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

Greetings. Welcome to the PNC Financial Services Group Q3 2024 Earnings Conference Call. [Operator Instructions] Please note that this conference is being recorded. I will now turn the conference over to Bryan Gill, Executive Vice President and Director of Investor Relations. Thank you, you may begin.

Well, good morning. Welcome to today's conference call for the PNC Financial Services Group. I am Bryan Gill, the Director of Investor Relations for PNC and participating on this call are PNC's Chairman and CEO, Bill Demchak; and Rob Reilly, Executive Vice President and CFO. Today's presentation contains forward-looking information. Cautionary statements about this information as well as reconciliations of non-GAAP measures are included in today's earnings release materials as well as our SEC filings and other investor materials. These are all available on our corporate website, pnc.com, under Investor Relations. These statements speak only as of October 15, 2024 and PNC undertakes no obligation to update them. Now I'd like to turn the call over to Bill.

Thank you, Bryan and good morning, everyone. As you've seen, we had a very good third quarter. We executed well and saw strong momentum across our franchise. We generated $1.5 billion in net income or $3.49 diluted earnings per share. Rob will take you through the details shortly but I wanted to highlight a few points. First, we generated positive operating leverage for the third consecutive quarter. And as an aside, our strong performance has positioned us to deliver positive operating leverage for the full year of 2024. Inside of the third quarter performance, NII grew 3% as we continue our growth trajectory towards expected record NII in 2025. Our fee income grew 10% with a very strong quarter in capital markets and we remain disciplined on the expense front. Second, we continue to see strong growth and activity across our franchise. C&IB continues to have great momentum as new loan production and commitments increased this quarter. While overall loan utilization has remained soft, the recent Fed actions to lower interest rates and the expectation of further cuts is likely to spur greater demand as we move ahead. Importantly, we are well positioned to serve our customers on loan growth returns. Within retail, we continued to invest heavily in our branch network to build density in our most attractive growth markets and we are seeing success. We continue to grow customer households and checking accounts with the highest customer growth being realized in the Southwest markets. AMG is accelerating growth in high opportunity markets and benefiting from favorable equity markets. Third, our overall credit quality remains relatively stable, reflecting our thoughtful approach to managing risk, customer selection and long-term relationship development. While we expect additional charge-offs in the CRE office segment, we're adequately reserved. Lastly, we continued to strengthen our capital levels during the quarter. And with the ongoing improvement in AOCI, our tangible book value per share increased 9%. In summary, we delivered strong results in the quarter and we remain well positioned to continue our momentum. In fact, we're in the middle of our strategic planning process and I can't recall a time when our organic growth opportunities have ever been more attractive. Now before I turn it over to Rob for more detail on the financial results and outlook, I'd like to say thank you to our employees for everything that they do for our customers and our company. And with that, I'll turn it over to Rob to take you through the quarter. Rob?

Thanks, Bill and good morning, everyone. Our balance sheet is on Slide 4 and is presented on an average linked quarter basis. Loans of $320 billion were stable. Investment securities increased slightly by $1 billion or 1%. And our cash balances at the Federal Reserve were $45 billion, an increase of $4 billion or 10%. Deposit balances grew $5 billion or 1% and averaged $422 billion. Borrowed funds decreased $1 billion or 2%, primarily due to the maturity of FHLB advances, partially offset by parent company debt issuances. At quarter end, AOCI was negative $5.1 billion, an improvement of $2.4 billion or 32% compared with June 30. Our tangible book value increased to approximately $97 per common share, which was a 9% increase linked quarter and a 24% increase compared to the same period 1 year ago. We remain well capitalized and our estimated CET1 ratio increased to 10.3% as of September 30. Regarding the Basel III endgame, while certain aspects of the proposed rules are likely to change, we estimate our revised standardized ratio, which includes AOCI to be 9.2% at quarter end. We continue to be well positioned with capital flexibility and we returned roughly $800 million of capital to shareholders during the quarter through common dividends and share repurchases. Slide 5 shows our loans in more detail. Average loan balances of $320 billion were flat compared to the second quarter as well as the same period 1 year ago. And the yield on total loans increased 8 basis points to 6.13% in the third quarter. Commercial loans were stable at $219 billion linked quarter as utilization rates remained low and well below the historical average of roughly 55%. We continue to have confidence that commercial loan demand will return in the coming quarters as our loan commitments continue to increase and we expect business investment to return to historical levels. Consumer loans averaged $101 billion and were stable with the second quarter as growth in auto loans was mostly offset by a decline in residential real estate balances. Slide 6 details our investment security and swap portfolios. Average investment securities of $142 billion increased $1 billion or 1%. The securities portfolio yield increased 24 basis points to 3.08%, driven by higher rates on new purchases and the full quarter impact of the securities repositioning. As of September 30, our securities portfolio duration was approximately 3.3 years. Our active receive fixed rate swaps pointed to the commercial loan book totaled $33 billion on September 30. And the weighted average rate increased 58 basis points to 3.08%. Our forward starting swaps were $15 billion with a weighted average receive rate of 4.26%. Importantly, with our forward starting swaps, we've locked in the replacement yield on the majority of our 2025 swap maturities at levels higher than existing swaps and current market rates. Turning to Slide 7. We expect considerable runoff of lower-yielding securities and swaps, which will allow us to continue to reinvest into higher-yielding assets over the next couple of years. Accumulated other comprehensive income improved by approximately $2.4 billion or 32% to negative $5.1 billion on September 30 compared to negative $7.4 billion on June 30. The linked quarter improvement in AOCI was primarily due to lower rates, which benefited our swap and available-for-sale portfolio valuations. Going forward, AOCI related to these securities and swaps as well as our held-to-maturity portfolio will accrete back as they mature and prepay, resulting in further growth to tangible book value. Slide 8 covers our deposit balances in more detail. Average deposits increased $5 billion or 1%, reflecting an increase in interest-bearing commercial balances as well as higher time deposits. Regarding mix, noninterest-bearing deposits were stable at $96 billion and remained at 23% of total average deposits. Our rate paid on interest-bearing deposits increased 11 basis points during the third quarter to 2.72%, reflecting growth in commercial interest-bearing deposits. We believe our total rate paid on deposits has reached its peak level and with the 50 basis point cut in September, we've already begun to reduce deposit pricing. Looking forward, we expect the Federal Reserve to cut the benchmark rate by 25 basis points at both the November and December meetings, which will accelerate deposit repricing, particularly within our high beta commercial interest-bearing deposits. Turning to Slide 9.We highlight our income statement trends. Third quarter net income was $1.5 billion or $3.49 per share. Comparing the third quarter to the second quarter, total revenue of $5.4 billion increased $21 million. Net interest income grew by $108 million or 3% and our net interest margin was 2.64%, an increase of 4 basis points. Fee income increased $176 million or 10%. Other noninterest income was $69 million and included negative $128 million of Visa-related activity. Noninterest expense of $3.3 billion decreased $30 million or 1%. As a result, PPNR grew 2% linked quarter and we generated positive operating leverage for the third consecutive quarter. Provision was $243 million, reflecting portfolio activity and our effective tax rate was 19.2%. Turning to Slide 10. We highlight our revenue trends. Third quarter revenue increased $21 million, driven by higher fee and net interest income, partially offset by lower other noninterest income. Other noninterest income included negative $128 million of Visa-related activity. Net interest income of $3.4 billion increased $108 million or 3%, driven by higher yields on interest-earning assets. Fee income was $2 billion and increased $176 million or 10% linked quarter. Looking at the detail, asset management and brokerage income grew $19 million or 5%, reflecting favorable equity and fixed income market performance. Capital markets and advisory fees increased approximately $100 million or 36%, driven by higher M&A advisory activity as well as broad growth across most categories. Card and cash management decreased $8 million or 1% as higher treasury management revenue was more than offset by credit card origination incentives. Lending and deposit revenue grew $16 million or 5% due to increased customer activity. Mortgage revenue was up $50 million linked quarter, driven by a $59 million increase in the valuation of net mortgage servicing rights. Other noninterest income of $69 million included Visa derivative fair value adjustments of negative $128 million, primarily related to Visa's September announcement of a $1.5 billion litigation escrow funding. Notably, we continue to see strong momentum across our lines of business and throughout our markets. And year-to-date, noninterest income of $6 billion grew approximately $400 million or 7% compared to the same period last year. Turning to Slide 11. Our noninterest expense of $3.3 billion declined $30 million or 1%. Excluding the second quarter $120 million contribution expense to the PNC Foundation, noninterest expense increased $90 million or 3% linked quarter. Personnel expense increased $87 million or 5%, reflecting higher incentive compensation related to increased business activity. Importantly, all other categories declined or remained stable. Year-to-date noninterest expense has increased by $80 million or 1%. Excluding the $130 million FDIC special assessment and $120 million foundation contribution expense in 2024, noninterest expense is down 2% compared to the same period a year ago. We remain diligent in our continuous improvement efforts. We increased our CIP goal last quarter from $425 million to $450 million and we're on track to achieve that goal in 2024. As you know, this program funds a significant portion of our ongoing business and technology investments. Our credit metrics are presented on Slide 12. Nonperforming loans increased $75 million or 3% linked quarter, primarily driven by an increase in CRE office loans. Total delinquencies of $1.3 billion were stable at June 30. Net loan charge-offs were $286 million. The $24 million linked quarter increase was driven primarily by lower commercial recoveries. And our annualized net charge-offs to average loans ratio was 36 basis points. Our allowance for credit losses totaled $5.3 billion or 1.7% of total loans on September 30, stable with June 30. Slide 13 provides more detail on our CRE office credit metrics. We continue to see stress in the office portfolio given the challenges inherent in this book and the lack of demand for office properties. CRE office criticized loans were essentially stable linked quarter but NPLs increased due to the migration of criticized loans to nonperforming status. Net loan charge-offs within the CRE office portfolio were down slightly. However, going forward, we expect additional charge-offs on this book, the size of which will vary quarter-to-quarter given the nature of the loans. As of September 30, our reserves on the overall office portfolio were 11.3% and inside of that 16% on the multi-tenant portfolio, both up slightly from prior quarter. The modest increase in reserves reflects the continued valuation adjustments across the portfolio and specific reserves for certain credits. Furthermore, CRE office balances declined 4% or approximately $270 million linked quarter as we continue to manage our exposure down. Accordingly, we believe we are adequately reserved. In summary, PNC reported a solid third quarter. Regarding our view of the overall economy, we're expecting continued economic growth in the fourth quarter, resulting in real GDP growth of approximately 2% in 2024 and unemployment to remain slightly above 4% through year-end. We expect the Fed to cut rates 2 additional times in 2024 with a 25 basis point decrease in November and another in December. Looking at the fourth quarter of 2024 compared to the third quarter of 2024, we expect average loans to be stable, net interest income to be up approximately 1%, fee income to be down 5% to 7% due to the elevated third quarter capital markets and MSR levels, other noninterest income to be in the range of $150 million and $200 million, excluding Visa activity. Taking the component pieces of revenue together, we expect total revenue to be stable. We expect total noninterest expense to be up 2% to 3%, and we expect fourth quarter net charge-offs to be approximately $300 million. Importantly, considering our year-to-date results and fourth quarter expectations, we're on track to generate full year positive operating leverage. And with that, Bill and I are ready to take your questions.

[Operator Instructions] Our first questions come from the line of Erika Najarian with UBS.

Rob, if you could just unpack little bit of the commentary you made on the swaps. So I guess, first part of this question is, I noticed that the receive fixed rate on your asset -- on your active swaps went up quite a bit quarter-to-quarter, implying that what's rolling off is well [ sub 1 ]. You went from 2.50% to 3.08%. So I'm wondering if you could confirm that. And looking forward, I think you said something in your prepared remarks about replacing expiring '25 swaps at a higher fixed rate -- receive fixed rate than you thought. So maybe just clarify that statement as well.

Sure. So yes, you're right. And again, all of this in terms of your question, that points to what is occurring, which is that our repricing of our fixed rate assets, including our securities loans and swaps is occurring at higher rates. So that's all of what we've been talking about for a while. True, in terms of the swaps, new swaps are at a higher rate than the old swaps and then as you recall, back in the spring, we did execute some forward swaps that locked in rates for maturing assets in '25 that contribute to our statement, which we might as well confirm upfront, our NII being at record levels in 2025. We're sticking to it.

Got it. Okay. And just the second part of my question, that's the mechanical side, now on the strategic side. Bill, it's been such a long time since the market has seen a neutral rate of not 0. Everybody has talked about deposit betas. But as we think about what the natural deposit cost is for PNC, how should we think about what the spread is, let's say, we settle at 2.75%, 3% in terms of Fed funds. What's the spread in terms of Fed funds versus your funding costs naturally? And additionally, just as a quick follow-up to Rob, as we're on the liability side of the balance sheet, is there -- what drove the strength in deposits? And was that mostly corporate? And is that permanent balances? Or is that sort of some corporate balances just parked for now, given the uncertainty in the market?

I can't give a specific answer to where we might end up if rates -- front rates kind of hold at 3% and change, which I expect they will, practically, you can do most of that yourself, right? So the 0 cost deposits are obviously worth a lot more. If there's any steepness to the curve, we get that benefit with our fixed rate assets. So maybe inside of your question is, all else equal, if we end up in an environment where front rates are 3% and change and back rates are somewhat higher than that, that's the really attractive environment for banks, ourselves included.

Yes. And then the second part of that, Erika, was that the outperformance in our deposit balances came on the commercial interest-bearing side, as commercial clients continue to build cash on their balance sheet. Our expectation is that will hold for the most part through the end of the year.

Our next questions come from the line of John Pancari with Evercore.

On the loan side, still -- balances are clearly still pressured and you flagged loan utilization down a bit to 50.7% and below your historical. Can you maybe talk about the demand -- the underlying demand trends that you are seeing? And what do you think is going to be the biggest catalyst to get borrowers off the sidelines in borrowing? Is it continued rate cuts confidence in that front? Is it the election? If you could just maybe give us some thoughts there? And what do you think a growth rate is reasonable as you enter 2025?

John, it's Rob. So yes, all year, we've yet to deliver the loan growth that we thought was coming at some future point. And for all the obvious reasons that you've seen, utilization is low. And there is a bit of a pause feeling, obviously, with the election coming up and the rate environment. What we point to in terms of -- on the constructive front is, we do continue to add customers. We do continue to add loan commitments quarter-over-quarter. So our commercial clients are putting those lines in place with the anticipation of borrowing. So that's a constructive sign. And then you've seen the lower inventory levels, the low CapEx to sales levels. So it does feel as though we're at the point in the cycle where loan growth is not too far off.

Okay. Got it. And then separately, capital markets clearly has been a point of strength. Can you maybe just provide us a little bit of color on the pipeline there? And do you expect a pullback in the fourth quarter off these high levels? Just how should we think about that?

Yes, yes, we do. I'll expand that a little bit in terms of our fee guidance for the fourth quarter. So we're pointing to down 5% to 7%. And all of that decline is being driven by the elevated MSR levels and the elevated capital markets levels that we achieved in the third quarter. So for the fourth quarter, the MSRs is pretty straightforward. We don't expect to have those levels in the fourth quarter. And then on the capital markets side, the short answer is, we probably pulled a little bit of the fourth quarter activity into the third quarter. A lot of that is in our Harris Williams M&A advisory businesses that had a really strong third quarter as well as some of the other broader capital markets story. So it's a little bit lumpy. The pipelines though are strong. The momentum is strong. Capital markets year-over-year is up north of 23%. The back half of '24, including our capital markets guidance for the fourth quarter is up 20% over the first half. So the momentum is there, it's just not necessarily going to fall linearly quarter-to-quarter.

Our next questions come from the line of Scott Siefers with Piper Sandler.

I guess, I wanted to follow up just a little bit on sort of the lending and deposit discussion. I guess, first, just kind of qualitatively, do you have a sense for what a lending recovery might look like when it does come back? And I guess the context of that is, I recall a time when the bank loans used to grow at some multiple of GDP but it's been quite a while since we've seen that. So maybe just some top-level thoughts there. And then on the other side of the balance sheet, just maybe your sense for how deposit costs behave if lending does come back better. You all and I think a lot of the industry are great from a liquidity perspective. So curious how much competition factors into your thinking as well.

We -- I can come up with 10 different theories on why loan growth hasn't been there and why it might come back but all of them are making up theories. It's been below trend on utilization. There's a bunch of uncertainty, not the least of which is the election and rates and all the other things that may impact it. But it's one of the reasons why we kind of said, look, we'll produce growth for our shareholders without having to rely on some made-up story as to why there might be loan growth. If there is, it's terrific and at some point, it will come back. But even I'm trying to forecast it personally. On the funding side, we are very liquid. So we have an opportunity should it arise. We have a lot of capital and cash and that would be a great thing for us [indiscernible] balance that the Fed [indiscernible]

[ 35 spot, 45 average ], so a lot.

Yes. So I don't know that it's going to impact our funding costs whatsoever.

Our next questions come from the line of Matt O'Connor with Deutsche Bank.

Any updated thoughts on where you think your net interest margin normalizes? I think at one point a couple of months ago, you said it could approach 3%. I think it was by the end of next year. But updated thoughts on that, given the forward curve and your outlook for the mix of balance sheet.

Matt, it's Rob. I do recall you asking the question before. And the answer is going to be the same, which is, our NIM is increasing. We don't manage the NIM. It's an outcome. We've operated close to 3%. My expectation is that we'll approach those levels. I don't remember saying by the end of '25 but maybe that's something that you added in but we're on our way up and 3% is reasonable through time.

Okay. And actually, maybe it was by the end of '26. I had my -- I know it's hard to read. And then just separately, you've always been very strong in commercial lending and some of the fee businesses that come from that. The consumer side has always been a little bit less of a focus but I think you've been leaning in areas like credit card around the edges. And just any updated thoughts in terms of what could be growth drivers as we think about consumer lending, consumer fees next couple of years?

Look, we've -- historically, we have underinvested and we've -- we are underpenetrated with our existing clients.

On consumer.

On consumer. Yes. And that's our opportunity set. I don't know that we need to be heroic and be -- go beyond that but we ought to have the same penetration rate that our peers do with respect to our consumer lending. And there's fairly material upside should -- if we can pull that off and we're investing to be able to do so.

And we've introduced a new credit card and plans to continue to do that along those lines.

Okay. And when do you think you'll start -- we'll start seeing some of those efforts kick in? I mean we are seeing pretty good credit card volume growth for the industry and at most peers. And obviously, there's a little bit of a lag but when do you think some of those efforts will be a little bit more evident?

I don't know that I have a time line on it. I would tell you that we're investing in people. We're investing in our credit management capabilities in our marketing and our product delivery, all of the above that will, hopefully, through time, allow us to get the penetration we should have. I don't know what the time line is on that but I know it's a journey and I know we need to start it.

And we're beginning now [indiscernible]

Our next questions come from the line of Bill Carcache with Wolfe Research.

Following up on your loan growth commentary. You've had a lot of success over the years in taking share within C&I. If we do get a reacceleration in loan growth over, say, the next year or so, how does that influence your ability to continue to take share and perhaps outpace industry growth, recognizing your competitors are obviously not willingly ceding share.

Well, I think that will show up. We are growing DHE and winning new clients at a record pace, I think. So when utilization comes back, to be honest, as we have in the past, my best guess is, we would outperform.

Well, DHE is our loan commitments. They're unfunded at the moment but they've been put in place. And I think the -- most of the momentum that we see is in our Southwest markets, where we are achieving record levels and would expect to be above average, if it all plays out as we expect.

That's helpful. And then separately on noninterest-bearing deposits, you expect rates on your interest-bearing deposits to decline starting next quarter but how long before you'd expect to see the effect of lower rates relating to compensating balances?

Yes, I don't know. That's a tough one to answer. I mean, what we're encouraged about is we've clearly stabilized now for a couple of quarters at the levels that we are, following several quarters of pretty substantial decline. So we've stabilized. There's a lot of theories in terms of what sort of the magic short-term rate is that kicks that up. But no one has a definitive answer.

Right. But is the credit that you give customers on compensating balances to sort of lever that you'd expect to use or be willing to use as you look to grow noninterest-bearing deposits? Just trying to think through whether that's a potential -- something that could spur growth?

You should assume that crediting rate is below market versus open deposit rate. And so it's not going to have a moving beta for some period of time relative to rates coming down.

It's relatively constant and we're fine with that.

Okay. Great. And if I could squeeze in one last one. If the NII trajectory that you laid out for 2025 plays out as anticipated, is there any reason why -- the positive operating leverage commentary that you laid out is very helpful but any reason why the efficiency ratio wouldn't get down into sort of that high 50% range? It seems like the math would suggest that, that could get there but would appreciate your thoughts.

We'll have to see. Bill, we're in the process of doing our budgeting for next year right now. So we'll have more for you on that in our January call.

Our next questions come from the line of Mike Mayo with Wells Fargo.

I think, Bill, your prior comment that you expect record NII in 2025, do you feel more, less or just as confident as before? And what sort of loan growth do you kind of assume for next year?