PNC Financial Services Group Inc (PNC) — Q1 2022 Transcript

Thanks, Bryan, and good morning, everybody. As you've seen, we had a solid start to the year as we grew loans and securities, controlled expenses and our credit quality reserves and capital levels remain very strong. As we previously disclosed, noninterest income was below our expectations for the quarter. And while we had expected fees to be down sequentially, reflecting typical first quarter seasonality, the decline actually exceeded normal interest rate volatility and probably the Russian-Ukraine conflict adversely impacted certain of our capital markets businesses among other areas. As we look forward, we're clearly in an environment of uncertainty here. We're also in an environment with rising interest rates, which benefit banks with increased loan demand. In PNC's case, a bank that never changed its credit box on credit terms got really easy business, has a very solid mix of fee-based businesses, and importantly, has substantially expanded its geographic presence. I want to hit on that in a second just as it relates to our progress on BBVA. I couldn't be more proud of what we've accomplished over the last 15 months in total, but particularly over the last couple of quarters. We still have a lot of work to do, but to put it in perspective, our staffing is largely complete. Our calling effort, particularly versus the fourth quarter, has increased substantially, and our sales and pipelines are robust. In the legacy BBVA USA geographies, corporate commercial banking costs have doubled since the fourth quarter, and sales have increased almost 50%. Nearly half of these sales were non-credit related. On the retail side, we're obviously focused on building customer relationships. Our sales per branch were approximately 60% higher in March compared to what they were in December with improvements across mortgages, cards and referrals to PNC investments. In our Asset Management group, we're making great progress with strategic investments to hire key people in business development and adviser roles, and importantly, our client opportunity pipelines are strong. From a balance sheet perspective, we continue to deploy our excess liquidity with solid loan growth and securities purchases. Spot loans grew $6 billion in the quarter, driven by the commercial side, which saw a nice increase in utilization. If we exclude the impact of PPP loan forgiveness, spot commercial loans grew $7 billion. The fastest organic quarterly growth we've seen since the commercial defensive draws we saw at the start of the pandemic. We've seen that growth carry into the early part of April. We remain active on the security side with net purchases of almost $6 billion during the quarter, offset by unrealized losses due to rising interest rates. This doesn't impact our regulatory capital or earnings, but during the quarter, we moved approximately $20 billion of our securities available for sale to help maturity to limit future valuation changes due to interest rate movements. Importantly, we saw a solid rebound in the yield on our securities. We believe we are well positioned for the rising interest rate environment to deliver net interest income growth and NIM expansion throughout the year. During the quarter, we returned about $1.7 billion of capital to shareholders through share repurchase dividends. Based on our performance and strong capital levels, the Board has confidence in our execution of our strategic priorities, and we recently announced a substantial increase to our quarterly dividend of $0.25 per share to $1.50, or 20%. I want to thank our employees for their hard work and dedication to our customers and communities. Moving forward, we believe we are well positioned to continue to grow shareholder value as the economy normalizes, and we realize the full potential of the combined PNC and BBVA USA franchise. With that, I'll turn it over to Rob for a closer look at our results.

Thanks, Bill, and good morning, everyone. Our balance sheet is on Slide 3 and is presented on an average basis. During the quarter, loans increased by $2 billion or 1%. Investment securities grew $6 billion or 5%, and Federal Reserve cash balances declined $13 billion or 17%, reflecting higher securities and loan balances as well as lower borrowed funds. Deposit balances averaged $453 billion and were relatively stable compared to the prior quarter. Our tangible book value was $79.68 per common share as of March 31, a 15% decline linked quarter, which was entirely driven by mark-to-market adjustments in our securities and swap portfolios as a result of higher interest rates. As a category 3 institution, we opted out of recognizing AOCI in regulatory capital, and as of March 31, 2022, our CET1 ratio was estimated to be 9.9%. Given our strong capital ratios, we continue to be well positioned with significant capital flexibility. As Bill just mentioned, our Board recently approved a $0.25 increase to our quarterly cash dividend on common stock, raising the dividend to $1.50 per share. Additionally, during the first quarter, we completed share repurchases of $1.2 billion or 6.4 million shares. Slide 4 shows our loans in more detail. Average loans increased $2 billion linked quarter, and on a spot basis, loans grew $6 billion or 2%. PPP loan balances continued to decline, impacting first quarter growth by approximately $2 billion on both an average and spot basis. Excluding the impact of PPP loans, average loans increased $4 billion driven by $5 billion of growth in commercial and industrial loans, partially offset by a $1 billion decline in commercial real estate balances. Average consumer loans were stable linked quarter. On a spot basis, loans grew $8 billion. Commercial loans grew $7 billion, driven by higher utilization and new production within corporate banking and business credit. The utilization rate increased 85 basis points, and our overall commitments were 2% higher compared to year-end 2021. Consumer loans increased $900 million as higher mortgage balances were partially offset by lower auto and credit card loans. Moving to Slide 5, average deposits of $453 billion remained stable compared to the fourth quarter. Total deposits at period end were $450 billion, a decline of $7 billion or 2% linked quarter, all in the commercial side where deposits were $10 billion lower, primarily driven by seasonal cash deployments. Partially offsetting the commercial decline, consumer deposits increased $3 billion, reflecting seasonally higher balances related to tax refund payments. Our rate paid on interest-bearing deposits remained stable at 4 basis points, and we remain core funded with a loan-to-deposit ratio of 65% at the end of the first quarter. Slide 6 details the change in our average securities and Federal Reserve balances. We've maintained high levels of liquidity over the past year while opportunistically purchasing securities. This trend continued into the first quarter as we added primarily U.S. treasuries and agency RMBS. As a result, average security balances increased by 5% or $6 billion compared to the fourth quarter of 2021, now representing 27% of interest-earning assets. Slide 7 highlights the composition of our high-quality securities portfolio as well as the balance changes from year-end March 31. During the first quarter, we added to our portfolio with net purchases of approximately $6 billion. However, the increase in rates during the first quarter resulted in higher net unrealized losses of approximately $6 billion, and accordingly, our period-end balances remained relatively stable. To moderate the impact of rising rates on security values and accordingly AOCI, we transferred approximately $20 billion of securities from our available-for-sale portfolio to held-to-maturity at quarter end. Importantly, fluctuations in AOCI did not impact our earnings, but we are mindful of the AOCI impact on tangible book value and will continue to evaluate potential opportunities to further transition. Turning to the income statement on Slide 8, as you can see, first quarter 2022 reported EPS was $3.23, which included pre-tax integration costs of $31 million. Excluding integration costs, adjusted EPS was $3.29. During the first quarter, integration costs reduced revenue by $16 million and increased expenses by $15 million. First quarter revenue was down $435 million or 8% compared with the fourth quarter. Expenses declined $619 million or 16% linked quarter, and excluding the impact of integration expenses, noninterest expense declined 7%. The first quarter provision recapture was $208 million, primarily reflecting the impact of improved COVID-19-related economic conditions, and our effective tax rate was 17%. In total, net income was $1.4 billion in the first quarter. Our first quarter expenses were down by $619 million or 16%. Excluding the impact of integration expenses, noninterest expenses declined $243 million or 7%. The majority of the decline was lower personnel expenses, reflecting the lower incentive compensation. We remain deliberate around our expense management. At year-end 2021, we achieved our objective to reduce BBVA USA's annual operating expense run rate by $900 million. As we previously stated, we have a goal to reduce costs by $300 million in 2022 through our continuous improvement program, and we're confident we'll achieve our full year target. Our credit metrics are presented on Slide 11. Nonperforming loans of $2.3 billion decreased $182 million or 7% compared to December 31, and continue to represent less than 1% of total loans. Total delinquencies were $1.7 billion on March 31, a $286 million decline from year-end, reflecting lower consumer and commercial loan delinquencies. The majority of these decreases resulted from our progress in resolving BBVA USA conversion-related administrative and operational delays. Net charge-offs for loans and leases were $137 million, an increase of $13 million linked quarter. Our annualized net charge-offs to average loans continue to be historically low at 19 basis points. During the first quarter, we reduced our allowance for credit losses by approximately $300 million, and our reserves now total $5.2 billion or 1.8% of total loans. In summary, PNC reported a solid first quarter, and we're well positioned for the remainder of 2022 as we continue to realize the potential of our coast-to-coast franchise.

In regard to our view of the overall economy, we expect strong growth over the course of 2022, resulting in 3.7% average GDP growth. 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 2% to 2.25% by year-end, and all of this is consistent with the update in our recent 8-K filing. Looking at the second quarter of 2022 compared to the first quarter, we expect average loan balances to be up 2% to 3%, which includes a $1.3 billion decline in PPP loans. We expect net interest income to be up 10% to 12%. We expect noninterest income to be up 6% to 8%, resulting in total revenue increasing 9% to 11%. We expect total noninterest expense to be up 3% to 5%, and we expect second quarter net charge-offs to be between $125 million and $175 million. Considering our reported first quarter operating results, second quarter expectations and current economic forecasts for the full year 2022 compared to the full year 2021, we expect average loan growth of approximately 10% and spot loan growth of 5%. We expect total revenue growth to be 9% to 11%. We expect expenses, excluding integration expense, to be at 4% to 6%. We now expect our effective tax rate to be approximately 19%. With that, Bill and I are ready to take your questions.

Want to see if you could give us a little bit more color on how you're thinking about the capital markets revenues here? Obviously, you saw a pretty good step down this quarter, given the activity in the broader markets. Just wanted to get your thoughts on how we can expect to think about the remaining quarters, if you think you could see an increase from here? And if the capital markets outlook has impacted your full year revenue view, is that baked in there as well?

Yes, sure. John, it's Rob. Regarding capital markets, you'll recall, at the beginning of the year, our expectations for capital markets was to be down approximately 20% or so from 2021 levels just because 2021 levels were so elevated. The first quarter was slower than we expected even at those reduced levels, but for the full year guide, I have most of that back in there. So most of what we expected to occur in the first quarter that didn't occur is still in the full year guidance, which is why we're still expecting 9% to 11% growth.

Okay. Got it. All right. That's helpful. And then, Rob, secondly, on the deposit side. Just given the move in rates that we're looking at here, clearly, a lot of focus on deposit flows. For the spot balances, you saw about a 2% decline in your deposits there. Can you maybe give us a little bit of color on what you're seeing in terms of the positive behavior here near term? Is that more commercially oriented in terms of the deposits that you saw in terms of the decline? And then can you talk about your betas that you think you'll see in the near term as rates rise and then further after the first 100 Fed hikes?

Yes. Okay. This is Rob again, John. On the deposits in the quarter, we saw a spot decline, and all of that was on the commercial side, which we see as largely seasonal. Consumer deposits on a spot basis were actually up, reflecting tax refunds and some seasonality there. That's the story on the deposits. For the full year, regarding the betas relative to what we expected at the beginning of the year, we have increased our betas consistent with the increase in the Fed rate hike forecast. Along the lines of what we saw in the last cycle, a little bit less just because we're working off such high levels. Very quiet on the first 100 basis points or so, but showing up in the third and fourth quarters if our rate forecast is correct.

Got it. If I could ask just one more thing on the loan side. I mean you mentioned the higher line utilization on the commercial side. Are you beginning to see CapEx plans drive loan demand? And then lastly, are you seeing any of the volume coming back from the capital markets back to the bank loan market yet on the commercial side?

I think the utilization reflects part of the slowdown on the capital market side in bonds. Clients continue to be active. So yes, some pickup in CapEx build-in inventory. Beyond utilization change, we saw a similar increase in new dollars out with new DHE commitments. Some of it is utilization driven by capital markets being a bit in disarray together with increased CapEx.

And higher inventory levels, of course, yes.

So Rob, it was great to see you reiterate the full year 2022 revenue outlook. I think you sort of addressed this in response to the capital markets question previously, but I was hoping broadly you could just kind of parse the guide between what comes from NII and what comes from fees? I think 90 days or so ago, you guys had been thinking maybe mid-single digit all-in growth for 2022, if I remember correctly, but just given the change in reporting and back others, et cetera. Just curious to your thoughts.

Sure, sure. So 9 to 11 total for the full year. Compared to the beginning of the year, net interest income is a bigger component of that because of the rate increases and the higher balances. So we're looking at that to be inside of that 9 to 11, the NII in the high teens. On the core fee piece, looking more towards flattish to maybe down low single digits, with most of the change there being on the mortgage outlook from the beginning of the year. Most of our fee categories are tracking to what we expected for the full year, including capital markets, as I just mentioned, but mortgage is off from what we thought at the beginning of the year because of rates. So residential and commercial mortgage, we expect it to be down low single digits. We're now looking at maybe down 25% or 30% year-over-year. That’s where the fee change is largely resident.

So you’re guiding for 9% to 11% revenue growth at 4% to 6% expense growth. You’re guiding now for 500 basis points of positive operating leverage. I’m just curious, aren’t you tempted to spend some of that and invest more of that spread? There's always a trade-off. I want to tie this back to your CEO letter, Bill, where your first goal was to gain share in especially our new markets. The second goal was to improve share with your customers. What kind of share you'd like to improve by market and by corporate and consumer customer? And to do that, are you tempted to spend some of that excess revenue growth over expense growth?

Thanks for the question, Mike. In short, we don’t have to. We’ve always been investing in our franchise. If you think about our new markets, they're largely staffed at this point. In terms of people spend, we’re kind of where we need to be. With our technology spend, we’ve been investing heavily for several years, and we’re more concerned with what we can accomplish in a given timeframe rather than simply increasing spending. The short answer is, no, we don't need to spend the money, and not spending the money does not detract from the growth that I think we’re capable of.

Another way to put it, we're not spending more money on investments, and that’s part of the guidance.

Can you put some numbers around your CEO letter? Your three goals are to gain share in your markets, improve share with customers, and technology for your first two goals. Where is your share today? Where do you hope to get it to?

It’s a fair question. I don't know that you want to define share by share of C&I loans in the market. What we are working on is presenting our progress in underpenetrated markets compared to our execution in mature markets and then tracking that for you. We look at loan balances, fees, percent of fees as a percentage of total revenues, calling volume, new clients, and we need to create metrics so you can track it over time.

As it relates to buybacks, you have the book value, regulatory capital dichotomy here. Which wins out when you think about buybacks?

I’m not sure I follow the question. Our CET1 ratio is at 9.9%, which is good, but our book value went down. Do you still buy back the same amount of stock, do you slow buyback? Yes, we view our available capital based on the 9.9%. We’re going to be in the market. I think it’s more attractive today to buy back shares than it was towards the end of the year. We expect to continue at the current pace. That average quarterly pace, we increased a little this past quarter.

Following up on your deposit beta expectations being a bit lower in this cycle, you said on the last call that you'd expect to see higher betas if the Fed shrinks its balance sheet dramatically. Could you discuss the risk that the pace the Fed has communicated could lead to higher deposit flight risk?

There are two opposing forces. When the Fed shrinks its balance sheet, it will pull deposits from the system. At the same time, loan growth puts deposits back into the system. Collectively, we think that while deposit growth will slow, it will still be positive. As the Fed gets rates substantially higher, betas will need to catch up since interest rates will start to matter again.

That makes sense. Taking that thought process and going inside your outlook, does that contemplate the possibility of simply letting some of the liquidity that you're sitting on today outflow, if necessary, instead of paying to keep it to fund loan growth?

We haven't had to pay up. Our average cost of funds is stable. We assume that there will be a portion of commercial deposits that will look for substitutes from competitors or money market funds on any given day. If our forecast holds, we can expect that to reflect in our model.

That's helpful. Can I squeeze in one last one? Bill, you shared a vision of giving consumers the ability to use Zelle at the point of sale for retail payments. Can you update us on whether that’s something you still support? How do you think about the risk of potential cannibalization?

I'm not going to speak on behalf of EWS as that's a collective decision from the ownership group. Everyone’s interest is to make payments easier and more fraud-resistant. The payment landscape will evolve with Zelle allowing purchases for services and small businesses. It’s not a direct competitor to card rails for various reasons, but it's on the way.

Can you share with us more about the capital utilization rates going up, possibly customers with capital expenditure? Where are they now? What would you consider to be a normal rate of capital utilization at your organization?

Right now, we're in the low 50s, up from the high 40s that we saw through the bulk of last year. Normal might be somewhere in the mid-50s. So we're moving towards that, but not there yet.

Is there any difference you discovered yet with the BBVA customer C&I customer versus a legacy PNC customer?

No, it's interesting. On the commercial side, we're seeing very similar borrowing trends. There is no significant difference in terms of the utilization of the lines.

When you transferred over some of the available-for-sale securities to held-to-maturity, did you transfer at a discount? Will that discount accrete into your capital over time?

Yes, exactly. It doesn't affect earnings. We balance between the flexibility benefit of available-for-sale versus the AOCI component. It will run its course, but again, it will not impact earnings.

I know you were quite excited about the money transfer business between the U.S. and Mexico. Can you share how is that going? Is it going as well as you expected? Have you been able to expand it?

We've been really happy with it. It has expanded, and we're currently looking to extend it through several countries in Latin America and potentially into Europe. It's a big business that we white label for others and are excited about.

Thanks, everybody.

Thanks, folks.