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

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Very well done.

Rob Reilly, PNC, CFO. Thank you so much for joining us.

Good morning, Betsy. Great to be with you.

Really delighted to have you with us this morning. I did want to kick off with a strategy question.

Sure.

The reason here is that you're in a great spot given your size, $560 billion in assets. And there's questions here around. How are you thinking about utilizing that size and scale you have? Is there any appetite for potentially expanding more materially over the next several years in either industries, geographies, products, any place you'd particularly like to lean into, and I ask it with the backdrop of coming capital rules and expenses for other institutions that are much smaller than you?

Is that, simple questions?

Yes.

I got it, yes.

5 minutes overall.

Yes, there you go. No, we're delighted to be here this morning. And -- as far as our franchise goes, we're really excited about what we've built over the last couple of years, particularly most recently with the acquisition of BBVA USA, which as you know, made us a real player and entered into the Southwest U.S. market. So we're now officially a coast-to-coast bank national footprint. We're running our plays, our products and services across the United States. And really, what's right in front of us at the moment is the opportunity to sort of harvest all that. Not only in terms of the new markets, but also obviously, the legacy markets that we're in, where we're growing, if not geographically, digitally into deeper and more meaningful client relationships. So I feel really great about our franchise, feel great about the success that we've had recently with the new geographies. Bill mentioned a couple of weeks ago and he was right. Said the revenues are exceeding our expectation in terms of the growth. In some instances, we're up 50% year-over-year. So we've got a lot to do. In terms of expanding that in terms of acquisitions, which is implied in the question, in the near term, not likely to see an acquisition, and that's largely a function of the rate environment, as you know in terms of the fair market value that's required in terms of acquiring fixed rate assets that would create a capital hold that's probably too big in terms of an acquisition. But that's not necessarily going to slow us down in the medium and the long term when things can change. In the meantime, we'll do some bolt-on acquisitions like we've done in our treasury management businesses and such. And we like what's ahead of us. We've got a lot to do.

Okay. Great. Excellent because your scale could deliver more revenue growth?

Yes. And that was largely the plan in terms of our deliberate build-out, not only in terms of the acquisitions that we made, but the technology investments that now that we've been at for some time that is sort of the infrastructure that allows for that scale, and we're seeing the benefits of it.

So let's talk a bit about deposits. It's a hot topic at the conference. Just want to get a sense from you as to how you're seeing deposits Q-to-date as well as give us a sense of the mix and the mix shift that you're seeing?

Yes, pretty consistent. In terms of our deposit balances, so far in the second quarter, we're tracking largely with the H8 numbers. We outperformed in the first quarter. We grew -- we were a bit of an anomaly. We grew both spot and average deposits in the first quarter. So year-to-date, we're a little bit better than the H8 data. Second quarter right on that H8 data as deposits leave the system, but no departure from our expectations. We see some pressure, obviously, in terms of noninterest-bearing going down, which is what we've called for, which is natural at this point in the cycle, largely coming from our commercial deposits. But very much in line with our expectations.

Great. And on noninterest bearing, you were at 27%, I think, of the overall...

That's where we expect to go to, yes, about now in terms of where we're running with the ultimate sort of destination maybe in the mid 20s and there's been a lot of discussion around that. And that's just based on [indiscernible], but that's based on our own sort of extrapolation of history and our business mix and where we think things are likely to settle out.

Right? Because I remind people that noninterest-bearing deposits actually pay for services.

That's right.

And your payments business is quite robust.

That's right.

Right. Okay. At the same time, your deposit rates have been running at a lower level than peers. So you've been able to keep this in line H8 deposit activity with lower rates. Why do you think that's the case?

Well, some of that's just the nature of the business composition and you mentioned treasury management, which is a big provider. So those deposits are serving other things than just simply looking for the highest rate. Beyond that, our deep relationships, diversification in terms of the types of customers, both consumer and commercial. That's a function of that. And also, we don't have a screaming need to grow deposits. We've got a lot of liquidity. We did a debt issuance last week, which is TLAC compliant by the way, in terms of that. So you can raise deposits. We were talking about this earlier. You can raise deposits -- any bank can raise deposits but you're going to pay 4.5%, 5% -- you're going to pay that rate, and that's available to everyone. We don't need to do that as much as others.

And as I'm thinking about what we're seeing with the funding cost changes and the betas there, obviously, the next question is, how are betas looking on loans? And asset -- other asset yield?

Yes, we'll see that. We'll move into that phase. We're sort of -- we were talking about the 3 phases of a rate cycle. The first phase all your variable rate loans, prices up and deposits lag. That's the fun phase. Then we got into the second phase where we are now where the deposits are rapidly catch up at a rate faster than your fixed rate assets repricing. And then we'll get into the third phase when our fixed rate assets do reprice, which is happening and will continue to happen, both in the securities portfolio and our loans.

And on the securities portfolio, is there any changes to how you're managing it given the rate environment that's changed so much over the last 12 months?

Yes. I mean, we slowed down, and we've told everybody that our securities balances, we're not actively investing or growing. We are short duration, one of the shortest among our peer groups. And in terms of our asset sensitivity overall, we're slightly asset sensitive and neutral. So we feel good about our positioning. We're positioned in a neutral way as rates sort of transition. And we're not sure in the near term where they're going to go. But the good point is we're not exposed in either direction.

Sharp uptick or downtick is not going to make a big difference for you.

Yes.

And the other question we get is just on the duration of deposits and impact on duration of securities. Is there anything there to talk about or not really?

No. The only thing I think on the duration of the deposits is -- and it's worth mentioning, is the surge deposits that we received and a lot of others received, we have signed no-life too. So there -- so we never viewed those as core deposits. We never manage them as core deposits. We didn't invest those core deposits. And I think that's important because, obviously, what you've seen in the industry, that wasn't always the case.

Got it. Okay. So let's turn to loans.

Sure.

And the question here is around how you're thinking about loan growth. You've got a pretty decent, I would argue, loan growth that we've seen over the past few quarters. But just wondering if there is a slowdown coming as demand seems to be weakening, but wanted to get your views on that.

So we expected loan growth in '23, and that's happening compared to what we did in '22, which, as you know, was very strong. We called for at the beginning of the year, spot loan growth of 1% to 3%. Average was a little bit higher because of that strong performance in 2022, and we're still seeing that. So some loan growth, not as much as we had experienced, but we're tracking along those lines. If you break it down further, commercial is fairly slow right now. We do expect an uptick in the fourth quarter of this year as we sort of get through some of the doldrums that are slowing down sort of corporate activity. And then on the consumer side, we'll see some growth, not quite as much as the H8 data. We -- most of the growth there is coming through card. We're smaller in card, and we tend to be more prime. Prime customers don't carry as much balances, but we'll see some growth there.

Just on C&I. Can you give us an update on how the line utilizations are trending? Has that peaked out?

No, I don't think it's peaked out. We -- so pre-COVID, our line utilization was always around 55%. During COVID, as utilization dropped, I think we hit down to 47% range, 47% or something. And we've worked our way back up in the last year or so to around 52% or 53%. So we're still a little bit -- couple of percent shy of normal per se. But importantly, that 52% or 53% has been pretty steady -- pretty steady over the course of the last year. So line utilization has been flat.

So, you're back to normal?

A little below normal. And we could see close tick there. And that's part of the thinking in the back half of 2023.

Okay. I think Bill mentioned recently that you're seeing spreads widen out as well, maybe 100 bps versus a year ago.

Year-over-year. Right.

Could you talk about where that's most pronounced? And does it make you want to lean in more to whatever asset class spreads are widening in?

Well, yes, we'd like to lean into wider spreads. That sounds good to us. Now I think that's been coming for some time. And we were calling for that even in the last half of last year, where the market conditions were such and the public debt markets were such that wider spreads were justified in terms of the risk and the return, but the banking market just wasn't delivering it. Because there was a lot of supply out there. So I think this has been coming for a long time. I think it's encouraging. I think it's sustainable. The downside just is we don't have a lot of volume right now. So it's not making a big dent in it. But I think it bodes well for us going forward as we couple that up with some ultimate loan growth in the next couple of years.

Okay. I want to turn to commercial real estate.

Okay.

So you are in a unique position amongst folks we cover given that you own Midland loan services, right? Commercial loan services. So you really see...

That's a service, yes.

You see what's happening on the ground Yes, we do. So can you give us a sense as to what it is you are seeing and how you're reflecting that in your own book?

Yes. So, so far, it's pretty quiet. We've seen some elevated levels in terms of some special servicing, but nowhere near our expectations in terms of where we thought it would possibly be at this time. So that's encouraging. Deals are still being taken out and recapitalized, which is encouraging. In terms of our own loan book, we went to a pretty good detail -- or into pretty good detail, rather, in our first quarter call in terms of the breakdown where our focus is within the office space on the multi-tenant properties. We are among the higher reserved on commercial real estate and inside that office. Importantly, that's not a reflection of we think that we have a higher risk book. In fact, we think we may have a lower risk book than average, just simply reflects our expectations in terms of what might happen.

And so when you're talking about the reserve, I'm assuming that that's a function of what you might anticipate roll rate risk might be. Is that there?

Yes, yes. Well, obviously, there's a lot of dynamics to it in terms of what we think we have real time. The message we wanted to get across was that we weren't relying on a bunch of old appraisals that suggested loan to values much lower than, in fact, they are real time. So it's a dynamic process. The good news for us is it's a relatively small percentage of our portfolio. It's a hands on. We know the deals. So it's not some giant portfolio that we're just extrapolating some assumptions on to it. It really is a case-by-case project-by-project analysis.

And it's interesting that the stress you're seeing in Midland loan services is actually less than expected...

It is less than expected. Yes. No. It is.

Demand for yield, I would guess, from the people that are...

Yes, I think so. Yes. And there's a lot of money out there looking for appropriately risked and appropriately priced deals.

Okay. Last thing on loans is the consumer portfolio. Can you just give us an update on how you're thinking about that?

Yes. I think on the consumer side, we touched on this. We tend to be more on the prime. But I think the bigger story for us is a multiyear story within our consumer book. We've historically been undersized, more oversized commercial. But with the franchise that we've built out, so that -- we just talked about, we have close to 11 million consumer clients, the bulk of which still borrow away from us and that all else being equal, would borrow from us. And we're seeing that and that's nothing new. That's something that's been in place for a while. So we see sort of this core underlying growth in our consumer balances, which is encouraging, which is just reflective of our franchise sort of normalizing out. So we'll see slow, steady growth there over multiple years. That's our plan. And to the extent that we can dial up appropriately risked assets in some of these new markets, that will be a plus.

Can we talk a little bit about the fee lines, in particular, treasury management, mortgage and M&A?

Yes, sure. Well, now we're not going to run out of time before you ask me about guidance, sorry.

No, no. We still have....

Maybe that might be a good shift if I go into that -- if I into some of the categories if you'd like.

Oh, for sure. I think that's a great idea.

But I don't want to -- I don't -- you got a lot of questions there. So you've now where you want to go.

No, no. Dealers choice.

Dealers choice. Okay. Why don't we do that? Just -- because I know people aren't that interested, but to bring the drama down, the second quarter is largely shaping out like we expected it to play out. Couple of parts, obviously, moving in that. Importantly, NII is right on our expectations in every way in terms of deposit balances, loan balances, deposit rate paid, betas right on our expectations. On our fee categories, which I'll go into a little bit. We're a little bit softer there than our expectations back in April. Bill mentioned this a couple of weeks ago. We had said maybe stable to down. We're probably down 1%, we'll probably be down a little bit more than that, all of that coming from capital markets, softness in capital markets, which is not a surprise knowing what we know now in June. But in April, we expected a little bit more, and I'll circle back to those fee categories. Expenses are right in terms of where we expected and credit is a little bit better. So all in, tracking largely within our expectations. On the fee businesses, the good news with our fee businesses is that they're big businesses in and of themselves. So we have grown those as part of with our franchise. And just in the order that we report them. Asset Management business continues to do well, better than what we expected at the beginning of the year, largely driven by the equity markets, which have outperformed everybody's expectations. Importantly, in terms of the asset management business, a big part of it is building out our franchise into these new markets because BBVA USA didn't have a big wealth management business. So a lot of what we're doing there is sort of organic hiring, building out the teams, which has largely happened in running our plays. The next category is our capital markets business, the largest component of which is Harris Williams. M&A, after having several years, great years, has slowed down a bit. We saw that in the first quarter, second quarter running somewhat similar. The issue with M&A when we get into these transition times is if you're selling a company, you want yesterday's prices, and if you're buying a company you want tomorrow's prices. So -- but I don't need to tell Morgan Stanley about that. Do I? You guys could probably help me out with that. So there's -- we need a little time for everybody to get back on sort of the same level. Some of the softness that we're seeing in the second quarter goes beyond that, another big driver in our capital markets is our loan syndications where we arrange large loans and then syndicate those with less corporate loan growth. There's been some less of that. The next category in terms of our card and treasury management, that's our Steady Eddy. That continues to grow. That's a high single-digit growth business for us on an annual basis, and that's going to continue for some time. The lending fees, deposit fees, pretty stable and then mortgage is soft, but we expected that to be the case. So the fee businesses are all doing well. They're all addressing the short-term issues there. But importantly, they're a big part of our franchise and a big part of our expectations for growth over the multiple year period.

All right. I do just want to lean in treasury management a little bit because of a rate environment should be supportive and be the digital capabilities you have.

Treasury management. Well, treasury management is our highest profile business. It's our largest fee component. It's something that we've been at for a long time. And we're recognized across the industry as being one of the leading industry providers. It's been supported by years and years of technology, everything that's going on in terms of technology, in terms of advancing and accelerating payments and receivables we're doing. And it's an important business to us. So we invest considerably in it. We apply it regularly. And not surprisingly, it is our most successful product in terms of new relationship generation.

And you've got some nice sleeves in there, too, in particular, health care, right?

Yes. Oh, yes, lots of verticals in there. And like I said, it's the best way to initiate a new corporate relationship because typically speaking, virtually every company that we run into, there's a treasury management product or service that they could use.

That's great. I want to leg into the tech question then since tech investments is important for treasury management. And I know -- but the first question here around tech is the fact that you have spent the last couple of years retooling your own core systems. And maybe you could give us a sense as to how far along that journey you are and put it in the context too of where that's driving your annual tech budget?

Yes, sure. So you know I mean how many years have we been doing this, Betsy. We've been doing this...

14.

Yes. Well, I might not have been to all 14, but I'm close to 10 of it.

You mean this conference?

Yes. We've been at a pretty aggressive build-out of our technology infrastructure over that time period. We completed the infrastructure part a number of years ago. And even though the dollars in terms of what we invest continue to expand, most of that's now going into customer-facing development applications, largely within treasury management, but not just limited to treasury management. So we're sort of in the fun part of it all. But technology is going to continue to be a big driver of our industry. It is a key differentiator in terms of becoming even more so in terms of providers, either you have it or you don't have and it's expensive. In our case, we say our tech budget is $2.5 billion a year, about 12% of our revenue is growing each year double digits. I'm the CFO. I'll take the over on that number because that's our line item in terms of technology, but what is it that we spend on that isn't technology. So I could say it's a lot more than that. But it is a priority for our company. We had a proof point. We had a favorable proof point because everybody says, "Oh, we spend a lot on technology, and we're the best in class." We proved it with our BBVA integration and conversion literally fully integrating within a 4-month time period, lifting their tech stack and putting it right on top of ours, which at that time was record timing. I don't know if anybody has broken it since. But it gives you an example in terms of the capabilities that we have on top of what we've already invested and why that has been differentiating for us.

And I do have to ask the question about AI. As it relates to tech, just is this something that you're thinking about? How are you going to leverage it? And what parts of the business are you most eager to employ it?

Well, we were doing AI before AI was cool. So we've been at it for a little while. And we've seen some gains. Principally where we apply it is in customer service where -- that's come a long way. Fraud -- our fraud AML work, a lot of AI, which is perfect for AI because it's large volumes of data being able to see patterns and then some of our regulatory reporting. Within finance, we've got pilots going on in terms of accounts payable, accounts receivable. It turns out in finance AI requires more people than you think. That's somewhat my attempted humor. So what are all these people doing here? I thought it was just going to be computers. So yes, so we've got to work through that. We're in the early phases there.

Got it. And is that just a function of, hey, you need to train the system.

Yes, that's right. In all seriousness, there's real application within banks. We've been at it for a while, and we'll continue with that.

So it's more of a gradual impact as opposed to [ step ] function.

Absolutely. Yes.

Okay. Very good. Let's just turn to credit, and you mentioned in your guidance update for the quarter, a bit of a change on the...

Credit is good.

Yes. Okay. So let's talk through what's going on there?

Yes. So far, what we're seeing across all our portfolios is good credit performance even within CRE in terms of actual charge-offs or anything along those lines. CRE is obviously on the main stage in terms of everything that we're looking at inside of that office and inside of that office is a multi-tenant that we've talked about for a good bit. So well, we think we've got adequate reserves there by definition in terms of where we are. Outside of commercial real estate and commercial, very good. A little bit of concern around big box retailers just in terms of those entities that are selling goods as the consumer shifts from purchasing goods to services, maybe some vendors and suppliers of those big box where there's some outsized inventories, but nothing terribly flashing red. Health care, to a lesser extent -- and that's health care providers, which is still sort of this tight labor market and the concerns -- around the inflationary concerns around that. But generally, very good. And then on the consumer side, again, we operate on the prime space. Credit quality has been very good. We'll see some normalization around some delinquencies but nothing that's alarming.

So we all try to forecast credit, right, in our models over the next few years...

Yes, yes, for people requires it.

Exactly. So how are you thinking about where the credit cycle goes. Where peak [ NCOs ] go and...

Yes. Well, we'll probably see -- and so in terms of our reserves, we're just under 1.7% -- 1.67%, and we think that's the right number in terms of -- we don't see big shifts occurring there. We could see some elevated charge-offs. We've talked about a normalization of charge-offs that were not there. We had, for the last 10, 20 years, 30 basis points. And if you go longer, 50 basis points. So we're below that. So we could see some normalization occurring. We've been calling for that now for, I don't know, a couple of years. But importantly, we're running a pretty high reserve ratio. So charge-offs do go up. In many instances, it will be a reflection of what was already reserved and the economic hit already taken.

Okay. Got it. Feels pretty...

Yes, it's good. Credit feels good.

Right?

Yes.

It's interesting just because the cycle we have the inflation as headwind, but then still we're sitting with excess savings on the...

There's a lot of anomalies going on in that regard. And we've got tight employment. So is there a possibility of a recession with full employment, I don't know. We'll see whether that exists. But as it relates to credit, with the exception of CRE in the office space, which is legitimate concern, looks good.

Okay. So 2 other topics, expenses and capital. You've got a goal of $400 million in cost saves for '23 right? Maybe you could give us a sense of what you're doing to drive that outcome? And are there any risks to achieving it?

So that $400 million number is what we call our continuous improvement program, which is a program we've had in place for as long as I've been CFO, and hopefully, after I'm CFO. So we've become very good at it. And what it is, is it's an internal muscle where we take a look in terms of our budgeting in terms of those savings that we need to extract for prefer efficiency purposes to be able to apply against our investments, largely technology. And that's one of the ways that we've been able to keep our actual expense levels and growth levels down because we sort of self-fund what would otherwise be growth. And we've gotten good at it. It's an annual part of our process. It's across the entire company, and it's averaged out to be just about 3% of our spend. So that's how we get to that $400 million number. We're dead on track for it. I fully expect to realize it, and we'll keep that continuous improvement program in that muscle going in the future.

Okay. And no one area really feeding that?

No. It's proportional across the company, which is great. Naturally, where the costs are higher in absolute dollars that we expect more savings. So the retail side of the house generates more savings, but proportional to their part of the expense base. And like I said, we're good at it.

And is there anything in the branch network? Is that what you mean when you're talking [indiscernible]?

Yes, the branch. Well, the branch network in terms of taking out some of the expenses in terms of the efficiency of the delivery, the multiyear strategy in terms of converting a lot of our branches to: a, optimal places; and then b, optimal configuration, which -- and again, this has been happening for some time. It will continue to happen, where the focus is less on the transactions, the day-to-day transactions, which can be accomplished through ATMs or digital means and more of the high touch. So that's a continuation of that process, not anything big right in front of us.

Right. Okay. I'll just see if there's any questions in the room before we...

We forgot about capital.

No, don't worry. I have my final follow-up. I'm just seeing if there's any questions that people want to go to. All right. So on capital...

No questions?

No. There appears to be no questions. All right. My last question here is regarding, yes, where you sit right now with your CET1. It's at 9.2%, right? It's at the high end of your target range. It's above -- your range is what?

8.5%, as currently defined.

Right. So I guess there's a couple of follow-ups here. One is, how are you thinking about the rule sets that are coming your way? And do you have any sense of the timing? What's your thoughts on CCAR? And just give us a sense as to how comfortable you are with this 9.2% and why -- where we think you should be trajecting from here?

Yes. Well, I think if you take a look. So there's a lot of proposals out there. And generally speaking, it's our expectation that the capital requirements would be going up for all the banks PNC included. How much and where and how defined, I don't know. But there's obviously a lot of speculation around not only the SCB in terms of the stress tests that are occurring right now. But then on top of that, defining capital regulations that may include AOCI and some way shape reform, which for us is a Category 3 bank, today is not in our CET1. And then there's this concept of operational risk that will be part of the RWAs that would obviously require some more capital. So lots going on. It's our expectations. We'll certainly our strong expectation that the CCAR results will stay on the schedule, and we'll get those here at the end of the month, which will establish our SCV. And then beyond that shortly after that at least is our expectation, we don't know. But that we'll receive a notice for proposal for some new rules that contemplate the AOCI and the operational risk component. The way that we look at it is right now, our CET1 requirement is 7.4%. As you mentioned, we like a management buffer of about 1 point, so we say 8.5% is our operating guideline, and we finished the quarter -- the first quarter at 9.22%, as you pointed out. So we're starting from an excess cash or excess capital position. So ultimately, wherever we need to go above that, there will be a shorter route for us than it had we've been simply as said. I think the important part though for this morning or for this conference is that -- and I think you know this, we have strong capital-generating capabilities through our core profitability. We have got diversified businesses. We're profitable. So our ability to accrete capital to whatever extent is necessary. We can do in pretty straight order. The AOCI, if that is included in the new capital requirement, we burned down pretty fast. We've got -- as we've talked about, we've got pretty short duration in terms of our securities portfolio. So we'd expect that to accrete back to. So wherever we need to go, we can get to and we'll be just fine.

Okay. Because you will have time with the new...

Yes, that's the -- well, the expectation is obviously that they'll be a transitional period, which should be sufficient. And there's potential for tailoring within that for some of those components which we would expect to show up at least in part. But we'll have to see.

You've been really efficient with the time, so I can give you back...

Oh. Excellent. Excellent, Betsy. Always a pleasure to be with you.

Thank you so much, Rob, for joining us today.

Thank you.