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

Okay. So I'm delighted to welcome our next presenter, who is CEO and Chairman of PNC, Bill Demchak, who is joined by Rob Reilly, who's the CFO. Bill is joining us here for the sixth time since becoming CEO. And over the last several years, Bill has significantly broadened PNC's footprint. And with the recently announced acquisition, Bill has played a critical role in reshaping PNC into really a national bank with, I think, a very exciting story ahead of it. So Bill, Rob, thank you very much for joining us. I know it's a very busy time of year.

Bill, I thought, look, I'd start off with the question we always start off with, which is your take on the economy today, what you're expecting for 2021? And I know there's a huge amount of uncertainty. There's a lot of different moving pieces. So perhaps you can couch the answer given that since you last spoke, it does seem we have an effective vaccine, or hopefully, we have an effective vaccine that will get rolled down in the first quarter. How does that change your view of the world? And perhaps you can also touch on fiscal stimulus and how important the outcome is in terms of fiscal stimulus in terms of your view of 2021?

Sure. The -- there's a lot in there. So since the start of the pandemic, we've obviously been able to kind of put a floor on the potential downside that we're going to see in the economy. Remember, when the pandemic started, we had mortality rates that people were worried about being as high as 10%. Obviously, since that period of time, treatments have come online. Now we have the news of the vaccine. And I think, certainly, in my own view, the downside scenario has been taken off the table. And in fact, things have been much better than my original assumptions, in terms of the economy's ability to recover, largely on the back of the gigantic monetary stimulus from the Fed and fiscal stimulus. Near term, we have seen -- just as we finish out the fourth quarter here, we've seen a fairly substantial drop-off in consumer spending. We see it in card data. We see it in commercial card data. You've seen it in the Visa data that's coming up. Clearly, the spike in case load that's occurred over the last month is having an -- but I think will be the localized economy here in the fourth quarter and into the first quarter. Our basic assumptions, and I think this is right, is that we'll get somewhere around $1 billion of fiscal stimulus that will go to individuals, probably reopen PPP and perhaps something to smoke -- or something to municipalities that will allow us to muddle through this until the vaccine is widely distributed. I think without it, the pain is going to be more severe. I would tell you the data we see on kind of what happened in the last stimulus package that the $1,200 and excess unemployment that the lower income individuals that are clients of ours largely saved that, and those balances are still high. So we track people who were employed, went on unemployment, increased their savings. They've probably decreased that total by 20% from the peak, but it's still double what it was pre-COVID for our lowest earning customers. For more wealthy affluent customers, I think they spent it. And you saw that in the consumer spending data, and it's helped prop up the economy. So a long-winded answer, I think in the very near term, we're going to have a bit of rough water probably for a couple of quarters and then likely see probably above trend growth for the quarters outside of that.

Yes. So that's actually very interesting. So are you seeing any changes in the liquidity position of corporates? Or is it just spending patterns that you've seen change over the last quarter?

So liquidity of corporates continues to be really high. Obviously, there's exceptions to that for the industries impacted directly by COVID. But for the most part, Corporate America got very liquid, cut back on capital expenditures, cut back on payroll, dropped inventories and built massive liquidity. And of course, they have access to liquidity today and very open and low-priced public bond markets and bank loans where they have wanted, although demand is low. Consumers are a bit different. I think affluent consumers, for the most part, have been a part of the economy that's been able to work remotely and continue operating. And the people who -- the individuals who were hourly workers and directly impacted by the massive layoffs and unemployment have been able to bank a lot of the money that came their way, either directly from the government or some of the deferments that banks put in place for consumer loans. And they are more liquid today than they've been. It's kind of this conundrum because you hear all of the bankers, including me and the Fed and everybody saying, look, we need another fiscal stimulus package, which I believe, yet at the same time, when we look at the balances of these individuals, they -- the lower paid individuals, they feel pretty healthy today. My own view is that part of that, at least, is driven by people outside of the banking system, whose balances we don't see. And then also the data I'm referring to are people who were able to have direct deposit before all this started. Obviously, gig workers didn't have that capability.

So you kind of alluded to this, but we're at this really unusual point in time where infection rates are picking up again, where you've got selective shutdowns across the country, yet there's this enthusiasm in financial markets because of the rollout of the vaccine, hopefully in the first quarter. How is that impacting corporate's willingness to invest? How is that impacting things like loan demand? And how is it kind of feeding through in terms of just the overall corporate confidence picture that you see?

I mean, look, this is just my own view. I wouldn't confuse the exuberance for all assets at the moment with confidence in Corporate America. I think people are still hesitant on capital expenditure. I think, I know actually, inventory builds aren't there yet. We see it in the utilization of our loans. So we haven't seen people build inventory going into the end of the year, which would typically be the case. So what you see in public markets for all assets, basically, I think, is just driven by the massive liquidity thrown in by the Fed. And the fact, there's nothing with a real yield today that's causing some of this. Corporate sentiment is certainly better than it was. But I don't know how it approaches the rally we've seen in the public markets.

Okay. So before we talk about the acquisition that you announced, can we just spend a couple of minutes talking about your strategic priorities? How those have evolved? And what are the 2 or 3 most important things that you're looking to achieve, not just for 2021, but when you think about the next 3 years?

Yes. So look, we've talked for a long time about the need for scale, the desire to be national, the desire to take our model, which works into more markets. Obviously, the BBVA acquisition allows us to do that and accelerate that beyond what we were doing on a de novo basis. That has become more critical than ever post-COVID. So this race towards a digital world has accelerated, it hasn't slowed down. The need, therefore, to invest dollars into technology to keep up with it is greater than it was. The need for scale to be able to invest those technology dollars is greater than it was. And I think the need for this notion of being national, this need for ubiquity across consumer clients in particular, but basically being in all places at all times, digital, physical, mobile, however, people want to interact with you is going to be critical. And we see the very largest players playing exactly that playbook. They are going to be everywhere with very good products and services, competing with every bank that used to think that they had a moat around their castle. And so in terms of what we've been focused on, first of all, I think it was right. Secondly, the need for it has accelerated. I think banking, in general, is going to be a tough place to make money in traditional ways in the next couple of years because of very low rates, rising expenses because of the technology agenda. Now you could choose not to spend that money. But I think you see only your fate if you take that course. And elevated credit costs, maybe not to the extreme we were afraid of, but higher than they were pre-COVID. All of that stuff makes banking a tough environment. And what we have set up here is the ability -- the old fashion way, you take costs out of something and run it more efficiently, but we've also opened up markets importantly to deliver our model, which will allow us growth for years to come.

So let's talk a little bit about the BBVA Compass transaction. I know it's top of mind for pretty much all of your investors. And I think, look, the strategic rationale of the deal, I think, is very solid, and it fits in with what you are trying to achieve, which is make PNC in 5 years' time, just a larger scale version of what it is today. I know you also said that it was high on your list of acquisition targets. So a couple of questions. The first is, what did the due diligence process look like in a virtual world? What stood out to you about their business as you went through that due diligence? And ultimately, what made you decide that it was the right fit for you against other alternatives that you had?

Yes. Well, look, it was high on our hit list for years simply because of the number of major MSAs it opened up for us. So all of their markets were kind of on our target list at some point, and they got us there immediately, obviously, in massive scale in Texas but also adding opportunities in Phoenix and Denver and California and so on and so forth. The due diligence process itself in a world of -- hit on a digital world actually worked just fine. One of the things about BBVA being -- BBVA USA being part of a large international company is their technology, their processes, their file organization, the way they underwrite loans, their compliance systems, their risk systems were all -- this was all a CCAR based firm, right? This is a big company who knows how to do that stuff. And so what we were able to do through due diligence and an online data room is basically reunderwrite the majority of their loan book, the vast majority of their criticized and classified list, including down the specific reserves on those loans, all of their legal contracts, personnel files, management reports, things through a 40-day process that you would actually never have been able to find and organize and digest inside of an old school data room. What was missing, and -- versus normal due diligence is simply the interaction that you would normally have with large groups of people. [Technical Difficulty] -- we know their management team well. We don't know today their banker teams as well as we'd like, and that's going to be part of the process that we go through as we go -- work our way towards close. And just some of the interaction that you can have in a real-world context that just doesn't work on video. We found through due diligence, while they take greater risk than we do at the margin, Richard, they are intelligent about the way they do it. So they didn't cut corners on underwriting. They just had their credit box a little bit more to the left than where PNC would have its credit box. They participate in certain lines of business that we would choose not to participate in. So for example, they're a leveraged cash flow lender in small amounts. But as you know, we stay away from that. They have more small balance investor on real estate than we would choose to do. But the files on those and the way they underwrote them were pretty good.

So if we look at the stated returns for BBVA Compass in 2019, I think it was in the 60 to 70 basis point ROA range, which is obviously a lot lower than what the industry did in 2019. Can you help us just -- first of all, I mean, how relevant are the stated numbers, given as you said that this was part of a much larger organization? And then secondly, when you disaggregate the gap, how much of that is cost inefficiencies, how much of that is lower product penetration? How much of that is under utilization of just the franchise, in general? And is there anything structural in terms of the gap, when you think about it?

Well, there's nothing structural. They had a cost and a revenue. Should the cost issue -- it comes in a couple of forms, I guess. One is being part of this large international organization where they had to spend a lot of money on process and technology that didn't benefit them directly, but rather tie them into the international presence. Second thing on the cost side is that they invested an awful lot of money in technology that they just weren't able to bring to scale on the revenue side. Much of it on the consumer side, very little of it on the corporate side, which is kind of where the fees are. So they just ran a high cost base. They have structurally, I think, largely because they're part of the -- again, big international business, structurally, they have more management layers than you would typically see, more process and bureaucracy, I think, than you would typically see in our organization. On the revenue side, bluntly, they kind of sold loans. They didn't have much product on the C&I side to cross-sell. So TM is the one we always talk about, but FX, FX netting, derivatives, very low penetration. They don't have equipment finance. They don't have advisory businesses. They don't have cash escrow businesses. They don't have -- on the consumer side, they don't have merchant. They have low penetration on all their credit products. Their debit card activation is well, well below our normal activation processes. So it is this combination of we can see costs that we can absolutely take out by the end of '21. And then if we bring their business model to our cross sell, which we've done, if you track -- if you look back at RBC, we've grown revenue there at an 8% compound rate since we closed it. And we've grown their fee penetration more than doubled it, so that all of the RBC markets are like PNC markets today with 50% of those revenues coming in the form of fees. [Technical Difficulty] -- franchise. This is a giant RBC to us. Go into the markets, cross-sell the clients, bring more products to bear, grow new clients, take the costs out that are in the core shell of running this thing because we don't need those, and the model works.

I mean, is there a significant difference in the profile of clients, either on the corporate or consumer side relative to what you have at PNC today?

Yes. They're -- so on the C&I side, which is probably the easiest place to talk about, their clients are what we would map predominantly to our commercial banking sector. So think of that as $50 million and under in sales. They have specialty segments. So they have oil and gas and real estate where they would probably overlap directly with us, perhaps a little bit on the riskier side. But for most of their corporate business, it's what we would call commercial business. The -- and then again, like I said, there's a few segments inside of that, that over time, we would likely run down as we grew a new book of business. On the consumer side, it's pretty similar. It's just -- it's interesting. They have a much higher acquisition rate than we do, which I think is reflective of their markets, and we get really excited about that. But they have -- they also have a much higher attrition rate than we do. So our net growth, if we compare their consumer markets to ours, our net growth is higher than their net growth. We're pretty excited about the notion of maintaining their consumer growth, but dropping the attrition way down once we introduce our client service model and the product set that we have.

So you mentioned that their underwriting standards were slightly, I guess, to the right of yours, if that's the right expression.

I don't know what's right or left, actually. We probably shouldn't use that.

Let's set the standards just to the right to yours. But are there businesses that you think you need to get out of because they just don't fit your risk profile or they're just businesses that you just don't ultimately think you can get scale in? And are they material? And I guess really what I'm trying to get to is, when we think about the jumping-off point in terms of the revenue generation of what you're buying, is it really that different to what we can see in the stated numbers?

It's a fair question. I think the easiest way to answer it is there are books of business that we will run-off over the course of a handful of years. I think what you will see, if all goes to plan in loan balances, for example, you would see largely flat balances in those markets as we run down existing balances and grow new. The same thing we saw in the markets when we did RBC, and I suspect that will repeat itself. Maybe we can outgrow the runoff. I don't know, our assumptions assume that it's kind of flat. We also, on the fee side, we will be growing what I will call good fees, certainly in C&I and even in retail through debit card activation and other products and services, while at the same time, dropping what I will call bad fees, which is, in our view, they had kind of an excess reliance on overdraft fees, which I think much of the industry does. And so inside of our assumptions, again, Richard, that it will actually drop down some of their consumer-based fees, particularly on overdraft, while we grow new fee streams, we'll run down some of their loan books over time as we grow new loan books. All of that is in kind of the numbers we presented. And what it means is we'll have a couple of years of flattish kind of growth followed by pretty aggressive acceleration, the same type we've seen in all the new markets we've entered.

So can we just spend a second on the revenue synergies? When you announced the deal, you didn't give a revenue synergy number, but you did say that you thought they could be significant. Do you think you will be willing to give a revenue synergy number at some point? And do you think they will be evenly weighted between the consumer and corporate businesses?

Well, I don't know that I can answer the latter question that the C&I -- we'd have to go back and look at history for what RBC did and actually see if the products were similar. But on the C&I side, we ought to be able to track that, and it's pretty substantial. I mean we -- in the RBC markets, for example, we literally doubled the fee penetration that they had received. We think we can do that again. We have 85% penetration in TM across all of our clients. They actually have mid-60s. But mid-60s means most of them have a DDA account. They don't -- they just don't have advanced TM products to offer to clients. And we should be able to track that. Rob and I were actually talking about the ability to just track fee growth by market over time to kind of put a lens on exactly what we're able to accomplish here. We'll have to go back, I think, on the consumer side. I don't know, Rob, if you have a particular view into that, but I don't.

Not at the moment. Like you said, our priorities at the moment are to integrate, get together, achieve the expense savings and then the revenue growth opportunities that the principal point of enthusiasm will emerge.

Okay. So can you spend a couple of minutes talking about how this impacts the consumer strategy overall for PNC? So obviously, separate to this acquisition, you've been building out the national digital retail product offering now for a while. How does this acquisition change the strategy? And does it in any way change where you think the business will be in over a 3- to 5-year period?

I don't think it changes the strategy. I think it accelerates certainly what we were doing. I think the basic notion of branches or solution centers matter, physical matters is real. I think the process that you see occurring across the country of thinning branches out of thick markets as you build new locations will continue. What that means for our combined network, PNC and BBVA is, we will continue to consolidate branches where we have too many in the wrong place, and we will continue to add branches into newer markets where we have less penetration than we would like. The totality of that ultimately is less branches by a long shot than what collectively we have today and what the country sees because I think this trend continues. But physical matters, what we see just back to our solution centers, they grow -- the solution centers in the new market are growing at twice the pace in every measure of a de novo in a thick market. The conversion to full-time clients when an account is opened in a solution center versus online is exponentially higher. So it's really easy to gather high cost deposits online. It's tough to create a real customer that's using all of your products and services. That's happening in these solution centers. Even if they never go in there again, Richard; even if they just go in there to meet somebody and open the thing up, it matters. And I think that model is going to continue to matter because I continue to believe money is just different. This notion that we can live in a completely virtual world, where somebody's personal finances are involved, I just don't buy into yet. When there's a problem, you go to your bank to fix it. In the first place, you go to somebody where you can actually see somebody.

So let's talk a little bit about the operating environment. So I guess a couple of questions. The first is, how would you characterize the competitive environment today? And I guess, look, the key question is, do you think the market is pricing credit rationally, given all the uncertainty and given everything that you can see? And then secondly, we have seen this pickup in consolidation. I think most people expect that it's going to continue. What do you think a more consolidated banking industry means for you going forward in terms of the overall operating environment that you're going to be faced with?

Yes. So I think it's interesting. Structurally, I think C&I credit is okay. The industry is staying away from stuff, they probably should stay away from -- we can argue about some high-yield bond issues. Price-wise, prices are really compressed and competition is fierce. There's way more liquidity in the system today than people can find an intelligent use for. And like I said, I don't know that, that changes anytime soon. So that's kind of true on the C&I side. I would tell you, on the consumer side, people have behaved more rationally. I think part of that was because when consumers went into forbearance, even though they didn't have "a negative mark" on their credit score, there was a note in their file saying that they had some credit that was in deferral, and it made it difficult to underwrite those clients during that period of time. It's one of the reasons you saw, I think, consumer credit shrink to a certain degree, which is tough to figure out how to underwrite a consumer credit. But pricing has been pretty rational thus far on the consumer side, and it's gotten on the price side, pretty aggressive on the C&I side, not so much on the structural side, not so much doing loans that shouldn't be done.

Okay. And then on operating leverage, you obviously got a very good track record of driving operating leverage. I think it was one of the things that was very, very important to your shareholders. Given this acquisition, how should we think about shorter-term operating leverage versus the longer-term improvements that this transaction is obviously going to bring to the P&C franchise over a period of time? How are you going to balance those?

Well, first of all, our goal is always to produce positive operating leverage. I think this deal sets us up to be able to do that on an accelerated basis versus what we could do on our own. '21 is obviously going to have a whole bunch of onetime charges in it. But outside of '21, we actually see an ability to return to positive operating leverage at a pretty healthy clip, not relying on rates going. Now some of that is the big cost takeout, just leverage you get on cost that we'll see by the end of '21, and some of it is on the revenue side, where we'll start to grow those markets through greater penetration on the fee side.

Okay. So just spend a couple of minutes talking about credit. So you set your reserves, obviously, at the end of the third quarter. That was before we had an effective vaccine or hopefully had an effective vaccine. It now looks as if the rollout of that could be faster than I think people would have thought maybe a few months ago. How does that filter through into how you think about reserve adequacy in the CECL world?

Yes. So this is where Rob gets hives. All else equal, things are better today than the last time we ran a reserve model, right? So when you run the reserve model, you put in an economic forecast, we have 1 million variables in there that we track, and you fit your data to historical experience and you produce life of the loan losses. And by all accounts, things have gotten better since the last time that we've run that. Having said that, we have this big period of near term uncertainty, which makes us nervous. And so CECL wasn't designed really well for a period of time where we're looking and saying, well, if there isn't fiscal stimulus to help small business in the next couple of quarters, you're going to have a real spike in defaults that currently isn't captured by our economic models or by anything -- yes. So where I'm going with that is -- we're going to work our way through the fourth quarter. My gut tells me that things are better. And so therefore, reserving will certainly be less than it was before. And as you know, for both us and for the BBVA books, the marks we put on that were kind of pre-vaccine marks. So all else equal without surprises, we're fairly healthily reserved. Now the problem is we live in a world full of surprises. We got to work our way through that.

So I'm just looking at the questions that have come in. There's a bunch of questions on commercial real estate. You obviously have a unique window into that. Can you spend a couple of minutes talking about what you're seeing within your servicing book and within your commercial real estate loan portfolio?

Yes. So the servicing book, again, those assets aren't for our account. They're serviced by Midland. The flow in of that has been -- has slowed down. In total, it's less than what we had expected. The turnaround, the workout of the loans that are showing up, either because the borrower is able to cure the issue or because the asset can be sold, there's capital outside the system looking to be deployed. So the turnaround is faster than we thought. Having said that, the criticized assets in the real estate space, so think about hotels, think about retail, those assets continue to get worse, right? They're marked and they continue to get -- they're not getting better, they're getting worse. So hotel at 50% occupancy doesn't get better. And that's kind of what's happening. So those are grinding largely into a bad place. Now we're reserved for that and aware of it. But I think isolated sectors of real estate are going to struggle. Similarly, dependent on geographies, office space is going to struggle. You're starting to see a little bit of that in some of the major metros, but I think that could be true across the country. And then finally, the verdict on multifamily, which thus far has behaved pretty well, rent collection is only a couple of percent down from what it otherwise would be, I think the verdict on that is out as well depending on market, right? You've seen massive drops in rents in a couple, New York City and San Fran and so forth that I think are going to have impact long term.

So look, we've got a couple of minutes left. And I think, look, the last question is on capital returns. And look, you still have excess capital after this transaction. So how should we think about both your ability and appetite to return that capital ahead of this deal closing? And if the Fed does lift the moratorium on buybacks early in 2021, is share buyback something that we should expect from PNC?

Well, look, we need to work towards the close and the approval. And I think you're right, we have excess capital, I think, trying to use that in the midst of trying to get approval is probably not a wise choice. So you won't see us pursue it prior to close. Post close, I think, you'll see us go back to kind of where we were, where we would put close to 100% of the capital generated out in terms of dividend and share repurchase, perhaps more than that. One of the things kind of lost on people and one of the things attractive about this deal is, for years, we try to buy ourselves down from our higher capital ratio, the target of getting to 8.25, 8.5 or something. And we're never able to do it because we made too much money, great problem to have. But it's tough to deploy capital. Banks can generate more capital than they can intelligently deploy. And one of the really nice things about BBVA is we put $12 billion to work at high teens IRR, find some other place to do that in a world where real returns are negative right now.

Okay. So with that, we're out of time, but we greatly appreciate you joining us. And hopefully, we get to see you next year in person. Rob, Bill, thank you very, very much for your time. That's really, really helpful.

We look forward to that. Thank you.

Thank you.

Take care.