The PNC Financial Services Group, Inc. (NYSE:PNC) Q4 2023 Earnings Call Transcript

The PNC Financial Services Group, Inc. (NYSE:PNC) Q4 2023 Earnings Call Transcript January 16, 2024

The PNC Financial Services Group, Inc. beats earnings expectations. Reported EPS is $3.16, expectations were $2.99. PNC isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Bryan Gill: Good morning. And 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, 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. These statements speak only as of January 16, 2023 and PNC undertakes no obligation to update them. Now, I’d like to turn the call over to Bill.

Bill Demchak: Thank you, Bryan, and good morning, everyone. During a challenging and volatile operating environment for the banking industry, PNC performed well during 2023 and delivered a solid finish in the fourth quarter. For the full year 2023, adjusting for the fourth quarter impact of the FDIC special assessment and expenses related to a staff reduction initiative that we completed in the fourth quarter, we earned $14.10 per diluted share compared to $13.85 per diluted share in 2022. Throughout the year and amidst all the disruption, we continue to grow our customer base and deepen relationships across our coast-to-coast franchise. Importantly, we generated record revenue and controlled core expenses, which allowed us to deliver a modest amount of positive adjusted operating leverage.

For the fourth quarter, we reported $883 million in net income or $1.85 diluted per share and $3.16 per share on an adjusted basis. Rob is going to take you through the financials in a moment, but I’d like to highlight a few points. First, as we announced in early October, we closed on the acquisition of the capital commitment loans from Signature, which is immediately accretive to earnings. Secondly, as we expected, we saw meaningful growth from non-interest income during the fourth quarter, driven primarily by a rebound in capital markets and advisory fees. Third, we completed the actions to reduce our workforce and we are positioned to realize $325 million of expense savings in 2024. This is in addition to our CIP savings target for 2024 that Rob will discuss in a few minutes.

Expense discipline remains a top priority for us and accordingly we are targeting stable expenses for 2024 even as we continue to invest in key growth initiatives. Fourth, our credit quality remained strong during the quarter, reflecting our thoughtful approach us to growing our balance sheet. While we continue to expect credit charge offs to increase over time, particularly in the CRE office segment, we’re adequately reserved. Finally, during the fourth quarter, we increased our capital position, saw solid improvement in our AOCI intangible book value and repurchased a modest amount of shares. In summary, we run our company with a focus on delivering through the cycle performance and feel very good about our strategy, our capabilities and the strength of our balance sheet as we enter 2024.

And we believe we are well positioned to drive growth and deliver shareholder value in the coming year and beyond. As always, I want to thank our employees for everything they do to meet the needs of our customers and make our success possible. And with that, I’ll turn it over to Rob.

Rob Reilly: Thanks, Bill, and good morning, everyone. Our balance sheet is on Slide 3 and is presented on an average basis and compared to the third quarter. Loans were up 2% and averaged $325 billion, which includes the acquired Signature capital commitment loans. Investment securities declined $2 billion or 2%. Cash balances at the Federal Reserve increased $4 billion to $42 billion and deposits increased $1.4 billion and averaged $424 billion. Borrowed funds increased $5 billion to $73 billion, driven by higher FHLB borrowings and parent company senior debt issuances. At year end, P&C was fully compliant with the proposed holding company long term debt requirements. And we expect to reach compliance with the bank level metrics through our normal course of funding well in advance of the phase in period.

AOCI improved $2.6 billion to negative $7.7 billion at quarter end, primarily reflecting the impact of favorable interest rate movements during the quarter. Accordingly, tangible book value increased to $85.08 per common share, up 9% linked quarter and 18% compared to the same period a year ago. We remain well capitalized with an estimated CET1 ratio of 9.9% as of December 31st, which increased 10 basis points linked quarter. Our estimated fully phased in expanded risk based CET1 ratio based on the new proposed capital rules would be approximately 8.2% at year end, which is well above our current requirement of 7%. We continue to be well positioned with capital flexibility. During the quarter, we resumed modest share repurchase activity of approximately $100 million or roughly 0.5 million.

And when combined with $600 million of common dividends, we returned a total of $700 million of capital to shareholders. Slide 4 shows our loans in more detail. Compared to the third quarter, average loan balances increased 2%, driven by higher commercial loan balances and modest growth in consumer. Commercial loans were $223 billion, an increase of $5 billion, driven by the acquisition of the Signature capital commitment portfolio. Excluding the $8 billion full quarter average impact from the Signature loan portfolio, commercial loans declined $3 billion or 1%, driven by lower utilization and soft loan demand. Consumer loans grew approximately $130 million driven by higher residential mortgage balances, partially offset by lower home equity and credit card balances.

And loan yields increased 19 basis points to 5.94% in the fourth quarter. Slide 5 covers our deposits in more detail. Average deposits grew $1.4 billion to $424 billion during the quarter as seasonal growth in commercial deposits was partially offset by a decline in consumer deposits. In regard to mix, consolidated non-interest bearing deposits were 25% in the fourth quarter, down slightly from 26% in the third quarter and consistent with our expectations. We continue to expect the non-interest bearing portion of our deposits to stabilize near current levels. Our current rate paid on interest bearing deposits increased to 2.48% during the fourth quarter, up from 2.26% in the prior quarter. As of December 31st, our cumulative deposit beta was 44% and in line with our expectation for the quarter.

As we stated previously, we expect betas to drift modestly higher, while interest rates remain at current level. And our current forecast calls for the first rate cut to occur in mid-2024, at which point, we believe the rate paid on deposits will begin to decline. Slide 6 details our investment security and swap portfolios. Average investment securities of $137 billion decreased 2% as curtailed purchase activity was more than offset by portfolio pay downs and maturities. The securities portfolio yield increased two basis points to 2.59%, reflecting the runoff of lower yielding securities. As of December 31st, the duration of the investment securities portfolio was 4.1 years. Our received fixed swaps pointing to the commercial loan book totaled $33 billion on December 31st.

The weighted-average received fixed rate of our swap portfolio increased three basis points to 2.1% and the duration of the portfolio was 2.3 years. AOCI improved by $2.6 billion in the fourth quarter, reflecting lower interest rates. Importantly, as lower rate securities and swaps roll-off, we expect a continued meaningful improvement to tangible book value from AOCI accretion. Turning to the income statement on Slide 7. Fourth quarter net income was $883 million or $1.85 per share, which included pre-tax non-core expenses of $665 million or $525 million after tax related to the FDIC special assessment and the workforce reduction charges incurred in the fourth quarter. Excluding non-core expenses, adjusted EPS was $3.16. Total revenue of $5.4 billion increased $128 million or 2% compared to the third quarter of 2023.

Net interest income declined modestly by $15 million. And our net interest margin was 2.66%, a decline of five basis points. Non-interest income increased to $143 million, or 8%. Non-interest expense of $4.1 billion increased $829 million or 26% and included $665 million of non-core expenses. Core non-interest expense was $3.4 billion and increased $164 million or 5%. Provision was $232 million in the fourth quarter and our effective tax rate was 16.3%. Full year 2023 revenue grew 2% compared to 2022. Core non-interest expense was well controlled and grew 1%. Importantly, our disciplined expense management and CIP savings allowed us to deliver modest positive operating leverage and PPNR growth of 2% on an adjusted basis. Turning to Slide 8, we highlight our revenue trends.

Fourth quarter revenue was up $128 million, or 2% compared with the third quarter, driven by strong fee income as net interest income of $3.4 billion was down modestly. Fee income was $1.8 billion and increased $99 million or 6% linked quarter. Looking at the detail, capital markets and advisory fees rebounded as expected and increased $141 million, or 84%, driven by higher M&A advisory fees. Asset Management and Brokerage revenue grew $12 million or 3%, reflecting favorable market conditions. And residential and commercial mortgage revenue declined $52 million or 26%, primarily due to a decrease in the valuation of net mortgage servicing rights. Other non-interest income of $138 million increased $44 million or 47% and included favorable valuation adjustments and gains on sales.

The fourth quarter also included a $100 million negative Visa fair value adjustment compared to a $51 million negative adjustment in the third quarter. As a reminder, at December 31st, PNC owned 3.5 million Visa Class B shares with an unrecognized gain of approximately $1.5 billion. Turning to Slide 9, our fourth quarter non-interest expense of $4.1 billion was up $829 million and included $665 million of non-core charges. Core non-interest expense of $3.4 billion increased to $164 million, or 5% linked quarter, reflecting higher business activity, seasonality and asset [impairments]. During the quarter, we incurred $42 million of impairment charges, which were largely related to building write-offs. Notably, in 2023, we reduced our non-branch footprint by 2 million square feet, or approximately 17%.

For the full year, core non-interest expense of $13.3 billion increased $177 million or 1%. Expense growth was well controlled due in part to the $50 million midyear increase in our CIP goal to $450 million, which we exceeded. As a result, we generated 41 basis points of adjusted positive operating leverage for the full year. Looking forward to 2024, our annual CIP target is $425 million. This program funds a significant portion of our ongoing business and technology investments. And as of year-end, we completed actions related to the workforce reduction that will drive $325 million of cost savings in 2024. Taken together, we’re implementing $750 million of expense management actions, all of which are reflected in our 2024 guidance that I will cover in a few minutes.

Our credit metrics are presented on Slide 10. While overall credit quality remained strong across our portfolio, we did see a slight uptick in NPLs and delinquencies. Non-performing loans increased $57 million or 3% linked quarter and included a $12 million increase in CRE. Total delinquencies of $1.4 billion increased $97 million, or 8% linked quarter. The increase included seasonally higher consumer delinquencies, the majority of which have already been resolved. Net loan charge offs were $200 and in the fourth quarter and came in at the low end of our expectations. Our annualized net charge-offs to average loans ratio was 24 basis points. And our allowance for credit losses totaled $5.5 billion or 1.7% of total loans on December 31st, stable with September 30th.

The CRE office portfolio is where we continue to see the most stress and fourth quarter’s net loan charge offs were $56 million. We continue to expect future losses on this portfolio. However, we believe we’ve adequately reserved for those potential losses. As of December 31st, our reserves on the office portfolio were 8.7% of total office loans and inside of that 12.9% on the multi tenant portfolio. Importantly, our overall CRE office portfolio declined 6% or approximately $550 million linked quarter, reflecting a higher level of payoff. Criticized office loans were flat and nonperforming loans increased 2% linked quarter. Naturally, we’ll continue to monitor and review our assumptions to ensure they reflect current market conditions. And a full update of this portfolio is included in the appendix slides.

In summary, PNC reported a solid fourth quarter and full year 2023. In regard to our view of the overall economy, we’re expecting a mild recession starting in mid-2024 with a contraction in real GDP of less than 1%. We expect the federal funds rate to remain unchanged between 5.25% and 5.5% through mid-2024 when we expect the fed to begin to cut rates. We expect a reduction of 75 basis points in 2024 with a 25 basis point decrease in July, November and December. Looking ahead, our outlook for full year 2024 compared to 2023 results is as follows. We expect spot loan growth of 3% to 4%, which equates to average loan growth of approximately 1%. Total revenue to be stable to down 2%. Inside of that, our expectation is for net interest income to be down in the range of 4% to 5% and non-interest income to be up 4% to 6%, core non-interest expenses to be stable and we expect our effective tax rate to be approximately 18.5%.

Our outlook for the first quarter of 2024 compared to the fourth quarter of 2023 is as follows. We expect average loans to be stable, net interest income to be down 2% to 3%, fee income to be down 6% to 8% due to seasonally lower first quarter client activity as well as elevated fourth quarter capital markets and advisory levels. Other noninterest 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 down 3% to 4%. We expect total core noninterest expense to be down 3% to 4%. We expect first quarter net charge offs to be between $200 million and $250 million. And with that, Bill and I are ready to take your questions.

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Q&A Session

Operator: [Operator Instructions] Our first question comes from John McDonald with Autonomous Research.

John McDonald: I wanted to ask, Rob and Bill, about the loan growth outlook for 2024, the spot guidance of up 3% to 4% seems a bit better than what we’re seeing in H8 currently? And I thought you could give some color on the drivers of your outlook there.

Rob Reilly: On the outlook, so average loans up 1%, spot 3% to 4%, as you mentioned. We see most of that being on the commercial side and most of that being on the back end of the year. Consumer, we do have some growth throughout the year but pretty modest.

John McDonald: And Rob, on the net interest income guidance, it sounds like you’re assuming three rate cuts, a little bit less than what the forward curve has. Just kind of wondering what would be the sensitivity if the forward curve played out and we saw more rate cuts than what you’re assuming. Is that helpful to the NII outlook, all else equal or relatively neutral? Could you update us on the sensitivity there, please?

Rob Reilly: Yes, the short answer is it’s relatively neutral because, as you know, we’ve worked hard to get our balance sheet into a neutral sensitivity position. So not a lot of variance in terms of the forwards and our own expectations in terms of the impact on NII. The big question, obviously, is going to be on deposit pricing and how that behaves as the year plays out, but we don’t expect a lot of variance.

Operator: Our next question comes from John Pancari with Evercore.

John Pancari: On the capital markets revenue, the numbers certainly came in really solid this quarter. As you look into 2024 and in the context of your up 4% to 6% non-interest income guidance for the full year. How are you thinking about capital markets trajectory through the year off of this level?

Rob Reilly: So with capital markets, we did get the rebound that we were expecting in the fourth quarter and the bulk of that is in our Harris Williams, our M&A advisory business. As far as ’24 guidance goes, we expect — the pipelines are good. We expect sort of the fourth quarter and the first quarter of ’23 to be the range of what we would see on a quarterly basis going through in 2024. The anomalies were the soft quarters of Q2 and Q3 in 2023. So take a look at the first quarter of ’23, the fourth quarter of ’23, and that’s the range of what we would expect the quarterly run rate to be through ’24.

John Pancari: All right, thanks for that. And then separately…

Rob Reilly: I’ll even help you, it’s up about 20% year-over-year. I’ll save you the math there.

John Pancari: And then on the — your guidance for 2024 implies about 100 basis points negative operating leverage using the midpoint of the guidance, which actually screens relatively well versus your peers. How sustainable is that if the rate environment does not pan out as you’re modeling and — or better put, if your revenue outlook is worse. Do you think you can sustain at that expected negative 100 basis points operating leverage or could it be worse?

Bill Demchak: Look, we’re fairly neutral to the — for our NII forecast toward as a function of rate cuts or not. So the outcome ought to be the same.

Rob Reilly: Well, I would add to that, John. So we worked hard. We took some actions to position ourselves to have stable expenses year-over-year. So that’s a lot. And then as Bill pointed out on the revenue side, the NII is fairly predictable on a relative basis outside of rates and the fees, we feel good about the guidance. So that’s what we think is going to occur.

Bill Demchak: I think if there’s variance anywhere, it’s going to be on our assumptions as it relates to deposit betas, the continued shift to interest bearing versus non-interest bearing and ultimately, the steepness of the yield curve, the rates at the long end of the curve as opposed to the front end of the curve. We’ve tried to be to the best of our ability a little bit on the conservative side of all of those things and we feel pretty good about where our forecast is.

Operator: Our next question comes from Scott Siefers with Piper Sandler.

Scott Siefers: I was hoping you might be able to share just some updated thoughts on sort of where and when NII might bottom and I think perhaps more importantly, magnitude of rebound that it might see thereafter. I know you sort of suggested last month that NII ultimately could be a record in 2025. I guess I’d just be curious for any updated context around your thoughts there.

Bill Demchak: So as we pointed out, we do see NII going down in the first half of the year, troughing around the time of the cuts and then growing from there and beyond. So think about where we are now, go down on a bit and then grow back to where we are now. And then in ’25 what gives us a lot of confidence around record NII is we will get the compounded effect of the repricing of our fixed rate assets as that continues into ’25. So that’s what we laid out a month ago and that’s still what we think.