The PNC Financial Services Group Q1 2023 Earnings Call Transcript

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April 14, 2023

There are 13 speakers on the call.

Operator

Morning and welcome to today's conference call for the P&C Financial Services Group. Participating on this call are P&C's Chairman, President and CEO, Bill Demchak and Rob Reilly, Executive Vice President and CFO. Today's presentation contains forward looking information. Cautionary statements about this information as well as reconciliations of non GAAP measures are included in today's earnings release materials as well as our SEC filings and other investor materials. These are all available on our corporate website, pnc.com under Investor Relations.

Operator

These statements speak only as of April 14, 2023, and P&C undertakes no obligation to update them. Now, I'd like to turn the call over

Speaker 1

to Bill. Thank you, Brian, and good morning, everybody. As you can see on the slide, our quarterly results were And we reported $1,700,000,000 in net income or $3.98 per share. Inside of this, we grew deposits and loans, increased Our capital and liquidity positions generated positive operating leverage and maintained strong credit quality. Now for the past month, we've Seeing market volatility across the broader industry.

Speaker 1

And while we take this situation seriously and are closely monitoring the environment, it's important to note that these events have taken place within a few banks with very unique business models. Inside of our company, we really haven't seen any meaningful impacts from the events of the past month. Our balance sheet remains strong and stable, and we're operating the company in the same way we were at the beginning of March. Ultimately, over time, we expect the dynamics playing out in the banking system today to contribute to changes in the competitive landscape. And while it's still early innings, we believe that PNC will be a beneficiary from this process.

Speaker 1

That said, in the near term, we're not immune to competitive environment and the deposit dynamics that will ultimately impact our NII in the near term, and Rob is going to cover that in more detail in a second. We remain focused on growing relationships across our lines of business and we continue to execute on key priorities including the expansion in the BBVA legacy markets. Rob will provide more details on our financial performance in a moment. However, for this particular call, he'll review our Q1 earnings in a slightly condensed manner to allow time to also cover key balance sheet focus points that have been top of mind for our investors in the last couple of weeks. And of course, following that, we'll be able to discuss your specific questions in the Q and A segment.

Speaker 1

Finally, I'd like to thank our 61,000 employees for helping deliver a Strong quarter and everything they do to support our customers. Now with that, I'll turn it over to Rob.

Speaker 2

Thanks, Bill, and good morning, everyone. Our balance sheet is on Slide 4 and is presented on an average basis. Loans for the Q1 were $326,000,000,000 an increase of $3,600,000,000 or 1% linked quarter. Investment securities were relatively stable at 143,000,000,000 Cash balances at the Federal Reserve averaged $34,000,000,000 and increased $4,000,000,000 during the quarter. Deposits of $436,000,000,000 grew on both a spot and average basis linked quarter.

Speaker 2

Average borrowed funds increased $4,000,000,000 which reflected Q4 2022 activity as well as senior note issuances in January of this year. At quarter end, our tangible book value was $76.90 per common share, an increase of 7% linked quarter. And we remain well capitalized with an estimated CET1 ratio of 9.2% as of March 31, 2023. During the quarter, we returned $1,000,000,000 of capital to shareholders, which included $600,000,000 of common dividends and approximately $370,000,000 of share repurchases or 2,400,000 shares. Due to market conditions and increased economic uncertainty, We expect to reduce our share repurchase activity in the Q2.

Speaker 2

And of course, we'll continue to monitor this and may adjust share repurchase activity as appropriate. Slide 5 shows our loans and deposits in more detail. During the Q1, loan balances averaged $326,000,000,000 an increase of $4,000,000,000 or 1%, largely reflecting the full quarter impact of growth in the Q4 of 2022. Deposits averaged $436,000,000,000 in the Q1, increasing $1,300,000,000 We continue to see a mix shift from non interest bearing to interest bearing, and I will cover that in more detail in a few minutes. Our rate paid on interest bearing deposits increased to 1.66% during the Q1 from 1.07% in the Q4 of 2022.

Speaker 2

And as of March 31, our cumulative deposit beta was 35%. Turning to the income statement on Slide 6. As you can see, Q1 2023 reported net income was $1,700,000,000 were $3.98 per share. Total revenues of $5,600,000,000 decreased $160,000,000 compared to the Q4 of 2022. Net interest income decreased $99,000,000 or 3%, primarily driven by 2 fewer days in the quarter and higher funding costs, partially offset by higher yields on interest earning assets.

Speaker 2

Our net interest margin of 2.84% declined 8 basis points, reflecting the increased funding costs I just mentioned. Non interest income also declined 3% or $61,000,000 as growth in asset management and brokerage was more than offset by a general slowdown in capital markets activity as well as seasonally lower consumer transaction volumes. 1st quarter expenses declined $153,000,000 or 4% linked quarter, even after accounting for the increase to the FDIC's and we will now take a look at the balance sheet, which equated to $25,000,000 Provision was $235,000,000 in the first quarter and included the impact of updated economic assumptions as well as changes in portfolio composition and quality. And our effective tax rate was 17.2%. Turning to Slide 7, we highlight our revenue and expense trends.

Speaker 2

As a result of our diversified revenue streams and expense management efforts, we generated positive operating leverage of 2% linked quarter and 15% compared to the same period a year ago. And as we previously stated, we have a goal to reduce costs by $400,000,000 in 2023 through our continuous improvement program and we're confident we will achieve our full year target. And as you know, this program funds a significant portion of our ongoing business and Technology Investments. Our credit metrics are presented on Slide 8. Non performing loans remain stable at $2,000,000,000 and continue to represent less than 1% of total loans.

Speaker 2

Total delinquencies of $1,300,000,000 declined $164,000,000 were 11% linked quarter. Notably, the delinquency rate of 41 basis points is our lowest level in over a decade. Net charge offs were $195,000,000 a decrease of $29,000,000 linked quarter. Our annualized net charge offs to average loans ratio was 24 basis points in the Q1. And our allowance for credit losses totaled $5,400,000,000 or 1.7% of total loans on March 31, essentially stable with year end 2022.

Speaker 2

Before I provide an update on our forward guidance, as Bill mentioned, we want to take a deeper dive into some of the key balance sheet items that are top of mind in the current environment related to deposits, securities and swaps, capital and liquidity and the impact of potential regulatory changes and finally, office exposure within our commercial real estate portfolio. In our view, we believe we are well positioned across all these key areas of focus. Turning to Slide 10. Our $437,000,000,000 deposit base is broken down between consumer and commercial categories to give you a view of the composition and granularity of the portfolio.

Speaker 3

At the

Speaker 2

end of the Q1, our deposits were 53% consumer and 47% commercial. Inside of our $230,000,000,000 of consumer deposits, approximately 90% are FDIC insured. The portfolio is very granular with an average account balance of Approximately $11,500 across nearly 20,000,000 accounts throughout our coast to coast franchise. Our $207,000,000,000 of commercial deposits are 20% insured, but importantly approximately 95 And of the total balances are held in operating and relationship accounts. These include deposits held as compensating balances to pay for treasury management fees, escrow deposits at Midland Loan Services and broader relationship accounts, all of which tend to provide more stability than deposit only accounts.

Speaker 2

Importantly, we have approximately 1,400,000 commercial deposit accounts, representing a diverse set of industries and geographies. Turning to Slide 11, we highlight our mix of non interest bearing and interest bearing deposits. Our consumer deposits non interest bearing mix has been stable, remaining at 10% compared to the same period a year ago. The commercial side is where we expected to see a continued shift from non interest bearing into interest bearing deposits as rates have risen and that has played out, albeit at a somewhat faster pace than we had expected. The commercial non interest bearing portion of total deposits which was 45% as of March 31, down from 58% a year ago.

Speaker 2

Importantly, commercial non interest bearing deposits include compensating balances and mid loan escrow deposits I mentioned previously, which provide support to this mix through time. On a consolidated basis, our level of non interest bearing deposits was 27% at the end of the Q1 of 2023, down from 33% a year ago. P and C has historically operated with a higher percentage of non interest bearing deposits relative to the banking industry, due in part to strength of our treasury management business and granular deposit base. As a result, we expect our non interest bearing portion of deposits to continue to Industry averages and approach the mid-twenty percent range by year end 2023. In addition to our mix shift, we have seen a faster increase in our deposit costs this year as the Federal Reserve has continued to raise short term interest rates.

Speaker 2

Slide 12 shows our recent trends and our current expectations for deposit betas through the end of 2023. The increase in our current deposit beta expectations are largely driven by recent events that have increased the intensity and focus on rates paid and ultimately has added incremental pricing pressure sooner than we previously expected. We expect the Federal Reserve to raise the benchmark rate by 25 basis points in May. This coupled with heightened competition for deposits has accelerated our expectations for the level and pace of beta increase. And we now expect to reach a terminal beta of 42% by year end.

Speaker 2

Slide 13 details our investment Our securities balance averaged $143,000,000,000 in the Q1 and were relatively stable linked quarter. The yield on our securities portfolio increased 13 basis points to 2.49% as we continue to replace runoff at higher reinvestment rates. Yields on new purchases during the quarter exceeded 4.75%. Our portfolio is high quality and positioned with a short duration of 4.3 years, meaningfully shorter than many of our peers. Approximately 2 thirds of our securities are recorded as held to maturity and 1 third is available for sale.

Speaker 2

Average security balances represent approximately 28% of interest earning assets. Our received fixed swaps pointed to the commercial loan book remain largely stable at $42,000,000,000 notional value and 2.25 year duration.

Speaker 4

At the

Speaker 2

end of the Q1, our accumulated other comprehensive loss improved by 1 point to $9,100,000,000 driven by the impact of lower interest rates during the quarter and normal accretion as the securities and swaps pulled apart. Slide 14 highlights the pace of expected security and swap maturities as well as the related AOCI runoff. By the end of 2024, we expect about 26% of our securities and swaps to roll off. This will drive increases in our securities and commercial loan yields as well as meaningful tangible book value improvement as we expect approximately 40% AOCI accretion by the end of the year 2024. Slide 15 highlights our strong liquidity position.

Speaker 2

Our strong liquidity coverage ratios continue to improve in the Q1 and exceeded regulatory requirements throughout the quarter. Our cash balances at the Federal Reserve totaled $34,000,000,000 and we maintained substantial unused borrowing capacity and flexibility through other funding sources. PNC has a robust liquidity management process, which includes a required statutory daily liquidity coverage ratio assessment as well as a monthly net stable funding ratio calculation. In addition, we perform monthly internal liquidity stress testing that covers a range of time horizons, as well as systemic and idiosyncratic stress scenarios. Our mix of borrowed funds to total liabilities has historically averaged approximately 17% and reached an unprecedented low level of 6% in 2021.

Speaker 2

On March 31, our mix was 12% and we expect to move closer to the historical average over time. In light of the current environment, we anticipate that we will be subject to a total loss absorbing capacity requirement in some form and at some point with a reasonable phase in period. Importantly, as our borrowed funds continue to return to a more normalized level, we would expect to be compliant through our current issuance plans under existing TLAC requirements. Slide 16 shows our solid capital position with an estimated CET1 ratio of 9.2% atquarterend. As a Category 3 institution, we don't include AOCI in our CET1 ratio, but understand why there is focused on this ratio with the inclusion of AOCI.

Speaker 2

As of March 31, 2023, our CET1 ratio, including AOCI, CI was estimated to be 7.5%, which remains above our 7.4% required level, taking into account our current stress capital buffer. However, we also believe it's important to take a look at the balance sheet positioning of a bank from a market value of equity perspective, similar to our understanding of Basel IRR BP Rules. Market value of equity doesn't truly get reflected on the balance sheet today due to generally accepted accounting principles, which results in a skewed approach of valuing certain items primarily on the asset side. While AOCI takes into account the current valuation of the securities and certain portions of our swap portfolios that does not account for the valuation of the deposit book, which can be a meaningful offset in a rising interest rate environment. In fact, looking at P&C's change in market value of equity over the past year, the increase in the market value of our deposits and the rapidly rising interest rate environment has significantly outpaced all unrealized losses on the asset side of the balance sheet, including securities and fixed rate loans.

Speaker 2

Total market value of equity increased substantially in the rising rate environment and further our duration of equity is now essentially 0 and well positioned in the current environment. Importantly, our models use conservative assumptions regarding estimates for betas, mix, balances and deposit lives. We also recognized early on that large inflows of deposits during the pandemic were driven by a combination of QE and fiscal stimulus, which were likely to be short lived. Recall, our Fed balances peaked in the Q1 of 2021 around $86,000,000,000 As a result, we modeled an economic value associated with those deposits at a fraction of the value of core deposits. Turning to Slide 17, I wanted to spend a few minutes talking about our commercial real estate portfolio.

Speaker 2

While credit quality is strong across the majority of our CRE book, office is the segment receiving a lot of attention in this environment due to the shift to remote work and higher interest rates. So we thought it would be worthwhile to highlight our exposure and our position with this portfolio. At the end of the Q1, we had $8,900,000,000 or 2.7% of our total loans in our office portfolio. Turning to Slide 18, You can see the composition of this portfolio, which is well diversified across geography, tenant type and property classification. Reserves against these loans, which we have built over several quarters, now total 7.1%, a level that we believe adequately covers expected losses.

Speaker 2

In regard to our underwriting approach, we adhere to conservative standards, focus on attractive markets and work with experienced well capitalized sponsors. The office portfolio was originated with an approximate loan to value of 55% to 60% and a significant majority of those properties are defined as Class A. We have a highly experienced team that is reviewing each asset in the portfolio to set appropriate action plans and test reserve adequacy. We don't solely rely on 3rd party appraisals, which will naturally be slow to adjust to the rapidly shifting market conditions. Rather, we are stress testing property performance to set realistic expectations.

Speaker 2

To appropriately sensitize our portfolio, we significantly discounted net operating income levels and property values across the entire office book. Additionally, tenant retention, build out costs and concession levels are all updated to accurately reflect market conditions. Credit quality in our office portfolio remains strong today with only 0.2% of loans delinquent, 3.5% non performing and a net charge off rate of 47 basis points over the last 12 months. Along those lines, we continue to see solid performance within the single tenant, medical and government loans, which represent 40% of our total office portfolio. These have occupancy levels above 90% and watchlist levels of 3% or less.

Speaker 2

Where we do see increasing stress and a rising level of criticized assets is in our multi tenant loans, which represents 58% of our office portfolio. Multi tenant loans are currently running in the mid-seventy percent occupancy range, Watchlist levels are greater than 30% and 60% of the portfolio is scheduled to mature by the end of 2024. In the near term, this is our primary concern area as it relates to expected losses and by extension comprises the largest portion of our office reserves. Multi tenant reserves on a standalone basis are 9.4%. Obviously, we'll continue to monitor and review our assumptions to ensure they reflect real time market conditions.

Speaker 2

For each of the key areas of focus I just discussed, we believe we are well positioned. And Slide 19 summarizes our balance sheet strength during this volatile time. Our deposits are up, our capital and liquidity positions are strong and our overall credit quality is solid. In summary, P&C reported a strong Q1 2023. In regard to our view of the overall economy, we are expecting a recession starting in the second half of twenty twenty three, resulting in a 1% decline in real GDP.

Speaker 2

Our rate path assumption includes a 25 basis point increase and the Fed funds rate in May. Following that, we expect the Fed to pause rate actions until early 2024 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 1% to 3%, which equates to average loan growth of 5% to 7%. Total revenue growth to be up 4% to 5%.

Speaker 2

Inside of that, our expectation is for net interest income to be up 6% to 8%. At this point, visibility remains challenging and our full year NII guidance assumes the continuation of the recent intensity on deposit pricing, which is being driven by recent events. We expect non interest income to be stable, expenses to be up 2% to 3% and we expect our effective tax rate to be approximately 18%. Based on this guidance, we expect we will generate positive operating leverage in 2023. Looking at the Q2 of 2023 compared to the Q1 of 2023, we expect average loans to be stable, Net interest income to be down 2% to 4% fee income to be stable to down 1% other non interest income to be between 200 and $250,000,000 excluding net securities and Visa activity.

Speaker 2

Taking all the component pieces, We expect total revenue to decline approximately 3%. We expect total non interest expense to be up 1% to 2%. And we expect 2nd quarter net charge offs to be between $200,000,000 $250,000,000 Further, given our strong credit metrics, Our credit quality is trending better than our expectations. And with that, Bill and I are ready to take your questions.

Speaker 5

Thank You will hear a through tone prompt of One moment please for the first question. Our first question comes from the line of Betsy Krasnik with Morgan Stanley. Please go ahead.

Speaker 6

Hi, good morning.

Speaker 2

Hey, good morning, Krasnik.

Speaker 6

First off, I just want to say your slide deck is phenomenal. I just you answered so many of the questions that I had coming into this. I felt like you were reading my mind ahead of this call.

Speaker 2

Good

Speaker 6

It was great. You guys did a great job. I have two questions. One is on the beta, the deposit beta. When you're talking about the 42%, obviously that is aligned with the outlook that you just expressed for interest rate movements.

Speaker 6

I guess I wanted to just understand how you're thinking about the flex between deposit beta and deposit growth Because part of me says, hey, I could have expected even more deposit growth than you gave me QQ. And is there a rate paid element to that, that maybe you're holding back on and that's why the deposits weren't maybe as high as what some Folks like me had hoped.

Speaker 1

We're sitting here puzzled. We grew deposits average in spot against the backdrop of absent the volatility in the market deposits still overall leaving System, particularly in the government money funds and then the shrinkage of the total on the back of QT. Our rate paid, if you look year on year, I think our total deposits are down 3% or something, which is Less than most anybody would compare it to and we have purposefully been protecting the franchise In the course of doing that, I recognize some other people don't do that and that's we'll see how that plays out through time. But I we kind of feel we outperformed on deposits, so I'm a little bit on a lesser question.

Speaker 6

Yes. No, I QQ definitely and I would expect after all of the banks finish reporting, we can have a better conversation on this. I was just wondering if You felt that if you had a slightly higher rate paid, would you have pulled in more? And I So the way you answer that question is you don't feel the need to. So that's great.

Speaker 6

And then just separately, As a fallout of what has happened with SYSB, Signature, etcetera, do you feel like there's any need at all to reassess The duration of the commercial operating account deposit liability life, is that something that Having seen what happened at SIB, you would want to take a closer look at? Or do you feel like it's just Such a different animal given what you outlined on Slide 10 with the granularity you've got? Thanks.

Speaker 1

Well, first of all, we look at that all the time. And as Rob put into his comments, a large portion of the deposit growth that we saw Through COVID, so stimulus and the growth in the Fed's balance sheet, we just assumed had a life of a day, a 0, Because we are in an abnormal period of time. The core operating deposits that we have, particularly as you go in the middle market Are basically the monies, the working capital monies that companies use to run their companies. We truncate and always have truncated the modeled lives of those deposits well below What the practical experience would show us, yes. So it's conservative.

Speaker 2

And deposits that are spread out over diverse industries and diverse geographies.

Speaker 1

And accounts you almost can't compare what happened at Silicon Valley and Signature to any other bank I've ever seen in terms of the concentration of The deposit accounts and the nature of the client. Just the nature of them. I mean, a lot of that money was capital raise money that was sitting there.

Speaker 6

Right. Okay, that's super. Thank you so much. Appreciate

Speaker 4

it.

Speaker 5

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

Speaker 7

Hi. I guess this question goes in the category of no good deed goes unpunished. Your operating leverage in the Q1 year over year was over 10%. You've guided for positive operating leverage this year of 1% to 3%. Your cycle to date beta, I estimate That's been below 40%.

Speaker 7

So all that looks really good. But on the other hand, you Did, I guess, lower your guidance for how much positive RockTenn leverage this year? You mentioned NII. You mentioned the intensity on deposit pricing.

Speaker 8

So just can you help

Speaker 7

talk about the trade offs of pursuing growth with more deposits versus maybe scaling back if that deposit pricing is really that much more intense or do you see that Not being so at some point.

Speaker 1

I think Mike, the part of the issue that we face here Is you have an interest rate forward curve that's suggesting cuts out there. So if you believe that betas would be less. We kind of think the Fed is going to hold through the year and cut next year. Personally, I think they might hold longer than that. So everybody's NII guide is going to be all over the place depending on what they actually think the Fed is doing as we go into this the back end of Sure.

Speaker 1

Separately, we have seen just this heightened awareness of interest rates And what you do with deposits on the back of the banks that failed. You've seen the growth in the government money funds on the back of the Fed's reverse repo facility, Which is a real thing. As long as they allow that to keep growing, they're at the market deposits, but they're basically Getting drained from the banking system and making liquidity more expensive. So that's We took all that into account and said, look, if rates are higher for longer, if the Fed keeps Draining deposits through its reverse repo facility. The smaller banks really need to pay up at super high rates to fund their balance

Speaker 2

Demchak. And I would just add, we've focus on our core franchise and our clients. So on the commercial side, it's really the effect of commercial clients choosing to switch to interest bearing from noninterest Bearing. Yes. And their relationship is fully intact.

Speaker 2

And then on the consumer side, as Bill just mentioned, the interest bearing deposits and the pressure around rates paid there.

Speaker 7

And the one other point you guys have made is that either NII will be better or you might have to You might get to release some of your credit reserves. Have you seen any improvement in that loan pricing commensurate with some of The standards in the capital markets, you're pricing for risk a lot more. In the lending markets, you have not been pricing for risk and you brought that up before. Are Seeing that at all or still not yet?

Speaker 1

Our new production is a little bit better than it was. But in fairness, At the moment, credit looks much better than we otherwise would have assumed. So it's a trade off. Now it's going to be interesting, Mike, because the marginal cost of funds For the U. S.

Speaker 1

Banking system has just gone up a lot as a result of this flurry. And so all else equal, you would expect credit Spreads to widen here simply because the cost of funds for all banks has gone up. Haven't seen that play out yet, but it continues to be at least my expectation

Speaker 7

All right. Thank you.

Speaker 5

Our next The question comes from the line of Gerard Cassidy with RBC. Please go ahead.

Speaker 8

Hi, guys. How are you?

Speaker 2

Hey, good morning, Gerard. Bill,

Speaker 8

Can you give us you guys pointed out about, Rob, the expectations on TLOC in your prepared remarks. But Can

Speaker 3

you guys

Speaker 8

give us some color on what changes may come as a result of the signature in Silicon Valley Bank failures, the regulators look like they're going to reassess the situation. We'll get to postmortem on May 1, of course. But what do you guys think may happen in terms of additional requirements for regional banks like yours? And I know TLAC you're already planning on that, but outside of TLAC?

Speaker 1

I don't know what it is they might do. There's a lot of talk around Should they eliminate the available for sale opt in or opt out for Yes, AOCI for banks our size. And they may well do that. Part of me though The reason we put economic value of equity in our presentation is as soon as you start isolating specific fixed rate assets And ignore others. So what do you do with fixed rate whole loan mortgages?

Speaker 1

What do you do with held them it's all the same stuff. It's an accounting Sure. And so I would hope that they would have a more holistic look as they do in Europe on measuring balance sheet risk To interest rates. I don't know where that's going to end up. And whatever it is they do is going to take a period of time.

Speaker 1

TLAC, I think is a certainty at this point. It's a function of how much it will be and whether it's varied as a function of size and complexity of bank. There's some tailoring,

Speaker 9

correct? Yes.

Speaker 10

No. And Bill and Rob

Speaker 11

go ahead, Rob. I was

Speaker 1

just going to

Speaker 2

go ahead. Those are the 2 prominent subjects, TLAC and AOCI inclusion.

Speaker 3

But by the way, the issue,

Speaker 1

it's just it's worth mentioning, Basic interest rate risk management and the test around liquidity that banks go through, I mean, we did this. We run this stuff every single day with all sorts of different scenarios and that the regulators require us to And we get measured on it. We do even more than enough on it. Yes. And like I don't even know who was looking at these other banks.

Speaker 1

It's So to come in and say we ought to do more, we're already doing it is I guess my point.

Speaker 8

Very clear. And I'm glad you guys put the whole balance sheet, the equity evaluation because that message has to get out and I'm glad you guys did that. So thank you. Moving on to commercial and industrial loans, you guys have seen really good growth over the past year. Can you give us a little more color Do you see a re intermediation coming into the banking system because the capital markets are still disrupted?

Speaker 8

Or is it just you guys have had the success with BBVA and that's working for you? Can you give us some color of that growth that you're seeing?

Speaker 1

A couple of comments. If you look back to our history when we enter new markets, this Just particularly true back to RBC and what we've seen with the BBA. We tend to grow loans at a pace in the new markets That would be above what you would expect at a long term trend. And then over time, we cross sell into those new relationships. So I almost think of it as It's kind of advertising dollars.

Speaker 1

She would otherwise participate in a deal on the hope that you're going to get TM revenue and other things. What we'll see going forward is the cross sell into the new relationships we've established. The ability to Continue to grow loans at that pace should we choose to is probably still there. Do you get paid for it today The way you did when rates were much lower is a tougher question. Now the whole Reintermediation in the banks from capital markets.

Speaker 1

I've heard some of that buzz. By the way, I've heard the buzz the other way. All else equal, I Expect the long term trend will be less in the banking system and more out of the banking system over a long, long Period of time, notwithstanding what happens in the near future.

Speaker 9

Got it.

Speaker 8

Very helpful. Thank you. And to reiterate what Betsy Great deck. Thank you very much.

Speaker 2

Thanks, Gerard.

Speaker 5

Next question from the line of John Kari with Evercore. Please go ahead.

Speaker 11

Good morning.

Speaker 2

Hey, Chad Ong.

Speaker 11

And I agree on the slide deck. Very, very helpful detail. Thanks for giving it. On the deposit Just a couple additional bit of detail. The beta expectation, the terminal beta 42% looks a little bit more conservative Than the group and probably appropriately so, so it's good to see it.

Speaker 11

Can you maybe give us how that breaks down by Way of commercial deposit data expectation at this point versus consumer.

Speaker 2

Yes, sure. Hey, John. Good morning. It's Rob. The way that we look at it in terms of determining where we're going to end up, and again, it's an expectation.

Speaker 2

We'll See how it plays out ultimately, but you're on the right track. So if you take a look at our total deposits of $437,000,000,000 and you take Commercial and the high net worth, the consumer portion of which is high net worth, which is around $230,000,000,000 Those made us a move. They're already at terminal. It's done. So that leaves roughly $200,000,000,000 or so in consumer deposits.

Speaker 2

As I mentioned in my comments, 10% of those are non interest bearing, which are transactional accounts that we don't expect to change. Yes, you're at $170,000,000,000 the minority of our total deposits of interest bearing consumer deposits that are sort of in play And that we expect to pay higher rates on. So that's how we get to maybe a more conservative number than what you're seeing on peers that don't have the same mix.

Speaker 11

Okay, that's helpful. Also on the deposit front, if I could Also, to a little more detail on the amount of inflows that you may have seen during the March time period around the failures. Can you maybe quantify the amount and if you expect any outflow of any of those inflows that you saw?

Speaker 2

So we did see in mid March, we saw some inflows during that week that Yes, at the height of the disruption, but a lot of that settled out. So we don't expect to see that A factor for us positively or negatively, as we move into the Q2.

Speaker 1

The only thing I'd say, we actually opened, In March, twice the number of accounts in our C and I franchise that we would otherwise open in a month. So away from the deposits that came in, we actually got a bunch of clients. The deposits will Stay and get mixed, some will go, but we grew our account portfolio pretty substantially in 1 month.

Speaker 11

Okay, great. If I could put one more in there. Just on the office front, do you happen to have perhaps The refreshed LTVs that you're starting to see in that portfolio?

Speaker 1

That's a good question and I haven't seen them, but it's worth, I don't know we put in the deck or not, but we underwrite what, 55 to 60? 55 to 60. Yes. And all of that stuff is stale and all the appraisals that you get are stale. And so in effect, what we end up doing is You assume that less leases renew than you otherwise would in a normal cash flow analysis.

Speaker 1

You dropped that pretty materially. You assume that lease rates all else equal are going to go down and then you have to put in the rehab costs To release it. And then you just counted at lower rates. So we've done all that building by building And then taking reserves against it. And I guess the final point I'd make, if you think about Rob's number, it was at 9.6% we have against the tenant.

Speaker 2

The multitask. Effectively,

Speaker 1

you're saying, all right, I can have 20% of Class A office default and lose $0.50 on the dollar on a portfolio that was Generally underwritten at 60%. That's a pretty severe outcome.

Speaker 2

Yes. And I would just add to that, John. And Bill mentioned it, we have a relatively small portfolio. So we're able to go asset by asset Rather than just broad strokes across a general portfolio.

Speaker 1

Look, we know how to do this, right? We've been in the business for a long time. We have all the resources and have seen the activity in Midland. We know all the borrowers we're with and we think we've laid it out pretty clearly. We're going to have charge offs, But we've That's why we've built the reserves.

Speaker 1

Where they're coming from and we've built the reserves.

Speaker 11

Got it. Very helpful. Thank you.

Speaker 5

Next question from the line of Bill Carcache with Wolfe Research. Please go ahead.

Speaker 10

Thanks. Good morning, Bill and Rob. I wanted to follow-up on the deposit beta Commentary. Rob, you mentioned that mid-twenty percent non interest bearing deposit mix that's implicit, I believe, in your 42% terminal bid assumption. It looks like that would get you back to pre COVID levels on Slide 11, I think.

Speaker 10

How are you thinking about the risk That non interest bearing mix will continue to fall, not just to pre COVID levels, but potentially even lower. Perhaps some have talked about pre GFC loans.

Speaker 2

Yes, we can see and we take a look at the nature of the accounts. Mid-20s is our estimate. It could go lower. Our expectations are though that it would be in the mid-20s and that's really on the basis of the nature of the operating accounts that we have. But as we just were mentioning, we know really well and we know The nature of their activities.

Speaker 2

So it's really knowledge of our operating book that gives us that indication.

Speaker 10

Understood. And then separately following up on your commentary around Yes, potential regulatory uncertainty. In light of Barr's recent Senate testimony, so hoping you could address Broadly, how you're all thinking about the levers at your disposal to the extent that the regulatory environment grows more challenging. Certainly, you're It seems like you're well positioned. But in terms of levers, whether it's RWA growth, buyback dividend, if you could just frame How you think about those to the extent that it does get more challenging?

Speaker 1

I'm not sure. If you put ASCI and we're already kind of over All else equal, I think we're well positioned and fine. As Rob mentioned, we're at least at the moment Being conservative on our thoughts on share repurchase, but most of that is to kind of wait out the current environment, get through earnings and see where we are. I don't see any issue coming out of regulation that we won't be able to handle in the due course.

Speaker 2

And they would

Operator

Next question please.

Speaker 5

Next question from the line of Scott Siefers with Piper Sandler. Please go ahead.

Speaker 9

Good morning, everyone. Thank you for taking the question. So you reduced the full year 2023 loan growth expectation a bit. I was wondering if you could comment for a second on how much of that Is sort of lower either existing or anticipated demand? And how much is you guys just sort of being more conservative about where You'd hope to kind of direct your capital and liquidity.

Speaker 1

It's a great question. It's probably fifty-fifty. So demand has softened a little bit and then the marginal cost of sinking new clients has gone up, So we're a little more picky than we were. It's probably fifty-fifty.

Speaker 2

And that spread issue that we talked about that we think that we should be paid more for the risk.

Speaker 9

Okay, perfect. Thank you. And then, Bill, I was hoping you could expand just a bit on that commercial account opening comment you made a couple of questions ago. Maybe

Speaker 1

as you sort

Speaker 9

of think of how the sort of the world might look going forward for commercial customers, do you think they'll just Maybe diversify their relationships to protect themselves a little. How will an operational account Work, will people just keep less in their operational accounts and sprinkle it elsewhere? Any thoughts on how things might evolve?

Speaker 1

I'm not sure. We haven't seen Anything with our legacy clients in terms of behavior. Now they've we've seen money go into Sweep accounts, government funds from corporates and individuals largely is a function of rate. I don't know that it has anything to do with diversification. Now as you go for smaller banks, I suppose that could become an issue depending on how much visibility there is into that particular bank's But we just haven't seen any of that.

Speaker 9

Yes. Okay. All right. Perfect. Thank you very much.

Speaker 5

Yes. Next question from the line of Ken Usdin with Jefferies. Please go ahead.

Speaker 12

Thanks. Good morning, everyone. Hey, guys. I just want to dig on the guidance a little bit. The The second quarter guidance is clear for the revenue step down and kind of that implies in the full year guide that second half revenue is pretty Equal to first half revenue.

Speaker 12

I'm just wondering if you kind of maybe give us some NII versus fees? And are you expecting any just better stability or increase as you go through the year Perhaps in fees versus what might happen in NII? Thanks.

Speaker 2

Okay. I think you're asking in terms of the full year. We've given you the new guidance around our NII and then we've been through that. As far as fees go, we're calling it to be stable Year over year and there's some moving parts in there. Some of the fee categories are doing a little better than we expected, some are doing a little bit worse, but Altogether, it's still stable.

Speaker 12

Okay. And within that, can I just ask you a question? Your Harris and Williams Business has just been a great one over the years. And in this environment, obviously, M and A is slower, but is there also is there any sense or chance that also like Mid sized companies have to do a rethink here. I'm just kind of wondering just where you think the pipelines and outlook are for that business specifically?

Speaker 12

Thanks.

Speaker 2

Yes. So Harris Williams, you're accurate in terms of that's our biggest driver of our capital It's advisory businesses and they had a slower than usual quarter in the Q1, obviously reflecting a lot of the disruption. And The pipelines are still pretty good. We're not expecting a big rebound in the second quarter, but potentially in the second half. But to your point, a lot of that depends on the psychology at the time and the ability and the support for both buyers and sellers to do deals.

Speaker 12

Okay. Hey, Rob, one more quick one. I know your footnote on your beta slide says that you don't include time deposits in your beta calc. So are we Generally to assume that the beta on time deposits is obviously very high just given what we know the earlier point that Bill made about the industry funding costs?

Speaker 2

Yes, that's right. And again, that's a conventional measure. So that's not our own personal P and C measure. That's how the industry calculates

Speaker 12

Okay, understood. Thank you.

Speaker 5

Next question from the line of Stephane Schjet with Point 72. Please go ahead.

Speaker 4

Thank you. A quick question, if I may, on the commercial real estate. A follow-up one on criticized loans on Slide 18. You said 20% twice as much as your the rest of your So I would just like to understand what was this number before and why you how you would expect this number to evolve for me? Thank you.

Speaker 2

I'm sorry. I didn't follow all of that.

Speaker 4

Yes, yes, sorry. I'm going to interrupt. On Slide 18, you mentioned that our office That's our office. Loan ratio is 20%. I just would like to know what was this number before for previous quarters and how you expect this number To evolve for

Speaker 2

the year. So the 2.7%. No, it's been pretty steady. So it's been a small percentage of our total commercial real estate Hasn't changed nor do we expect it, certainly not to go well. Okay.

Speaker 4

That's it. Thank you.

Speaker 5

Next question from the line of Alan Davis, Matt West Markets. Please go ahead.

Speaker 3

Hi, thank you very much. Yes, Alan Davis here from NatWest Markets. Just a very quick question and to echo what everybody said that The disclosure and information here is fantastic. With all the market noise that went on after SVB and I totally get the And I totally agree with what you're saying about the accounting standards and so on. Nevertheless, there's a lot of keen interest in the Unrealized losses on the hold to maturity portfolio.

Speaker 3

Are you able to provide any Color or guidance there is I don't think all of that would be in AOCI. Is there anything that you can help guide me with in that regard?

Speaker 1

The add on health maturity, So inside of AOCI today is one number and then we have another smaller loss in held which we disclosed. 3,500,000,000. Yes.

Speaker 9

Yes. I

Speaker 3

apologize. I did not see that. Fantastic. Sorry, I didn't mean to waste your time.

Speaker 1

Thank you. No problem. No problem.

Speaker 5

We have no further questions on the phone line.

Operator

Okay. Well, thank you for joining our call and your interest in P&C. And if If you have any other additional questions or need follow-up, please feel free to reach out to the IR team. Thank you. Bye.

Speaker 1

Thanks, everybody. Thank you.

Speaker 5

That concludes today's call. We thank you for your participation and ask you to please disconnect your lines.

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Earnings Conference Call
The PNC Financial Services Group Q1 2023
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