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

Here we go. Next up, very pleased to have PNC Financial. We could put up the first ARS question as everyone takes their seat. From the company, we have Bill Demchak, Chairman, President and CEO. We've got Rob Reilly, CFO in the first row; Bryan Gill, Director of IR, next to him. Bill, thanks for coming this year.

Maybe to begin, we just talk big picture macro expectations for the economy. Rates may be peaking, inflation may be starting to moderate. Just maybe talk you through your expectations this year, maybe even next year, soft landing recession. I always appreciate your views there.

Our official forecast at the moment, we run all of CECL and everything off of still has a slight recession in there unemployment, still pushing towards 5% towards the end of next year. Although, I would tell you that the team is starting to lean into this soft landing a bit with the recognition that the tails or at least the one tail off of this soft landing could still be pretty severe, given some of the macro risks around the world. Our expectation, I guess, is rates have likely peaked here in the front end. Maybe there's one more move. I think we're still on the notion of kind of hire for longer. And I think the forward curve is finally caught up with that. So on a rate view, I'm largely in agreement with what we're seeing right now on the front end of the curve.

Got it. And we've been reading headlines from recently tellers that things are potentially softening from the consumer spending standpoint, due to loan payments resume next month. Can you maybe just talk to just how you think about the overall health of the consumer and their ability to meet financial obligations.

It's -- look, it's normalizing. It actually still isn't there, notwithstanding, we've seen growth in credit card balances. We've seen excess savings decline, but in all buckets are still appreciably higher than they were pre-COVID, if you measure that in terms of days of coverage of expenses and so forth. We've clearly seen a change in spend to -- it's showing up in some of the retailer numbers to more of the staple goods as opposed to the kind of nice to have. With respect to student loans, we've done a quick look at it. I think we have 10% of our retail clients who have student loans outstanding inside of that, we have more than half that have more than 12 months of payment coverage in terms of their normal outflows of their accounts. So I'm not sure we're sweating that at all.

Makes sense. If we can put up the next ARS question. I'm going to move capital earlier in discussion than maybe some others just kind of make sure we kind of spend some time here. I'm sure you'll have some views. I imagine you read the 1,100 pages of Basel III endgame over this summer. Any kind of initial thoughts, anything surprise you?

I actually did read it. Look, in the end, it's not a surprise to us in terms of the outcome. I don't know if I'm allowed to answer this question, but we're -- if I to answer it, I would tell you it's number one.

Really? So the buy side things up 15% to 20% and you think it's more flat to up to 5%?

Yes. Most -- so in simple form, if we mark-to-market today to the best of our knowledge, and we're digging through some of the details, we'd go from a 9.5 print at the under the old Basel to a 7.5 print. So a 2-point drop inside of the 2-point drop, it's probably 1.6 in change from AOCI and the rest is a mix between sin bucket and a little bit of op risk offset by credit risk down. So it's not a huge deal. I mean the basic proposal, I guess, there's a lot of things you could tweak at the margin. I think they're going to have to do something about mortgage. I think the assumption that you can't do investment grade middle market with not a public issuance is illogical. I think that the biggest issue with the whole thing was they basically set a target to just increase capital for people and eliminate tailoring and then shoved in some cases, nonsensical formulas into something that cause an outcome then I think there's parts of that, that will need to be rethought. But if it isn't, we're fine.

So all right, actually, so a little bit better than I think people were thinking. Maybe just talk to against that backdrop and how do you think about your target CET1 level? And how -- you need to be there and just how you think about share buyback?

Yes. So, so many ways to answer that. We've operated call it, between [ 8.25% ] is a target. We've kind of always never gotten down to our target. We're sitting at 9.5% today. By the way, with the phase-ins on this thing, we'll be over 9% our best expectation, absent a lot of buybacks, the whole way through the phase-in period. Our presumption here is that we'll have to run at somewhat higher capital, haven't figured that out yet, at least for the near term, both because of rating agency reaction and also just uncertainty in the market. Theoretically, we could actually run lower just because they put the op risk capital increase stress test or draw down all else equal could be somewhat less. We're not going to do that. But practically, you could, I think. So we're in a period of time right now where I think you -- because of the uncertainties that still exists, you build capital. We're in a position where we don't have to change a thing in terms of our operating model to comply with these rules, which is a good place to be.

So it's interesting because one of the things that we've heard from some of the other participants is this RWA optimization. Does it maybe allow PNC to go more on the offensive? Or just how do you think about RWA? Or is there stuff you still want to do against that Basel proposal?

Look, we'll play it through. But I guess I would just say, if you're -- if you were adding assets to your balance sheet simply because you had excess cash, that was probably a mistake, and now you're trying to subtract them. We've always kind of focused on client-based assets, and we're in businesses we like to be in. And yes, we continue to grow them. I mean just to give you an example, indirect auto, a lot of people have been getting out of indirect auto. Prices got really tight in indirect auto. So our balance has declined from the better part of the year. Everybody gets out, spreads go mile wide, and we're in there and making money. So I don't -- we don't have to -- nor do I want to mess with anything that we're doing. We chose our businesses and our balance sheet carefully.

And then long-term debt requirement, we got the -- I guess, I won't say the final proposal, but the real proposal a week or 2 ago. Maybe just help us [ further out ] how that impacts you?

So first of all, it's part of the -- it's one of the few parts of the proposal that I agree with. I mean, is it tailored exactly right, is it set up exactly right? I don't know. But we clearly saw in some of the failures that went through FDIC this lack of debt impacted and increased the loss of the DIF fund. We're at a place right now where we're just under $2 billion short, which is kind of a rounding Air Force. So we'll be compliant in the first quarter of next year at the holding company. The bank level will take perhaps a year longer, simply as we repaper bank notes from the bank to the holding company, so they have longer maturities and also as we take some of the bank level that down and replace it with holdco debt but by and large, we're there, and I think you've heard us talk about the actual amount of debt we'll have being compliant with this is below what we had as a total percentage of our liabilities pre-COVID. So in the ordinary course, we would run with wholesale liabilities that would be in excess of this amount. So nothing for [ out ranges ] put all that into perspective, we issued $10 billion plus out of the holdco so far this year. So it's fine. It landed about where we thought.

Got it. You touched on loan opportunities earlier, but if we kind of look at the H8 data loans trending really down modestly quarter-to-date. Maybe just talk to kind of some of the supply-demand dynamics and also love to hear about spread trends this quarter.

Yes. So C&I has been soft where some of that is just utilization decrease. Some of it is simply people holding off under the assumption, somehow it's going to get better and cheaper on rates. So we haven't seen the normal refi activity that we probably would. And some of it is the margin people being more selective, I suppose, in terms of being willing to take on new cross-sell. The result of that is activity is a little lower. Spreads are wider for our incoming new product [indiscernible] activity isn't high enough to cause that they have a material impact on the spreads of the entire portfolio because it's churning less. Consumer, we've seen card balances grow. Actually, I think we've seen a growth in mortgages. I'm not sure about auto, but consumer remains okay.

I think on the July earnings call, Rob told us average loans would be down like 1% in the third quarter.

Yes, that's about, right.

Maybe on the deposit front, H8 data, particularly x time, deposits are definitely kind of lower quarter-to-date. Just maybe talk about what you're seeing from a balance perspective, pricing mix, all that fun stuff?

So from our guide, we're doing a bit better than we thought we'd do in terms of total deposits so higher rate paid probably a little bit better than what we assumed. The end result of all that is get to sort of updates in the quarter, but likely to see NII notwithstanding loans declined a little better than we thought.

Got it. Maybe we'll put up the next ARS question. But this asked about '24 NIM. While the audience answers that, I guess, on NII, we talked about, I guess, your guidance called for down 3% to 4% in the third quarter. Do you want to provide a specific update to that?

I mean I would just say we're going to be the lowest end of that range, if not a little bit better, maybe.

We'll call it down 2% to 3% which the follow-up question, I think full year NII guide was up 5% to 6% last we checked.

I'm looking at Rob.

Yes, about the same, lower -- the better end of the range.

Got it. And then I guess before we get into next year, just kind of any thoughts in terms of how data expectations are? You mentioned kind of deposit trends a little bit better than expected, how you think that plays out?

We haven't changed our cumulative beta assumption. We kind of said we'd go to 44%, I think, and we're still holding to that. Remember, a big part of this is not just what the beta is but how much is moving from noninterest bearing to interest bearing. We still -- I believe we'll end up somewhere in the mid-20s right between 20 and 30, on noninterest-bearing deposits, but that's where the largest impact on costs show up.

Got it. And then as we begin to think about next year, from an interest rate perspective, kind of what -- if you had your druthers, is it flat to lower rates, higher for longer? Like how are you -- how are you kind of thinking about managing the balance sheet at such a dynamic rate backdrop?

We -- so we've remained largely neutral here. We haven't bought duration for months with most of the impact on our balance sheet occurring from live shortening on deposits, the [ convection ] in the balance sheet. Just recently, we dipped our toe into forward starting and we bought some floors and sold some caps. We hit a peak on kind of that 3-year rate a year forward for this cycle. And it feels about right to me there. But having said all of that, this is still a time to be pretty neutral. What we would wish for is a continual flattening steepen into the curve. I mean, it's been moving the way we expected, and I expect that there'll be more of that.

Got it. And then just looking at the audience response question on 2024 NIM, call it, they have it at 2.55% at the midpoint versus 2.80% in the second quarter. You talked about kind of your rate expectations at the onset. Maybe at what point do asset betas begin to outpace funding cost betas and we start to see NIMs maybe bottom and improve? And just how does that play out during the course of the next year?

There's so many variables in that question, but it's a function of what the yield curve looks like. But our presumption right now is kind of middle of next year, that starts switching. And then NII itself is a function of what we see in loan growth moving up as well. They did better on answering this question than they did on the risk weighted assets.

I guess maybe moving on to fee income. On your earnings call, you talked about a meaningful pickup in capital markets activity in the back half of the year. Maybe provide us an update on that.

Yes, it hasn't happened yet. You've heard this from others. I mean, the pipelines are its larger, larger than they have ever been. But all else equal right now, our capital markets business would probably end flat to the second quarter with some time to go in big pipeline, so we'll see where that ends up. The actual guide was, I think, up 10% or so on total noninterest income. And that number, at least as we sit today, looks to be closer to 5% absent what pulls through the pipeline before the end of the quarter. The pipeline is real. Literally Solebury at this point, has 134 IPO or secondary mandates. I mean, it's like 4 years' worth of work. And Harris Williams has a pipeline that's large as they've ever had. We just need people to start to transact. So it's -- the value is there, it will come. We assumed it would pick back up as you've seen from everybody else this quarter has been pretty slow.

So yes, I mean, so certainly July and August where I think were softer than people have anticipated. It feels like September though, there's a bit more optimism in the air and kind of getting those pipelines to revenues. Have you kind of felt that at all?

A little bit. I mean we just -- we're involved in a deal yesterday, perfect P&C deal where it covered the bank forever. We have -- or the company forever. We have all their TM. They just did a big acquisition, lead on the financing. So -- it will be when it will be. I'm not trying to catch a calendar day, I'm more interested in the pipeline and the realization of the pipeline through time because of the value is sitting there.

That's fair. Maybe just talk -- we'll talk maybe a bigger picture. Maybe just talk about some of the opportunities that you think you could drive fee income forward?

Well, look, the absent, the cyclical fee income that we're missing right now from capital markets, we'll talk about that in a second. The biggest driver is what we've seen out of our TM business just on its own, but importantly, in the new markets that we entered with BBVA, I just -- I remind you that the cross-sell ratio TM products in the BBVA clients was a fraction of what P&Cs was, and we've closed that gap, but not entirely, nor have we upsold those clients. So I think the growth we'll see in our payments business in TM is pretty impressive. And then this -- we don't get much credit for it perhaps, but the quality of the franchise that we actually have in the advisory business between Harris Williams, Sixpoint, which is a capital fundraising business. And Solebury is really powerful and the pipelines are huge. So eventually, that will come online and bring fee income up.

And then maybe just on expense management, obviously, an area of focus, particularly maybe given some of the revenue pressures that banks are seeing in general. Just talk about how you're approaching that. I know you upped your CIP guide last quarter. How you're approaching that?

Yes. So we upped our guide on continuous improvement from $400 million to $450 million. And by the way, you'll see some of that in our expense numbers this quarter. In addition, you should expect to see us probably in the third quarter call give you some details on a more structural program that will have a direct impact to '24 expenses.

Okay.

No, I don't want to answer anymore.

You got to give us more.

I mean the simple point here is we've been doing continuous improvement forever. A lot of that, as you know, gets reinvested, but it's what allows us to keep our expense growth as low as it's been. We -- even in this year, we're -- I don't know what...

Low single digits.

Yes. And this is something beyond that, is all I will say, and we'll give you some details in the third quarter. But it's an environment where we want to be able to invest into our newer markets and continue to grow them. And to do that, we're going to have to save elsewhere and save to the bottom line just given the revenue pressures.

We had one bank guest they announced a 5% expense reduction program.

Yes.

Do you want to give us a little bit more now?

No.

I guess when you think about this undefined potential savings that you're going to talk about...

It's really well defined. I'm just not telling -- undisclosed.

Is that something we'd expect to see part of the bottom line? Does that go through [indiscernible] new markets?

Yes. No, that's the -- I guess that's the key point is that there will -- this will fall straight to the bottom line in '24 and we'll still have our continuous improvement and everything else.

So it's real and structural?

Yes.

And I guess more near term, you were talking about stable expenses for the third quarter. Is there maybe a little better than that, given fee income is a little bit soft? Or how do you think about that?

Yes. No. So expenses will come in a little better, net interest income will come in a little better fee, so noninterest income will show up a little bit soft and credit will be -- I'll just say better. I won't say a lot better, but better.

All right. So you won't answer my expense questions, maybe we'll try credit. We'll put up the next ARS question as we go there. But I guess, PNC has always kind of been a good credit performer at least in the last decade or so. Maybe just talk to how you feel about current credit quality and just maybe how you think this cycle plays out?

We keep talking about normalization, but we don't necessarily see any evidence of it beyond what we're seeing in office, and we've talked a lot about what we have in office, particularly in multi-tenant office. At this point, we have, I think, over 7.5% reserves against our total office properties. But importantly, it's like 10.8% or something against our multi-tenant and structurally, we did kind of valuations and cash flow from the bottom up of every property in there. So we feel really good about our reserve. Charge-offs are going to be lumpy. We expect, and as we said, we would expect charge-offs to show up through the financial statements, but be fully reserved for upfront.

I guess the audience got 25 basis points of net charge-offs in the first half of the year probably going to 30, 35 basis points next year probably modest increase. You want to rate on this performance?

That's probably -- for what we know, by the way, we're -- Rob will kick me for this. We're reserved for more than that, but that's probably a pretty good guesses there.

Well, I'm not going to kick him. But I would say, we've always said 40 basis points is normal.

But we've never been wrong.

We've never been wrong. So we might be in a new normal, but probably not wrong.

And then I guess when we're on the topic of credit, obviously, Midland servicing, you see a lot of what's going on in the commercial real estate world in a different perspective. We kind of reading the journal every day, it seems like that -- all those loans are going to 0. But maybe talk to kind of what you're seeing, what you're thinking, not on TNT's balance sheet, but for the sector overall?

I mean there's been more news written about that is actually happening is, I guess, the simplest way to put it. Now we expect that there's going to be a lot of pressure. But before they get there, you got to remember all the leases that were in these properties that may or may not renew need to burn off and some of that's happening, right? Then you need to get to the end of the life of the loan and then it needs to get put to special service into Midland. So this whole workhouse situation that's going to occur through office in particular, in B&C Properties and office, a lot of which are in CMBS is just going to be a small part but taking a long period of time. But we do expect there to be fairly material losses. Again not for us...

I understand.

Within the CMBS market.

I guess the fee income opportunity for you?

Yes.

There's this notion that the industry needs to consolidate further, anything the regulators are kind of holding up at the moment. But I guess on M&A, do you think we'll see more deals? Or do you think it's difficult to get done? And how should we just think about that?

So I mean the regulators basically just said told us this price wins, right? They've gotten rid of tailoring and we saw a deposit flight after the March period of time. Having said that, and I should also say, inside of that, we think we are a good acquirer, right? We've proven ability to merge systems and do conversions and save money. However, the current market has gotten way ahead of itself in terms of assumptions about what we might do and separately, the franchise value some of the people who otherwise might be attractive to us. So the economics just don't work today. And for anybody, I know there's a lot of people who are talking about whether Bill Demchak forgot how to do math, you should assume I'm still really good at math, and we to do something, it would be similar to the deals that we've done in the past that add value to our shareholders.

All right. So I guess -- so assuming over the next few years, the math becomes a lot more palatable as some of these marks dissipate just with the notion of time. At what point do you think the regulatory environment will kind of allow you to do something?

I think the regulatory environment would allow us to do something right now. I think what happens over time, I know everybody is still hung up on the marks, if the marks are pure rate marks and not credit marks, those things pulled apart. That's a different use of capital than spending as a franchise multiple. But I'm just buying bonds. I'm going to use capital to do it, they're going to pull apart, they're going to give me the capital back. That's a simple thing to do. Problem is right now, the franchise value long term for somebody who basically needs to go through the elimination of tailoring and the risk management stuff and all the tech spend and the deposit flight, I just, I think they're too high, independent of what the bond marks.

All right. Why don't we pull up there and see if there's questions from the audience. I see one in the back and one there. We'll go there first.

You mentioned your domestic strategy, but could you perhaps elaborate on any international strategy in Canada, U.K., Europe?

Sure. The simplest way to think about our international strategy is we need to provide all the products and services that our domestic clients need abroad. So think about that in terms of TM capability, deposit licenses, payments capability and so forth. We have -- Canada is a little bit different because we will lend locally and we have asset-based lending up there. In the U.K., we also have a small asset lending franchise, which is quite specialized and somewhat isolated. But beyond that, the U.S. is still really fragmented in terms of the C&I market here, and we have a proven ability to gain share in with very good economics. So we don't have any intention to pick a fight internationally when the playground in the U.S. is wide open and we can win.

I think I heard you say that you agreed with the proposal for more long-term debt to be issued. I mean just thinking through Silicon Valley and just to watch with cash, really know where to deploy it. I mean if you have this wave of subordinated debt that gets issued, where would that go on a bank's balance sheet when you don't have demand for credit?

So you're conflating 2 different things. With Silicon Valley, they had a lot of deposits that they tied up in long-term debt. So really bad rate move. Had they simply taken the deposits and put them on deposit at Fed, they had a real liquidity management structure. They would still be here and be fine. I think the issue what we've seen when there is -- I mean we saw it particularly with a rate cycle, rates go up, everybody has a tangible issue when they bring balance sheets over to mark them to hit to the DIF fund because nobody has excess equity to be able to assume one of these defaulted banks is severe. And I think that provides that -- I also think in the ordinary course, Silicon Valley was a very unique animal in terms of the amount of operating deposits, uninsured deposits that they have in the ordinary course, as we said before. Our own debt structure would have us just the way we would fund our balance sheet would have us have this amount of debt or more in the ordinary course of doing business, right? So where we ever to go into resolution in some way, shape or form, that would be to protect the uninsured depositors.

Anything else from the audience? I guess while the audience is thinking of more questions. Bill, you just touched on kind of -- we talked about Basel and long-term debt. And then maybe your kind of thoughts around changes to potential liquidity [indiscernible] Category 3 banks, as you manage the balance sheet, does that kind of play [indiscernible] all?

We are exceptionally liquid at the moment. Notwithstanding that, they're clearly looking at uninsured deposits, operating deposits within that different forms of operating deposits and their live assumptions. They're looking at how federal liquidity programs might become more commonplace. We've turned the home loan into sort of the lender next to last resort. Maybe that's not a good place for them to be vis-a-vis the Fed. So all those things are out there. We're set up for whatever it is it would otherwise have us do.

Got it. Any other questions? I guess, Bill, I always kind of like to get your thoughts on this. But what do you think will be the catalyst again investors more excited about kind of large banks and kind of where do you think PNC will stand out over time?

I mean, look, some of the uncertainty you thought it would have been settled with the new capital raise, we'll see that's going to play out. But it's been a year of continual negative surprises for banks, rate environment, deposit flight, capital rules, so on and so forth. We do find through all that. The biggest thing that I would get excited about, I am excited about being PNC is we're not out there deconstructing our bank right now. There's a lot of people who are completely having to change what it is they do and react to being undercapitalized or not have enough liquidity and focused internally as opposed to externally. We're outgrowing clients and growing our business. We have great fee businesses. We have this massive opportunity in the new markets that we're going into. TM cross-sell and then a huge pipeline in the capital markets business that will show up. I just can't tell you when. So I mean I love where we sit right now. And as I said, one of the -- whenever there's an issue inside of the banking industry, some banks can go on offense, and we're one of those other banks are on defense trying to figure out how to optimize what it is they have to be able to survive to fight the next day. And we carry the momentum we had with us as we go forward.

Questions? I was hoping someone is going to ask him about his structural efficiency program because I can't.

Stay tuned.

I guess, Bill, you -- with the BBVA deal, you've got the cost saves integration, I feel like record time with that. Obviously, revenue synergies come further out. Just maybe where are you in terms of kind of bringing those new markets up to where you kind of think they could be? Is there -- what inning, what percentage or kind of maybe put some numbers or flavor to that?

Some of them were more developed for BBVA than our de novo markets, we always kind of talked about a 3-year breakeven on a de novo market, putting bankers and everything in there. A lot of the -- we had a lot of clients that came with BBVA in some of the markets we already had some people in there. So it's offering a meaningful contribution at the moment, and it's growing faster these "new markets" are growing materially faster than our legacy markets on all metrics. And we're nowhere near penetration, notwithstanding that growth rate off of a good base. We're nowhere near the penetration that we are in some of our established markets. So it's part of what makes us great. right? It's right there in front of us for years to come to continue to grow share in these newer markets off of a strong base that we're sitting on today.

Makes sense. Any questions from the audience? I guess, Bill, as we sit here today, I'm sure you're kind of starting the 2024 budgeting process. I guess, beyond your structural expense program, how are you beginning to kind of think about that in light of this kind of dynamic macroeconomic backdrop?

Well, we're just now starting to think about it. I mean a couple of things. We run our bank. We don't change our credit box. We grow new clients, we don't have to optimize anything. We'll grow into the new capital rigs and liquidity rigs without any structural change to how we run our company. So '24 is just a planning exercise for us as a function of where are we going to put resources for the fastest growth rate, we'll have macroeconomic drivers. Loan growth has to come back at some point just to even out and in fact, the stuff that hasn't taken place this year. We're likely to stay rate neutral straight through whatever comes on rates next year and build capital kind of straight through that as well until we get rid of some of these externalities that are kind of beyond our local economy.

Awesome. Super helpful. With that, please join me in thanking Bill for his time today.