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

All right. So thanks, everybody, for joining us again here this afternoon. I will read a disclaimer, and then we will be kicking it off with Rob Reilly, CFO of PNC. So for important disclosures, please see Morgan Stanley research disclosure website at morganstanley.com/researchdisclosures, taking a photography, taking a photograph and the use of recording devices is also not allowed. If you have any questions, please reach out to see your Morgan Stanley sales representative.

Well done there Betsy.

Rob, thank you so much.

Great to be here with you.

Yes. And we're thrilled to have you here and really appreciate you coming pretty much every single year now, really...

Yes, I think we're up to 10...

That's great.

Yes, you and me together.

Okay. Very good. Yes. I have -- this is my 15th year.

Congratulations.

Yes. Thank you. I do want to start off with a topic that everyone is interested in. And given that we are most of the way through the quarter, just wondered if you had any guidance updates for us.

Well, we'll go right to it. Yes. The guidance update is no change to our guidance either for the second quarter or the full year. So no change.

No change. All right. Now your guidance, I believe, does include 2 rate cuts.

That's right. Yes, that's right.

One in July and one in November?

Well, we've actually moved the July one back to November and December now. So we're not in the July camp. That's some fresh news there for...

My bad. So then I guess the question is, if we don't get any, I guess, it doesn't matter for the year anyway.

Yes. Well, one, because we're halfway through the year. But two, as you know, and we've spoken about recently, we're pretty neutral on the short end to interest rate movements. We've worked hard to get into that position. So really, particularly for '24, but just in general, not a big impact there, whether they happen or they don't happen.

And you said you worked hard to get there.

It's a bit neutral..

What did you do and what hard work involved.

Well, we're naturally asset-sensitive, as you know, over the years. So we tactically moved to that position late last year, so nothing new there, and that turned out to be the right move in terms of being sort of immune to what was going to occur. If you'll recall back in January, way back in January the world thought 6 rate cuts. We thought 3 and now we're 2 on the back end. So we're well positioned.

And you got there through swaps. Is that the primary way?

Well, some swaps much of what we were doing in terms of our position in terms of our duration, the swaps, the fixed variable. But again, nothing new there.

Okay. Now expectations, let me know if this is correct? For NIM and for NII is to bottom this quarter? And then increase towards the back of the year. Could you walk us through the driver of that uplift?

Yes, sure. So for us, we're sticking to not only our guidance but also that we see NII and NIM troughing here in the second quarter and then inflecting into what we've been waiting for some time, which is the ability to reprice our fixed rate assets, as you know. So we're entering into that period there that mechanically will continue to drive our NII higher into record NII into 2025, which were on the record for saying that it will be a record. And that's mechanical. That's just simply taking $100 billion plus of fixed rate assets and repricing them from pick your number, 2% up to 5%, and that's going to occur. It's a natural part of a rising rate environment cycle. This is the good part when you get to reprice your fixed rate assets.

Right. Okay. And that's it. You don't need anything else other than that?

No, nothing along those lines in terms of loan growth or other things outside of that, those would help. But the big move is the repricing.

Because your current guidance for 24% is for net interest income to go down?

That's right.

[ 25% ].

Yes, that's right. That stays the same.

So then getting to record 2025, obviously...

Some pretty good growth. Even I can do that math. Yes, that's right.

Punchy. And it's -- could you just help us understand how much of that 25% growth is coming from just the rollover...

Majority.

Majority, okay. So your front-end securities duration...

That's right. Okay. And we'll think about it. Most of the securities we put on and some swaps we put on in 2021, they're maturing. In 2021, they were yielding our securities yields right now and our whole book is 2.5%. So you get that ability to reprice up, and that's significant.

And how much of it is swap roll-off, is that helping at all?

Well, it's more -- it's not so much swap roll off as the swap repricing. So fixed rate swaps are a key piece in terms of how we manage the balance sheet. The difference will be the yield that we receive on those rates, which right now are below 2.5% will be that much higher.

Right. Okay. And so the duration of the securities book that's really driving this is...

Yes, and that's what we've been talking about. We're among our peers, our duration, no reveal here is shorter. So we're at the front of the line in terms of being able to reprice. Everyone will be able to reprice their fixed rate assets. But if they're not maturing, you got to wait, wait for that to happen, obviously.

Right. And then I think a couple of weeks ago, Bill mentioned that the NII guide for 2025 also includes an assumption the forward curve comes through?

Yes, that's right.

Doesn't matter if you don't get a rate cut?

No. So for us, an ideal would be a steep yield curve, less ideals and inverted or a more inverted yield curve. So we're neutral on the front end, asset sensitive on the medium to long term where we would reprice those, but because rates have moved so far, so fast, we're in that 5% range, plus or minus a quarter percentage repricing up from 2%. So we're asset sensitive. Obviously, the higher the rates in the medium term, the better as we go to reprice. But even if they're not really optimal, they're better than what we've got today.

And if we do not get rate cuts?

yes, I think, like I said, the short end we're somewhat neutral. There could be some pressure on the deposit pricing if we don't. But offsetting that, you've got to remember, we have 50% of our assets on variable, right? So that offsets that. So we could see some plus or minus on the margin, but it's a whole different world and the magnitude of the shift that we've seen when rates went from 0 to 5.

Got it. Okay. So it sounds like a pretty kickback year for you in '25.

I don't know. We don't -- there's always something to do. I don't know, kick back -- you and I have been doing this a long time. I don't remember any kickback years I wouldn't count on one. But we're optimistic, obviously, in terms of '25 with the NII growth combined with the fee growth that we'll produce this year and plan to continue. So yes, we're optimistic.

Okay. Good. Well, let's dig a little bit into some of the details on the NII driver as well relating to deposits first and then loans. So on the deposit side, cumulative deposit beta, I think has been about 45% this cycle. And the question here is, are you still seeing rate-seeking behavior among your customer set? Should we still expect some mix shift between NIB and IB, and then how are you thinking about deposit betas in a down -- in a rate decline environment?

Yes. So just deposits generally. The message is stable, really. We're probably outperforming what we expected at the beginning of the year, still down, but not down as much as we had thought. And we'll see if that continues to play out. Notably, in terms of mix shift. Right now, today, our spot to noninterest-bearing deposits are actually higher than they were at quarter end on March 30, higher.

Balances are...

Balances are higher. And that's the first time that, that's happened in a while.

What's driving that?

Well, a lot of -- in our end, it's a commercial noninterest-bearing deposits, which tend to be in our book, the larger corporations and state entities. But what's notable about it, and again, that's spot. So it could finish down. I could finish down. Average will be down. But I'm just saying for the first time in a long time, we've all been staring at that number. This is the first time I've seen it go up. So that tells me that at a minimum, things have stabilized considerably. Recall, last year, during the first 6 months of '23, our noninterest-bearing deposits declined by $20 billion. So the rate of that shift has dramatically slowed, so that's encouraging. As far as rates paid, we're up a little bit off of where we were in the first quarter, but not by a lot. We expect it to be. And again, that has slowed down. It could continue to drift a little bit, but again, on the margin. And then in terms of our mix, we said we'd sort of settle out in the mid-20s. That's where we are now. That's a good range, and that seems to be generally holding. But I'd say stable on the deposits in big contrast to year-over-year where it was down.

Right. Got it. Okay. Very good. How are you thinking about loan growth?

Well, loan growth, if you go all the way back to January at the beginning of the year, world thought 6 rate cuts. We thought fewer. We did expect sort of nominal growth on the consumer side, and we're seeing that. We expected some loan growth on the commercial side, but at the time we said the back half of '24, which we're rapidly approaching. We still hold to that, but that's our best thinking. We have acknowledged that its commercial loan growth has been more sluggish than what we thought even though we didn't expect a whole lot in the first quarter. And it's for all the reasons that we've talked about. But when we look out at the balance of the year, it's 2 things. One is utilization, which is down. It's down at the low levels that we finished '23 that we typically see an increase in that utilization, which hasn't occurred in '24, but when we take a look at sort of the leading indicators, we can see the capital expenditure to sales ratio is an all-time low. Inventories are low. New client acquisition, which is really strong, particularly for us in the Southwest United States, clients are putting in credit facilities, new credit facilities that they're paying for, that they're not yet drawn down, which is an indication of borrowing. So we see utilization picking up out of necessity in the back half of the '24. And generally, the economy is still pretty good. It's slowing, but it's still pretty good. We'd expect to see some new production but not a lot, not Herculean. So our best thinking is that we'll see some commercial loan growth here in the second half. We can't control it. We're not allowed to call them up and make them borrow. But in the meantime, we've got plenty to do. On the commercial side, we are adding record new clients, a lot of it coming out of the Southwest on top of last year record new clients. A lot of that operating business, a lot of that credit facilities that are being put in that are not yet drawn. So we're busy, and there's good indicators.

And typically, how long is it between a corporate client might put up that credit facility?

Not long. Yes, not long because -- well, it depends. It depends on, obviously, the size of the company, what they're doing and what they're funding, but there's some anticipation of funding. But in point of fact, they pay for that. So there's a facility fee and an unused fee. So typically, you wouldn't incur those costs if you didn't expect to use it in a reasonably short term.

So you're talking within a year?

Oh, yes. Most certainly.

Okay. All right. And what size companies are these that you're...

Well, for us, I mean, so we've got a broad book. But I'd say our wheelhouse in terms of generalities, tends to be large middle market private companies, $1 billion to $5 billion in revenue. Of course, we've got Fortune 500 customers, and we've got small business and commercial. But our wheelhouse is that general middle market corporate book.

Okay. Now that's also seemingly the book that private credit is interested in as well. How are you competing with that?

We get asked that a lot. We typically don't compete in terms of loans because in their model, they've got to make all their return on their loan, which means a higher-risk borrower, which is typically too risky for us. Our model is less risk. The credit return is supplemented by the operational services that are part of that relationship that the revenue in the aggregate justifies the return on capital. That's the way we've been for years. So in terms of private credit, they're typically looking for high single-digit yield, maybe double-digit yield, a different type of borrower. We have, however, and maybe this is going to be one of your questions, we announced a private credit partnership with TCW last month. And really, all that is a formalization of an informal process that's been in place for some time. We've worked with them over the years, mostly in our business credit commercial finance book, which tends to have higher leverage. And our whole goal there is in these types of companies when they undertake a transaction or put themselves into that type of higher-risk borrowing category that we'd be able to retain the operating business. And we're able to do that in these instances. That's our #1 driver. There may be some instances where we could lend into that structure if it's a senior secured piece, well collateralized and maybe some economics on the equity side. But the big driver is the operating business, which is so essential for us, as you know, and we're a leader, and we're very good at it.

And these are clients that you already work with but are looking for different types of structures...

That's right. It could be acquired by private equity or something along those lines.

So is it a different credit box than your credit bonds?

Yes, it would be -- it would definitely be a different credit box, that's the point -- we don't get dislodged. Our relationship doesn't get dislodged with this arrangement.

Could you acquire new through this arrangement? New customers through...

Possibly. Yes, possibly. But we've got a lot of customers.

Okay. All right. That's not the focus but it could happen?

Right.

Okay. And then the question on how it's being financed from PNC side? Is this equity capital you have invested?

Yes, again, and that will be through time and as it evolves. Like I said, there's some economics there, but the primary driver is the retention of the relationship.

Got it. Okay. All right. Very good. And I suppose the other question I have for you on loans is the rest of the book?

Yes, yes..

Let me just talk a little bit about growth. Card is like the industry, a little bit higher, but it's small.

Yes. Yes. So we're predominantly commercial, but we do have a big consumer customer base, which really resulted from the acquisition way back in 2009 when we acquired National Citibank. We recognize that we have 11 million consumer clients that would be inclined to borrow from us if we had appealing products and services. So we've been on that journey for a number of years. Consumers are sort of muted right now because the residential side is slow. We expect that to pick up mortgages, home equity when rates change. But we do have some growth opportunities, and we're seeing that in auto and card. To your point, notably, we've got a lot of new card offerings that are coming out to our client base that are very attractive. So we would expect to grow that. But right now, it's pretty small, $6 billion or $7 billion on our balance sheet. But real opportunity, not just because that penetration within the consumer base but also because of these expansion markets that we're in these growth markets that we're in, that will add to it as well.

And did I hear you correctly that you're leaning into auto?

We are, yes, properly structured. It's funny. If you take a look at PNC over the years, we don't make auto loans when everybody is making auto loans and we make auto loans when everybody is not making auto loans. And that's just sort of how we go about it. If the return is there and the structure is there, we'll do some more. And that's where we are currently.

And what about commercial real estate?

Popular topic...

How are you thinking about that? And it's interesting because the H8 data has growing lots of reasons why and how are you thinking about that book?

Well, when you talk about commercial real estate, everybody quickly goes to the office component, which we should talk about a little bit. But outside of the office, multifamily, there's some stress around the higher rate environment, but we're fine there from a credit perspective. There's some geographic hotspots, but we feel good about that book. And we could conceivably see that grow. Hotels are doing well, as you know. So outside of office, CRE is fine. Office is where the pressure is. And inside of that, and we've talked about this, and this hasn't changed. It's the multi-tenant office piece for us, where we see the most pressure and where we're seeing the losses that have occurred and where we expect charge-offs to continue. It's just under a $5 billion exposure. So not large in terms of percentages. And we're working through that. Importantly, we're adequately reserved is the right framework, about 14.5% against that book. So a lot of that has been recognized upfront. We reserved against the criticized portion of the book, which is about 26% of it even though they haven't yet hit nonperforming and not yet gone to charge-offs. So we expect that to happen. But again, we think we've front-loaded a lot of that. We get asked a lot in terms of, hey, how is it going, how you're working through it? And is there any insight in it. And I would just say, what inning are we in? We say we're probably about 1/3 of the way through the game. The maturities that we've seen -- about half of the maturities that we've seen have actually been fine. They've either repaid the loan or refinance because they qualified and extended it. The other half is where the work is. And probably 3/4 of that gets worked out into some new deal where there's some more support, more collateral or some principal curtailment and then the balance is NPL and probably charge-offs. So that's been sort of the case. There's a wide variance in terms of outcomes in terms of what the properties are worth because it's not a highly granular. There's wide disparity in terms of the different projects and all. So we continue to work through that and feel like the reserves are sufficient.

And the principal curtailment that would show up as a net charge-off?

Yes, that's right.

And I believe you have quite a bit of office maturing in the next 12 months. 42%?

Yes, that's right.

Can you give us an update on the conversation with the sponsors there and the strategy you have for that next 12 months?

Yes, it's pretty much of the same. So what I just described there is what we're seeing and what we're expecting. We've got a lot to work through. As I mentioned, NPLs will go up, but again, that's working, we reserve of criticized a bigger bucket than that. And charge-offs where it will occur. And we'll work through it.

And why does something move into criticized if it's not non...

Well, that's part of being an OCC bank, you can move into a criticized position simply if they've just lost a tenant or something material has happened even if they're perfectly current on their principal and interest payments. It's a forward-looking measure, that's conservative. And that's okay. That's the way that we operate. So the reason that I keep mentioning it is because some people say, "Oh, your NPLs are going up, it must be getting worse." And in reality, what we reserved off that bigger bucket, and that bigger bucket is feeding that bucket.

Right. Okay. right? Once it's criticized, you have more degrees of freedom around the reserving?

Yes, that's right. Well, or you reserve against that, which is a more conservative approach rather than waiting for it to go to nonperforming and then reserving.

Right. Okay. And then the other question I just had on this is you own a business that serviced as commercial real estate, special service. So you have a lot of great information on the...

Yes. We do. I'll watch that. So Midland is a commercial service commercial loan commercial mortgages in special servicing, which has euphemistic for trouble.

Yes.

And we've watched that clearly because that is a leading indicator in terms of where the market is and what's happening. Their volumes have gone up, but not up as much as we had thought. A lot of deals are still getting taken out. But as you mentioned, we still have a lot of maturities go, particularly in CMBS here in the next year or so. So we're likely to see an increase. So we'll keep you posted in terms of what we see.

All right. Very good. Yes, because Bill mentioned, I think office values being down between 30% to 40%, in some cases, I'm assuming that's coming from the Midland?

Well, yes, and in some of on book think what he was saying in that regard is sort of what I was saying earlier, which is just big variance. So everybody says, "Hey, what's the loan to value? What's the number that applies uniformly to everybody." And that's not available in this sense.

Got it. Okay. But your reserve is adequate even with that price action...

Yes, that's right.

Due to the quality of book or...

That's right. Yes. And in our case, we've got 100 properties that -- so it's not thousands that are on the criticized, we work them every day. We look at them every day and reserve accordingly. So it's real time. It's not just some big portfolio estimation.

Excellent. Okay. So then turning to net charge-off rates. Which portfolios would you say are running at normalized? And where.

Charge-offs?

Yes. Where are we in the process of still normalizing?

Yes. I would say -- so for us throughout the cycles because we occupy the prime space, both commercial and consumer, our charge-offs tend to be less than everybody's through the cycle. And you know that, you write it up on your own pieces. On the consumer side, we've seen some increases in delinquency and charge-offs are up a little bit, but not a lot. And again, I think that's reflective of the prime nature of the borrowers, particularly in card, where we're essentially all prime. On the commercial side, we've been running below our sort of what we underwrite to. So we underwrite to a 30 basis point sort of charge-off. And these are estimates and we've been doing 10 basis points. So we'll go up a little bit, particularly as the office rolls through in terms of some of those charge-offs. But the real question is, where are we seeing pressure or anything on the horizon that is problematic. The answer is no. Things look pretty good. Outside of CRE, we see some pressure in the Healthcare segment. Nothing new there just in terms of the tight labor issue. Some consumer goods manufacturers as it gives the consumer has moved to services. That's not new. And then maybe a little bit on transportation, reflecting some of the inflationary effects. But no big pocket or a portfolio that's blinking anything beyond that.

Okay. Very good. I keep on looking for when C&I losses are going to normalize. I've modeled it in by year-end, but so far, the orders coming in better than my expectation.

Yes, that's a good thing.

Okay. Yes. Adds to capital.

Adds to capital.

So let's turn to fees.

How they're going to turn to capital.

No, no. What we see in expenses...

Okay, you got it.

Chopping the bit to get capital.

Yes. We know just even you said capital, I thought that's where you going.

So on fees, you have several pockets or I should say, businesses that you're running capital markets advisory, asset management brokerage, treasury management, mortgage services. Can you help us understand where is the driver for you in fee growth, most importantly and how are you expecting that each of these business lines can ramp...

Yes. So fees are pretty good. We've got great fee businesses. They're big businesses. They all have sizable opportunities in our new Southwest markets as part of the BBVA USA purchase. Our largest and probably most important is our treasury management business, which we talked about, the operating services great business PNC is generally recognized as a leader, if not the leader in that product and service. And that's an essential piece to justifying the credit extensions that we make but it's also typically how we initiate a new relationship with the corporation that becomes a commercial customer. We have very appealing product services, and it's easy to start with us in that regard. So that's first top of mind. But if you go through sort of the fee businesses as we report them. Asset Management is a very attractive business. Everybody wants in the asset management business. We're a large provider, there's several hundred billion in assets under management. Unlike our other businesses, asset management was not a big business at BBVA USA. So unlike our other businesses, we didn't buy a whole lot when we bought BBVA USA. So the game plan there was to staff out the various markets. We've done that. We're growing. We've got asset inflows. So feel great about that. Capital Markets and Advisory. Our largest driver there is our Harris Williams M&A advisory which is doing well, is poised. Our capital markets as part of our full year guide is up 20% year-over-year. That's due in large part to the falloff that Harris Williams had last year in the second and third quarter as the world transitioned from zero interest rates in the buy and sell game. That was when buyers wanted yesterday's -- yes, sellers wanted yesterday's prices, buyers wanted tomorrow's prices, and there was a couple of quarter time out there as everybody kind of got to the same planet. So that's occurred. Harris Williams had a good first quarter. Their pipelines are really record pipeline. So we'll see growth here in the second and third quarter, whereas last year, it was a decline. So that's why you have a big percentage increase. We talked about treasury management card. We talked about we've got some new products there. So that feels good. The only soft area is residential mortgage in line with what we expected, not a lot of volume there, given the rate environment. But one day, that will come back, and we'll be ready to go there, too.

In Corporate Services.

That's part of treasury management and cash management.

Okay. Got it. Yes, Bill mentioned treasury management has grown significantly with high margins?

Yes, yes.

And is that high margin a function of the rate environment? Is that margin...

No. No. It's more just -- so you go back to hard roots PNC in Pittsburgh, serving the Fortune 500 company way back in the -- when I started in the 1980s. So we were -- our roots were providing corporate services to the Fortune 500. So it's a multiyear build over our businesses that we've invested in over the years. That gets a pretty high barrier to entry in terms of being able to get into the treasury management business if you're not in the treasury management business in the way that we do it. And that's what leads to steadier and less competed margins.

Okay. more scale, better plan in the quarter.

Yes, that's right, over multiple years.

All right. Well, let's turn to expenses then. You have a history of track record of delivering continuous improvement...

Well, thank you for saying that.

The CIP savings this year is expected to be $425 million, right? Is that the full year expectation. And so and you're going to be fully reinvesting that. Is that right?

Yes. that's right.

Okay. So expense is flat year-on-year?

Yes, that's right, which is good. So a couple of things there. This is a continuous improvement program is something that we've had in place for a number of years, as you know. And the whole function of that is when we go through our annual budgeting cycle, every area of the bank has a continuous improvement idea to be able to just be more efficient. And when you're spending north of $13 billion a year, you ought to be able to do that. We've got that as part of our muscle in terms of how we manage our business. We take those savings and apply those to the investments that we want to make, the majority of which are in technology spread across the bank, as you would expect. And that's how we stay stable.

You've got an investment in branch network, too, though, now, right?

Yes. I can address that.

$1 billion?

That's still all part $1 billion, and that's still all part of our guidance and our plan the only that we have. What I was going to say was last year, we did do a work restructuring program, which was unusual for us. When we hit the fall of last year, it was clear to us that positive operating leverage wasn't going to be possible in '24 because of the rate dynamic. So what we needed to ensure is that our expenses would be stable year-over-year. So we did that. And then you had the continuous improvement program. It's close to $750 million of expense actions that have occurred. So it's very dynamic to get to stable.

Okay and then the expense ratio in '23 for the whole organization is 61.5%, is there a room for that...

Yes. So our whole mindset and the way we want to manage this positive operating leverage, which we generated, as you mentioned, the better part of 10 years you and I -- you and I have been doing this maybe a little bit longer not so much the ratio because, obviously, some of the fee businesses have higher expenses, and we want to do more fees. So I always say, if nothing happened to PNC today other than Harris Williams getting a mandate, our efficiency ratio just went up. But that's a good thing. So that's why we don't get caught in that. We're very disciplined around expenses. We're stable this year. Last year, we were only up 1%. So we're showing that, and that will continue.

So there are 2 minutes left. Capital.

Okay. Capital. Okay. Sure.

So your CET1 is 10%, 10.1%, right?

Little north of that right, yes.

And Basel III rules as currently proposed, 8.3. How do you think about allocating capital, you're allocating it under current rules?

Yes. Sure. Yes, sure.

And then you've got that Visa gains?

Yes. So that's true. So 2 things. One on the capital -- and I don't want to run over on the clock here. One on the capital is, so the Basel III proposal is still out there. It's not finalized. They're in a rewrite position. We'll see how it impacts us. We're fairly certain that AOCI will be incorporated into it. So that $10.1 million, as you say, goes down to about 8.5%. Not so sure in terms of what the RWA calculations are or what they will be and what the impact on us will be other than we don't expect a lot. Even as they were proposed in their original form, our RWA only went up 3% or 4%. So presumably in the new form, there'll be less, but we don't know. So we need to wait that out and see what that is. But the good news is PNC's balance sheet is in very good shape. We've got lots of capital. We've got lots of liquidity.

So why should investors get excited about PNC here?

So I think there's a lot to be excited about at PNC. I mean we talked about in terms of looking into '25 in terms of the PNL the inflection in terms of the rates, the repricing of the fixed rate assets. So the revenue component from NII looks pretty strong. The fee businesses we talked about, they're well positioned to continue to grow. Expenses are under control and credit is manageable. That's all the number side of things. The practical side of things is we're in the best growth markets maybe in the world, certainly in the United States. We do well in our legacy markets. We are benefiting from the advantages that scale and increase scale provides. We'll look to continue to do that. And we like the hand that we have.

Super. Rob, thanks so much for joining us today.

Thank you Betsy. Thanks for taking the time.