Good morning. My name is Tina, and I will be your conference operator today. At this time, I would like to welcome everyone to The PNC Financial Services Group earnings conference call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer session. If you would like to ask a question during this time, simply press the 1 followed by the 4 on your telephone keypad. If you would like to withdraw your question, please press the 1 and the number 3 on your telephone keypad. As a reminder, this call is being recorded. I will now turn the call over to Director of Investor Relations, Mr. Bryan Gill. Please go ahead.
Hello. Thank you. Good morning, everyone. 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 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 materials are all available on our corporate website, pnc.com, under Investor Relations. These statements speak only as of October 16th, 2019. PNC undertakes no obligation to update them. Now I'd like to turn the call over to Bill Demchak.
Thanks, Bryan. Good morning, everybody. As you saw this morning, PNC reported third quarter net income of $1.4 billion or $2.94 per diluted common share. Overall, I think we had a really good quarter. We generated solid growth in loans and deposits. We grew total revenue by 1% as both NII and non-interest income increase. You saw we managed expenses well, even as we continued to invest in our businesses and infrastructure, and we improved our efficiency ratio. Overall credit quality also remains strong, and we increased the capital we returned to shareholders in the third quarter through share repurchases and the dividend. We continue to execute on our strategies to extend the reach of our middle market corporate banking franchise into new markets and to expand our retail banking brand nationally.
We delivered these results despite uncertainty in the market related to everything from slowing economic growth, trade restrictions, geopolitical concerns, and the interest rate environment. As we look toward the remainder of the year and ahead to 2020, there are obvious unanswered questions about the environment we are operating in, along with the intensity of entering a presidential election year. We will not be distracted by things that are beyond our control. Rather, you'll see us continue to invest and work to improve the customer experience, to reach more customers with our products and services, and to offer superior solutions to our customers' evolving banking and investment needs. Last week, you would've seen the Federal Reserve voted on the final rules for the tailoring proposals. The rules are essentially in line with what we expected. Rob's going to walk you through the details.
This is a positive outcome, obviously, as it gives us a degree of capital and liquidity flexibility beyond what we already have today. As always, I want to thank our employees for their hard work in the third quarter and their continued focus on serving our customers, the communities that we live in, and our shareholders. I'll turn it over to Rob for a closer look at our third quarter results, and then we'll take your questions. Rob?
Thanks, Bill, and good morning, everyone. As Bill just mentioned, we reported third quarter net income of $1.4 billion, or $2.94 per diluted common share. Our balance sheet is on slide four and is presented on an average basis. Total loans grew $2.8 billion, or 1%, to $238 billion linked quarter. Compared to the third quarter of 2018, growth was $14.4 billion, or 6%. Investment securities of $85.2 billion increased $1.5 billion, or 2% linked quarter, primarily due to purchases of agency residential mortgage-backed securities. Year-over-year, total securities balances increased $4.4 billion or 5%. Our deposits at the Fed averaged $15.3 billion for the third quarter, up $2.1 billion linked quarter. Deposits grew $6.2 billion, or 2% linked quarter, and $16.6 billion, or 6% year-over-year. We continue to maintain strong capital ratios.
During the quarter, we returned $1.5 billion of capital through dividends of $516 million and share repurchases of $1 billion. Since the third quarter of 2018, we've reduced our shares outstanding by 23 million or 5%. As of September 30th, 2019, our Basel III Common Equity Tier One ratio was estimated to be 9.6%, down slightly from 9.7% as of June 30th, 2019. As Bill mentioned, the Federal Reserve released the final regulatory tailoring rules last week. As expected, the rules are largely unchanged from the original proposals and are generally favorable to our liquidity and capital ratios. There are three significant impacts from a financial perspective for PNC. One, we'll get relief on threshold deductions in our CET1 capital calculation. Two, we'll have the choice to opt out of the inclusion of AOCI in capital.
Three, our LCR requirement will be lowered to 85% from 100% currently. If the rules were effective on September 30th, we estimate that the threshold deduction changes would generate a benefit of approximately 70 basis points to our Common Equity Tier One capital ratio. While the impact of opting out of AOCI would reduce that benefit by approximately 15 basis points. Through LCR relief, we would have flexibility to potentially increase net interest income between $20 million and $50 million annualized by reducing debt, redeploying excess liquidity in loans and securities, or a combination thereof. Our return on average assets for the third quarter was 1.36%. Our return on average common equity was 11.6%, and our return on tangible common equity was 14.6%. Our tangible book value was $82.37 per common share as of September 30th, an increase of 13% compared to a year ago.
Slide five shows our average loans and deposits in more detail. Loans grew $2.8 billion, or 1%, over the second quarter, with growth in both commercial and consumer lending. Commercial lending balances increased $1.3 billion, or 1%, primarily in our real estate and corporate banking businesses. Included in this growth was an increase in our average multifamily warehouse balances of approximately $700 million. On the consumer side, balances increased $1.5 billion, or 2%, linked quarter, driven by growth in residential mortgage, auto, and credit card, somewhat offset by runoff in our home equity and education loans. While not shown on the slide, spot loans increased approximately $200 million quarter-over-quarter. Consumer balances increased $1.6 billion, while commercial balances declined $1.4 billion, which was primarily driven by a decrease in our multifamily warehouse balances of $1.1 billion.
Compared to the same period a year ago, average loans grew 6%, or $14.4 billion, commercial lending balances increased $11.6 billion, or 8%, and consumer balances were higher by $2.8 billion, or 4%. Average deposits increased $6.2 billion, or 2%, in the third quarter compared with the second quarter, driven by seasonal growth in commercial deposits. Growth was primarily in interest-bearing deposits. However, non-interest-bearing deposits posted a modest increase as well. It's worth noting that spot deposits increased $12.3 billion, or 5%, compared to June 30th, 2019, and included approximately $4 billion of balances related to a sweep deposit product we began offering our asset management clients in September. Compared to the same quarter a year ago, average deposits increased $16.6 billion, or 6%. As the slide shows, the yield on our loan balances declined primarily as a result of lower LIBOR rates during the third quarter.
Importantly, our rates paid on deposits reached an inflection point, having declined one basis point linked quarter. As you can see on slide six, third quarter total revenue was $4.5 billion, up $54 million linked quarter, and $136 million compared to the third quarter of 2018. Net interest income, non-interest expense, and provision were all relatively stable compared with the second quarter. Total non-interest income increased $48 million, or 2%, linked quarter, reflecting higher fee income, partially offset by an expected decline in other non-interest income. Our effective tax rate in the second quarter was 17.5%. For the full year 2019, we continue to expect the effective tax rate to be approximately 17%. Let's discuss the key drivers of this performance in more detail. Turning to slide seven, net interest income of $2.5 billion was up slightly by $6 million compared with the second quarter.
The growth reflects higher interest-earning asset balances and an additional day, partially offset by the impact of lower rates. Net interest income grew $38 million, or 2%, year-over-year, driven by higher earning asset balances and yields, which were partially offset by higher funding costs and balances. Net interest margin decreased to 2.84% in the third quarter, mostly due to the net effect of lower interest rates, primarily LIBOR. Although lower rates reduced our borrowing costs, that was more than offset by the impact of LIBOR on our commercial loan yields. Separately, deposit rates began to decrease during the quarter, and we expect that decline to continue during the fourth quarter at a faster pace. Non-interest income of $2 billion increased $48 million, or 2%, linked-quarter, as higher fee income was partially offset by lower other non-interest income. Importantly, fee income grew 5% over the second quarter.
The main drivers of the increase were asset management revenue increased $19 million due to higher earnings from our equity investment in BlackRock. Consumer services increased $10 million attributable to higher brokerage revenue and seasonally higher debit and credit card transaction volumes. Corporate services declined $15 million, primarily due to a lower benefit from commercial mortgage servicing rights and M&A advisory fees. Residential mortgage non-interest income increased $52 million due to MSR hedge gains, as well as higher refinancing volumes. Service charges on deposits increased $7 million, reflecting a seasonal increase in consumer spending. Finally, other non-interest income was $342 million. The $25 million linked-quarter decline reflects lower asset sales related to the second quarter gain on the sale of the retirement record-keeping business, partially offset by higher revenue from private equity investments.
In the fourth quarter, we expect other non-interest income to be in the range of $300 million-$350 million, excluding net securities and Visa activity. This includes the estimated gain for the previously announced sale of our proprietary mutual funds, which is expected to close in the fourth quarter. Turning to slide eight, third quarter expenses remained relatively flat linked-quarter, with an increase of $12 million. Personnel expense increased $35 million, largely as a result of higher compensation related to business activity and an additional day in the quarter. Importantly, every other expense category declined quarter-over-quarter. Compared to the same period a year ago, expenses increased minimally by $15 million. Our efficiency ratio was 58% in the third quarter, improving from 59% for last quarter and 60% a year ago.
Importantly, we continue to generate positive operating leverage. Expense management continues to be a focus for us, and our expenses have been well controlled due in large part to our continuous improvement program. Through the first three quarters of the year, we're on track to achieve our annual target of $300 million in expense savings, which, as you know, contributes to funding our technology and business investments. Turning to credit quality, our metrics are presented on slide nine and remained strong. Provision for credit losses was $183 million, a $3 million increase linked quarter, as a lower provision for commercial loans was slightly offset by a higher provision for consumer loans, principally in auto and credit cards. Net Charge-Offs increased $13 million to $155 million linked quarter, and our annualized Net Charge-Offs ratio was 26 basis points.
Overall, our allowance for loan and lease losses to total loans was 1.15% as of September 30th, 2019, virtually unchanged for the previous five quarters. Non-performing loans were up $4 million, essentially flat linked quarter. Non-performing loans to total loans represent 73 basis points, consistent with the previous quarter, but down from a year ago. Total delinquencies were up $39 million or 3% linked quarter, primarily reflecting an increase in auto and credit card delinquencies, partially due to seasonality. As you know, we're approaching the adoption of CECL, the new accounting standard for credit losses, which will go into effect January 1st, 2020.
Based on our expectation of forecasted economic conditions and portfolio balances as of September 30th, 2019, we estimate that CECL could result in an overall allowance increase of approximately 20% as compared to our current aggregate reserve levels. We continue to expect the increase to be driven by the consumer loan portfolio, as longer duration assets require more reserves under the CECL methodology. Importantly, this remains an approximation, we'll further refine this estimate through year-end. In summary, PNC posted very good third-quarter results. For the balance of this year, we expect continued growth in GDP, albeit at a slower pace. We continue to expect one 25-basis-point cut in Fed funds rate in October. Looking ahead to the fourth quarter 2019 compared to third quarter 2019 reported results, we expect average loans to be up approximately 1%.
We expect net interest income to decline approximately 1%. We expect fee income to be stable to up 1%, as growth in our fee-generating activities is expected to more than offset the elevated MSR hedge gains in the third quarter. We expect other non-interest income to be between $300 million and $350 million, excluding net securities and Visa activity. We expect expenses to be up approximately 1%. Importantly, given our expense management efforts, we remain well-positioned to deliver positive operating leverage for the full year 2019. We expect provision to be between $175 million and $225 million. With that, Bill and I are ready to take your questions.
Thank you. At this time, if you would like to ask a question, please press the number one followed by the number four on your telephone keypad. Please hold while we compile the Q&A roster. And our first question comes from John Pancari of Evercore ISI. Please go ahead.
Morning.
Hey, good morning, John.
Bill, I think at a conference presentation in the quarter you had talked about 2020 net interest income and thought that it could be potentially flat or maybe down 1% or so, given the backdrop and given what you're looking at for rates. Can you just give us your updated thoughts there based upon how the curve is looking right now and Fed expectations and everything, what we can think about for NII for the year? Thanks.
I don't want to spend a whole lot of time on 2020, but since I talked about it before, we haven't seen a dramatic change. We talked about kind of down 1%, I think, on forwards. It's maybe a little bit worse than that today, but not a whole lot.
Okay. All right. Thanks. That's helpful. Separately, in terms of the newer market expansion, I wanted to get an idea if you have any indication on the returns that you're beginning to see in some of these newer markets where you've entered with both a lending product as well as your deposit gathering, but you've gone in branch light. Some of these newer markets, are you able to assess the profitability for some of these markets and how they are comparing now to some of your traditional brick-and-mortar markets?
Yeah. Two separate thoughts. The middle market expansion, we've kind of talked about a three-year break even per market. If anything, we're kind of running ahead of that. Of course, as we go through the aging of the markets we've entered a handful of years ago, they start coming online on an accelerated basis, which is one of the things you're seeing show up, I guess, in some of our loan growth. On the retail side, at this point it's clearly a net investment. What we would tell you is that the solution centers we're building are breaking even probably a bit faster than a traditional de novo branch, even though they are paying in effect market leading rates. The deposit growth rate is three and four and five times higher in some cases than what we would typically see.
That whole investment on the retail side at this point is an investment and is a net drain, but it is something long term that I think is important for our franchise.
We're encouraged by the early results.
Yeah. It's all going to plan thus far.
Okay, thanks. If I could just ask one more. On the expense side, or at least the operating leverage side, I know you're still confident in positive operating leverage for the year for 2019. Can you just talk about your expectations for 2020 in terms of the magnitude you may be looking to achieve for the year?
Hey, John, it's Rob. Yeah, absolutely. For 2019, we feel very good. We've run with positive operating leverage all year, and we expect to complete that for the full year. 2020 is premature. We haven't started our budgeting process yet, so we haven't worked through it all. Don't have anything for you this morning on that. We'll get to it later in the year, and certainly on our fourth quarter earnings call.
Okay, thanks. Understood.
Thank you. Our next question comes from Erika Najarian of Bank of America. Please go ahead.
Hi, good morning.
Good morning.
My first question is just a follow-up on the tailoring rule, and we really appreciate all the detail that you provided. As we think about the 70 basis point impact to CET1 on net 55, should we think about that as the amount allocated to an additional buyback? If so, one of your peers mentioned going back to the Fed during this CCAR year-end.
Okay
asking for that. Just wanted a little bit of color on that.
Yeah, sure. Erika, this is Rob. Yeah. The tailoring rule is largely favorable from a capital perspective. The threshold sort of relief adds 70 basis points. As of now, you'd subtract 15 for AOCI, presuming that you opt-out, which is a fairly good assumption, but we haven't made that decision yet. I think in regard to what our plans are for that capital, once the rules are finally implemented, which we expect to be somewhere in the early part of 2020, that would coincide with our CCAR process. We would take it up then in terms of what we would do from that new, at that time, official higher capital position.
Yeah. The one thing I'd mention, we obviously have a large buyback ongoing.
Yeah
today. Part of what we will need to do work on in the 2020 CCAR, is to look at the actual impact post-stress of some of these changes. We have a benefit on a spot basis, as Rob said, net $55 including AOCI, but we actually benefit a bit more in a severe stress because of the larger bucket in the SIN bucket effect. We need to work that through.
As you know, that just becomes more punitive in a severe scenario.
Yeah. In effect, our target ratio has the opportunity to decline from what we've said historically. We'll have guidance on that as we get into the new year.
Got it. I see. Just a follow-up, taking a step back. Obviously, the forward curve has been completely unpredictable. The October % in terms of the rate cut has increased just in the past few hours. As I just think about the business opportunities in terms of actually just executing strategy, the pace of business growth and lending growth as we think out to 2020, fully acknowledging all the different, that the economy could be slowing down, there's a volatility of presidential election. Does it feel like this pace of business growth can continue in 2020?
I think it can. Part of what gives us the degree of confidence we have is just the market expansion that we've done. We've been able to grow in effect by pulling share in newer markets without having to push on credit risk or other levers. Importantly, we've been able to grow fees concurrent with growing clients. I think that will continue. For the overall economy, the consumer's holding it up today as manufacturing weakens, and we'll see how long that is sustainable. The final comment I'd make, and I appreciate your comment on the fact that the forward curve's swinging all over the place. We put a NII guidance, and part of the issue, of course, is in the course of the last week, we've seen a Fed move get taken off the table, put back on the table, taken off the table.
Right.
When I get a question as to what NII is going to do next year, the best way I ought to answer it is to say that no matter what happens here, it's not a big move from where we are. We're not dependent on it. On a given day last week, I would've told you that it would've been down less than 1%. The day after that, it was going to be more.
One and a half %.
Yeah. It isn't critical to our business model at this point. We can obviously survive it, and we feel really comfortable about growing clients and the related portfolio of products that we serve those clients with, which gives us good fee momentum.
Great. Thank you.
Thank you. Our next question comes from the line of Betsy Graseck of Morgan Stanley. Please go ahead.
Hey, good morning.
Hi, Betsy.
Good morning.
Just one quick follow-up on that. When you think about the NII outlook, I understand it's not really a major driver of what you're going to be able to do, but just wondering, the 1%, does that include the LCR benefit you talked about? It's like 30-80 basis points or something like that.
No.
No.
Okay.
No.
All right. Yes, the LCR would be ameliorating that outlook. Okay, got it. I guess the other thing I get questions on, more from cross-asset class investors is we're seeing some little, I don't know, I don't even want to call it stress, but we're seeing a little bit of cracks in maybe CLOs or leverage loans. Spreads are beginning to widen. I look at your results and others and corporate just looks fantastic. Why do you think that is? Why do you think we're, in some parts of the market, seeing a little bit of stress, but in other parts of the market we're not seeing delinquencies go up meaningfully? I know you got a big C&I book, so I thought it would be a good question for you.
I'm trying to figure out how to answer that question without being critical of non-bank lenders.
Good luck.
I think that participants who pushed on credit to get deals struggle when there's any slowdown at all. Of course, we've seen that in manufacturing. It's starting to show up in some of the credit stats. We didn't push on that box. To the extent that the economy slows and our clients get downgraded, we'll have elevated provision through time. We just really haven't seen a crack with idiots or, sorry, with systemic risk across any part of our portfolio.
Because deliberately, we're not at the line or on the edge.
Yeah
which these others are.
Yeah. The quality of your book, obviously, we see coming through in delinquencies and NCOs and things like that. I don't know if there's any other details you could give maybe in the cure care or something like that around ratings and rankings. I suppose you do already, and I just need to find it, but that would be helpful just given your skew.
It's all our criticized and classified stuff is out there is probably what.
Yeah
we disclose to you.
Yeah.
Bizarrely, our corporate guys would probably, well, not probably, they would definitely tell you that a slowdown ultimately helps that business. Might hurt in the immediate term, asset-based lending spreads increase business volumes.
Less competition.
Yeah, less competition across the whole space. We're fine with where we sit. It's the same book we've had for the last 15 years.
Yep, got it. Thank you.
Yeah.
Thank you. Our next question comes from the line of Scott Siefers of Sandler O'Neill & Partners. Please go ahead.
Thank you. Good morning, guys.
Hey, Scott.
Hey. Just wanted to ask on the other non-interest income guide. The $300-$350 in the fourth quarter.
Yeah
is higher than the typical $250-$300.
Right.
It includes that business sale gain that you guys will close hopefully in the fourth quarter. I guess I'm just curious if you could either, one, give sort of order of magnitude of that anticipated gain or two, are we getting to a point where you have enough of a confidence that we sort of stay in this more elevated range?
No, I think, Scott, it's a good question. You're right. Historically, we have some volatility in that category quarter-over-quarter, but it tends to average out at around $300 million. If you look at the last three quarters of 2019 and then the previous four quarters in 2018, you do that average, it's around $300 million. Our low, I think was the first quarter of 2018, which was $249, and our high was second quarter of 2019, which was $364. That just gives you a sense of the order of magnitude, but it averages out around $300. I'm guiding up for the fourth quarter above that because of the announced sale of our proprietary mutual fund, which is about that magnitude. We're going up about $50 million, the $300-$350, that's why.
Okay
as we would expect.
Okay. That's perfect. I appreciate the-
Yeah
clarity on that.
Sure.
I was hoping if I could switch gears just a second to just the competitive dynamic on overall deposit costs. Sounds like you guys are pretty confident about an acceleration in decline in deposit costs in the fourth quarter.
Yeah.
Maybe just some broad thoughts on what you see going on. Are these just natural longer-term stuff sort of rolling off, or are you having some success in taking down rates, et cetera?
I'll start, Rob.
Yeah, okay.
You can jump in. I think, and you've heard us talk about this, we aren't fighting for deposits per se today. Our loan to deposit ratio was kind of around the level it's always been in the low 80s. We have taken down our rate on the national digital strategy, we're not one of the top posters there. We have been able to lower consumer promo rates and still grow deposits in households the way we want to. It seems to be working. The one thing I would tell you is that the one place where we see a lot of competition, we saw it throughout the third quarter and continuing is in small business banking where rate paid for small businesses, which give rise to a big chunk of deposits that are sort of retail-like, is really high.
That's one of the reasons our deposit costs didn't decline as much as they otherwise would have in the third quarter.
Yeah.
That's the one spot I can think of.
Well, I think that's clearly an impact. It's also just a lot of the moves that we made following the July rate cut are starting to take hold.
Yeah.
On the consumer side, you're just going to see rates that actions we've already made now show up in full force in the fourth quarter.
Yeah.
It hasn't affected our flows.
No.
Yeah. That's terrific. Thank you, guys.
Yeah.
Thank you. Our next question comes from John McDonald, Autonomous Research. Please go ahead.
Hey, good morning. Rob, I was wondering.
Hey, John.
could just ask you about the dynamics around the outlook for NII next quarter. You've got the average loans up-
Yeah
NII down a little bit. I guess with the deposit pricing maybe inflecting down, could we see the NIM decline a little bit less, next quarter than this? Are there some other factors at play there?
Yeah. Maybe, John. You're on it. That's the calculation. I think the biggest variable will be one-month LIBOR and how that affects our commercial loan yields. I think that's the biggest sort of unknown variable, and we'll have to see.
Yeah. You got the loans up, so you're expecting some degree of margin compression.
Yeah.
You're not sure how much, but overall guess is NII down a little bit.
Yeah. That's right.
John, the other thing that's rolling through everybody's income statement to one degree or another is amortization cost on mortgage-backed securities.
Correct.
The premium amortization.
Yeah.
We actually benefited a little bit in the third quarter versus what we thought we would have because rates sold off. I think that's going to drive a lot of people, and that will impact us at the margin as well, which is, of course, longer-term rates. The 10-year more so than what's happening in the front end.
Okay. Is that a little bit of a delayed impact of what happened already in the 10-year, Bill?
No. In the end, if the 10-year trades around 150, I'm making up a number, for the quarter, prepays are much higher. If it's up in the 70s, they're much lower. We put a forecast out there that was somewhere in between.
Right.
That-
That's your flexible line.
swings around $5 or $10 million either way. We have a small mortgage book relative to others. I think that's an industry phenomenon right now that's causing forecasting this number.
Right
to be a little tough.
Got it. Just on the 2020 outlook, understanding it's too early to get too precise there, but assuming in that outlook, which is generally reassuring about the ability to kind of grow with the forwards and keep NII relatively to a small decline. Rob, you're kind of assuming in those simulations, loan growth in the same ballpark that you've had kind of mid-single digits type of thing in that simulation?
Lower. Yeah, a little. Still loan growth more in line with our strategic plan, which is lower mid-single digits.
A little less than we've done this year.
Yeah. A little less. For five and a half, six, a little less than that.
Lower end of mid.
Lower end of mid. Yeah, right. Higher end of low.
Nothing heroic.
Yeah, nothing heroic. That's right.
Got it. Okay. Thank you.
Sure.
Thank you. Our next question comes from Matt O'Connor, Deutsche Bank. Please go ahead.
Hey, guys.
Hi, Matt.
I kind of focus more on the average loans and deposits. You did reference the period-end jump in deposits, in part driven by the new sweep strategy and asset management.
Yeah.
And obviously-
Right
period-end loans were flat. I guess the first question is, should we be thinking about the jumping off point more using the period end than average? If so, what do you do with all those extra deposits, both that you got this quarter and that'll come in from the sweep effort that you have?
I'll jump in on some of that and see if that answers your question. I think on the loans, the spot being below the average was entirely due to the multifamily sort of seasonal spike and some activity spike that we saw in the third quarter. Our loan guidance for the fourth quarter is up approximately 1%. We account for that. We see good activity coming up off those spot numbers in the fourth quarter. On deposits, we like deposits. More deposits are good. The AMG sweep was a bit of a one-timer. Everything else is in line with what we would've expected.
Hey, Matt, that loan growth guidance is off of average balances.
Yeah. I'm sorry. The loan guidance is off average-
Yes
Leaving with the spot will make the average.
Yeah.
Yeah.
Okay. The asset management sweep is just a one-time $4 billion versus
It'll vary around there. It's something most of our peers have done in the past. We just kind of moved it over and offered it to our clients. Maybe it'll grow with our client franchise. Not beyond that.
Right.
Okay. Helpful. Then just separately, the proprietary mutual fund business that you're selling, should we be mindful of the revenue and expense kind of impact going forward? Have you provided those numbers?
No, we haven't, and they're immaterial.
Okay. Just remind us what's left with kind of the PNC, I guess you used to call, like, advisor, and the strategy there?
Within our Asset Management Group, we have three segments, PNC Wealth Management, our institutional investments, and Hawthorn, which collectively we manage in excess of $300 billion in assets for our clients. The sale of the proprietary business, Matt, was really something that was a return to our past. Prior to a lot of the acquisitions that we made when I ran the business, we didn't have proprietary mutual funds. We were committed to open architecture, which we still are. Through the acquisitions that we made, and maybe this is more than you want to know, through the years, we picked those up, and they were good, but our core philosophy is advisory, and the open architecture is much, much more conducive to that.
Yeah. Another way to answer the question, we basically won't be in the manufacturing business except for some small short-term liquidity funds that we run for corporates in the institutional side.
Okay, perfect. Thank you.
Sure.
Thank you. Our next question comes from Ken Usdin of Jefferies. Please go ahead.
Thanks. Good morning, guys. On the fee side, it's good to see that the outlook is stable to plus one, especially given that you had that pretty healthy MSR gain this quarter of $40 million. I know there's some normal seasonality, but can you kind of talk us through just what your expectations are, especially given your prior answer that there's no immaterial loss from the sale of the mutual fund business, just how you expect things to trend within where the leaders and laggards are? Thanks.
Sure. Just on the fee side by category, for approximation, asset management, we'd expect to be sort of stable, maybe up a little bit. Consumer services up a bit, consistent with what they've been doing for some time on a quarterly basis. The big driver for the fourth quarter in terms of our increase will be on the corporate services side, which typically has a higher fourth quarter. Our pipelines would indicate that. Mortgage is probably stable to down a little bit just because of the MSRs and maybe some margin compression.
Great. Understood. Okay. Thanks, Rob. As a follow-on on the commercial side. Just bigger picture, the state of the commercial customer. You just mentioned still good pipelines on Harris Williams. Any changes to what you're seeing in the conversations and dialogues with commercial customers' willingness to do deals, invest in plant and equipment, et cetera, just given the big picture points that Bill made in his intro? Thanks.
Look, it's been muted, and we're hearing that from our customers is they're cautious in this environment the way you would expect them to be. We have seen, for what it's worth, given the recent rate rally, a lot of hedging activity. One of the things that's inside of our other line, Rob, is our Capital Markets, FX and derivative activity. That has picked up a lot, which is a big driver of fees inside the other line. No, there hasn't been a turnaround in sentiment on the corporate side. Small business is different. They're still bullish.
Yeah.
The consumer is still bullish, but the larger corporate is holding back, and we're seeing that.
One more thing just on the commercial side. Rob, your point on commercial fees, is that both the CMBS business and Harris Williams, or are they both acting pretty well?
Yeah. They both are. They're both acting pretty well.
TM as well, right?
Well, yeah, Treasury Management, of course. Yeah. Treasury Management's the largest component, but the sometimes seasonal or quarterly variances come more through Harris Williams than M&A advising.
Capital Markets.
Capital Markets.
Okay. Thank you.
Sure.
Thank you. Our next question comes from Mike Mayo, Wells Fargo Securities. Please go ahead.
Hi. Your efficiency improved 60% to 58% year-over-year. My question relates to how much of that is driven by what you're doing in the back office with technology? Could you just give us some more information about kind of what you're doing behind the scenes with tech? Like, I don't know, number of data centers at the peak, number of data centers you have now, and where that might go, or how much you've enabled to go to the public cloud, or how far along you are with that or some other metrics that show kind of what you're doing with your technological infrastructure.
I don't know how to answer that question inside of four hours. Mike, I think what technology has enabled us to do is to continue to grow the franchise without growing the kind of core cost base. You're starting to see that show up in the positive operating leverage we have. There's a million little benefits that we get that are too numerous to name, from everything on how fast it is to spin up a server, to how quickly you can change an app and release it, to the offerings we have for our commercial clients in PINACLE, on our TM side, on all of these things.
The margin.
at the margin make a difference. The savings we are getting finally out of the mortgage business, having replaced the servicing and origination platforms there and the digital experience we're offering to customers. Technology is showing up everywhere in the way we service our customers, and it's showing up in our operating leverage simply because it's allowing to scale without a commensurate increase in cost. Maybe that's the simplest answer I could give you. I know you're asking with your technology hat on, so I'll spend a second on what we're doing in core data center and cloud hybrid. We have chosen, for the time being, to basically run a hybrid model. We have an internal cloud.
We have the capability through a container layer to burst through to public cloud when we need it for excess compute, for test environments and other things where it's efficient to do so. We will run that hybrid model. Our plan is into the future. We do not see a benefit in cost savings by going to pure cloud, at least in an environment that we think we want to operate in as it relates to security and soundness and safety and cyber and so forth. As you know, we've been at this for the better part of probably seven years now. Most of those investments are kind of behind us, and you're also starting to see that show up.
Well, the data centers.
with a decrease in the acceleration of our equipment line.
Our height data centers was 13, and now we're three.
Yeah.
Yeah.
Is that enough?
Yeah. Yeah, no, that's good. No, look, I think you summed it up. Tech allows you to grow without growing expenses. 13 data centers down to three. One more attempt. I think you guys have done a little bit more with the cloud or cloud-enabling your apps. How many apps do you have, and how many might eventually go to the cloud? I know that's very technical and specific. Just a little bit more meat on the bone.
Mike, apps don't run in the cloud. I'm thinking of an app as a digital app. An application runs in the cloud. Virtually 100% of our applications today are cloud enabled. We're cloud native for everything. Our choice to put it in a public cloud is our choice.
Right.
It is not a decision or a work set we have to do to enable that application to then run in a cloud.
Yeah.
Every system that can be cloud enabled has been cloud enabled at this point.
Yeah.
That's what you mean about having done the hard work. You've cloud enabled. Now that you have a choice, what % do you think you might eventually transition to the public cloud?
I think it will be a small %. We'll certainly use it for some of our test environments where we need compute. Tests tend to have the potential to take servers down.
Correct. Yeah.
There's certain of our non-critical information applications that we could choose to run in the cloud. Of course, we have vendors who run in the cloud. I should clarify, Mike, we still are dependent for certain applications on mainframe. That is the last nut to crack for banks to get some of their core operations off a mainframe. We are not entirely there yet.
Sure. Well, that's helpful. All right. Thank you very much.
Yeah.
Thank you. Our next question comes from Kevin Barker of Piper Jaffray. Please go ahead.
Good morning.
I think that's Bill.
Just in regard to the consumer, some of the consumer lending picked up quite a bit in the third quarter. I'm assuming some of that is seasonality, but you also saw quite a bit of pickup in auto and residential real estate. Is there anything in particular that's occurring in the consumer that you're seeing a pickup, whether it's internally at PNC or just in general with seasonality?
The only thing that I think is perhaps different is on the mortgage side, the residential side, just the volume that we're doing through the new technology. Our volume is up. I don't know what the percentage is quarter-over-quarter or year-over-year, but high percentages, and frankly, without kind of the new system running in the background, we wouldn't have been able to do that volume. That's probably the only real change. We've been at the credit card game, largely converting our existing clients to our lending products. We've been at that for a long period of time and continue to have success.
That's the biggest driver.
Yeah.
We've had a strategic objective to grow our consumer loan book, which was and still is under-penetrated relative to what we can do. Strong growth in card, auto, residential mortgage reflecting that.
Good.
We've seen some headwinds on delinquency and loss rates on the auto side. Would that change any of your appetite in the near term, given you've been growing that portfolio quite a bit in the last year?
Yeah. Delinquencies are up at the margin, partly due to seasonality, but also partly due to some vintages a year or so back, and inside of our risk band, but at the lower end of prime. It's likely we'll dial that back in terms of originations. In truth, we've already done that, though.
Right.
I don't know that you're going to see that slow down our growth. It's just we won't be in the bucket that's causing the roll forward and the spike of delinquencies you're seeing.
Okay, we should see a little bit of a settling down just because of the mix of the back book versus the front book. Is that the way to think about it?
I think so, yeah.
Okay. All right. Thanks for taking my question.
Yeah.
Thank you. Our next question comes from Gerard Cassidy, RBC. Please go ahead.
Good morning, Bill. Good morning, Rob.
Hey, Gerard.
Bill, can you expand upon, obviously, you've had success in growing outside the traditional PNC footprint with your Treasury Management products on the commercial side. In the wins that you've had, can you share with us what's driving the wins? Is it the quality of the product, or do you price it so attractively that the person wants it or the company wants it, and then you can cross-sell other products into it to better build that relationship? What's really leading that success?
Well, it is not pricing. We don't differentiate pricing in markets, old markets, or established markets. Look, we hire really good people, and we're very patient. What you're seeing is today, as a result of seeds that we planted three and four, and even five years ago, if you go back to some of the stuff we've done in the Southeast. We hire good bankers. We call. We have good ideas. We eventually get a shot. Our TM product is such that once you get in the door, we have the ability to continue to show new ideas. We're always working with them. The ability to kind of upsell the initial offering, given all the products we have in TM, is pretty strong.
Through time, we move from being a participant in somebody else's credit deal to being right lead to left lead, that's just played out for us. You start with good people. You're consistent. You show good ideas. You have good products and services. You pick the right clients to begin with so that when we enter a market, we know the top 50 clients we want to bank. We don't get the 50 that will have us. We'll be very patient to get the right 50. We've been at this for a while, it's starting to play out.
I would add to that, and we've covered this on previous calls, that so-called top 50 that we've targeted, that Bill pointed out, the receptivity of those companies to our calling effort is very high.
Yeah.
Once you're accepted and that receptivity is encouraged, then we're just running our plays like we do everywhere else. We know how to compete. The key is the ability to have that dialogue.
But to-
And-
What's the num-
Go ahead, Bill.
How many markets have we opened since Mike started this?
I'll do it again. Let's see. Yeah, you're not.
We've grown from 12 to 30, and we're at 26.
Yeah.
We've opened 10. You think about the investment we put into it, right? We invested $, negative carry on 10 new markets, and people and community support and everything else, and we're finally starting to get into the return on that investment.
Yeah. That's right.
Very good. When you target those markets, you mentioned these 50 companies that you target. What's the sales size of a typical success story? Is it somebody with $250 million in revenue or quite a bit higher or lower?
It's all over the place. We do less on the commercial side, the smaller commercial, more on the mid-market to large corporate. I would tell you one of our largest wins this year was a Fortune 100 company in a new market.
It just depends. We happen to have a solution that that particular client needed that nobody else was selling.
Yeah, I think it's fairly similar, like you say. Those new markets where they differ than a legacy, they're just the lower end isn't there. It's middle market and above.
Very good. Coming back to profitability, you addressed the issues on capital and potentially giving back more capital next year with the tailoring rules, which obviously would boost your ROE. When you look at PNC going back many years, I know the world has changed from the 90s when PNC was able to earn ROAs in the high 1% range, I'm not suggesting you can get there today because of the new regulations you all have to deal with. What do you think peak profitability for a company like yours today, not so much an ROE standpoint, but more from an ROA standpoint? Is it where you are now, or is there actually room for improvement to bring it up to north of 150 on ROA?
I don't know. You can come up with so many iterations. Look, our margin, I was looking at this the other day. Our margin coming out of the crisis was 408-
Right.
including our accretion accounting.
Right.
Give me low provisions and the right interest rate environment, and I'll-
Have a poor handle on, yeah.
Yeah.
your margin. Right.
We'll show you a return on assets that's high. I think through time, right, drivers, take the interest rate curve out for a second. I think through time, our growth in fees continues, and that if anything, becomes a larger percentage of what we do, which in turn will drive up our ROA, all else equal across the interest rate environment and the basic notion that we aren't changing our credit mix. Whether you can go from where we are today to 150 is dependent, I think, more on the yield curve than what we can do in fees.
Yeah. It's a math drill.
Yeah.
Gotcha. All right. Appreciate it. Thank you.
Sure.
Yeah.
Thank you. Our next question comes from Saul Martinez of UBS. Please go ahead.
Hey, good morning, guys. I wanted to go back to capital and your capital strategy. Your CET1 is 96%. Even if you opt out of the OCI, the tailoring takes you to 10.1%. CECL's not really a material hit to your capital base, the day one impact, at least. I believe you guys have said your optimal capital, optimal CET1 is around 8.5%, and I think you mentioned you could even bring that down further. Once you get some of the questions that you kind of laid out answered on stress losses, how quickly can you bring your CET1 down to optimal levels, assuming no real acceleration in risk-weighted asset growth? Is this over a CCAR cycle, over a few CCAR cycles? How do we think about the glide path down to what an optimal capital level is?
Well, you hit all the variables. The numbers are basically right.
Yeah. Numbers are good.
Yeah. It is the right question, but I think we owe you further guidance on that, and I'm just not going to give it until we get into the fourth quarter and start working on next year's CCAR. Obviously, we could buy it down quickly. I don't know if that is the best thing to do for shareholder value long term. I think notwithstanding the near-term ROE impact, the practical implications of carrying excess capital. If that's what we choose to do, is it material long term, as long as we don't waste that capital, right? We're good stewards of the capital. Whether we buy it down in a hurry or we do it through the course of a year, we'll get to the right place and we'll do it intelligently. We'll give you more background on that as we start the work on CCAR 2020.
Yeah. Having that additional flexibility is a good thing.
Yeah.
Got it. What are some of the variables you think about in terms of answering that question for yourself?
Well, the biggest one right now.
How quickly you get there.
Yeah, the biggest one right now is the opportunity that might be presented by some of the chaos in the market.
If in fact, and we don't believe this to be the case, but if in fact there's a slowdown, we'll use that slowdown to accelerate. I think there'll be a lot of opportunities for us to do that. I'd hate to be in a place where, for the sake of driving up ROE near term or a few cents per share that we get from buyback, I'd hate to be in a place that we can't take strategic advantage of a slowdown to grow assets and clients and so forth.
Right.
That's the biggest one.
The intelligence required rather than.
Yeah.
Yeah.
Right. That's helpful. If I could change gears a little bit, how do you think about how the lower rate environment impacts your national digital strategy, if at all? You have been using higher cost CDs as sort of a client acquisition tool in these markets, and with lower rates, arguably that becomes less attractive, those CDs. Does a lower rate environment, you think, hinder your ability to grow in expansion markets?
First, to clarify, we haven't been using CDs. It's kind of been posted money market rates.
I see.
We've, in the course of our sort of experimentation across markets, we've probably grown 20%-25% of our total clients in straight traditional DDA account, our Virtual Wallet product.
Okay
impacted by rates. Obviously, the yield seekers will be less active in a lower rate environment, and we take that into account as we think about this going forward. It's one of the reasons why we continue to think our branches matter. It's one of the reasons brand matters. It's one of the reasons feet on the ground matter. All of that stuff we're thinking about as we plan for the future.
That strategy is not simply reliant on high rates.
Yeah.
Right. Okay. All right. Thanks a lot. Appreciate it.
Thank you. We have no further questions.
All right. Well, thank you everybody, and we'll see you in the fourth quarter.
Thank you.
Yep.
This concludes today's conference call. You may now disconnect.