PNC Financial Services Group Inc (PNC) — Q4 2022 Transcript

Thanks, Bryan, and good morning, everybody. 2022 was 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 $6.1 billion 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 the full year 2022. Turning to our results for the fourth quarter, we generated $1.5 billion of net income or $3.47 per share. 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 fourth 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. 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 fourth quarter with an outsized loss on one commercial credit pushing us outside of our expected range. We continue to manage our liquidity levels to support growth. Our deposits remain relatively stable, and we've increased our wholesale borrowings to bolster liquidity. During the quarter, we returned $1.2 billion of capital to shareholders through share repurchases and dividends, bringing our total annual capital return to $6 billion. Our progress within the BBVA influence markets continues to exceed our expectations, and we see powerful growth opportunities across our lines of business in these new markets. We continue to generate new customer relationships, and we have been thrilled with the quality of bankers we've been able to hire. In summary, it was a solid fourth quarter 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. As always, I want to thank our employees for everything they do to make our success possible. And with that, I'll turn it over to Rob to provide more details.

Thanks, Bill, and good morning, everyone. Our balance sheet is on Slide 3 and is presented on an average basis. Loans for the fourth quarter were $322 billion, an increase of $9 billion or 3% linked quarter. Investment securities grew $6 billion or 4%. Cash balances at the Federal Reserve totaled $30 billion and declined $1.5 billion during the quarter. And our average deposit balances were down 1%, while period-end deposits remained essentially stable. Average borrowed funds increased $15 billion as we proactively bolstered our liquidity with Federal Home Loan Bank borrowings late in the third quarter, and these are reflected in our fourth quarter average balances. On a spot basis, we increased our total borrowed funds by approximately $4 billion compared to September 30. The period-end increase was driven by $2 billion of FHLB borrowings and $3 billion 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 $1.2 billion of capital to shareholders through approximately $600 million of common dividends and $600 million of share repurchases or 3.8 million shares. Slide 4 shows our loans in more detail. Compared to the same period a year ago, average loans have increased 11%, or $33 billion, reflecting increased loan demand as well as our ability to capitalize on opportunities and our expanded coast-to-coast franchise. During the fourth quarter, we delivered solid loan growth. Loan balances averaged $322 billion, an increase of $9 billion, or 3% compared to the third quarter reflecting growth in both commercial and consumer loans. On a spot basis, loans grew $11 billion, or 3%. Commercial loans grew more than $9 billion 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&IB portfolio remained stable linked quarter. Consumer loans increased $1 billion 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% increased 77 basis points compared to the third quarter, driven by higher interest rates. Slide 5 covers our deposits in more detail. Throughout 2022, deposit balances have declined modestly, amidst the competitive pricing environment and inflationary pressures. Fourth quarter deposits averaged $435 billion 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 fourth quarter. And as of December 31, our cumulative beta was 31%. Slide 6 details our securities portfolio. On an average basis, our fourth quarter securities of $143 billion grew $6 billion or 4%. The increase was largely driven by elevated purchase activity late in the third quarter, which included $3 billion of forward starting securities that settled in the fourth quarter. On a spot basis, securities were $139 billion and increased $3 billion, or 2% linked quarter. 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 fourth quarter, our accumulated other comprehensive income improved to $10.2 billion 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. As you can see, fourth quarter 2022 reported net income was $1.5 billion, or $3.47 per share. Revenue was up $214 million, or 4% compared with the third quarter. Expenses increased $194 million, or 6%. Provision was $408 million in the fourth quarter, reflecting the impact of a weaker economic outlook as well as continued loan growth, which resulted in a $172 million reserve build. And our effective tax rate was 17.7%. Turning to Slide 8. We highlight our revenue trends. In 2022, total revenue was a record $21.1 billion and grew 10% or $2 billion 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 fourth quarter, total revenue was $5.8 billion, an increase of 4% or $214 million linked quarter. Net interest income of $3.7 billion was up $209 million, 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 $1.8 billion and increased $75 million, or 4% linked quarter. Looking at the detail, asset management and brokerage fees decreased $12 million, or 3% reflecting the impact of lower average equity markets. Capital Markets and Advisory revenue grew $37 million, or 12%, driven by higher merger and acquisition advisory fees, partially offset by lower loan syndication activity. Lending and deposit services increased $9 million or 3%, primarily due to higher loan commitment fees, reflecting our strong new loan production. Residential and commercial mortgage revenue increased $41 million, driven by higher RMSR valuation adjustments, partially offset by lower commercial mortgage banking activities. Other non-interest income declined $70 million linked quarter, reflecting a negative fourth quarter Visa fair value adjustment compared to a positive valuation adjustment in the third quarter, resulting in a change of $54 million. Turning to Slide 9. Our fourth quarter expenses were up $194 million, or 6% linked quarter. The growth was largely in personnel costs, which increased $138 million reflecting higher variable compensation related to increased business activity. Fourth 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 million 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 million. This program funds a significant portion of our ongoing business and technology investments. Our credit metrics are presented on Slide 10. Non-performing loans of $2 billion decreased $83 million or 4% compared to September 30 and continue to represent less than 1% of total loans. Total delinquencies of $1.5 billion declined $136 million, or 8% linked quarter. Net charge-offs for loans and leases were $224 million, an increase of $105 million linked quarter, driven in part by one large commercial loan credit. Our annualized net charge-offs to average loans was 28 basis points in the fourth quarter. Provision for the fourth quarter was $408 million compared to $241 million in the third quarter. The increase reflected the impact of a weaker economic outlook as well as continued loan growth. During the fourth quarter, our allowance for credit losses increased $172 million, and our reserves now total $5.4 billion or 1.7% of total loans. In summary, PNC reported a strong fourth quarter 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. Our rate path assumption includes a 25 basis point increase in Fed funds in both February and 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%. 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% and 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 the first quarter of 2023 compared to fourth quarter 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 two fewer days in the quarter. Fee income to be down 3% to 5% due to seasonally lower first quarter client activity. Other non-interest income to be between $200 million and $250 million, excluding net securities and Visa activity. We expect total non-interest expense to be down 2% to 4%, and we expect first quarter net charge-offs to be approximately $200 million. And with that, Bill and I are ready to take your questions.

Good morning. On the managed income side, I wonder if you can give us a little more thought around the deposit costs potentially maybe if you can give us your updated thoughts on where the cumulative beta, I know you're in that just over 30% now at 31%, where is that going to 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. How do you expect that trending over the course of the next year?

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. I'd imagine that over the course of '23, it will go down a bit our previous low in previous cycles was around 25%. So 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. As you know, betas lagged past historical increases for most of '22 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 to historical rises, but nothing particularly unusual. And of course, we don't control that; that will be an outcome.

John, if you're trying to understand, I mentioned at Goldman that we thought our net interest income might align with an annualized fourth quarter, and in our guidance, it looks slightly low. The pressure we’re experiencing isn’t coming from funding; it’s from the loan spreads. I’ve been surprised that we haven’t seen widening in corporate credit spreads. So, what I would say is there’s a disconnect that something has to change. Either corporate spreads will widen, or our current projection for CECL is incorrect. Right now, we are essentially guiding based on the current spread situation. It’s possible we could see some widening and incorporate a mild recession into our CECL forecast. There’s a bit of a disconnect in the numbers, but they are what they are.

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.

So that widening would provide upside to that 11% to 13%.

Yes. So, none of the change in kind of thought on NII is driven by any change in our assumption on betas or deposit growth. We had pretty healthy deposits this quarter. We think 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.

Got it. Okay. And then separately on the credit side, can you give us a little more color on the $100 million increase in charge-offs? What was the size of the commercial credit? What is the industry? Are you seeing any other developments related to that credit or other areas of your portfolio that were flagging just given the lumpiness and the size of that one issue?

Can jump in here, right? 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 were in. So it shows up as outsized. We had big reserves against it. As you've seen in our non-performers and our delinquencies, there is 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.

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

What was that industry?

Telecommunications.

Rob, I wanted to follow up on John's question about net interest income. Could you remind us about your current position regarding interest rates? Are you anticipating small rate increases at the start of the year, potentially followed by cuts? Also, how do you see these rate hikes affecting you? It would be helpful to get an update on your swap book and its impact on net interest income now and in the future.

Sure. Let me address some of that, and then we can discuss further. We are certainly positioned to benefit from the two anticipated rate hikes of 25 basis points each in February and March. There will be a 25 basis point cut in December, but that is not expected to significantly affect our 2023 performance. Consequently, we are well-positioned and expect our net interest income (NII) to grow between 10% and 13% year-over-year. Forecasting for a full year is always challenging, and this year, particularly, has proven to be more difficult than usual due to various uncertainties that many of our peers have also mentioned. We have provided guidance based on what we believe we can achieve. Bill and I have discussed the possibility of some upside in terms of loan spreads. Given the current uncertainties, this is our position. There are no significant changes in our rate management regarding the swaps, which are around $40 billion, and this plays a crucial role in balancing our fixed and variable rates.

The simplest way to think about that, John, is that over the course of the year, the sensitivity we have for our long positions has decreased. So consider that in relation to both the securities book and the swap book. We remain largely asset-sensitive and are satisfied with that position. Changes occur over time with the mix of swaps and securities. It’s somewhat irrelevant to examine the swaps separately, but they are very short and will roll off in large amounts over a couple of years.

2.5.

Okay. 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?

Yes. Yes. Sure, John. So, 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 two will be offset by continuing headwinds in 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.

Bill, coming back to your thoughts on the spreads that you guys just referenced on the commercial loan book relative to the CECL outlook. I'm glad you framed it that way because I think many of us are 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?

I'm unsure about the situation, to be honest. On the smaller end in some retail categories, which aren't our main focus, there's irrational competition happening. In the larger corporate sector, where we have growth opportunities with clients, especially in the new market and cross-selling, there hasn't been a significant gap like we've seen in the public markets. There has been no real change. Spreads aren't decreasing, and there hasn't been any noticeable change in the economic outlook. Unless there are significant defaults and charge-offs, which seems unlikely, one of these factors will eventually shift, but I can't predict which one it will be.

Very good. I noticed in your Table 10 in the supplement that the inflows of non-performance have been pretty steady. So, there's real evidence yet. As a follow-up, can you remind us of your outlook for returning capital to shareholders in the upcoming year with dividends and share repurchases?

Yes. Gerard, and just to finish up on that on the credit spot, to your point, in the supplement, the 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. Yes, on the share repurchases, a couple of things. One is we are going to continue our share repurchase program into '23. Secondly, it will be at a reduced rate relative to what we did in 2022 and likely to be less than what we did in the fourth quarter of '22, which was $600 million. A couple of things about that, one is, why lower? 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%. So, 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. And we plan to use that flexibility as circumstances present themselves.

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 normalize, say, somewhere in the 2.5% to 3% level? That would be great.

I need to note down all of your assumptions regarding this. We often receive inquiries about net interest margin, but we don’t provide guidance or manage specifically to that. If you take a moment to review, you'll see that we ended the quarter and the year at 2.92%. This is an increase from all of 2021, where we were at 2.27%. That represents about a 65 basis point increase. We don’t foresee such large fluctuations moving forward. Going ahead, we expect swings of about 5 or 6 basis points from these levels, and that’s how I view the situation.

Got it. Separately, there's been some concern that we could see the mix of time deposits and 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 PNC?

We are currently navigating a somewhat uncertain environment. The Federal Reserve is implementing quantitative tightening and taking in deposits via their reverse repo facility. In our case, we still have the capacity to increase loan growth. Therefore, it's possible that we may face a situation where deposits become limited. We have accounted for some of these factors in our forward guidance, but projections for this year and the next few years are more challenging than the stability we experienced before COVID. We are doing our utmost, and you have seen our most optimistic forecasts.

Yes, 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 is perfectly consistent with what we've seen historically and consistent with our expectations.

That's helpful, Bill and Rob. 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. 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.

We have many factors to consider, but the fundamental point is that we are fully reserved for our current portfolio based on our updated forecasts, which place a greater emphasis on a recession scenario compared to the third quarter. The charge-offs we experienced this quarter, particularly the more significant ones I mentioned, were mostly already accounted for in our reserves. Therefore, our reserve build is actually more substantial than it appears. The ratio remains consistent, but we have a smaller percentage of non-performing loans in our total portfolio. Regarding our current reserve level, it's important to remember that we have been taking a cautious and correct approach with CECL from the beginning.

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 to PPOP. 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 have been expecting coming into today.

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

Lane wise seasonal.

The deductibles occur when the company takes over afterward. This season, they were a bit higher than anticipated. Regarding marketing spend, the timing varies throughout the year. As for the impairments related to various investments and assets, there wasn't anything notable that stood out.

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

Well, that was part of it. That was part of it. So maybe Bill wants to answer these questions. But I would say there wasn't anything single. There's a handful of items that we took down in technology, and that shows up in our equipment expense in occupancy, with or were some facilities that we right-sized for our space needs going forward, that kind of thing. So, on the margin…

I'll talk about that.

Yes, certainly. Regarding the margin as we enter 2023, the impairments helped to lower some of our expense rates. Our guidance for the year is 2% to 4%. This is how everything remains interconnected.

It's frustrating because none of the items in our expense line for the fourth quarter relate to our spending. The comparison with new business looks good. We had to abandon a couple of tech projects that didn't pan out. We adjusted our occupancy, and marketing expenses increased slightly. Then this quarter, we faced some charge-offs. I'm not going to say they're artificially high; they are what they are, but they fluctuate based on something we've been monitoring for a while that has finally been reflected in our financials.

And we're largely reserved to your point.

Okay. So as I think about the guide into next year for total expenses up 2% to 4%, that is really related more towards your revenues of 6% to 8% and the crypto thing, whatever is a one-time one and done gone, that's down to zero.

And that's why I mentioned in my opening comments, we are experiencing strong positive operating leverage in 2023.

Okay. I wanted to ask about the capital and the decline in your CET1 ratio as you have been increasing lending. I noticed that the RWA density seems to have increased slightly, and I would like to know if this is solely due to loan growth or if there are other factors at play. Are there any changes in how you approach RWA calculations? Additionally, I would like to know what the lowest CET1 ratio you are prepared to maintain is, especially considering that demand for borrowing remains quite strong.

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

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

Yes.

I was wondering if you guys could talk about the still potential for the TLAC rules that come down to the category threes 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 a phase-in period?

There is a lot of discussion about this issue, but not much is taking place. If it were to occur, we do not agree with it; however, let's consider that at some point down the line, people may suggest this should happen, which would involve a phase-in period. When we look at the growth opportunities for our company, particularly with new client loan growth, we anticipate a limited ability to increase total deposits. As a result, we expect our wholesale borrowings to rise. Throughout this increase in wholesale borrowings, we will meet all aspects of the TLAC requirement. This is all reflected in the numbers we are discussing, and it will take longer than just next year to fully address it, but that is how we are approaching it.

In terms of to normalize as we move towards more normalized mix.

Yes. The simplest way to think about that is our wholesale debt historically has been in the mid...

15% to 19%.

Yes, mid-teens, I was going to say, and we're running at 5%. So if we normalize that's what home loan in there. As we normalize our borrowings over time, it's likely we'll meet that requirement without making a deliberate effort to do so. This is simply how we and others will finance institutions.

Yes. I would just add that we see it on our path. It's not particularly problematic, but there's a lot that still needs to unfold. We still don't believe it's necessary, and there's also a reasonable chance it would be adjusted, which would be less of a concern for us.

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. The percentage of earning assets is still around 28%. So how would you expect that to go vis-à-vis the use of wholesale borrowings to continue to support that growth as well?

You wouldn’t intentionally borrow money at wholesale rates to invest in a security for your portfolio. However, alongside all our self-managed requirements, we also have liquidity needs, including the Liquidity Coverage Ratio and the necessity to maintain high-quality liquid assets. Consequently, the proportion of our securities portfolio will likely decrease over time due to loan growth and some roll down. This securities portfolio is part of our cash and liquidity resources needed to meet the Liquidity Coverage Ratio. Therefore, we are not going to engage in borrowing money to purchase more treasuries. However, we do utilize this portfolio to hedge against the value of our deposits, and we will continue to do so while considering the Liquidity Coverage Ratio and other liquidity stresses we encounter.

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 and 600 basis points, your charge-offs were below 30 basis points every quarter. You're buying back some shares yet your guidance from one month ago was off and your results fell 1.8 below consensus. Now don't stop giving your guidance or anything like that and were 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 reserves, the NII and maybe your decision to lean into the securities purchases maybe because you think this is a relative top on yields?

Yes. So, you're overcomplicating 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. 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 changed. 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. We talk about charge-offs and the charge-off this quarter we felt was a bit anomalous. So nothing's 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.

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

I haven't provided a number regarding my CECL reserves. However, we did adjust our economic forecast negatively. The straightforward takeaway is that either spreads will widen or our economic forecast is incorrect. I believe that's a reasonable assertion.

So, there's an inconsistent.

You provide a detailed outlook in your release about your expectations for the economy, interest rates, and other factors.

You asked about the securities book. We've maintained a consistent position throughout the year. We're able to re-price the book, and the income from the securities book is showing solid growth. However, we haven't made any new investments in it, as it's a challenging market right now. As a deposit-funded institution, if we were to purchase something today based on our marginal cost of money, we'd essentially be at a break-even or loss. Currently, the expectation is that the Fed will reduce rates in the future, but I fundamentally disagree with the belief that the Fed will return to 2s on Fed funds. Therefore, I think the market is not conducive to investment at this time, and this will become clearer as the year progresses. I see potential upside as we navigate our securities book, but deciding to invest long-term in this environment seems unwise.

One more clarification, you are reserved for your existing book of business, assuming an unemployment rate of what level? I know it's above 5%.

5.1%.

On the NII guide, so I think you've spoken extensively about the spreads. Wanted 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-340 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?

Yes. This affects the net interest income guidance slightly in terms of our reinvestment yield when the current security portfolio matures. You’ve noticed that the yield on that portfolio has increased from its previous level to now around 260-something.

Yes, the total book.

As things evolve, our reinvestment in securities is yielding high fours and five handles. If the 10-year rate reaches 3%, we need to consider the implications for long-term rates to align with that. I doubt we will see an environment where the Fed adjusts short-term funds around 1%. I believe we will manage to control inflation, but it will be a challenge to keep it below three long-term. Front rates will likely remain high; they might cut but will probably do so from a level around 5%. The idea that they will cut and rates will return to two or one seems unrealistic to me. Consequently, I find the long end of the curve uninvestable. It could rally, which would be beneficial for those who hold it, but not for me.

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

We could potentially boost our earnings in the short term by becoming less competitive with deposits and allowing them to decrease. We have enough liquidity to do this, which would raise our loan-to-deposit ratio. However, this approach could harm our long-term business. If we lose deposits that aren't essential to our customer relationships, it might be acceptable. But losing customers during this process would be a mistake. This reasoning guides our decisions on deposit pricing and how we grow or maintain our deposits.

That's fair. And if I may, one last question, Bill. In terms of macro uncertainty, how do you evaluate the difference between credit normalization and a potential recession? Can you make a definitive assessment in the next few months, or will it only be clear once we are deep into a downturn in a few quarters?

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 to 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 really low charge-off environment.

Well, it's 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.

Could you provide a summary of the variable costs? Specifically, how much were the impairments? Additionally, you mentioned some variability from the long-term plan, which I believe affects both fees and compensation. It would be helpful if you could elaborate on the overall variable costs.

Yes. We don't have specific numbers, but you can see how they break down in terms of our impairments within the occupancy and equipment lines. In the long term, there was a benefit in the third quarter that then reversed in the fourth quarter. So, while the numbers aren't large, the difference between the two quarters caused the increase.

Okay. I heard you reiterate the 8.5% to 9% CET1 target over time, and I wanted to get your thoughts on the regional banks just below your size. It seems that they are all building capital close to 10%. I'm curious if there's pressure from rating agencies or regulators, or if it's just a conservative approach given where we are in the cycle. What are your thoughts on companies of your size maintaining a 9% target, especially when larger banks are operating at higher levels? It's interesting to see that banks around $200 billion in assets are also building closer to 10%.

I can share my thoughts on this. The guidelines for banks regarding the stress capital buffer are typically consistent across the board. It's important to consider how the stress tests are designed and the comparison of relative capital levels to those stress levels, rather than just looking at absolute figures. That's my perspective.

Okay. But I guess the point is like you feel comfortable with whatever kind of behind-the-scene stuff that's going on with the rating agencies, regulators, the 9% and maybe drifting down a little bit over time, but at 9% you feel hopeful with in the current environment?

Yes.

Yes.

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

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

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 synonymous later 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 clear signs of a lot more potential for rate cuts?

Yes, it's interesting to me, Vivek, since you're focused on fixed income. A lot of banks are engaging in forward starting swaps to avoid negative carry while hoping that by the time they mature, they will see a rate cut. So, everything is based on the forward curve in these trades, which doesn't make sense to me. It's like choosing to invest based on the current yield curve. That's my strategy for downside protection. We can sell options to give up some upside and buy downside protection. As it stands, we're not significantly asset sensitive, and it doesn't seem like the right time to be long, especially if you believe that rates in the coming decade will differ from those between 2012 and 2020. So that's our position.

Thanks, everybody.

Thank you.