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

Okay. We're excited to have PNC joining us next. With us today is Bill Demchak, CEO; and Rob Reilly, the CFO. Thanks both of you for joining us today.

Hey, good morning, John.

Hey, John.

I thought we'd start with the big news that you closed your acquisition of BBVA USA this week. Bill, maybe you could remind everyone listening why this is such an exciting opportunity for PNC, what you think it will do for your franchise and your growth runway over the next few years.

Sure. It's easy to do. I guess I should start by saying everything we thought at the beginning has proven true. And in many respects, that I'll get to, has turned out better than we had assumed when we announced the deal. The initial hypothesis was BBVA brought us into a number of markets that we have targeted for years. So we end up in 29 of the top 30 MSAs across the country, where we can effectively take their franchise and add on it the products and services that PNC brings, and grow our company for years to come, following a model that has proved successful for us first with National City and then with RBC. That's the thesis. Take -- we're good at what we do, do it in more markets with more clients. I would tell you, John, since the deal was announced, obviously, the economy has gotten a lot better on the back of good news on the pandemic, of course, and then stimulus, which continues, which in turn helps marks on their balance sheet, helps our earnings and has allowed us, frankly, to be a lot more comfortable in what we bought and how aggressive we can grow it going forward. So we're really excited by it. A couple of soundbites. I think when we announced the deal, Rob, we said it'd be 1.4x tangible book. And we're not going to have the final numbers, and we'll take you through those at the end of the quarter. But look, it's going to be meaningfully below 1.3, 1.4 in terms of the purchase price. We'll end up having earned 2 months. We already basically said 1 when we moved our guidance from $600 million to $700 million, I guess, Rob, but now we got another month because we closed it early, which will show up in earnings. We've been able to build out the markets in C&IB. We have hired or will have hired by the end of this week as many as 80 people into these new markets. So we're going to hit the ground running. Many of the markets we were already in, in a small way. We basically, at this point, have all of those new markets at a little bit over 80% staffing today in terms of product support, bankers and so forth to go on the top of that franchise. So we'll hit the ground running in terms of growth opportunities. And we're just thrilled. We think there's a massive opportunity in front of us for years to come.

Great. Now we've got a bit of a generalist audience here today, Bill, and maybe you could remind us. Cost saves are a big part of every big bank merger, and usually it's the elimination of branch overlap. That's not as much the case in this deal. So maybe you could help people understand how you plan to take out about 1/3 of the acquiring institution despite that branch overlap.

Yes. So Rob, we announced $900 million -- what did we say the cost saves would be, $900 million...

Yes. In that range. Yes, in that $900 million range. [ That's ] 30-plus percent.

Yes. And by the way, we are on track and confident in those numbers that they'll be in our full run rate for '22. We get there -- you're right. I mean traditionally, people would look at branch overlap and close branches, take big charges, eliminate people from the branch network. For us, our investments in technology and automation over the years basically allows us to take out core infrastructure and not branches. So we'll have some branch closures, but not a lot. What we do have is a platform where we're going to take 600-plus of their applications, eliminate them in their entirety, including the data centers and simply move the data that runs those applications over to 300-and-something applications that PNC runs to convert clients. So we're just lifting and shifting data. All of that tech infrastructure and support goes away. Our back-office operations, all the automation that we've put in place over time, allows us to scale the volume through that without adding lots of people. Same with audit. Same with risk. Same with finance. Same with legal. So the core infrastructure inside of that company, we don't really need. We're going to -- and I should be careful to say that we're actually taking -- even in those areas where for the best of our ability, keeping the best of their people even as we make choices against some of PNC's people. But practically, we don't need the headcount, I shouldn't say the individuals, in that space. It actually -- we get the cost savings. And more importantly, we get the cost savings with a degree of certainty that -- and specificity that I think is a lot easier to execute on and to point to than when you're broadly saying, "Oh, I'm going to eliminate it over time."

Yes.

The other big category there, John, too, it's vendor savings, third-party spend, which is all tracking very well, frankly, a little bit more than we had thought.

Got you. Okay. So before we leave this topic, Rob, correct me if I misstate anything here. But just to summarize, the implications of closing a month earlier, you get another month or so relative to what we might have expected in terms of contribution from that franchise.

That's right. That's right. That's right. Bill has referenced, we had mentioned in the first earnings call, we had upped our expectations for PPNR mostly through true-ups, not timing. And then the timing change of that additional month adds to that. That's right.

Got you. And then at a broad level, you'll update the final deal marks, but we can expect a smaller credit mark and less of a hit to book value because credits improved since you announced the deal.

Yes, that's right. That's right.

And their earnings over the period of 6 months, growing their own book value have been better than what we expected in the pro forma.

Yes, the terms of the deal was a fixed price purchase. So earnings to close from announcement would -- accrue to our benefit.

Great. Very helpful. Okay. Bill, thought we'd transition and get some of your macro views. Obviously, a lot of this happened from a positive perspective over the past few months in terms of economic recovery and business activity. But there also are some concerns about inflation and potentially higher taxes. Maybe give us your thoughts on the economy going forward.

Look, I don't know that I have any news versus what you guys have heard. We have -- internally, we think we're going to grow at 7% this year and an accelerated pace still in '22, we'll see what happens afterwards. Consumers are really flush with cash. We expect that as spending goes up, and we're seeing it through our card volumes, we expect that to continue to drive the economy. Frankly, independent of whether they push an infrastructure bill through. Obviously, if we get an infrastructure bill, that will add more. We think there'll be a shift in trade as consumers go back more towards services consumption as opposed to goods, which is a good thing and that, that trade imbalance that has hurt our growth is going to help our growth. But all that -- the economy is on fire. And of course, the big question is as we start printing higher inflation numbers, does that inflation stick or is it transitory? I would tell you, our economists say it's going to be transitory. I'm worried about it individually. I just -- inflation becomes a -- expectations. We've all gotten used to, we're going to look at tips and say, okay, the expectation for inflation is whatever is embedded in tips. The expectation for inflation is really whether Procter & Gamble thinks they can -- I'm just using their name, thinks they can get away with increasing the price of soap again because they got away with it last time. And the more we see this sort of trend, the longer it plays out, I worry that it is no longer transitory and becomes an expected and realized issue for the economy. And that's my view, but our economists disagree with me.

Can you talk a little bit -- inflation is obviously something investors are focused on a lot and some see bank stocks as relative inflation winners? Can you talk about the kind of the pros and cons for running a bank in an inflationary environment?

Yes. I mean, look, the yield element of it is sort of self-evident and ultimately depends on the shape of the yield curve that plays out, obviously. All else equal, banks like higher rates and a steep yield curve. That rarely ever happens. You would think as we got into an inflationary environment, you'd see probably the curve flatten a little bit, front rates go up. That probably helps us simply because of the amount of noninterest-bearing deposits we hold today. And what I think is going to be a really low beta on deposit repricing, independent on what short rates do, simply because there's so much cash in the system nobody wants it. Until the Fed actually shrinks their balance sheet, there's so much cash in the system. I think deposit betas are going to lag. So from that respect, inflation is a good thing. You have to look at the shape of the economy if it happened and whether or not there'd be loan demand, which is maybe something you'd lose on the other side. But we'd have to see.

And then credit as the cost of borrowing goes up and whether there's implications there.

Yes.

Yes. Okay. Great. And then let's talk a little bit about some of the dynamics at play with net interest income. You guys have talked about accelerating the pace at which you're deploying liquidity. I think in the first quarter, you mentioned that you plan to take your investment securities from about 20% of earning assets up to 25 to 30 by year-end. Is that still kind of the plan? Have you been deploying security so far? And what kind of yields and securities are you looking at?

Yes. So we have continued and we will continue. I would tell you that notwithstanding continuing to buy, our balances haven't actually moved that much at the Fed. I mean they moved with one big check as we paid for BBVA. But beyond that, we've actually grown deposits and balances there, even as we purchased securities. We're not doing anything heroic. I mean given the volume that we have to buy -- and you're basically buying some combination of treasuries and mortgages. You buy mortgages today, you're buying more often than not premium securities given the rally you've seen in mortgages. You buy premium securities, you get ultimate decent yields at the bottom, but you also increase your amortization expense. So we'll get some benefit of that. We're going to continue to do it. I personally think, even though I'm worried about inflation, that there is such a massive bid for duration for the back end of our yield curve that it's going to anchor long-end yields. Everybody else is sitting on negative rates. So we have negative real yields, they're still better than most everywhere else in the world. So we continue to do that. Loan demand, you've heard from everybody else, you heard from me in the first quarter, someday it will come back. It hasn't shown up yet. So that's going to hurt us a bit in this quarter. The security buys help us a little bit. We'll see where we end up as we close the books at the end of the month.

John, just to add to that, and you referenced it, just to sort of underscore the thinking there, we do view this excess liquidity being in the system for some time. And where historically we ran at roughly 20% of securities balances to earning assets, structurally, we're going to change that. So that's the thinking behind moving that up to that 25% to 30% range.

Is that still something that could happen by the end of the year?

Oh, yes, for sure.

Yes.

Yes, yes, for sure.

Got it. And as Bill mentioned, you had about $85 billion of cash at the Fed, probably use some of that for the deal. But...

Minus -- yes, minus 11.5, right?

Yes. So that's something that you could end up as long as liquidity and deposit growth is continuous here, you could end up having a big kind of pile of cash and liquidity?

It could end up -- look, it could end up -- depending what the Fed does with its balance sheet and the amount of liquidity in the system, we have more liquidity than we need, and we're still overall short if you kind of look at hedging the balance sheet. So we can continue to deploy. Our modeling says we get to 25%, 30%, but there's nothing magic about that. It could go beyond that in theory. Simply is a function of you've got cash and no loan demand, put it to the highest and best use. But we'll see what plays out here.

And on the loan growth side, what signs or indicators are you watching to gauge loan demand, Bill? And what do you think will be the drivers? Is it just kind of cash running down? Or is it activity levels that need to pick up?

It's got -- I mean, ultimately, the largest component of loan demand is going to be inventory build, which isn't happening yet. If you look at sales to inventory ratios, they're as low as they've ever been, I think. And people -- just given the heat of the economy, people -- and supply chain issues, people are struggling to build inventory today. We've seen some of that. So we've seen utilization increase in our asset-based lending group, which usually occurs faster than other lines of credit. But we haven't seen it in straight up cash flow revolvers. I would tell you that we put more, what we call, new money out through client wins. So we continue this process of winning clients. We've put more new money out in the last bunch of months than we've done in a couple of years. But it's not funded money, it's DHE. So someday, they'll draw on that. They're not drawn today. So a lot of good activity with clients. They just don't need the money today. And I think until they're able to start building inventory here, we're going to struggle.

And how much do you worry about the competition from capital markets being open, nonbanks willing to commit capital? Is that something that's new, something that's always been the case, you don't worry about it too much?

No. It's interesting, structures where we play have held up. The competitors have been pretty rational. Pressure on pricing is there and is real. And that's not new, right? We'll always compete on price for good clients, particularly when we have a lot of cross-sell. Structures have held up. The nonbank players play in a space we never go near. So I don't worry about that a lot. In fact, a lot of that business drives business for us and our asset-based lending group, where the nonbank players will come to us and effectively ask us to administrate the loan and take the very top slice of a tier of funding for a highly levered company. And if the company gets in trouble, we work it out. We don't lose money, but we get paid big fees in the process.

The other thing to add there, too, John, just as the majority -- and we've said this before, the majority of our customers and our commercial loan balances are to private companies, largely middle-market companies. So the higher end, the Fortune 500, the public markets clearly have diminished what otherwise might have been borrowings. But that sort of core borrowing group of ours is largely reliant on bank loans. And to Bill's earlier point, largely around working capital. But the need just isn't there.

Yes. I saw something internally that showed for our public companies, the line utilization average is something in the mid-20s right now, John?

That's right. That's right.

Private companies, it's in the mid-40s. So it's the public guys who are really flush with cash right now. It's just -- people just aren't building inventories and expanding at the moment.

So Rob, how does that all kind of net out into how we should think about the near-term NII trajectory, with loan growth being still subdued but you're putting some money to work?

Yes, yes. I think there's some near-term pressure for it, obviously, in terms of everything that Bill covered. But during the course of the year, we're still where we think, down a little bit year-over-year. Not fundamentally changed from what we talked about in the first quarter. And that does rely on some second half pickup, which is yet to emerge, but we still expect to occur.

Yes, yes. And fair to think that new security yields are coming on lower than the existing book...

That's right, yes.

Putting some pressure on NIM percentage?

Yes, yes. No, there's pressure.

There's pressure on NIM, but there's pressure on NIM because it balances at the Fed also.

Exactly. There's a lot of components, yes.

Yes.

But right, putting on new securities at 1.3% when the books at 1 97, that's one component that hurts.

Yes.

Yes. And Bill, you touched on this. If we do see the Fed needing to hike faster than expected, you do think that the industry will be able to kind of lag deposit pricing due to all the liquidity that it has. Anything else that's unique to this cycle in terms of how you think about how deposit behavior might play out?

No, I -- it's interesting, John, who wants deposits right now? So depending how the Fed did it, do they just move short-end rates, do they dramatically shrink their balance sheet, what actually happens. My guess is the liquidity stays in the system. And if that's the case, there's just not going to be pressure to pay up for deposits.

Yes. Let me switch over to asset quality. Maybe you could talk broadly about how the outlook has evolved there with all the support that went into the economy and these cash balances, I assume that you see a pretty stable outlook on credit. Maybe you guys could talk a little bit about that.

Yes. It's -- I'll let Rob jump in here. But we've actually seen in the straight C&I book, non-COVID affected, so back out real estate, and affect travel and entertainment. We've actually seen the upgrade downgrade ratio go to 2:1 upgrades versus downgrades. So it's getting a lot better. In real estate, it's the reverse, right? We've seen 2 downgrades for 1 upgrade. And that's not surprising. That's going to grind out. You would have seen in the first quarter. While we had a reserve release, we actually continued to build reserves against the real estate sector. To date, we've had losses largely in kind of the public REIT space that played in retail. But there's -- there continues to be clients out there that are hurting we're well reserved for, but that's going to play out over a long period of time, I think. Consumers are great.

Yes. So I'd say overall...

Consumers have never been better, yes.

Yes. Overall, it's good largely because consumers' flushed, as you know. And then Bill said as well, in commercial, we're seeing improvement coming off of sort of the concern of the pandemic affecting all [ boats ]. So that's helped. But we do have concerns, particularly around the commercial real estate in terms of how that holds up when the world returns to normal. And nobody knows the answer [ to that ].