Good morning. My name is Colin. 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 number one followed by the number four on your telephone keypad. If you would like to withdraw your question, please press one and then the number three on your telephone keypad. As a reminder, this call is being recorded. I would now turn the call over to the Director of Investor Relations, Mr. Bryan Gill. Sir, please go ahead.
Thank you, Colin. 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 Chief Executive Officer, Bill Demchak, 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 financial measures, are included in today's earnings release, related presentation materials, SEC filings. These materials are all available on our corporate website, pnc.com, under Investor Relations. These statements speak only as of July 13, 2018. PNC undertakes no obligation to update them. Now, I'd like to turn the call over to Bill Demchak.
Thanks, Bryan. Good morning, everybody. You've seen this morning that PNC reported second quarter net income of $1.4 billion, or $2.72 per diluted common share. Overall, we thought it was a really good quarter, highlighted by continued solid execution on our strategic priorities, with our key financial metrics all moving in the right direction. You would've seen we grew loans on both the corporate consumer side. We also grew deposits this quarter. We grew our net interest income in NIM, as we increased investment securities and reduced our cash position at the Fed. We grew fees and customers. We managed expenses well, achieving positive operating leverage and improving efficiency. Credit quality remains strong, with non-performers declining and losses stable. We maintained our strong capital and liquidity positions in the quarter. The Fed accepted our capital plan without objection.
The CCAR severely adverse scenario this year was definitely much tougher than it's ever been before. As the results indicate, we would remain well above the post-stress minimums. In regard to our capital return plan, I would point out our focus this year was to deliver a solid increase in our dividend, which we did. On the share repurchase component, with the benefit of hindsight, we were obviously more conservative with our submission than we needed to be. Importantly, though, I want to emphasize that we continue to see buybacks as being attractive at current levels. Finally, we continue to invest in our businesses. These investments include our digital product and service offerings, new consumer and small business lending projects, healthcare payments processing, the ongoing expansion of our middle-market corporate banking franchise.
In fact, I'm happy to announce that on the back of the early success we've had in our previously announced expansion markets over the last 18 months or so, we're looking forward to further expanding the franchise into Boston and Phoenix in 2019. Halfway through the year, we feel good about our execution. Our relationship-based business model is working, and that is creating growth opportunities for us. All that said, we have a lot of work to do in the back half of the year, including the launch of our national retail digital model. Before handing it over to Rob, I just want to thank our employees for their continued hard work, as well as our clients for their trust in us. With that, over to you, Rob.
Great. Thanks, Bill. Good morning, everyone. As you've seen by now, Bill just mentioned, we reported net income of $1.4 billion, or $2.72 per diluted common share, and it was a good quarter by virtually all measures. Our balance sheet is on slide four and is presented on an average basis. Total loans grew by 1% linked quarter, and 3% compared to the same quarter a year ago. Investment securities increased 4% linked quarter, as we continue to deploy our liquidity. Relatedly, our cash balances at the Federal Reserve were down linked quarter and year-over-year. Deposits were relatively stable linked quarter and up 2% year-over-year.
As of June 30th, 2018, our Basel III common equity Tier 1 ratio was estimated to be 9.5%, down from 9.6% as of March 31st, 2018, reflecting continued strong capital return to shareholders and a decline in accumulated other comprehensive income. Importantly, we maintained strong capital ratios even as we returned $1.2 billion of capital to shareholders, or 92% of second quarter net income. We repurchased 5.7 million common shares for $823 million and paid dividends of $354 million. Following the CCAR results last month, we announced a new plan to repurchase up to $2 billion of shares over the next four quarters. Earlier this month, our board also approved a 27% increase in the quarterly dividend to an all-time high of $0.95 per share, effective in August. Our return on average assets for the second quarter was 1.45%.
Our return on average common equity was 12.13%, and our tangible book value was $72.25 per common share as of June 30th, an increase of 5% compared to a year ago. Turning to slide five. Average loans were up $1.6 billion, or 1% linked quarter, and $6.3 billion, or 3%, compared to the same quarter last year. Commercial lending was up $1.5 billion compared to the first quarter. The growth was broad-based across our C&IB businesses, led by corporate banking and business credit. Pipelines remain healthy. Compared to the same quarter a year ago, commercial lending increased $5.5 billion, as strong growth was partially offset by declines in our real estate business. CRE remains challenged as we continue to see fewer deals that meet our risk appetite. Payoffs continue at a steady rate.
Consumer lending increased by approximately $100 million linked-quarter and $800 million year-over-year, reflecting growth in auto, residential mortgage, and credit card loans. This was partially offset by declines in home equity and education lending. Investment securities of $77.5 billion increased to $2.8 billion, or 4% linked-quarter. Purchases were primarily agency residential mortgage-backed securities and U.S. Treasuries. Our cash balances at the Fed averaged $20.7 billion for the second quarter, down $4.7 billion linked-quarter and $1.4 billion year-over-year as we continue to deploy our liquidity. Turning to slide six. Deposits increased approximately $300 million linked-quarter, driven by growth in consumer deposits, partially offset by seasonally lower commercial deposits. Compared to the same period last year, deposits increased by $4.6 billion or 2%. As expected, deposit betas continued to increase in the second quarter.
Our cumulative beta since December 2015 was 26%, up from 21% last quarter, while our current beta since March 2018 was 50%. Our expectation is that cumulative betas will continue to increase throughout the remainder of the year, particularly on the consumer side, as they still lag stated levels. As you can see on slide seven, net income in the second quarter was $1.4 billion. It was a strong quarter, and we delivered positive operating leverage both in the second quarter and year-to-date. Revenue was up 5% linked-quarter, driven by growth in both net interest income and non-interest income. Non-interest expense increased 2% compared to the first quarter, reflecting our continued focus on cost management. Provision for credit losses in the second quarter was $80 million, as overall credit quality remained strong. Our effective tax rate in the second quarter was 18.3%, impacted by strong pre-tax earnings.
For the full year 2018, we continue to expect the effective tax rate to be approximately 17%. Let's discuss the key drivers of this performance in more details. Turning to slide eight. Net interest income increased $52 million or 2% linked-quarter and $155 million or 7% compared to the same period last year, as growth in earning assets and higher yields were partially offset by higher funding costs. The linked-quarter comparison also benefited from an additional day in the second quarter. Net interest margin was 2.96%, an increase of five basis points compared to the first quarter. Non-interest income increased 9% linked-quarter and 6% year-over-year, as we remain focused on growing fee-based revenue. Importantly, fee income grew 5% linked-quarter despite softness in residential mortgage. The main drivers of the $72 million linked-quarter fees are as follows.
Corporate services fees increased $58 million or 14%, reflecting higher M&A advisory, treasury management and loan syndication fees, as well as a benefit from commercial mortgage servicing rights. Consumer services fees increased $24 million or 7%, largely due to seasonally higher customer activity in debit card, merchant services, and credit card. The growth in these categories was partially offset by lower residential mortgage non-interest income, which declined $13 million. Servicing fees decreased as a result of higher payoff volumes. Loan sales revenue also declined despite higher originations. Increased competition and a shift in mix away from refinancing to purchases pressured our gain on sale margin. Finally, other non-interest income of $334 million increased $89 million compared to the first quarter and included a $27 million net benefit from Visa fair value adjustments. Additionally, we had higher revenue from private equity investments and commercial mortgage loans held for sale activity.
Going forward, we continue to expect a quarterly run rate for other non-interest income to be in the range of $225 million-$275 million, excluding net securities and Visa activity. Turning to slide nine. Second quarter expenses increased by $57 million or 2% linked quarter, reflecting seasonally higher business activities and marketing. Our efficiency ratio was 60% in the second quarter, down both linked quarter and year-over-year. As you know, we have a goal to reduce costs through our continuous improvement program by $250 million in 2018, and we remain on track to achieve our full-year target. In 2018, these savings, which are across all expense categories, are helping to offset higher personnel expenses related to new initiatives, as well as the increase in the minimum hourly wage commitments we made to our employees at the end of 2017.
Our credit quality metrics are presented on slide ten, and overall, we improved in every measure. Compared to the first quarter, total non-performing loans were down $123 million or 7% and continue to represent less than 1% of total loans. Total delinquencies were down $28 million or 2% linked quarter, driven by a decline in consumer delinquencies past due 90 days or more. Provision for credit losses of $80 million decreased by $12 million linked quarter, reflecting a lower provision for commercial loans. Net charge-offs declined $4 million linked quarter and were essentially unchanged year-over-year. In the second quarter, the annualized net charge-off ratio was 20 basis points, down one basis point linked quarter. In summary, PNC posted strong second quarter results. For the remainder of the year, we expect continued steady growth in GDP.
We continue to expect one more 25 basis point increase in short-term interest rates this year, but we now expect it to occur in September rather than December. Looking ahead to third quarter 2018 compared to second quarter 2018 reported results. We expect modest loan growth. We expect total net interest income to be up low single digits. We expect fee income to be up low single digits. We expect other non-interest income to be in the $225 million-$275 million range. We expect expenses to be stable, and we expect provision to be between $100 million and $150 million. Taking into account our third quarter guidance, I would like to take this opportunity to refine our full-year outlook.
In light of our view on interest rate increases that I just mentioned, as well as the strong fee income performance we've seen in the first half of the year, which we expect to continue into the second half, we now expect full-year total revenue to grow in the upper end of the mid-single-digit range. Commensurate with our expectations for higher fee income, we now expect marginally higher full-year expenses, resulting in lower mid-single-digit growth. To be clear, our full-year 2018 guidance compared to adjusted 2017 results is as follows: We expect mid-single-digit loan growth. We expect upper mid-single-digit revenue growth. We expect expense growth in the low end of the mid-single-digit range. Importantly, we remain positioned to deliver positive operating leverage in 2018. 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 QA roster. Your first question comes from the line of John Pancari with Evercore ISI. Your line is open. Please go ahead with your question.
Morning.
Hey, John.
On the revenue growth outlook that you just mentioned, and your rationale in pushing it higher, I get the first part of the year so far, and particularly the second quarter coming a little bit better. Is the rest of it only the revision given your Fed outlook, or is there still other strengthening in the back half of the year on the revenue front that you're factoring in now?
Hey, John. This is Rob. Good morning. I'd say it's all of the above. I think the important takeaway is we are running a little higher to date than we expected, and we expect that to continue for all the reasons that you mentioned.
Okay. All right. Separately, on the loan demand side, just want to see if you can talk a little bit about what you're seeing. I know you indicated that pay downs are still elevated in commercial real estate. Wondering what you're seeing in terms of demand on the commercial side, do you expect any impact related to the trade wars? Because I know your loan growth outlook was unchanged despite any maybe underlying improvement we're seeing in CapEx, for example. Thanks.
Yeah. I'd say that when we look at the second half of the year, as I mentioned, the pipelines for loan and C&IB growth is healthy. I think the big change, nothing new this quarter, but the big change over the last couple of years has been the CRE component, which has been flat. Corporate banking, our middle market, the pipeline's healthy. Our business credit secured businesses, specialty businesses, all look pretty good. Large corporate's not as strong as it was, we think in part that's due to some of the cash repatriation and some of the tax reform. I'd say generally speaking, it looks healthy.
Yeah. Notwithstanding all the daily news on trade, it doesn't seem to be showing up in the sales pipeline or loan demand or even in dialogue with clients. There's obviously a handful who are impacted, maybe more than that. As a practical matter, when we look at our pipeline, it doesn't seem to be playing into it at this point.
That's right.
Our next question comes from the line of John McDonald with Bernstein. Your line is open. Please go ahead.
Hi. Good morning, guys. Wanted to ask a little bit about rates and the curve. The bank stocks have really been weighed down by the flattening 2 to 10. Investors focus on that. This quarter, we saw you benefit from higher short rates, and you put cash to work kind of in the mid to longer end. Kind of wondering where is the curve relevant for you and where is it not relevant, and how you think about this kind of curve debate that's happening relative to your fundamentals.
I don't know that it's a debate. As the curve flattens, it ultimately hurts us. We benefit from the floating rate loans as LIBOR goes up, our yield on invested securities, to the extent the 10-year keeps trading inside of three years, suffers. We did increase securities this year, I would tell you some amount of the duration from that was offsetting interest rate swaps that we unwound which helps on that yield front as well. At the end of the day, if we hang around some range bound around 3% on the 10-year, we're going to see our securities portfolio track that.
Our next question comes from the line of Erika Najarian with Bank of America. Please go ahead with your question.
Hi. Good morning. The one question I've gotten the most from your investors recently is on the buyback. I think everybody got the message, Bill and Rob, that you wanted to focus on the dividend. I guess they were wondering, would you be open to the de minimis option where you could repurchase 25% of your Tier 1 capital without an additional ask in the CCAR cycle?
That's a new rule. 25% of your Tier 1 capital without an-
Oh, sorry, 25 basis points.
Yeah. They're saying, yeah. Correct.
25 basis points. Not 25%. Just dialing that down.
Yeah. Look, at this point, we just got done with the CCAR process, we'll take a look at it. Of course, they also put in a commentary that you can resubmit if you want to. We'll watch that play out through the course of the year. The one thing I would say on the buybacks is the other question you guys have relayed to us is are we saving capital for some sort of acquisition? The answer to that is no. At the end of the day, whether we do a little bit more this year or we do extra next year, holding capital and not doing anything stupid with it, but investing in our business is a good thing. We have a lot of, as you've heard us talk about, growth opportunities inside the company itself.
We'll look at it as the year goes on as to whether we resubmit or use the de minimis and the other stuff, but in the meantime, we're not going to do anything silly with your capital.
We do see the current share price as attractive.
Yeah.
Our next question comes from the line of Scott Siefers with Sandler O'Neill & Partners. Please go ahead with your question.
Morning, guys. Just was hoping you could touch a bit on the provision guidance. I guess we're sort of getting back into that phenomenon where even the $100 million-$150 million range starts to look kind of conservative, just given how strong the trends are. Was hoping you could just chat a little about what it would take to get you back into that range, and just overall trends broadly.
One of the things you have to keep in mind, and the reason we kind of have it higher than we're printing is, it's so low now that single credits can impact it. We could have a blip on a few credits go in a quarter and put us back in that range pretty easily. Even that range that we're guiding to right now is below what you would expect sort of on average through the cycle. We're just at really low levels, and maybe we're conservative in saying we'll be a little higher-
Yeah
We keep surprising ourselves.
Yeah. No.
It just takes a tiny blip to move it.
Yeah. That's right, Scott. This is Rob. We're just working off such low absolute levels that literally, particularly in the commercial portfolio, literally a deal or two moving in either direction can affect the range.
Yeah.
That's a good thing and a good place to be.
There's a lot of volatility around a low number.
That's right.
Our next question comes from the line of Betsy Graseck with Morgan Stanley. Your line is open. Please go ahead.
Hey, good morning.
Betsy.
Question on just as we're thinking about NIM outlook and trajectory, I know we talked about the deposit beta side and FHLB, et cetera, could you give us a little color on how you're thinking about the non-deposit funding? Is there any type of mix shift we could see you do there over time? Is there any kind of restructuring that you might consider? Those cost of funds came up quite a bit in the past couple of quarters, maybe there's an opportunity there to restructure that and slow the uptick in cost of funds on that side of the balance sheet.
No, I'm not sure I follow. I mean, the cost of funds increase is just related to the increase in LIBOR as much as anything else, as we swap effectively our wholesale borrowings back into floating. It hasn't gone up on sort of a relative cost basis other than the impact on interest rates. Of course, net-net, we benefit from that increase in rates on our floating rate loan portfolio. No, I don't see any opportunity.
Need to shift, right.
Yeah.
Okay. Like on just the mix between sub-debt or senior debt or FHLB or other borrowed, there's no need to mix it up at all?
No. We're in a pretty good place.
Okay. Just follow up on the digital banking strategy. I know you're rolling that out.
Yeah.
Could you give us a sense as to where you're really pushing that more than others? Because it feels like as you roll that out, it's a marketing push, and I'm just wondering, are you really doing it on a nationwide basis, or is it specific MSAs that you're focused on first?
Well, it will be enabled as a function of specific geographies and zip codes. Both the ability to find it and search, ultimately to open an account and move money. We do that purposely so we don't in effect get contagion back with our existing markets. At launch, it will be basically available on a national basis in all markets where we currently don't have core branch presence. We will focus our marketing efforts on a few select markets, which we'll announce sometime over the next month probably. They'll be obvious to you when we do it. It'll be available basically on a national basis, but we'll focus it on markets where we already have a presence, just not retail, and where we are actually building branches, just in a very thin network relative to.
To complement that effort
yeah.
Got it. That would include Boston and Phoenix that you announced you're going to.
Eventually. They won't be.
Okay
our early ones.
Got it.
It'll be available there day one. It's just that you won't see billboards and branches.
The physical. Yeah. The physical.
How do you measure success in those types of markets?
That's a fair question. I think, at this point, and you've heard me talk about this, what we're doing is chasing deposits with a low, in effect, marginal cost to them because we don't have a big physical plant cost associated where the deposits come in. It doesn't take much to offset the cost of what we'll deploy in marketing in the small branch build. I would think, given the offering we'll have out, the simplicity of it, the linkage to the rest of the bank and our brand, that we ought to be able to grow that deposit base at least as quickly as some of the other larger digital players that you see out there.
Okay. The pricing on the deposits?
It's going to be competitive.
Okay.
We're looking to learn.
Yeah. I think part of this is, the trend is definitely moving towards digital account opening to digital deposits and the ability to pay higher rates with a low cost base behind it. I don't think anybody knows the actual pace at which this is going to grow. When and if you get a convergence between digital deposit pricing and what we pay in core accounts as we thin the rest of the network. We're going to kind of test and learn. By the way, we'll do it somewhat differently in each market as it relates to the way we spend marketing dollars. We'll see what happens, and we'll report back as we learn.
The competitive is competitive versus the online deposit gatherers?
Yes.
Yeah. Okay. All right. That's helpful. Thanks.
Yeah.
Our next question comes from the line of Gerard Cassidy with RBC Capital Markets. Your line is open. Please go ahead.
Good morning, Bill. Good morning, Rob.
Good morning.
Hey, Gerard.
Can you guys give us a little more color in the other revenue category? You touched on the private equity gains in generating that revenue. The number was up nicely. Can you give us a little more detail of what's in there and what was private equity and maybe one-time in nature?
Yeah, sure, Gerard. This is Rob. The other category includes a lot of various line items, but the three biggest drivers tend to be private equity, asset sales, and CVA. In this quarter, as we mentioned, private equity had a very strong performance. On top of that, we had the Visa valuation adjustment. Those were really the two big drivers. We guide $225 million-$275 million because that's where it tends to be on average. Because of the lumpiness of that category, it can be higher in one quarter and lower in the next. This quarter, it was just higher.
I see. Thank you. To follow up on your conversation on digital, have you guys figured out, or do you have a sense of, we know a lot of folks go and purchase savings accounts or money market funds through the digital channel, opening up checking accounts seems to be maybe a little bit more of a hurdle. Have you guys done any, I know it's not going to be rolled out until later this year, but what's your guys thinking of actually new customers opening checking accounts online through the digital channel? What kind of success you might have this time next year?
That's the big unknown question. We have spent a lot of time on the design and simplicity by which you can first open a high yield savings account and then ultimately convert it to a Virtual Wallet account. We believe, as evidenced by the fact we're going to go in and build this branch-thin network, that we will have some amount of success with that. That's what we're going to have to figure out. The research basically says that there is an excess of 60% of consumers who are comfortable with a largely digital relationship with their bank, subject to sort of a thin presence, giving them some amount of comfort that they can go in a building and scream at somebody if we get something wrong. We've set it up to the best of our ability.
We're going to test and learn, we'll see through time. My own belief is that over time, we will see that succeed. I just don't know how long it's going to take. You're absolutely correct, that thus far, people haven't been able to do that to much extent.
Great. Thank you very much.
Yeah.
Our next question comes from Ken Usdin with Jefferies. Your line is open. Please go ahead.
Thanks. Good morning, guys. Rob, on the securities portfolio, noticed that obviously you had put a lot of the liquidity to work. I wanted to ask you, 291 average yield, what are you finding? What are your new money yields coming on at? How much more remix into securities and out of cash do you still have the ability to do, especially with still quite attractive loan-to-deposit ratio? Thanks.
Sure, Ken. In regard to the securities book in terms of what we're purchasing, as you can see, is in our residential agencies and treasuries. In total, new adds are higher than the 291 around the 3% level, which is why you've seen some of that movement. We still have a lot of liquidity, the approximately $20 billion or so at the Fed, all of which could be moved, by definition, into high-quality level 1 securities. We still have a lot of flexibility, and we'll continue to deploy more money on a tactical basis.
Okay, great. One question on just the regulatory outlook. The Crapo bill didn't have a lot to offer banks of your size. Any incremental hopes of what might come down the pike that you might see some benefits from down the road or hopes that you might see?
Yeah. Governor Quarles has made a lot of public comments, separately in conversation with some of the industry groups. They at some point intend to put out what I think will be a more scaled approach to both LCR and some of the SIFI bucket items. Effectively, the things impacted by Basel II and the hard line at $250 billion. My hope would be to see that they would, in effect, rather than have, for example, on LCR, a 70 and 100, they would instead scale that number as a function of asset size and other measures of complexity, rather than have a binary trigger at a certain dollar amount. All the body language out of the Fed suggests that they're going to do something like that.
Obviously we're receptive to that, the more the tailoring approach versus a sheer simple asset size.
Yeah.
Next question, please.
Our next question comes from Kevin Barker with Piper Jaffray. Your line is open. Please go ahead.
Good morning.
Hey.
Thank you. Kevin.
Rob, you made a mention that the consumer deposit betas are expected to accelerate through the rest of this year, even though they've accelerated quite a bit here in the second quarter from the first quarter up to 40% for consumer betas.
Yeah.
Is that catch-up in the back half of the year, and do you expect it to go above 50% as we move through the second half?
Yeah, I think catch-up's probably a good word. That's why we put that chart. We break that chart between current betas and cumulative betas. What changed this quarter was across commercial and consumer, and as a result, total, our current betas went above our stated betas. You can see on the cumulative beta, we're still lagging. I do see some acceleration on the current beta, which by definition will pull up the cumulative beta, but the cumulative just moves a little slower.
Okay. Given the outlook for rates in the back half this year and given your revenue guidance, it implies that you probably have quite a bit of acceleration in loan growth combined with a little bit of expansion in NIM. Are you assuming that deposit betas and borrowing funds continue to grow or at least move higher at the same rate that we saw in the first half of this year?
Well, what I'd say to make it easy is in terms of our guidance for the year, all those thoughts are baked into that. A lot of moving parts there, but that's our best estimate.
Okay. Thank you very much.
Sure.
Our next question comes from the line of Brian Klock with Keefe, Bruyette & Woods. Your line is open. Please go ahead.
Good morning, guys.
Hey, Brian.
Good morning.
I want to follow up a little bit on the deposit side. Not the beta question, but on just overall balances and looking at the end-of-period spot balances. It looks like the DDA balances have been declining since the third quarter of 2016, roughly. We're over $82 billion at the end of the third quarter 2016, now at $79 billion and then down about 1% year-over-year. Bill, are you seeing commercial companies shifting into to try to get some rate? I guess, is there conversations with those customers about earnings credit or are some of those deposits actually going out of the system and being used?
I guess a couple things. Look, the net liquidity into the system from QE has been gradually dropping, but I don't think that's impacting us. What you're seeing is a shift both on the consumer and the corporate side to interest bearing where they can get it. Lazy money is moving, and that's not really a surprise to anybody.
Gotcha. Do you have the mix, the interest-bearing deposit growth kind of help them move total deposit growth? Do you have the mix of how much of that's in the CDs versus the money market accounts?
It's still predominantly-
Yeah
It's still predominantly money market. We've, I think just last quarter, Rob started getting a little more aggressive on sort of 18 months to two-year CDs. It's a small-
Still small. Yeah. Active in contrast to what it's been the last handful of years.
Yeah.
Got it. Okay, thanks. I guess just as a follow-up on the expense guide, it seems like the fourth quarter guidance, if I plug in numbers, maybe it's down $10 million or $15 million from what you're guiding for the third quarter. It seems like the FDIC surcharge, we took an estimate of something in the neighborhood of 30%-40% that could be benefiting your fourth quarter. Are you including a potential for that surcharge to go away in the fourth quarter in your guidance or what are your thoughts if you are including it? What are your thoughts on sort of reinvesting that savings?
Well, in terms of our expense guidance for the balance of the year, we took it up a little bit commensurate with the higher revenue activity that we saw. We estimate and handicap events that might occur, including FDIC relief, which isn't assured. We blend that all into our estimate.
You're giving us way too much credit for being exact. We have 50 items.
Yeah.
50 different things that we focus.
A lot going on
try to give you our best shot.
A lot going on within an approximate $10 billion spend.
Yeah.
That's a fair point. Thanks, guys. Thanks for your time.
Our next question comes from the line of Matt O'Connor with Deutsche Bank. Your line is open. Please go ahead with your question.
Hi, this is Rob from Matt's team.
Hi, Rob.
Treasury management seemed especially strong this quarter. I know this is a business you've been pretty positive on and have highlighted in prior presentations. Any color you can provide on the strength this quarter, maybe just the outlook for that business going forward?
Nothing unusual. It's just working. If anything, you're probably seeing an acceleration as we cross-sell into some of the newer clients we've gotten out of the Southeast and get a greater proportion of fees from relationships that we sort of started through a credit relationship. The offering is the offering. We continue to invest pretty heavily in technology-based solutions for our clients, it's working.
Separately, your borrowing costs were up meaningfully again this quarter, presumably on the widening 90-day LIBOR spread on an average basis. That said, that spread has come in a bit more recently. Given that, should we expect that to be a benefit in 3Q, or have you guys started to swap that out at all? I know you may have mentioned that on the last call.
The borrowing costs, again, are up largely because LIBOR rates are, broadly defined, rates are up. We did, in fact, hedge out a fair chunk of the basis between 3s/1s over the course of the last four or five months. I don't know that you'd see any impact going into the third quarter beyond whatever rates. Yeah. This is Rob. I can jump in there, too. We pointed that out on the first earnings call. Mostly just not because of its size relative to our total NII, but it's just that it was a bit of a surprise.
Yeah.
We weren't sure at that time whether it was going to persist for the year, so we wanted to identify it. I think when we got into the second quarter, Bill mentioned we were able to move on a tactical basis to some one-month index. Also to your point, the gap narrowed, and it narrowed in a good way with one-month LIBOR going up, three-month LIBOR staying relatively flat because we benefit from that from our loan book.
Yeah.
That whole issue, bottom line, subsided substantially quarter-over-quarter.
Got it. Thanks for the color.
Sure.
Okay. Our next question comes from the line of Chris Kotowski with Oppenheimer & Co. Inc. Your line is open. Please go ahead.
Yeah. Good morning. I guess looking at the trading action in your stock and most of the other banks, it seems to me everyone is concerned about the rising deposit betas and the flattening yield curve. I guess when I stand back and look at it big picture, I see 2.9% year-over-year loan growth and 6.9% net interest income growth. Clearly you're still getting a very significant benefit, and I assume most of that is coming from the free funds, demand deposits, equity, and other float. I guess, when does a further Fed rate increase not become a benefit? It just seems to me you'd have to have an extreme view of deposit betas or curve in order for further Fed hikes not to have a beneficial impact for you.
I think that's right. I don't know. It's interesting to watch as people talk about betas. Remember, if our deposit betas 50%, make up a number here that's beyond our stated beta, the Fed goes by another 25 basis points, we get 12.5 basis points.
Yeah. That's right.
every time.
Right.
On top of what we're carrying into it with a cumulative beta of wherever we are at this point. I don't particularly understand that logic. Of course, betas were going to accelerate in the simple notion that you build a gap between what you're paying and where the Fed is. Then you gradually get to pace with where the Fed is, maintaining that gap the whole time so it doesn't get worse. The other thing in our case, we're not an NII shop. We like it when rates grow up and we make more money, we continue to grow fees at a pace that has an opportunity at least as great as what we do in NII through time. It's less volatile and less dependent on the environment. The market will do what it'll do. We feel good. We tend to agree with you.
Yeah.
Yeah.
Yeah. It's still a benefit, right?
Yeah.
I guess I think the thing is, it seems to me most bank kind of business models were kind of calibrated in an environment when short rates were between 3% and 6%. That was kind of historically the normal range, and we're still below that. Would you say that-
I was just going to say the one fear that could be out there is just to what extent people have fixed rate assets that ultimately because mortgages quit prepaying and so forth, that you just lose carry on. If the balance sheet ends up being constrained by legacy fixed rate assets as they raise the front end of the curve, you can see margins contract. That isn't our case.
Right. All righty. Thank you. That's it for me.
Sure.
Our next question comes from the line of Marty Mosby with Vining Sparks. Your line is open. Please go ahead.
Thank you. Bill, want to ask you about the loan growth. Given the competition that we're seeing in pricing and maybe some underwriting loosening. Are you really still kind of keeping the PNC legacy that, in this part of the cycle, when you start to see that growing half of what the market's growing is probably the right position to be in?
We don't purposefully throttle our growth one way or the other. We maintain the credit box that we always have. If a deal works for us, it works for us. We'll compete on price, and in fact, for the last several quarters, we've seen spreads stay pretty constant, where this quarter we saw them come in a couple of basis points, on average. We're not necessarily tightening credit, we're just not loosening credit to chase, and that means that all else equal, we win less deals in competition, which is why total growth is both down. That's most apparent in CRE, where coming out of the crisis, we had quite strong growth and it's tapered off over time as that market, in our view, has gotten overheated.
Rob, I've got two questions for you. If you look at the way the yield curve kind of lays out right now, the flatness between the two and 10, but yet still a big kind of cliff down to the short rates, that steepness of the curve, you get all the benefit from going from one day or one month to one or two years. You don't have to take much duration and you get all the benefit.
Correct.
Is that part of why you began to deploy some of that liquidity? Really, it almost becomes a no-brainer to create something with that much cash flow, that shorter duration, and get that much benefit. Lastly, when do mortgage fees start to work again? I mean, we've watched this whole cycle waiting on that business to kind of kick in, and we just haven't gotten it yet.
Yeah. I mean, I'll just comment on the rates. I mean, your comment's exactly right. You go twos, tens, you get an extra 20 basis points. You'd have to really buy into a big curve inversion with the 10-year rally from here to want to do that. That's part of what we're doing.
That's right.
On mortgages, look, volume's down. Our purchase volume versus refi is north of 60%, 70%.
Oh, yeah. 30-70. Yeah.
Yeah.
To purchase.
With that much capacity in the market, and you're basically relying on purchase volume, you're going to see margins squeezed.
Any hope that the mortgage activity kind of kicks in as we get home formation picking up again?
I mean, there's always a hope.
Yeah.
I mean, beyond the market overall, we would like to believe that given the changes we've made in our technology around mortgage, that we would do better on a share basis through time, independent of what the market itself does. Look, we're in a fairly tough market for mortgages, and you're seeing that in everybody's results.
For us, Marty, right, mortgage is obviously a smaller component. It's a strategic product need for us. We want to be able to do it for our customers. I think the refi wave is over for a while. To Bill's point, we just have to set ourselves up for further purchase volume.
Thanks.
Sure.
Our next question comes from Mike Mayo with Wells Fargo Securities. Your line is open. Please go ahead.
Hi. I had a follow-up on the national digital bank. Did I hear you right? You're creating a national digital bank. You're going to really focus on a few select markets. In those few select markets, you'll eventually be opening up bank branches?
Yeah. In fact, pretty much concurrent with the launch, we'll open a handful of branches. I mean, it'll be a very, very thin network. It won't look like any of our traditional retail markets. We think you have the potential for a much broader set of consumers to the extent you have physical presence and brand and the trust that comes with that as you launch digital.
I think this is the first time PNC has ever expanded retail de novo to new markets. I'm just wondering what gives you extra confidence at this stage of the corporate life cycle to do that. I'm also noticing your marketing spend was up one third quarter-over-quarter. Is that increase in marketing spend related to the new expansion?
Somewhat related to the new expansion. Banking has changed. The ability to go de novo into a new market, you're right, I don't think we've ever done it. By the way, we've never really done it on the C&IB side either, and that's going gangbusters, and then trailing that with a digital retail offering on the back of the brand presence that we'll get with the regional president model, the local marketing, the local presence. We think it works. You now have the ability through digital marketing and social media to get brand awareness for a thin branch network in a way that you just didn't have.
Wasn't available.
20 years ago. Yeah.
Should we think of first, I guess you didn't identify the cities. I'm going to guess it might be Dallas, Kansas City, Minneapolis, Denver, Houston, Nashville. In other words, does it make sense?
If you were throwing darts, that's where I'd aim.
Okay. It's kind of like Goldman Sachs Marcus, but with branches, or?
Yeah.
Yeah. That's right.
Yeah. No, that's right. Priority number one, Mike, we want to be able to find a different channel to grow deposits, because right now we have national loan growth capability against regional funding. Long, long term, we have an imbalance there. Right. Simply the high-yield savings product is a good way for us to grow some stable deposits through time. Beyond that, because we have such a powerful platform in our Virtual Wallet product and the brand, we think we have a shot at least as good as anybody in converting those high-yield savings accounts into full PNC relationships with these customers. And we spent a lot of time building the technology that's going to make it very simple for somebody to convert those accounts.
The handful of branches that we might have in a market just is kind of the tipping stone to give somebody comfort that they're not dealing with the person behind the curtain here, that there's actually a presence, that they can go in and talk to somebody if they need to.
Last follow-up. I can see why you'd have an advantage, say, against some fintech firm in Silicon Valley. You have the expertise with consumer banking. On the other hand, going against an incumbent in their backyard, just like if someone were to come to Pittsburgh trying to get the consumers away from you, isn't that a tough challenge?
Yes and no. We are going to offer into that market, including the customers that convert to a full relationship, a full digital price. Right? The yield that we offer on savings products in these markets will be as high as any of the online banks today, and we will have with that, we'll augment that with a handful of branches. When they convert to Virtual Wallet, that savings product inside a Virtual Wallet will offer this online rate. In a world where rates are no longer zero, that makes it a big difference to people.
All right. We'll keep a close watch. Thank you.
Will we.
There are no further questions.
Okay. Well, thank you very much for participating on the call.
Thanks, everybody.
Thank you.
This concludes today's conference call. You may now disconnect.