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Comerica Incorporated (NYSE:CMA)
Q2 2018 Earnings Conference Call
July 17, 2018, 8:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good morning. My name is Regina and I will be your conference operator today. At this time, I would like to everyone to the Comerica second quarter 2018 earnings conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. If you would like to ask a question during this time, simply press * then the number 1 on your telephone keypad. If you would like to withdraw your question, press the # key.

I would now like to turn the conference over to Darlene Persons, Director of Investor Relations. Ma'am, you may begin.

Darlene Persons -- Director of Investor Relations

Thank you, Regina. Good morning and welcome to Comerica's second quarter 2018 earnings conference call. Participating on this call will be our Chairman, Ralph Babb; President, Curt Farmer; Chief Financial Officer, Muneera Carr; and Chief Credit Officer, Pete Guilfoile.

During this presentation, we will be referring to slides which provide additional details. The presentation slides and our press release are available on the SEC's website, as well as in the Investor Relations section of our website, comerica.com.

This conference call contains forward-looking statements, and in that regard, you should be mindful of the risks and uncertainties that can cause actual results to vary materially from expectations. Forward-looking statements speak only as of the date of this presentation and we undertake no obligation to update any forward-looking statements. I refer you to the Safe Harbor statement in today's release and Slide 2, which I incorporate into this call, as well as our SEC filings for factors that could cause actual results to differ. Also, this conference call will reference non-GAAP measures and in that regard, I direct you to the reconciliation of these measures within this presentation.

Now I'll turn the call over to Ralph, who will begin on Slide 3.

Ralph W. Babb, Jr. -- Chief Executive Officer

Good morning. Thank you for joining our call. Last month, the Federal Reserve announced that bank holding companies of our size are no longer subject to supervisory stress testing, including both the Dodd-Frank Act stress test and CCAR.

Our solid financial performance and strong capital levels position us well to meaningful increase the capital return to our shareholders. We will continue to properly manage our capital base while supporting growth and investments in our business. Our Board will now be able to more efficiently and effectively take capital actions quarterly. Its next meeting is on July 24th, and we expect to issue a press release announcing our planned capital actions at that time.

In addition, the Fed recently announced that we are no longer subject to certain regulations and reporting requirements such as the liquidity coverage ratio and liquidity-related reporting and disclosures. We are still in the process of evaluating the positive effects of these changes. Our focus remains on achieving the most efficient use of our resources for the benefit of all of our constituencies, including our customers and the communities we serve, while managing our business prudently.

Turning to our financial results, we reported second quarter earnings of $326 million or $1.87 per share. Our earnings per share increased 18% over the first quarter. Relative to the second quarter of last year, our earnings per share increased 65% and pre-tax income is up 39%. This is primarily due to our management of loan and deposit pricing, as interest rates have moved higher, improved credit quality, as well as continued successful execution of our gear-up initiatives.

On Slide 4, we are outlining adjustments related to certain items including restructuring, impacts from the new tax law and the tax benefit related to employee stock transactions. The adjusted return on assets was 1.89% and adjusted return on equity was 16.7%. Please note in the first quarter we adopted a new accounting standard for revenue recognition, which nets certain expenses against the related fee income. The adjusted non-interest income and expense figures for the second quarter 2017 can be found in the Appendix.

Turning to Slide 5 and an overview of our second quarter results, average loans for the second quarter were up $804 million or 2% compared to the first quarter. Seasonality helped drive increases in mortgage banker and national dealer services. Technology and life sciences, specifically the equity fund services component, grew over $300 million. Also, we have posted growth in middle market, as well as several of our specialty and national businesses.

As far as deposits, average balances declined primarily due to seasonality and non-interest bearing deposits. Starting mid-quarter, we began seeing a rebound in deposit balances, which is consistent with trends in prior years. Net interest income increased $41 million or 7.5% and our net interest margin increased 21 basis points to 3.62%.

The net benefit from increased interest rates was $21 million. With the faster rise in LIBOR, we increased deposit rates to benefit our customers. In addition, non-accrual interest recoveries were particularly strong. We had a broad-based decline in problem loans, as well as net recoveries of charged-off loans. This led to a reduction in our allowance for loan losses, and a negative provision of $29 million. Non-interest income was up $4 million, with a $5 million increase in customer-driven income, including commercial lending fees and customer derivative income. Non-interest expenses were relative stable. A seasonal decrease in salaries and benefits expense was offset by increases in outside processing and advertising. Also, lower restructuring expense was offset by a business tax refund we received in the first quarter, which was not repeated.

We increased our capital return to shareholders. Equity repurchased increased to $169 million or 1.8 million shares, and our dividend was increased 13%. Now, I'll turn the call over to Muneera, who will go over the quarter in more detail.

Muneera S. Carr -- Executive Vice President and Chief Financial Officer

Thanks, Ralph. Good morning, everyone. Turning to Slide 6, second quarter average loans increased $804 million compared to the first quarter. Mortgage banker loans grew nearly $350 million, with a normal pickup in Spring home sales. Our portfolio continues to be heavily weighted to home purchases, with approximately 87% purchase versus refi compared to the industry average of 74%. We have solid growth in technology and life sciences, specifically equity fund services and general middle market increased nearly $150 million with growth in all three of our markets.

Our auto dealer [inaudible] portfolio also increased over $100 million due to seasonal buildup in auto inventory. In addition, we saw growth across a number of our key specialty and national business lines, including commercial real estate, environmental services, and entertainment. Partly offsetting this growth was a decrease in private banking as a result of a few large loan payoffs. Also, we remain selective in the large corporate space, maintaining our pricing and underwriting standards in a highly competitive environment.

As anticipated, the pace of decrease in energy loans has slowed, but continues due to capital markets activity and asset sales resulting from firmer commodity prices. Total period-end loans increased $552 million, with the largest contributions from mortgage banker and technology and life sciences. Also, commitments were up $1.6 billion, driven by increases in nearly all business lines.

Overall, the sentiment is positive, reflective of the improving economy, yet customers continue to be cautious given uncertainty regard evolving trade discussions. Our loan yield increased 37 basis points. Higher rates, including a 32-basis point increase in average 30-day LIBOR added 27 basis points to our yield. Non-accrual interest recoveries, which are difficult to predict, increased $9 million and added 8 basis points.

Finally, the quarter dynamics such as a mix shift in the portfolio and loan season to margin added 2 basis points. Importantly, we are focused on our relationship strategy to appropriately manage loan pricing. As you can see on Slide 7, average deposits declined $260 million in the second quarter, primarily as a result of seasonality. Municipal deposits decreased, as they typically do, following tax collection in the first quarter. Also, middle market was impacted by seasonality, as customers utilizing their cash in their businesses.

Midway through the quarter, we began to see positive trends. Average deposits in June grew $749 million over May. This included the highest growth in interest-bearing deposits for Junes we have seen in many years. We expect deposit growth to continue in the back half of the year in line with this historical pattern.

In conjunction with the faster rising LIBOR, we increased deposit rates. We rely on our relationship models to stay close to our customers and help ensure we are offering competitive and appropriately priced products. Our primary objective is to retain and attract deposits by managing our costs. We believe we are well-positioned and at the present time, do expect similar incremental, standard pricing actions.

Our securities book remains at about $12 billion, as shown on Slide 8. The portfolio's unrealized loss position of $328 million had a minor impact on the carrying value. The yield on the portfolio continues to trend up. Recent securities purchases have been in the low $3.40's, which was about the average rate of $2.25 on the $450 million in paydowns we received in the quarter.

Turning to Slide 9. Comerica's income increased $41 million and net interest margin was up 21 basis points. Our loan portfolio added $59 million ad 29 basis points to the margin. Increased interest rates provided the largest benefit, along with higher loan balances and unusually high levels of non-accrual interest recoveries, and one additional day in the quarter. As far as our deposits of the Fed, the benefit from the higher Fed funds rate was mostly offset by a decrease in average balances. This resulted in a net benefit of 3 basis points to the margin.

On the funding side, deposit costs were up $12 million, primarily due to increased pay rates as are previously discussed. This had a 7 basis points impact. Also, wholesale funding costs increased $5 million, as a result of the increase in 6-month LIBOR and $2 million as the result of some FHLB funding that was added in the first quarter at attractive rates.

In summary, the interest impact from increased rates contributed $21 million, or 11 basis points to the margin. Credit quality remains strong, as shown on Slide 10. Gross charge-offs of only $20 million were more than offset by unusually high recoveries of $22 million. Total criticizes loans declined $355 million or 17% and now represent 3.5% of total loans at quarter end. This included a decrease in non-accrual loans, which comprise only 51 basis points of our total loans.

Energy criticized and non-accrual loans continue to decrease. The positive credit migration resulted in a reserved release at a reserve ratio of 1.36%. We remain vigilant and continue to look for signs of stress. At this point, we are not seeing any concerning trends.

Turning to Slide 11. Non-interest income grew $4 million. This included a $5 million increase in commercial loan fees primarily related to syndications, as well as customer derivative income. This was slightly offset by a decline in investment banking fees. In addition, we increased the reserve for derivative contracts related to Visa Class B shares by $2 million. We remain on track to achieve our year-up revenue target. To highlight our progress, you can see the growth we have achieved on a year-over-year basis in card, fiduciary, and brokerage.

Expenses remain well controlled and our efficiency ratio fell to 53%, as shown on Slide 12. Salaries and benefits decreased $5 million following annual share-based comps and higher payroll taxes in the first quarter. This was partly offset by annual merit raises, higher incentives related to our financial performance, and one additional day.

We continue to execute our gear-up initiatives as evidenced by our total workforce reduction of 1% from the first quarter and nearly 2% over the past year. We had increases in outside processing, which was mostly tied to revenue generating activity, as well as advertising expense which we seasonally note in the first quarter. You may recall that we had a business tax refund of $5 million in the first quarter and it was not repeated. Restructuring charges were $11 million, a decrease of $5 million from the first quarter.

In the second quarter, we repurchased $169 million or 1.8 million shares under our equity repurchase program, as you can see on Slide 13. In addition, we increased our dividend 13% to $0.34 per share. Together with dividends, we returned $227 million to shareholders. Employee stock activity added about 200,000 shares during the quarter. This activity resulted in a credit to our income tax provision of $3 million, or $0.02 per share. As Ralph indicated, we expect to provide an update on our planned capital actions after our Board meets next week.

Turning to Slide 14, our balance sheet continues to be well positioned to benefit from increases in rates. Our asset sensitivity is illustrated by our beta this cycle, with accumulated loan beta of 94%, while our cumulative deposit beta is 18%. Our asset betas have outperformed our expectations, allowing us some flexibility to manage deposit costs, while significantly adding to our bottom line.

We expect the net benefit from 2018 from the first quarter rate increase to be $70 million and $35 to $40 million in additional net interest income for the second quarter rate increase. Out of that $35 to $40 million, $6 million is already in the second quarter run rate. In total, we estimate $270 million in additional net interest income in 2018 resulting from the full-year impact of the three rate increases from last year and the March and June hikes this year.

For the remainder of the year, we're assuming that short-term rates remain at the current level and average deposit rates increase 8 to 10 basis points from here. We remain focused on our relationship approach to manage loan and deposit pricing to attract and retain customers. Of course, the ultimate outcome depends on a variety of factors, such as the pace at which LIBOR moves, loan and deposit competition, and balance sheet movement.

It is likely that the Fed could be raising rates one or two more times this year and we stand to further benefit with our well-positioned balance sheet. We have not added hedges to change our asset sensitivity. Our Asset Liability Committee continues to assess our position to determine the appropriate path given balance sheet movement and our outlook for rates.

Now, I will turn the call back to Ralph to provide an update on our outlook for the remainder of 2018.

Ralph W. Babb, Jr. -- Chief Executive Officer

Thank you, Muneera. As usual, our outlook assumes a continuation of the current economic and interest rate environment. As I mentioned at the beginning of the call, recent regulatory developments such as elimination of CCAR and LCR are certainly positive, but it's too early to provide guidance on the effects of these changes. As far as loans, following a seasonally strong second quarter, we expect to drive moderate growth in the back half of the year. This includes increases in most business led by mortgage banker, primarily due to seasonality, as well as technology and life sciences, tempered somewhat by a seasonal decline in dealer and a slight reduction in the pace of middle market growth due to the typical summer slowdown.

Regarding net interest income, as Muneera indicated, we expect to continue to see the net benefit of the recent rise in short-term rates. Also, we expect contributions from loan growth and additional days. Recalling the second quarter, we had non-accrual interest recoveries of $11 million. This elevated level is not expected to repeat, as we typically collect $1 million to $2 million per quarter. While not included in this outlook, we are well positioned to benefit from any further rate increases.

We expect the provision to be between $10 million and $20 million per quarter, as credit quality remains strong. Our fee income growth trend is expected to continue with the execution of our gear-up initiatives, helping drive growth in card fee, treasury management, and fiduciary income. Excluding restructuring costs, expenses are expected to increase modestly from here, primarily a result of additional days in the back half of the year. We continue to be on track to fully realize our gear-up change.

We expect rising technology project costs, as well as typical, seasonal, and inflationary pressures on occupancy and advertising. Restructuring expenses for the second half of the year should be about $20 million to $25 million. We expect to continue to achieve positive operating leverage and drive our efficiency ratio lower. Finally, we are maintaining our expectation for our effective tax rate to be approximately 23%, excluding any impact from employee stock transactions, which are difficult to predict. All together, we expect our pre-tax, pre-provision net revenue to continue to grow.

In closing, our second quarter results were solid, as we have continued to manage loan and deposit pricing in a rising rate environment. Loan growth and favorable credit metrics combined with higher fee income and well-controlled expenses helped drive a 16% increase in our bottom line relative to the first quarter.

As I mentioned at the start of the call, as a result of recently announced changes in registration, our Board will review our capital plan next week. We are well positioned to meaningfully increase our capital return to our shareholders. Furthermore, we expect to benefit from additional rate increases and economic growth. We remain focused on maintaining momentum and driving shareholder returns.

Now, we will be happy to take any of your questions.

Questions and Answers:

Operator

At this time, I would like to remind everyone in order to ask a question, please press * followed by the number 1 on your telephone keypad. Our first question will come from the line of Steve Alexopoulos with JP Morgan. Please go ahead.

Steve Alexopoulos -- JP Morgan -- Analyst

Good morning, everybody. Ralph, I wanted to start on capital. What are your updated thoughts on how much CET-1 you guys need to run the business long-term?

Ralph W. Babb, Jr. -- Chief Executive Officer

We really haven't put a view out there as to what our point will be at this time. That will come in the future, I think, as we look and as we see how things develop.

Steve Alexopoulos -- JP Morgan -- Analyst

Okay. As we think about this upcoming Board meeting, Ralph, could you help us think about what's on the table for this meeting? Could paths move to 150% plus where you were historically? What range of options are you now looking at?

Ralph W. Babb, Jr. -- Chief Executive Officer

Well, I wouldn't put ranges on it, but I would tell you that it will be looked at from the standpoint of what is appropriate based on what we see with the business and what we feel comfortable with moving forward. I think that puts the ability to manage capital back in our hands along with the Board. I think you will see that.

Steve Alexopoulos -- JP Morgan -- Analyst

Okay. Thank you. Then on the commercial business, the general middle market is still a [inaudible] year-over-year. What are most of your middle market customers doing at this point with the benefit of lower taxes?

Ralph W. Babb, Jr. -- Chief Executive Officer

Curt, do you want to give an update on that?

Curtis C. Farmer -- President

Steve, we did see growth in all three of our middle market regions and we've had good momentum in the first half of the year. Having said that, as Muneera alluded to, I think middle market customers remain cautious. Probably the greatest source of caution right now relates to what may or may not happen on the tariff side of the house.

In the short term, the tax reform probably works against us a little bit in terms of loan growth, in terms of the fact that our customers have more cash, less expenses to funnel back into their business lines. But we are not yet seeing what I would call a lot of traditional CapEx spending occurring. Most of the borrowing that we have anticipated has been either M&A-type transactions or customers borrowing for traditional working capital needs.

Steve Alexopoulos -- JP Morgan -- Analyst

Okay. Got you. Then just a final one on deposit strategy with the loan to deposit ratio at around 87% and you're now out of LCR. Do you expect to be active trying to grow deposits or going forward do you think it's more likely you'll fund loan growth from cash and securities, not necessarily need to grow the size of the balance sheet? Thanks.

Muneera S. Carr -- Executive Vice President and Chief Financial Officer

Our objective always is to grow both loans, as well as deposits. We will be focused on that. You can see that we are doing what we need to do on the deposit cost side to be able to retain and attract deposits. I would also [crosstalk] from a securities standpoint, clearly that is an option that is available to us going forward. Our securities book is more of a liquidity for us, not being subject to LCR certainly frees up that sort of funding.

Steve Alexopoulos -- JP Morgan -- Analyst

Yeah, got you. Okay. Thanks for all the color.

Ralph W. Babb, Jr. -- Chief Executive Officer

Thank you.

Operator

Your next question will come from the line of Ken Usdin with Jefferies. Please go ahead.

Ken Usdin -- Jefferies & Co. -- Analyst

Thanks. Good morning, Ralph. Good morning, Muneera. Muneera, can you expand a little bit on your comment about deposit costs in the second half? So the 17-basis point increase we got in interest-bearing deposits to 42 basis points. You said 8 to 10 for the rest of the year. Can you tell us what that means in terms of how you're thinking about the trajectory both in the third and the fourth? I know this is one of the hot topics out there.

Muneera S. Carr -- Executive Vice President and Chief Financial Officer

Good morning, Ken. So, I will tell you thus far we've done a great job of managing our deposit costs with accumulative beta of 18%. We've been talking about the fact that Q2 was different. We saw LIBOR increasing 32 basis points in the first two quarters. We were in a position to make some changes to our deposit costs that we believe position us well competitively. We don't expect to see another jump of 17 basis points, something in that magnitude again. We have signals that generally the public cost will continue to increase with every rate rise. For June, you heard my comments. I said the increase would be 8 to 10 basis points. That translates to a beta of 30 to 40%.

Then if you're asking me about trajectory advancings will go, for now I will refer you to our standard model, which includes a 50% beta and has some fairly conservative assumptions both for deposit run-offs. We will continue to update both at the rate rises get closer and we can see the movement on our own balance sheet, as well as what's happening in the competitive environment. What I'll tell you is even with a 17-basis point increase, our total deposit cost of 42 basis points will still be one of the lowest deposit costs in our peer group.

I clearly expect that we will be able to hold on to the benefit that we've seen from lower deposit costs so far in this cycle. I don't expect that we will give it up. But you'll see some variability in betas going up and down, depending on what's transpiring out there.

Ken Usdin -- Jefferies & Co. -- Analyst

Very good. As a follow-up to that, you mentioned that you'd done the standardized increase and you don't expect to do one at least right now. What would change your view about having to go back to the entire rate sheet and put through a broad, standardized increase again? It seems like your advice is to not do that, to your point.

Muneera S. Carr -- Executive Vice President and Chief Financial Officer

A lot depends on what's happening in the competitive environment. It depends on what's happening with loan to deposit ratios. I would say that so far overall, the industry continues to be well behaved. There's still a fair amount of liquidity in the system. We see corporate treasurers having a bias to maintaining higher levels of liquidity. That's what shows up in our own non-interest bearing deposits. So, to the extent all of that continues, I think that we won't necessarily be looking to make another broad-based price change. But having said that, you know that the Fed is unwinding it's balance sheet. Where that goes and how that affects the system, all that remains to be seen.

Ken Usdin -- Jefferies & Co. -- Analyst

Okay. Then last final thing is just the 8 to 10 basis points you said, is that expected to be each quarter from here or is that your aggregate view of what happens in the second half?

Muneera S. Carr -- Executive Vice President and Chief Financial Officer

That is our view specific to the June rate rise. I'll tell you beyond that, I said look at the model, which is at 50%. For any given single rate rise, there will be some variability. It'll go up, it'll go down. But like I said, I expect to hold on to the benefits that we have thus far to date.

Ken Usdin -- Jefferies & Co. -- Analyst

Okay. Thank you very much.

Muneera S. Carr -- Executive Vice President and Chief Financial Officer

You're welcome.

Ralph W. Babb, Jr. -- Chief Executive Officer

Thank you.

Operator

Your next question will come from the line of John Pancari with Evercore. Please go ahead.

John Pancari -- Evercore -- Analyst

Good morning. On the expense side, specifically on comp, it came in higher than what we had expected. Overall expenses appear to have come in for the quarter higher than what you guided to. I believe you guided to down modestly, also the first quarter core base of $430 million. What drove the somewhat higher level than you had expected for the quarter? If you could give us some specific color around comp as well. Thanks.

Muneera S. Carr -- Executive Vice President and Chief Financial Officer

Overall expenses from the outlook that we provided earlier this year hasn't really changed. What has changed is that outlook was based on a continuation of economics and rate environment. As time has progressed, we've received two more rate rises. We've done a good job of managing loan and deposit pricing. The credit situation is improved. If you look at the company's performance metrics, you can see that they're doing very well across the board.

All that means is that we have to look at incentive comp interest and actual performance. That's one of the movers that you see when it comes to salaries and benefits expense. I mean, I pointed out workforce numbers. We continue to watch our overall expenses, but that's the main reason for the shift.

John Pancari -- Evercore -- Analyst

So, was there a formal change in your incentive comp structure?

Muneera S. Carr -- Executive Vice President and Chief Financial Officer

No, there isn't. The comp structure is exactly the same. It depends on performance and moves with good years and bad years. We are having a good year and then hence the increase.

John Pancari -- Evercore -- Analyst

Okay, all right. Then separately, on the loan growth side, when you look at the update that you gave us that accounted for April and May, it appears that there might have been some moderation off that pace in June. Is that what you saw and what you cited on the middle market side, some of that cost just getting dialed in?

Curtis C. Farmer -- President

John, I think that's the case. When you look at sort of the go-forward for us, the important thing to remember for our company, given the seasonality of mortgage banker finance and dealer, second quarter tends to be a strong quarter for us, specifically around mortgage banker finance. Dealer tends to be a strong quarter in the fourth quarter. So, we're using language like moderate growth for the remainder of the year.

What we're taking into consideration is that remaining seasonality for the year in mortgage banker finance and dealer. And probably some seasonality as well in the third quarter that we normally see in the middle market with sort of the summer slow-down for many of our middle market clients. But we are expecting growth in most of our businesses, and specifically I might point out continued growth in technology and life sciences, commercial real estate, and a few of our other select specialty lines of business.

John Pancari -- Evercore -- Analyst

Okay, got it. Thanks, Curt.

Operator

Your next question will come from the line of Ken Zerbe with Morgan Stanley. Please go ahead.

Ken Zerbe -- Morgan Stanley -- Analyst

Great, thanks. Good morning. I wanted to start off in terms of the asset beta. I was hoping you can kind of go over that a little bit more. I think I calculated your total asset beta like 128% of Fed funds. I know you tied off the LIBOR, loosening up more than Fed funds in the quarter. But can you just talk about the timing of resets? Was there something besides LIBOR that drove it higher in terms of how the loans reset? Just would love to get more detail. Thanks.

Muneera S. Carr -- Executive Vice President and Chief Financial Officer

Good morning, Ken. I know asset beta is doing really well, 37 basis points up this quarter. You saw the effects of non-accrual interest recoveries, which were elevated. But really this is us pulling through and having more [inaudible] than we typically do. I would expect that as LIBOR increases, our actual pull-through rate is about 80% to 85%. So, if LIBOR goes up on average 20 basis points, we see an improvement of, I don't know, about 16, 17 basis points in our yield. That should be what you expect going forward on the asset side.

Ken Zerbe -- Morgan Stanley -- Analyst

Okay. So this quarter is just particularly unusual. Okay. Go ahead.

Muneera S. Carr -- Executive Vice President and Chief Financial Officer

The only thing I was going to point out. LIBOR did go up 32 basis points on average, so and we're just pulling through the benefits of that.

Ken Zerbe -- Morgan Stanley -- Analyst

Understood. I guess just to be super clear on the margin for third quarter, if we use just, I know it's a generic example if LIBOR goes up 20 basis points whatever, but am I thinking about it right that your loan yields will go up 16, 17 basis points in your example and then you're also saying deposit costs, the interest rate and deposit costs go up, I think it was 8 to 10 basis points. So, and we can run the math on non-interest bearing, etc., but that's the kind of magnitude of NIM expansion we should be looking at for third quarter. Am I thinking of that conceptually correct?

Muneera S. Carr -- Executive Vice President and Chief Financial Officer

You're thinking about it conceptually correct. I just used 20 as an example. I don't know where average LIBOR is going to go. I would say adjust accordingly.

Ken Zerbe -- Morgan Stanley -- Analyst

Understood. Okay. Thank you very much.

Operator

Our next question will come from the line of Erika Najarian with Bank of America. Please go ahead.

Erika Najarian -- Bank of America -- Analyst

Hi, good morning. As we think about some of the flexibility afforded to you by some of the regulatory change, how much do you have in HQLA currently today and how much of that HQLA pool can we think as flexible to potentially fund loan growth?

Muneera S. Carr -- Executive Vice President and Chief Financial Officer

It's a meaningful number, just in broad strokes. But clearly we have ample funding available today. This is just something we can have as the balance sheet changes.

Erika Najarian -- Bank of America -- Analyst

Got it, OK. Just following up, one last follow-up question, at least for me, on all the deposit questions that you've answered so far, and thank you so much for your answers. As we think about the dynamics, just following up to Ken's last question, as we think of the interest rate environment continuing to normalize and, of course, you mentioned, Muneera, the Fed reducing it's balance sheet, how should we think about a normal level of non-interest bearing deposits for Comerica? And outside of the seasonality that you saw with municipal deposits this quarter, what are you observing broadly about mix shift trends?

Muneera S. Carr -- Executive Vice President and Chief Financial Officer

A couple of points on that. When we look at the changes in our portfolio, you're right. Year-over-year, municipal deposits have been a headwind for us. But beyond that, when we look at our customer balances, when we look at Comerica's historical trend, the portfolio is behaving in line with what we've seen in times past. So, it's very typical for Comerica to have a decline in deposits in the first half of the year. It's very typical for us to go up in the back half of the year. This trend holds true for several years in the past. That's what we base our view on as to where things are going for us, at least in the near term.

We do see some of our customers putting their money to work. It's what we said we would be seeing. People are reducing leverage. They are using their money for M&A, for working capital needs. So, that certainly continues. Beyond that, we'll just have to wait and see how things evolve. It's really difficult for us to predict what happens with deposit balances.

Erika Najarian -- Bank of America -- Analyst

Got it. Just one final question for me. Just comparing the guidance slide in terms of your outlook for non-interest expenses and just looking at what you had put forth last quarter, last quarter you mentioned that you were expecting a 1% increase over an adjusted 2017 number, which I think at the time implied a $1.713 billion base for '18. I just wanted to clarify that the different language that you put on this quarter's slide did not indicate a change in expense guidance.

Muneera S. Carr -- Executive Vice President and Chief Financial Officer

We are indicating that expenses will be slightly higher than what we originally estimated because our original estimates were based on a continuation of the interest rate and economic environment. Of course, these things have improved. It means that certain comp like incentive comp has to be adjusted. When we get interest recoveries of $11 million, there is compensation that goes along with that. That's what it reflects. Also, I wanted to point out that our FDIC expense -- we were hoping that the surcharge would go away in the back half and clearly there's been some run-up there. It just isn't quite reaching the percentage it needs to, so that's another reason for us to make a slight change.

Erika Najarian -- Bank of America -- Analyst

Got it. But end of the day, the efficiency will continue to improve meaningfully?

Muneera S. Carr -- Executive Vice President and Chief Financial Officer

Absolutely.

Erika Najarian -- Bank of America -- Analyst

Okay. Thank you.

Muneera S. Carr -- Executive Vice President and Chief Financial Officer

Thank you for reminding me. Yes, the efficiency will increase. We expect fully to have payments operating leverage.

Erika Najarian -- Bank of America -- Analyst

Thank you.

Operator

Your next question will come from the line of Bill Carcache with Nomura. Please go ahead.

Bill Carcache -- Nomura -- Analyst

Thank you. Good morning. I had a follow-up question on capital. Specifically, the pace of capital return. Under CCAR, there had been this view that you had to take payouts up gradually over time through the process. In light of the regulatory changes that we've seen, do you now feel like you guys have greater freedom to simply keep what you need and return the rest? Implicit in that question is, can you just clarify for us the degree to which you feel bound by the submission that you made that ultimately you guys didn't have to go through the process but nevertheless you made the submission. If you could give a little bit of color around that, that would be great.

Ralph W. Babb, Jr. -- Chief Executive Officer

Well, as we discussed earlier, when you look at what we will be doing, basically on a quarterly basis, we'll be reviewing where we are from a capital standpoint and where we believe we need to be and what effects, what the normal effects out there as to growth and the economy and so forth. We then have the ability to manage our capital going forward.

We haven't put out, as was asked earlier, a point of where we want to be from a capital standpoint. We may do that in the future, but I think we want to move down the road a while first. Our CET right now is well over 11%. I think we all understand that is pretty high.

Bill Carcache -- Nomura -- Analyst

Right. So, in essence, there is a recognition that you the rules have changed and that evaluating on a quarterly basis your capital levels, you're able to take that into consideration and therefore arrive potentially at a different outcome than you would have arrived at under the previous rules?

Ralph W. Babb, Jr. -- Chief Executive Officer

We can be more focused on what is happening today versus having to look out and consider what is happening over a year purposes or more. That makes us much more agile in managing our capital going forward.

Bill Carcache -- Nomura -- Analyst

That's great. Thank you. If I may follow up on a related M&A question. Now that you've been released from CCAR, some investors have expressed concern with the potential that some of your excess capital could be consumed in an M&A deal that could significantly dilute tangible values, similar to the recent deals that we've seen from others. Could you speak a little bit to your appetite for M&A, whether that has or has not changed after your release from CCAR?

Ralph W. Babb, Jr. -- Chief Executive Officer

I would say it has not changed. It is as we have always said. When things become available, we will take a look at them. But we feel very comfortable with out footprint today. Especially in the states where we are doing business in the growth potential there. Adding internally to grow that is top of the chart at the moment where our focus is for expansion.

Bill Carcache -- Nomura -- Analyst

Thank you very much. I appreciate you taking my questions.

Ralph W. Babb, Jr. -- Chief Executive Officer

Thank you.

Operator

Your next question comes from the line of Scott Siefers with Sandler O'Neill & Partners. Please go ahead.

Scott Siefers -- Sandler O'Neill & Partners -- Analyst

Good morning. Ralph, quick question on sort of behavioral changes post-DFA and CCAR. Not as it relates to what you'll do with the excess capital, but just for practically what being released from this stuff means for how you'll go through measuring your own levels of risk, etc. Under CCAR, for example, it's been a year and you have dozens of people again in the same place that you can with a few assumptions and much more rapidly. So, presumably there's some opportunity to flex expenses. Even if you don't want to get into the savings, what will you be doing differently internally now that you've got some of this flexibility or release?

Ralph W. Babb, Jr. -- Chief Executive Officer

As I mentioned in the remarks earlier, what we'll be doing now is going through and looking at all of the things that we've done and put together for the previous process -- some of those are strengths going forward -- and deciding exactly what we want to do going forward and there will be some savings there, as well. But it will be building the process we're going to use going forward, I guess is the right way to say that. But it will save expenses.

Muneera S. Carr -- Executive Vice President and Chief Financial Officer

I was going to highlight the same thing. It's going to be a lot of efficient.

Scott Siefers -- Sandler O'Neill & Partners -- Analyst

Yeah. Okay. I guess that's probably an iterative process, but it's not something that you've come to definitive conclusions on now, right? You're just sort of seeing what's appropriate to continue to spend money versus get some savings out, etc.? Is that the best way to look at it.

Ralph W. Babb, Jr. -- Chief Executive Officer

That's right. That's the best way to look at it, but we want to go through it fairly quickly and make a determination of where we feel we are and where do we need to be today. We'll be doing that. It will take a little while to do it, but.

Scott Siefers -- Sandler O'Neill & Partners -- Analyst

Okay. All right. That sounds good. Thank you very much.

Ralph W. Babb, Jr. -- Chief Executive Officer

Thank you.

Operator

Our next question will come from the line of Geoffrey Elliot with Autonomous Research. Please go ahead.

Geoffrey Elliot -- Autonomous Research -- Analyst

Good morning. Thanks for taking the question. In terms of capital and the split between dividend and buy-back, does the regulatory change shift the way you're thinking about the emphasis there?

Ralph W. Babb, Jr. -- Chief Executive Officer

I don't think the change causes an issue there. We will be looking at that based on what we foresee in the future and taking the appropriate position, obviously, because we know there are ups and downs in the economy that we have to be prepared for. I think we've done that in the past very well. That'll be something we'll look at as we go.

Geoffrey Elliot -- Autonomous Research -- Analyst

Can you explain the role of the regulators now? Are there still sort of certain guardrails, if you like, in terms of what you can and can't do on capital return from a regulatory perspective? What do you need to get approval to do from the regulatory and where do you just kind of have flexibility to have the Board meeting and go ahead and take your own decisions?

Ralph W. Babb, Jr. -- Chief Executive Officer

I think there are things that are still developing there, so I really don't have a feel for exactly how it may settle in the future. But I would say that even before CCAR and all of the tests, we routinely reviewed what our thoughts were and our planning was for the future with our local regulators to make sure that they were comfortable with it as much as we are.

Geoffrey Elliot -- Autonomous Research -- Analyst

Great. Thank you.

Operator

Our next question will come from the line of Brett Rabatin with Piper Jaffray. Please go ahead.

Brett Rabatin -- Piper Jaffray -- Analyst

Hi, good morning, everyone. I wanted to ask first, Ralph, is there any explicit reason why you can't be a little less opaque about the capital return process? You're obviously being able to manage capital more on a real-time basis. I guess I want to make sure there's not something missing about why you can't be a little more effusive about what you plan.

Ralph W. Babb, Jr. -- Chief Executive Officer

Well, I think the reason for that is that it just happened. We are getting used to it and I think the regulatory environment is looking at it as well. It takes a little bit of time for that to develop.

Brett Rabatin -- Piper Jaffray -- Analyst

Okay. Fair enough. Then I wanted to ask on the deposit side, in terms of what you're expecting on deposit betas from here. What kind of assumptions does that entail from a seasonality perspective and municipal deposits and what happens from here with some of the various categories in terms of growth, especially on a core basis?

Muneera S. Carr -- Executive Vice President and Chief Financial Officer

As I mentioned earlier, I do expect that there will be variability as far as deposit betas go, from one rate rise to the next. But overall, I would say for now our standard model with the 50% beta is the best thing I can point you to. That remains to be seen on how balance sheets evolve. I think the industry as a whole has a fair amount of liquidity and know the deposit ratios are healthy. At least in the near term, as best I can tell, I would expect that the standard model assumptions should hold true.

Brett Rabatin -- Piper Jaffray -- Analyst

Okay. Then just lastly, the credit obviously is really good right now. Just from a recover perspective, is there a pool of loans, whether from energy or otherwise that could still result in net charge-offs being negative going forward or can you give us any color maybe on that pool?

Peter W. Guilfoile -- Executive Vice President, Chief Credit Officer

It's been a long time since we've been in a net recovery position like this. It doesn't happen very often. We wouldn't expect going forward to see those kinds of recovers.

Brett Rabatin -- Piper Jaffray -- Analyst

Thanks. Fair enough. Thanks for all the color.

Ralph W. Babb, Jr. -- Chief Executive Officer

Thank you.

Operator

Your next question will come from the line of Peter Winter with Wedbush Securities. Please go ahead.

Peter Winter -- Wedbush Securities -- Analyst

Good morning. When you guys talk about modest loan growth in the second half, can you just define modest loan growth? Secondly, it sounded like customers are more cautious than they were in the first quarter. Is that solely just related to the trade wars or is there something else going on?

Curtis C. Farmer -- President

I might start, Peter, with the second half of your question. I don't think there's anything else going on. I do think that tariffs and trade-related issues, especially given the market set we're in -- Michigan, California, Texas -- all of them have some economic reliance on trade and some of the industry verticals that we operate in. Given that, I would say that is probably the primary concern that we're hearing from customers right now. That's, I think, factored in to somewhat our more moderate view on a go-forward basis.

But I do want to emphasize that part of that moderate view as well is just the seasonality that we see, especially in the third quarter and middle market and the seasonality in both dealer and mortgage banker finance.

Peter Winter -- Wedbush Securities -- Analyst

When you say modest, is that more like 1% to 3% type range?

Curtis C. Farmer -- President

I wouldn't quote a specific number, but just would guide you toward to the language that we've used.

Peter Winter -- Wedbush Securities -- Analyst

Okay. Then just separately, now that you're no longer a CIFI bank, is there some type of informal stress test exams that you have to participate in?

Ralph W. Babb, Jr. -- Chief Executive Officer

No, but there will be and there was said in some of the announcements that there will be a development of how it will be looked at over a longer term. So, I think they will be adjusting what they're looking at and how they're looking it as well as we going through the process for us.

Peter Winter -- Wedbush Securities -- Analyst

Got it. Thank you.

Operator

Your next question will come from the line of Jennifer Demba with SunTrust. Please go ahead.

Jennifer Demba -- SunTrust -- Analyst

Thank you. My question is for Pete. Just wondering how the problem loan levels stand in the energy portfolio now and when that portfolio should stabilize or grow.

Peter W. Guilfoile -- Executive Vice President, Chief Credit Officer

We'd like to see it keep from running hot. It's been coming down quicker than we've been adding new deals. We like the energy space. We're highly selective there. But we like it a lot. We still have 19% criticized. We would expect that 19% would continue to come down. Not just through payoffs, which would reduce loan balances, but also upgrades as well. So we're hopeful that the energy portfolio will stabilize on the balance standpoint from where it is today.

Jennifer Demba -- SunTrust -- Analyst

Thanks a lot.

Ralph W. Babb, Jr. -- Chief Executive Officer

Thank you.

Operator

Your next question comes from the line of Steve Moss with B. Riley FBR. Please go ahead.

Steve Moss -- B. Riley FBR -- Analyst

Good morning. I want to start off just on the credit topic and more actually CCL. Just wondering what your preliminary thoughts could be with regard to the provision and the capital impact come 2020?

Peter W. Guilfoile -- Executive Vice President, Chief Credit Officer

We're not prepared to release anything with regard to CCL yet. We're working toward the 2020 date when we'll be implementing. The only thing that I am comfortable saying is that if you look at our portfolio relative to our peers, the duration of our portfolio, which is a big driver of CCL, is substantially less than a lot of our peers. We would expect whatever impacts there are from a level standpoint and then from a provision standpoint should impact us less because of bench order duration.

Steve Moss -- B. Riley FBR -- Analyst

Okay. And then on deposits here, your non-interest bearing deposit mix remains really strong here, over 50%. Just wondering, the balances are down a bit year-over-year. Just wondering where do you think that goes if we see another 50 to 100 basis points in rate hikes?

Muneera S. Carr -- Executive Vice President and Chief Financial Officer

When you look at our deposit rates, and you mentioned non-interest bearing, 90% of that is commercial. In the past, we've mentioned that of those commercial deposits, the vast majority of them are tied to our management products. We have a lot of connectivity with these depositories. As I mentioned earlier in my comments, there is desire by corporate treasurers to maintain higher levels of liquidity. All that plays in. For all those reasons, at least as far as we're concerned, we expect things to be stable. When we grow loans, the full relationship proposition, the profits come along with that. All of that kind of goes into our thinking about the fact that generally things should be fairly stable.

Steve Moss -- B. Riley FBR -- Analyst

All right. Thank you very much.

Ralph W. Babb, Jr. -- Chief Executive Officer

Thank you.

Operator

Your next question comes from the line of Dave Rochester of Deutsche Bank. Please go ahead.

David Rochester -- Deutsche Bank -- Analyst

Good morning, guys. On expenses, I know 2019 is still a bit further out, but was just curious how you're thinking about expense growth next year as the gear-up efforts wind down. Why you should still get the benefit of the roll-off of the FDIC's surcharge that you were talking about. Any preliminary thoughts there?

Muneera S. Carr -- Executive Vice President and Chief Financial Officer

Looking forward, I would say you're right. FDIC surcharge will go away. We intend to continue the expense discipline that we have used in the last couple of years. We intend to continue leveraging technology to simplify our processes and be efficient. There will be your typical inflationary factors. But overall, I mean, that's sort of what I see looking out.

David Rochester -- Deutsche Bank -- Analyst

Are you thinking that the -- sorry, go ahead?

Muneera S. Carr -- Executive Vice President and Chief Financial Officer

I was going to add, I do expect that the efficiency ratio will keep moving in the right direction and that will maintain positive operating leverage.

David Rochester -- Deutsche Bank -- Analyst

Are you thinking that we could perhaps see a little bit of a pickup in expense growth because of the efforts that you're talking about and the fact that the tailwinds from gear-up are done? Or do you think you can remain in this low, single-digit range of growth?

Muneera S. Carr -- Executive Vice President and Chief Financial Officer

I believe we will remain in the low, single-digit level of growth.

David Rochester -- Deutsche Bank -- Analyst

Okay, great. Then just switching to the NIM real quick. In the absence of rate hikes, so if we don't get a rate hike in September, for example, I was just curious what your thoughts are on how the NIM would trend without the benefit of a bump-up in the loan yield. Are you thinking we could see some stability in that kind of scenario or would you expect to see some kind of an upwards movement in deposit costs eating into the NIM a little bit? Just any thoughts there would be great.

Muneera S. Carr -- Executive Vice President and Chief Financial Officer

Given our asset sensitivity, certainly NIM benefits most with rising rates. But I would still expect that without a raise, we would have stability in our NIM. I don't expect the deposit costs will rise in a more stable rate environment.

David Rochester -- Deutsche Bank -- Analyst

Okay, great. Thank you very much.

Ralph W. Babb, Jr. -- Chief Executive Officer

Thank you.

Operator

Your next question comes from the line of Brock Vandervliet of UBS. Please go ahead.

Brocker Vandervliet -- UBS Securities -- Analyst

Good morning. I think most of the metrics on deposit costs have been covered. I was just curious operationally, when you look to make the increase that was manifest in the second quarter, how is that pushed down to clients? Was that broad brush across the board increases or more of a pull-through in granting exceptions, that kind of thing?

Curtis C. Farmer -- President

Brock, I think first and foremost for us, whether it's loan pricing or pricing on any of our fee income products for deposit pricing is to make sure that we're taking a relationship approach. We really take that into consideration when we're looking at competitive landscape and also our customer relationships. When we look at pricing increases, we really try to make sure we're passing that on to the majority of our clients as appropriate. I think we've done that effectively thus far.

Brocker Vandervliet -- UBS Securities -- Analyst

Okay. Separately, within equity fund services, I know that's been called out several times as an area of strength. Could you quantify that at all in terms of the annualized growth we should expect there? Secondly, has there been any change in resource allocation to that area?

Curtis C. Farmer -- President

First of all, I would say that it has been an area of accelerated growth the last several years. That's really in response to what's been happening in the private equity venture capital. there's been a lot of new fund formation. There's been a lot of corporate or institutional and private money flowing into private equity, for example, which has created a lot of the demand there. In terms of resource allocation, we look across all our businesses to make sure that we're appropriately resource allocated and we can shift resources as needed and move relationship managers and credit support staff, analysts, etc. to various business lines.

Part of what we've been doing through gear-up, we talked before about the Indian credit initiative, which really requires rethinking some of our processes around loan origination approval servicing going forward. That is creating through automation and changing some processes, additional capacity for us and equity fund services would be one of the businesses that's benefiting from that.

Brocker Vandervliet -- UBS Securities -- Analyst

Great. Thank you.

Ralph W. Babb, Jr. -- Chief Executive Officer

Thank you.

Operator

Our final question will come from the line of Brian Klock with KBW. Please go ahead.

Brian Klock -- KBW -- Analyst

Good morning, everybody. I just want to follow up. I apologize if you guys answered this already, but maybe it's a question for Pete on the interest recoveries. Can you give us a size of the loans that paid off with that interest recovery?

Peter W. Guilfoile -- Executive Vice President, Chief Credit Officer

Most of the unusually large interest recovery was driven by on-site, two or three credits. They were good sized credits. It wasn't so much the size of the credit though. It was how long we were accumulating the interest and not running it through the P&L. So, some of these were [inaudible] for some time and that's why the recovery was so large.

Brian Klock -- KBW -- Analyst

Gotcha. I guess what I'm trying to figure out is when you look at the criticized debt that draft so meaningfully and then non-accrual of the draft. So we look at debt drop and say that your core growth outside of those sort of paydowns, I mean, you had some solid growth this quarter, don't get me wrong. But just thinking about quarter to quarter on a period basis, it's a lot stronger core loan growth than the 4.5% quarter annualized growth that just looking at it from spot.

Ralph W. Babb, Jr. -- Chief Executive Officer

That's correct. That did impact our loan growth. The fact that we were successful in getting payoffs on some non-accrual loans this quarter.

Brian Klock -- KBW -- Analyst

Got it. Just a follow-up for Muneera, I think you mentioned something about the FDIC surcharge when you talked about the expense guidance for the second half of the year, it looks like the dip is about 130 and it looks like it's on it's way to getting 135 by the second half of the year. Are you including any expectation of getting that $6 million to $7 million surcharge eliminated in the fourth quarter or is that not in your guidance at all for the second half of the year?

Muneera S. Carr -- Executive Vice President and Chief Financial Officer

It's not in our guidance.

Brian Klock -- KBW -- Analyst

Got it. Okay. Thanks for your time. Appreciate it.

Ralph W. Babb, Jr. -- Chief Executive Officer

Thank you.

Operator

I will now turn the call back over to Ralph Babb, Chairman and Chief Executive Officer, for any closing remarks.

Ralph W. Babb, Jr. -- Chief Executive Officer

We appreciate very much your interest in Comerica and thanks for being on the call today. We hope everybody has a great day. Thanks for very.

Operator

Ladies and gentlemen, this concludes today's conference. Thank you all for joining and you may now disconnect.

Duration: 64 minutes

Call participants:

Ralph W. Babb, Jr. -- Chief Executive Officer

Muneera S. Carr -- Executive Vice President and Chief Financial Officer

Curtis C. Farmer -- President

Peter W. Guilfoile -- Executive Vice President, Chief Credit Officer

Darlene Persons -- Director of Investor Relations

Steve Alexopoulos -- JP Morgan -- Analyst

Ken Usdin -- Jefferies & Co. -- Analyst

John Pancari -- Evercore -- Analyst

Ken Zerbe -- Morgan Stanley -- Analyst

Erika Najarian -- Bank of America -- Analyst

Bill Carcache -- Nomura -- Analyst

Scott Siefers -- Sandler O'Neill & Partners -- Analyst

Geoffrey Elliot -- Autonomous Research -- Analyst

Brett Rabatin -- Piper Jaffray -- Analyst

Peter Winter -- Wedbush Securities -- Analyst

Jennifer Demba -- SunTrust -- Analyst

Steve Moss -- B. Riley FBR -- Analyst

David Rochester -- Deutsche Bank -- Analyst

Brocker Vandervliet -- UBS Securities -- Analyst

Brian Klock -- KBW -- Analyst

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