The PNC Financial Services Group Q4 2022 Earnings Call Transcript

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Provided by Quartr
January 18, 2023

There are 16 speakers on the call.

Operator

Good morning. 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 Reilly, Executive Vice President and CFO. Today's presentation contains forward looking information. Cautionary statements about This information as well as reconciliations of non GAAP measures are included in today's earnings release materials as well as our SEC filings and other investor materials.

Operator

These are all available on our corporate website, pnc.com under Investor Relations. These statements speak only as of January 18, 2023, and PNC undertakes no obligation to update them. Now, I'd like to turn the call over to Bill.

Speaker 1

Thanks, Brian, and good morning, everybody. 2022 is a Successful year for our company and our strong performance during the year reflects the power of our Main Street bank model and our coast to coast franchise. For the full year, we reported $6,100,000,000 in net income or $13.85 per share. Inside of that, We grew loans and generated record revenue during a rapidly rising rate environment, while at the same time we controlled expenses resulting in substantial positive operating leverage for full year 2022. Turning to our results for the Q4, we generated $1,500,000,000 of net income or $3.47 per share.

Speaker 1

Growth in both net interest income and fee income contributed to a 4% increase in revenue. Our expenses were up 6% This quarter primarily due to increased compensation from elevated business activity, particularly in our advisory businesses. Rob is going to provide more detail on our 4th quarter expenses as well as our outlook in a few minutes. Average loans grew 3% during the quarter, driven by growth in both commercial and consumer. For the full year, average loans were up 15% and we continue to grow our loan book in a disciplined manner.

Speaker 1

As we look ahead, we are operating our company with the expectation for a Shallow recession in 2023. Accordingly, this outlook drove an increase in our loan loss provision in the quarter and a modest build in reserves under the CECL methodology. Importantly, as the credit environment continues to trend towards normalized levels, our overall credit quality metrics remain solid. I'd add that with charge offs having been so low, it's not surprising to see volatility quarter to quarter. And we saw this in the Q4 with an outsized loss on 1 commercial credit, pushing us outside of our expected range.

Speaker 1

We continue to manage our liquidity levels to support growth. Our deposits remain We've increased our wholesale borrowings to bolster liquidity. During the quarter, we returned $1,200,000,000 of capital to shareholders through share repurchases and dividends, bringing our total annual capital return to $6,000,000,000 Our progress within the BBVA influenced markets continues to exceed our We see powerful growth opportunities across our lines of business in these new markets. We continue to generate new customer relationships We have been thrilled with the quality of bankers we've been able to hire. In summary, it was a solid Q4 as we further built on our post acquisition momentum, delivered for our customers and communities across the country, generated strong financial results for our shareholders and put ourselves in a position of strength as we move into 2023.

Speaker 1

As always, I want to thank our employees for everything they do to make our success possible. And with that, I'll

Speaker 2

turn it over to Rob to provide more details. Rob? Thanks, Bill, and good morning, everyone. Our balance sheet is on slide 3 and is presented on an average basis. Loans for the Q4 were $322,000,000,000 an increase of $9,000,000,000 or 3% linked quarter.

Speaker 2

Investment securities grew $6,000,000,000 or 4%. Cash balances at the Federal Reserve totaled $30,000,000,000 and declined 1,500,000,000 And our average deposit balances were down 1%, while period end deposits remained essentially stable. Average borrowed funds increased $15,000,000,000 as we proactively bolstered our liquidity with federal home loan bank borrowings late in Q3. And these are reflected in our 4th quarter average balances. On a spot basis, we increased our total borrowed funds by approximately $4,000,000,000 compared to September 30.

Speaker 2

The period end increase was driven by $2,000,000,000 of FHLB borrowings and $3,000,000,000 of senior debt, partially offset by lower subordinated debt. At year end, our tangible book value was $72.12 per common share, an increase of 3% linked quarter. And we remain well capitalized with an estimated CET1 ratio of 9.1% as of December 31, 2022. We continue to be well positioned with capital flexibility. During the quarter, we returned $1,200,000,000 capital to shareholders through approximately $600,000,000 of common dividends and $600,000,000 of share repurchases or 3,800,000 shares.

Speaker 2

Slide 4 shows our loans in more detail. Compared to the same period a year ago, Average loans have increased 11% or $33,000,000,000 reflecting increased loan demand as well as our ability to capitalize on opportunities and our expanded coast to coast franchise. During the Q4, we delivered solid loan growth. Loan balances averaged $322,000,000,000 an increase of $9,000,000,000 or 3% compared to the Q3, reflecting growth in both commercial and consumer loans. On a spot basis, loans grew $11,000,000,000 or 3%.

Speaker 2

Commercial loans grew more than $9,000,000,000 at period end, driven by strong broad based new production in both our Corporate Banking and Asset Based Lending businesses. Importantly, Utilization rates within our C and IB portfolio remained stable linked quarter. Consumer loans increased $1,000,000,000 compared to September 30, driven by higher residential mortgage, home equity and credit card balances, partially offset by lower auto loans. And loan yields of 4.75 percent increased 77 basis points compared to the 3rd quarter driven by higher interest rates. Slide 5 covers our deposits in more detail.

Speaker 2

Throughout 2022, deposit balances have declined modestly admits the competitive pricing environment and inflationary pressures. 4th quarter deposits averaged $435,000,000,000 and were generally stable linked quarter. Given the rising interest rate environment, we continue to see a shift in deposits from non interest bearing into interest bearing. And as a result, at December 31, our deposit portfolio mix was 71% interest bearing and 29% non interest bearing. Overall, our rate paid on interest bearing deposits increased to 1.07% during the Q4.

Speaker 2

And as of December 31, our cumulative beta was 31%. Slide 6 details our securities portfolio. On an average basis, our 4th quarter securities of $143,000,000,000 grew 6 dollars or 4%. The increase was largely driven by elevated purchase activity late in Q3, which included $3,000,000,000 of forward starting securities that settled in the 4th quarter. On a spot basis, securities were $139,000,000,000 and increased $3,000,000,000 or 2% linked quarter.

Speaker 2

The yield on our securities portfolio increased 26 basis points to 2.36%, driven by higher reinvestment yields as well as lower premium amortization. And during the quarter, new purchase yields exceeded 4.75%. At the end of the 4th quarter, our accumulated other comprehensive income improved to $10,200,000,000 reflecting the accretion of unrealized losses on securities and swaps. Importantly, we continue to estimate that approximately 5% of AOCI will accrete back per quarter going forward without taking into account the impact of rate changes. Turning to the income statement on Slide 7.

Speaker 2

As you can see, Q4 2022 reported net income was $1,500,000,000 or $3.47 per share. Revenue was up $214,000,000 or 4% compared with the Q3. Expenses increased $194,000,000 or 6%. Provision was $408,000,000 in the 4th quarter, reflecting the impact of a weaker economic outlook as well as continued loan growth, which resulted in a $172,000,000 reserve build. And our effective tax rate was 17.7%.

Speaker 2

Turning to Slide 8, we highlight our revenue trends. In 2022, total revenue was a record $21,100,000,000 and grew 10% were $2,000,000,000 compared to 2021. Within that, net interest income increased 22% due to both higher interest rates and strong loan growth. Non interest income declined 5% as lower market sensitive fees more than offset strong card and cash management growth. Looking more closely at the Q4, total revenue was $5,800,000,000 an increase of 4% or $214,000,000 linked quarter.

Speaker 2

Net interest income of $3,700,000,000 was up $209,000,000 or 6%. 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 10 basis points to 2.92%. Fee income was $1,800,000,000 and increased $75,000,000 or 4% linked quarter. Looking at the detail, asset management brokerage fees decreased $12,000,000 or 3%, reflecting the impact of lower average equity markets.

Speaker 2

Capital Markets and Advisory revenue grew $37,000,000 or 12%, driven by higher merger and acquisition advisory fees, partially offset by lower loan syndication activity. Lending and Deposit Services increased $9,000,000 or 3%, primarily due to higher loan commitment fees, reflecting our strong new loan production. Residential and commercial mortgage revenue increased $41,000,000 driven by higher RMSR valuation adjustments, partially offset by lower commercial mortgage banking activities. Other non interest income declined $70,000,000 linked quarter, reflecting a negative 4th quarter Visa fair value adjustment compared to a positive valuation adjustment in the 3rd quarter, resulting in a change of $54,000,000 Turning to Slide 9, our 4th quarter expenses were up $194,000,000 or 6% linked quarter. The growth was largely in personnel costs, which increased $138,000,000 reflecting higher variable compensation related to increased business activity.

Speaker 2

4th quarter personnel costs also included market impacts on long term incentive compensation plans as well as seasonally higher medical benefits. The remaining balance of the increase in expenses linked quarter included higher marketing spend as well as impairments on various assets and investments. The majority of these impairments will lower our expenses going forward and are included in our expense guidance. As you know, we had a 2022 goal of $300,000,000 in cost savings through our continuous improvement program and we exceeded that goal. Looking forward to 2023, We will be increasing our annual CIP goal to $400,000,000 This program funds a significant portion of our ongoing business and technology investments.

Speaker 2

Our credit metrics are presented on Slide 10. Non performing loans of $2,000,000,000 decreased $83,000,000 or 4% compared to September 30 and continue to represent less than 1% of total loans. Total delinquencies of $1,500,000,000 declined 100 and $6,000,000 or 8% linked quarter. Net charge offs for loans and leases were $224,000,000 an increase of $105,000,000 linked quarter, driven in part by 1 large commercial loan credit. Our annualized net charge offs to average loans was 28 basis points in the 4th quarter.

Speaker 2

Provision for the 4th quarter was $408,000,000 compared to $241,000,000 in the Q3. The increase reflected the impact of a weaker economic outlook as well as continued loan growth. During the Q4, our allowance for credit losses increased $172,000,000 and our reserves now total $5,400,000,000 were 1.7% of total loans. In summary, P&C reported a strong Q4 and full year 2022. In regard to our view of the overall economy, we're now expecting a mild recession in 2023, resulting in a 1% decline in real GDP.

Speaker 2

Our rate path assumption includes a 25 basis point increase in Fed funds in both February March. Following that, we expect the Fed to pause rate actions until December 2023, when we expect a 25 basis point cut. Looking ahead, our outlook for full year 2023 compared to 2022 results is as follows. We expect spot loan growth of 2% to 4%, which equates to average loan growth of 6% to 8%. Total revenue growth to be 6% to 8%.

Speaker 2

Inside of that, our expectation is for net interest income to be up in the range of 11% to 13% and non interest income to be stable to up 1%. Expenses to be up between 2% 4% and we expect our effective tax rate to be approximately 18%. Based on this guidance, we expect we'll generate solid positive operating leverage in 2023. Looking at Q1 of 2023 compared to Q4 of 2022, We expect spot loans to be stable, which equates to average loan growth of 1% to 2% net interest income to be down 1% to 2%, reflecting 2 fewer days in the quarter fee income to be down 3% to 5% due to seasonally lower Q1 client activity other non interest income to be between $200,000,000 $250,000,000 excluding net securities and Visa activity. We expect total non interest expense to be down 2% to 4% and we expect 1st quarter net charge offs to be approximately $200,000,000 And with that, Bill and I are ready to take your questions.

Speaker 3

Thank Domchick. And our first question is from the line of John Pancari with Evercore. Please go

Speaker 4

ahead. Good morning.

Speaker 2

Hey, good morning, John. Good morning, John.

Speaker 4

On the Managed Income side, I wanted to see if you can give us a little more thought around the deposit cost. Potentially, maybe if you can give us your updated thoughts on where the cumulative data, I know you're in the 30 just over 30 percent now, 31%. Where that could trend to? What's your updated expectation there? And then also maybe on the non interest bearing mix, I know it's 29% of total deposits now.

Speaker 4

How do you expect that trending over the course of the next year? Thanks.

Speaker 2

Sure. Why don't I take the second one first in terms of the mix. Consistent with our expectations in a rising rate environment, we expect the mix to go More into interest bearing and we're seeing that. But it's right on track, no big surprise there. We're right now at 29% non interest bearing.

Speaker 2

I imagine that over the course of 2023, we'll go down a bit. Our previous low in previous cycles was around 25%. I think that's a good way to sort of think about it. In terms of the betas, you're right. We finished the year Right on top of where we expected.

Speaker 2

As you know, beta has lagged past historical increases for most of 2022 for us and for the industry. And going forward, we expect maybe that lag to sort of compress a bit and we'll start tracking 2 historical rises, but nothing particularly unusual. And of course, we don't control that. That'll be an outcome.

Speaker 1

Hey, John. If you're trying to dig into I had made a comment at Goldman that we thought our NII might track to an annualized 4th quarter. And in our guide, we look a little light to that. All of that pressure, it's not coming from funding, it's coming from the spread on loans. So we've been surprised, I've been surprised is we just haven't seen spreads widen in corporate credit.

Speaker 1

So I guess what I would say to you is there's this disconnect and something is going to give, either Corporate spreads are going to widen or our current scenario that we have forecasted for CECL is wrong. So right now, we basically guide against kind of where spreads are. Maybe we get some widening and we put in This mild recession in CECL. So we have a little bit of disconnect in the numbers, but they are what they are.

Speaker 2

Yes. And that gets, Of course, to our guidance for the full year in terms of NII. So the upside would be, to Bill's point, that loan spreads would widen as they should If we get into the economy that everybody is prepared for.

Speaker 1

Yes.

Speaker 4

So that widening would provide upside to that

Speaker 1

So none of the change in kind of thought on NAI is driven by any change in our assumption On betas or deposit growth, we had pretty healthy deposits this quarter. We think we can continue that. It's all on this. We have an ability, particularly in the new markets, To grab a whole bunch of new clients, make new loans that are good credit loans, kind of invest into this as we've done in our new markets For years, invest into client growth. The problem is the return right now struggles because we haven't seen Spreads, gap the way we've seen in the public markets, the way we might expect given the economy we're kind of forecasting.

Speaker 4

Got it. Okay. Thanks, Bill. And then separately on the credit side, can you give us a little more color on the $100,000,000 increase Charge offs, what was the size of the commercial credit? What was the industry?

Speaker 4

Are you seeing any other developments in related to that credit or other Areas of your portfolio were flagging just given the lumpiness and the size of that one issue. Thanks.

Speaker 2

Yes. Maybe you can Jump

Speaker 1

in here, Rod. That one credit has been staring us in the face for a while. We've been working on it. It's a credit that both BBVA and PNC So it shows up as outsized. We have big reserves against it.

Speaker 1

As you've seen in our nonperformance Our delinquencies, they're going down. This is kind of I don't know what you call this, something going through a snake, But we've been staring at it and we charged it off and that's showing the elevation this quarter, but I wouldn't read into that.

Speaker 2

Yes. No underlying trend or Same problematic with asset category.

Speaker 4

And what was that industry?

Speaker 2

Telecommunications.

Speaker 4

Okay. All right. Thank you.

Speaker 5

Sure.

Speaker 3

Our next question is from the line of John McDonald with Autonomous Research. Please go ahead.

Speaker 6

Hi, good morning. Rob, wanted to just follow-up on the NII Questions from John there.

Speaker 7

Can you

Speaker 6

just remind us where you are on kind of interest rate positioning, building in Small rate hikes in the beginning of the year, maybe cut later. How do rate hikes from here kind of impact you? And just a reminder of where you are on the swap book and how that's influencing NII today and how it rolls off would be helpful.

Speaker 2

Well, sure. Let me I'll try to Yes, for some of that and then we can follow that up. I mean definitely we're positioned to benefit from the 2 rate hikes that we expect, 25 basis points each in February March. We do have a 25 basis point cut in December, but that won't play largely into 2023 performance. So we're positioned well against that, and we'll grow our NII.

Speaker 2

We're pointing to between 10% 13% In terms of that range year over year. Yes, I will say, and we jumped into this right away, forecasting for a full year in terms of guidance is always difficult. This year in particular, it's more difficult than most. You've heard that sentiment from some of our peers that have already reported. Really Because of all the uncertainties that we all know about.

Speaker 2

So we put out what we think we can achieve. That's Bill and I talked a little bit about maybe some Side to that in terms of loan spreads. But everything that we know now with all the uncertainties, that's where we're positioned. No big change in terms of our rate management in terms of the swaps we've disclosed at around $40,000,000,000 or so. But of course, that's all Part of how we manage the balance between our fixed and variable.

Speaker 1

Yes. The simplest way to Think about that, Jonas. We through the course of the year, the DV01 or the sensitivity we have For our long positions has, if anything, decreased. So think about that in terms of both the securities book and the swap book. So we remain largely asset sensitive, happy with that position.

Speaker 1

I mean that over time changes with the mix Swaps and securities. The swaps themselves, it's kind of irrelevant to look at Separately, but they're very short and they roll off in big bulk in a couple of years.

Speaker 2

2.5 years.

Speaker 8

Yes.

Speaker 6

Okay. Thanks. And Rob, maybe as a follow-up, could you unpack a little bit of the outlook for the fee revenues that you gave for 2023, just Some of the headwinds and tailwinds that are leading to that outcome on the non interest income we've got.

Speaker 2

Yes, sure, John. Just in terms of the categories where we expect to see growth, capital markets, we do expect Mid single digit growth, which is good and consistent with our expectations. Our Steady Eddie card and cash Management will probably be up high single digits. And then those 2 will be offset by continuing headwinds And our asset management, given the equity markets, as well as lower mortgage production. So you put all that together, And that's how we get into our stable to up 1% for the full year.

Speaker 6

Got it. Thank you.

Speaker 9

Sure.

Speaker 3

Our next question is from the line of Gerald Cassidy with RBC. Please go ahead.

Speaker 9

Thank you. Hi, Rob. Hi, Bill.

Speaker 2

Hey, good morning, Gerard, Gerald. Hi. All sundown as you.

Speaker 9

I've been called worse, Rob. Bill, coming back to your thoughts The spreads that you guys just referenced on the commercial loan book relative to the CECL outlook. And I'm glad you framed it that way because I think many of us Or in that camp that you just described. But in terms of the spreads, is there any capacity issues, meaning there's too much lending capacity, which has Kept the spreads maybe lower than normal?

Speaker 1

I'm not sure what's going on, To be honest with you, I mean there's on the smaller end in certain retail categories, which really isn't our focus, There's just irrational competition in certain asset categories. In the larger corporate space, Where we have this opportunity to grow clients, particularly in the new market and ultimately cross sell, there just hasn't Any sort of gap the way you've seen in the public markets, there hasn't been any real change. Spreads aren't going down, but there hasn't been any change At all with respect to kind of the outlook in this economy and until and if there's real defaults and charge offs Probably won't be. So one of these things is going to give. I just don't know which one it is.

Speaker 9

Very good. No, I noticed in your Table 10 in the supplement, the inflows of non performance had been pretty steady. So there's real evidence yet. Thank you for that. And then as a follow-up, can you just remind us your outlook for returning capital to shareholders in the upcoming year With dividends and share repurchases.

Speaker 2

Yes. Hey, Gerard. And just to finish up on that on the credit spot, to your point in the supplement, The new non performers, but also you take a look at our NPAs and our delinquencies, which are down. So the leading indicators are still very strong.

Speaker 1

Agreed.

Speaker 2

Yes. On the share repurchases, a couple of things. One is, we are going to continue our share repurchase program into 2023. Secondly, it will be at a reduced rate relative to what we did in 2022 and likely to be less And what we did in the Q4 of 2022, which was $600,000,000 Couple of things about that. One is Why lower?

Speaker 2

One is, given all the uncertainties that we're seeing, obviously, we need to be smart and tactical in terms of our capital deployment as the year plays out. But secondly, and just logically, the rate of repurchases slows when your capital ratios go from 10% to 9%. We still have a lot of capital flexibility, but by definition, as we get closer to those operating guidelines, we slow the pace of repurchases. All that said, There's flexibility, as you know. So with the stress capital buffer, we're allowed a lot of flexibility around it.

Speaker 2

And we plan to use that flexibility as circumstances present themselves.

Speaker 9

Great. Thank

Speaker 3

you. Our next question is from the line of Bill Carcache with Wolfe Research. Please go ahead.

Speaker 10

Thank you. Good morning, Bill and Rob. Following up on your swaps commentary, could you speak broadly to how you're thinking about downside protection In this environment, any color you can give on where you'd expect your NIM to settle if the Fed ultimately pushes the economy into, say, a mild recession, Cuts rates and Fed funds normalizes, say, somewhere in the 2.5% to 3% level. That would be great.

Speaker 2

I have I have to write all that down in terms of your assumptions there. I would say in terms of NIM, Obviously, we get that question a lot. It's obviously an outcome, so we don't guide to it. We don't necessarily manage to it. I think when you just take a step back, you can see that we finished the quarter and finished the year at 2.92.

Speaker 2

That's up from all of 2021 where we lived at 2.27. So that 65 basis point jump or so, that's occurred. We don't expect those kinds of swings going forward. So going forward, we're now probably more like 5 or 6 basis point swings Off of these levels, and that's sort of the way that I think about it.

Speaker 10

Got it. Separately, there's been some concern that we could see the mix of time deposit to non interest bearing deposits return not just to pre COVID levels, But perhaps back to even pre GFC levels in this environment, can you speak to that risk both broadly At the industry level and more specifically as it relates to P&C?

Speaker 1

I mean, look, we're in a bit of an unknown environment. We have the Fed going Through QT, we have the Fed absorbing deposits through their reverse repo facility. We have, At least in our case, the ability to grow loans. So you could see a scenario where deposits get scarce. We've priced some of that that's in our forward guide in terms of our best look on that.

Speaker 1

You can draw Upside and downside to that, kind of to Rob's point, this coming year and the years after that Are harder to forecast and model than some of the stability we had pre COVID. So we're doing our best and you've seen our best expectations. Yes.

Speaker 2

I think that's right. And in regard to the mix between non interest bearing and interest bearing so far, the shift that has occurred It's perfectly consistent with what we've seen historically and consistent with our expectations.

Speaker 10

That's helpful, Bill and Rob. Thank you. If I may squeeze in one last one. I wanted to dig in a little bit into your expectation for a weaker economic outlook and mild recession And sort of square that with your reserve rate, having been basically unchanged sequentially. So it suggests that most of the reserve build was really growth driven.

Speaker 10

Maybe if the economic outlook does grow more challenging consistent with that mild recession scenario, would it be reasonable to expect that your reserve rate could actually hold Your current levels or would it still likely drift a little bit higher from here? Any thoughts around that would help.

Speaker 1

Yes. So a lot of moving Peace is here. But, start with the basic notion that we are fully reserved for the book that we hold today against a forecast That we just we more heavily weighted the recessionary forecast than we had in the Q3. And then remember, the charge offs That we took this quarter, particularly the lumpier ones, we mentioned 1. Those We're in a large way already reserved.

Speaker 1

So our build, right, is actually more than you think. The ratio ends up the same, but we have kind of less we have lower low nonperformers inside of that total book as a percentage. Maybe think of it that way In terms of coming to that 1.7%. And then I'd also just remind you of our wherever we sit Today at 1.7, both first day CECL So now or what we have now relative to others against the composition of our loan book, we've been at this in a fairly, We think correctly, but nonetheless conservative process approach using CECL.

Speaker 10

Super helpful. Thank you for taking my questions.

Speaker 3

Our next question is from the line of Betsy Graseck with Morgan Stanley. Please go ahead.

Speaker 11

Hey, good morning.

Speaker 2

Good morning.

Speaker 11

I wanted to talk a little bit about the expense side. And I know you mentioned that there was a part of the Expenses this quarter that was associated with revenue generating activities like capital markets. And so that is a net positive So let's leave those expenses aside. I wanted to dig in more to the expenses that did not come with Commensurate revenues and understand what the drivers were behind those increasing And then talk a little bit about your outlook for 2023, off of what is now higher based on what people had been expecting coming into today.

Speaker 2

Sure. Mike, I can start there. So in regard to the Q4 expenses, the biggest driver of the increase was personnel expense. And to your point inside of that, the variable comp associated with the higher business activity. In addition to that, we did have some medical expenses that we Back seasonally, but they came in a little bit higher than what we would have expected.

Speaker 2

Outside of that Explain why seasonal. Seasonal. Well, sure. Well, essentially It's not

Speaker 1

a made up thing. You basically burn through your

Speaker 2

The deductibles. Yes, the deductibles and then the company takes over after So and that happens seasonally. This season, it was a little bit higher than what we expected. Outside of that, When you look at the marketing spend, that's sort of timing in terms of how that falls in the year. But the impairments that we took On various investments and assets, which is part of your question.

Speaker 2

There wasn't anything singular that would stand out. It was

Speaker 1

Yes, there was. We wrote off everything we had to do with crypto.

Speaker 2

Well, that was part of it. So maybe Bill wants to answer these questions.

Speaker 12

But I

Speaker 2

would say there wasn't anything Singular. There's a handful of items that we took down in technology and that shows up in our equipment expense. In occupancy, there were some facilities that we rightsized for our space needs going forward, that kind of thing. So on the margin

Speaker 6

Yes, sure.

Speaker 2

And then on the margin, the I'm sorry, just going into Bill's giving me another question, but I'd say on the margin going into 2023, Those impairments reduce some of our expense rates, so that sort of helps. So our guide is 2% to 4% in all of 2023. That's how that all stays connected.

Speaker 1

Betsy, it's kind of frustrating because none of the stuff in our expense line in the 4th quarter Has anything to do with how we spend money. I mean, the comp with new business is great. Everything else was kind of we flushed a couple Tech projects just didn't work out. We right sized occupancy. Marketing went up a little bit.

Speaker 1

And then we get hit this quarter on charge offs, which are I'm not going to call them artificially high. They are what they are, but they're kind of lumpy as a function of something that we've been staring at for a while that finally hits the books.

Speaker 2

And we're largely reserved to your other point.

Speaker 11

Yes. Okay. So as I think about the guide into next This year for total expenses up 2% to 4%. That is really related more towards your revenues of 6 And this crypto thing, whatever, is a one time, one and done. Yes.

Speaker 12

That's right.

Speaker 2

You're taking that down to 0.

Speaker 12

Yes. All right. That's

Speaker 2

right. And that's why and I said in my opening comments, we point to strong positive operating leverage in 2023.

Speaker 11

Okay. All right. And then separately, I know we talked a little bit earlier about the capital and the fact That your CET1 has been migrating down as you've been doing some nice lending, etcetera. Just wanted to understand The RWA density, it looks like it's gone up a bit. And I just wanted to understand, is that just loan growth?

Speaker 11

Or is there Something else going on there. Is there some changes in how you think about RWA factors? And then I'm just wondering Like how what is the low on CET1 that you're willing to drive to as we think about demand for borrowing is still pretty robust?

Speaker 2

Well, so a couple of things on that. I would say in terms of the RWA increase, it's entirely loan driven. So we've had a lot of loan growth in 22%, a lot in the 4th quarter with that 3% growth in average loans. So that's the key driver of the RWA increase. Our CET ratio is at 9.1%.

Speaker 2

We've talked about an operating guideline of between 8.5% and 9%. We're still above our operating guidelines and that's a good place to be.

Speaker 11

Okay. So 8.5% below, really that's how we should read it.

Speaker 1

Yes.

Speaker 12

Yes.

Speaker 11

Okay. All right. Thank you.

Speaker 2

Sure.

Speaker 3

Our next question is from the line of Ken Usdin with Jefferies. Please go ahead.

Speaker 13

Thanks. Good morning. I was wondering if

Speaker 14

you guys could talk about the still potential for the TLAC rules to come down to category 3s and how you would be thinking about either getting ahead of that or starting to issue or do you just have to wait for The final notice and then consider the phase in period.

Speaker 1

I mean, a lot of people talking about this, not a lot happening around it. Were it to happen by the way, we disagree with it, but let's walk down the path and say somehow down the road, people suggest that this should happen and there'd be a phase in period. Practically, as we look at the growth opportunity in our company, new clients' loan growth against what is likely to be a constrained ability to Strain ability to grow total deposits, right? You're going to see our wholesale borrowings increase. And in the course of Our wholesale borrowings increase in the ordinary course of business.

Speaker 1

We're going to fulfill all our parts of that TLAC requirement. All of that is The numbers we're talking to you about, it will take more than next year, but in the way we think about how

Speaker 2

we In terms of we normalize as we move It's more normalized mix.

Speaker 1

Yes. So put in its simplest way to think about that maybe is our Wholesale debt historically ran, I don't know, in the mid 16% to 19%. Yes, mid teens, I was going to say, and we're running 5%. So if we normalize that's with home loan in there.

Speaker 7

Yes.

Speaker 1

As we normalize our borrowings Through time, it's likely we're going to get and fulfill that requirement without purposely trying to do it, Just because that's the way we and other people will be funding institutions.

Speaker 2

Yes. I'd just add to that. We see it on our path. It's not particularly problematic, but there's a lot to be played out. We still don't think it's necessary.

Speaker 2

And there's also a reasonable chance there'd be some tailoring to it, Which would be reduced in our case.

Speaker 14

Yes. And as a follow on to that, to your point about wholesale borrowings Funding loan growth incrementally. Can you just talk about how you're thinking about the securities portfolio? I know you saw some growth this quarter. I know you're getting good front book, back book on it.

Speaker 14

The percentage of earning assets is still around 28%. So how would you expect that to go visavis the use of wholesale borrowings And to support that growth as well. Thank

Speaker 1

Look, you wouldn't purposely borrow wholesale and then invest in a security to hold in your securities book. However, inside of all the requirements that we manage ourselves to, we also have liquidity requirements, LCR, And they need to hold high quality liquid assets. So the securities book will likely Fade in terms of total percentage over time simply because of loan growth that we see and some of the roll down. That securities book is part of what we have in terms of cash and liquidity to satisfy LCR. So it's Yes.

Speaker 1

We're not going to say, hey, let's borrow some money to buy more treasuries, right? That isn't going to happen. But practically, we use that book to hedge the value of our deposits. We'll continue to do that inside of the lens of LCR and other liquidity stresses that we run.

Speaker 14

Got it. Okay. Thank you, Bill.

Speaker 3

Our next question is from the line of Mike Mayo with Wells Fargo Securities. Please go ahead.

Speaker 8

Hi. Hey, Mike. Well, I guess in the category of no good deed goes unpunished, I mean, you did have positive operating leverage last year of 300 basis points. You're guiding for positive operating leverage this year between, I guess, 200 basis points, your charge offs were below 30 basis points every quarter. You're buying back some shares, yet Yes, your guidance from 1 month ago was off and your results fell 1 8th below Consensus.

Speaker 8

Now don't stop giving your guidance or anything like that. And we're all subject to the uncertainties out there. But Just a little bit more about what's changed in the past month. So, I guess unemployment, your end rate assumption, you're saying it's over 5%, maybe Where that's going to and I guess that drove some of the CECL driven reserve part of the reserves, the NII And maybe your decision to lean into the securities purchases, maybe because you think this is a relative top on yield. Thanks.

Speaker 1

Yes. So you're over complicating it. One thing changed from a month ago And one thing only. And that was basically the spread we thought we'd earn on new business, Right. We know, Mike, that we can go out and grow loans.

Speaker 1

Our ability to gain clients, cross sell those clients, We've never been more bullish on that. The process of doing that is not earning what we would otherwise Expect in the moment because spreads have not widened and of course you take a full life of the loan reserve when you book that loan. That's the only thing that's really The expenses this quarter are noise. The guide for next year is Tempered simply by that question of whether spreads are going to rise on loans, maybe they will or our CECL analysis will be wrong. We haven't We never guide on what our provision is going to be.

Speaker 1

We talk about charge offs and the charge off this quarter we felt was a bit anomalous. So nothing has really changed other than the sweat factor of, hey, can I actually earn what I thought I was going to earn on new loan production? That's it.

Speaker 8

So you're saying you're too conservative either on CECL reserves or your NII guide for the year?

Speaker 1

And I haven't given you a number on my CECL reserves, right? So but We put in we worsened our economic forecast. And the simple sound bite is either spreads are going to widen or our economic forecast is wrong. I think that's a fair statement.

Speaker 2

So there's an inconsistent

Speaker 8

You give a by the way, if the CEO gig doesn't turn out, maybe Come to The Economist, because this is such a detailed outlook in your release that way you expect the economy and interest rates and everything else.

Speaker 2

So you give a lot of detail.

Speaker 1

Yes. You asked a question on the securities book. It's just we basically Stayed pretty much in the same position all year. We get to reprice the book and you see the income coming out of the securities book growing nicely. We haven't invested into it.

Speaker 1

It's a tough market to invest into if you are, in effect a deposit Funded institution, right. If you want to go out and buy something today against your marginal cost of money, you're basically carrying flat to negative. Today, on the Theory that the Fed is going to cut to what down the road. And you got to believe that the Fed is going to go back into 2s On Fed Funds, which I just fundamentally don't believe. So I think kind of the market is just uninvestable at the moment.

Speaker 1

And I think that's going to be figured out through the course of the year. And so there's upside. My view on that plays out in the way we'd run our securities book. But at the moment, there's Choosing to go long in this environment, I think is a mistake.

Speaker 8

One more clarification. You are reserved for your existing book of business, assuming an unemployment rate of what level?

Speaker 2

I know it's above 5%. 5.1. 5.1. 5.1. Yes.

Speaker 8

Got it. All right. Thank you.

Speaker 3

Our next question is from the line of Ebrahim Poonawala with Bank of America. Please go ahead.

Speaker 8

Hey, good morning. Good morning.

Speaker 7

On the NII guide, so I think you've spoken extensively about the spreads. Want to get how much of the inversion in the yield curve was a factor in impacting the NII outlook? And tied to that, like with the 10 years sub-three forty this morning, like do you just not invest right now and wait for things to shake out? Or how do you think about balance sheet management in a world where maybe the 10 years headed to 3% not 4% next? Thanks.

Speaker 1

Yes. So that impacts the NII guide a bit only in terms of what our

Speaker 12

reinvestment yield is and

Speaker 1

will be when we The yield is and will be when we when the existing security book rolls down. Right. So you've seen the book yield on that rise From wherever to what is it now 260 something?

Speaker 2

Yes, the total book, yes.

Speaker 1

Yes. And that continues to increase as we As things roll off, we're reinvesting with high 4s, 5 handles on securities. Look, if the 10 year goes So 3%. If you look at the 5 year 5 years, the implication of where long Term rates really have to head for that to be true. I just don't buy.

Speaker 1

I don't think we're going to be in an environment Where the Fed is bouncing short term funds around 1%, which I just don't think it's going to happen. I think we're going I think we will get inflation under control, but I think it's going to be a struggle to get it under 3 long term. And I think front rates will raise will stay higher. They might cut and likely will cut from some 5% level. But this assumption that they're going to cut and therefore rates are going to go The 2 or 1, I just think is absurd.

Speaker 1

And so therefore to me, the back end of that curve is uninvestable. You're right. It could rally to there. Good for the people who own it, as long as it's not

Speaker 7

me. Yes. No, that's fair. And again, I'm not saying it makes sense, but it's the world we live in. And I guess tied to that, I'm not sure if you gave explicit guidance in just terms of deposit growth outlook.

Speaker 7

I mean, still a lot of room when we look at the loan to deposit ratio. Just give us a thought around how you're thinking about letting additional sort of rate sensitive deposits run off, having a smaller balance sheet, creating more excess capital?

Speaker 1

Look, there's obviously we could, In the near term, increase earnings by being less competitive with deposits and let deposits run off. We have the liquidity to do that. We could increase our loan to deposit ratio. The challenge with that is in the course of doing that, you're damaging your long term franchise. So if you're losing deposits that are not core relationship deposits, then maybe that makes sense.

Speaker 1

But if you're losing customers in Process of that runoff, that's a mistake. And that's the logic we use in figuring out how we price deposits and how We grow or maintain deposits.

Speaker 7

That's fair. And if I may, one last question, Bill. In terms of Just a macro uncertainty, how do you assess like the difference between credit normalization and Whether or not we are getting into some version of a recession, like can you conclusively think about that over the next few months or we are not going to know that Until we are well into the depths of a downturn a few quarters from now.

Speaker 1

We've given you our best forecast. Yes. I mean, look, there's a lot of unknowns here. Technically, we could see ourselves heading into a full employment recession Because you'll have stale GDP for a couple of quarters, but unemployment not ticking up High levels and I don't even know how to think about that environment in terms of what charge offs might be. I mean that's probably a really low charge off environment.

Speaker 1

Yes.

Speaker 2

Well, Well, just to your point in terms of what I said at the beginning, it's really difficult for the full year, particularly this year. We've put together what we think we can do.

Speaker 7

That's fair. Thanks for taking my questions.

Speaker 3

Our next question It's from the line of Matt O'Connor with Deutsche Bank. Please go ahead.

Speaker 7

Good morning.

Speaker 8

Hey, Matt. Also, if we

Speaker 5

could just circle back on some of the lumpy costs. I guess just in aggregate, like how much were the impairment? And then I think there was also you called out some lumpiness from the long term incentive plan, which I think impacts both fees and comp. So If you could just kind of flush out the aggregate lumpy costs, that would be helpful. Thank you.

Speaker 2

Yes. Without we don't have specific numbers. You can see them and you can see them They break down in terms of our impairments within the occupancy line and the equipment line. The long term was just the effect of a benefit in the 3rd And then it swung against us in the Q4. So not big numbers, but just the delta between the two quarters drove the increase.

Speaker 5

Okay. And then separately, I mean, I heard you earlier kind of reiterate the 8.5% to 9% CET1 target over time. And Just any thoughts on the regional banks kind of just below your size? It seems like they're all kind of Building capital close to 10%. And I don't know if it's pressure behind the scenes from rating agencies or regulators or just conservatism for where we are in the cycle.

Speaker 5

But Any thoughts on a company your size being able to run 9 when the ones obviously, the banks that are bigger are running higher, but It's just been interesting to note that the ones below you kind of $200,000,000,000 in assets, all seem to be building closer to 10.

Speaker 12

Well, the only thing

Speaker 2

the only I the only thought that I have just reacting is, the guidelines are typically drawn out for all banks in terms of the stress Capital buffers, so how they stress, you got to look at that. And then, it's the relative capital levels to the stress levels as opposed To the absolute levels, but that's just my reaction.

Speaker 5

Okay. Well, I guess the point is like you feel comfortable With whatever kind of behind the scenes stuff is going on with the rating agencies regulators, the 9% and maybe drifting down a little bit But at 9% you feel more comfortable with in the current environment?

Speaker 2

Yes. Yes, ma'am.

Speaker 5

Okay. Thank you.

Speaker 3

Our next question is from the line of Vivek Juneja with JPMorgan. Please go ahead.

Speaker 15

Hi. Just a couple of quick ones. Any color on criticized assets, How they did how those did in the quarter?

Speaker 2

Yes, relatively flat. Not a big change at all.

Speaker 15

Okay. And Bill, just not to beat a dead horse to death, but the whole sort of question on NII and swaps and protection. Given that you think of swaps and securities sort of a synonymously to in terms of expressing your view on rates, I would expect that you're going to hold off, therefore, even on the swap side in terms of adding protection yet Until you see clearer signs of a lot more potential for rate cuts?

Speaker 1

Yes. I mean, it's strange to me, Vivek, you're a bit of a fixed income guy. This notion of protection, I mean, what a lot of banks They're doing is they'll put on forward starting swaps and they'll not have to eat negative carry in the course of doing that. And they'll hope Sometime by the time those come due that there is a negative carry because there'll be a cut. So you effectively I mean everything's priced at the forward When they do that trade, it makes no sense to me.

Speaker 1

It's the same as choosing to invest at the moment and where the yield curve is. That's my downside protection. I can buy we can sell it, we can use options and sell away upside and buy some down As a practical matter, we're not wildly out of bounds in terms of while we're asset sensitive, we're not wildly asset sensitive. And it just doesn't feel like the moment when you're supposed to be long. Particularly, if you have a view that rates And the go forward decade are not going to look like rates during the 2012 to 2020 era.

Speaker 1

So that's where we sit.

Speaker 15

Okay. All right. Thanks.

Speaker 3

And there are no further questions on the line at this time. I'll turn the presentation back to Brian Gill for any closing remarks.

Operator

Well, thank you all for joining the call today. If you have any other follow ups, please reach out to the IR team. We'd be happy to help you out. Thank you.

Speaker 1

Thanks, everybody.

Speaker 2

Thank you.

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Earnings Conference Call
The PNC Financial Services Group Q4 2022
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