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

Thanks for joining us this morning. I'm going to read a disclosure statement and then get into our conversation. For important disclosures, please see Morgan Stanley research disclosure website at www.morganstanley.com/researchdisclosures. If you have any questions, please reach out to your Morgan Stanley sales representative. So with that out of the way, I'm delighted to have with us here today Bill Demchak, Chairman, President and CEO of PNC; and Rob Reilly, PNC's CFO. Thanks so much for joining me this morning.

Thank you for having us.

Okay, great. Bill, to start, the past year has been very eventful, especially for you, not only with the pandemic, but also the sale of your equity stake in BlackRock, the acquisition of BBVA USA. So when you think about all of that and look forward to the year or 2 or 3 ahead, what makes you most excited about PNC and the future of PNC?

Look, I think we just set up 10 years of growth opportunity through the acquisition. But if you break the pieces apart, legacy PNC basically has made the investments through time to allow us to scale and grow and do so efficiently. BBVA accelerates all of that. If you think about legacy PNC, we have massive liquidity. We're underinvested. It's a low rate environment. At some point, that benefits us. And we've talked about adding to our security balances. Loan growth has been unexciting thus far, but we're set up as well as anybody to benefit from that when it comes back. We don't talk a lot about it, but our penetration into consumer credit products over time has actually improved pretty dramatically from when we started that effort 3 or 4 or 5 years ago. We just started to take [ a good share in ] consumer. And now we get to bring that platform into all these new markets through BBVA. So we're really excited about what this can do. BBVA is kind of like the old RBC acquisition on steroids in terms of size. It's a model that we know how to work. We have teams in place to do it. We're set up. We did the close. We're set up to do the conversion and off we go.

It's interesting, right, with the integration that is sounding like it's going to come pretty quickly. Before we get into the details on that, I did want to just dive into some legacy PNC tailwinds that you might have. First and foremost is excess liquidity. You're known on The Street as being a business model that has a significant amount of opportunity set to reinvest this excess liquidity. Can you give us a sense as to how you're thinking about that? What the progress is that you've already done and delivered on? And what kind of yield you're thinking you're getting on your new purchases? We've seen yields come down a little bit, are you on hold now? Just give us a sense as to how you're thinking about using your excess liquidity as we go through the rest of this year?

So we've talked about -- hold loan growth aside for a second. We've just talked about the fact that the Fed's expanded balance sheet. And therefore, the deposits in the system, we think, are going to be elevated for a period of time. And because of that, the percentage of our balance sheet that would likely be dedicated to the securities portfolio is going to grow through time. And I forget the exact percentage we put out there, Rob. But if you could jump in here.

Yes. Historically, we were at 20%. We said we're going to move to 25% to 30% by year-end.

Yes. And what's happened is, at the end of the first quarter, we had done some purchases in the first quarter. We did some forward settle TBAs that hit in the second quarter, and we've continued to buy. Yields that we're getting are, call it, 1.5%. If you think about just the scale that we and everyone else are buying and the only thing is you can really buy are mortgages and treasuries. More recently when even weighted towards treasuries. And there's more to do. As you always hear us say, Betsy, we're not all in or all out. We have -- we'll scale our way into this as we continue through the year and watch development here -- developments here. Importantly, deposits continue to grow. We -- basically, even though we've been investing into securities, absent the big check we wrote for BBVA, which was a drop in the balances, deposits have basically been growing at the pace we've been deploying into treasury -- or into securities at this point. So I'm not sure we've actually changed our rate sensitivity so much.

Got it. Does BBVA do anything, in particular, for your asset sensitivity? Does it change it at all?

Not really. They're very similar to us. If anything, they're a little bit more asset sensitive than we were.

Okay. What about the loan growth side? You indicated that it's a bit of a headwind right now, but how quickly could it flip to a tailwind, if I dare say so? Maybe you can give us some color on utilization rates and what would drive them up from there pretty low levels at this stage?

Yes. So just to level set, and this is just legacy PNC, BBVA's portfolio. I'm sure it's not terribly different, but a 1% change in utilization is worth what is about 2% loan growth? Did I get that right?

Yes.

And we're running 10% below the peak utilization rates, which were artificially high because of the pandemic. But I think we're probably running 400 or 500 basis points below where we otherwise could be across the C&I space. And that's driven largely by the lack of inventory build and the lack of the ability to build inventory because of supply chain disruption, and people just aren't utilizing their revolvers as much. In terms of what we're seeing, we've actually seen utilization pick up a bit this quarter, more so in asset-based stuff than in straight C&I. But even in C&I, it's up 39, 40 basis points or something. We have seen our -- what we call our new money out. So new commitments of capital have actually increased beyond pre-pandemic period. So if we look at the money in the DHE not funded, that's actually business we're winning. It's really strong. It's just they're not borrowing under it today. So I think back to one of the things I said at the start, when inventory build comes and CapEx comes back, we probably benefit as much or more than most other people. The other thing to remember is by numbers of clients, the vast, vast majority of our clients are private companies. And if you disaggregate private versus public companies, it's the public companies that are awash with cash because of the capital markets. The private companies will need to borrow when they start building up their balance sheets again.

Okay. So with that slight increase in utilization, maybe there's some positivity in at least some of the asset classes in lending this quarter, is that fair to say?

Look, I think lending on a spot basis is going to be a little bit better in C&I, on an average basis, maybe a little bit worse. There were some weird ups and downs in some of our public finance and mortgage finance business, CMBS finance business. But more importantly, we keep trying to look for this growth in C&I balances. We see the activity in the economy. You see the manufacturing index, you see all the things that should point to utilization increases, and we just haven't seen that; 30 or 40 basis points is great, but it's not anywhere near what should be happening here. And I think it will come. I can't predict when.

So then just thinking through a little bit of the other elements of the quarter or anything else in terms of updates that you care to share at this stage?

I don't know if you got anything, Rob?

No, I don't know -- I don't think there's any update. The only thing I'd say about the loan growth is, as Bill said, we've seen some spot growth outside of PPP forgiveness. So a little bit of that element, but there is some slight growth, not a lot, but that is different than what we saw in the first quarter.

Okay. And the rest of guidance, outlook for 2Q remains in line with what you indicated at earnings?

Well, what we said most recently, which is NII because of the soft loan demand, NII is under pressure. The fees are still pretty good, expenses are good and credit's very good.

Okay. On the subject of fees, you've got a lot of opportunity here with organic growth with BBVA USA footprint, but I'm just thinking a little bit more broadly in terms of the different services that you have, treasury management, asset management, capital markets, mortgage servicing, is there anywhere in these lines of business or in others that you're not in, say, for example, corporate trust or insurance that you would want to be adding to in terms of either organically or is there anything out there on the acquisition footprint that could be of interest?

So there's a lot of, I'll call it, capability add-ons that we look at inside of the treasury management space. Some of this, we've built organically, some of this we'll acquire. We've been doing that in C&IB, in particular, for different product sets you would have seen over the years, going all the way back to Harris Williams and then Solebury and then Fortis. In the TM space, we recently purchased Tempus Technologies, which is a payment gateway, which opens up all sorts of avenues down the road and merchant and other things we can do. And we'll continue to do that. That's kind of adding core capability on what we have. I think the likelihood -- I should just kind of say it's probably 0. The probability that we would look to just bolt-on a massive scale business, so think corporate trust custody, the platforms that are for sale, the scale technology inside of that, the ability to build that compete. I think that's a massive commodity scale matters business that you wouldn't see us go into. Insurance isn't wildly different. It's not an unattractive business, if you're the biggest player, but getting there from scratch is not likely.

What about on the treasury management side, international with BBVA USA, there's some threads there. Is that something that you would just continue? Or is there something that you could build out on top of what you've just acquired with BBVA USA, international treasury management?

We've been -- the way to think about our international business is we want to be able to provide products and services for our domestic clients to fulfill their needs abroad. So think of that in terms of treasury management capability, deposit licenses in various jurisdictions. We do have some isolated businesses, so asset-based lending in the U.K. Harris Williams has various offices around the world, but you won't see us go into a "local market abroad" and pick a fight with local players on commodity-based products. BBVA, both because of their proximity and some of their legacy businesses, obviously exposes us to Lat Am more than we've been in the past. And BTS is part of that, but there are also other parts of that. The border, notwithstanding all the news, you read about big walls and everything. The border is almost flexible down there in terms of business, one side or the other. And so that is something that we will adapt to. We're actually pretty excited about. We are going to continue to work with BBVA and other partners on cross-border referrals. Think about wealth and clients that have needs on both sides of the border. So that will be pretty exciting through time, and that's new to us.

Interesting. Okay. So you can take your products out and leverage that even more through not only the footprint you're acquiring, but working with BBVA as well, just for the large outcome?

Yes.

Just thinking about the balance sheet and credit, Rob, you said credit's great. Maybe you can give us a sense as to how you're thinking about credit relative to the reserve ratio you have? And is there any room for credit box expansion to drive some loan growth utilization?

You want to hit the first part, Rob, because I'm done talking about CECL and then...

Sure. Sure. I was ready to jump in. Well, as I said, credit's very good. Clearly on the consumer side, the consumer is flushed with cash that we're all aware of and well positioned going forward in terms of everything that they -- that bodes in the economy. And on the commercial side, things are good as well. A lot of the reserves and concerns that we had last year had dissipated as the economy started to come back with the one exception of commercial real estate where we're still cautious. There's still a lot of pressure in that space as we get into this new normal around lodging, retail, office space. So still a bit of some caution there. And you saw we built reserves actually in the first quarter on commercial real estate, even though we brought our total reserves down. Going forward, we'll keep an eye on that, obviously. As things continue to improve in the economy, the expectation across the industry and PNC as well, there'll be some reserve releases. But of course, that has to play out.

Yes. I think that the one sound bite that's interesting is we always track this upgrade-downgrade ratio across our portfolio, Betsy, and we're continually refreshing ratings. And on the non-COVID sectors, we're seeing upgrades outpace downgrades by 2:1, right? That had been easily the flip side as we -- through the pandemic. And on CRE, it's still 0.5. So you still have [indiscernible] the downgrades that you have for upgrades in CRE, specifically. And so I think that's going to take some time to play out, as Rob mentioned. We don't -- we never change our credit box. I mean the Fed puts out the survey, and -- are you easing or tightening credit conditions, we lend through the cycle. I don't know that we've ever changed our response on the survey. We'll change pricing, but we won't change structure.

Okay. That's clear. Well, I'm still looking for some opportunities for loan growth. One of them might be, and I'd like to get your opinion on this, but anything climate-related, right? There's a push towards green, green financing. There's companies out there promising that they're going to be bringing down the -- or helping to bring down the emissions of their borrowers through green financing. It feels kind of like you need to get in early to get your share. What do you think about that? Is there any opportunities on the ESG climate green side that could help out on the loan growth?

Yes. Although I would tell you, we've been at this for a pretty long time. So I don't -- it's making headlines now, but I think we did $35 billion and $36 billion in sustainable financing since 2016 or something. So we've been quite large in this. Some of it related to our tax credit business, which, as you know, we were fairly large in and some of it just creative financings whether it's green bonds or any of the other stuff out there. So there's an opportunity set there. And I think, importantly, and this is kind of one that [ Larry thinks big themes, ] and I think he's right about it. The CapEx that is going to go into carbon transition, as we transition out of a carbon intense environment, is going to be quite large, but I think that plays out over a long period of time, and I think will be a credible player in it.

I would think you have a good footprint to leverage this, given your customer set and your geography?

Yes, it's interesting. We had a big discussion yesterday just on a regional economic council, I'm on with whole bunch of the researchers at Carnegie Mellon and [indiscernible] and so forth, talking about how you take what is historically a carbon intense environment around Pittsburgh, so think natural gas and fracking and steel and so forth, and turn it into a bit of a transition hub in the sense of we have the technology here and the geology for carbon capture and sequestration, I said that right, using the geology from the fracking wells. We have the pipelines. We have -- if we move more towards hydrogen, which I think we're going to, we have a larger opportunity in the region for blue hydrogen as opposed to green, but I think that's going to be part of the transition. So I think all that's incredibly exciting, and I think both, through fiscal stimulus from the government that we'll see on infrastructure and some tax abatement and credit, less capital from financial institutions, it's going to be a very exciting part of the economy, and we're heavily involved in it.

Great. All right. That will be something interesting to keep on top of. Green hydrogen, that's a new one for me. I got to go figure out what that is.

Green -- I'm not the expert, right? But there's gray, green and -- sorry, gray, blue and green. Green is green. It's basically evaporating water, right? So the challenge is the chemicals you need to cause that to happen and traditionally takes more energy to actually crack water in hydrogen than you get from hydrogen. You can crack methane, but then you have, which is the lube, then you have then you have carbon offset. You need to capture the carbon and sequester it as you crack methane.

Okay. So Bill, we're going to have you back on our ESG panel later on. In the meantime, we're...

This is all fascinating. It's actually -- there's -- this is an exciting opportunity for our country, I think, to get this right. We actually have the technology. We have the core infrastructure. There's interest in it. There's capital behind it. We can cause this to happen.

Okay. You're invited back as a key speaker on that panel. In the meantime, we're going to move on to capital before we get into the BBVA USA acquisition and talk about some of the opportunities that you're going to drive out of that. But before we get there, just on capital and the dividend, give us your thinking. We're moving into CCAR period next Thursday. Your CET1 target is 8.5%. In theory, you can get there really quickly once the SCB is put into place just in a couple of weeks. So how do you think about the pace to get to your ultimate capital -- optimized capital target, which would be the first time in almost a decade, you're allowed to do that, versus what you want to do with the dividend?

Well, there's a whole bunch of things mixed up in that question. I'll just lead off with the notion that our capital ratio, and we'll obviously show this in second quarter earnings, but our capital ratio post the close of BBVA is much better than what we had as soon when we announced the deal. So we had more capital than we thought we would have. We closed the deal a month sooner, at least a month sooner than kind of we thought we would be able to. And now we're in a place where CCAR is going to come out, and we have the deal closed, and we're moving up towards conversion which then asks -- which then bakes the question of, is there something we should or could do vis-à-vis capital and dividend at a pace that is faster than what we had originally said. We kind of said, Hey, we'll do something in the second half of the year -- second half of the year, 6 months. Can we move some of that up a little bit sooner than once we thought. In respect to dividend versus buyback, dividend is an important part of our capital return. It's an important part of the valuation metrics of banks. I think we have ample room to increase our dividend. Having said that, as a bank, I think, as an industry, we generate more capital than we can intelligently use. And I think given our growth opportunities that we see, I think we're a good value here. So we'll be back into the buyback market. This issue of can you buy down to the 8.5% market. Look, we put in a CCAR plan every time that says we're going to get there, and we never get there because we always make more money than kind of what you put in your CCAR base assumption. So we'll see as that plays out. I also think, Betsy, we're going to have some turnover in the Fed, and we have, let's say, the SCB route, the thing they can add to the buffer, they're worried about financial bubbles, all this stuff is going to play out. So I don't know that everybody wants to race to the bottom at the moment here.

Got it. Okay. And on the dividend payout ratio, is it where you want it to be?

Today, it's low. But I mean, the numbers are all up in the air because we're going to have onetime charges and so on and so forth. But we have -- against our expectations of what we think we can earn with BBVA, we have ample room to increase it.

Okay. Let's talk...

Yes, I think the key is that we're going to finish, and we'll have these numbers for you here at the end of the second quarter, we're going to finish in a better capital position than we expected. So we're well positioned for capital return.

Yes. Okay, great. Let's talk a little bit about the BBVA USA acquisition. The first question I get from investors is how is the new footprint relative to your -- what now is the legacy footprint, including the Southeast, obviously? And is there anything that we should expect over the next, call it, 3 years that might shift your composition either in terms of credit quality or in terms of mix between, say, consumer corporate, CRE, et cetera?

No. I think -- look, the new footprint is faster-growing than our legacy footprint, even with our Southeast exposure that we got through RBC and some of National City. So that is exciting. The mix of BBVA's balance sheet, they have lower penetration in their consumer lending products, more single product households just utilizing checking and nothing else than we do. But as you remember, that was one of our issues, and we've increased our penetration fairly meaningfully over the years. Having said all that, the balance, our consumer book is smaller than our C&I balance. And there's no way you could grow consumer intelligently at a pace that, frankly, probably will ever catch up the C&I apps and us doing something standalone on the consumer side, which doesn't excite us. The mix of the customers, there's some credit risk in their book. We've talked about this where over time, we'll run some things down either because between the 2 of us, we have a bit more than we want or they've -- they're telling a couple of spaces that we don't particularly like, it's not material.

How about on an efficiency perspective because you are bringing them in $900 million of expenses coming out. And given the fact that, it seems like the activity level here is trending even better than expected, maybe your cost saves are going to move higher. And even if they don't, how should we be thinking about the overall impact to the expense ratio for PNC?

Well, Rob can maybe give you more specifics. But the math is the math. If you're on the math, the efficiency ratio gets better. You got to normalize for the -- when we get those cost savings in hand, which we think that will be pretty quickly along with the onetime charges, but get to a normal run rate, it's going to [Technical Difficulty]

Yes, that's exactly right. And as you know, Betsy, we managed a positive operating leverage. So long term, as long as revenues are growing faster than expenses, particularly in those revenues are driving good expenses like fees, that works too.

And on top of that, is there any kind of COVID-related expenses that are coming out that we should also be baking in?

I don't think so. But in terms of what we guide, it's all inclusive, so to speak. There's substantial expense savings, and we're going to get to it.

Okay. I wanted to ask a little bit about your technology investments and how you're positioned to leverage that going forward because you have been doing quite a bit with retooling, right, the infrastructure that you have. I don't even know -- I mean, you might have a couple of data centers left, not many, which are core to your operation. And so maybe you can give us a sense as to how much more scale you could drive off of the architecture that you've created here?

I think as much as you want. Basically, we will always have -- I shouldn't say always because the world always changes. But today, we purposefully have 2 primary data centers in a tertiary hot backup. And everything that runs in those data centers is cloud native, and we're very far along the process of containerization using Kubernetes to basically be able to go up into any cloud provider for compute. And that's an important point. So we have contracts with several providers where we will go up and rent to compute, but not develop in the cloud. And that's important because then you're not held hostage in that environment. We control our own destiny for heavy intense environments. We'll just run it in a public cloud or run it in our own data, there's no difference. We can move it wherever we want. And my guess is that's where we will be for some period of time. Given that model, you basically can just continually add compute. It's your -- what we're spending time on and have been spending time on for years now is taking old applications, even though they're cloud native, they're not necessarily modern. So rebuilding old applications into -- think of it as an API framework where you can plug-and-play, much more real time. We're using agile and DevOps. So agile, the business and the technologists together doing small bits of change. And then DevOps just does automated testing on those developments. So we're continually running that code real time in test environments, which means you can do much more frequent releases instead of batch releases every 6 months. So we have most of the bank in that space, not all of it. We'll keep doing that. We're in the middle of -- actually past the middle, pretty far along and updating our core systems, everything will be real time. You've seen some of that implemented with low cash mode. I know we're going to talk about that. Real time drives all sorts of future innovations for not just consumers, but C&I clients as well. So we're excited with what we have, and you'll see the result of that as we do. We call it this lift and shift thing, but we're just simply mapping data out of BBVA's applications to our central data mark, right? We're no longer in a world where each application stores the data itself. We have a centralized data mark. We just map from whatever they have into our data mark and then our applications pull out of that data mark. Very, very different than what you would have seen in a traditional integration, and you still see in most integrations.

It's interesting that you bring up real-time because I've often asked people, do your clients want it? Is there demand for it? Typically, I'm asking it from a corporate side. But your point on low cash mode, is this something that clients wanted or like Apple, you kind of figured out what they needed and put it in front of them and then you got some nice utilization out of it?

Little -- it's a little of both. Overdraft is its own thing, and I'm happy to talk about that. But I'm easily accessible to clients, whether it's through LinkedIn. It's not hard to guess my e-mail or whatever. And a lot of the complaints I got through the years is people saying, "Hey, I don't understand this available balance, pending balance and why didn't -- I thought I fixed this and I didn't fix this, and I don't know what's happening." And that not knowing what's happening because nobody balances our checkbook anymore. Nice people, crazy. And what real-time does is it fix it. It says, here's your balance. This is it. None are pending of it and all that stuff goes away. And then once that's there, you start getting pretty excited about what you can do with it because in the moment, in a low cash mode gives you the ability to say, well, first, we warn you saying, Hey, you're getting into trouble. Okay, now you're negative. Here's 5 ways to fix it, and here's a running clock that gives you time to fix it. By the way, one of the ways you can fix it, since we're suspending time, is you can just change your payments, just swipe left and right. Shut stuff on and off. That capability, and I'll let your mind wonder what can you do with real-time payment capability in the moment? All sorts of things. Think of fraud protection. You can see anything that leaves your account and just stop it. I don't know what this cash app thing is that's pulling money out of my AC, just stop. It's a remarkable thing, and I think we're entirely unique in having that capability at this point.

So just wrapping up here with a question from the audience. As you think about your opportunity that you're delivering to customers with low cash mode and to corporates with real-time payment, too, right, and you've got the new geography with the BBVA USA, how are you thinking about growth, not only in your customer side, but in some of the products and services that you can deliver on top of all of this new technology that you're delivering?

So I mean, just start with the really easy stuff. We have between the BBVA teams that were in place and people we have hired since we announced this in these new markets, we are largely staffed. I think I saw them over 80%, 85% staff. So we're joint calling today cross-sell -- this is -- we're already at this. BBVA just didn't have the product set we have, particularly in C&I on the treasury management side. So that's a really easy upsell. We have great products, right? We're #1 rated Phoenix-Hecht. This isn't easy sell. And that's #1, #2, #3 thing that you do, and then you pick out clients that you're not covering today and grow clients through time, the way we did with RBC. The immediate lift, we get this question, is this -- should this be faster or slower than some of the market penetration we had in RBC. This is, in many ways, going to be faster because we've been in some of these markets. We have the playbook now. We've pre-hired all the people and BBVA actually has a big client, much larger than RBC had, which we can cross-sell into.

Okay. Great. Well, it sounds like there's an opportunity for ramping revenue growth and with a very sharp eye on expenses, we should get some positive operating leverage here as we go through the next several years.

That's the plan.

Absolutely.

Okay, great. All right. Well, thank you so much for joining me this morning. Bill, Rob, really appreciate your time.

All right.

Thanks, Betsy.

Take care.

All right. And we'll move on to the next session now. Thanks.