Comerica Case Study Essay

The purpose of this physical composition is to recomm demolition Jack to farseeing the Comerica corporal (CMA) stock. In this paper we explain how lingos melt and bring in a small ass ground on the issue Comerica is facing. wthusly we more than(prenominal) on to pecuniary statements abstract of CMA, which does not present a precise strong outlook of the community, entirely because of the pecuniary crisis, whole industry is experiencing financial stress. Next, our military rating methods show that CMA is on a lower floorvalued sexual congress to its peers, and and so is a safe(p) high society to invest in. patronizeground k nowadaysledgeSimply putting, cashboxs accept puts from public slide by some of those deposits with them and lend the rest to bank linees and individuals. Businesses and individuals in turn pay sideline on those loanwords and banks pay rice beer to depositors, do funds from the spread. Nowadays banks ope dimensionns deem go away more and more complicated, and hence more important to enceinte trades. To get in to more detail, banks doughs bed from the avocation several shipway Differences between worry Rates on Loans and DepositsAs already explained Banks lend loans at the sp atomic number 18-time activity set out that atomic number 18 high than the ones they pay for deposits. A large part of banks profits come from the spread between banks depositing and lending rates. assist FeesBanks provide financial work to their clients and depend upon received summate of fees. By charging fees for managing customers bank accounts and providing other financial services much(prenominal) as issuing letter of faiths, banks arrive at another source of income, known as non stakes income. Now banks services bring in any case expanded into investment consulting and information disseminating. These services usually cost expensive fees. financial ProductsBanks provide financial products to help clients conte nd their property and generate noninterest income. A salutary example can be that banks cheat on mutual funds to their clients and gain income from some(prenominal) commissions and certain shargonage of the funds returns. In addition, banks sometimes in any case act asbrokers and generate r purgeues from bid-ask spread. InvestmentSome banks quicken an active role in take chances ceiling industry. By making investments in promising small companies, banks earn the benefits uniform capital investors or buy-out funds do. In addition, banks can in addition explore profit opportunities within currency exchange marketplace. Circulation mediator for CashBank can procession the economy by reallocating idle property to investors who need bullion. Banks can gather the trenchant money by absorbing deposit and then lend out loans, in that respectby increasing the liquidity of cash and expand investment activities. Create Derivative jimmyBecause of banks, several times the valu e of maestro deposit is formd. People save their money in banks, and banks lend the money out. brand- new(a)found loans through with(predicate)out the banking system generate new deposits elsewhere in the system. Thus new deposits be derived by the loan and create more sources of cash for banks to lend out. fee ChainsBanks encourage the business between companies by managing the shift of funds through corporate accounts. Banks can also introduce their clients to make payments and help their clients to honor cash. Comerica incorporated (CMA), one of the 20-largest banks operating in America, has study ope symmetryns in Midwest, California, Texas and Florida. Comerica operated under ternary business segments the business bank, the retail bank and the wealth and institutional management. Due to the financial crisis of 2008, banks, especially ones with high exposure in mortgage think loans, were under a lot of stress. Comerica, macrocosm one of them, is being evaluated by the Jack, as a effectiveness investment. CHARACTERISTICS OF CMAs FINANCIAL HEALTH base on the financial statements provided and the face 5, we hold up outlined the of import characteristics which define CMAs financial health. Increase in opinion Loss ReservesCredit vent provisions atomic number 18 the estimated loan leavinges from the currentoperating period, which means that high society is not expecting to receive these loans back and hence expensing them out, by increasing the al deplorableance for acknowledgement passes on balance planing machine. in that location is a substantial increase in the accompanys reference work dismission provisions for Comerica. The partage of credit loss provisions to PBT plus credit losses skyrocketed, from 3.6 pct in 2006 to 66 percent in Jun 2008, indicating the Corporations knobbed situation in collecting the superior loans.Increase in Non-Performing AssetsReserve reporting ratio, despite the increase in loss militia, is dec reasing dramatically, from 213% in 2006 to 87% in June 2008, indicating an enormous increase in non-performing assets (NPA). The main reason on increase in NPAs the incident that high parcel (32.9%) of companys total loans is Real mutualwealth loans. This is the reason that companys interest income has decreased despite the increase in loans make in 2008. Efficiency ratio is basically an operating expense strand m, the lower the better. The above 60 percent efficiency ratio, 50 percent broadly regarded as optimal, is an indicator of companys deteriorating performance. Use of Long Term and perfectly Term Debt to Finance Loans end sheet show that Comericas total deposits are maintaining a level since 2005, however companys loot loans have increase by almost $10 Billion. Balance sheet clearly shows that these loans are pay from the increase in short-term and capacious term debt, which cast doubts on the lucrativeness of company going forward. Un hold outability of the Divi dend Pay-out Ratio stage 5 shows an increasing trend in the dividends, which Comerica has tried to maintain despite the low gain. In the June 2008 nates, company paid $99 million as dividends against the straighten out income of $56 Million during the same quarter. These levels of dividends are not sustainable in the current recessive environment, and when the company does cut dividends, it leave alone ventilate a bad signal to the market. descending(prenominal) Revision in the federal removeicial money RateWe noticed that spread, which equals to net interest expense as a % of earning assets minus net interest expense as a percentage of interest air liabilities, is decreasing. One of the reason of this phenomenon is that interest mission deposits are increasing which is bad for the company. More e very(prenominal)where, there has been a downward revision of 3.25 percent in the federal funds rate from its original level of 5.25% in July 2007, to 2.0% in 2008 limiting the banks ability to direct higher spreads. Moreover, commercial loans are predominantly go rate, so decrease in the plyeral Funds rate entrust necessitate companys interest income. We do count that decrease in the Feds rate will increase the demand for loans but given the credit crunch, it seems unreasonable in the short run. reducing in Interest Income Percentage MeasuresThe shrinkage of interest income can be seemingly seen from the Corporations net interest income as a percentage of earning assets, from 6.82% in 2007 to 4.86% by the end June 2008. This decrease is delinquent to both fixingss of the ratio, one interest income is decreasing, second earning assets for Comerica Inc., which is loans, investment securities available-for-sale and short-term investments are increasing. Moreover, net interest margin, which is metrical as a difference between net interest income and net interest expenses divided by earning assets, show a downward trend. valuationTo value Comeric a, we have apply both methods Jack is planning to use. We will prototypic do the aesthesia analysis ( shew 7 in the case) to find the commit of genuine handwriting value, wampum and dividends. employ that sensitivity analysis table, we will find the range of firms value employing corresponding and dividend discount archetypes. Sensitivity AnalysisIn the Exhibit 7 at the end of the case, we have already been given the existing quarterly boodle estimates and concrete hold value at the end of 2009. Those estimates are base on budge-off ratio of 0.85%. We have completed the sensitivity analysis based on the following givensPercentage of charge off is annual, and dollar value of the charge off will be distributed over each quarter equally. accompanys charge-off ratio taken in 2008 will continue to be the same in 2009. We think this is areasonable assumption because of current low reserves for credit losses to NPA ratio of Comerica, as compared to its peers. Company will maintain a certain level of allowance of loan losses. therefore any increase in percentage of charge off will infer to decrease in unmistakable watchword value of the company through the income statement.Dividends are taken to be 48% of lettuce in case of positive net income and zero in case of ostracize net income. Company is trying unexpressed to keep the level of dividends constants, to avoid displace bad signals. But company will not be able to sustain this level of dividends, so it will drive out to the historical median(a) of 48% dividend payout ratio (Exhibit 1). Using these assumptions, we get the range of tangible allow value, at the end of 2009, of $5,247 Million in case of 0.85% charge off to $4,647 Million in case of 2% charge-off. fine calculations are provided in the Exhibit 2. Comparable MethodWe have elect two multiples to value Comerica i.e wrong to tangible book value and wrong to earnings ratio. Since, due to the current financial crisis, earnings of the companies are very volatile, we think price to tangible book value is a better multiple. consequently, we will use price to earnings ratio just as a check multiple. Now that we have decided which multiples to use, we need to assign weights to the corresponding companies to find out the leaden average multiples. To assign weights, we considered the following factors in monetary value of similarity between Comerica and comparable companies. geological location of the operationsPercentage of loans from incompatible business segmentsFinancials Including total revenue give away up, return on blondness and assets, reserves for loan losses to total loan and total NPAs etc. undercoatd on these weights assigned we calculated the comparable weighted average of the price to tangible book value ratio and price to earnings ratio. Following table summarizes values calculated by both the methods and their sensitivity to the charge-off percentage. Detailed calculations are given in Ex hibit 2 and 3.As we mentioned before, earnings are very volatile right now and are suppressed because of the financial crisis. So we think price to tangiblebook value is a better measure of companys intrinsic value. Therefore we think, company is undervalued right now and hence Jack should propose to long its stock. Dividend brush off Model (DDM)We have also used DDM to find the intrinsic value of the company. We think that company will not be able to sustain its dividends of $0.66 per share per quarter in the short run. However, by yr 2010 company will have copious earnings to come back to its old level. Keeping in mind the fact that company has been growing its dividend payout ratio, and earning are also expected to increase in the long run we have assumed that companys dividends will grow at the rate of 2% in perpetuity. Using these assumption, and cost of equity 8.8%, dividend discount model gives us the share price of $40.39 per share, which also indicates that company is undervalued right now. Detailed calculations are provided in Exhibit4. FUTURE patience OUTLOOKThe collapse of mortgage market has taught financial industry an expensive less(prenominal)on, making a lot of financial institutions ineffectual to fully recover even public treasury now. One of the major factors that cause a lot of banks failure and bankruptcy during financial crisis is the banks overconfidence in real estate market and issuing huge amount of new debt without the checking credit quality of borrowers. afterwards the financial crisis, banks have become very cautious when dealing with mortgage related loans. Requirements regarding borrowers personal incomes and documentation have been considered necessary and valuation process about mortgages has asleep(p) very conservative. Facing the illiquidity during the financial crisis, banks are required to rectify their capital bases to improve their insolvency. One regulation from Base trey incorporates a significant expansio n in risk coverage and introduces modified ways to calculate risk-based capital. Moreover, complex hybrid capital instruments, which used to be considered as a part of banks equity, has been exclude from banks equity calculation.Base III also puts increasing localize and emphasis on banks to acquire common equity that can be readily cashed out when facing out of the blue(predicate) situation. The enactment of Base III and the self-improvement happening in the banking industry or, even broader, financial industry have made bank valuation focus more on banks conventional originate-to-hold business, and associated banks securitization activities with higher risk. increase focus has also been put on a banks capital base, which has everything to do with a banks solvency and liquidity. Banks, whose equities have complex hybrid equity capital instruments, tend to be less liquid and have higher business risk. Funding source is another factor considered. Banks with less retail funding on their balance sheets are more threatened when unexpected situations happen. Loan quality, which had been largely ignored when everyone had big overconfidence to housing market before the burst of the financial crisis, has been brought back to the valuation table and greatly reemphasized. These improvements in the regulatory requirements have restored the confidence of investors in the banking industry to some extent. Thats wherefore we see the financial industry fostering to the level where it was before the financial crisis. cobblers lastFinancial statements analysis of CMA does not present a very pretty picture, but because of the financial crisis, whole industry is under stress and experiencing the same deterioration in the quality of earnings. However, our valuation methods show that CMA is undervalued relative to its peer companies and hence is a good investment to hold right now.