PNC Financial Services Group Inc (PNC) — Q4 2020 Transcript

Well, thank you, Kathy, and good morning, everyone. Welcome to today's conference call for the PNC Financial Services Group. Participating on this call are PNC's Chairman, President and CEO, Bill Demchak, and Rob Reilly, Executive Vice President and CFO.

Thanks, Bryan. Good morning, everybody. As you've seen this morning, we had a solid fourth quarter and full year 2020 amidst a challenging operating environment. Over the course of the year, we grew loans and deposits, delivered positive operating leverage, and executed well on all of our strategic priorities. Our balance sheet finished the year in a very strong position, with record levels of capital and liquidity, and significant credit reserves. In addition, we grew tangible book value per share by 17% year-over-year. While the economy improved modestly this quarter and we're encouraged by the rollout of the vaccines, we continue to operate amidst the pandemic, a low rate environment, and weak loan demand. Before Rob walks you through the full details of our results, I wanted to share a few high-level observations. First, the investments we've made over the years in talent and technology have allowed us to navigate this pandemic, the related economic crisis, and the widespread social unrest while supporting our stakeholders and coming out stronger as a company. In addition to taking steps to help keep our employees and customers safe, we provided billions of dollars of credit to our clients. We granted $14.8 billion in loan modifications and registered more than 70,000 loans worth approximately $13 billion through the federal government's first round of the Paycheck Protection Program. Our team is actively working with our clients right now through the second round of PPP. In response to the widespread social unrest and as part of our efforts to address systemic racism, we committed $1 billion to advance social justice and economic empowerment among Black Americans in low and moderate-income communities. As you're aware, in the second quarter of 2020, we sold our passive equity stake in BlackRock. In November, we announced our plan to redeploy those proceeds to acquire BBVA USA. Since that announcement, we've spent a lot of time with BBVA's employees and have become even more excited about our combination, given their talent in high-growth markets and the similarities in how we serve clients, manage risk, and support our communities. This transaction will create a leading national franchise, significantly accelerate our growth and enhance our profitability. Finally, I'd like to close by thanking our employees for their steadfast commitment to our customers through a very challenging year. With that, I'll turn it over to Rob for a closer look at our results, and then we'll take your questions.

Great. Thanks, Bill, and good morning, everyone. As you've seen, we've reported fourth quarter net income of $1.5 billion or $3.26 per diluted common share, resulting in full year 2020 net income from continuing operations of $3 billion or $6.36 per diluted common share. Our balance sheet is on Slide 4 and is presented on an average basis. During the quarter, lower utilization and soft loan demand drove a $7 billion or 3% decline in loans. Low rates pressured investment securities, which declined by $5 billion or 5%. Our cash balances at the Federal Reserve grew to $76 billion in the fourth quarter. Our elevated liquidity position is a result of continued deposit growth, as well as lower loan and securities balances. On the liability side, deposit balances averaged $359 billion and were up $9 billion or 3% linked quarter. Borrowed funds decreased by $5 billion compared to the third quarter as we used our strong liquidity position to continue to reduce debt. Our tangible book value was $97.43 per common share as of December 31st, an increase of 2% linked quarter and 17% year-over-year. As of December 31, 2020, our CET1 ratio was estimated to be 12.1%. In regard to capital return, our Board recently approved a quarterly cash dividend on common stock of $1.15 per share or $500 million. Consistent with the Fed mandate, we had no share repurchases during the fourth quarter. Our expectations for share repurchases in 2021 remain the same, as we stated this past December, meaning we will refrain from share repurchases, excluding employee benefit-related purchases during the period leading up to our pending BBVA USA transaction close date, expected to be mid-summer 2021. Following the close, all else being equal and subject to CCAR 2021, we'd expect to resume share repurchases in the second half of the year. Slide 5 shows our average loans and deposits in more detail. Average loan balances of $246 billion in the fourth quarter were down $7.3 billion or 3% compared to the third quarter. This decline included a $5.3 billion decrease in commercial loan balances, which was broad-based, reflecting lower loan utilization and softer loan production, partially offset by higher multifamily warehouse lending. In our C&IB segment, utilization rates are currently running at historic lows and approximately 2.5% below pre-pandemic levels as customers continue to maintain strong liquidity positions, evidenced by high levels of deposits. Consumer loans declined by $2 billion and balances were lower across all consumer categories. Compared to the same period a year ago, total average loans grew by 3% or $7 billion.

Kathy, could you please open up the line for questions?

I had a question on the outlook here for revenue, full year or stable. And obviously, that's a stand-alone basis, right? I just wanted to understand how you get there and what's going on, given the fact that the guide for NII in 1Q is down. And so can you talk through what you're doing and how much of that is loan growth? Thanks.

So I'm glad you asked that question because I included that in the forecast in terms of our guidance for the full year that we expect total revenues to be stable. Inside that, our current net interest income forecast is down modestly. But we do acknowledge potential for deposit growth and further rate steepening in excess of our current forecast. So there's potential upside there...

And it's offset by higher fees.

In terms of total revenue, yes, in terms of that. That's right. In regard to the NII, it's tough. As you take a look in terms of the rate backdrop, we had headwinds all during 2020 and we expect that to continue through 2021. We will put more money to work on the securities balances. We do expect loan growth. And there may be some room in terms of the liability side to reduce some of those costs. So that's how we get to the NII component.

Betsy, one of the internal debates that we're having -- so the forecast stays as the forecast stays. But one of the internal debates that there's no winner on is this basic notion that as the Fed continues to size their balance sheet and grow it, and we have loan growth towards the back end of 2021, that drives deposit growth. It's a closed system. And as that happens, PNC benefits disproportionately, at least has and I suspect will, given some constraints on the largest banks on deposit growth, which in turn gives us NII. So we kind of say, fine, call NII flat but there's a macro variable in here that will hit the industry as a function of loan growth and what the Fed does; it's going to drive this opportunity.

Maybe you could speak a little bit to the loan growth and where that's going to come from. That's probably the biggest single debate point that we're having with investors right now. What will drive that back up?

So Rob can jump in here. But a chunk of it simply comes back because utilizations are so low. So as the economy comes back on, you just see utilization and the basic revolvers we have. The other issues, the deleveraging of the consumer balances ought to pick up once the vaccine is widely distributed and people kind of go back to more normalized behavior. That remains to be seen, but I think those are the two biggest opportunity sets.

And some consumer on the back end of the year, that's normalized.

Rob, in response to the last question, you alluded to the possibility of potentially investing a little of the securities portfolio. And I feel like you guys just have such a mass of money just sitting at the Fed. So we've had this backup in higher rates. How much, in your mind, is it more attractive to potentially invest some of that stuff that's just sort of sitting there earning virtually nothing at this point?

Well, it's more attractive than it was a couple of months ago. I think you would have seen, right, that the outright security balances declined just as we got into the low rates and the prepays. We have been more aggressively investing money of recent. We'll continue to do that. We have a lot to go, as you point out. We don't do it all at once. And you should assume that will accelerate into a steepening curve and moderate into a flattening curve, as you would expect. But we have an awful lot of money to put to work. And then that issue compounds, again, if we get the deposit growth that at least I expect is going to happen across the industry, given the macro factors.

And that's that piece that we talked about that could be potentially above our current forecast.

And then the second question, I know it's not necessarily huge for me, but I think a lot of investors are trying to figure out what is this new round of PPP going to look like? Just sort of qualitatively, how are you guys thinking about your own participation in it? And to the degree that any benefit is baked into the guidance for 2021, how does that end up looking quantitatively as well?

I can answer that, particularly as it relates to the first quarter. So we will participate in the second wave. We anticipate that the total balances, because the program is smaller, will be less than the first wave. But to give you numbers, we finished 2020 with the average balances under the first PPP program of $12.5 billion. We expect $2 billion of forgiveness in the first quarter, so that first wave would be about $10.5 billion. For the second wave, we expect to originate approximately $4 billion in the first quarter. So that would take our total PPP in the first quarter to about $14.5 billion. That's how I size it and that's how I think it. Beyond that, we'll have to see because the levels of forgiveness and how that goes is fluid.

If I can follow up on the last question, Rob, can you help us understand -- I know there's so many moving parts with Part 1 and Part 2. You had said, I think, you had less forgiveness in the fourth quarter than you expected. Can you help us understand just like what the PPP benefit to NII was in '20? And then how much are you expecting in '21, or how much that informs that slightly down NII?

Yes. I think it is probably, Ken, you have to look at the 2021 first quarter and give you a number. Of that $14.5 billion that we expect to have in total PPP loans, the NII will be approximately $140 million. And inside that $30 million -- and these are approximate numbers. Approximately $30 million represents the forgiveness of that $2 billion that we expect from program one.

And then there will be some moving parts with regards to like run rating versus forgiveness as we go through the year as well?

Yes, that's right. And we'll keep you posted, but that's my best thinking for the first quarter.

And the second question is following on your BBVA second half PPNR comments, Rob, just wondering, is that $600 million also inclusive of the initial saves you're expecting this year? Or is that just like what they're bringing over kind of on day one? Because I think you did say you were expecting some saves to happen in the back half.

Yes, it's that, Ken. There are some saves in the back half that are included in that number.

And has there anything changed with regards to your expected trajectory of the timing around when you think the saves would come in?

No, our original assumptions are holding.

I guess one of the questions that I've gotten about you guys over the course of the last couple of months since the BBVA transaction was announced is just given the somewhat different credit profiles between legacy PNC and the BBVA franchise. How much of that loan book that you'll carry over do you anticipate keeping? And will there be some sort of a runoff portfolio that sort of impairs what would eventually be a higher growth trajectory from that franchise, or are we going to be sort of steady state and all the kind of stuff will get rationalized in the upfront mark?

There's a lot embedded in that question. But there are parts of BBVA's balance sheet that are more sectors; it's not necessarily credit risk but the things we choose to focus on versus what we don't. So there are parts of their balance sheet that will run off over time. At the same time, because of many of our lending specialties and the presence we'll have in the market, we expect that we will grow balances in the new franchise. So you're going to see both. Our base assumptions assume a rundown, I don't know when the trough is, Rob, but a rundown in balance sheet for a short period of time before we sort of offset it with new growth.

Yes, at the beginning, 2022 and 2023. So there is some revenue reconfiguration along those lines.

Yes.

But of course, we'll keep you up to speed. We don't own the bank yet. So that will be something that once we close, we'll be able to give you more color.

You had positive operating leverage last year; your efficiency improved. Fourth quarter, it didn't look as good, though. Was there anything that's unusual? And also your guidance for next year is for flat operating leverage when I know you guys pride yourself on having positive operating leverage on a core basis. Thanks.

Well, the fourth quarter, most of those expenses that jumped, as you saw, were incentive compensation for much, much higher activity, particularly in our Harris Williams unit. So those are good expenses. When Harris Williams and activity goes up, that's a good thing, but there are obviously expenses associated with that. Then there are some seasonal things that we expect. But you're right, for the full year, our expense management was successful. Full positive operating leverage for the year was our objective, and we did that. When you look at 2021, we're going to fight for it. We're not folding on that. We've got revenues stable and expenses stable. It's going to require tight expense management. But yes, we're going to battle for it.

And as far as BBVA, your loan loss reserve assumptions might have improved since you had the Pfizer vaccine out; you didn't have Moderna or J&J. So would the outlook be a little bit better and the same reason you had reserve releases when you have a better outlook for BBVA?

We didn't even actually have Pfizer out when those were put together. So in theory, you're right, Mike.

Well, again, we don't own the bank. They're going to release their results...

These are in our assumptions...

Yes. But as in our assumptions, all else being equal, yes, they'd be less.

I wanted to follow up on your comments about investing more of the securities portfolio into a curve steepening. Some of the dynamics around QE have led agency MBS spreads over treasuries to turn negative. You guys, along with most other banks, have a substantial portion of your securities portfolio invested in agency MBS. It seems like the benefits of the steeper curve are being tempered somewhat by those dynamics. Can you give a little bit of color on where you're seeing the opportunity to invest on the security side? And then maybe on the lending side, if you could remind us what percentage of the loan portfolio is anchored to the short versus the long end of the interest rate complex and just frame how we think about the benefit to P&C of a steeper curve on the lending side as well?

You're way too far into the weeds. But you should assume that for now, in terms of where current spreads against the mix of the portfolio, we'd otherwise normally be buying, our reinvestment yield is about 80 basis points. How we get there, I'm not going to go into detail. But that's on average what we would be purchasing today. The fixed and floating component and the one and three month LIBOR component of our loans. I don't remember those numbers off the top of my head.

Yes. I mean we're short -- on the commercial loans, they tend to be three-year type commitments, and on the consumer, it's floating.

The other thing that makes us somewhat unique is our entire debt stack is floating as well. You see that in our liability costs. That's one of the reasons our wholesale funding cost has dropped, last time I looked, much more materially than most of our competitors.

And separately, on expenses, some investors have expressed a little bit of concern that after so many years of you guys having the benefit of being able to reinvest a strong growth from BlackRock into the business that the loss of that strong growth is going to make it more challenging to continue to invest at the same pace without hurting the efficiency ratio. Rob, I heard your CIP target sound like they're unchanged for the year. But I was hoping you guys could just broadly speak to that notion.

I don't fully understand…

It's more driven by CIP rather than...

Yes, I mean our investment capability obviously comes from just the firm growing and then recycling expenses, which we'll continue to do. BlackRock's growth through time in terms of revenue to us was helpful. Of course, as we go forward here, and assuming we close, which is a good assumption of the BBVA acquisition, we have a whole new set of expenses in effect to recycle that gives rise to this investment...

And revenues, so it won't slow down our investment...

At all, yes.

If I can squeeze one more in on credit. So I had a question on how I think about the excess capital as it relates to Slide 12. In the absence of the BBVA deal, one could make the case that, that 1.54% reserve rate on day one is the level that we should revert to once we get past COVID. Any level of reserves above that could be viewed as excess. But can you speak to the reasonableness of that thought process? And then maybe frame for us how to think about the onboarding of BBVA onto this slide and what it would mean for your reserve rate and excess capital?

I don't think -- I mean, look, our reserve as of today and presumably their reserve as of today is reflective of the best expectations of the forward economy here. So they'll release their results, and you'll be able to look at that CRs. I don't know how we can…

You have sort of two parts to that question. One was the BBVA USA overlay, and that's to come when their results come out. The second question just is sort of what is the normal level of reserves under CECL. 1.54 was our day one after CECL level were those normal times maybe, and if so, that's the normal level.

Can you guys share with us, and I apologize if you've addressed this already; I may have missed it. Obviously, prior to the BBVA transaction, you guys were growing organically in the commercial footprint around the country. Is that strategy still underway, or has that been put on pause as you integrate the BBVA transaction?

No, not on pause, Gerard. Naturally, in cases where the BBVA USA footprint was where we were going to go, that's part of that transaction. But everything else holds in terms of opening offices, both consumer and commercial throughout the country.

Yes. And the other thing, Gerard, is going back to kind of the prior question on investments. We're actually ramping up investments in those markets prior to close. So we're not going to wait to close before we think about the totality of the products and services we want in a particular market. We're going to have it ideally the day we close and then convert.

You guys gave very good detail on your nonperforming assets. I noticed in Table 11 that you had some nice rise in return to performing status of nonaccrual loans. Can you share us any color on what success you had in bringing them back into performing status?

I think just in general, Gerard, it's just some of these companies have adapted, particularly on the commercial side, have adapted to the new economy and are actually performing well. Simple as that.

Okay. Well, thank you all for your support of PNC, and we look forward to working with you in 2021. Thank you.

Thanks, everybody.

Thank you.