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

So it's 1:00. We're going to get started. We're delighted to welcome CEO and Chairman of PNC, Bill Demchak. Rob Reilly is here as well, sitting in the front row. Rob, good to see you. I think, Bill, this is your ninth time at this conference, I believe. So...

That sounds right.

So thank you very, very much for coming so consistently. It's really a pleasure. I think you're going to start off with a few slides, which I think is different this time around.

Yes, it's something different. I thought we'd start off with just a couple of slides because a couple of key points we wanted to make. And if I step through those, and feel free if you want to interrupt me as we go through some of this stuff, but I'll just lead off with our forward-looking statements. I'm not going to read them, but they're on our website. And what I wanted to jump into and we're going to cover here in a handful of slides are 2 big topics on everybody's mind. What's going to happen to net interest income? And then what is happening or will happen inside of credit? And for NII, the dialogue has shifted to when is the inflection point. And by the way, on this slide, we're -- we show what's happened in 3 phases back when -- or 4 phases, actually, back when interest rates were 0. Wasn't a fun period of time. Rates start going up. That's a wonderful period of time because you lag deposit pricing. Deposit pricing catches up, so we've had 3 or 4 quarters of declining NII, and we're about to trough at some point, and we do this as a thick line because I'm not sure if we're going to trough in the first quarter, the second quarter or the third quarter, but what I am sure about is that we are going to trough and we're going to climb out of it and produce record levels of net interest income in 2025. Now we drew a couple of points here. The first is, at some point, everybody's going to trough and there's debate about that. And I'll go through our deposit repricing assumptions inside of some other assumptions here. But the second point is when NII starts to climb, the pace at which it climbs is going to be a function of your asset repricing. So your known fixed rate assets that basically mature that you reinvest. And I'll go through some proof points on that in a second. But inside of this chart, when we compare ourselves to peers, we think this repricing will happen faster and henceforth, lead to a steeper curve. The other thing just inside of that, just the assumptions, we're assuming here that we have 2 rate cuts at the end of next year, and then we have I guess, a 0.50% and 0.25% into 2025. We're also assuming that we continue to get deposit cost creep, even though our assumption is the Fed is done. So we expect betas to continue to climb. I think history would say they go up by 1.5% or something, 1.25% post the Fed stopping raising rates. And we would expect, and as also forecasted in here, a continued shift, albeit slowing down from noninterest-bearing to interest-bearing. We may be wrong and conservative on this. To be honest with you, I'm tired of chasing NII forecasts. So if we're conservative, so be it. But the key point on this chart is whether it's first quarter, second quarter, third quarter, we're going to climb out of the hole and actually end up in a really good place. If we go -- if we look at just drivers on how we get comfortable for this, the asset side of it's mechanical, and this is all disclosed. We know what is going to reprice. Our securities book, our swaps book and our fixed rate loan book are all mechanical things that will show up and be repriced and reinvested. And what we assumed in the prior slide is if you just reinvested them into the same duration credit quality assets, you'd get the pickup in yield that you see. We compare ourselves to all of our peers. Our securities portfolio duration is one of the shortest out there. Our yield on our securities portfolio, and you'll remember this, when we bought BBVA, we effectively had to take all of their fixed rate assets to market, which at the time were record low yields. So our yield is today very low. Swaps are short. We have a smaller percentage of residential mortgages. All this stuff is going to reprice and be reinvestable. And the final point I would make, which is perhaps not as obvious. All of our wholesale funding is floating rate. We swap 100% of it into floating rate, meaning that we already ate all the cost on the way up as the Fed raised rates, and we'll actually benefit dollar-for-dollar when it comes down that. I think we're maybe the only peer that actually does that. So that's NII. I'd also say, before we jump off into credit risk management here for a second, if you look at big levers of what drives income, NII is a big one, it's in focus. Expenses, we've held flat, and we've basically signaled that we'll hold them flat again in '24. Since 2021, we're good at managing expenses, and we'll stay focused on that. We think we'll keep them stable into '24. And fees, we've grown mid-single digits through cycles and would otherwise expect that to continue. So what can wreck the picture? And we don't expect this, but credit. So let's talk about credit. This is just a chart of our historical charge-offs against our peer group through time. You obviously see the spikes back in the financial crisis, and I'd remind you that those spikes for us at the time included the balance sheets of National City and some legacy from Mercantile Bank and actually don't reflect what was core PNC underwriting. You'll also notice from this chart that today, we are reserved at peak charge-offs to the financial crisis. And the final point I would make is as you see in the fourth quarter of '21, where we sort of touched briefly the industry line, those were the charge-offs we had to take with the consolidation of BBVA. And then, of course, we trend back to our normal path of running fairly far below what the industry does. And we would expect this to continue. If we jump into credit, what am I worried about in credit? What are the headlines? First, I would tell you that absent some de minimis exposures in health care, we see it in discretionary goods and manufacturing. We see it the consumer normalizing. Nothing really bothers us inside of the credit book. The headline item everybody wants to talk about is the CRE portfolio. And we'll break that down for you. And then we break out 2 pieces here: first, multifamily. And by the way, we bring up multifamily here not because we're worried about it, but because people ask questions. Can you flip that, Bryan? Get to the end of the story first here. We have no charge-offs this year in this book. We have no delinquencies. We have no NPLs. The book is cash-flowing, and it's 90% occupied. We're not worried about it. We don't think there's much loss content in it. At the margin, we have had downgrades, largely based on debt service coverage ratio, but still with lots of equity inside of the portfolio. If you look at the statistics, our average loan commitment of $30 million is a lot higher than some of the stats you might see. We work with big developers in Class A projects with people that we've worked with for a long period of time. So we are not worried about this. We highlight it only because there's questions about it. If you jump to office, particularly with a focus on multi-tenant, we are worried about this. Now let me just lead off by saying there is nothing new on this slide. Nothing has changed. It's no worse or no better than what we had assumed before. We're just highlighting for you what we've already done, the breakdown of what we have in office. A couple of bullet points. You've heard us talk about multi-tenant is the place of focus, largely because medical government, the single tenant is highly occupied and current and doing fine. In the multi-tenant space, we have seen a drift into criticized and then into nonperforming. And ultimately, we will have charge-offs. We also have 12.5% reserves against that loan book that was underwritten to 55% or 60% loan-to-value when it was done. We take something -- I want to spend just a second on the CECL process because I think people get a little bit confused here. In CECL, we effectively reserve for an outcome that expects a mild recession and 5% unemployment and reserve to a value on these buildings that we think will be realized if, in fact, they can't pay us back in the initial terms of the loan. That's very different than a lot of banks, frankly. You get different ways to reserve against real estate if you're an OCC bank or an FDIC bank or a Fed state bank. If you're an OCC bank, basically, you take something to nonperforming, even if it is current, which all of our loans are, but you take it to nonperforming if you expect that there might be difficulty in refinancing it at the maturity of our loan. Other people won't take it to nonperforming until it actually doesn't pay you. There's a big difference. So this moving through the cycle on CECL, nothing has changed. We're going to see these loans go from criticized, some to nonperforming, and we're going to have charge-offs. And we've already set aside the 12.5% of reserves that would otherwise cover the charge-offs against the static book. And the final point I'll make and then let you have at me with questions, there's 59 properties total in this criticized list. 59 loans over $5 million in notional or something, meaning that we have line of sight into each and every one of them and an asset manager on each and every one of them. We've done all the cash flows on each and every one of them. We've done appraisals on each and every one of them. It's not a whole bunch of thousands of little loans that are scattered across the country. Big developers, Class A, 59 properties. We know what's going on. We know what they're worth and we're reserved against it. And with that, thought we'd get into discussion.

That's great. So let's talk a little bit about the NII slide, which I think is really interesting. And I guess my first question is, does the picture change much if we don't get rate cuts? I mean if we go through next year, rates remain higher for longer. How does that picture change in terms of your expectations around trough in NII?

It doesn't -- it depends what the back end of the curve does. All else equal, higher for longer makes us more money.

And the sensitivity to the shape of the curve? [indiscernible]

Steeper is better. So our expectations in this forecast is -- and I think this is right, we're going to see some cuts towards the end of next year and perhaps into the year after. I think you're going to end up seeing a much flatter if not positive slope yield curve with some term premium, just given I think inflation will be a bit sticky and I think the issuance calendar for the government is heavy enough that, that's going to be the case.

And then secondly, maybe you can just talk through how your expectations of loan growth feature into this, how important that is, what are your expectations for loan growth are? But maybe also touch about how you're thinking about changing the duration, if at all, of the securities portfolio as we kind of move further through this rate cycle? And again, how that factors into this analysis?

Yes. Well, this slide has fairly benign loan growth assumptions into like low single digits, I think, into '24 and the out years. So we're not relying. There's no heroic assumptions in here. This is kind of a mechanical slide where we're replacing like-for-like both in terms of duration and then the underlying types of fixed rate loans. So an auto loan with an auto loan and a mortgage with a mortgage and so on and so forth. The actual duration of the balance sheet today is largely neutral, maybe a little bit positive. As I think about what we might do in the future, it would have more to do with locking in the shape of that forward curve than it would have to do with materially changing the duration of what we have today. So think about -- if I know I have -- and I know this, I know I have $20 billion of something maturing in the third quarter of next year, I can choose a rate and lock that in today to make sure that the slope of that line is what we see there.

Okay. And then just your comments around deposit betas. How dependent is that on what the deposit picture looks like next year? So I guess one of the surprises, I think, this year relative to last year is just how well deposits in the system have actually held up for most banks, especially the larger banks. If we get back into a situation next year where QT is perhaps bigger than people think, and you've got deposit outflows. Is that in any way material in terms of your assumptions around deposit betas and the...

It isn't, really, because inside the dynamics of our balance sheet, crystal ball, we're -- I think we are a record long cash right now at the Fed. I'm looking at Rob. As the securities book rolls down, we generate cash. We don't have dramatic loan growth, we generate cash. We are necessarily issuing into, although almost finished, with the long-term debt requirement that will come out of new regulation, which generates cash. So our need to compete at the margin for deposits that aren't from our core clients, I think, isn't very great. So I don't know that there's a huge amount of sensitivity. If you think of the dynamic that's happening today, you have smaller banks who are basically really afraid of showing any decline in deposits, so they're paying up full freight, brokered or otherwise are reinsuring to keep deposits. And we're kind of inclined to just have our share of what the collective market offers, if that makes sense. So the Feds, if we're shrinking deposits in the system, I think you would expect us to behave like that absent our new client growth, which by the way, we're seeing a lot of in the new markets.

Okay. That's helpful. Let me ask you a couple of other questions on deposits since we're talking about it. I mean mid-40s terminal deposit beta is something you've talked about. Is that still your expectation? Has that changed? Anything in terms of mix shift between noninterest-bearing and interest-bearing? How has that evolved? And then just take a step back. I mean, if you think about the competitive environment for deposits relative to where we were, how has it evolved relative to your expectations, let's say, 6 months ago?

So I don't know that we've talked about a terminal beta, but if you did math against where we've expected to end at the end of this year and we say we don't expect the Fed cut till middle of next year, you'd see a couple of points in increase in our beta through time, which would be in that pricing. We expect that we'll continue to see some shift in commercial noninterest-bearing to interest-bearing. That has slowed down, and we think that will continue, but you're still going to have some of that bleed. So we don't have wildly hopeful optimistic assumptions on deposits in that NII slide. I'm tired of chasing NII guidance, which perhaps gets to your other question on what surprises me over the last 6 months. And I think -- look, we've been surprised by the speed and amount that the Fed went, which in turn caused mix shift from noninterest-bearing to interest-bearing faster than we thought. And then the dynamics in deposit competition after the failure of a couple of banks has just priced everything at the margin. All new money, right, is now fully marginally priced, All of that's it a bit of surprise, but it's all in what we expect in that slide.

Okay. So let's talk a little bit more about credit. I think look, the CRE slides, I think, are really helpful. Outside of CRE, office, in particular, anything else that you're monitoring? And maybe even within office, can you talk a little bit about how some of the delinquency trends have tracked so far this quarter relative to your expectations? And maybe comment on what you're seeing in the Midland servicing business as well.

Yes. Outside of real estate, or actually even inside of real estate, we don't have any delinquencies. So we're taking this stuff to criticized and nonperforming, and they're still current. It's just we don't think they can be refinanced at the same structure when they mature. And so we reserve against it today and call them nonperforming. We might do that if we know a large tenant lease is going to roll between now and maturity, and they're going to be cash flow starved on a refinance, it will go to nonperforming today. So I want to be real clear about what that means, at least in our books. Inside the broader credit book, you hear everybody talk about consumers perhaps normalizing. We see a little bit of that in card. Not much. It's a prime book. There's struggle inside of health care, costs in health care and labor, which we all know about. Some at-the-margin struggles and manufacturers for discretionary product, but none of it. It's kind of ordinary course stuff. And I'll just remind you, our CECL scenario that gives rise to that totality of that reserve is assuming a mild recession and a 5% unemployment rate. And that's what we've reserved today. So better than that outcome, money comes back.

So I mean, you talked about the CECL reserve assumption. So let's just kind of segue into just your views about the broader economy heading into next year. You talked about rate expectations. But based on everything you can see, I mean, what is your take on the general state of the economy? What are the risks that you're most focused on perhaps outside of credit? I think you've mentioned you expect inflation perhaps to be maybe a little bit stickier, so maybe you can maybe talk a little bit about the risks of a policy mistake and how you're thinking about that heading into next year?

Look, I think everybody has been surprised all year long on the strength of the consumer and underlying strength of the economy. I think that continues, albeit we are definitely seeing a softening in the data. And our official forecast is assuming that we'll get a slowdown and even a mild recession into the first half of next year. I'm not so sure -- I think we can see that in GDP. I'm not so sure we're going to see labor get to a 5% unemployment, but that's my view. We'll see. There's a lot of things that can derail that, geopolitical events and so forth. But basically, I think the Fed is close to having pulled this off. I think they're done. I think they're going to stay there for a long period of time because I think inflation is going to be sticky. And absent a real melt in the economy, there's no reason for them to do differently.

Okay. So let's switch gears. Let's maybe talk about the current quarter. You always give very clear guidance. You've done so for the current quarter. How are things tracking towards the guidance that you've given? And has anything changed since you last spoke around any of the key items?

No. The guidance is fine. We do now know our FDIC allocation, which I'll stare at Rob to make sure I get this right, but $530 million pretax, $420 million after tax, and of course, we have the $150 million charge we'll take against our restructuring that gives rise to the $325 million run rate savings next year. But inside all those things, no, everything is tracking. At the margin, loan growth is probably a little bit slower, but it's offset by deposits being a little bit better. So NII is fine. Fees are fine. Capital markets is actually all the way back to kind of first quarter levels, so doing really well.

So let's talk about capital markets and how that -- you mentioned that it seems to be tracking actually quite well, which is actually different, I think, to what some of your peers have said. So maybe you can talk a little bit about why that's the case. And then maybe talk a little bit about the growth potential in that part of the business heading into next year. I'm particularly interested to hear whether your view of the opportunity set has changed just given the Basel III proposals and the fact that I do think some banks at the margin are rethinking parts of the capital market businesses, but they're typically, I think, in businesses you're not that interested in. But I'm curious. Does it change the opportunity set?

I don't know that our opportunity set has changed. I mean we're in that capital-light capital markets businesses. Our improvement in the fourth quarter is largely Harris Williams and Solebury's pipelines pulling through kind of back to first quarter levels. And by the way, their pipelines keep growing even as they're executing deals, which is good news. The Basel III endgame and some of the disruption on interest rates affords us near-term opportunities as other people are changing their balance sheets, so the ability to acquire assets or assume risk or just acquire clients is other people shrink.

Are you actually seeing that?

Yes.

Any particular products or businesses that you think are more pronounced than this?

I mean look, at the end of the day, everybody is reviewing their relationships. And if you can't earn a return on your equity deployed through your credit relationship against new funding costs, you shrink it. Now if we have other products and services, our TM products, for example, which give us a bigger wallet and we were long, massive amounts of cash at the moment, we have an ability to pull on clients that are full relationship clients right out of the gate, and we've done a lot of that with some pretty material clients.

Okay. So let's talk about operating leverage, obviously, a very important topic for investors. I mean if we take what you think on NII, which sounds really reasonable, maybe you can talk a little bit -- as well as the cost plan that you announced. And if we put it all together, what does the operating leverage picture look like as we think about 2024? And maybe you can also talk about the longer-term opportunity in terms of continuing to drive operating leverage. I mean there's a lot of different themes here around AI, what that could mean in terms of efficiency gains, obviously increased scale in the consumer business, the geographic expansion in the commercial business, deeper penetration, obviously, into your client base. So if you kind of put that all together, maybe you can talk both near term in terms of how you're thinking about operating leverage, but also about how we should think about the longer-term progression.

Well, we think about it all the time, near term and long term. I'll just start with next year. Next year is going to be a fight. It's one of the reasons we went through the cost exercise that we did and ultimately, it's going to be driven by where that trough point on NII occurs. I don't get terribly hung up about it because I know that trough point is going to happen, whether it's the first quarter or the third quarter. And if we didn't just draw a calendar, nothing would -- I wouldn't be bothered because the steepness of the curve out is pretty good. Beyond that trough, positive operating leverage becomes fairly easy to achieve. And importantly, inside of that, we are not starving our franchise at all for investment. In fact, '24 will be one of our largest investment years.

So can you just -- so what exactly are you investing in versus last year? I mean, how has it changed? Is it more of the same? Or is it...

No, so it's forever investing into the new markets in terms of people and presence and advertising. So we've been adding people into our West Coast, Southwest markets aggressively for the last year, and we continue to do that. It's a continual technology investment. So we are about to land a multiyear investment on taking all of our consumer-facing technology, think mobile, online and our service browser, in effect, for our tellers and care center and self-service for clients. We're about to land a digital-first, so mobile-first, cloud native real-time system across that whole thing, we've been working on it for years. We're pivoting. So if we say, what are we investing in next year? We are putting a decent amount of money into a data lake capability that is history near real time and real time for our AI capabilities. Everybody will talk about AI. AI is only relevant if you have good data. So we're investing in that data lake. We're investing in the core processing behind our consumer lending and behind our wealth management business. And then we're -- then we've kind of taken every legacy system out of the place. But we do that continually. It's not -- we've done this for 10 years now. So if we stopped investing, we'd cut costs a lot, but we don't. We continually flow the investment as we rebuild our core.

I mean does structurally higher interest rates change your thought process around the return on investment? I assume at some level they do, but I'm curious how do you think about that?

They do. But I would also say, we got into this investment cycle going back a bunch of years because -- and it has proven, I think, correct, that to be successful in the long run in banking, you have to have cutting-edge technology, not just to service your clients, but to create a low-cost product, right? The winner ultimately in retail banking is going to be the person who delivers a pretty good product at the lowest cost. And to do that, you need a really strong technology backbone.

So in terms of investment, you've done a really good job growing the bank both organically but also inorganically. So let's talk about the inorganic opportunity set. I think look, the most recent acquisition you announced was the signature loans. I mean what is the pipeline like for those types of deals? I mean it sounds like it could actually improve, given everything you said about obviously increased capital, increased funding requirements. But what's the competition for buying those assets today just given the growing...

It depends what the assets are. So we look at -- I mean, that was an easy portfolio because it was -- it needed a lot of liquidity, but it was high quality and had a good spread. So that was kind of an easy one. Other asset portfolios that are high risk, so for example, the rest of the signature real estate book, that's a lot of work and probably off strategy for us. We're seeing a lot of stuff on some of the risk elimination trades that other banks are doing, where we'd be the receiving end on just buying the risk from other banks. But the best stuff is when you actually get to pitch an entire client relationship across TM lending and everything else and just win that out right on a refinance. And we spend a lot of time on that, and we've had some really big wins.

And then I know I ask you this every year, but conceptually, what's your appetite like for a whole bank acquisition? What do you think the M&A environment for the banking industry looks like going forward? Obviously, there's a lot of changes coming on the regulatory front, both in terms of capital and liquidity for some of the smaller banks. So how do you think about the attractiveness? Maybe you can just remind us around the return thresholds that any acquisition needs to meet. And look, what do you think the regulators and I guess politicians broadly think about bank consolidation from here?

Yes. I think scale matters today more than it ever has. Prior to March and the mini-crisis, we knew the technology mattered, we knew scale on brand mattered. They just eliminated tailoring in regulation for all intents and purposes, and now they've added to that, to the extent you want to be in corporate banking, this notion that too big to fail matters. So corporate treasurers have migrated to a world where they trusted the regulators to do their job to a world where now they say, I'm not sure who I can trust, so I just want to be with the mega banks. And we've seen that in deposit flows. And I think that is never going to be reversed. And so I think scale, therefore, particularly if you have our strategy of wanting to be ubiquitous and coast-to-coast really matters. And if you look at our earnings drivers through time, which is largely our C&I franchise, and it continues to be, and we continue to win, scale matters in that. The regulatory response to this, you've obviously seen the public comments on being more open to M&A. You'll hear -- you'll see public comments around being open to "good" M&A.

What does good M&A look like versus bad M&A when they...

I'll give you an example of good M&A, and I won't give you an example of bad. But good M&A is we basically buy, close, convert BBVA in 11 months and do the entire conversion and be done with it in a weekend.

That's good M&A.

That's good M&A.

Okay.

And I think there's a recognition on the part of regulators to the extent you're a well-managed bank with the technology infrastructure that could scale. But we could effectively -- it gives us a massive cost advantage post acquisition to be able to take costs out and be right up and running and broadly serving whoever we might buy with better products and services the day after we convert. And there's a recognition of that.

Okay. So I think we've only got a minute or so left. Let me just ask about capital, capital returns and how you're thinking about that. I mean, obviously, you're in a very strong capital position, even factoring in the changes that are coming down the pike in terms of changes. So look, how should we think about your approach in terms of managing excess capital? How are you thinking about the value of increasing dividends versus buybacks? Does it make sense to actually run with excess capital today, just given the opportunities that you could see in terms of asset acquisitions? So how are you thinking about that heading into 2024?

So part of the story remains the same, right? Dividends are perhaps the most important right now to our investors, maintaining and growing a dividend, organic growth and opportunity set, right? We have an ability to generate capital at a pace that's beyond our ability to intelligently deploy it, so we're always going to be returning a large amount of capital to shareholders. And for the last year, you've heard us talk about we have been -- we're holding back even though we have capacity for share repurchases because we're already above the Basel III endgame proposals. And I think they're going to fade on some of those, which would suggest we're even further above than what we already assumed. Heretofore, we've said we're going to stay out of the share repurchase game because there's still some tail risks out in the market. I think that's still true, but I would tell you that we have started to dip our toe into the share repurchase market. We're likely to keep doing that, probably not in size, but enough so that there's a bid in the market against our stock. And we're trading at a value. If you believe half of the things, which I do, that we went through on these slides, we're pretty good priced to be buying back shares right now.

Okay. I think with that, we are out of time. So thank you for joining us. We really look forward to seeing you. But thanks a lot.

Thank you.