PNC Financial Services Group, Inc. (The)

Well, 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 Demchek, and Rob Riley, 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 July 18th, 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, everyone. As you can see on the slide, we delivered solid results in the second quarter, generating exactly $1.5 billion in net income, or $3.36 in diluted earnings per share. While the macro environment and the competitive dynamics playing out within the banking sector pressured our revenue during the quarter, our results reflect the overall strength of our franchise and balance sheet. And importantly, through it all, we remain focused on executing on our strategic priorities. Our momentum across our markets remains strong, especially in the Southwest. We are growing households and commercial customers throughout our footprint. Rob will take you through the details of our second quarter results in a moment, but I'd like to call out a few highlights. First, we grow our capital during the quarter and feel very good about our positioning of our balance sheet in the current environment. In the next few weeks, we expect the Fed will announce changes to the Basel III capital framework. We believe our strong capital and liquidity levels, as well as our earnings power, provide the strength and flexibility to address upcoming regulatory changes. At the same time, we continue to support our customers, grow our business, and deliver returns for our shareholders. And in line with our focus on shareholder returns, we recently increased our quarterly common stock dividend by 5 cents. Our financial strength and stability are evidenced in the Fed's latest stress tests, resulting in an improvement in our stress capital buffer to the regulatory minimum level of 2.5% in October. Second, expense control is in focus. Rob will touch on this in a moment, but we have increased our continuous improvement program target for 2023 and are taking a hard look at opportunities for even further expense improvements across the franchise. Third, credit quality for the quarter remains strong, reflecting our diversified lending franchise and our focus on developing valuable, sustainable businesses based on long-term customer relationships. And finally, I'd like to thank our employees for their efforts and contributions during the quarter. And with that, I'll turn it over to Rob.

Thanks, Bill, and good morning, everyone. Our balance sheet is on slide three, and we're presenting on an average basis and comparing to the first quarter. Loans were stable at $325 billion. Investment securities declined $2 billion, or 2%. Cash balances at the Federal Reserve were $31 billion and decreased $3 billion. Deposits of $426 billion declined $10 billion, or 2%. Borrowed funds increased $3 billion. As an aside, since 2021, we've been deliberate in issuing TLAC-compliant debt, so we're confident we'll meet the upcoming TLAC requirements through our normal course of funding. At quarter end, AOCI was a negative $9.5 billion. Intangible book value was $77.80 per common share, an increase of 5% compared to the same period a year ago. We remain well capitalized with an estimated CET1 ratio of 9.5% as of June 30, 2023, which increased 30 basis points linked quarter. We returned approximately $700 million of capital to shareholders in the quarter, which included $600 million of common dividends and approximately $100 million of share repurchases for 1.1 million shares. And as Bill just mentioned, our board recently approved a $0.05 increase to our quarterly cash dividend on common stock, raising the dividend to $1.55 per share. Our recent CCAR results underscore the strength of our balance sheet, and as previously announced, our current stress capital buffer of 2.9% will improve to the regulatory minimum of 2.5% for the four-quarter period beginning in October 2023. Due to the expected issuance by the federal banking agencies of proposed rules to adjust the Basel III capital framework, share repurchase activity in the third quarter is expected to remain modest. We will continue to monitor this and may adjust share repurchase activity as appropriate. Slide four shows our loans in more detail. Second quarter loans averaged $325 billion and increased $20 billion, or 6%, compared to the same period a year ago. This growth reflected strong loan demand during the back half of 2022 and our ability to capitalize on opportunities in our expanded franchise. Average loan balances were stable linked quarter as growth in consumer was offset by a decline in commercial, with commercial balances reflecting generally weaker demand. Consumer loans grew $400 million compared to the first quarter, reflecting higher residential mortgage, credit card, and auto balances. Commercial loans averaged $223 billion in the second quarter, a decline of $1 billion, as limited new production was more than offset by paydowns. Loan yields increased 28 basis points to 5.57% in the second quarter, predominantly driven by the higher rate environment. Slide five covers our deposits in more detail. Deposits declined 2% on both a spot and average basis-length quarter, reflecting the continuing pressure of quantitative tightening and increased spending activity, as well as consumer tax payments. Deposits continue to move from non-interest-bearing to interest-bearing accounts. As expected, the mixed shift is being driven by commercial deposits. In the second quarter, commercial non-interest-bearing deposits represented 45% of total commercial deposits compared to 47% in the first quarter. Our consumer deposit non-interest bearing mix has been stable, remaining at 10%. On a consolidated basis, our level of non-interest bearing deposits was 27% in the second quarter, down slightly from 28% in the first quarter, consistent with our expectations. And we still expect the non-interest bearing portion of our deposits to stabilize in the mid 20% range. Our rate paid on interest bearing deposits increased to 1.96% during the second quarter, up from 1.66% in the prior quarter. And as of June 30th, our cumulative deposit beta was 39%. Looking forward, we expect the Federal Reserve to raise the benchmark rate by 25 basis points in July. We believe this will put additional pressure on betas, and as a result, we expect our third quarter and year-end cumulative betas to be 42% and 44%, respectively. Slide 6 details our investment securities and swap portfolios. Average investment securities of $141 billion decreased $2.4 billion, or 2%, as limited purchase activity during the quarter was more than offset by portfolio paydowns and maturities. The securities portfolio yield increased three basis points to 2.52%, reflecting the runoff of lower-yielding securities. And as of June 30th, the duration of the investment securities portfolio was 4.2 years. Our received fixed swaps pointed to the commercial loan book totaled $40 billion at the end of the second quarter. The weighted average received fixed rate of our swap portfolio increased 25 basis points linked quarter to 1.73%, and the portfolio duration was 2.3 years as of June 30th. During the second quarter, our accumulated other comprehensive loss increased by $400 million. Paydowns and maturities were in line with our expectations, but were more than offset by the negative impact from higher-than-expected rates throughout the quarter. Notwithstanding this AOCI impact, our tangible book value increased 1% to $77.80 compared to March 31st. Importantly, as lower-rate securities and swaps roll off, we expect our securities yields to continue to increase, resulting in a meaningful improvement to tangible book value from AOCI accretions. Turning to the income statement on slide seven, for the first half of 2023, revenue grew 11% compared to the same period a year ago, reflecting higher interest rates and overall business growth. Non-interest expense grew 4% and was well controlled despite a higher FDIC assessment rate and inflationary pressures. As a result, PPNR grew 24%. For the second quarter, net income was $1.5 billion or $3.36 per share. Total revenue of $5.3 billion decreased $310 million, or 6%, compared to the first quarter of 2023. Net interest income declined $75 million, or 2%. And our net interest margin was 2.79%, a decline of five basis points. Non-interest income declined $235 million, or 12%, driven by both lower fee income and other non-interest income. which included visa fair value adjustments of a negative $83 million that I will discuss in a moment. Second quarter expenses increased $51 million, or 2% linked quarter. Provision was $146 million in the second quarter, reflecting portfolio activity and changes in macroeconomic variables. And our effective tax rate was 15.5%, which included the favorable impact of certain tax matters in the second quarter. Turning to slide eight, We highlight our revenue trends. Second quarter revenue was down $310 million or 6% compared with the first quarter. Net interest income of $3.5 billion decreased $75 million or 2% as higher yields on interest earning assets were more than offset by increased funding costs and lower loan and security balances. Fee income was $1.7 billion and decreased $106 million or 6% linked quarters. The primary driver of the decline in fee income was residential and commercial mortgage revenue, which was down $79 million. Inside of that, $58 million was related to lower net valuation of mortgage servicing rights. Beyond that, capital markets and advisory revenue decreased $49 million, or 19%, driven by lower merger and acquisition advisory fees and loan syndication revenue. Going forward, we expect this activity to meaningfully increase in the second half of the year, which is included in our guidance that I will cover in a few minutes. Partially offsetting these declines was a $38 million or 6% increase in card and cash management fees, reflecting seasonally higher consumer transaction volumes and increased treasury management product revenue. Other non-interest income of $129 million declined 50% linked quarter, driven by lower private equity revenue, and included negative visa fair value adjustments related to litigation escrow funding and other valuation changes totaling $83 million. Turning to slide nine, our second quarter expenses were up $51 million or 2% length quarter and remain well controlled. The growth was primarily due to a $35 million increase in marketing expense reflecting seasonality. Personnel expense increased by $20 million or 1% which included the full quarter impact of annual employee merit increases. Every other expense category remains stable or declined compared to the first quarter of 2023. As Bill mentioned, we remain diligent in our expense management efforts, particularly when considering the current revenue environment. At the beginning of the year, we set a continuous improvement program goal of $400 million. Recently, we've identified initiatives that support increasing our CIP by an additional $50 million. raising our full-year target to $450 million. Further, we'll continue to look for additional efficiencies during the remainder of 2023, and importantly, as we begin to plan for 2024. Our credit metrics are presented on slide 10. Our credit quality remains strong, and notably, the leading indicators for credit quality continue to perform well. Non-performing loans were down $97 million, or 5%, and continue to represent less than 1% of total loans. And total delinquencies of $1.2 billion decreased to $114 million, or 9% linked quarter. Net charge-offs of $194 million were stable linked quarter. Our annualized net charge-offs to average loans ratio was 24 basis points in the second quarter. And our allowance for credit losses totaled $5.4 billion, or 1.7% of total loans on June 30th, essentially stable with March 31st. While overall credit quality remains strong across our portfolio, the office category within commercial real estate continues to be a key area of concern. As expected, we saw increases in charge-offs related to office during the quarter. However, the portfolio metrics remain largely similar to those presented in our comprehensive view last quarter. Naturally, we'll continue to monitor and review our assumptions to ensure they reflect real-time market conditions, and a full update is included in the appendix slide. In summary, P&C reported a solid second quarter 2023. In regard to our view of the overall economy, we're expecting a mild recession starting in early 2024 with a contraction in real GDP of less than 1%. Our rate path assumption includes a 25 basis point increase in the Fed funds rate in July. Following that, we expect the Fed to pause rate actions until March 2024 when we expect the Fed to begin to cut rates. Looking ahead, our outlook for the third quarter of 2023 compared to the second quarter of 2023 is as follows. We expect average loans to decline approximately 1%, net interest income to be down 3% to 4%, non-interest income to be up 10% to 11%. Taking the component pieces, we expect total revenue to be up approximately 1%. We expect total non-interest expense to be stable and we expect second quarter net charge-offs to be between $200 and $250 million. Considering our reported operating results for the first half of 2023, third quarter expectations, and current economic forecasts for the full year 2023 compared to full year 2022, we expect spot loans to be relatively stable, which equates to average loan growth of 5% to 6%. Total revenue growth to be approximately 2% to 2.5%, Inside of that, our expectation is for net interest income to be in the range of up 5% to 6%. This is a move to the lower end of our previous guidance, largely driven by anticipated deposit costs moving a bit faster than we expected and slightly lower loan growth expectations. We expect non-interest income to decline 2% to 4%, which is down from our earlier expectations of stables. This change is resulting from softer than expected capital markets revenue in the second quarter and $127 million of visa-related charges that have been incurred year-to-date. Expenses are expected to be up approximately 2%. Credit quality is trending better than expected. And we expect our effective tax rate to be approximately 18%. And with that, Bill and I are ready to take your questions.