PNC Financial Services Group Inc (PNC) — Q3 2024 Transcript

Well, good morning. Welcome to today's conference call for The PNC Financial Services Group. I am Bryan Gill, the Director of Investor Relations for PNC, and participating on this call are PNC's Chairman 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. These are all available on our corporate website pnc.com under Investor Relations. These statements speak only as of October 15, 2024, and PNC undertakes no obligation to update them. Now I'd like to turn the call over to Bill.

Thank you, Bryan, and good morning, everyone. As you've seen, we had a very good third quarter. We executed well and saw strong momentum across our franchise. We generated $1.5 billion in net income, worth $3.49 diluted earnings per share. Rob will take you through the details shortly, but I wanted to highlight a few points. First, we generated positive operating leverage for the third consecutive quarter. Our strong performance has positioned us to deliver positive operating leverage for the full year of 2024. Inside of the third quarter performance, net interest income grew 3% as we continue our growth trajectory towards expected record net interest income in 2025. Our fee income grew 10% with a very strong quarter in capital markets, and we remain disciplined on the expense front. Second, we continue to see strong growth and activity across our franchise. CNIB continues to have great momentum as new loan production and commitments increased this quarter. While overall loan utilization has remained soft, the recent Fed actions to lower interest rates and the expectation of further cuts are likely to spur greater demand as we move ahead. Importantly, we are well positioned to serve our customers when loan growth returns. Within retail, we continue to invest heavily in our branch network to build density in our most attractive growth markets, and we are seeing success. We continue to grow customer households and checking accounts, with the highest customer growth being realized in the Southwest markets. AMG is accelerating growth in high-opportunity markets and benefiting from favorable equity markets. Third, our overall credit quality remains relatively stable, reflecting our thoughtful approach to managing risk, customer selection, and long-term relationship development. While we expect additional charge-offs in the CRE office segment, we're adequately reserved. Lastly, we continued to strengthen our capital levels during the quarter, and with the ongoing improvement in accumulated other comprehensive income, our tangible book value per share increased 9%. In summary, we delivered strong results in the quarter, and we remain well positioned to continue our momentum. In fact, we're in the middle of our strategic planning process, and I can't recall a time when our organic growth opportunities have ever been more attractive. Now before I turn it over to Rob for more detail on the financial results and outlook, I'd like to say thank you to our employees for everything that they do for our customers and our company. And with that, I'll turn it over to Rob to take you through the quarter.

Thanks, Bill, and good morning, everyone. Our balance sheet is on slide four and is presented on an average linked quarter basis. Loans of $320 billion were stable. Investment securities increased slightly by $1 billion or 1%. Our cash balances at the Federal Reserve were $45 billion, an increase of $4 billion or 10%. Deposit balances grew $5 billion or 1% and averaged $422 billion. Borrowed funds decreased $1 billion or 2%, primarily due to the maturity of FHLB advances, partially offset by parent company debt issuances. At quarter end, accumulated other comprehensive income was negative $5.1 billion, an improvement of $2.4 billion or 32% compared with June 30. Our tangible book value increased to approximately $97 per common share, which was a 9% increase linked quarter and a 24% increase compared to the same period a year ago. We remain well-capitalized and our estimated CET1 ratio increased to 10.3% as of September 30. Regarding the Basel III endgame, while certain aspects of the proposed rules are likely to change, we estimate our revised standardized ratio, which includes accumulated other comprehensive income, to be 9.2% at quarter end. We continue to be well positioned with capital flexibility, and we returned roughly $800 million of capital to shareholders during the quarter through common dividends and share repurchases. Slide five shows our loans in more detail. Average loan balances of $320 billion were flat compared to the second quarter, as well as the same period a year ago. The yield on total loans increased 8 basis points to 6.13% in the third quarter. Commercial loans were stable at $219 billion linked quarter, as utilization rates remained low and well below the historical average of roughly 55%. We continue to have confidence that commercial loan demand will return in the coming quarters as our loan commitments continue to increase and we expect business investment to return to historical levels. Consumer loans averaged $101 billion and were stable with the second quarter as growth in auto loans was mostly offset by a decline in residential real estate balances. Slide six details our investment security and swap portfolios. Average investment securities of $142 billion increased $1 billion or 1%. The securities portfolio yield increased 24 basis points to 3.08%, driven by higher rates on new purchases and the full quarter impact of the securities repositioning. As of September 30, our securities portfolio duration was approximately 3.3 years. Our active received fixed rate swaps pointed to the commercial loan book totaled $33 billion on September 30, and the weighted average rate increased 58 basis points to 3.08%. Our forward starting swaps were $15 billion with a weighted average received rate of 4.26%. Importantly, with our forward starting swaps, we've locked in the replacement yield on the majority of our 2025 swap maturities at levels higher than existing swaps and current market rates. Turning to slide seven, we expect considerable runoff of lower yielding securities and swaps, which will allow us to continue to reinvest into higher yielding assets over the next couple of years. Accumulated other comprehensive income improved by approximately $2.4 billion or 32% to negative $5.1 billion on September 30 compared to negative $7.4 billion on June 30. The linked quarter improvement in accumulated other comprehensive income was primarily due to lower rates, which benefited our swap and available-for-sale portfolio valuations. Going forward, accumulated other comprehensive income related to these securities and swaps, as well as our held-to-maturity portfolio will accrete back as they mature and prepay, resulting in further growth to tangible book value. Slide eight covers our deposit balances in more detail. Average deposits increased $5 billion or 1%, reflecting an increase in interest-bearing commercial balances, as well as higher time deposits. Regarding non-interest-bearing deposits, they were stable at $96 billion and remained at 23% of total average deposits. Our rate paid on interest-bearing deposits increased 11 basis points during the third quarter to 2.72%, reflecting growth in commercial interest-bearing deposits. We believe our total rate paid on deposits has reached its peak level, and with the 50 basis point cut in September, we've begun to reduce deposit pricing. Looking forward, we expect the Federal Reserve to cut the benchmark rate by 25 basis points at both the November and December meetings, which will accelerate deposit repricing, particularly within our high-beta commercial interest-bearing deposits. Turning to slide nine, we highlight our income statement trends. Third quarter net income was $1.5 billion or $3.49 per share. Comparing the third quarter to the second quarter, total revenue of $5.4 billion increased $21 million. Net interest income grew by $108 million or 3%, and our net interest margin was 2.64%, an increase of 4 basis points. Fee income increased $176 million, or 10%. Other non-interest income was $69 million and included negative $128 million of visa-related activity. Non-interest expense of $3.3 billion decreased $30 million, or 1%. As a result, PPNR grew 2% linked quarter, and we generated positive operating leverage for the third consecutive quarter. Provision was $243 million reflecting portfolio activity, and our effective tax rate was 19.2%. Turning to slide 10, we highlight our revenue trends. Third quarter revenue increased $21 million, driven by higher fee and net interest income, partially offset by lower other non-interest income. Other non-interest income included negative $128 million of visa-related activity. Net interest income of $3.4 billion increased by $108 million or 3%, driven by higher yields on interest-earning assets. Fee income was $2 billion and increased $176 million or 10% linked quarter. Looking at the detail, asset management and brokerage income grew $19 million or 5%, reflecting favorable equity and fixed income market performance. Capital markets and advisory fees increased approximately $100 million or 36%, driven by higher M&A advisory activity, as well as broad growth across most categories. Card and cash management decreased $8 million or 1%, as higher treasury management revenue was more than offset by credit card origination incentives. Lending and deposit revenue grew $16 million or 5%, due to increased customer activity. Mortgage revenue was up $50 million linked quarter, driven by a $59 million increase in the valuation of net mortgage servicing rights. Other non-interest income of $69 million included visa derivatives fair value adjustments of negative $128 million, primarily related to Visa's September announcement of a $1.5 billion litigation escrow funding. Notably, we continue to see strong momentum across our lines of business and throughout our markets. Year-to-date, non-interest income of $6 billion grew approximately $400 million or 7% compared to the same period last year. Turning to slide 11, our non-interest expense of $3.3 billion declined $30 million or 1%. Excluding the second quarter $120 million contribution expense to the PNC Foundation, non-interest expense increased $90 million or 3% linked quarter. Personnel expense increased $87 million or 5%, reflecting higher incentive compensation related to increased business activity. Importantly, all other categories declined or remained stable. Year-to-date, non-interest expense has increased by $80 million or 1%, excluding the $130 million FDIC special assessment and the $120 million foundation contribution expense in 2024. Non-interest expense is down 2% compared to the same period a year ago. We remain diligent in our continuous improvement efforts. We increased our CIP goal last quarter from $425 million to $450 million and we're on track to achieve that goal in 2024. As you know, this program funds a significant portion of our ongoing business and technology investments. Our credit metrics are presented on slide 12. Non-performing loans increased $75 million or 3% linked quarter, primarily driven by an increase in CRE office loans. Total delinquencies of $1.3 billion were stable with June 30. Net loan charge-offs were $286 million; the $24 million linked quarter increase was driven primarily by lower commercial recoveries. Our annualized net charge-offs to average loans ratio was 36 basis points. Our allowance for credit loss totalled $5.3 billion or 1.7% of total loans on September 30, stable with June 30. Slide 13 provides more detail on our CRE office credit metrics. We continue to see stress in the office portfolio given the challenges inherent in this book and the lack of demand for office properties. CRE office criticized loans were essentially stable linked quarter, but non-performing loans increased due to the migration of criticized loans to non-performing status. Net loan charge-offs within the CRE office portfolio were down slightly. However, going forward, we expect additional charge-offs on this book, the size of which will vary quarter-to-quarter given the nature of the loans. As of September 30, our reserves on the overall office portfolio were 11.3%, and inside of that 16% on the multi-tenant portfolio, both up slightly from the prior quarter. The modest increase in reserves reflects the continued valuation adjustments across the portfolio and specific reserves for certain credits. Furthermore, CRE office balances declined 4% or approximately $270 million, linked quarter as we continue to manage our exposure down. Accordingly, we believe we are adequately reserved. In summary, PNC reported a solid third quarter. Regarding our view of the overall economy, we are expecting continued economic growth in the fourth quarter, resulting in real GDP growth of approximately 2% in 2024 and unemployment to remain slightly above 4% through year-end. We expect the Fed to cut rates two additional times in 2024, with a 25 basis point decrease in November and another in December. Looking at the fourth quarter of 2024, compared to the third quarter of 2024, we expect average loans to be stable, net interest income to be up approximately 1%, fee income to be down 5% to 7% due to the elevated third quarter capital markets and MSR levels. Other non-interest income to be in the range of $150 million and $200 million, excluding visa activity. Taking the component pieces of revenue together, we expect total revenue to be stable. We expect total non-interest expense to be up 2% to 3%. And we expect fourth quarter net charge-offs to be approximately $300 million. Importantly, considering our year-to-date results and fourth quarter expectations, we're on track to generate full-year positive operating leverage. And with that, Bill and I are ready to take your questions.

Hi. Good morning.

Good morning.

Rob, can you elaborate on your comments regarding the swap? I noticed that the received fixed rate on your assets and active swaps increased significantly from last quarter, suggesting that what's rolling off is below one. It rose from 250 to 308, so can you confirm that? Also, I recall you mentioned in your remarks about replacing the expiring 2025 swaps with a higher fixed rate. Could you clarify that as well?

Sure. Good morning, Erika. So, yes, you're right. And again, all of this in terms of your question points to what is occurring, which is that our repricing of our fixed rate assets, including our securities, loans and swaps, is occurring at higher rates. So that's all of what we've been talking about for a while. It's true in terms of the swaps; new swaps are at a higher rate than the old swaps. And then as you recall back in the spring, we did execute some forward swaps that locked in rates for maturing assets in ‘25 that contribute to our statement, which we might as well confirm upfront, our net interest income being a record level in 2025, we're sticking to it.

Got it. Okay. Regarding the second part of my question about the strategic side, Bill, it's been quite some time since the market has experienced a neutral rate that isn't zero. Everyone has discussed deposit betas, but as we consider the natural deposit cost for PNC, how should we approach the spread? If we assume a settling point around 2.75% to 3% for Fed funds, what would be the spread relative to your funding costs? Additionally, a quick follow-up to Rob: concerning the liability side of the balance sheet, what contributed to the strength in deposits? Was this primarily from corporate accounts, and are these balances expected to be permanent, or are some corporate funds just temporarily parked due to market uncertainties?

I can't give a specific answer to where we might end up if rates, you know, Fed rates kind of hold it pre-end change, which I expect they will. Practically you can do most of that yourself, right? So the zero-cost deposits are obviously worth a lot more. If there's any steepness to the curve, we get that benefit with our fixed rate assets. So maybe inside of your question is all else equal if we end up in an environment where front rates are three and change and back rates are somewhat higher than that, that's a really attractive environment for banks, ourselves included.

Yes, and then the second part of that, Erika, was the outperformance that our deposit balances came on the commercial interest-bearing side. As commercial clients continue to build cash on their balance sheet, our expectation is that'll hold for the most part through the end of the year.

Got it. Thank you.

Good morning.

Good morning, John.

Good morning, John.

On the loan side, still balances are clearly still pressured and you flagged line utilization down a bps to 50.7 and below your historical? Can you maybe talk about the demand, the underlying demand trends that you are seeing? And what do you think is going to be the biggest catalyst to get borrowers off the sidelines in borrowing? Is it continued rate cuts, confidence in that front? Is it the election? If you could just maybe give us some thoughts there? And what do you think a growth rate is reasonable as you enter 2025? Thanks.

Hey, John, it's Rob. So, yes, you know, all year we've yet to deliver the loan growth that we thought was coming at some future point and for all the obvious reasons that you've seen utilization is low. And there is a bit of a pause feeling obviously with the election coming up and the rate environment. What we point to in terms of the constructive front is we do continue to add customers, we do continue to add loan commitments quarter-over-quarter. So our commercial clients are putting those lines in place with the anticipation of borrowing. So that's a constructive sign. And then you've seen the low inventory levels, the low CapEx to sales levels. So it does feel as though we're at the point of the cycle to where, you know, loan growth is not too far off.

Okay, got it, thanks Rob for that. And then separately, capital markets clearly has been a point of strength. Can you maybe just provide us a little bit of color on the pipeline there? And do you expect a pullback in the fourth quarter off these high levels? And just how should we figure out that? Thanks.

Yes, yes, we do. I'll expand that a little bit in terms of our fee guidance for the fourth quarter. So we're pointing it down 5% to 7% and all of that decline is being driven by the elevated MSR levels and the elevated capital markets levels that we achieve in the third quarter. So for the fourth quarter, you know, the MSRs is pretty straightforward. We don't expect to have those levels in the fourth quarter. And then on the capital market side, the short answer is we probably pulled a little bit of the fourth quarter activity into the third quarter. A lot of that is in our Harris Williams M&A advisory businesses that had a really strong third quarter, as well as some of the other broader capital markets stories. So it's a little bit lumpy. The pipelines, though, are strong. The momentum is strong. Capital markets year-over-year is up north of 23%. The back half of ‘24, including our capital markets guidance for the fourth quarter, is up 20% over the first half. So the momentum's there. It's just not necessarily going to fall linearly quarter-to-quarter.

Got it. All right. Thanks, Rob.

Sure.

Good morning, everyone. Thanks for taking the question. I guess I wanted to follow up just a little bit on sort of the lending and deposit discussion. I guess first, just kind of qualitatively, do you have a sense for what a lending recovery might look like when it does come back? And I guess the context in that is I recall a time when bank loans used to grow at some multiple of GDP, but it's been quite a while since we've seen that. So maybe just some top-level thoughts there? And then on the other side of the balance sheet, just maybe your sense for how deposit costs behave if lending does come back better? You all, and I think a lot of the industry, are great from a liquidity perspective, so curious how much competition factors into your thinking as well?

You know, we can come up with 10 different theories on why loan growth hasn't been there and why it might come back, but all of them are me making up theories. It's been below trend on utilization. There's a bunch of uncertainty, not the least of which is the election and rates and all the other things that may impact it. But it's, you know, it's one of the reasons why we said, look, we'll produce growth for our shareholders without having to rely on some made-up story as to why there might be loan growth. If there is, it's terrific, and at some point it'll come back, but I've given up trying to forecast it personally. On the funding side, we are very liquid, so we have an opportunity, should it arise. We have a lot of capital and cash and that would be a great thing for us.

35 spot 45 average, so a lot.

Yes, so I don't know that it's going to affect our funding costs whatsoever.

Perfect, okay good. All right, thank you very much.

Good morning. Any updated thoughts on where you think your net interest margin normalizes? I think at one point a couple months ago you said it could approach 3%. I think it was by the end of next year. But updated thoughts on that given the forward curve and your outlook for the mix of the balance sheet? Thanks.

Yes, hey, Matt, it's Rob. I do recall you asking the question before, and the answer is going to be the same, which is, you know, our net interest margin is increasing. We don't manage the net interest margin as an outcome. We've operated close to 3%. My expectation is that we'll approach those levels. I don't remember saying by the end of ‘25, but maybe that's something that you added then, but we're on our way up, and 3% is reasonable through time.

Okay, and actually maybe it was by the end of ‘26 I had my no time to read. And then just separately, you've always been very strong in commercial lending and some of the few businesses that come from that. The consumer side has always been a little bit less of a focus, but I think you've been leaning in from areas like credit card around the edges and just any update thoughts in terms of what could be growth drivers as we think about consumer lending, consumer fees, the next couple of years? Thanks.

Yes, we have historically not invested enough in this area, and we have not reached our full potential with our existing clients.

On consumer.

On consumer, yes. And that's our opportunity set. I don't know that we need to be heroic and go beyond that, but we ought to have the same penetration rate that our peers do with respect to our consumer lending. And there's fairly material upsides if we can pull that off and we're investing to be able to do so.

And we've introduced a new credit card and have plans to continue to do that along those lines.

Okay. When do you think you'll start seeing some of those efforts kick in? I mean, we are seeing pretty good credit card volume growth in the industry and at most peers, and obviously there's a little bit of a lag, but what do you think some of those efforts will be a little bit more evident?

I don't know that I have a timeline on it. I would tell you that we're investing in people. We're investing in our credit management capabilities and our marketing and our product delivery, you know, all of the above that will, you know, hopefully through time allow us to get the penetration we should have. I don't know what the timeline is on that, but I know it's a journey and I know we need to start it.

And we're at the beginning now.

Thank you.

Thanks. Good morning, Bill and Rob. Following up on your loan growth commentary, you've had a lot of success over the years in taking share within C&I. If we do get a reacceleration in loan growth over, say, the next year or so. How does that influence your ability to continue to take share and perhaps outpace industry growth, recognizing your competitors are obviously not willingly ceding share?

Well, I think that will show up. We are growing DHE and winning new clients at a record pace, I think. So you know, when utilization comes back, we ought to, as we have in the past, my best guess is we would outperform.

Yes. Well, DHE is our loan commitment. They're unfunded at the moment, but they've been put in place. And I think the most of the momentum that we see is in our Southwest markets, where we are achieving record levels and would expect to be above average if it all plays out as we expect.

Thanks. That's helpful. And then separately on non-interest-bearing deposits, you expect rates on your interest-bearing deposits to decline starting next quarter. But how long before you'd expect to see the effect of lower rates relating to compensating balances?

Yes, I don't know. That's a tough one to answer. I mean, what we're encouraged about is that we've clearly stabilized now for a couple of quarters at the levels that we are following several quarters of pretty substantial decline. So we've stabilized. There's a lot of theories in terms of what sort of the magic short-term rate is that kicks that up. But no one has a definitive answer.

Right, but is the credit that you give customers on compensating balances a sort of lever that you'd expect to use or be willing to use as you look to grow non-interest bearing deposits? Just trying to think through whether that's a potential something that could spur growth?

You should assume that crediting rate is below market versus open deposit rate. And so it's not going to have a moving beta for some period of time relative to rates coming down.

It's relatively constant, and we're fine with that.

Okay, great. And If I could squeeze in one last one, if the net interest income trajectory that you laid out for 2025 plays out as anticipated. Is there any reason why, you know, the positive operating leverage commentary that you laid out is very helpful, but any reason why the efficiency ratio wouldn't get down into sort of that high-50% range? It seems like the math would suggest that, that could get there, but we would appreciate your thoughts?

We'll have to see, Bill. We're in the process of doing our budgeting for next year right now, so we'll have more for you on that in our January call.

Thanks for taking my questions.

Hi. I think, Bill, your prior comment that you expect record net interest income in 2025, do you feel more, less, or just as confident as before? And what sort of loan growth do you kind of assume for next year?

We wouldn't have said it if we didn't feel confident to begin with, so I don't know levels of confidence, but we feel pretty good about that.

That's confident. That's for sure.

And we don't have any loan growth in there whatsoever to get to that number.

So no loan growth for next year?

We have something, but it's...

Well, we will have something, but the record net interest income level is not reliant on it.

Okay. And then back, I know, I think last quarter you used the word befuddled as to why loan growth wasn't coming back. I guess number one could be the election, number two could be private credit, number three could be disintermediation of capital markets, number four, companies could just be managed differently today or number five, you could have a weaker economy or it could be all of the above. Just give us your best stab at why loan growth remains just so weak in an economy that's still growing?

I think all of your reasons other than three and four. I don't think private is causing the utilization rate on middle market companies to remain low, for the businesses we play in. And I'm not sure, I mean at the margin, public markets being wide open has caused some of our larger clients to pay down outstanding balances and hit the capital market. So that's probably true at the margin. But this basic notion of people just aren't using working capital the way they used to. And maybe that's the way they run the company post-COVID. Maybe that's the uncertainty. It's going to play out over time. And we can all guess about it. I just don't know the answer, so I'm still befuddled.

Okay, and then lastly, your reserves on office CRE were taken even higher, especially multi-tenant. Last quarter, you said the industry is in the first inning. I think a lot of people disagree with that. I'm not saying, yes, I'm not sure. We're two years into this at least, and it's still a big question mark, I think, in a lot of people's minds. So when you said the industry's in the first inning and clearly your reserves are higher than others. Why do you say it's only the first inning? What's your reasoning?

I think we're just now starting to clear buildings in sales, right? We've had some extensions, we've had maturities hitting, we have a whole slew of term loans in the CMBS market and with small banks that will be out there three, four, five years. I just think this plays out over a long period of time. Office vacancies, pick your market, are quite high. And we're just now realizing the market-to-market value of that as we resolve properties. That's why we're reserved where we are and that's why I'm not worried about it per se from PNC standpoint, but no, this is going to be noisy for a while.

I might refine that a little...

Go ahead.

Early innings. Early innings, yes.

But we're not, I mean, importantly, we're not in early innings with respect to how we're reserved. Yes. I mean, you know, you can love or hate, but you know, to the best of our ability, we've taken all that up front.

And then sneaking one more last one. As far as acquisitions, I know you'd like to buy them on the cheap. I mean, National City, you know, you go down the list. It's getting tougher for you to buy things on the cheap. Maybe if a bank does have an office or CRE problem that you swoop in there, but am I right in thinking it's a lot less likely you do an acquisition now that some of these stocks have come back or what you're thinking?

Yes, you're right. We don't see value in an acquisition at the moment.

Okay. Thank you.

Okay, well thank you all for participating on the call this quarter and feel free to reach out to the IR team if you have any follow-up questions.

Thanks a lot, everybody.

Thank you.