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

Today, CEO, Bill Demchak. Bill, thanks for joining us again.

Happy to be here, John.

So we could start off talking about deposits and customer behavior. A lot of us went into the year expecting to see a slowdown in mix shift and yield-seeking behavior across consumers and corporates. So I guess the first question is, is that happening? Are we starting to see that slowdown in mix shift? And is higher for longer kind of rate expectations starting to have an impact? Or do we not know yet in terms of that mix shift and deposit behavior?

Well, we've definitely seen the slowdown in behavior. The biggest change in value, of course, was from noninterest-bearing or super low interest-bearing into real interest-bearing accounts. The secondary effect was beta on interest-bearing accounts, but all of that has slowed. Corporates, if you think about we're the fastest to move and consumers through time, kind of optimize the amount of cash they want to keep around for transactions, which is noninterest-bearing, but also interest-bearing checking and sort of our super low interest-bearing money fund that goes along with the checking account. And -- I mean we were definitely seeing that sort of slope to an optimal level. Lots of questions, does that change and higher for longer? And of course, at the margin, it has to because you'll continue to see some amount of bleed, but that bleed is slowing appreciably during the course of the last 6 months.

So does that suggest what folks have left in their accounts is kind of working capital and what they need generally?

That's the hypothesis. We're actually doing some work behind that, but as a practical matter, the money -- the way I think about it is that the money that somebody thinks about as investment dollars I want to return on has been moved. The money that sits in the super low interest-bearing accounts or noninterest-bearing accounts today is largely transactional. It's what you have because you're going -- you think about that as money you're going to spend. That's the behavior we're seeing.

Yes. And what about on the bank side in terms of the price competition? Anything surprised you there? And it feels like there's a bifurcation a bit between bigger banks that are flushed with deposits and maybe competing a little bit less and then smaller. Is that true? Are you seeing that?

It is true. I mean if you just look at excess reserves on the Fed's balance sheet, something on the order of 80% of them are held by the handful of largest banks, plus some foreign banks. On the other side, you have a bunch of smaller banks that are short. And the Fed funds market doesn't really work today, right? We all hold excess reserves. We don't necessarily lend those the way we used to in the Fed funds market, because you -- if you're a borrower, you don't get credit for the liquidity and if you're a lender, they don't want you to give the money away. So yes, A Tale of 2 Cities. A bunch of us are flush and a bunch are in need. And I think you're seeing that play out in some of the back-end costs of CD rates, online brokered CD rates, some of the online posted Internet money, I don't know what else to call it.

And then how about on the loan side? I mean, we've all kind of seen the weakness in [ H8 ]. It just feels like utilization of lines has been low. You've talked about that. What are some of the drivers that are keeping folks from borrowing on the lines?

Look, I'm guessing all the same guess as you are. There seems to be a big wait and see around interest rates. I mean the presumption that rates were going to go lower. We started the year with the everybody saying there's going to be 7 cuts who wants to borrow, let's wait for the 7 cuts. So I think people are trying to get in their heads, what are rates going to be through the cycle here. We have an election coming up. We have corporate margins that have been squeezed and therefore, I think people are unwilling to expand working capital or do CapEx. All of these things cause pent-up demand. As an aside, we're winning clients, and we're actually increasing what we call DHE or the total exposure we give to corporates. They're just not borrowing under those lines.

So we need to see some more certainty perhaps on rates and maybe some more M&A activity.

M&A would drive it. But it's not even, I mean, certainly with respect to rates, but eventually, markets meet, right? So think about M&A, right? We've had this agreement between buyers and sellers on price, and now I'm going to wait for rates to go down. So my financing rate will go down, so that my price will go up. Eventually, there's a market. And I think that's going to affect not just M&A, but it will affect the basic loan market where [ people say, ] I got to run my company. I need working capital. I'm going to borrow because I got to have inventory, and we'll get back on the normal cycle.

And how much is nonbank competition, private credit and others kind of weighing on loan growth for banks? Is there a big [ good as ] spread between the 2 and just demand-wise?

I don't think so. I mean in the first quarter -- I mean to be fair in the first quarter, you saw a big high-yield leverage lending boom in terms of activity that included banks and nonbanks in terms of investors. The way we think about that market, you might have seen our announcement on TCW, where we formed a joint venture to hold or run a fund where we are an originator and underwriter with TCW who's been a 25-year partner, leveraged cash flow loans. For us, it's less about the asset. It's more about the relationship. So over the course of the last 20 years, we've seen a lot of really good clients being purchased by private equity. And in the course of that because we don't want to be the capital provider, neither then nor now. We'd lose a relationship. We absolutely want the relationship and the fees that come with it. This new partnership with TCW allows us to stay in the game with a lot of great clients even if they change their ownership structure.

So if we think about the deposit side, we're talking about the loan side, how does that play out in terms of kind of the outlook that you have for net interest income to kind of trough this quarter? It seems like you're relatively neutral to what happens to rates in the near term. And then maybe you can kind of talk about how that rolls forward to a fixed asset reprice story into next year.

Yes. So our -- we've talked about trough in this quarter, we talked about record NII in 2025, and we still hold to that view. That view is less dependent on heroic loan growth assumptions. In fact, it's not dependent on much loan growth assumptions. It's most dependent on the mechanical maturity of fixed rate securities. So treasury matures on a certain date or an auto loan or fixed rate assets and then reinvesting that 1% coupon into a 4.5% coupon. So a lot of that when we look at '25, that's kind of assuming the forward curve is correct, we kind of lock that in. The higher rates are when that happens, the more revenue we get. Offset by the front rates are higher for longer, there's some deterioration in the cost to our deposit base. Thus far, what we thought and what we're seeing is that increase in term rates on the forward curve and our ability to lock those in a little bit at the margin is more beneficial than slower loan growth and/or bleed in deposit cost.

The only real risk to that mechanical reprice would be if rates really came down on the...

A big inversion if you, for whatever reason, had the Fed holding and just term rates really rally from here. Hard to imagine that given the size of the deficit in term inflation expectations. But yes, that would be a risk.

So it feels like we kind flipped into a little bit, just talking about your outlook on NII. Just in general, any update for the quarter or generally things as expected so far.

As expected. Yes.

Okay. So talk a little bit about M&A and kind of how you think about the structure of the industry and kind of winners and losers longer term. Most M&A deals over time have not created shareholder value in bank land. What do you believe the most important criteria are that have kind of distinguished good and bad? And how do you make sure you're on the right side there -- continue to be on the right side of that?

Well, I want to go back to M&As were subject, which is what's a good deal and what's a bad deal in terms of what we look at. Number one, certainty of execution on costs. Like you can't just say other people say that. So I can probably say that. I think you actually need to know dollars and cents, where they're coming, on what day they're coming, why they're coming, what systems you're shutting down, which buildings you're shutting down, which people are going, you have to know that and lock it down. You need to put parameters around the balance sheet and the risks associated with credit. And importantly, you need one throat to choke. Somebody's got to be in charge, co-heads of people making joint decisions on a merged culture is tough. And then you need the backbone. You're sitting now with our technology just the ability to have a single surviving technology. So you're not spending the next giant period of time trying to merge all the systems together, you're just literally shutting down one and merging it into another. That kind of -- that, by the way, is what gives you certainty on execution and cost saves.

And on the bigger topic, you pointed to the advantages of something that the biggest banks have in terms of gathering deposits, whether it's brand footprint. Maybe you could just talk about what is driving the success of those that...

Well, I mean, let's just talk about the facts for a second, right? JPMorgan [indiscernible] public about this in [indiscernible]. They have organically grown, over the last 4 years, a cumulative total larger than U.S. Bank, P&C and Truist, put together in total asset size. You can say whatever you want to say about scale doesn't matter, and now I have a secret plan, but scale is winning. It's right there. I think it's happening for -- it's been happening for a lot of years. It accelerated during the mini crisis because larger is better if you're worried about deposits, particularly if you're a corporation, Well, let's face it. They're pretty good at what they do. They're good at what they do because they have an ability to spend into technology, products and service to clients. They are ubiquitous. They are in every market. If you move out of New York, wherever you go, JPMorgan is going to have a branch that wasn't -- historically wasn't the case 25 years ago. This is why scale matters. And when I'm out on speaking, [ you are ] saying scale matters, it's all about making sure that we don't set into stone today merger guidelines, which the Biden administration has asked people [ to write ] that basically lock up zombie banks for the next 20 years and cause frankly, a structural risk, a systemic risk, I think, to the system, if that's what you caused.

Do you think there's something the regulators are missing about the benefits of mergers or anything your worried about?

I actually think they understand it quite well. I mean a couple of agencies who maybe are putting things out for reasons other than what they necessarily go there, but they're different than others. Well, I think regulators are stuck. They see the giant banks winning. They don't necessarily want to consolidate the whole system. But if they do nothing, they're going to see the giant banks who win on a larger basis. So who do you let to merge? And you'll hear them talk about good mergers and bad mergers. I think that's pretty simple. If the merger results in an institution that's stronger than the sum of the 2 individuals, then that's a good merger. Stronger in the sense of safety and soundness in management and capital and liquidity and technology and cyber and all the other different things. Part of that answer comes back to the 4 things of what do I think is important to be successful in a merger.

Yes. And so your strategy is to be opportunistic, to be available with great balance sheet technology and to be able to be a strong acquirer rather than looking at geography that you want to...

We are a strong acquirer. I don't think anybody is in the mindset to sell a bank today. I don't think it's going to be any time in the near future because I think everybody's thinking interest rates are going to make their lives easier and they'll worry about the rest later. By the way, that's probably true for the industry. What we do know is we have an objective to build a ubiquitous coast-to-coast bank that builds a retail network that is of scale to allow us to grow and fund our C&IB network, right? You don't want to be an imbalanced institution. How we get there? We'll keep investing organically. You've seen the $1 billion commitment in branch build and refurbishment, we'll keep doing that. We've been investing for technology forever. We've been hiring armies of new people in our newer markets. And if the right acquisition comes along in a way that accelerates that pace, terrific. But if it doesn't, we'll be fine. Look, I like where we are. I talk about scale and I say, oh, my god, look at these giant [ tanks, ] how much they're growing. I still like our hand better than 4,500 other banks. So it's a relative game. I think we'll do just fine.

So that $1 billion investment, I think, included refurbishment -- completing a bunch of refurbishments and also new branches and some of your expansion markets. How are you doing new branches differently than in the past in terms of the strategy in new markets?

I don't know we're doing it. I mean, we're building more. But we're thinking about -- we've gone into a lot of new markets, some that were very thin with BBVA, some on our own where we just don't have branch share to be able to gain mind share and market share. So most of the branch builds, look, there throughout Texas, they're in Denver, they're in hot markets of transient communities that are growing quickly. At the same time, by 2028, we will have finished refurbishing 100% of our own branches. And then, of course, we'll continue the process of thinning and optimizing where we've had legacy branches over time. So none of that changes, by the way, any of our expense guidance or anything else. It's just part of how we run the bank, but we're going to have to invest into these markets. By the way, just to give you an idea, when you get into a Texas market, we're growing DDA accounts in Texas at almost 5 -- almost -- well, BBVA influence markets, not just Texas but -- at 5% a year. In our legacy markets, they're less than 1% a year. We're doing the same thing, but that's the difference of -- you're going to the markets where people are moving as opposed to hanging out in the markets that are slower growth.

Where else are you kind of winning and gaining share in the expansion markets across some of the other businesses besides the branches?

Everywhere.

It's hard for us to tease that like so -- teasing out where it is on the commercial side?

Yes. So I mean, if we go all the way back to -- we talked about the easy, easy wins at the start was we could cross-sell PNC's TM product into BBVA's customers because they had very low penetration of TM, and that has been quite successful. We're not quite at the rate we are in our legacy markets, but it continues to climb. We've also just been winning new clients. I think our new client volume BBVA markets was up 33% in '23 over '22. Just new primary clients to the bank and it continued the pace in the first quarter. So if you just -- if you look across sales, which eventually grow into repeated revenue, right, the growth in our newer markets is far outpacing our legacy markets.

Let's switch gears a little bit and talk about credit. We see some debate whether CECL reserves can ever be used or not, and we haven't been around long enough. We -- CECL [ hasn't ] been long enough for us to kind of exactly know. But how do you see that dynamic working out? You kind of build reserves for problems you see coming. Any idea how that kind of plays out in the mechanics of how it should operate over different stages of the cycle?

Well, we know exactly how it should operate. Look, you have a default rating and a recovery rating on a credit, which gives rise through a different economic environment, you run a stressed outcome for the migration of that credit. So as your economic outlook changes, your ultimate loss content in your portfolio changes for good or bad, as you update scenarios. That's for a static book of business. So once you have a reserve set, if you're exactly right from the start, your reserve is ultimately going to run down to 0, and you're going to charge off those loans equal to that amount. And you'll have no loans and no reserve. Everything else is new business that you're reserving for at the time or it's the economics change. So that's how it should work. You should absolutely be able to draw down on it. Is there going to be pressure at the margin? Not too. Is there going to be thumbs on this? Probably. But we know it's supposed to happen.

Yes. And maybe just more broadly talk about what you're seeing in terms of credit, C&I, we'll talk about office and CRE and just consumer.

Look, consumer is maybe normalizing, but we're not -- you have to stare at it to see it. It's not materially different for us. C&I is fine. The multi-tenant office product, which is admittedly a train wreck for the country, we see we reserve for it's an own thing. It's [ brownerized ], it's -- if we're wildly wrong, it doesn't really matter. It's fine. And the rest of it feels pretty good. I just remind you, if you go back over the last 10 years, our charge-off rates been like 23 basis points about where we're running now. I mean even if you include the financial crisis, which included National City's balance sheet, maybe it was double that. So I'm not losing sleep over credit outlook by any structure.

And just remind folks how well reserved you are on kind of the multi-tenant office and what ...

Yes, when you drill in that, right? You drill into real -- just start from the [indiscernible] you talk about real estate broadly. Real estate assets broadly are probably losing value because of higher rates. But again, they're cash flowing, so multi-tenant -- or sorry, multifamily people worried about. It's -- for us, it's 97% occupied, that's throwing out cash is probably worth less because rents aren't going as high as they once were so on and so forth. Multi-tenant office is the only real estate product, where just nobody is in the building. It's distinctly different than everything else going on in real estate right now. We have $4.8 billion [indiscernible] of outstandings in this product. We have 14.7% reserves against that product set. We've been actively working through maturities, sometimes selling, sometimes charging off, sometimes taking pay downs and extending. The bulk of that book matures this year and next. So it's a manageable problem in the context of how large we are and what we have in the reserve, I think, is I'm allowed to say it's adequate. But we thought about it pretty hard and gone building by building to figure out what that number should be.

So on capital, you have over 10% CET1 in today's rules. You have kind of low to mid-8s on the Basel III version, the [indiscernible] version. How are you thinking about kind of building capital versus retaining capital or holding steady on -- choose your definition there.