Comerica - 10-Q quarterly report FY

 

 

(Mark One)

or

(Exact name of registrant as specified in its charter)

Comerica Tower at Detroit Center
Detroit, Michigan
48226
(Address of principal executive offices)
(Zip Code)

(248) 371-5000
(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 þ No o

     Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act (Check one):

Large accelerated filer þ Accelerated filer o Non-accelerated filer o

     Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes o No þ

     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 April 14, 2006: 162,427,929 shares

 

 

This report includes forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. In addition, the Corporation may make other written and oral communication from time to time that contain such statements. All statements regarding the Corporation’s expected financial position, strategies and growth prospects and general economic conditions expected to exist in the future are forward-looking statements. The words, “anticipates,” “believes,” “feels,” “expects,” “estimates,” “seeks,” “strives,” “plans,” “intends,” “outlook,” “forecast,” “position,” “target,” “mission,” “assume,” “achievable,” “potential,” “strategy,” “goal,” “aspiration,” “outcome,” “continue,” “remain,” “maintain,” “trend,” “objective,” and variations of such words and similar expressions, or future or conditional verbs such as “will,” “would,” “should,” “could,” “might,” “can,” “may” or similar expressions as they relate to the Corporation or its management, are intended to identify forward-looking statements.

The Corporation cautions that forward-looking statements are subject to numerous assumptions, risks and uncertainties, which change over time. Forward-looking statements speak only as of the date the statement is made, and the Corporation does not undertake to update forward-looking statements to reflect facts, circumstances, assumptions or events that occur after the date the forward-looking statements are made. Actual results could differ materially from those anticipated in forward-looking statements and future results could differ materially from historical performance.

PART 1. FINANCIAL INFORMATION

Item 1. Financial Statements

     CONSOLIDATED BALANCE SHEETS

     Comerica Incorporated and Subsidiaries

See notes to consolidated financial statements.

     CONSOLIDATED STATEMENTS OF INCOME (unaudited)

     Comerica Incorporated and Subsidiaries

See notes to consolidated financial statements.

     CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY (unaudited)

     Comerica Incorporated and Subsidiaries

See notes to consolidated financial statements.

     CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited)

     Comerica Incorporated and Subsidiaries

See notes to consolidated financial statements.

     The accompanying unaudited consolidated financial statements have been prepared in accordance with U.S. 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 U.S. 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. The results of operations for the three months ended March 31, 2006, are not necessarily indicative of the results that may be expected for the year ending December 31, 2006. Certain items in prior periods have been reclassified to conform to the current presentation. 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, 2005.

     The Corporation uses derivative instruments to manage exposure to interest rate and foreign currency risks. Derivative instruments are carried at fair value in either, “accrued income and other assets” or “accrued expenses and other liabilities” on the consolidated balance sheets. The accounting for changes in the fair value (i.e., gains or losses) of a derivative instrument is determined by whether it has been designated and qualifies as part of a hedging relationship and, further, on the type of hedging relationship. For those derivative instruments that are designated and qualify as hedging instruments, the Corporation designates the hedging instrument, based on the exposure being hedged, as either a fair value hedge, cash flow hedge or a hedge of a net investment in a foreign operation. For further information, refer to Note 9.

     In the first quarter 2006, the Corporation adopted the provisions of Statement of Financial Accounting Standards (SFAS) No. 123 (revised 2004) (SFAS No. 123(R)), “Share-Based Payment,” using the modified-prospective transition method. The Corporation recognizes compensation expense under SFAS No. 123(R) using the straight-line method over the requisite service period. Measurement and attribution of compensation cost for awards that were granted prior to the date SFAS No. 123(R) was adopted continue to be based on the estimate of the grant-date fair value and attribution method used under prior accounting guidance. Prior to the adoption of SFAS No. 123(R), the benefit of tax deductions in excess of recognized compensation costs was reported in net cash provided by operating activities in the consolidated statements of cash flows. SFAS No. 123(R) requires such excess tax benefits be reported as a cash inflow from financing activities, rather than a cash flow from operating activities; therefore, these amounts for the three months ended March 31, 2006 are reported in net cash provided by financing activities in the consolidated statements of cash flows.

     In 2002, the Corporation adopted the fair value recognition provisions of SFAS No. 123, “Accounting for Stock-Based Compensation” (as amended by SFAS No. 148, “Accounting for Stock-Based Compensation — Transition and Disclosure”), which the Corporation applied prospectively to new share-based compensation awards granted to employees after December 31, 2001. Options granted prior to January 1, 2002 were accounted for under the intrinsic value method, as outlined in APB Opinion No. 25, “Accounting for Stock Issued to Employees.” Net income and earnings per share for the three months ended March 31, 2006 fully reflect the impact of applying the fair value recognition method to all outstanding and unvested awards. There would have been a nominal effect on net income and earnings per share if the fair value method required by SFAS No. 123 (as amended by SFAS No. 148) had been applied to all outstanding and unvested awards in the three months ended March 31, 2005.

     SFAS No. 123(R) requires that the expense associated with share-based compensation awards be recorded over the requisite service period. The requisite service period is the period an employee is required to provide service in order to vest in the award, which cannot extend beyond the retirement eligible date (the date at which the employee is no longer required to perform any service to receive the share-based compensation). Prior to the adoption of SFAS No. 123(R), the Corporation recorded the expense associated with share-based compensation awards over the explicit service period (vesting period). Upon retirement, any remaining unrecognized costs related to share-based compensation awards retained after retirement were expensed. Share-based compensation expense, net of related tax effects, would have decreased $2 million in the three months ended March 31, 2006 and decreased a nominal amount in the same period in the prior year, had the requisite service period provisions of SFAS No. 123(R) been applied on a historical basis.

Applying the requisite service period provisions to all 2006 share-based compensation awards is expected to result in a net increase of approximately $16 million in compensation expense ($10 million, or $0.06 per diluted share, net of related tax effects) related to these awards in 2006, of which $10 million ($7 million, or $0.04 per diluted share, net of related tax effects) was recorded in the first quarter 2006.

     The Corporation has elected to adopt the alternative transition method provided in the Financial Accounting Standards Board Staff Position No. FAS 123(R)-3, “Transition Election Related to Accounting for Tax Effects of Share-Based Payment Awards,” for calculating the tax effects of stock-based compensation under SFAS No. 123(R). The alternative transition method includes simplified methods to establish the beginning balance of the additional paid-in capital pool (APIC pool) related to the tax effects of employee stock-based compensation, and to determine the subsequent impact on the APIC pool and Consolidated Statements of Cash Flows of the tax effects of employee stock-based compensation awards that are outstanding and fully or partially unvested upon adoption of SFAS No. 123(R).

     Munder Capital Management (Munder), a 96 percent-owned subsidiary of the Corporation, had share-based compensation awards that were accounted for as liabilities at the time SFAS No. 123(R) was adopted. The liability reflected the fair value of ownership shares (points) held by minority-interest holders. SFAS No. 123(R) requires vested, unexercised option points and a pro-rata portion of unvested option and restricted points be classified as liabilities and recorded at current fair value. Fair value for option points was determined using an option pricing model. As a result of the adoption of SFAS No. 123(R), the Corporation incurred a transition expense of $8 million, net of related tax effects, on January 1, 2006, which was reported as “cumulative effect of change in accounting principle, net of tax” on the consolidated statements of income. After a further valuation change at the end of March 2006, Munder modified its share-based compensation plans such that the plans no longer have a mandatory redemption feature, which changed the accounting prospectively from liability accounting to temporary equity accounting. Temporary equity, which was not material, and was included in “accrued expenses and other liabilities” on the March 31, 2006 consolidated balance sheet, reflected the fair value or intrinsic value of points owned and options held by minority-interest holders.

     For further information on the Corporation’s share-based compensation plans, refer to Note 7 to these consolidated financial statements and Notes 1 and 14 to the consolidated financial statements in the Corporation’s 2005 Annual Report.

     At March 31, 2006, investment securities having a carrying value of $1.9 billion were pledged where permitted or required by law to secure $624 million of liabilities, including public and other deposits, and derivative instruments. This included securities of $1.0 billion pledged with the Federal Reserve Bank to secure actual treasury tax and loan borrowings of $8 million at March 31, 2006, and potential borrowings of up to an additional $842 million. The remaining pledged securities of $882 million are primarily with state and local government agencies to secure $616 million of deposits and other liabilities, including deposits of the State of Michigan of $232 million at March 31, 2006.

     The following summarizes the changes in the allowance for loan losses:

     The following table provides an analysis of the changes in the allowance for credit losses on lending-related commitments.

     A loan is 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 that are restructured and meet the requirements to be on accrual status are included with total impaired loans for the remainder of the calendar year of the restructuring. There were no loans included in the $119 million of impaired loans at March 31, 2006 that were restructured and met the requirements to be on accrual status. Impaired loans averaged $130 million and $293 million for the three month periods ended March 31, 2006 and 2005, respectively. The following presents information regarding the period-end balances of impaired loans:

     Those impaired loans not requiring an allowance represent loans for which the fair value of expected repayments or collateral exceeded the recorded investments in such loans.

     Medium- and long-term debt are summarized as follows:

     The carrying value of medium- and long-term debt has been adjusted to reflect the gain or loss attributable to the risk hedged with interest rate swaps.

     In February 2006, Comerica Bank (the Bank), a subsidiary of the Corporation, issued an additional $250 million of 5.20% Subordinated Notes under a series initiated in August 2005. The notes are classified in medium- and long-term debt, pay interest on February 22 and August 22 of each year and mature August 22, 2017. The Bank used the net proceeds for general corporate purposes.

     The provision for income taxes is computed by applying statutory federal income tax rates to income before income taxes as reported in the consolidated financial statements after deducting non-taxable items, principally income on bank-owned life insurance and interest income on state and municipal securities. State and foreign taxes are then added to the federal tax provision. During the first quarter 2006, the Internal Revenue Service (IRS) completed the examination of the Corporation’s federal tax returns for the years 1996 through 2000. Tax reserves were adjusted to reflect resolution of those tax years, and to reflect an updated assessment of reserves on certain types of structured lease transactions and a series of loans to foreign borrowers. The effect of these adjustments decreased federal taxes ($16 million) and caused the increase in interest on tax liabilities ($23 million, $15 million after-tax).

     Other comprehensive income (loss) includes the change in net unrealized gains and losses on investment securities available-for-sale, the change in accumulated net gains and losses on cash flow hedges, the change in the accumulated foreign currency translation adjustment, and the change in accumulated minimum pension liability adjustment. The Consolidated Statements of Changes in Shareholders’ Equity on page 5 include only combined other comprehensive income (loss), net of tax. The following table presents reconciliations of the components of accumulated other comprehensive income (loss) for the three months ended March 31, 2006 and 2005. Total comprehensive income totaled $166 million and $114 million for the three months ended March 31, 2006 and 2005, respectively. The $52 million increase in total comprehensive income in the three month period ended March 31, 2006, when compared to the same period in the prior year, resulted principally from a decrease in net losses on cash flow hedges ($42 million) and a decrease in net unrealized losses on investment securities available-for-sale ($13 million) due to changes in the interest rate environment, partially offset by a decrease in net income ($5 million).

     The following table summarizes the income statement impact of all share-based compensation plans:

     The following table summarizes unrecognized compensation expense for all share-based plans at March 31, 2006:

     The Corporation has share-based compensation plans under which it awards both shares of restricted stock to key executive officers and key personnel, and stock options to executive officers, directors and key personnel of the Corporation and its subsidiaries. Restricted stock generally vests over periods ranging from three to five years. Stock options vest over periods ranging from one to four years. The maturity of each option is determined at the date of grant; however, no options may be exercised later than ten years from the date of grant. The options may have restrictions regarding exercisability. The plans provide for a grant of up to 16.5 million common shares. At March 31, 2006, 2.1 million shares remained available for grant. A significant majority of restricted stock and stock option grants planned for 2006 occurred in the first quarter of 2006.

     The Corporation used a binomial model to value stock options granted subsequent to March 31, 2005. Previously, a Black-Scholes option-pricing model was used. Option valuation models require several inputs, including the expected stock price volatility, and changes in input assumptions can materially affect the fair value estimates. The model used may not necessarily provide a reliable single measure of the fair value of employee and director stock options. There were only a nominal number of stock option and restricted stock grants in the three months ended March 31, 2005. The risk-free interest rate assumption used in the binomial option-pricing model in the table below was based on the federal ten-year treasury interest rate. The expected dividend yield was based on the historical and projected dividend yield patterns of the Corporation. Expected volatility assumptions during the first quarter 2006 considered the historical volatility of the Corporation’s common stock over a ten-year period and implied volatility based on actively traded options on the Corporation’s common stock with pricing terms and trade dates similar to the stock options granted. The expected life of employee and director stock options, which is an output of the binomial model, considered the percentage of vested shares estimated to be cancelled over the life of the grant and was based on the historical exercise behavior of the option holders.

     The weighted-average assumptions used are as follows:

     A summary of the Corporation’s stock option activity and related information for the three months ended March 31, 2006 follows:

     The aggregate intrinsic value of outstanding options shown in the table above represents the total pretax intrinsic value at March 31, 2006, based on the Corporation’s closing stock price of $57.97 as of March 31, 2006. The total intrinsic value of stock options exercised was $14 million and $11 million for the three months ended March 31, 2006 and 2005, respectively.

     Cash received from the exercise of stock options during the three months ended March 31, 2006 and 2005 totaled $15 million and $10 million, respectively. The excess income tax benefit realized for the tax deductions from the exercise of these options during the three months ended March 31, 2006 and 2005 totaled $5 million and $4 million, respectively.

     A summary of the Corporation’s restricted stock activity and related information for the three months ended March 31, 2006 follows:

     The total fair value of restricted stock awards that fully vested during the three months ended March 31, 2006 and 2005 was $2 million and $1 million, respectively.

     The Corporation expects to satisfy the exercise of stock options and future grants of restricted stock by issuing shares of common stock out of treasury. As of March 31, 2006, the Corporation held 16.5 million shares in treasury.

     The Corporation’s Munder subsidiary has share-based compensation plans under which it awards ownership shares (points) in the subsidiary to key executive officers and key personnel. At March 31, 2006, 235 thousand points remained available for grant under the plans. The estimated fair value at March 31, 2006 of the points available for grant was $2 million.

     For further information on the Corporation’s share-based compensation plans, refer to Note 1 to these consolidated financial statements and Notes 1 and 14 to the consolidated financial statements in the Corporation’s 2005 Annual Report.

     Net periodic benefit costs are charged to “employee benefits expense” on the consolidated statements of income. The components of net periodic benefit cost for the Corporation’s qualified pension plan, non-qualified pension plan and postretirement benefit plan are as follows:

     For further information on the Corporation’s employee benefit plans, refer to Note 15 to the consolidated financial statements in the Corporation’s 2005 Annual Report.

     The following table presents the composition of derivative instruments, excluding commitments, held or issued for risk management purposes, and in connection with customer-initiated and other activities.

Note 9 - Derivative Instruments (continued)

     Fluctuations in net interest income due to interest rate risk result from the composition of assets and liabilities and the mismatches in the timing of the repricing of these assets and liabilities. In addition, external factors such as interest rates, and the dynamics of yield curve and spread relationships can affect net interest income. The Corporation utilizes simulation analyses to project the sensitivity of net interest income to changes in interest rates. Cash instruments, such as investment securities, as well as derivative instruments, are employed to manage exposure to these and other risks, including liquidity risk.

     As an end-user, the Corporation employs a variety of financial instruments for risk management purposes. As part of a fair value hedging strategy, the Corporation has entered into interest rate swap agreements for interest rate risk management purposes. These interest rate swap agreements effectively modify exposure to interest rate risk by converting fixed-rate deposits and debt to a floating rate. These agreements involve the receipt of fixed rate interest amounts in exchange for floating rate interest payments over the life of the agreement, without an exchange of the underlying principal amount. For instruments that support a fair value hedging strategy, no ineffectiveness was required to be recorded in the consolidated statements of income for the three months ended March 31, 2006 and 2005.

     As part of a cash flow hedging strategy, the Corporation entered into predominantly 2 to 3 year interest rate swap agreements (weighted-average original maturity of 2.8 years) that effectively convert a portion of its existing and forecasted floating-rate loans to a fixed-rate basis, thus reducing the impact of interest rate changes on future interest income over the next 2 to 3 years. Approximately 19 percent ($9 billion) of outstanding loans were designated as hedged items to interest rate swap agreements at March 31, 2006. During the three month period ended March 31, 2006, interest rate swap agreements designated as cash flow hedges decreased interest and fees on loans by $25 million, compared to an increase of $17 million for the comparable period last year. Other noninterest income in the three month period ended March 31, 2006 included $2 million of ineffective cash flow hedge losses. If interest rates, interest yield curves and notional amounts remain at current levels, the Corporation expects to reclassify $72 million of net losses on derivative instruments from accumulated other comprehensive income to earnings during the next twelve months due to receipt of variable interest associated with existing and forecasted floating-rate loans.

     Foreign exchange rate risk arises from changes in the value of certain assets and liabilities denominated in foreign currencies. The Corporation employs cash instruments, such as investment securities, as well as derivative instruments, to manage exposure to these and other risks. In addition, the Corporation uses foreign exchange forward and option contracts to protect the value of its foreign currency investment in foreign subsidiaries. Realized and unrealized gains and losses from foreign exchange forward and option contracts used to protect the value of investments in foreign subsidiaries are not included in the statement of income, but are shown in the accumulated foreign currency translation adjustment account included in other comprehensive income, with the related amounts due to or from counterparties included in other liabilities or other assets. During the three month period ended March 31, 2006, the Corporation recognized a nominal net gain in accumulated foreign currency translation adjustment, related to the forward foreign exchange contracts.

     Management believes these strategies achieve the desired relationship between the rate maturities of assets and 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 strategies will be successful. The Corporation also uses various other types of derivative instruments to mitigate interest rate and foreign currency risks associated with specific assets or liabilities, which are reflected in the preceding table. Such instruments include interest rate caps and floors, foreign exchange forward contracts, foreign exchange option contracts and foreign exchange cross-currency swaps.

     The following table summarizes the expected maturity distribution of the notional amount of risk management interest rate swaps and provides the weighted-average interest rates associated with amounts to be received or paid on interest rate swap agreements as of March 31, 2006. Swaps have been grouped by asset and liability designation.

Remaining Expected Maturity of Risk Management Interest Rate Swaps:

     The Corporation had commitments to purchase investment securities for its trading account portfolio totaling $14 million at March 31, 2006 and $6 million at December 31, 2005. Commitments to sell investment securities related to the trading account portfolio totaled $9 million at March 31, 2006 and $6 million at December 31, 2005. Outstanding commitments expose the Corporation to both credit and market risk.

     Fee income is earned from entering into various transactions, principally foreign exchange contracts, interest rate swaps and energy derivative contracts at the request of customers. Market risk inherent in customer contracts is often mitigated by taking offsetting positions. The Corporation generally does not speculate in derivative instruments for the purpose of profiting in the short-term from favorable movements in market rates.

     Fair values for customer-initiated and other derivative instruments represent the net unrealized gains or losses on such contracts and are recorded in the consolidated balance sheets. Changes in fair value are recognized in the consolidated income statements. The following table provides the average unrealized gains and losses, and noninterest income generated on customer-initiated and other interest rate contracts, energy derivative contracts and foreign exchange contracts.

     The following table provides a reconciliation of the beginning and ending notional amounts for risk management and customer-initiated and other derivative instruments for the three months ended March 31, 2006.