The PNC Financial Services Group Q2 2022 Earnings Call Transcript

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Provided by Quartr
July 14, 2022

There are 13 speakers on the call.

Operator

Welcome to today's conference call for the P&C Financial Services Group. Participating on this call are P&C's Chairman, President and CEO, Bill Demchak and Rob Rowley, 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 materials are all available on our corporate website, pnc.com under Investor Relations.

Operator

These statements speak only as of July 15, 2022 and PNC undertakes no obligation to update them. Now, I'd like to turn the

Speaker 1

call over to Bill. Thanks, Brian, and good morning, everybody. As you've seen, we had a strong second quarter highlighted by 9% revenue growth and solid positive operating leverage resulting in PPNR growth of 23%. We maintained strong credit quality and fees rebounded from the Q1, driven primarily by capital markets activity, including Harris Williams and continued growth in card and cash management. The strong loan growth and rising rates helped us to increase both net interest income and net interest margin meaningfully.

Speaker 1

Loan growth was driven by C and I, where new production increased significantly and utilization returned to near pre pandemic levels. Consumer loans also grew driven by mortgage and home equity. Higher rates continued to adversely impact the unrealized value of our securities book. In response, We continue to reposition the portfolio during the quarter, resulting in 60% of our securities portfolio now being held and held to maturity. We returned $1,400,000,000 of capital to shareholders during the quarter through share repurchases and dividends.

Speaker 1

Looking forward, there is uncertainty in the environment we are operating in and including the impact of higher rates, supply chain disruptions and inflation. But regardless of the path ahead macroeconomically, we believe having a strong balance sheet, a solid mix of fee based businesses, continued focus on expense management and differentiated strategies for organic growth will continue to provide the foundation for our success. And our focus is on executing the things we can control and not getting distracted by what is beyond our control. Along those lines, we delivered well on our strategic priorities in the quarter, including the build out of our new BBVA and expansion markets, modernizing our retail banking technology platform, bolstering our asset management offering and building differentiated and responsible capabilities for our retail and commercial customers in the payment space. As I've talked about recently at conferences, our performance in the BBVA markets has exceeded our own expectations.

Speaker 1

On Slide 3, you can see that the strong growth we have generated in these markets across customer segments. In Corporate Banking, we've seen sales increase 40% linked quarter and maintained a 50% non credit mix of sales since conversion. We've seen similar growth within commercial banking where sales in the BBVA USA markets are up 32% linked quarter and non credit Sales to total sales have been approximately 55% since conversion. In Retail Banking, we've experienced a notable increase in sales for both small businesses and Consumers of 16% 22%, respectively. And we continue to invest in AMG and a big part of that is building a strong customer focused team that can deliver our brand across our footprint.

Speaker 1

We have built good momentum in our recruiting efforts over the past few quarters, hiring advisors across all areas of the to help deliver for our clients. I'll close by thanking our employees for their hard work and dedication to our customers and communities. Moving forward, we believe that we're well positioned to continue to grow shareholder value. And with that, I'll turn it over to Rob for a closer look at our results, and then we'll take your questions.

Speaker 2

Well, thanks, Bill, and good morning, everyone. Our balance sheet is on Slide 4 and is presented on an average basis. During the quarter, loan balances averaged $305,000,000,000 an increase of $14,000,000,000 or 5%. Investment securities grew approximately $1,000,000,000 or 1%. And our average cash balances at the Federal Reserve declined $23,000,000,000 Deposit balances averaged 447,000,000,000 a decline of $7,000,000,000 or 2%.

Speaker 2

Our tangible book value was $74.39 per common share as of June 30, a 7% decline linked quarter, entirely AOCI driven as a function of higher rates. And as of June 30, 2022, Our CET1 ratio was estimated to be 9.6%. Given our strong capital ratios, we continue to be well positioned with significant capital During the quarter, we returned $1,400,000,000 of capital to shareholders through $627,000,000 of common dividends and $737,000,000 of share repurchases for 4,300,000 shares. Our recent CCAR results underscore the strength of our balance sheet and support our commitment to returning capital to our shareholders. As you know, our stress capital buffer for the Q4 period beginning in October 2022 is now 2.9% and our applicable ratios are comfortably in excess of the regulatory minimums.

Speaker 2

Earlier this year, our Board of Directors authorized a new repurchase framework, which allows for up to 100,000,000 common shares, of which approximately 59% were still available for repurchase as of June 30. This allows for the continuation of our recent average share repurchase levels in dollars, as well as the flexibility to increase those levels should conditions warrant. Slide 5 shows our loans in more detail. During the Q2, we delivered solid loan growth across our expanded franchise, particularly when compared to 2021 growth rates. 2021, as you know, was characterized by low utilization levels, PPP, loan forgiveness and in P&C's a repositioning of certain acquisition related portfolios.

Speaker 2

Loan balances averaged $305,000,000,000 an increase of $14,000,000,000 or 5% compared to the Q1, reflecting growth in both commercial and consumer loans. Commercial loans excluding PPP grew $13,000,000,000 driven by higher new production as well as utilization. Included in this growth was approximately $5,000,000,000 related to high quality short term loans that are expected to mature during the second half of the year. Notably, in our C and IB segment, the utilization rate increased more than 120 basis points and our overall commitments were 5% higher compared to the Q1. PPP loan balances declined $1,200,000,000 and at the end of the quarter were less than $1,000,000,000 Consumer loans increased $2,000,000,000 as higher mortgage and home equity balances were partially offset by lower auto loans.

Speaker 2

And loan yields increased 10 basis points compared to the Q1 driven by higher interest rates. Slide 6 highlights the composition of our deposit portfolio as well as the average balance changes linked quarter. We have a strong core deposit base, which is 2 thirds interest bearing and 1 third non interest bearing. Within interest bearing 70% are consumer and within non interest bearing 50% are commercial compensating balances and represents stable operating deposits. At the end of the Q2, our loan to deposit ratio was 71%, which remains well below our pre pandemic historic average.

Speaker 2

On the right, you can see linked quarter change in deposits in more detail. Deposits averaged $447,000,000,000 in the 2nd quarter, a decline of nearly $7,000,000,000 or 2% linked quarter. Commercial deposits declined $8,000,000,000 or 4%, primarily in non interest bearing deposits due to movement to higher yielding investments and seasonality. Average consumer deposits increased seasonally by $2,000,000,000 or 1%. Overall, our rate paid on interest bearing deposits increased 8 basis points linked quarter to 12 basis points.

Speaker 2

Deposit betas have lagged early in the rate rising cycle, but we expect our deposit betas to accelerate in the Q3 and throughout the remainder of the year given our increased rate forecast. And as a result, we now expect our betas to approach 30% by year end compared to our previous expectation of 22%. Slide 7 details our securities portfolio. On an average basis, our securities grew $800,000,000 or 1% during the quarter, representing a slower pace of reinvestment in light of the rapidly rising interest rate environment. The yield on our securities portfolio increased 25 basis points to 1.89 percent driven by higher reinvestment yields as well as lower premium amortization.

Speaker 2

On a spot basis, our securities remained relatively stable during the Q2 as net purchases were largely offset by net unrealized losses on the portfolio. As Bill mentioned, in total, we now have 60% of our securities and held to maturity as of June 30, which will help mitigate future AOCI impacts from rising interest rates. Net pre tax unrealized losses on the securities portfolio totaled $8,300,000,000 at the end of the Q2. This includes $5,400,000,000 related to securities transferred to held to maturity, which will accrete back over the remaining lives of those securities. Turning to the income statement on Slide 8.

Speaker 2

As you can see, Q2 2022 reported net income was $1,500,000,000 or $3.39 per share, which included pre tax integration costs of $14,000,000 Excluding integration costs, adjusted EPS was $3.42 Revenue was up $424,000,000 or 9% compared with the Q1. Expenses increased $72,000,000 or 2%, resulting in 7% positive operating leverage linked quarter. Provision was $36,000,000 and our effective tax rate was 18.5%. Now let's discuss the key drivers of this performance in more detail. Slide 9 details our revenue trends.

Speaker 2

Total revenue for the Q2 of $5,100,000,000 increased 9% or $424,000,000 linked quarter. Net interest income of $3,100,000,000 was up $247,000,000 or 9%. The benefit of higher yields on interest earning assets and increased loan balances was partially offset by higher funding costs. And as a result, net interest margin increased 22 basis points to 2.5%. 2nd quarter fee income was $1,900,000,000 an increase of $211,000,000 or 13% linked quarter.

Speaker 2

Looking at the detail of each category, asset management and brokerage fees decreased $12,000,000 or 3%, reflecting lower average equity markets. Capital market related fees rebounded as expected and increased $157,000,000 or 62 driven by higher M and A advisory fees. Card and cash management revenue grew $51,000,000 or 8%, driven by higher consumer spending activity and increased treasury management product revenue. Lending and deposit services increased $13,000,000 or 5 reflecting seasonally higher activity and included lower integration related fee waivers. Residential and commercial mortgage non interest income was essentially stable linked quarter as higher revenue from commercial mortgage banking activities offset lower residential mortgage loan sales revenue.

Speaker 2

Finally, other non interest income declined $34,000,000 and included a $16,000,000 Visa negative fair value adjustment related to litigation escrow funding and derivative valuation changes. Turning to Slide 10. Our 2nd quarter expenses were up by $72,000,000 or 2% linked quarter, driven by increased business activity, merit increases and higher marketing spend. These increases were partially offset by seasonally lower occupancy expense and lower other expense. We remain deliberate around our expense management and as we've previously stated, We have a goal to reduce costs by $300,000,000 in 2022 through our continuous improvement program and we're confident we'll achieve our full year target.

Speaker 2

As you know, this program funds a significant portion of our ongoing business and technology investments. Our credit metrics are presented on Slide 11. Overall, we saw broad improvements across all categories. Non performing loans of $2,000,000,000 decreased $252,000,000 or 11% compared to March 31 and continue to represent less than 1% of total loans. Total delinquencies were $1,500,000,000 on June 30, a $188,000,000 decline linked quarter, reflecting lower consumer and commercial loan delinquencies, which included the resolution of acquisition related administrative and operational delays.

Speaker 2

Net charge offs for loans and leases were $83,000,000 a decrease of $54,000,000 linked quarter driven by lower consumer net charge offs, primarily within the auto portfolio. Our annualized net charge offs to average loans continues to be historically low at 11 basis points. And during the 2nd quarter, Our allowance for credit losses remained essentially stable and our reserves now total $5,100,000,000 or 1.7 percent of total loans. In summary, P&C reported a solid second quarter and we're well positioned for the second half of twenty twenty two as we continue to realize the potential of our coast to coast franchise. In regard to our view of the overall economy, we expect the pace of economic growth to slow over the remainder of 2022, resulting in 2% average annual real GDP growth.

Speaker 2

We also expect the Fed to raise rates by an additional cumulative 175 basis points through the remainder of this year to a range of 3.25% to 3.5% by year end. Looking at the Q3 of 2022, Compared to the Q2 of 2022, we expect average loan balances to be up 1% to 2%. We expect net interest income to be up 10% to 12%. We expect non interest income to be down 3% to 5%, which results in total revenue increasing 4% to 6%. We expect total non interest expense to be stable to up 1%.

Speaker 2

And we expect Q3 net charge offs to be between $125,000,000 $175,000,000 Considering our reported operating results for the first half of twenty twenty two, third quarter expectations and current economic forecast for the full year 2022 compared to the full year 2021. We expect average loan growth of approximately 13% an 8% loan growth on a spot basis. We expect total revenue growth to be 9% to 11%. Our revenue outlook for the full year is unchanged from the guidance we provided in April. However, relative to our expectations at that time, We now expect more net interest income from higher rates offset by somewhat lower fees.

Speaker 2

We expect expenses excluding integration expense to be up 4% to 6%. And we now expect our effective tax rate to be approximately 19%. And with that, Bill and I are ready to take your questions.

Speaker 3

Thank you. And our first question comes from the line of Gerard Cassidy with RBC. Please proceed.

Speaker 4

Good morning, guys. How are you?

Speaker 2

Hey, good morning, Gerard.

Speaker 4

Rob, can you elaborate a little further on the deposit beta Change, is it purely just the rate of change in interest rates going up so fast? Or is there a deposit mix That's also influencing your new outlook for the beta?

Speaker 2

Yes. Hey, good morning, Jared. Yes, Probably both, but a little bit more of the former. We're just at that point now where we're seeing rights rising to the point where betas are becoming active. They were not that active on the consumer side, a little bit on the commercial side in the Q1, and that's picked up a bit, more on the commercial side as we expected.

Speaker 2

And in our case, it's our non operating deposits that explains the decline there in the Q2. Betas are beginning to move. We expected that and we're ready for it.

Speaker 4

Very good. Credit quality obviously was quite strong for you folks, similar to the prior quarter. And Bill, I don't know. I know there's a lot of uncertainty out there with what's going on in the world, but it just seems that for your company at least, You are so well positioned from a credit quality standpoint. And are we just going to go off a cliff or something at the end of the year with Some sort of big recession that has frightened everybody about credit quality for banks in general.

Speaker 4

And any elaboration on your outlook on Credit and the outlook for the economy?

Speaker 1

Yes. Look, I don't think there's any cliff involved. I do think that the trouble ahead lies somewhere in the middle of next year, not anytime in the next six But what you're seeing inside of our credit book, you got to remember that during this period of time, we continue to kind of run off A higher risk book from BBVA and our loan growth is largely in higher quality names. So the overall quality of our book actually Proves quarter on quarter. Eventually that has to stop.

Speaker 1

And eventually I think the Fed has to slow the economy to The pace to get inflation under control and I think that's going to be harder to do than the market currently assumes. And I think it's going to take longer than the market currently assumes. And when that happens, we're going to see credit costs go up at least back to what we would call normalized levels. But I don't think I don't see any particular bubbles inside of the banking system as it relates to credit. I think you're just going to see Slow grind with credit losses increasing over time as we get into the slowdown.

Speaker 1

And some compensation.

Speaker 4

I'm sorry. What was that, Rob? I'm sorry.

Speaker 5

I was

Speaker 2

saying that just and Bill mentioned it Gerard, just some normalization, which is inevitable.

Speaker 4

Yes. No. Agreed. Thank you, guys.

Speaker 3

Sure. And our next question comes from the line of Bill Carcache with Wolfe Research. Please proceed.

Speaker 6

Thanks. Good morning, Bill and Rob. There was a time where you talked about increasing the mix of your The securities given all the liquidity in the system, but as the Fed engages in QT and with the strong loan growth that you're seeing, could we see you go the other way and perhaps redeploy some of your securities portfolio pay downs to fund more of your growth such that you actually remix more a larger mix of your earning assets Towards loans.

Speaker 1

I think over Time that is probably likely if we continue to see loan growth the way we do. But you shouldn't mix security balances With the way we think about, fixed rate exposure hedging our deposits, right? Securities are one way we do that, swaps are another way and then of course our fixed Great assets themselves. And then inside of that, the duration of the securities we buy. So long story short, the balance is probably decline, But we're sitting in a period of time right now where we're very asset sensitive.

Speaker 1

You'll notice our balances Basically stayed flat through the course of the quarter as we kind of purposely watch and let things roll off here, Given our view on what we think longer term rates are going to ultimately do. So balances Could go down, just as a matter of sort of algebra in the balance sheet. But our ability to invest in rising rates is still there in a large way.

Speaker 2

Yes, that's right. Well, the context Bill, as you know, the context of your question is Historically, pre sort of the rapid increase in liquidity over the last couple of years, we did run about 20% of our securities To our earning assets, we raised that because of all the liquidity in the system. So we're still pretty high on a historical basis, but as Bill Demchak just said, That's not likely to change anytime soon.

Speaker 6

That's very helpful. Thank you. And separately, as the Fed proceeds through the hiking cycle, at Some point, I think as you've both alluded to in your comments, that's going to presumably slow the pace of growth. But you're taking your loan growth guidance higher For the year, maybe could you speak to how much of that improved outlook is idiosyncratic? Because it certainly does sound like You're expecting a deceleration at some point at the macro level?

Speaker 1

A lot of it just comes from our ability to win new business. Utilization rates have largely approached where we were, I think, Rob, pre Pandemic at this point. Yes. So there's a little bit of room there. But these new markets and our Just our ability to win new business.

Speaker 1

And by the way, new business that is 50% fee based It's pretty strong and we feel confident we'll be able to continue to do that independent of what happens in the economy. Yes.

Speaker 2

And I would just Add to that in terms of the loan growth outlook for the 12 months, we're up a bit mostly because of the outperformance in the first half relative to our expectations. So that's sort of trueing up, so to speak.

Speaker 6

Got it. And if I could squeeze in one last one. I think It's interesting, Bill, to think about your commentary around the normalization of credit as the That proceeds through its hiking cycle and sort of we think about the long and variable lags that Between monetary policy and when that ultimately starts to show up in credit. And then we sort of juxtapose that with what's happening with Reserve rates, which it's notable that for most of your peers, they've drifted below their day 1 levels. And I know for you guys, there's a BBVA deal and lots of other That 1.65 seems relatively conservative.

Speaker 2

How are

Speaker 6

you thinking about the trajectory of that from here in the context of The thought process you just laid out of the Fed hiking cycle eventually leading to credit normalization probably as we get into maybe the middle of next year or somewhere in that timeframe.

Speaker 1

That's an impossible question to answer given the dynamics of CECL. But you should assume, we assume that all else Equal credit quality is going to deteriorate at some pace from here through the next 2 years. I just don't think it's going to be all that dramatic. And it almost has to be a And it almost has to be a true statement given the charge off levels we've been seeing.

Speaker 2

Right. And I would add to that, our reserve levels are above our day 1 CECL even adjusted for the BBVA acquisition. We're appropriately reserved now and feel good about it.

Speaker 6

Very helpful. Thank you for taking my questions.

Speaker 3

And our next question comes from the line of Ken Usdin with Jefferies. Please proceed.

Speaker 7

Hey, guys. Just wanted to just ask to dissect A little bit. Rob, you mentioned that your outlook for NII is a little bit better, your outlook for fees a little softer. The NII one I think we get, just wondering if you can help us understand now What kind of curve are you building in? And is it more just that uptick of rates that offsets that new 30% beta outcome?

Speaker 2

Yes, that's right. Good morning, Ken. Yes, that's exactly right. So higher rate environment, NII And the balances that we've generated contribute to the improved NII look. And then you sort of referenced it in terms of the fees, mostly in terms of our full year expectations compared to what we thought at the beginning of the year and last quarter, some softer on AMG and mortgage, as you would expect with the equity markets performing like they are for AMG and Interest rates on the mortgage side.

Speaker 2

So it's sort of the trade off of the higher rates.

Speaker 7

Got it right. Sorry, I missed your 3.25, 3.5 comment from earlier. So thank you. And then just on the fee side then, you had a really good bounce back as you expected, especially in that capital market. So what's changed there in terms of what you're Seeing as far as the outlook on the fee side.

Speaker 2

So on the fee side again for the full year, most of the change relative to our full year is within AMG and mortgage. On capital markets, you recall we had a soft first quarter relative to our expectations. So we did see the bounce back in the Q2. So we're back in position with our full year expectations. The second half obviously remains to be seen.

Speaker 7

Okay. And if I could just sneak one more in. You mentioned Bill, you mentioned all the different ways that you can get exposure to Variable rates and such. I'm just wondering how are you guys thinking about just swaps portfolio? You had done some ads in terms of Protecting and managing the near term upside versus the potential of what happens down the road based on Fed Funds future Curved expectations and your general view of the economy.

Speaker 7

Thanks guys.

Speaker 1

We don't think about the swaps book separate from our Basic investing and fixed rate exposure. Where we sit across the securities book and swaps and everything we do fixed rate, We're looking at a curve now where I kind of think the year end rates in my own mind are probably largely right, but I think there's a I think the assumption that the Fed is going to start easing in the spring of next year is absurd, which means we're holding off at this point because We think there's going to be there's still value to be had in the longer end of the curve as people come to the realization that inflation isn't as easy to tame as People might assume and separately that the Fed isn't going to immediately cut simply because the economy slows, If inflation is still running hot. So we're going to sit pat, but it's not we don't think swaps are one thing and bonds are another. We just we look at our interest We're very asset sensitive. We have an opportunity to deploy in multiple places.

Speaker 1

We're just not doing it. We basically let everything run down thus far this year.

Speaker 7

Understood. Okay. Thank you.

Speaker 3

And our next question comes from the line of Erika Najarian with UBS. Please proceed.

Speaker 8

Hi, good morning. I'm sure

Speaker 3

this is the question

Speaker 8

that Ken asked, but I just wanted to clarify The loan growth expectation rose, the performance has been spectacular. The revenues didn't move even though we had the higher loan growth and the higher rate outlook. And that's because of The higher beta assumed and also lower fees, Rob?

Speaker 2

Well, in part. I think the earlier question, you might have missed it, Erica, was the improved outlook for the full year loan growth. The answer was most of that was a true up to our outperformance in the first half. So we grew loans faster than we thought we would in the 1st 6 months, which is great. So we true up that full year expectation.

Speaker 2

So all of that is built in to the full year guidance.

Speaker 1

Part of the impact That we're seeing in NII and NIM is actually on our loan yields Where the quality of our book is it improves fairly substantially. We put a lot of very high grade stuff on and spreads have actually come in Quarter on quarter. So when we look at the out forecast on NII, together with loan growth, which will be Pretty healthy. We have in there embedded in there this notion that spreads are tighter than they were as we basically improve the quality of the books. That's another component.

Speaker 1

Yes.

Speaker 2

That's right.

Speaker 8

Got it. And just as a follow-up question, how should we think about deposit growth from here? Bill, I think you've been the one that has been vocal about the notion that if loan growth is positive, deposit growth should be Positive. How should we weigh that relative to probably your willful desire to work out the non operating deposits out of your balance

Speaker 9

And QT. Yes. Well, it's

Speaker 1

a good question and the answer to that remains to be seen a little bit. We've Clearly seen the larger corporates move liquidity out of the banking system into In the money markets, government money markets. And I think as we go forward, the combination of QT from Fed and what they do with their repo facility is going to drive some of the yields available in those funds, which in turn is going to drive how much of that sits on bank's balance Outside of those deposits, it's more about a rate paid game. And I think Deposits kind of inside of the retail space and the smaller bin market commercial space, I think deposits actually grow simply because of the loan volume. But the mix shift that we've seen in commercial from a little bit less non interest bearing into interest bearing that game is It's going to play out.

Speaker 1

So thus far, I mean, if you look at the total liquidity in the system, it really hasn't moved. And of course, the Fed hasn't really started their QT program What we've seen is a movement of liquidity from banks into money funds As money fund yields started to grow. So this is going to take a while to play out.

Speaker 2

Yes. And our expectations, Eric, are generally stable. But as Bill pointed, the mix could be different. And then an open question on the Not operational deposits, which will either do or not do.

Speaker 1

Yes. A big part of what we've seen go thus far are Deposits that we don't really care about. They were we kind of call them surge deposits internally, which were non core clients parking liquidity That now have kind of gone into funds.

Speaker 2

And importantly are by definition low margin. Yes.

Speaker 8

Got it. And my last question, Bill, you said earlier you don't really see any bubbles within the banking system. I think a lot of investors are more concerned about It's outside of the banking system. And interestingly, I'm sure you know the statistic very well. Corporate lending in terms of the bank share of it has declined to 18%.

Speaker 8

I guess my question to you is, do you see an opportunity as rates rise and The economy slows down. Is some of that market share available back to banks in terms of what's happened in the private market? Or was that never a credit that you wanted to do anyway? And don't you have a unit within P&C that does 3rd party Recoveries, in terms of if you have corporate defaults, you could Be a 3rd party recoverer if that's the term?

Speaker 1

Yes. Well, first I want to see the audit Only 16% of corporate credit being inside of banks, but I'm sure there's some way you can get it. It's credit Outside of the banking system melts, we play on that in 2 ways. One is, if it's in the real estate space, we do that Inside of our special servicing arm in Midland. 2, is we are very good at working corporate credits And we wouldn't be afraid of buying portfolios of troubled assets.

Speaker 1

And 3, and I think this is what you're referring to, Is in our asset based lending group, we play the role of senior lender on a very secured basis For and basically the agent for the entire capital structure. And as pieces below us struggle, The fee opportunity for us to work those loans out on behalf of the B lenders is quite high. Furthermore, we continue to be approached By multiple B lenders to basically run their books as they look at what's coming their way. Thus far, we haven't agreed to do any of that. And were we to do it, I think it'd be quite lucrative.

Speaker 2

And we've done that in the past. Yes.

Speaker 8

Got it. All right. Thank you.

Speaker 3

And our next question comes from the line of Mike Mayo with Wells Fargo Securities. Please proceed.

Speaker 9

Hi. Can you hear me?

Speaker 2

Yes. Good morning.

Speaker 9

Okay, great. I guess All these questions get down to NIM. So are you forecasting deposits to run off for the year? Because you've mentioned betas are starting to move. And I missed the updated guidance, because you're guiding for good NII growth.

Speaker 9

So How much deposit runoff are you assuming or deposit growth?

Speaker 2

I can jump on that. And we covered some of that, Mike. Generally speaking, And we recognize the fluidity for the second half. We're calling for stable deposits, some mix change between non interest bearing and interest bearing. Also an open question in terms of non operational deposits and what betas are required for that and whether we choose to keep those or not.

Speaker 2

So that all remains to be seen. But the outlook is stable. And NIM, we do expect to expand.

Speaker 9

And you talked about tighter loan yield spreads just because you're going up in quality. Are you getting rewarded for this more uncertain outlook? I mean, capital markets, some Assets are pricing in near recession levels, but I feel like the lending markets are not doing the same. And are you getting more Spread for the added chance of a recession?

Speaker 1

It depends On the lending sector. So we are, for example, an asset based straight spreads on a High rated stuff has kind of stabilized. A lot of what we're seeing is just a mix shift in the quality of our book, not The change in the market in terms of spread, where I think the market continues to be irrational is on the consumer side. So auto lending seems in our view to be a little bit of a bubble. And some of the things we're still seeing being done on the consumer side.

Speaker 1

But on the corporate side and the real estate side, The shift is moving back towards the banks in terms of our ability to negotiate and get spread and get covenants and get structure. Just not a dramatic shift the way you've seen in some of the headline stuff and capital markets related issues.

Speaker 9

So you're getting some of that. Bill, can you put this in context? This looks like the past is commercial loan growth in 14 years and we haven't had a cycle like this In quite some time. And I guess I'm repeating what I think what you've said in the past. It's inventory, It's greater utilization, it's capital expenditures, it's working capital, some business from capital markets back to the bank.

Speaker 9

Did I miss anything there?

Speaker 1

No. I mean, thank you for Remind, I mean that's what happened, right? We've had inventory build and CapEx and a little volume back to the banks and boom, you get big loan growth.

Speaker 2

Yes. And particularly, and it overlaps, Mike, particularly on the utilization, which

Speaker 1

has grown. But that's coming off of their inventory, Bill, which

Speaker 9

The one I didn't mention that some other banks have mentioned, you did not. So I don't want to leave the witness here. But in terms of gaining share from non banks, because you're seeing some non bank entities Not on a solid footing as they were in the past. Are you gaining share from them? Do you expect to gain share from them?

Speaker 9

Are there opportunities to do so? Are you shifting resources? Because I get it. You're the National Main Street Bank. You're in 30 MSAs.

Speaker 9

You've a lot on your plate to try to gain share in all those markets. Meanwhile, you have some verticals where you might be able to gain share. What are you doing to try to capitalize on that?

Speaker 1

Yes. Mike, Most of those players play in a risk bucket that we don't like to play in, right? So the exception to that Is in our asset based lending book where borrowers who might have been able to do a cash flow loan with a BDC at On point are now going to come back to the banks and do it asset based. But on the consumer side, The guys who are out there playing subprime consumer or even in the leverage lending side, cash flow on Secured. We just don't have a big book of business there nor do we want one.

Speaker 9

Okay. And last one, just on CECL, you didn't I mean, you've been on credit, your credit is great, you've always been high quality, you proved it through the global financial crisis, We get it. But with all this talk about a recession out there, doesn't that give you cover to go ahead and increase reserves? Like, I get it, you're above day 1 CECL, but Why not just take more reserves out of conservatism?

Speaker 1

We have a model and we run by a model. So we're not allowed to just That's right. As much as I'd like to sometimes put my thumb on the scale. We don't

Speaker 2

do that. We'll do that. CECL is a model driven approach. And as you pointed out, Mike, we're above our day 1. We're appropriately reserved relative to our book.

Speaker 2

Okay. Thank you.

Speaker 3

And our next Question comes from the line of John Pancari with Evercore ISI. Please proceed.

Speaker 10

Good morning, guys.

Speaker 2

Good morning, John.

Speaker 10

On the back to the commercial loan growth topic, I'm Sorry if I missed the detail on it, but I know you mentioned the $5,000,000,000 in high quality short term loans that were brought on that you expect to mature in the second half. Can you give a little bit of color on that, on those balances and what drove it? And maybe a little bit in terms of outlook, could you see additional Flows in that type of lending as well. Thanks.

Speaker 1

We'd like to see additional flows in that type of lending. It's kind of that was client handful of clients, but client specific timing issues That we were able to serve client needs and there are big balances and they're going to

Speaker 2

run off. Yes, we'd like to do that.

Speaker 1

Yes. It happens again, that's great. But these were specific ones we called out both because of their size and also because they're lower spreads in the rest of the book and That had some impact on the loan yield this quarter.

Speaker 2

Okay.

Speaker 10

And then also related to that, in what areas do you Expect that you could see some moderation in commercial loan demand as we do get some slowing in economic Activity if the Fed succeeds here with the tightening.

Speaker 1

Eventually what you're going to see, We've seen utilizations go up as people have built inventories. Now that will reverse itself as we get into a slowdown and people struggle to move inventories, it will peak And then I'll grind it to a halt. But I think that's going to end up being the driver. We'll Continue to go work and gain share. And ultimately, against the money we put out, we look at what happens To utilizations, the utilizations will start to drop through a slowdown, Peak early into it and then slow down as they try to free up working capital.

Speaker 5

Okay. Got it.

Speaker 10

Thanks, Bill. And then back to the Lomas reserve front, I hear you again in terms of the adequacy of your reserve. In your scenarios, did your economic scenarios that you run that support CECL, did they Get worse at all versus last quarter? Or did they like how did that change? And then separately, did you have any reallocations Within the reserve that were noteworthy like coming from commercial going into consumer, if you can maybe talk about that.

Speaker 10

So just trying to Get a better feel

Speaker 1

of your confidence. Yes. Without getting into the details of CECL, I would tell you that Within our overall provision, we added 2 reserves as a function Of the scenarios we run.

Speaker 2

Yes. I mean it's pretty stable, John. So no big mix changes, no big dollar The percentage came down a little bit just because of largely the high credit quality, large underwritings we just spoke about, improving the mix. So pretty much unchanged. Well, no, so I'd clarify that in terms of the dollar amounts and the stable.

Speaker 2

But inside of that, obviously, our scenarios build in Some worsening concepts, but there's QFRs as part of that process that offset that. So end of the day, stable.

Speaker 10

Got it. Okay. All right. Thanks, Rob.

Speaker 5

Sure.

Speaker 3

And our next question comes from the line of Ebrahim Poonawala with Bank of America. Please proceed.

Speaker 11

Hey, good morning.

Speaker 2

Good morning.

Speaker 11

I guess just one follow-up, Rob. In terms of as we think about the outlook For deposit betas and margins, if the Fed stops at the end of the year, you talked about the deposit beta and deposit growth expectations in the back half. But give us a sense of the asset sensitivity profile of the balance sheet in a world where the Fed stops hiking, the 210 remains inverted for 6 to 12 months. And as Bill alluded to, we may not get cuts as quickly. In that backdrop, do you still expect the margin to drift higher?

Speaker 11

Or do we start seeing Some liability sensitivity where deposits are repricing higher, but you're not seeing the benefit on the asset side?

Speaker 2

We don't give explicit NIM outlooks, but I would say your question is when does NIM peak? We see NIMs continuing to expand and peaking in 2023. So with everything that you described, we still see upside in NIMs.

Speaker 11

Got it. So safe to assume that even in a backdrop where the Fed stops hiking, the NIM should still at least drift higher a bit for a few more quarters. So Point noted.

Speaker 2

Yes, possibly. And again, we're in sort of that context, we're talking about 2023 then, 2023. 23,

Speaker 11

Yes. And I didn't mean to pin you down or ask for 'twenty three guidance. I'm just trying to conceptualize anything if we go into this period where we've not been, Where the curve remains flat to inverted for a while, what that does to the name and it's not unique to you, but appreciate the color.

Speaker 1

Yes. You have to the number of pieces that are moving inside of that, even if let's assume they get out there and they Freeze and you have a small inversion in the curve and you sit there. In that instance betas probably don't move from wherever they were Post the last hike and instead what you're going to see is an increase in fixed rate asset yields So they basically roll off from very low yields into higher yields. And then the upside to the extent we want to deploy at that point. So you see a gain in yields inside of the security book in a static environment simply because everything that Was purchased with 1.5% Handles Rolls off.

Speaker 2

Yes, that's right. That's why we're still some part some ways from the peak.

Speaker 11

That's fair. Appreciate the perspective. And on the lending side, just Bill wanted to follow-up on 2 things. One, like do you have a sense of where customers are in terms of Rebuilding inventories like that's been a big driver of growth for the last 2 to 3 quarters. But compared to pre pandemic, our customer inventory is back To those levels, like how would you frame that?

Speaker 11

And secondly, would love to hear your thoughts about just outlook for the commercial real estate market in this backdrop, especially if we get a recession. You've been cautious in the past, so we'd love to hear your thoughts.

Speaker 1

The inventory question is all over the place because you have a bunch of customers who have more inventory than they want. Then you have others who are still struggling to build inventory to keep up with supply because of Continued supply chain disruption. So I don't know that there's a simple answer on inventories. Real estate, with the absence With the exception of the slow burn on office, where we just we continue to be worried, we continue to see Slow deterioration, we think we're really well reserved. But absent that kind of slow burn, the rest of it Continues to kind of do okay to improve.

Speaker 1

And I think that holds even at least in the slowdown that's In the back of my mind, again, I just don't see some big spike into a really ugly recession. So we have our eye on real estate. We have exposure into the office space that we're reserved against. It's kind of doing what we expected. And beyond that, we're not particularly worried about it.

Speaker 2

Yes. And to your point, we're well reserved, and multifamily, which is the biggest component of that, it's very strong.

Speaker 11

Got it. And just one quick one, sorry if I missed it. Did you talk about the pace of buybacks? How we should think about that in the back half of the year?

Speaker 2

I did in my opening comments. We're going to continue buying back shares roughly at the average rate of what we've been doing the last couple of quarters.

Speaker 11

No joke. Thanks for taking my questions.

Speaker 2

Sure.

Speaker 3

Our next question comes from the line of Matt O'Connor with Deutsche Bank. Please proceed.

Speaker 5

Good morning. As we think about loan loss reserves and call it a moderate recession, how high or how much add Do you think you have to do? I think for COVID, it was around $2,500,000,000 ex the day one CECL impact. But obviously, there's been mix shift, The BBVA deal and a lot of factors. But as you guys run your stress test, what would Cumulative reserve bill B for a moderate recession.

Speaker 1

No way Bill said there was an earlier impossible question.

Speaker 2

Yes, that one might be a number 2.

Speaker 1

But I mean remember that reserve build in COVID, Right. The scenarios we're running, I don't remember off the top of my head, it was jack unemployment to 15% and GDP. We're not this has nothing to do with that, right. We're going to go into a slowdown and we're going to see an increase in reserves at some point, but They're not even going to be related to the thing we saw when COVID hit the economy down. Yes, just In terms of size.

Speaker 1

So you almost have to take that whole example set and remove it from the framework of how you think about provisions going forward.

Speaker 5

Right. So it seems like you're implying and we've heard it from some others that it should be a lot less, I guess we'll see.

Speaker 1

No, no, no. I can't I mean only if you're Think about what those forecasts were, right? I mean, do you remember they were unemployment going to 15% to 20%. 15%. Yes.

Speaker 1

I mean, it was I don't think there's anybody out there who thinks we have to crater the economy by that amount to get inflation under Dumpchekstraw. That was a look, there could be some world event that causes that, but it's not going to be a function of the Fed raising rates and slowing the economy to get inflation Under control.

Speaker 5

Yes, agreed. I mean, obviously, that's what the market is still worried about. And it's just interesting, if you put it relative to capital, Even if you did, what you did for COVID, it's only 50 basis points of capital. So, that's helpful.

Speaker 1

Look, you're bringing up This whole issue is the issue I think that investors just have completely wrong about the banking system right now. If you look at the market cap that's been pulled out of the banking system and take your worst case reserve build and charge offs through some cycle, It's just wildly wrong. We'll have increased losses, but relative

Speaker 2

Not to that extent.

Speaker 1

Not to anything close like what we put in during COVID. And more importantly, I think there's a growth opportunity through a mild downturn for us. Just given the way we run our business and the business it will come back into the banking system So, not of the capital markets. I'm personally confused about all the Concern that sits out there on banking reserves in the coming recession and the impacts on the profitability of banks. It will hurt a little bit, but Well, to

Speaker 2

your point, if it's being extrapolated from COVID scenario.

Speaker 1

That's just a data point that needs to remove. Right.

Speaker 5

And then just the flip side, you've got a little over $8,000,000,000 of losses in OCI. Obviously, A lot of that comes back over time, the part that's related to the bond book. Just give us a rule of thumb like how much of that accretes back each year If rates stay here on the kind of the medium, longer term part of the curve?

Speaker 1

Well, the held to maturity Recretes back independent of rates at this point. I don't know if you guys

Speaker 2

We disclosed that, Brian. It's Couple of 100,000,000. Yes. I

Speaker 1

mean, the way we kind of think about it internally given how much we moved is We ought to have pulled a par on the held to maturity book adding to our capital base at a pace that largely hedges us Against further declines in AOCI and the available for sale book, depending how much of a spike their rates are versus They're all done, but we feel pretty good about the mix we have at this point. And obviously, it's not impacting our capital flexibility Visavis the way we look at AOCI in terms inside of regulatory capital.

Speaker 9

Yes. I guess what I

Speaker 5

was asking It's like if we just think over the next few years, right, like all that OCI essentially gets reversed back as the bonds mature. Yes, that's right.

Speaker 2

You

Speaker 5

are saddled with $8,000,000,000 of losses like a lot of banks having a drag. I'm just wondering what's a good rule of thumb? Does that $8,000,000,000 come back kind of maybe $1,500,000,000 $2,000,000,000 a year or something like that?

Speaker 1

I mean, what's the we've got a duration of 4.7 years or something.

Speaker 2

Well, the short answer is approximately $200,000,000 a quarter, dollars 1,000,000,000 a So that's the number you're looking for, but that's the right neighborhood.

Speaker 1

Sorry, that's out of the held to maturity. Held to maturity.

Speaker 2

Yes, the held to maturity.

Speaker 1

You have a separate AOCI loss and available for sale.

Speaker 2

Which is dependent on rates, right.

Speaker 5

Okay. Thank you.

Speaker 3

And our next question comes from the line of Betsy Graseck with Morgan Stanley. Please proceed.

Speaker 12

Hi, thanks. Just one follow-up on that, on the AFS book. I guess the underlying question is, is the duration roughly the same as the HTM book? I get that Rates will move that mark around, but let's say rates never change, is it the same duration as HTM?

Speaker 2

Yes, roughly. Yes, roughly.

Speaker 12

Yes, yes, yes. Okay. And then just separately, I know there's a lot of questions earlier about deposits, etcetera. And I'm just wondering, Your loan to deposit ratio, I think, today is around 70%, maybe 71%. And in 4Q 2019, it was at 83%.

Speaker 12

So there's lots of room there in the LDR. I'm wondering how you think about it. Are you happy to go back to 83 In the near term or is there a trajectory or a pace that you're comfortable with?

Speaker 1

Look, if it's high quality, we'd love to go back to 83. If it's in our risk box and coupled with Client relationships where we have really strong cross sell, that'd be a great outcome.

Speaker 2

Well, and then that also relates to the deposit pricing and what we choose to do.

Speaker 1

Right.

Speaker 2

So yes, you're right. We have room and flexibility there as we go through these increased betas and in a growing loan environment.

Speaker 12

Right. So part of the question is just trying to get a sense as to The pace of LDR increase, you kind of control with the deposit pricing.

Speaker 2

Right.

Speaker 12

You could let a lot more run off

Speaker 2

before you

Speaker 6

started to

Speaker 2

Yes, that's my point. That's the flexibility. So Can and we can view these deposits in terms of whether we want to pay for them.

Speaker 1

Yes. I don't think I mean, Look, our intention here is to keep deposits and grow deposits if we can without having to be aggressive on rate. It's very simple. And inside of that, we'd like to grow loans. And We managed to do the 2 things there and grow loan to deposits to 83%, we'll be making a boatload of money given the fee mix we get when we That's a good thing.

Speaker 1

That's right. That'd be a great thing to be able to do. Yes.

Speaker 12

Well, I mean, I guess part of the question is, You don't have to be more competitive on deposit rate right now. You could wait a few more quarters and then move.

Speaker 2

Yes. That's what I said.

Speaker 12

Okay. All right. Thank you.

Speaker 9

Sure.

Speaker 3

Our next question comes from the line of Mike Mayo with Wells Fargo Securities. Please proceed.

Speaker 9

Hi. I wanted to follow-up just Because Bill, you're just you seem so adamant that the market cap that's been taken out

Speaker 5

of your

Speaker 9

stock far Exceeds credit loss hits that you have in a scenario. So a personal question, you've owned a lot of stock For a long time, you have a lot of skin in the game. At what point would you put more skin in the game and buy some shares? We haven't seen that, I think by any bank CEO. And if you think this is like a dislocation and you think it's so unlikely to have Yes, some kind of deep recession, global financial crisis, pandemic sort of situation.

Speaker 9

Have you thought about that? I mean, would you do that?

Speaker 1

I think about it all the time. I don't know when I go into details on my own financial situation. It's I see a lot of value there. It's interesting. We've had a bunch of senior execs actually enroll And our employee stock purchase plan, which maybe is a simple way for me to get a few shares here and there.

Speaker 1

But Look, I think there's a lot of value. I don't know that you're going to see me make a giant purchase because as you've said, I own a lot of stock and it's most of my net worth.

Speaker 9

Just an extra tone for the top, but I guess you said

Speaker 5

it on the call.

Speaker 9

Just one more time on that question. Again, you have this disconnect between pricing in the capital markets With some other areas and your own expectations. So what you were saying before is that the power or The control has gone back to the banks from the borrower in terms of terms and structure, maybe not the same degree of pricing though. And I'm just it's that pricing element that it's tough for you or anyone to really know how much you should be pricing these loans if you think We might be going into a recession. So how do you get to that level?

Speaker 1

Look, it's I mean pricing ultimately is market driven. And it's I would expect for a given credit quality, we're going to see small backup. Of course, pricing Is also based on a grid. So as we go into a slower economy and people run another turn of leverage given their performance, we'll see jumps in spreads That's built into the existing contract because spreads are performance based in a lot of the loans that we do. Yes, we'll get there.

Speaker 1

More important to us, Mike, is the cross sell that we ultimately get. At the end loan pricing, as long as we get good structure, pricing is important. But pricing along with The majority of the TM relationship and Capital Markets business really ups the return that you get from that client relationship.

Speaker 9

Yes, there's

Speaker 2

a structure component. There's a lot of good companies out there that don't have structures that we would lend into that They could change that.

Speaker 9

And then I guess one more, just in terms of your 30 MSAs, your newer markets, your BBVA markets, Do you have any metrics on what market share you have there versus your legacy franchise? Because that would size the opportunity.

Speaker 1

It's small. Yes, big opportunity. It's big.

Speaker 9

Big opportunity. So big that we don't need to worry

Speaker 2

about that No, we just need to do more. Okay.

Speaker 9

All right. Thanks a lot.

Speaker 3

There are no further questions.

Speaker 1

Thanks everybody.

Speaker 2

Thank you.

Speaker 3

Thank you. That does conclude the call for today. We thank you for your participation and ask that you disconnect your lines. Have a great day.

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Earnings Conference Call
The PNC Financial Services Group Q2 2022
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