PNC Financial Services Group, Inc. (The)

Good morning and welcome to today's conference call for the PNC Financial Services Group. Participating on this call are PNC's Chairman, President, and CEO, Bill Demchak, and Rob Riley, Executive Vice President and CFO. Today's presentation contains forelooking 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 April 14, 2023, and PNC undertakes no obligation to update them. Now, I'd like to turn the call over to Bill.

Thank you, Brian, and good morning, everybody. As you can see on the slide, our quarterly results were strong, and we reported $1.7 billion 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 seen market volatility across the broader industry. 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. That said, in the near term, we're not immune to the competitive environment and the deposit dynamics that will ultimately impact our NII in the near term, and Rob's 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 first quarter 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&A segment. 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.

Thanks, Bill, and good morning, everyone. Our balance sheet is on slide four and is presented on an average basis. Loans for the first quarter were $326 billion, an increase of $3.6 billion, or 1% length quarter. Investment securities were relatively stable at $143 billion. Cash balances at the Federal Reserve averaged $34 billion and increased $4 billion during the quarter. Deposits of $436 billion grew on both a spot and average basis linked quarter. Average borrowed funds increased $4 billion, which reflected fourth quarter 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 31st, 2023. During the quarter, we returned $1 billion of capital to shareholders, which included $600 million of common dividends and approximately $370 million of share repurchases, or 2.4 million shares. Due to market conditions and increased economic uncertainty, we expect to reduce our share repurchase activity in the second quarter. And of course, we'll continue to monitor this and may adjust share repurchase activity as appropriate. Slide five shows our loans and deposits in more detail. During the first quarter, loan balances averaged $326 billion, an increase of $4 billion, or 1%, largely reflecting the full quarter impact of growth in the fourth quarter of 2022. Deposits averaged $436 billion in the first quarter, increasing $1.3 billion. We continue to see a mixed 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 first quarter, from 1.07% in the fourth quarter of 2022. And as of March 31st, our cumulative deposit beta was 35%. Turning to the income statement on slide six, as you can see, first quarter 2023 reported net income was $1.7 billion, or $3.98 per share. Total revenues of $5.6 billion decreased $160 million compared to the fourth quarter of 2022. Net interest income decreased $99 million, or 3%, primarily driven by two fewer days in the quarter and higher funding costs. partially offset by higher yields on interest-earning assets. 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 million, 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. First quarter expenses declined $153 million, or 4% linked quarter, even after accounting for the increase to the FDIC's deposit assessment rate, which equated to $25 million. Provision was $235 million 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 seven, we highlight our revenue and expense trends. 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 million 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 eight. Non-performing loans remain stable at $2 billion and continue to represent less than 1% of total loans. Total delinquencies of $1.3 billion declined $164 million, or 11% linked quarter. Notably, the delinquency rate of 41 basis points is our lowest level in over a decade. Net charge-offs were $195 million, a decrease of $29 million linked quarter. Our annualized net charge-offs average loans ratio was 24 basis points in the first quarter. And our allowance for credit losses totaled $5.4 billion, or 1.7% of total loans on March 31st, essentially stable with year-end 2022. 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 billion deposit base is broken down between consumer and commercial categories to give you a view of the composition and granularity of the portfolio. At the end of the first quarter, our deposits were 53% consumer and 47% commercial. Inside of our $230 billion 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 million accounts throughout our coast-to-coast franchise. Our $207 billion of commercial deposits are 20% insured, but importantly, approximately 95% 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. Importantly, we have approximately 1.4 million 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 percent 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 was 45% as of March 31st, down from 58% a year ago. Importantly, commercial non-interest-bearing deposits include the 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 first quarter of 2023, down from 33% a year ago. PNC has historically operated with a higher percentage of non-interest-bearing deposits relative to the banking industry, due in part to the 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 exceed industry averages and approach the mid-20% range by year-end 2023. In addition to our mixed 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. 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 deposit, 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. Slide 13 details our investment securities and SWOT portfolios. Our securities balance averaged $143 billion in the first quarter, and we're a 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 two-thirds of our securities are recorded as held to maturity, and one-third is available for sale. Average security balances represent approximately 28% of interest-earning assets. Received fixed swaps pointed to the commercial loan book remain largely stable at $42 billion notional value and 2.25-year duration. At the end of the first quarter, our accumulated other comprehensive loss improved by $1.1 billion, or 10%, to $9.1 billion, 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 positions. Our strong liquidity coverage ratios continue to improve in the first quarter and exceeded regulatory requirements throughout the quarter. Our cash balances at the Federal Reserve totaled $34 billion, and we maintain 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. On March 31st, 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% at quarter end. As a Category 3 institution, we don't include AOCI in our CET1 ratio, but understand why there is focus on this ratio with the inclusion of AOCI. As of March 31, 2023, our CET1 ratio, including AOCI, 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 IRRBB 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 PNC's change in market value of equity over the past year, the increase in the market value of our deposits in a 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. Total market value of equity increased substantially in the rising rate environment, And further, our duration of equity is now essentially zero 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 first quarter of 2021 around $86 billion. 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. While credit quality is strong across the majority of our CRE book, office is a 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 first quarter, we had $8.9 billion, 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. 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 the 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 third-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. To appropriately sensitize our portfolio, we've 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 watch list levels of 3% or less. 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-70% occupancy range, watch list 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. 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, PNC reported a strong first quarter 2023. In regard to our view of the overall economy, we are expecting a recession starting in the second half of 2023, resulting in a 1% decline in real GDP. Our rate path assumption includes a 25 basis point increase in 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%. 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 percent. Based on this guidance, we expect we will generate positive operating leverage in 2023. Looking at the second quarter of 2023 compared to the first quarter of 2023, we expect average loans to be stable, net interest income to be down 2 to 4 percent, fee income to be stable to down 1 percent, other non-interest income to be between $200 and $250 million, excluding net securities and visa activity. 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 second quarter net charge-offs to be between $200 million and $250 million. 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.