Good morning. My name is Edison. I'll 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'd like to ask a question during this time, simply press the number one followed by the number four on your telephone keypad. If you'd like to withdraw your registration or question, please press the one and then the number three on your telephone keypad. As a reminder, this conference is being recorded. I'll now turn the call over to the Director of Investor Relations, Mr. Bryan Gill. Sir, please go ahead.
Thank you, Edison. 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 July 17th, 2019, and PNC undertakes no obligation to update them. I'd like to turn the call over to Bill.
Thanks, Bryan, good morning, everybody. As you've seen this morning, PNC reported net income of $1.4 billion or $2.88 per diluted common share for the second quarter. By virtually every measure, it was a successful quarter. You saw we generated really strong growth in loans and deposits. We grew total revenues, both NII and non-interest income increased, managed expenses well, generated positive operating leverage, and delivered strong returns. Building on the strong first quarter, we're pleased where we sit on performance through the first half of this year. Credit quality remains strong. We continue to see no cracks really on either the commercial or the consumer side. Our loan growth this quarter continued to be driven by the commercial side, we did see growth in consumer as well.
Inside of our strong commercial loan growth, we saw a drop in yields, consistent with lower interest rates, LIBOR sets basically, some further spread compression. The effect was particularly impactful on the margin this quarter. At the same time, we continue to have great success in cross-selling fee-based products to these clients, our economic profit on the total relationships continues to be really healthy. Pipelines are solid going into the third quarter. Sales in our corporate banking segment in June actually tied a monthly record high, treasury management and capital markets revenue also set quarterly records. In terms of market expansion, we continue to generate strong results in C&IB with our new markets, we will take our middle market corporate banking franchise into two additional markets next year with moves into both Portland and Seattle.
On the retail side, our national digital expansion effort continued to make good progress this quarter. Our high yield savings product continues to be an attractive entry point for new customers in our expansion markets and beyond. We've now opened three new branch locations under our Solution Center model in Kansas City and Dallas to support our digital offerings and outreach in our expansion markets. We've been very pleased to see the growth in those branches. They're growing at nearly five times the pace we'd expect for a de novo branch in our legacy markets. Looking ahead, we plan to accelerate the pace of new Solution Center openings over the next 18 months or so in Boston, Dallas, Houston, and Nashville. We continue to return capital to shareholders, even as we maintained a strong capital position.
I'm sure you've seen we recently announced a 21% increase in our quarterly cash dividend on common stock, raising the dividend to $1.15 per share, on top of a substantial increase in our share repurchase programs. As we look at the current environment and the remainder of the year ahead, there's obviously some uncertainty in the economy and the outlook for rates. That, of course, is beyond our control, but we will continue to invest in our businesses, particularly in customer-facing innovation, to keep improving the customer experience and further expand our product and service offerings to meet our customers' evolving needs. As always, I want to thank our employees for the continued hard work. With that, I'll turn it over to Rob to take you through our second quarter results in a little more detail.
Thanks, Bill, and good morning, everyone. As Bill just mentioned, we reported second quarter net income of $1.4 billion, or $2.88 per diluted common share. Our balance sheet is on Slide four and is presented on an average basis. Average total loans grew $6.3 billion, or 3%, to approximately $235 billion linked quarter. Loan growth compared to the second quarter of 2018 was $12.2 billion, or 5%. Investment securities of $83.6 billion increased $1.3 billion, or 2%, primarily due to purchases of agency RMBS. Securities increased $6.1 billion, or 8%, year over year. Our cash balances at the Fed averaged $13.2 billion for the second quarter, down $1.5 billion linked quarter, and $7.5 billion year over year. Deposits grew $5.7 billion, or 2%, linked quarter, and $11.9 billion, or 5%, year over year.
As of June 30th, 2019, our Basel III Common Equity Tier 1 ratio was estimated to be 9.7%, compared with 9.8% as of March 31st, 2019. Our tangible book value was $80.76 per common share as of June 30th, an increase of 12% compared to a year ago. Our return on average assets for the second quarter was 1.39%, up 5 basis points from the first quarter. Our return on tangible common equity was 14.82%, an increase of 69 basis points. Slide five shows our loans and deposits in more detail. Average loans grew $6.3 billion, or 3%, over the first quarter, with broad-based growth in both commercial and consumer lending. Commercial lending balances increased $5.4 billion, or 3% linked quarter, with particularly strong growth in our secured lending portfolio.
On the consumer side, balances increased approximately $900 million, or 1% linked quarter, with growth in residential real estate, auto, and credit card somewhat offset by runoff in our home equity and education loans. Compared to the same period a year ago, average loans increased 5%, or $12.2 billion. Average deposits increased approximately $5.7 billion in the second quarter compared with the first quarter, reflecting growth in both commercial and consumer deposits. The growth was primarily in interest-bearing deposits. However, average non-interest-bearing deposits posted a small increase as well. Compared to the same quarter a year ago, average deposits increased by $11.9 billion, or 5%. As you can see on Slide five, our capital return to shareholders has been substantial over the past several years through a combination of share repurchases and dividends while maintaining an overall strong capital position.
In the second quarter, we completed the common stock repurchase programs we announced last year. Last month, we announced a new plan to repurchase up to $4.3 billion of shares over the next four quarters. This represents a 48% increase over our recently completed share repurchase programs. Additionally, last week, our board of directors approved a 21% increase in the quarterly dividend to an all-time high of $1.15 per share, effective with the August dividend. As you can see on Slide six, first quarter total revenue was $4.4 billion, up $153 million linked quarter, or 4%. Net interest income was up $23 million, or 1%, compared with the first quarter. Non-interest income increased $130 million, or 7% linked quarter, reflecting seasonally higher fee income as well as an increase in other non-interest income.
Non-interest expense increased $33 million, or 1%, compared with the first quarter, as expenses continued to be well managed. Provision for credit losses in the second quarter was $180 million, a $9 million linked quarter decrease. Our effective tax rate in the second quarter was 16.6%. 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 $23 million, or 1%, compared with the first quarter. The increase reflects higher loan balances as well as an additional day in the quarter, partially offset by lower commercial loan yields and higher interest-bearing liability balances.
Net interest income grew $85 million, or 4%, year-over-year, driven by higher earning asset yields and balances, which were partially offset by higher funding costs and balances. Net interest margin decreased to 2.91% in the second quarter. The primary driver of this decline was commercial loan yields, which were impacted by a decrease in LIBOR rates as well as narrower spreads. Additionally, deposit rates increased 5 basis points during the quarter. Non-interest income increased 7% linked quarter and 2% year-over-year. Importantly, fee income grew 5% linked quarter, with increases across all fee categories. The main drivers of the $71 million linked quarter fee increase were asset management revenue, which includes our equity investment in BlackRock, increased $8 million, reflecting higher average equity markets. Consumer services increased $21 million, and service charges on deposits increased $3 million due to seasonally higher transaction volumes and customer growth.
Corporate services increased $22 million, driven by higher treasury management product revenue and loan syndication fees. Residential mortgage non-interest income increased $17 million due to higher loan sales revenue and a positive RMSR valuation adjustment, partially offset by lower servicing revenue. Finally, other non-interest income increased $59 million linked quarter, reflecting higher capital markets-related revenue, including a record quarter in our corporate securities business and asset sale and valuation gains. Second quarter other non-interest income included a gain on the sale of the retirement record-keeping business, which was announced in the first quarter and was included in our second quarter guidance. In the third quarter, we expect other non-interest income to be in the range of $250 million-$300 million, excluding net securities and Visa activity. This reflects our expectation for lower asset sale gains compared with the second quarter.
Turning to Slide eight, second quarter expenses increased 1% for both the linked quarter and year-over-year comparisons as our expenses remain well controlled. The largest percentage increase was in our marketing expense, which supports our national retail digital strategy. Our efficiency ratio improved to 59% in the second quarter, compared with 60% for both last quarter and a year ago. Expense management continues to be a focus for us, and we remain disciplined in our overall approach. As you know, we have a goal to realize $300 million in cost savings through our continuous improvement program, and we're on track to achieve our full-year 2019 target. Our credit quality metrics are presented on Slide nine. Overall, our credit quality remains strong, and we continue to see strength broadly in both our commercial and consumer portfolios.
Provision for credit losses was $180 million, a $9 million decrease linked quarter. Net charge-offs increased $6 million - $142 million linked quarter, and our annualized net charge-off ratio was unchanged at 24 basis points. Overall, our allowance for loan and lease losses to total loans was 1.15% as of June 30th, 2019, virtually unchanged from the previous four quarters. Non-performing loans were up $71 million or 4%, driven by the commercial portfolio. Total non-performing loans to total loans represent 73 basis points, a small increase in the quarter, but down year-over-year. Total delinquencies were down $127 million or 9% linked quarter, reflecting a decline in both commercial and consumer delinquencies. 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.
We've been in parallel run since the beginning of this year, based on our expectation of forecasted economic conditions and portfolio balances as of June 30th, 2019, we estimate that CECL could result in an overall allowance increase of 15%-25%, as compared to our current aggregate reserve levels. The majority of the increase is expected to be driven by the consumer loan portfolio, as longer duration assets require more reserves under the CECL methodology. Importantly, these are still estimates at this point, and we will continue to refine them through the balance of 2019. In summary, PNC posted very good second quarter results, which contributed to an overall strong first half of 2019. For the balance of this year, we expect continued growth in GDP, albeit at a slower pace over the second half of 2019.
We now expect two 25-basis-point cuts in the Fed funds rate in 2019, one in July and one in October. Looking ahead to third quarter 2019 compared to second quarter 2019 reported results, we expect average loans to be up approximately 1%. We expect total net interest income to be stable. We expect fee income to be up low single-digits. We expect other non-interest income to be between $250 million and $300 million, excluding net securities and Visa activity. We expect expenses to be stable, and we expect provision to be between $150 million and $200 million. Turning to Slide 12 and taking into account our third quarter guidance, we'd also like to take this opportunity to reaffirm our full-year outlook.
Our income statement guidance remains intact. We're increasing our outlook for average loan growth based on the strong performance we've experienced in the first half of the year. We're now expecting full-year average loans to be up approximately 5%. We expect the net interest income benefit of this incremental loan growth to partially offset the lower than expected rate environment, which will support our ability to achieve our original full-year revenue target. Importantly, in the first half of 2019, we generated positive operating leverage and remain well-positioned to deliver positive operating leverage for the full-year of 2019. With that, Bill and I are ready to take your questions.
Edison, could you poll for questions, please?
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. Your first question comes to the line of John Pancari with Evercore. Please proceed.
Morning.
Hey, John.
Morning, John.
On your guidance for the full-year, it's good to see the revenue outlook unchanged despite the rate backdrop. I'm wondering if you could break out that revenue expectation at the higher end of the low single-digits between what your expectation would be for the full-year for NII versus fees. It seems likely that your fee outlook is improving here and helping keep that revenue outlook unchanged in the backdrop of the lower rate environment.
Hey, John, this is Rob. When you take a look at in terms of our full-year guidance, what we originally expected, we said the upper end of the low single-digits, probably at that time, a little more in NII and a little less in non-interest income. Fast-forward to today, accounting for now a rate environment where we expect declining rates, we'd see the NII back off a little bit and the non-interest income pick up. NII is not down as much as it would be, as I pointed out in my comments, because of the higher than expected loan growth. Probably a little bit more to answer your question, probably a little bit more equal contribution both from NII and non-interest income.
Yeah.
John?
Rob.
Yeah.
To be clear, though, what Rob's saying, NII down a little bit, it's relative to our guidance
Expectation
of the
Yeah. Of our original expectation. That's right.
Right. Got it.
Yeah.
Okay. As it pertains to NII, can you give us a little bit more granularity on how you see the margin trending? I know previously you looked for a couple basis points impact through the remainder of the year, but curious what your expectation is now that you're looking for cuts. Then also, what would be the NII or NIM impact of 25 basis point cut each? Just curious on your rate sensitivity. Thanks.
Cool. We could both jump in.
Yeah, sure.
This was a bit of a weird quarter, John, because the LIBOR sets kind of got in front of the expectation that the Fed's going to cut. We had that drop in loan yields that wasn't really offset by any drop in deposit rates and other things. I don't know that you're going to see a drop like you saw this quarter. Interestingly, all of what we saw, or virtually all of it, was on the asset side as opposed to the liability side of our balance sheet here. I think going forward, and we do have two cuts in the forecast, you'll still see NIM under pressure, but it shouldn't be at all like the drop we saw this quarter. Having said all that, there's a million caveats to mix and other things in there that affect that.
Yeah, I think I can add to that. Just in simple terms, this quarter, interest-bearing assets were down, largely driven down by commercial loan yields. On the liability side, we actually went up 1 basis point because even though borrowings came down, the deposit rates were up. Going forward, we can expect
Well, the deposit rates are up because of mix shift
That's right. Yeah
not because of betas. Yeah.
Competitive factors. Going forward, we see the liabilities be more in tandem, so less compression to Bill's point. On the NII itself, in terms of the approximate amount relative to the two cuts that we have, we approximate that to be about $100 million.
Relative to our-
Yeah, relative to what it would've been otherwise.
If you didn't get the cuts.
If we didn't have the cuts, right.
Got it. Okay.
Yeah.
All right. Thank you.
Sure, John.
The next question comes to the line of John McDonald with Autonomous Research. Please proceed.
Yeah. Hi Bill, the loan growth came in. A little more color on where things have been picking up, where they might and how versus the legacy?
Hey, John, you're breaking up a little bit. You there? Okay, let's go to the next question. We'll get it comes back.
Yeah, we'll do the next question, yeah.
The next question comes to the line of Betsy Graseck with Morgan Stanley. Please proceed.
Hi. Good morning.
Hi, Betsy.
Hi. I wanted to understand a little bit more about the loan growth that you generated this quarter. You guys are known for being very conservative and careful, and this is really eye-popping growth. Just wanted to understand what the drivers were, in particular on the C&I side, and what kind of legs do you think this has? Just want to see if this was a really unusual quarter or if there's more to come.
Yeah, hey, Betsy, it's Rob. I can start. We had a great quarter in terms of loan growth, as you've mentioned, largely on the commercial side, although consumer growth was good, too. On the commercial, I think it was a bit elevated in the second quarter. The primary drivers of our loan growth, which we'd expect to continue, maybe not at the same rate. We are in new geographies, all of which are doing well. In this quarter, similar to what we've been seeing for the last couple of years, really, strong growth in our secured lending segment, which has better competitive dynamics. Those two things happened in the quarter, On top of that, we had strong growth in some high-quality commercial, just general commercial credit.
A little bit more in the second quarter than we'd expect going forward, which is why we guide to 1% loan growth in the third quarter. Those fundamentals are still in place.
Yeah. We haven't changed the risk bucket. Actually, the quality of what we've been originating on average has been better.
Higher
over the course of the first half of this year than it was last year.
It's interesting because we see in some of the data a little weakness in the manufacturing, transportation area, energy, and those are big borrowers. Is there other industries that's really driving the bus for you than those?
It's pretty diversified. The one thing that's in there is we did see some pickup in utilization this quarter, which helps a little bit, particularly in the asset-based lending book. I would say that it actually came down in June, so I don't know that that's a strength that necessarily continues. It was broad based. It's new clients. I don't remember the stat off the top of my head, Rob, the new markets are growing at multiples.
Multiples, yeah. Very high percentages off a small base.
Yeah.
Clearly a factor.
Adding materially to the balances. Things are just working. They're doing a good job.
Do you feel like that is in part because of your size going into these new markets? Folks are looking for somebody a little bit larger that can take down bigger bites. Is that part of it? Maybe you can speak to the quality of the loans that you're doing. Is it more like cash flow, asset based, or is it to fund buybacks and M&A?
Well, remember that the asset-based business has been national for years.
Yeah. Nothing new there.
We're not actually counting that when we talk about our new market growth. Most of the new market growth is coming from our traditional middle market products. It's not differentiated by risk. The cross-sell ratio in the new markets is accelerating quickly and approaching legacy markets. We're just executing well. I don't know how else to explain it. They're doing a good job.
Well, taking the same approach in those new markets that we do in our legacy markets. We know how to compete. We don't win them all, we win our fair share.
Yeah. Okay. Thank you.
You bet.
We will try with Mr. John McDonald from Autonomous Research. If you could proceed with your question, please.
Okay. Is this thing on?
Yep. There you go.
Yeah. Much better.
All right. Sorry about that, guys. I'll move on to the next topic. Got a big authorization on the CCAR with the buyback. I guess, Bill, just kind of wondering about your philosophy there. Some banks front load, others are more opportunistic. How are you going to approach executing the buyback?
We spread it through time. You can't really front load it anyway. I forget the exact rules.
Well, in terms of our plan going forward is what we've done in the past years, which is pretty much evenly distributed throughout the year. Some others have front loaded, but that's part of their submission. We're opting to do otherwise.
Yeah.
Okay. Rob, you'll obviously get some benefit based on the tailoring proposal. Have you guys done any fine-tuning of the estimates of how much that could help on the capital fund if the tailoring goes through as proposed?
Yeah, John, we have. Again, this is proposed. The quick answer is about 65 basis points on our CET1 ratio. That's down a little bit from the last time we were asked that question, mostly because AOCI has changed around. 65 basis points is a good estimate.
Is that pretty much all BlackRock then as the benefit?
Pretty much, yeah. The threshold deduction.
They've come down as well, threshold deduction.
BlackRock's the biggest piece. Bryan's right, the other components, MSR and DTAs are down a little bit, BlackRock's the big piece.
Okay. Just on the credit quality, Rob, anything to note there? The NPLs are up a touch. Is that just kind of lumpy stuff going on there? Overall credit looks good. Just maybe a comment there.
Yeah. That's our view, John. Just a couple of deals coming off of really low levels last year. When you take a look at the percentages to the total loan portfolio, they're virtually unchanged. We had a couple deals on the commercial side go to the NPA list. One of which went to the top there that we've disclosed. They're unrelated and have instances and circumstances that mitigate what would be further broader concerns.
Okay. Got it. Thanks.
Yep.
The next question comes from the line of Erika Najarian with Bank of America. Please proceed.
Hi, good morning.
Hey, Erika.
As we think about deposit strategy in the midst of rate cuts, could you share with us what kind of sensitivity you assume as you think about mitigating the first few rate cuts? Are you going to continue to separately think about your expansion markets in terms of pricing versus your legacy markets?
I'll take the first.
Yeah, sure, Erika. I can start on that. Obviously, going forward in a declining rate environment, we'll keep an eye in terms of our deposit rates. If we do get the cuts that are proposed, it's likely that our rates would either, subject to competitive pressures, stable or go down. I think in regard to the national retail digital strategy, the deposits, although they've increased nicely percentage-wise, they're still pretty small relative to our total deposits. We'll remain pretty aggressive there in terms of the rates that we pay.
Yeah.
Of course, that'll be largely subject to the rate environment and the competitive pressures.
I think, practically, betas lagged on the way up there, so we don't have as much to go down. The national market's interesting. If you post in the top couple rates, you gather lots of deposits. If you're off that frontier, it slows down. Our strategy right now isn't actually to go out and try to grow those deposits aggressively. Instead, it's to go out and learn exactly the dynamics of how marketing dollars spent give you a return on your investment, and the combination of marketing dollars and the physical branch presence affects volume. You won't see, as a practical matter, I don't think rate impact causing any change in our national expansion in the near term, because we're still in the stage of kind of figuring out the levers that drive success in that effort.
Elsewhere inside of deposits, we're going to drop rates subject to what the market does.
That's very helpful. As a follow-up, as you think about studying those new markets and how you entered those markets, is that affirming the decision that we're really in a digitally initiated world, and therefore the value of that traditional brick-and-mortar acquisition for someone like PNC is much lower, particularly if it's small in size?
A couple of things that are showing up very clearly to us. The branch builds that we're putting in place are much more successful, dramatically more successful than we had assumed, and they affect the quality of the customer that you actually book online. Our bias, and I had that in my comments, is probably to go with more branch builds than we had originally assumed in our national expansion. The other thing that's very clear is that this online market is growing. We can measure deposits that leave us to go to competitors as well as the deposits that come to us, and it's very clear that through time, at least in my mind, this is going to take a greater and greater portion of the market.
For banking to be profitable, as you see mix shift to interest-bearing from non-interest-bearing, and the margin on interest-bearing declining in effect, for banking to be profitable, you're going to continue to see this branch thinning in our saturated markets, which we've talked about as we build out the fin. I think this is in motion, not just for us, but for the whole industry. I don't think there's anything that's going to slow it down.
Got it. I think I was unclear in my last question. I heard you loud and clear that the branch experience enhances the customer acquisition. I meant it more that the organic build seems more valuable than the traditional tuck-in depository deal.
Oh, yes.
Yeah.
Got it. Thank you. Go ahead.
Were you going to add to that or?
No, that math is fairly straightforward when small depository institutions are trading at multiples of book value.
That was one of the things that we wanted to test with this experiment, and it is proving out that way.
Yeah.
Perfect. Thank you.
The next question comes from the line of Scott Siefers with Sandler O'Neill + Partners. Please proceed.
Morning, guys. Thanks for taking the question. Rob, I guess first just kind of a housekeeping one. The retirement record-keeping business.
Yeah.
Can you maybe quantify the size of the gain that was in other income? I guess in a sense it doesn't matter since you'd given guide for other income in the third quarter.
I can help you with a little bit of the math. You'd be able to do it yourself when you take a look at the AMG segment information. The gain on the sale of the business came in two components. One was a $60 million gain in other non-interest income. Associated with the transaction was $20 million of expenses. The primary driver of that was the write-off of the software of our own administrative system that was not part of the sale. A net $40 million gains. Again, you could see that pretty clearly in the AMG segment info in terms of elevated revenue and expenses.
Yep. Okay.
As you pointed out, it was part of our second quarter guidance.
All right, thank you. Maybe Bill, just sort of a broader question. If the Fed indeed does go into this rate cutting mode, can you talk a bit about what you think sort of the stimulative impact, if any, would be on your customers? I guess on the consumer side it's a little more self-evident, but as it relates to your commercial customers, would it generate any change in demand or how are you or your customers thinking about that dynamic?
I don't know that I have any insight into that. In theory, that's why they would do it. As a practical matter, I continue to think we have really low rates today. I struggle to see how another 25 basis points or 50 basis points actually is going to impact what is already pretty low cost of funding for people. We'll see.
The psychological aspect of that sometimes helps.
Yeah. Okay, perfect. Thank you guys. I appreciate it.
Sure.
The next question comes from the line of Gerard Cassidy with RBC. Please proceed.
Good morning, Bill. Good morning, Rob.
Hey, Gerard.
Good morning.
Bill, you talked a couple of times about the success of the solution branches outside your footprint. They're growing much faster than expected. What are you finding as the reason for that success?
I don't know.
That's a fair answer. Okay.
Yeah. No, part of it is we designed them purposefully to be different in terms of the numbers of employees and types of employees. The employees in those branches spend more time than a traditional branch outside of the branch. They're out working events and neighborhoods and centers of influence more than you would see in a traditional branch. I think the advertising that is in play in these markets makes people aware of us and our offer. I still think that particularly for large deposits, branches matter. Somebody says, Look, it's a great offer, but I'm willing to drive the 20 minutes to go see somebody face-to-face rather than do it digitally. That's kind of common sense, but I think that's had a stronger impact than I otherwise would've suspected.
Circling back to the strong C&I loan growth outside your traditional footprint. Obviously from what you've said, you're not making the loans at prices that are completely different than your competition or underwriting standards. The guys on the front line that are building these relationships for you folks in the C&I area, what are they telling you why people are coming? Again, I'm assuming it's not just the loan. Is it the treasury management products that you have, which everybody knows are very strong? Or what's bringing these people to you guys if it's not pricing or underwriting?
Well, first, John, you have to remember that we're just kind of starting to see the roll-on of this new business as we've been in these markets for a couple of years. Our strategy is just to call on people sometimes for several years before we get any business. We go into a market, we figure out who we want to have as customers, and then we just focus on them for however long it takes. What you're seeing in terms of our results is, Mike Lyons calls it the wave, but basically kind of this catch-up of the investments we've made as we're starting to see growth come from three years of planting seeds. If you remember all the way back when we bought RBC, we kind of did the same thing, right?
We planted seeds and that effort kind of came alive two and three years later. That's what you're seeing now. It's traditional clients. I would tell you that TM makes a big difference. Our ability to go in and cross-sell. More often than not, you end up leading with capital, with credit as part of your intro to the relationship. As you pursue cross-sell, we just have more to offer in terms of variety of products for treasurers and CFOs to choose from. We have good products. It's worked for us.
Yeah. Gerard, I'd add to that. I agree with all that. What I'd add is that what we found is the receptivity of potential clients in all these geographies to a PNC calling effort has been very high.
Yeah.
Which, 20 years ago was difficult. The receptivity is very high. Once the dialogue occurs, it's all the points that Bill pointed out. We tend to compete very well with our products and services.
Just lastly, your Federal Reserve balances obviously are down year-over-year quite nicely. How low can they go before they just have to be maintained? Are you there already?
How low can we go? That's a good question.
No, it's a function of LCR.
Well.
They can go down to zero.
Right
if we wanted to put all that stuff into-
Yeah
level 1 securities.
That's right.
One of the issues you saw this quarter was we actually changed the mix on balance of our securities bit to 2A which otherwise would've allowed us to have either less wholesale borrowings in or drop the balance more.
Yeah. I think that's all true. I think we're essentially at the levels that we expect to be at. What I would point out, though, as part of the tailoring proposals.
Yeah
is a possible reduction in the LCR levels. If that occurs, we could go down substantially our maths as much as maybe $10 or $20 billion, depending on whether it's 70% or 85% coverage.
Great. Thank you.
Yep.
The next question comes from the line of Matt O'Connor with Deutsche Bank. Please proceed.
Good morning.
Good morning.
I know the period-end balances can whip around a little bit. I was just wondering if we look at the securities portfolio, the cash, you had pretty big increases there that seem like it's being funded with wholesale, and just trying to think through, is that as you think about your interest rate positioning, or are you pre-funding some of your securities, or is it just some of that period-end noise that I'm overthinking?
Yeah. There's some mischief between the average and the spot at period-end. You are correct that because we added some 2A securities, we funded that with home loan advances, actually. You see that jump. That's all inside of our rate management process. We saw value in largely certain types of MBS this quarter and took advantage of it.
Yeah.
Okay. I guess, I think there's a view out there that the rate curve is maybe overly ambitious in terms of predicting rate cuts. I think folks are still trying to keep some dry powder. If the rate cuts don't materialize or they reverse quickly, which could happen, how would you think about managing the balance sheet and some of the securities and some of the actions that you've taken here to what seems like reduce the asset sensitivity a little bit?
You shouldn't confuse the increase in balances with an assumption that we simply added duration, is maybe the best way I could answer that question. We saw what we think were irrational prices on certain types of securities that offered a fairly protected return inside of fairly wide rate moves. If rates stay where they are or in fact follow the forward curve, there's not a whole lot of reason to want to add duration at this point. Obviously, because like you, I don't believe that forward curve. If that reverses, we'll take a look at it and there's opportunity there.
Nothing radical.
Yeah.
Okay. All right. Yep. Thank you.
The next question comes to the line of Kevin Barker with Piper Jaffray. Please proceed.
Good morning.
Hey, Kevin.
Last quarter, you guys mentioned that you had some expense levers you could pull if there was a lot of pressure on rates, and if that were to continue. Are you still seeing some flexibility on the expense side, if possible, in order to continue to generate operating leverage given the current rate environment?
Hey, Kevin. This is Rob. I'm not sure what the levers that we were talking about before, but we could look on the script. I'll answer in the sense that you know we do manage to positive operating leverage. We've had a good first half, solid positive operating leverage, and we expect that to deliver full-year positive operating leverage. That's what we manage to. On the expense side, I feel good about it in terms of what we've managed. If you just go through the categories, our personnel expense is up 2%, which is consistent with merit. That contrasts where we were this time last year where we were making a lot of investments in personnel, and it was much higher. Occupancy is essentially flat. Equipment expense is up just a little bit, reflecting our technology investments. Marketing is up.
That's deliberate, discretionary, and part of our buildout, and we expect to continue that. The real savings has been in the all other category, which is our second largest behind personnel, which is down year-over-year. That's where our CIP program shows up the most. I feel good about our expense management, what we've done so far this year and what we plan to do for the balance.
Okay. To shift gears back to some of the loan growth comments. Consumer loan growth was a focus for you and has consistently lagged the commercial loan growth. Is there anything there that we can see that maybe develop on the consumer side that will maybe start to emerge and maybe diversify your balance sheet a little bit more between commercial and consumer lending?
I don't think so. The places we are growing are actually growing at reasonable percentages off of smaller balances because we haven't been that large a consumer. They're being offset by the continued rundown of home equity.
Education
student lending which masks some of the underlying growth. At the end of the day, our consumer loan growth is always in effect, I shouldn't say always, but practically always is going to be slower than C&I simply because it's on a much smaller base. By the way, if you see a dramatic change in that, you ought to start asking questions. We're growing at, I think, an appropriate pace off the base we're in with the products we have as we increase penetration with the clients we have. I don't know that you'd see a dramatic turn
I don't think it'd be dramatic, just to add to that, card and auto are growing nicely, that's all part of our plan. Residential mortgages are up, that's a function of just higher client activity, particularly in the jumbo space. One day the home equity runoff will stop running off. We'll get the benefit of that. That's the plan.
Longer term, or more broadly, do you view having a more balanced commercial versus consumer lending book as ideal, or do you feel comfortable with the way it is right now, 70/30 give or take?
Yeah.
Look, optically because we are light on consumer, we screen poorly on efficiency ratio and some other things, our NIM is lower because our loan yields are lower. That doesn't have anything to do with true economics, optically, people screen and say we're perhaps doing something wrong. The only way to materially change that would be through some sort of acquisition of some type, we aren't. Just as an aside, consumer lenders who come for sale typically have some sort of big problem, we're not necessarily
Interested in that
the people to fix a consumer lending problem. I'd probably answer that differently if it was a C&I problem. I don't see that we have either the need economically or the opportunity to dramatically change that mix given where we're starting from.
Nor do we want to slow down the high-quality commercial growth-
Yeah
which we're good at.
All right. Thank you for taking my questions.
Yep.
The next question comes to the line of Mike Mayo with Wells Fargo Securities. Please proceed.
Hi. I just wanted to follow up more on the Solution Center expansion and understand your thought process a little bit more. I thought, going back a few years, you were looking at out-of-market digital-only expansion, and you called that an experiment. Should we take from this that now, as you expand out of market, you're only doing that with the Solution Center s? How many Solution Center s do you think you need in each of these markets to have the critical mass that's necessary?
That's a fair question, Mike. We always talked about going out digitally thin and building branches largely following our C&I expansion. What's changed is we're going to build more than we had originally assumed. In Dallas, if I was thinking five, we're now thinking 10 or 15. Those are soft numbers. Having said all that, of course, national digital is national and in markets where we have no presence. In fact, some of our greatest growth is coming from parts of the country where we don't have any presence in C&I or retail, and we don't intend to build branches. It'll be a mix. All I'm suggesting here is that certain markets where we thought we'd build a couple of branches, it's becoming clear that you can actually get a higher return in those markets by building more branches.
I don't know if that's a function of just better brand presence, a higher return on your marketing, or exactly what's driving it. That's exactly why we're doing test and learn in all these different places with different levers to see what gives us the most economic growth.
Just how do you frame who you are? When I go to your website, it doesn't say that you're a national retail bank. Is your intention to be across the country with Solution Center s? You highlighted, I guess, four cities here along with.
That's interesting. I didn't know that was on our website. I'm going to change that this afternoon.
No, that wasn't.
No. It says the East, it says the Midwest, it says the Southeast, and that's it.
I think traditionally, of course, we're following where we have physical footprint. As a practical matter, Mike, our ambition is to be a national retail bank. The form that that takes for us and for everybody continues to evolve. My own belief is that over time, that will involve having physical presence in all the MSAs in this country done over whatever period of time as we continue to thin our saturated markets. I don't have a timeline on when that plays out. We have this belief that fundamentally, if you sit in your existing region and simply try to protect your region while you have the large banks coming in, B of A and JPMorgan are in Pittsburgh. If I simply sit and protect Pittsburgh, I will lose because they will take share.
Therefore, we have to go out and compete in markets where they have share today and we pull share. If you sit in your existing region, you will atrophy through time. Our strategy is to go national.
When you say physical-
We think we can execute on that. Sorry?
When you say a physical presence in all MSAs, you mean like the top 50, top 20, top 100?
Yeah.
DDD.
Yeah, to be determined. Assume it's the top 50. All of that isn't next year's plan and it isn't the year after that.
Got it.
It's that the practical outcome of the transformation you're seeing in banking, where more and more is done digitally, the bigger banks are getting larger. The inability to simply defend a regional footprint, in my view, on a cost-efficient basis, suggests that you need to reach the whole country and pull share where you can pull share. That's what we're going to do over time. It'll evolve as we go, and that's why we're doing the test and learn we're doing today, so we don't do a massive spend and then have to reel it back in.
Right.
Yeah.
Last follow-up, and this is very helpful. Isn't it tougher if you don't have the brand name outside of the market? Some of the largest banks are already known when they go into market, whereas PNC going into, I don't know, what do you have here? Houston, Dallas, it's not going to be as well known on the retail side. Why not just jumpstart the whole process and buy a bank? I know everybody always says, We're not going to buy a bank. Look, National City, your annual report highlights a decade later that was a success. Why not accelerate this kind of national retail bank ambition with an acquisition?
I'm not exactly sure what that has to do with brand because the brand build ultimately comes from spend in the local market and national markets as well. You could most definitely accelerate share through an acquisition. At issue, and you've heard me talk about this, Mike, if you buy the small bank, you're getting a lot of stuff you really don't want at a multiple of book value. We want the accounts, but we more often than not don't want to have anything to do with the balance sheet. The branches that you get are in the wrong place with the wrong technology, with the wrong style and the wrong employees. There's just not a return on it. I wish there was.
If you jump up in scale, look, if there was another National City at less than book value that we could do, of course we would do it, that's a value question. Yes, that would accelerate what we're doing, today, at today's prices and today's opportunities, it's a much, much lower return than doing what we're doing.
Got it. All right.
Mike-
Thanks a lot.
The next question comes to line of Brian Klock with Keefe, Bruyette & Woods. Please proceed.
Good morning, gentlemen.
Good morning.
Rob, I just had a quick follow-up question on the guidance around revenue for the full-year.
Yeah.
It seems like taking the first half of the year and the guidance for the third quarter, it seems like the fourth quarter would imply somewhere around $140 million-$150 million of revenue higher than the third quarter guide. I think you have in there's probably the gain in there related to the mutual fund business, that part that you're selling to Federated.
Yeah. Right.
Is there anything else in there or is that I think that was like a $52 million sale price, if I remember correctly.
Yeah. Let me just take a shot at sort of.
Okay
the answer. I think the spirit of your question is, yeah, we stand by our guidance and feel confident around that. There is some volatility in that other non-interest income number, that's nothing new. It tends to average out over the course of the year. In the second quarter, it was a bit elevated because of all the reasons that I mentioned in addition to the sale of the retirement business. It ran a little bit higher than what we expected. That was included in our guidance. When I look at the third quarter guidance, how I do that is I combine what I see in the next 90 days along with patterns that tend to emerge. Then beyond that, I go by the pattern.
Probably a little bit less in the third quarter, another non-interest income than we had in the second quarter. In the fourth quarter, to your point, we do have a sale of the mutual fund business that we've announced that will be in there that will otherwise elevate that number. You're on the right track. Yeah.
Okay. The rest of it, like you said, you had some good capital markets business, that other piece of it could just be some of the seasonality that might go through-
Yeah, that's right
lower third and so forth.
There's a lot of component there. Yeah, that's right.
Okay. All right. Thanks for your time. Appreciate it.
Sure.
The next question comes to the line of Saul Martinez with UBS. Please proceed.
Hey, guys. Wanted to get your perspective on sort of the trajectory of deposit costs and deposit betas on the way down. Obviously, deposit betas were low on the way up. You can make the argument that they'll be low on the way down. Also wanted your perspective on the timing of when we actually see Fed rate cuts start to filter into interest-bearing deposit costs because historically, if I look at the data, there's usually a quarter, two quarter lag between when the Fed cuts and when you actually start to see the benefit in deposit costs. There's even a little bit of a lag in terms of when deposit migration stops happening into interest-bearing accounts. If we were to see a July cut, how quickly do you think it actually filters into your overall deposit cost?
Is there a one or two-quarter lag, or do you feel like you should be able to see that filter into the deposit cost, which I think was 103 basis points this quarter?
Remember that the wholesale C&I deposit rates will kind of drop instantaneously. We're really talking about what happens in retail.
Consumer.
I think you will see it take effect, all else equal, pretty quickly. The one thing that concerns me a little is if you look at the entire industry, there are people who have been pushing on loan-to-deposit ratios.
Protecting them by effectively allowing deposits to run off, they're now trying to reverse that. Competition for deposits, even as rates drop could continue, as we've seen loan growth outpace deposit growth for most of the middle-sized banks for a period of time now. That's kind of the unknown in my mind in terms of what actually happens to consumer deposit costs.
just to add to that.
Yeah.
It'll be driven more by competitive pressures rather than the bank's abilities to move quickly.
Yeah.
Do you think the greater importance of online banks, digital banks today than we've had in the past also plays into that and maybe limits the ability or willingness of banks to reduce costs, especially on the consumer side?
Yeah, I think it does. I think we have seen the impact of online banks on deposit growth and mix generally. I think that's going to have an impact not just on if rates go down, but as we roll forward increasingly over time. I think you'll see betas actually be faster and faster because the online bank rate is more deposits migrate-
Right
towards that becomes real time.
Right.
Yeah, I don't have a timeline for that. It's happening.
Right.
You can't ignore it.
Right. Quick follow-up on commercial credit. Obviously, you made clear that the uptick in NPAs, you're not overly worried about that. Are there any segments or geographies or size of companies that you feel have a little bit more strain? Is there anything you're keeping a closer eye out for in terms of potential credit weakness?
It's the traditional stuff. There's some real estate on the margin on the retail side that everybody's talked about, but it's fine. There's transportation companies are struggling for a variety of costs at the margin, but we're not overexposed to that.
Got it.
There's a bunch of little stuff, but there's nothing. To Rob's point, I went through every single add to our watch list. They all had their own idiosyncratic story, all in separate industries, all with a reasonable explanation that largely had nothing to do with the economy.
Right. Okay. Thank you very much.
Sure. Yep.
The next question comes line of Ken Usdin with Jefferies. Please proceed.
Hey, guys. Thanks. Just one follow-up on tailoring. Bill, having heard all the commentary you made about just the long-term environment for the sector, how would you start to prioritize the potential benefits from that capital free-up? If even you go forward and say there's no value opportunities for traditional banks, how do you start to strategize and prioritize about what the best and incremental uses of that capital if a deal is not the right usage at the time? Thanks.
Well, I think, look, you're going to get the standard answer. Of course, we invest in our business, and we've been investing a lot in our business for the last multiple period of years, and that will continue. But we have an ability for the foreseeable future, in my view, to generate capital in excess of what we can intelligently deploy in growth. We get into a question of dividend and share buyback. I would suggest you just look at our actions this year to foreshadow the way we think about this.
A sense of conviction
yeah, what we might be doing going forward.
Yep. Is there anything left in the kit that you don't have on the non-bank side that you've been getting out of some businesses as you've culled up and streamlined some other things? Is there anything that you're still looking forward to deepening or aspects of things that you don't have that you still need to offer as you, again, round out that product offering?
There's a lot of stuff we look at the margin inside of payments, and other things we're doing in the C&I space on advisory. The issue in the payment space is finding value there given the multiple you pay and our need to be able to scale whatever that business model is to justify the multiple. We look, we haven't really hit on anything of any size. We'll continue to look.
There's no material-
There's not a hole.
Right.
Yeah.
Got it. All right. Thanks, guys.
Yep, thank you.
Thank you.
There are no further questions.
Okay.
Okay.
Thanks, everybody.
Thank you.
This concludes today's conference call. You may now disconnect.