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

We're going to get started. So I'm delighted to welcome our next presenter, who is CEO and Chairman of PNC, Bill Demchak, who I think is well known to everyone. This is Bill's seventh time since becoming CEO that he has presented at this conference, and we're delighted to have him back again in person. So Bill, thank you very much for making the trip and thank you for joining us.

It's good to be here in person. It's great to see everybody.

So I thought what I would do is just start off with a couple of broader questions around your view of the economy. And I guess 2 specific questions, the first is, what do you think happens in terms of rate structures next year? What are you focused on from a macro perspective? And maybe you can talk about some of the risks that I think people are focused on like supply chain disruptions, risk of inflation going higher and the risk of a policy mistake from the Fed?

Yes. So look, I think the economy is strong, maybe stronger than people think. Consumers are still flush with cash. They're still spending. Supply/demand on goods isn't going to equilibrate anytime soon. And I think we're blaming it on supply chain. Some of it is just simply -- there's a lot of demand for hard goods right now. So I think we go into '22 set up pretty well. However, I think inflation is real. I think we are at full employment or beyond full employment. The participation rate ticked up the other day, but it's the first time in a while that we've seen it move. And I think we've just seen tremendous wage pressures across all sorts of different -- starting with the lower paid people, but through the structure. And you've now heard Chair Powell talk about it, it's no longer transient. So what I think happens, and this is very different than what our economists think happens, I think if you basically have the bit in your mouth to fight inflation, you're going to go much harder, much faster than what the market is pricing in today. And I think they do that at the same time as they're shrinking their balance sheet. I don't have a particular view on term structure because there is a -- there continues to be a massive bid for duration that the Fed has taken out of the market from pension and everybody wants to be [indiscernible]. I have less of a view on the long end, although I think it will spike more on review on the speed of when they're going to move front-end rates.

And then just briefly on supply chain disruptions, I think you've got a unique picture into that, just given your middle market business. Have you seen any of that easing? Do you think that's going to persist late into 2022? What have you seen on that?

No easing at all. It seems to roll through the economy. So you'll see pressures in one place that might abate and then they show up somewhere else and when we still can't get truck drivers. So even if we manage to unload the crates, we don't have anybody to move them. You see that in housing supply. Housing demand is massive and is going to continue and will drive part of the economy next year. Supplies are tough to come by. Every single one of the clients we go to talk to the first 5 things they talked about is inflation and their inability to build inventory as they try to get ahead of inflation. So I think we'll live with this for a period of time.

Okay. All right. So let's segue and talk a little bit about your strategic priorities. And look, a lot has changed over the last year. I know when we did this virtually last year, there was a lot of focus on the pace of recovery, whether vaccines are going to be successful? When are we going to get a rate hike? I think we're predicting it was 2025 back then. So can you just talk a little bit about how your strategic priorities have evolved over the course of the year? What you're most focused on? And what are the milestones you'd like to achieve over the next few years?

So I mean the biggest thing we did was we purchased, closed and integrated BBVA inside of 11 months, fully done. And we now have our teams in the markets. We're probably 90% staffed in all of the new markets for product services, coverage and so forth. So part of strategy, and it's not really what I would call strategy, but part of execution in our growth promise for the foreseeable future is actually just executing on these new markets, right? It's now integrated, and we see this opportunity. Now we have to go out and execute and in fact, grow the share that we believe we can. And in some ways, that's a lot easier than some of the other stuff that we're focused on, which is heavy investment, continued investment in the payment space. The future of banking as an industry is going to be driven by the payment space, in my view. It's depending on what numbers you count, it's a $500 billion industry. It's -- and it is getting increasingly disintermediated by different players. And I think you're going to see industry response to that around some of the utilities we collectively own and control. So real-time payments through the clearinghouse, EWS and Zelle. And the power of Zelle taking on new venues and [ play ] in the aggregation space. And then independently inside of that, PNC needs to build the capabilities to be able to tie into that infrastructure. And we're very far along in that, if not leading that. So it's an exciting time, but it's also -- if I look at risk for the industry, we need to gain back control of the payment space as an industry, which I think we can do, and then go back to fighting each other. You hear Chair Powell talk about equal regulation for equal activities. And I think that plays itself out as some of these new technologies evolve. And I think that plays to our advantage.

So let's come back and talk about that in a few minutes. So I think that's really important and really interesting. But before we do that, let's talk about the integration of BBVA USA. Because as you said, that was completed really in a record time. So a couple of questions. The first is, how has your assessment of the franchise evolved, now it's fully integrated? And second, can you talk a little bit about what stood out to you in the integration process, both positively and negatively, given that this was the first time that you did an integration with a new technology stack, which I think was a real game changer for you?

So there weren't any negative surprises. I mean there were positive surprises on the franchise, much of which was driven by the economy. Of course, when we did the deal, we were still very concerned about what might happen in the credit book that hasn't come to pass. We looked at what might have been risk in their credit book. Oil and gas would have been in there, that hasn't come to pass. So some economic drivers have just made the book we bought much better. The teams are great. We're kind of -- we have integrated teams in all the markets we've made. On the middle market side, I think I saw a number, 14,000 calls since we announced this deal -- or sorry, since we closed the deal, and we're winning new business. So nothing really negative. I think the power of the technology, we always get the question, everybody sits up here and say, "Hey, we're the best tech firm there is, we're tech forward, we're a technology -- we're actually a technology company pretending to be a bank." I hear a lot of people say that. We're a bank that's empowered by good technology. And the proof point on that was we were literally able to move 9 million different accounts in a course of 4 months into a data lake, apply them to our application, shut all the other applications down, turn them on and have it work in a weekend. And that gives us a very powerful engine to be, what I'll call, both creative and value-added going forward.

Okay. So let's talk a little bit about revenue synergies because you acknowledged that there's significant potential, I think those were your exact words for revenue synergies as a result of this. Now that it's integrated, you've had more time to spend with the customer base, they're exposed to your product set, what's the response? What's the reception been?

So the clients who -- just step back a little bit. BBVA's clients were credit-heavy fee-light. They didn't have much of a treasury management product, and what they had was fairly simple. So we go through a conversion. We take what was their TM platform for the clients they had and introduced our TM platform. And we've already seen kind of massive aha moments on the parts of the clients as to what they can turn on, on our platform. Automatically, I can do this, I could do this, I can do this. It gives us [ peak-time's ] fee revenue. And then, of course, the bankers are now kind of in a candy store, right? We show up with all this fun stuff that can go sell that they didn't have before, and that's been very positive as well. So we see -- I think they had 20 -- if I am looking at [indiscernible] 25% penetration or something, that we have 50-plus. So it's -- we do have massive upside.

So is this customers transferring relationships from other banks to you? Or is this just you expanding the pie overall?

It's both. And that's an important distinction, actually. So many of the customers we run into actually don't know what can be done with a modern TM platform. Our platform automatically integrates into their ERP systems. So you don't have to go through some horrific 3-month changeover where your technologists are writing code to reach our code. It's automatically integrated with most of the ERP systems that are out there, and they can just turn on features, which is upselling existing clients. And then new clients, things change through RFP, you'll win a piece of something, a purchasing card, opportunity or whatever it might be, an FX netting opportunity. And then once you get something, they see what your menu looks like and you're good, you get more.

Okay. That's interesting. I'm sure we're going to hear a lot more about this over the coming months and years as you roll it out.

Yes.

So let's talk a little bit about loan growth. Obviously, people care a lot about this. We saw an inflection point in Q3, both for corporate and consumer. The H8 data suggests that it's continued to improve over the course of the quarter. Can you talk a little bit about what you've seen, maybe touch a little bit on whether supply chain disruptions are actually holding back corporate loan demand? And maybe talk a bit about what you're expecting in terms of the loan growth picture for next year?

Yes. So we're following trends in the industry, no surprises, which is in great shape, by the way. I mean utilization is maybe marginally up, but it's still multiple percentage points below what it would normally be at this point in the cycle. And when you talk to clients, the reason that is, is they simply can't build inventory, right? So you see sales to inventory levels at [indiscernible] lowest levels ever. And I don't know that that's going to necessarily change any time soon. The behavior, if you think about it, we're in an inflationary environment where raw materials cost for whatever you're producing, right, are compounding at 6% right now depending what you're buying, you'd want to build inventory as fast as you could to get ahead of that, particularly because the other thing we're hearing from clients is they all have pricing power. They can pass that price along in a way that they've never been able to so they can't build inventory. When does it change? Somebody asked me this question on our first quarter earnings call. I don't know. I will tell you that we continue to win business. We have more new money out the door through new clients in increasing lines, but utilization isn't moving. So our balances are growing at a somewhat tepid pace until we see that shift.

Okay. And I know you've been asked this before, but when the supply chain disruptions normalize, do you think there is pent-up loan demand that will come as a result of that? Or are corporates just using the cash that they built up over the last couple of years to fund some of those?

So it's tale of 2 cities. The very large corporates are -- continue to be very liquid because of the public bond markets and just raising money ahead of time. Middle market is different. So if you looked at excess cash across the cap structure from large corporate down to middle market, down to commercial, down to small business, small business commercial have burned through their PPP funds and need money. Middle market, somewhere in between; and corporate -- large corporate doesn't really need it at all. We get through the supply chain disruption/massive imbalance between demand and supply right now in material goods, they're going to build inventory, and you'll see utilization go back up.

Okay. So maybe we can talk a little bit about liquidity. And I listened very carefully to what you said about your rate expectations. You're obviously sitting on a very significant liquidity pool. I think it was at $75 billion last year at the end of Q3. How are you thinking about redeploying that? And other levels at which you'll be more aggressive in terms of redeploying cash into securities? And where do you see value over the curve?

So we have been pretty public about just the mechanical fact that our securities balance is going to increase as a percentage of our total assets. Some of that is just a function of lack of loan demand. So you see our securities book going from historically 20% to somewhere 25% to 30%. That doesn't tell you anything about duration because we could be buying very short-duration securities. But we continue to put money to work somewhat opportunistically, as you would expect. So you see the tenure back up to the mid-60s, we buy some, you see it rally to where it is, we stay out of the market. All of those in some ways are a bad deal, but they're a better deal than earning 5 basis points in excess reserves at the Fed, all inside of a negative real rate environment. So we deploy as necessary, but practically, we've only been investing the cash we've been generating, not really covering the structural short that's in the balance sheet.

Okay. So let's talk a little bit about one of your primary strategic initiatives, I guess, pre-pandemic, which was the growth of your corporate business and the middle market expansion, in particular, which was very, very successful in terms of PNC outgrowing the market into the C&I growth at a time that frankly, there wasn't a lot of growth. And I think it would be just helpful to get an update on what that strategy now looks like and maybe talk about that in the context of the acquisition?

Well, the strategy hasn't changed. When we bought RBC, we went into a whole bunch of new high-growth markets with a -- actually a smaller book of business market-by-market than what you would see with BBVA, and with very underdeveloped teams. What we learned is if you are -- we use these 3 words, patient, persistent and consistent in choosing who you want to cover and having the willingness to spend years to get them to be your client, that you create a growth curve on revenue that -- and what we do with RBC, right, you'll see our fee base is fully 50% of the revenue base from those clients. It's only half from credit, 50% from other fees. We now have BBVA with full teams on the market much -- in the market much sooner than we had with RBC. At existing book of business it's underpenetrated and all these high-growth markets. So we're incredibly excited about the opportunity set in front of us that we have just to go execute on what we do every day.

And then maybe you can just talk about Harris Williams as well. I mean that's obviously been a real bright spot for you. I mean that business is actually much, much bigger than it was even a few years ago. What are the puts and takes in terms of adding more capital market functions? Do you think there's a real opportunity for you to grow that to something much bigger than it is today?

We probably do a poor job actually, like I know we do a poor job talking about the collective capital market business that we do. So we have Harris Williams; we have Solebury, which basically advises on secondaries and IPOs. You might know better than I do, but I think they're 50% market share or something in new IPOs; we have Sixpoint which raises money for private equity shops; we have a full suite of syndication loans on bonds, in municipals, mortgage secondary sales, FX through to pegging, everything you'd otherwise need. What we have done is be very focused on the commodity type businesses to choose to compete where we have some particular advantage. So in the bond space, think about REITs. We're providing capital through lending. We should get all their bond business. Utilities are the same way. And we've done very well with that. That industry, [ in ] my view, is going to become more and more electronic and less and less about people on the sales side, in particular. And I think as that happens, you will see us accelerate our participation in that.

Okay. So maybe we can segue a little bit to the consumer businesses? And obviously, the pandemic has significantly accelerated this whole shift towards digital. So maybe you can talk a little bit about how your thought process around the consumer business has evolved over the last 12 to 24 months? And maybe talk about it in the context of how you're thinking about the value of physical distribution? And whether or not rationalization of the branch network is something that you actually think could happen at a much faster rate than what we saw 1 or 2 years ago?

Branches matter. We had a bit of a science experiment when we went out with our national digital expansion, when we were able to directly measure the difference between going to dual market with just digital and marketing versus putting a solution center in place. And 1 solution center in a market that was largely digital, the conversion you had to real clients, primary bank clients, from that 1 solution center was massive. It made a huge amount of difference. That doesn't tell you anything about how thick the network should be. And so I think you'll see ourselves and everybody else, thinning our legacy thick networks as we continue to build into some of these newer markets where we just don't have presence, and we need to. And I don't think that changes. The branch traffic continues to come down. But when people go into a branch, that interaction is much more valuable than the traditional on going into cash a cheque.

And just more broadly, can you just take a step back and talk about the competitive environment? And I think the comments you made at the beginning were interesting around what's happening in payments. Obviously, a huge focus on this intermediation. And it does seem as if, look, the shift to digital has really prompted a number of tech companies and payment companies to really expand their product set and to start thinking, I guess, much more aggressively around what they want their footprint to be in financial services. So can you just talk a couple -- just a few minutes talking about, one, how concerned you are about this intermediation? Two, talk about what you think the industry can do to respond? And maybe three, talk about what PNC specifically plans to do?

I'm worried about disintermediation. I think we've already seen certain players give up, in effect, say, we call them random banks, all I'm going to do is be the back office for a fintech or I'm going to partner with an Apple or a Google or Amazon or somebody and be their bank and basically give away my relationships to them because I just want to generate volume. And you have all the different players from the big wallet providers of the world through to every startup who wants to go through an aggregation engine and use the ACH rails to move money. And then you have Visa and Mastercard, who are increasingly empowering fintech in a way that is kind of against their basic providers today, which are the banks. So there are lot of pressures coming at the banks from different areas, I think. What can we do about it is pretty exciting. We own -- we, the industry, own basically the primary payment rails of ACH and now real-time payments. EWS, you saw as an industry, what we can do when we launched Zelle. We need to empower Zelle real-time, to be empowered to do basically everything, my view. Personally, I think we should shut ACH off to accelerate the adoption of real-time payments. It's a 50-year-old system that is ripe with fraud, it powers the fintech industry. Largely, you think about it through screen scraping into data and doing a pull based on an account number and a routing code is absurd. That's what we do today. That is absurd that we allow that to happen, but that's, in fact, how all these other payment apps work unless they go over the debit rails. So I think we can get control of that. Some of that is safety and soundness, some of that's regulation, some of that is the way we work to offer a much better experience to our clients than we can do today. PNC's involving in that? We need the engine, and we keep talking about real-time core and micro services and our payments engine. We need to be able to take advantage of all these things in the moment. So we can't sort of do a 3-year build to be ready for this. I want to be able to go instantly on every one of these things. And we have that capacity with our backbone to be very fast as we see this move around to empower our clients to use.

Can you just spend a second on disintermediation on the corporate side? I mean I'm thinking more small -- definitely small business, middle market business because I was just listening to PayPal and it's interesting how they talk about the fact that most small businesses, now their first point of interaction is with a payments company, it's not with a bank, and that's very different to the past. How do you think about that? I mean is that a concern that you have? And again, how do you respond to that?

Yes. It's a big worry. Shopify taught us how to do it. Basically, you build an ERP system and add banking on as an afterthought. And they're right. They made setting up a small business, running a small business, very easy. So if you're a bank, today, if you want to use payment services from a bank, it's go to the branch, fill out a lot of paper, go through all that stuff. We need to automate that whole thing, and we're far along the process of doing it where we could just do an electronic integration in the same way Shopify does. We need to have a [ payback ] upfront. We need our own merchant network. We need payment gateways, all of which we have are in the process of building to be much better at that. We have the old school for smaller merchants of business banking is going to be a lousy business if all you're left to be as the dumb capital that's associated with small business lending. The other thing, and I mentioned this earlier, is as you move slightly upstream, our larger TM offerings, so much more than a Shopify-type company would offer. Have the -- they're already in effect fully integrated to the ERP system. So Shopify built an ERP system, we can integrate into the big systems for larger companies. Basically, you choose which version of our TM service matches your operating system and turn it on.

And then, I guess, the last question on this whole disintermediation subject is, is it [ bringing ] the lack of a level playing field? I mean how real is that? Is that something that the banking industry is overemphasizing from your perspective? And again, how do you think that evolves given that you've got all these new regulators coming in and they're going to be probably looking at this with a different perspective to...

Some of it can be changed by regulation. Some of it, frankly, will need to be changed by law. But this basic notion of same activity, same regulation, I think, is real and embraced by the existing regulatory bodies. And by the way, embraced by [indiscernible] in the house. So it's just how do we go about doing that? I mean some of it is very obvious. You see certain fintechs who make their living off of [indiscernible] interchangeables. That shouldn't happen, right? That's got to change. Regulation on who should get a Fed bank account and how they should be regulated, where they should be responsible for AML and know your customer, all that stuff's basic stuff that I think changes through time. And partly, it takes the size of this nonregulated base to get large enough that people start screaming about it, and that's kind of what's happening now.

Okay. So let's talk a little bit about credit and capital. So very, very low levels of delinquencies across both for you but also across the industry. So a couple of questions. I mean the first is, are there areas within your portfolio that you're watching more closely? And then secondly, do you think that interest rate normalization is going to prompt some sort of credit normalization? Or do you think that 2 are going to be disconnected, just given the health of corporates and consumers today?

Yes. I think they're going to be somewhat disconnected unless we see a bit of runaway on rates. I think on the corporate side, they're largely hedged against this, consumers are flushed with cash. I think it's going to be a fairly lengthy period of time before you see structural increase in delinquencies. I think we continue to live with some of the problems we knew we had as an industry, so more office properties, hotels have come back a bit, but they're still struggling, retail is probably heft and gone. So all those things we're going to know about the reserve for and then it will play out through time. The other stuff I think will kind of play out through a normal cycle, except for the fact people are flushed with cash and could afford it at the moment.

Okay. And then capital, you've got a lot of excess capital. How are you thinking about the value of buybacks today relative to dividends, relative to really the opportunity to redeploy that capital into the business, given the opportunity set over the next 2 to 3 years? And I appreciate even all 3, but has the waterfall changed over the last year?

Look, I think a higher focus on dividends, just given where valuations are at the moment. And we've always had a focus on, let's call it, fintech for a second, but buy-on capabilities that build our brand promise and our services we can offer to clients. Buyback is always going to be there. We have a lot of capital. We generate more capital than we can intelligently use in our own business. So we're going to be in buyback. But at the margin, just where valuations are, ourselves in the industry, you'd probably weight them less than you do dividends and some other things.

Okay. We've got a few minutes left. So let me ask an operating leverage question. And I think that the market has got your efficiency ratio moving from, let's call it, mid-60s into the 50s over time. Do you agree with the view that the market has on where your efficiency ratio can get to? And maybe you can talk a little bit about what you think the longer-term efficiency ratio looks like, just given the acquisition you've made, given the shift to digital, given the fact you've got a lot more scale. And given the fact that, frankly, look, interest rates do look as if they are poised to increase quite rapidly from here?

So the math is the math and the market is right. If you run the math forward, the business we ought to generate our ability to control expenses, we'll have positive operating leverage and our efficiency ratio will improve through time. I never know -- I don't have the crystal ball on what can be new 3 or 4 years from now, but in today's operating environment everything else the same, yes, we ought to get there. I'm looking at Rob here -- am I allowed to say more. We have an issue with whether...

Yes, you are doing well.

Am I allowed to say more. We have an issue with whether...

[indiscernible]

Okay. Great. Okay. Just see, I've only got a few minutes, okay? We take a -- I think we have time for 1 question. So go ahead.

[indiscernible]

So let me just repeat the question. So the question is around real-time payments and what it means relative to ACH from -- so...

So real-time payments do come with an information layer. So think about today if your corporate, you get settled at the end of the day on a batch ACH bucket of cash that's on your balance sheet. You actually don't know how to apply it. You traditionally have a whole bunch of accountants around that figure out how to apply that ACH against the receivables you had. In real-time payments, the payments show up and they actually both show what they're for in an integrated treasury management system, actually self-clearing your ERP system. So that entire partner goes away, which is the benefit to clients. And the reason why ACH should eventually disappear. Real-time payments in the consumer space is something different. So we use the same rails and we integrate the directory from EWS and Zelle through the clearinghouses real-time directory, that all of a sudden gives an ability for corporates to both pay money. So think about gig workers who want paid in the moment or insurance claims, all through the same directory, all real-time as I go, but importantly, also allow the ability to request for payment, which is incredibly important. So the old school where you used to do your bill pay and you'd list AT&T as one of your payees, today, AT&T texts you and say, "You have a $30 phone bill, do you want to pay it?" Yes, through Zelle I pay that. So the whole way that system works changes fundamentally over the next couple of years.

Okay. I think with that, we're actually out of time. So Bill, thank you very, very much for joining us.

Thanks for having me.

Looking forward to seeing you next year. So thank you.

Yes. Thanks a lot.