before income taxes - - - (5,029) - - - (5,029) Provision for income taxes related to nonowner changes in equity - - - (1,760) - - - (1,760) Nonowner changes in equity, net of tax - - - (3,269) - - - (3,269) Net income and nonowner changes in equity - - - - - - - 291,497 Cash dividends declared: Preferred stock - - - - (8,550) - - (8,550) Common stock - - - - (99,965) - - (99,965) Purchase of 2,136,450 shares of common stock - - - - - - (141,070) (141,070) Purchase and retirement of 60,000 shares of common stock - (300) (3,182) - - - - (3,482) Issuance of common stock under employee stock plans - 2,161 18,071 - (13,447) (1,794) 21,101 26,092 Amortization of deferred compensation - - - - - 506 - 506 -------- -------- --------- --------- ---------- --------- --------- ---------- BALANCES AT JUNE 30, 1998 $250,000 $785,938 $ 14,889 $ (5,206) $1,904,223 $ (3,071) $(119,969) $2,826,804 ======== ======== ========= ========= ========== ========== ========= ========== /TABLE
5 <TABLE> CONSOLIDATED STATEMENTS OF CASH FLOWS Comerica Incorporated and Subsidiaries <CAPTION> Six Months Ended June 30 --------------------------- (in thousands) 1998 1997 ------------ ------------ <S> <C> <C> OPERATING ACTIVITIES: Net income $ 294,766 $ 253,482 Adjustments to reconcile net income to net cash provided by operating activities: Provision for credit losses 56,000 75,000 Depreciation 28,332 29,850 Restructuring charge (13,974) (33,944) Net (increase) decrease in trading account securities 3,979 (114) Net increase in assets held for sale (22,464) (383) Net (increase) decrease in accrued income receivable 19,127 (6,403) Net decrease in accrued expenses (194,383) (40,250) Net amortization of intangibles 13,464 14,069 Other, net 154,483 (23,243) ------------ ------------ Total adjustments 44,564 14,582 ------------ ------------ Net cash provided by operating activities 339,330 268,064 INVESTING ACTIVITIES: Net (increase) decrease in interest-bearing deposits with banks (20,473) 19,313 Net increase in federal funds sold and securities purchased under agreements to resell (22,862) (92,600) Proceeds from sale of investment securities available for sale 36,295 155,183 Proceeds from maturity of investment securities available for sale 611,325 522,543 Purchases of investment securities available for sale (100,105) (735,033) Net increase in loans (other than purchased loans) (1,122,522) (1,507,761) Purchase of loans (1,115) (47,909) Net proceeds from sale of consumer businesses 2,006,091 - Fixed assets, net (16,776) (11,014) Net (increase) decrease in customers' liability on acceptances outstanding (7,860) 2,365 ------------ ------------ Net cash provided by (used in) investing activities 1,361,998 (1,694,913) FINANCING ACTIVITIES: Net increase in deposits 32,316 309,368 Net increase (decrease) in short-term borrowings 398,617 (454,625) Net increase (decrease) in acceptances outstanding 7,862 (2,365) Proceeds from issuance of medium- and long-term debt 1,500,000 3,230,000 Repayments and purchases of medium- and long-term debt (3,124,207) (1,401,226) Proceeds from issuance of common stock and other capital transactions 27,886 21,747 Purchase of common stock for treasury and retirement (144,552) (131,833) Dividends paid (103,874) (96,126) ------------ ------------ Net cash provided by (used in) financing activities (1,405,952) 1,474,940 ------------ ------------ Net increase in cash and due from banks 295,367 48,091 Cash and due from banks at beginning of year 1,927,087 1,901,760 ------------ ------------ Cash and due from banks at end of period $ 2,222,463 $ 1,949,851 ============ ============ Interest paid $ 658,920 $ 572,773 ============ ============ Income taxes paid $ 150,107 $ 152,185 ============ ============ Noncash investing and financing activities: Loan transfers to other real estate $ 2,355 $ 3,705 ============ ============ </TABLE>
6 Notes to Consolidated Financial Statements Comerica Incorporated and Subsidiaries Note 1 - Basis of Presentation and Accounting Policies The accompanying unaudited financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, the statements do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the six months ended June 30, 1998 are not necessarily indicative of the results that may be expected for the year ending December 31, 1998. For further information, refer to the consolidated financial statements and footnotes thereto included in the annual report of Comerica Incorporated and Subsidiaries (the "Corporation") on Form 10-K for the year ended December 31, 1997. The Corporation may use derivative financial instruments, including foreign exchange contracts, to manage the Corporation's exposure to interest rate and foreign currency risks. These instruments are treated as hedges, and accounted for on an accrual basis, since there is a high correlation with the on-balance sheet instrument being hedged. If this correlation ceases to exist, the existing unrealized gain or loss is amortized over the remaining term of the instrument, and future changes in fair value are accounted for on a mark-to-market basis. Derivative financial instruments executed as a service to customers are accounted for on a mark-to-market basis. For further information, refer to the Accounting Policies footnote in the Corporation's 1997 annual report. In June 1998, the Financial Accounting Standards Board issued Statement No. 133, "Accounting for Derivative Instruments and Hedging Activities," which is required to be adopted in years beginning after June 15, 1999. The Statement permits early adoption as of the beginning of any fiscal quarter. The Corporation expects to adopt the new Statement effective January 1, 2000. The Statement will require the Corporation to recognize all derivatives on the balance sheet at fair value. Derivatives
7 Notes to Consolidated Financial Statements Comerica Incorporated and Subsidiaries Note 1 - Basis of Presentation and Accounting Policies (continued) that are not hedges must be adjusted to fair value through income. If the derivative is a hedge, depending on the nature of the hedge, changes in the fair value of derivatives will either be offset against the change in fair value of the hedged assets, liabilities, or firm commitments through earnings or recognized in other comprehensive income until the hedged item is recognized in earnings. The ineffective portion of a derivative's change in fair value will be immediately recognized in earnings. The Corporation has not yet determined what the effect of Statement 133 will be on the earnings and financial position of the Corporation. Note 2 - Investment Securities At June 30, 1998, investment securities having a carrying value of $2.3 billion were pledged where permitted or required by law to secure liabilities and public and other deposits, including deposits of the State of Michigan of $21 million. Note 3 - Allowance for Credit Losses The following analyzes the changes in the allowance for credit losses included in the consolidated balance sheets: <TABLE> <CAPTION> (in thousands) 1998 1997 --------- --------- <S> <C> <C> Balance at January 1 $ 424,147 $ 367,165 Charge offs (66,630) (59,537) Recoveries 25,358 21,897 --------- --------- Net charge offs (41,272) (37,640) Provision for credit losses 56,000 75,000 --------- --------- Balance at June 30 $ 438,875 $ 404,525 ========= ========= </TABLE> Statement of Financial Accounting Standards (SFAS) No. 114, "Accounting by Creditors for Impairment of a Loan," considers a loan impaired when it is probable that interest and principal payments will not be made in accordance with the contractual terms of the loan agreement. Consistent with this definition, all nonaccrual and reduced-rate loans (with the exception of residential mortgage and consumer loans) are impaired. Impaired loans averaged $79 million and $74 million for the
8 Notes to Consolidated Financial Statements Comerica Incorporated and Subsidiaries Note 3 - Allowance for Credit Losses (continued) quarter and six months ended June 30, 1998, compared to $52 million and $65 million for the comparable periods last year. The following are period-end balances: <TABLE> <CAPTION> (in thousands) June 30, 1998 December 31, 1997 ------------- ----------------- <S> <C> <C> Total impaired loans $72,650 $70,470 Impaired loans requiring an allowance 38,561 60,376 Impairment allowance 7,087 20,358 </TABLE> Those impaired loans not requiring an allowance represent loans for which the fair value exceeded the recorded investment in the loan.
9 Notes to Consolidated Financial Statements Comerica Incorporated and Subsidiaries Note 4 - Medium- and Long-term Debt Medium- and long-term debt consisted of the following at June 30, 1998 and December 31, 1997: <TABLE> <CAPTION> (in thousands) June 30, 1998 December 31, 1997 ------------- ----------------- <S> <C> <C> Parent Company 9.75% subordinated notes due 1999 $ 74,923 $ 74,877 10.125% subordinated debentures due 1998 - 74,965 7.25% subordinated notes due 2007 148,586 148,509 ---------- ---------- Total parent company 223,509 298,351 Subsidiaries Subordinated notes: 7.25% subordinated notes due 2007 198,200 198,100 7.875% subordinated notes due 2026 146,967 146,914 8.375% subordinated notes due 2024 147,976 147,938 7.25% subordinated notes due 2002 149,324 149,246 6.875% subordinated notes due 2008 99,258 99,220 7.125% subordinated notes due 2013 148,279 148,224 ---------- ---------- Total subordinated notes 890,004 889,642 Medium-term notes: Floating rate based on Treasury bill indices 486,998 487,000 Floating rate based on Prime indices 350,000 1,100,007 Floating rate based on LIBOR indices 3,311,926 2,811,793 Floating rate based on Federal Funds indices - 349,998 Fixed rate notes with interest rates ranging from 5.97% to 6.65% 399,743 1,349,596 ---------- ---------- Total medium-term notes 4,548,667 6,098,394 Total subsidiaries 5,438,671 6,988,036 ---------- ---------- Total medium- and long-term debt $5,662,180 $7,286,387 ========== ========== </TABLE>
10 Notes to Consolidated Financial Statements Comerica Incorporated and Subsidiaries Note 5 - Income Taxes The provision for income taxes is computed by applying statutory federal income tax rates to income before income taxes as reported in the financial statements after deducting non-taxable items, principally interest income on state and municipal securities. State and foreign taxes are then added to the federal provision.
11 Notes to Consolidated Financial Statements Comerica Incorporated and Subsidiaries Note 6 - Off-Balance Sheet Derivatives and Foreign Exchange Contracts <TABLE> <CAPTION> June 30, 1998 December 31, 1997 ------------------------------ ------------------------------ Notional/ Notional/ Contract Unrealized Fair Contract Unrealized Fair Amount Gains Losses Value Amount Gains Losses Value (in millions) (1) (2) (3) (1) (2) (3) ------------------------------- ------------------------------ <S> <C> <C> <C> <C> <C> <C> <C> <C> Risk Management Interest rate contracts Swaps (4) $ 7,465 $159 $ (3) $ 156 $ 8,515 $137 $ (14) $ 123 Floors purchased 50 - - - 52 - - - Foreign exchange contracts Spot and forward 779 11 (14) (3) 445 12 (9) 3 Swaps 127 5 - 5 154 5 - 5 ------- ---- ----- ----- ------- ---- ----- ----- Total risk management 8,421 175 (17) 158 9,166 154 (23) 131 Customer Initiated and Other Interest rate contracts Caps and floors written 277 - - - 314 - - - Caps and floors purchased 160 - - - 32 - - - Swaps 160 4 (4) - 150 6 (6) - Foreign exchange contracts Spot, forward and options 596 6 (2) 4 1,837 37 (33) 4 ------- ---- ----- ----- ------- ---- ----- ----- Total customer initiated and other 1,193 10 (6) 4 2,333 43 (39) 4 ------- ---- ----- ----- ------- ---- ----- ----- Total derivatives and foreign exchange contracts $ 9,614 $185 $ (23) $ 162 $11,499 $197 $ (62) $ 135 ======= ==== ===== ===== ======= ==== ===== ===== (1) Notional or contract amounts, which represent the extent of involvement in the derivatives market, are generally used to determine the contractual cash flows required in accordance with the terms of the agreement. These amounts are typically not exchanged, significantly exceed amounts subject to credit or market risk, and are not reflected in the consolidated balance sheets. (2) Represents credit risk, which is measured as the cost to replace, at current market rates, contracts in a profitable position. Credit risk is calculated before consideration is given to bilateral collateral agreements or master netting arrangements that effectively reduce credit risk. (3) The fair values of derivatives and foreign exchange contracts generally represent the estimated amounts the Corporation would receive or pay to terminate or otherwise settle the contracts at the balance sheet date. The fair values of customer initiated and other derivatives and foreign exchange contracts are reflected in the consolidated balance sheets. Futures contracts are subject to daily cash settlements; therefore, the fair value of these instruments is zero. (4) Includes index amortizing swaps with a notional amount of $2,851 million and $3,521 million at June 30, 1998 and December 31, 1997, respectively. These swaps had net unrealized gains of $9 million and net unrealized losses of $4 million at June 30, 1998 and December 31, 1997, respectively. As of June 30, 1998 index amortizing swaps had an average expected life of approximately 2 years with a stated maturity that averaged 4 years. /TABLE
12 Notes to Consolidated Financial Statements Comerica Incorporated and Subsidiaries Note 6 - Off-Balance Sheet Derivatives and Foreign Exchange Contracts (continued) Risk Management - --------------- Interest rate risk arises in the normal course of business to the extent there is a difference between the repricing and maturity characteristics of interest-earning assets and interest-bearing liabilities. This gap in the balance sheet structure reflects the sensitivity of the Corporation's net interest income to a change in interest rates. Foreign exchange rate risk arises from changes in the value of certain assets and liabilities denominated in foreign currencies. The Corporation employs on-balance sheet instruments such as investment securities, as well as off-balance sheet derivative financial instruments and foreign exchange contracts, to manage exposure to these and other risks, including liquidity risk. As an end-user, the Corporation mainly accesses the interest rate markets to obtain off-balance sheet derivatives instruments for use principally in connection with asset and liability management activities. The Corporation principally utilizes interest rate swaps with the objective of managing the sensitivity of net interest income to interest rate fluctuations. To accomplish this objective, the Corporation primarily uses interest rate swaps to modify the interest rate characteristics of certain assets and liabilities (for example, from a floating rate to a fixed rate, a fixed rate to a floating rate or from one floating rate index to another). Management believes this strategy achieves an optimal match between the rate maturities of assets and their funding sources which, in turn, reduces the overall exposure of net interest income to interest rate risk, although there can be no assurance that such a strategy will be successful. The following table summarizes the expected maturity distribution of the notional amount of interest rate swaps used for risk management purposes. The table also indicates the weighted average interest rates associated with amounts to be received or paid on interest rate swap agreements as of June 30, 1998. The swaps are grouped by the assets or liabilities to which they have been designated.
13 Notes to Consolidated Financial Statements Comerica Incorporated and Subsidiaries Note 6 - Off-Balance Sheet Derivatives and Foreign Exchange Contracts (continued) <TABLE> <CAPTION> - ----------------------------------------------------------------------------------------- Remaining Expected Maturity of Risk Management Interest Rate Swaps: 2003- Dec. 31, (dollar amounts in millions) 1998 1999 2000 2001 2002 2026 Total 1997 ----------------------------------------------------------------------------------------- <S> <C> <C> <C> <C> <C> <C> <C> <C> Variable rate asset designation: Receive fixed swaps Generic $ - $ - $ 700 $1,625 $ - $ - $2,325 $ 700 Amortizing - - - - - - - 100 Index amortizing 507 919 652 302 321 136 2,837 3,504 Weighted average: (1) Receive rate 6.34% 6.36% 6.35% 6.06% 6.42% 6.20% 6.24% 6.33% Pay rate 5.68% 5.69% 5.69% 5.69% 5.68% 5.66% 5.69% 5.90% Floating/floating swaps $ - $ - $ - $ - $ - $ - $ - $ 55 Fixed rate asset designation: Pay fixed swaps Generic $ - $ 2 $ - $ - $ - $ - $ 2 $ 2 Index amortizing 3 2 9 - - - 14 17 Weighted average: (1) Receive rate 5.66% 5.70% 5.66% -% -% -% 5.67% 5.97% Pay rate 5.34% 7.21% 5.34% -% -% -% 5.76% 5.85% Medium- and long-term debt designation: Generic receive fixed swaps $ 200 $ - $ 200 $ - $150 $ 900 $1,450 $2,200 Weighted average: (1) Receive rate 5.97% -% 6.91% -% 7.37% 7.66% 7.29% 6.84% Pay rate 5.56% -% 5.69% -% 5.69% 5.69% 5.67% 5.83% Floating/floating swaps $ 800 $ - $ 37 $ - $ - $ - $ 837 $1,937 Weighted average: (2) Receive rate 5.67% -% 5.55% -% -% -% 5.67% 5.73% Pay rate 5.59% -% 5.68% -% -% -% 5.59% 5.77% Total notional amount $1,510 $ 923 $1,598 $1,927 $471 $1,036 $7,465 $8,515 - ----------------------------------------------------------------------------------------- (1) Variable rates are based on LIBOR rates paid or received at June 30, 1998. (2) Variable rates paid are based on LIBOR at June 30, 1998, while variable rates received are based on prime. - ----------------------------------------------------------------------------------------- /TABLE
14 Notes to Consolidated Financial Statements Comerica Incorporated and Subsidiaries Note 6 - Off-Balance Sheet Derivatives and Foreign Exchange Contracts (continued) The Corporation also uses various other types of off-balance sheet financial instruments to manage interest rate and foreign currency risks associated with specific assets or liabilities, including interest rate caps and floors, forward and futures interest and foreign exchange rate contracts, and foreign exchange rate swaps, which are reflected in the table above. At June 30, 1998 and December 31, 1997, the notional amounts of commitments to purchase and sell U.S. Treasury and municipal bond securities related to the Corporation's trading account totaled $78 million and $2 million, respectively. The notional amounts of commitments to sell mortgage loans totaled $30 million at December 31, 1997. No such commitments were outstanding at June 30, 1998. These commitments, which are similar in nature to forward contracts, are not reflected in the above table due to the immaterial impact they have on the financial statements. Customer Initiated and Other - ----------------------------- The Corporation earns additional income by executing various transactions, primarily foreign exchange contracts, interest rate caps and forward rate agreements, at the request of customers. The Corporation minimizes market risk arising from customer initiated foreign exchange contracts and forward rate agreements by entering into offsetting transactions. Average fair values and income from customer initiated and other foreign exchange contracts were not material for the six-month period ended June 30, 1998 and for the year ended December 31, 1997. Customer initiated interest rate caps generally are not offset by other on- or off-balance sheet financial instruments; however, the Corporation has established authority limits for engaging in these transactions in order to minimize risk exposure. As a result, average fair values and income from this activity were not material for the six- month period ended June 30, 1998 and for the year ended December 31, 1997. Available credit lines on fixed rate credit card and check product accounts, which expose the Corporation to the risk of a reduction in net interest income as rates increase, totaled approximately $1.4 billion at
15 Notes to Consolidated Financial Statements Comerica Incorporated and Subsidiaries Note 6 - Off-Balance Sheet Derivatives and Foreign Exchange Contracts (continued) June 30, 1998 and $1.8 billion at December 31, 1997. Management believes that market risk exposure arising from these revolving credit commitments is very limited, however, since it is unlikely that a significant number of customers with these accounts will simultaneously borrow up to their maximum available credit lines. Off-Balance Sheet Derivative and Foreign Exchange Activity - ---------------------------------------------------------- The following table provides a reconciliation of the beginning and ending notional amounts for interest rate derivatives and foreign exchange contracts. <TABLE> <CAPTION> Customer Initiated Risk Management and Other --------------------- --------------------- Interest Foreign Interest Foreign Rate Exchange Rate Exchange (in millions) Contracts Contracts Contracts Contracts --------------------- --------------------- <S> <C> <C> <C> <C> Balances at December 31, 1997 $ 8,567 $ 599 $ 496 $ 1,837 Additions 1,627 3,241 281 18,940 Maturities/amortizations (2,624) (2,934) (180) (20,181) Terminations (55) - - - ------- ------- ----- -------- Balances at June 30, 1998 $ 7,515 $ 906 $ 597 $ 596 ======= ======= ===== ======== </TABLE> Additional information regarding the nature, terms and associated risks of the above off-balance sheet derivatives and foreign exchange contracts, along with information on derivative accounting policies, can be found in the Corporation's 1997 annual report on page 33 and in Notes 1 and 18 to the consolidated financial statements.
16 ITEM 2. Management's Discussion and Analysis of Results of Operations and Financial Condition ----------------------- Results of Operations - --------------------- Net income for the second quarter ended June 30, 1998 was $150 million, up $20 million, or 16 percent, from $130 million reported for the second quarter of 1997. Diluted net income per share increased 18 percent to $0.92 from $0.78 a year ago. Return on average common shareholders' equity was 22.57 percent and return on average assets was 1.74 percent, compared to 21.31 percent and 1.49 percent, respectively, for the comparable quarter last year. Net income for the first six months of 1998 was $1.80 per share or $295 million, compared to $1.52 or $253 million for the same period in 1997, increases of 18 percent and 16 percent, respectively. Return on average common shareholders' equity was 22.33 percent and return on assets was 1.67 percent for the first six months of 1998, compared to 20.86 percent and 1.48 percent, respectively, for the first six months of 1997. On January 15, 1998, the Corporation's board of directors declared a three-for-two stock split, effected in the form of a 50 percent stock dividend paid on April 1, 1998, as well as increased the quarterly cash dividend 12 percent to $0.32 per share. All per share data included in the financial statements and managements discussion and analysis have been retroactively adjusted to reflect the split. Net Interest Income - ------------------- The rate-volume analysis in Table I details the components of the change in net interest income on a fully taxable equivalent (FTE) basis for the quarter ended June 30, 1998. On a FTE basis, net interest income was $366 million for the three months ended June 30, 1998, unchanged from the comparable quarter in 1997. Net interest income and the net interest margin were both affected by the sale of $2.0 billion of indirect consumer loans and non-relationship credit card receivables. Excluding the impact of the consumer sale, net interest income would have increased 4 percent, primarily due to a 20 percent increase in average commercial loans. The net interest margin for the three months ended June 30, 1998, was 4.62
17 percent, an increase of 5 basis points from 4.57 percent for the second quarter of 1997. Table II provides an analysis of net interest income for the first six months of 1998. On a FTE basis, net interest income for the six months ended June 30, 1998, was $734 million compared to $720 million for the same period in 1997. This increase is primarily attributed to the growth in commercial loans cited in the quarterly discussion. The net interest margin for the six months ended June 30, 1998, was 4.56 percent compared to 4.58 percent for the same period in 1997. Net income generated by the risk management interest rate swap portfolio resulted in a contribution of 17 basis points to the net interest margin in the second quarter of 1998, compared to a 16 basis- point contribution in the year-earlier quarter. The contribution for the first six months of 1998 was 16 basis points compared to an 18 basis-point contribution in 1997. Interest rate swaps permit management to control the sensitivity of net interest income to fluctuations in interest rates in a manner similar to on-balance sheet investment securities but without significant impact to capital or liquidity. These instruments are designated against certain assets and liabilities, therefore, their impact on net interest income is generally offset by and should be considered in relation to the level of net interest income generated by the related on- balance sheet assets and liabilities. In addition to using interest rate swaps and other off-balance sheet instruments to control the Corporation's exposure to interest rate risk, management attempts to monitor the effect of movements in interest rates on net interest income by regularly performing interest sensitivity gap and earnings simulation analyses. At June 30, 1998, the Corporation was in an asset sensitive position of $2.6 billion (on an elasticity adjusted basis), or 8 percent of earning assets. The earnings simulation analysis performed at the end of the quarter reflects changes to both interest rates and loan, investment and deposit volumes. The measurement of risk exposure at June 30, 1998 for a 200 basis point decline in short-term interest rates identified approximately $35 million, or 2 percent, of net interest income at risk during the next 12 months. If short-term interest
18 <TABLE> TABLE I - QUARTERLY ANALYSIS OF NET INTEREST INCOME & RATE/VOLUME (FTE) <CAPTION> Three Months Ended ------------------------------------------------------------- June 30, 1998 June 30, 1997 ----------------------------- ----------------------------- Average Average Average Average (in millions) Balance Interest Rate Balance Interest Rate - ---------------------------------------------------------------------------------------------- <S> <C> <C> <C> <C> <C> <C> Loans $28,143 $591 8.42% $27,046 $579 8.59% Investment securities 3,500 60 6.81 4,806 84 6.90 Other earning assets 160 2 5.92 157 3 6.24 - ---------------------------------------------------------------------------------------------- Total earning assets 31,803 653 8.23 32,009 666 8.32 Interest-bearing deposits 15,931 161 4.05 16,412 170 4.15 Short-term borrowings 3,223 45 5.62 4,140 57 5.49 Medium- and long-term debt 6,087 94 6.18 5,525 86 6.28 Net interest rate swap (income)/ expense (1) - (13) - - (13) - - ---------------------------------------------------------------------------------------------- Total interest-bearing sources $25,241 287 4.56 $26,077 300 4.61 -------------- --------------- Net interest income/ Rate spread (FTE) $366 3.67 $366 3.71 ==== ==== FTE adjustment $ 2 $ 2 ==== ==== Impact of net noninterest-bearing sources of funds 0.95 0.86 - ---------------------------------------------------------------------------------------------- Net interest margin as a percent of average earning assets (FTE) 4.62% 4.57% ============================================================================================== (1) After allocation of the income or expense generated by interest rate swaps for the three months ended June 30, 1998, to the related assets and liabilities, the average yield on total loans was 8.52 percent as of June 30, 1998, compared to 8.68 percent a year ago. The average cost of funds for medium- and long-term debt was 5.73 percent as of June 30, 1998, compared to 5.80 percent a year earlier. Increase Increase (Decrease) (Decrease) Net Due to Due to Increase Rate Volume* (Decrease) ---------- ---------- ---------- (in millions) Loans $ 1 $ 11 $ 12 Investment securities (1) (23) (24) Other earning assets (1) - (1) ------------------------------ Total earning assets (1) (12) (13) Interest-bearing deposits 1 (10) (9) Short-term borrowings 1 (13) (12) Medium- and long-term debt (1) 9 8 Net interest rate swap (income)/expense - - - ------------------------------ Total interest-bearing sources 1 (14) (13) ------------------------------ Net interest income/Rate spread (FTE) $ (2) $ 2 $ - ============================== * Rate/Volume variances are allocated to variances due to volume. /TABLE
19 <TABLE> TABLE II - YEAR-TO-DATE ANALYSIS OF NET INTEREST INCOME & RATE/VOLUME (FTE) <CAPTION> Six Months Ended ------------------------------------------------------------- June 30, 1998 June 30, 1997 ----------------------------- ----------------------------- Average Average Average Average (in millions) Balance Interest Rate Balance Interest Rate - ---------------------------------------------------------------------------------------------- <S> <C> <C> <C> <C> <C> <C> Loans $28,530 $1,199 8.46% $26,640 $1,126 8.51% Investment securities 3,673 125 6.83 4,776 165 6.86 Other earning assets 164 5 5.94 149 4 6.20 - ---------------------------------------------------------------------------------------------- Total earning assets 32,367 1,329 8.27 31,565 1,295 8.24 Interest-bearing deposits 16,116 328 4.11 16,186 329 4.10 Short-term borrowings 3,214 89 5.58 4,195 112 5.39 Medium- and long-term debt 6,618 204 6.20 5,189 162 6.29 Net interest rate swap (income)/expense (1) - (26) - - (28) - - ---------------------------------------------------------------------------------------------- Total interest-bearing sources $25,948 595 4.62 $25,570 575 4.53 ----------------- ------------------ Net interest income/ Rate spread (FTE) $ 734 3.65 $ 720 3.71 ====== ====== FTE adjustment $ 4 $ 5 ====== ====== Impact of net noninterest-bearing sources of funds 0.91 0.87 - ---------------------------------------------------------------------------------------------- Net interest margin as a percent of average earning assets (FTE) 4.56% 4.58% ============================================================================================== (1) After allocation of the income or expense generated by interest rate swaps for the six months ended June 30, 1998, to the related assets and liabilities, the average yield on total loans was 8.55 percent as of June 30, 1998, compared to 8.63 percent a year ago. The average cost of funds for medium- and long-term debt was 5.79 percent as of June 30, 1998 and 1997. Increase Increase (Decrease) (Decrease) Net Due to Due to Increase Rate Volume* (Decrease) ---------- ---------- ---------- (in millions) Loans $ 9 $ 64 $ 73 Investment securities (3) (37) (40) Other earning assets - 1 1 ------------------------------ Total earning assets 6 28 34 Interest-bearing deposits 3 (4) (1) Short-term borrowings 4 (27) (23) Medium- and long-term debt (2) 44 42 Net interest rate swap (income)/expense 2 - 2 ------------------------------ Total interest-bearing sources 7 13 20 ------------------------------ Net interest income/Rate spread (FTE) $ (1) $ 15 $ 14 ============================== * Rate/Volume variances are allocated to variances due to volume. /TABLE
20 rates rise 200 basis points, net interest income would be enhanced by approximately $18 million, or 1 percent. The results of these simulations are within established corporate policy guidelines. Provision for Credit Losses - --------------------------- The provision for credit losses for the second quarter of 1998 was $28 million, a decrease of $6 million from the second quarter of 1997. The provision for the first six months of 1998 was $56 million compared to $75 million for the same period in 1997. The Corporation establishes this provision to maintain an adequate allowance for credit losses, which is discussed in the section entitled "Allowance for Credit Losses and Nonperforming Assets." Noninterest Income - ------------------ Noninterest income was $149 million for the three months ended June 30, 1998, an increase of $28 million, or 23 percent over the same period in 1997. Included in second quarter 1998 noninterest income is a $9 million gain on the aforementioned sale of consumer loans and the mortgage servicing business. Excluding the effect of certain nonrecurring items and divestitures in both periods, noninterest income increased 15 percent in the second quarter of 1998 compared to the second quarter of 1997. Accounting for the majority of this increase were higher levels of fiduciary income, service charges, brokerage fees and commercial fee income. For the first six months of 1998, noninterest income was $284 million, an increase of $33 million, or 13 percent, from the first six months of 1997. Noninterest Expenses - -------------------- Noninterest expenses were $253 million for the second quarter ended June 30, 1998, an increase of $4 million, or 2 percent, from the second quarter of 1997. For the first six months of 1998, noninterest expenses were $503 million, an increase of $5 million, or 1 percent, from the first
21 six months of 1997. These nominal increases reflect management's continued focus on efficiency and recognition of the positive effects of the Corporation's Direction 2000: Phase III program to improve efficiency, revenue and customer service. Provision for Income Taxes - -------------------------- The provision for income taxes for the second quarter of 1998 totaled $82 million, an increase of 13 percent compared to $72 million reported for the same period a year ago. The provision for the first six months of 1998 was $160 million compared to $140 million for the same period in 1997. The effective tax rate was 35 percent for the second quarter and the first six months of 1998 compared to 36 percent for the comparable periods in 1997. Strategic Lines of Business - --------------------------- The Corporation has strategically aligned its operations into three major lines of business: the Business Bank, the Individual Bank and the Investment Bank. The following table presents the financial results of these business lines for the six months ended June 30, 1998 and 1997. For a description of the business activities of each line of business and the methodologies which form the basis for these results, refer to the discussion entitled "Strategic Lines of Business" on page 26 of the Corporation's 1997 annual report.
22 <TABLE> Table III - Strategic Lines of Business Financial Results <CAPTION> Six Months Ended June 30 Business Individual Investment Bank Bank Bank* Other Total - ----------------------------------------------------------------------------------------------------------------- (in millions) 1998 1997 1998** 1997 1998 1997 1998 1997 1998 1997 - ----------------------------------------------------------------------------------------------------------------- <S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> Average assets $22,129 $19,113 $8,320 $9,518 $ 41 $ 24 $4,780 $5,691 $35,270 $34,346 Total revenues (FTE) 430 378 503 505 61 50 24 38 1,018 971 Net income 175 158 143 122 3 2 (26) (29) 295 253 Return on average assets 1.60% 1.67% 1.59% 1.39% 5.40% 4.48% -0.47% -0.51% 1.67% 1.48% Return on average common equity 27.66% 30.68% 37.34% 32.07% 21.61% 16.49% -10.92% -11.34% 22.33% 20.86% * Net income was reduced by charges for fees internally transferred to other lines of business for referrals to the Investment Bank. If excluded, Investment Bank net income would have been $5 million and $3 million, and return on average common equity would have been 39.99% and 23.68%, in 1998 and 1997, respectively. ** Financial results for the Individual Bank for 1998 were affected by the sale of $2.0 billion of indirect consumer loans and non-relationship credit card receivables and the mortgage servicing business. Net income includes a $9 million gain and reflects the reduction of the Individual Bank's allowance for loan losses as a result of the sale.
23 Financial Condition - ------------------- Total assets were $35.1 billion at June 30, 1998, compared with $36.3 billion at December 31, 1997. The Corporation has continued to generate commercial loan growth in 1998. Since December 31, 1997, commercial loans have increased $1.1 billion, or 7 percent. Total loans decreased $892 million, or 3 percent, since year-end 1997 as a result of the sale of $2.0 billion of indirect consumer loans and certain credit card receivables in the Individual Bank. The increase in commercial loans was partially funded by runoff of investment securities, which declined $609 million, or 15 percent, since December 31, 1997. Total liabilities decreased $1.3 billion, or 4 percent, to $32.2 billion since December 31, 1997. Medium- and long-term debt decreased $1.6 billion, or 22 percent, primarily as a result of the consumer loan sales. This decrease was partially offset by a $456 million increase in federal funds purchased and securities sold under agreements to repurchase. Allowance for Credit Losses and Nonperforming Assets - ---------------------------------------------------- The Corporation maintains the allowance for credit losses at a level that in management's judgement is adequate to provide for estimated probable credit losses inherent in on- and off-balance sheet credit exposure. The allowance for credit losses attributable to off-balance sheet exposure is not material. Management determines the adequacy of the allowance for credit losses by applying projected loss ratios to the risk- ratings of loans, both individually and by category. The projected loss ratios incorporate such factors as recent credit loss experience, current economic conditions and trends, geographic dispersion of borrowers, trends in past due and nonaccrual amounts, risk characteristics of various categories and concentrations of loans, and transfer risks. However, the Corporation cannot assure that the actual loss ratios will not vary from those projected.
24 At June 30, 1998, the allowance for credit losses was $439 million, an increase of $15 million, or 3 percent, since December 31, 1997. The allowance as a percentage of total loans increased to 1.57 percent, compared to 1.47 percent at December 31, 1997. As a percentage of total nonperforming assets, the allowance increased from 413 percent at year-end 1997 to 458 percent at June 30, 1998. Net charge-offs for the second quarter of 1998 were $19 million, or 0.27 percent of average total loans, compared with $21 million, or 0.31 percent, for the year-earlier quarter. Net charge-offs for the first six months of 1998 were $41 million, or 0.29 percent of average total loans, compared with $38 million, or 0.28 percent, for the same period last year. An analysis of the allowance for credit losses is presented in Note 5 to the consolidated financial statements. Nonperforming assets decreased $7 million, or 7 percent, since December 31, 1997, and were categorized as follows: </TABLE> <TABLE> <CAPTION> June 30, December 31, (in thousands) 1998 1997 ------------- ------------ <S> <C> <C> Nonaccrual loans: Commercial $ 64,273 $ 58,914 International 4,500 1,000 Real estate construction 2,092 3,438 Commercial mortgage 6,405 11,088 Residential mortgage 3,744 3,719 ------------- ------------ Total nonaccrual loans 81,014 78,159 Reduced-rate loans 8,260 7,583 ------------- ------------ Total nonperforming loans 89,274 85,742 Other real estate 6,591 17,046 ------------- ------------ Total nonperforming assets $ 95,865 $ 102,788 ============= ============ Loans past due 90 days or more $ 37,423 $ 52,805 ============= ============ </TABLE> Nonperforming assets as a percentage of total loans and other real estate at June 30, 1998 and December 31, 1997, were 0.34 percent and 0.36 percent, respectively.
25 Capital - ------- Common shareholders' equity was up $68 million from December 31, 1997 to June 30, 1998, excluding the change in unrealized gains/(losses) on investment securities available for sale. The increase was primarily due to the retention of $186 million in earnings, offset by the repurchase of 2.2 million shares of common stock under various corporate programs. Capital ratios exceed minimum regulatory requirements. Previously reported risk-based capital ratios were revised as a result of corrections to the data used to determine risk-based assets. The revised ratios at June 30, 1998 were as follows: <TABLE> <CAPTION> June 30, 1998 ------------- <S> <C> Leverage ratio (3.00 - minimum) 7.52% Tier 1 risk-based capital ratio (4.0 - minimum) 6.47 Total risk-based capital ratio (8.0 - minimum) 10.09 </TABLE> At June 30, 1998, the capital ratios of all the Corporation's banking subsidiaries exceeded the minimum ratios required of "well capitalized" institutions as defined in the final rule under FDICIA. Other Matters - ------------- Included in this report are forward-looking statements based on management's current expectations and/or the assumptions made in the earnings simulation analyses, but numerous factors could cause variances in these projections, and their underlying assumptions, such as changes in interest rates, the industries where the Corporation has a concentration of loans, changes in the level of fee income, economic conditions and continuing consolidations in the banking industry.
26 PART II. OTHER INFORMATION ITEM 6. Exhibits and Reports on Form 8-K - ----------------------------------------- (a) Exhibits (10.1)* Employment Agreement dated May 29, 1998 between the Corporation and Ralph W. Babb. (10.2)* Supplemental Pension and Retiree Medical Agreement dated May 29, 1998 between the Corporation and Ralph W. Babb. (11) Statement re: Computation of Earnings Per Share (27) Financial Data Schedule (b) Reports on Form 8-K The Corporation did not file any reports on Form 8-K during the six months ended June 30, 1998. * Management compensation arrangement
27 SIGNATURE Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. COMERICA INCORPORATED -------------------------------------- (Registrant) /s/Ralph W. Babb, Jr. -------------------------------------- Ralph W. Babb Jr. Executive Vice President and Chief Financial Officer (Principal Financial Officer) /s/Marvin J. Elenbaas -------------------------------------- Marvin J. Elenbaas Senior Vice President and Controller (Principal Accounting Officer) Date: August 6, 1998