The PNC Financial Services Group, Inc. (PNC) Earnings Call Transcript & Summary

I am Jason Goldberg. I cover the U.S. large-cap banks here at Barclays. Thank you for sticking with us. Next up, very pleased to have PNC Financial. Before we begin, as in prior presentations, the left-hand of your screen are audience response questions, polling questions. Please take the time to kind of answer those. There's 4 questions per company. After you answer the first question, we'll go back to the top and hit the next button and you can answer those. And time permitting, we'll go through them at the end. In addition, feel free to send in questions. Click the question button towards the top of your screen. And if we have time, we can get to those as well. Very pleased to have PNC Financial with us next. From the company, Bill Demchak, Chairman and CEO. And before I ask Bill the first question, I'm going to do my Bryan Gill impersonation. Today's presentation contains forward-looking information. Cautionary statements about this information as well as a reconciliation of non-GAAP financial measures are available on PNC's corporate website at pnc.com under the Investor Relations tab. Forward-looking statements in this presentation speak only as of the date of this presentation and PNC takes no obligation to update that.

And with that out of the way, Bill, it's interesting, PNC has been a bit of an outlier in the industry with a relatively, I would say, more bearish stance on the economy. Maybe have your views changed at all? And just what's your current thinking?

Well, I think, Jason, I don't know that our view on the economy has necessarily been more bearish. If you looked at kind of our base case we put forward in the second quarter for where the economy will go, it's pretty similar to what other people are doing. I think what was different was our expectation on credit and not because of what we have on our balance sheet. If you look at metrics on what we have exposed to COVID sectors or what we have in criticized classified or growth in criticized classified, I mean, everything is -- we actually stand out to the good side on that versus peers and things have been behaving well. Having said all that, we look where we are today, data has been better than what we would have had in our economic forecast. Unemployment, in particular, which is a bit puzzling, because the unemployment roll numbers don't necessarily foot to the unemployment rate, they're 2 different surveys, so we're kind of digging our way through that. And all else equal, we've seen some headline numbers that look a little bit better. But I'll remind you, we continue to kind of just push this thing down the road in terms of the delays on charge-offs and so forth. We've seen -- we've clearly seen a befit from the government programs and the Fed programs in terms of allowing companies to build liquidity and consumers to build liquidity. We'll see how that plays out. I think one of the things that perhaps had us stand out as it relates to our provision in the second quarter is we didn't, going to use the term, put our thumb on the scale, I know it's probably not the right description. We didn't really put overlays into our models as it relates to government support. So clearly, we knew that the CARES Act was going to do something to help small business and consumers, but we didn't really build that into the model as an effect as a qualitative overlay, which I suspect other people did. And at least thus far, that looks like that may play out. But we'll see. We're still in early innings, right? We're just in this eye of the storm where we don't know the long-term impact of what's necessarily going to happen as we work our way through this.

And I guess maybe you're obviously out, talking to customers all the time, just what you're already hearing from your customers that kind of informs those dues and sentiments?

Yes. So you have to kind of break them into pieces, right? The clients that are in the eye of the COVID storm, so think travel and leisure and lodging and retail, they're struggling for survival. We haven't necessarily experienced losses to date, but we have a lot of stuff moving towards watch list. We're going to have to watch and see what happens as PPP funds run out against some of those smaller balances. But if you kind of take that aside and you just look at our basic C&I customers, I think what you're seeing is everybody -- not everybody, but the majority of people running below potential, the majority of people focused on liquidity and cutting costs as opposed to investment in growth, which is good for credit near term, not great for economic growth long term. And the majority of people basically feeling pretty good about their cash position into middle of 2021. I'd remind you during this whole period of time, we've seen corporate leverage, which was already high at sort of 3x, actually grow to 4x on average in this environment into what -- no matter who's right here into a slower economy that they're going to struggle in. So we're not out of this yet. This is going to be tough, and I think you're going to see the charge-offs kind of start showing off down the road.

We'll get to credit quality in a moment, but maybe just to shift gears and kind of talk about some of your -- I guess, 2 of your larger strategic initiatives, national middle market expansion in your commercial businesses and, obviously, your national digital retail efforts on the consumer front. Just maybe talk to how those are going?

Yes. Both are going well for different reasons, I guess. We've been at the middle market expansion for a number of years. In some ways, going back to the RBC acquisition, where we kind of took that franchise and added our core C&I capabilities to their markets. And it's grown to be a meaningful part of our revenue and a disproportionate amount of our growth. Remember that on average, it takes kind of 3 years for a new market to breakeven and then kind of accelerates from there. And we're building on this wave of -- Mike Lyons uses this chart of sort of a cresting wave as you get enough markets in progression, eventually, it accelerates and grows at an ever faster pace. And we continue to do that. Importantly, we've always gotten this question, are you just out there doing bad loans or somehow growing your loan book in an unhealthy way. And I'd remind you that the credit box we use at PNC is the same box independent of market, it goes through the same credit approval process. And in those markets, we're running close to 50% of fee-based income out of total revenue. So there's a lot of cross-sell associated with what we're doing in those markets and it grows through time. And we'll continue to do that. The other thing I would say is, and we didn't necessarily see this coming, but part of our model is, obviously, local delivery. So we put products -- we don't just put bankers in the market. We put product people in the market, so TM and capital markets and credit authority and so forth. And in this COVID environment where travel has basically stopped to nothing, it's actually helped us to have somebody local as clients are struggling through this environment. If you jump to retail, you'll remember, we talked about kind of learning 2 things, we learned more than 2, but 2 big things since we launched this. And the first one was the importance of our solution centers was more than we thought. So having physical presence was more important than we thought, and we moved from assuming we needed -- I forget what the original number was, Rob, but the branch within 25 miles or something to kind of cutting that distance in half. And the other thing was that our product offering in Virtual Wallet, which was great in person, didn't work digitally. It was too complex and we saw a lot of people dropping from the application on the click through rate. So we've launched a new product called Virtual Wallet Pro that vastly simplifies that digital offering. And we've seen a substantial pickup in acquisition volumes. I think we're up 300% year-over-year on the back of this new product that we've launched. We now have -- just as an aside, we have 13 solution centers open now across Kansas City, Dallas, Houston, Nashville, we'll have 12 more by the end of the year that we'll open, so 25 total and we'll do an additional 25 in '21. The other thing I'd mention, and I'm not sure I could even explain this, but when we -- pre-COVID since the launch of solution centers, we've seen them grow checking accounts, not just balances, but households at twice the level of a traditional de novo branch. When COVID hit, it dropped to 50% below what it had been running before. So I guess that means it was equal to a de novo branch. Since we have been basically reopening these solution centers to prospecting in digital sales, it's now running 25% above the pre pandemic levels. And I think that's a function of this whole thing on digital acquisition, Jason, where it accelerated as we closed branches. We launched great new products and, all of a sudden, the solution centers are outperforming as we have branch outreach in these markets. But while we're kind of early at that, it's really encouraging. I'd also say that, I don't know how much you follow Net Promoter Scores, but the solution centers themselves have an 86% Net Promoter Score, which is astronomically high and the higher -- the highest of any of our activities inside of PNC. We feel good about it and we're going to continue to do it.

So some really interesting stats on the solution centers. I guess, what does that mean to your traditional footprint? And do you need all those branches?

It's a great question. So in 2020, I think traditionally, you would have seen us probably close 80 to 90 branches, and that probably was what was in our original plan, Rob, what we will do, though, in 2020, is actually close 160, so twice what we had originally intended. And then as we look into '21, we will also have an accelerated closings, probably as many as 120. So you're going to see us continue to thin out our thick networks as it was and invest in these solution centers as we build our national franchise. And of course, the metric on that is for that to work, your digital sales have to pick up at a pace that offsets the sales you would get from the branches you're closing. And so far, that is happening in then some. So digital sales are more than offsetting what's happening as we close legacy branches.

Interesting. Maybe kind of shift gears and maybe kind of take a kind of quick one through the income statement, you returning to net interest income at the top. But clearly, low level of rates and expected to persist, H.8 loan growth data has been soft. Maybe just talk to what levers you have and how do you think about managing the balance sheet over the next year or so?

So you can't run from reality. And rates are low, and they are going to be low for a period of time. We're massively low on cash, that sitting is excess deposits at the Fed. Securities opportunities are few and far between in terms of incremental and deploying that cash. So what you try to do is you drop your deposit yields. I think we printed 22 basis points plus or minus at the end of the second quarter, I think 21 basis points, Jason, was the low point during the financial crisis, then you'll see us print below that would be my expectation in the third quarter. So you drop your cost, not just on deposits, but also liabilities as we run off wholesale funding, given all the liquidity we have. On loan growth, H.8 has been weak, and we can talk about that a little bit. And it's been weak, not just because of the bond market and people basically refinancing out at cheap rates in public markets, but also because utilizations are down as business activity is lower, and we're impacted by that as well. But we benefit on an ongoing basis from kind of our specialty lending areas, which we have an outsized capacity, I think, versus our peers. Many of those products, particularly asset base are becoming very relevant in a stressed credit environment. We have, I think the number is in excess of -- I don't get the number right here, so I'm not guessing. We have 65% of our loan book in C&I with floors in it, 23% of it's fixed, 9%, in fact, has -- only 9% has no floor or is not fixed. So all else equal in what is a lousy environment, I think we're set up okay, and we'll be intelligent about that.

I guess more near term, any downside to net interest income or loan growth guidance you gave?

Yes. So I think we said in the second quarter here that when we gave second quarter guidance that we'd see loan growth down kind of 1% or so, I think we're going to see it closer down to 4% or 5%, correct me, Rob, if I go wrong here, but -- and NII dropping as a result of that. Having said that, fee income has surprised us to the upside. So we had fee income dropping quarter-to-quarter. And in fact, we'll see that grow. So it's -- call it a push, but fee income taking up some of the slack we're seeing in loan growth expectations.

Yes. Just to clarify that, Bill, so Jason, our guidance was loan growth down low single digits than it's likely to be, as Bill mentioned, down mid-single digits. So a little bit less than what we thought. And then on net interest income, we had said down 1%, and we'll probably be down a little bit more than that, in line with that lower loan growth.

With the offset in fees, Rob?

With the off -- so in terms of total revenues and outperformance on the noninterest income side in effect offsetting that.

Got that. Got that. I guess, maybe stick with fee income then. Obviously, the pandemic has caused some impact to some of the categories. I mean, maybe just talk to -- were you surprised by any of the results you saw last quarter or maybe what you're seen this quarter in these categories? And I guess, do you expect these to fully recover to pre-COVID levels? And if so, how quickly? And do you think 2Q was actually the low point for fee income if it's going to be up in 3Q?

Well, certainly on the consumer side, our C&I fees were actually pretty good in Q2. But on the consumer side, fees were way down for a variety of reasons, not the least of which was we waived them all. The industry and certainly ourselves worked to help customers who are struggling during that period of time and so waived a lot of fees. The other thing that was happening is the balanced growth that we have seen in our traditionally lower balance customers. So think about the accounts that would have kind of on average, $500 or so in their account. Because of the CARES Act, we've seen those balances grow substantially. And because of that, service charges on deposits have dropped independent of us having to waive them, and that was in the second quarter. So as we go into this quarter, we've seen a lot of that rebound as we see the spend data on both debit and credit card pickup, service charges on deposits up a bit, brokerage up, kind of across all categories. So all else equal, we ought to get close to where we were pre-pandemic. I think there is going to be, for a period of time, a consumer-friendly approach from banks on fees, which might mitigate that or slow that growth rate down. But the trends in debit and credit, obviously, mortgage has been doing phenomenally well, all kind of allow us to rebound. And it's one of the reasons we're saying our fees are growing quarter-on-quarter. In C&I, just as an aside, TM year-on-year, I think, is up 6.5% PxV, basically struggling in the purchasing card area, right, because there's no travel from companies. But every other area in TM is doing really well and not surprising again because corporates are kind of going through the same thing that consumers did, they're trying to do more digitally as they are working remotely as well. So lots of interest and rollout of various payment solutions using real-time payments and receivable optimization and so forth. So that's actually coming back, just growing stronger than it historically had.

Helpful. Maybe shift gears to the cost side of the equation. The sale of BlackRock, the BlackRock investment last quarter, obviously, provisions do well from a capital standpoint, which we're going to get to in a bit, but hurt the efficiency ratio. I guess, given some of the revenue challenges, bank spendings on NII, just how are you thinking about the trajectory of the efficiency ratio over time?

Yes. So just to level set, I mean, obviously, our efficiency ratio had been coming down through time. We kind of had always said we had under -- we were under earning, not overspending. And as we grew our top line, that was dropping. Of course, combination -- or actually -- and within that framework, as you know, because we pay some shares tax and because we have the tax credit business, our print looks artificially high by as much as maybe 120 basis points. Then we sell BlackRock, where we basically take a fee stream without related expenses out of it, and we print high, and we're going to print high until we redeploy that capital. Having said that, within -- inside of those constraints, we are very focused -- we'll always be very focused on the way we spend dollars. As you know, we push towards positive operating leverage. We're going to grind our way there this year, hopefully. We'll see what next year brings. But we'll be very smart about the way we spend dollars, where we don't spend dollars. We will remain committed to our investments. But what COVID has done for us, is allowed us, in effect, showed us where to prioritize investments. So think digital simplification for consumers, in some cases, cyber, given the growth in fraud, solution center rollout. But at the same time, it has shown us that we can take expenses out of things that are less relevant than they once were. And you see that inside of our branch count and probably some of our physical occupancy going forward as well. So we'll stay very focused on it. We think we have an opportunity -- not just an opportunity, it's our obligation and we're good at it, at managing expenses. We use continuous improvement to do it. We're going to be operating in a tough revenue environment. So we'll see what happens to positive operating leverage as we go out a couple of years, but we'll stay focused on it.

I guess you brought up CIP and positive operating leverage. And I suspect we're entering the 2021 budgeting process. I guess, how does positive operating leverage enter the decision-making process? Do you think you could have expenses come down next year? And maybe talk about the role in CIP of that?

Well, it's way too early to be giving you guidance on what we do next year. But I mean, just through the process, Jason, we need to stay focused as we always have on the long term, right? So you don't cut -- people are in an environment today where they're going to announce expense plans and basically cut off their forward growth opportunities. Right at a time when to, in my view, compete in the future, you're going to have to -- you should be investing, technology is going to matter, convenience is going to matter, the world of banking is changing, and if you instead pull back and cut back on those priorities, you just slow your long-term growth. I think we have an opportunity to maintain because we've always been in that investment mode. I think we have an opportunity to continue that, prioritize it perhaps a bit more than we have historically and then push hard on continuous improvement. You see what we're doing with branches. We're doing, what I will call, operating improvements inside of our tech headcount that we'll roll out over the next couple of years. We are changing the way we are thinking about physical occupancy and remote working. We've been very aggressive on headcount adds to the company, forcing promotions from within as opposed to external hires. So all of that stuff is just in our DNA, and we'll keep doing it. And as we get closer to 2021, we'll give you guidance as to where that ends up. But we'll stay focused on it, but we're not going to short change the growth trajectory of this company.

Got it, that's fair. Let's move on to credit quality. Obviously, you built a sizable reserve in the last 2 quarters and losses haven't really materialized, as you talked about earlier. When I look at your third quarter outlook, you're not really expecting any significant deterioration. Obviously, CECL and government stimulus are making this cycle a bit different than any other cycle. But maybe just talk to how do you see this playing out? And is it possible we could see reserve releases at some point in the next few quarters?

Sure, it's possible. I don't suspect that. I would say that's more likely than us adding to reserves. Maybe that's the simplest way to answer that question. But inside of this, Jason, just because we haven't seen the charge-offs materialize, I would tell you, in our C&I book, for example, we've re-rated at least once 86% of that book. And inside of that book, I think we've downgraded at least once 56% of those that were re-rated. So this march towards trouble continues. Now CECL dictates that we knew all that when we put that reserve up in the second quarter, right? So none of what's happening is necessarily bad versus what we expected. In fact, to your point, it could actually be better than what we expected. Nonetheless, independent of what the reserves are, credit charges are going to be a lot worse for the industry as we roll into 2021, both on the consumer and on the C&I side and in particular in the C&I side and some of the COVID sensitive areas that we talked about.

Bill, if I can just interject there, too, just to clarify, Jason. The -- so long term, we see charge-offs as Bill just said occurring. Short term, near term, in the third quarter, we had given guidance around charge-offs between $250 million and $350 million, and we see that coming in, in the third quarter on the lower end of that guidance. Just wanted to clarify that.