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

Good morning, everybody. What a day to have a bank conference. So I'm very excited for this next session. We have with us today Bill Demchak, the Chairman, President and CEO of PNC; and Rob Reilly, Executive Vice President and CFO. Thank you so much for joining us, gentlemen.

Good morning.

Sure.

So Bill, I'm going to kick it off with you. Since we last heard from management, we've all seen a global and national spike in COVID-19 picking up cases and a positive news about the vaccine, and of course, a presidential election now behind us. How has your view on the economic recovery for '21 shifted, if at all?

Look, even both for the election and the vaccine announcement and the spike in cases, I think, and I've said this before, that the downside scenario, the really ugly scenario, in my view, was kind of taken off the table largely because of the actions in the Fed and the fiscal response from the government. Since then, we've largely seen good news with the vaccine announcement this morning, the cases spiking but the fatality rate a lot less than it once was given treatment and so forth. So if anything, we're more constructive on the economy. But that said, we do seem to be grinding along at a lower pace with the speed of the recovery obviously slowing, and that will be affected by the spike in cases. As -- if nothing else, people tend to be out less than they were, independent of what the government tells them to do. We have seen, a little bit to my surprise, consumer spending hold up. Just last week's data on card and debit, both was really strong. And I had expected, and in fact, we saw a little bit of evidence of it falling off post the expiration of the CARES Act's unemployment number. So all things considered, better than I would have thought on the downside, probably in for a long grind here. At the moment, we're obviously seeing kind of the have and have-nots in terms of the COVID-impacted industries versus the rest of the economy, and that's going to play out over time.

Yes. Speaking of haves and have-nots, a lot of pundits talk about a K-shaped recovery. And I'm wondering, you go find a lot about how you're seeing the banking industry evolve. Do you see a similar K-shaped recovery and fundamentals in performance in terms of stronger banks and weaker banks?

I think you will naturally see that, I think, for 2 different reasons. One, for the balance sheet construction. So banks who were or heavily exposed to COVID-sensitive industry, so think real estate, think smaller business and commercial and even oil and gas, those banks will struggle. And as well, I think the shift to digital that was kind of this forced shift from the pandemic is going to start to separate out user experience and how people choose banks. So I think you're going to kind of have a pounded effect, frankly, on the smaller banks to the downside as a function of the economy, low rates, digitization and just the nature of their balance sheets.

Yes. Bill, you mentioned on the earnings call that a sizable portion of the small businesses and smaller corporate that you surveyed said they would be out of business in a year if the current environment were to continue without further stimulus. And so is it crucial for the government to get a PPP version 2 in the next round of stimulus?

Yes. Well, first off, I actually misspoke. So in my -- in the earnings call, I suggested there were 60% of our businesses who responded to be out of business in a year. It was, in fact, 31%, which is still a substantial number. But I'm not sure, to be honest with you where I came up with the 60%. Somewhere in my notes, but related to something else.

That's good news.

It is good news. But even inside of that, in the survey, it's approaching 90% of the survey respondents who are basically saying that PPP is very important to them, that there's 85-plus percent who are saying that business is not back to normal for them, and they view it crucial that we do another program. The other thing about PPP to the extent that it keeps businesses going and paying people is continuation of medical benefits and other things that aren't necessarily captured simply through supplemental unemployment. But I do think all else equal, notwithstanding the news on the vaccine, which will take a while to get out and about, we should and I expect we will see another fiscal package that helps small business and consumers.

Bill, there was certainly a concern about corporate leverage even before the pandemic. And you yourself have mentioned corporate leverage has grown to 4x from 3x. Outside of the debt markets, lending financing has certainly been a major competitor for the banks. That being said, given the amount of support the Fed is giving to the system, do you think that some of the leverage bubbles that had built up pre-COVID-19 won't pop outside of the industries that are clearly impacted or most severely impacted by COVID?

I think in the near term, that's right if for no other reason, rates are so low. In effect, an extra turn of leverage doesn't hurt that service coverage. So at least in the near term with low rates, people can survive with higher leverage and somewhat subdued performance, just given where the economy is. The other thing that's happened is notwithstanding the speculative grade default rate, which is, I think, running kind of twice its historic norm right now, the capital structures of nonbank finance vehicles have survived this, right? So CLOs have permanent capital. And while there are restructurings and losses that are occurring in the lower tranches of these vehicles, by and large, they are surviving. And the combination of that and the massive liquidity that the Fed put in the system is it kind of allowed this to function. So I don't see financial disruption per se in the markets because of the excess leverage. I do think we'll continue to see defaults. But thus far, we've seen pretty orderly liquidations and repacks and bankruptcies going through and the market operating as it otherwise should in a slower period of time.

So do you see the role of nonbank lenders evolve post pandemic? Is it going to be similar to 2019? Or do you think that they are going to be even harder your competitors, given this -- the circumstances?

Well, it's a fintech. The fintech players who are in the payment space are obviously doing well. And the changes that we've seen through digital adoption in the end will benefit them. The fintech players, if that's what you want to call them, are in the financing space. Nothing has really changed, and some of them had some near-death experiences prior to the Fed coming in with massive liquidity. We've seen that in the nonbank mortgage originators and services, given the monies that we all have to advance against deferrals. And we've obviously seen that in some of the consumer lending vehicles. So I don't know, again, that lending per se in a fintech base that doesn't have a core deposit base is going to be a good business. And I don't think this changes it at all. You muted yourself, Erika.

There you go. Let's shift to some of your national expansion efforts, Bill. You mentioned that in middle market expansion, it typically takes 3 years for a new market breakeven. And in this environment, where businesses are focused on liquidity and cutting costs, does it take longer to be established in the new market?

I guess in theory, yes, although I would lead off by telling you that we've kind of talked about a 3-year breakeven. We've actually outperformed that pretty handily and outperformed our expectations. The other thing I would say is that one of the things that we see in our new markets is 50% of the revenues that we get in these expansion markets is actually fees. And if anything, that is accelerating during this environment, not slowing down because it does get to this cost savings mode. We've seen a massive pickup in what we're doing in the treasury management space, helping corporates take out costs using automation in their payment space. And I think that will continue. So maybe at the margin, less because of cost saving and that's of liquidity more because of just the ability to call on new clients in a virtual world, it's probably a little harder to get new clients than it once was. But that's at the margin. It doesn't at all slow us down from our expansion efforts. And thus far, what we're -- what is it, 8 months into this thing now, it hasn't actually slowed down what we're doing in the markets we're in, in terms of our conversations with clients and our ability to cross-sell.

Got it. So on the retail side, you've talked about learning about the importance of solution centers being greater than you thought. And as you merge that data with digital regarding use of digital solutions during a pandemic, what does that tell you about the balance of physical presence with digital? And is this balance naturally different in expansion markets versus legacy markets where in the latter, I think you're closing 160 branches in 2020 and 120 in 2021.

Yes. I think first of all, think about the mindset. When we're in an existing, what we call, a thick market where we have substantial share, we're largely servicing customers and cross-selling customers. So the activity of our employees and the deployment of our technology is in pursuit of a good customer experience. When we're in a new market, we're acquiring new customers. And the energy of our employees is spent around acquiring new customers. But we see with digital customers only, so those acquired through digital channels, is that they're lower valued customers than the ones that come into the solution side. Some of that, I guess, would be self-evident. But in the solution center, we are finding production precrisis that was twice a typical de novo. During the crisis, it fell by 50%. I mean they were largely closed. And since we reopened, they're up 25% beyond where they were precrisis. I think that's the products and services that we offer. We just launched a new product called Virtual Wallet Pro that you remember going back 6 or so months ago, we talked about the complexity we had in opening digital accounts. We simplified that. We allowed people to separately open a checking account with a lot of features from the saving account, with a lot of features, they can join them if they wanted to. They didn't have to take both. So it's a whole bunch of things that somehow is driving traffic into the solution centers, and we're more convinced than we ever were that they ultimately matter. Physical presence matters. Now what digital does is allow the frequency by which you have to visit a physical branch to go way down. And therefore, we can space them out a lot more than you would have even 10 years ago, and that's what you see us doing. The other thing I would say is we are certainly learning from the success in the solution centers in the new markets and deploying some of those things into our legacy markets, both the format of the branches, the way people spend their time in terms of appointment setting and outreach, some of the product capability that heretofore was just in our national expansion. We're starting to bring that back in the footprint. So hopefully, we'll be able to take some of what we've learned and accelerate what we're doing in legacy markets as well.

Yes. So that's my follow-up question. I think you're one of the -- there are 2 banks I know, and you're one of them that disclosed their Net Promoter Score.

Yes.

And I don't even have to look at my notes because it sticks out so much, 86% than new solution centers.

Yes.

So what are those learnings that -- like you said, what specifically can you roll out to the legacy markets that you think is really working in those new solutions centers?

Well, some of it is this new Virtual Wallet Pro, which is just -- it's just real simple to open and logical. It comes with good benefits. It's a free product. Some of it is the outreach by our employees. I mean it's a natural -- this is kind of logical, right? If you're gathering a new customer, and you can spend all your time working with new customers as opposed to servicing existing customers in the crowd that comes in all day long, I guess it doesn't surprise me that our Net Promoter Score in the new market is slightly higher than what is already an elevated score. Our traditional retail channels have really high scores as well. It's just that the solution centers are blowing away any metric we've seen from financial like companies in the past.

So Bill, taking a step back, you've clearly demonstrated success in your organic expansion, and now you have a treasure trove of excess capital. How do you see PNC quality of franchise over the next 5 years? Maybe another way to put it, whenever that time is that you retire, what does PNC look like as a franchise?

Look, I think we look largely like we do today, serving more geographies. I think that partly because of the capital we have but also because of our proven ability to expand, I think we can grow our franchise on the back of the success of the businesses we have today. We know how to do this. And I think that notwithstanding that banking is going to be a tough environment, I think, for the next bunch of years because of rates and slightly higher credit costs and all the stuff we know about technology spend, I think there's going to be real separation between winners and losers inside of that slow growth environment. Our intention is to be a winner in that space. We think we have the tools to do it, and in the process of doing that, be a much larger institution over time than we are today.

So you've mentioned that you've wanted to place the earnings that you sold something with a higher growth trajectory. And I thought it was interesting, when we pulled the data, BlackRock had a historic 5-year earnings CAGR of 6% and SMID-cap banks, 12%. But nevertheless, you've been met with skepticism, given that investors see banking industry as low growth, especially in rates where they are. How do you respond to that pushback?

A little bit that the way I just answered the previous question. I think banking is likely to be slow growth, the industry is slow growth over the next period of years. But inside of that, I actually think we can be much faster growth than the average, simply on the back of the technology spend we already have behind us. That products and services that are relevant to our clients, our ability to go into new markets and gather share, I think, is going to allow us to differentiate ourselves as we go forward here and in a big way, actually. The issue with BlackRock, phenomenal company, but we didn't control it, right? We had a massive part of our market path basically sidelined within somebody else's control. And arguably, tying up that capital was slowing down our ability to grow as a stand-alone franchise and ultimately succeed on our own. And so what we talk about, we think is completely doable is to take the capital generated from the sale of BlackRock and redeploy it into an asset that we then control and can take our track record, product set, people go-to-market strategy and actually grow at a pace that's faster than the rest of the industry in a larger market in more geographies. So all else equal, inside of what is going to be a consolidating industry that might, on the surface, look pretty boring, there's still 5,000 banks out there. And it's really a massive, massive, massive revenue generator and profit generator inside of the U.S. economy. We just want to get more share of that.

So this next question is well matched with the kind of market we're experiencing today. So you've been pretty clear about wanting to use that capital to buy depositories with traditionally commercial focus. If the valuations of midsized banks recover better than expected, would you look to other opportunities? Many investors have asked me about why we're not considering consumer finance businesses are a part business, for example.

A couple of different reasons. The primary one is most of the consumer finance businesses that ever show up on the market for sale are broken. And our ability to fix in scale a large broken financial or consumer finance business, maybe we can do it, but I'd have a lot more confidence in our ability to fix a C&I franchise. Number two, consumer finance is a stand-alone unless it's somehow integrated into your broader client relationship strategy as a stand-alone asset generator. It's a low capital return. It's in good markets, it's a great net interest margin generator, an NII generator. But through time, unless you can -- on the totality of that relationship, it's not a real high return on capital in our view. So we never say never, right? Consumer products that we could add and scale to our existing consumer base would be great. But they're not of a size that's going to utilize a substantial portion of the capital that we generate.

And one more question in this vein. I think some investors may have misread or misunderstood your comments during the third quarter call on having "seller's remorse" on the sale of BlackRock. Did you want to clarify your point here? And also, could you please remind us how important for you that single counterparty credit limit was in your decision and the timing of the decision?

Yes. I should never try to answer a simple question with a long statement. We don't have seller's -- I don't have seller's remorse on selling BlackRock. I think what I said, and I'd say today is all else equal, I would rather sell BlackRock at $680 or wherever they are today than the price we sold them however many months ago. Of course, we'd all like to be investors who could go back and pick the winners after the fact. BlackRock became too large a part of our capital structure. Eventually, we were going to have to deal with the regulatory consequences of owning that. There was a single counterparty credit limit which basically suggested that -- and Rob can give you details on it. But effectively, we -- once their -- once our book value of that holding got to a certain point, we would be in violation of that single counterparty limit, would have to sell that down. There were consequences that were very visible inside of our stress test results because the squeeze out in the same bucket. So on and on and on. We knew for a long period of time that as good an investment as BlackRock was, ultimately, structurally being held by regulated bank with margin percentage as it was of our earnings stream was not sustainable. So it was the right decision to sell it. And it's the right decision to pursue a strategy that allows us to grow through time and something that we control, and that's what we're going to do.

Great. Rob, anything to add here on the SCCL?

Yes. No -- Bill hit it there, Erika. It's -- BlackRock, through its size, was becoming increasingly cumbersome from a regulatory standpoint. And we saw that through the CCAR and the threshold deductions, et cetera, that went away, then the SCCL was up net. So it wasn't per se the SCCL. It was just that as they continued to grow, we were always going to need to confront the reality that at some point, we could potentially now hit a road that we had to do something in a forced way rather than an elective.

Yes. The other issue was that we balanced that fine line to maintain equity accounting based on our ownership stake. And of course, BlackRock has their own ambitions to grow. And given their multiple, there's always the possibility that they were going to do something that would have diluted us down in ownership the same way we were diluted down when they bought Merrill Lynch or BGI. And in that instance, we would have been forced to sell in a period of time where we have no control.

Got it. So before I kind of move on to the next topic, I just want to remind the audience, there's nearly 200 of you in the room. This would be a good time if you have any questions for Bill and Rob to submit it through the webcast portal. The next topic, I wanted to touch on expense management in this backdrop. On the earnings call, you noted that you're on track to deliver positive operating leverage in the 3% to 4% range for 2020. Given the expectations for a challenging revenue environment in '21, is it possible to achieve positive operating leverage next year?

Like -- first of all, it's too early to comment on what we can and can't do exactly in '21. Not -- the least of it, we don't have a budget on, but also because things are changing so quickly. Having said that, that is a focus of ours and our effort to recycle costs to support our investments, I think, is well understood. And if anything else, we've gotten much more aggressive on that given the environment that we were in pre-COVID. But at this point, Rob, unless you want to say anything else, I think it's probably premature to say what we can and can't do in '21 other than we're going to push as hard as we can to possibly...