The PNC Financial Services Group, Inc. (PNC) Q2 2018 Earnings Report, Transcript and Summary

Good morning. My name is Colin and I will be your conference operator today. At this time, I would like to welcome everyone to the PNC Financial Services Group Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. [Operator Instructions] 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.

Well, thank you, Colin, and 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 financial measures are included in today’s earnings release, related presentation materials and 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, and PNC undertakes no obligation to update them. Now, I'd like to turn the call over to Bill Demchak.

Thanks, Bryan, and 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 have seen we grew loans on both the corporate consumer side and we also grew deposits this quarter. We grew our net interest income and NIM as we increased investment securities and reduced our cash position at the Fed. We grew fees in customers and we managed expenses while achieving positive operating leverage and improving efficiency. Credit quality remains strong with non-performers declining and loss is stable. We maintained our strong capital and liquidity positions in the quarter and 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 but 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 continued to invest in our businesses. These investments include our digital products and service offerings, new consumer and small business lending projects, healthcare payments processing and the ongoing expansion of our middle-market corporate banking franchise. In fact, I am 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 are looking forward to further expanding the franchise in the Boston and Phoenix in 2019. Half way 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 the continued hard work as well as our clients for their trust in us. With that, over to you Rob.

Great. Thanks, Bill, and good morning, everyone. As you are seeing by now and 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 4 and it’s 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. And 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 30, 2018, our Basel III common equity Tier-1 ratio was estimated to be 9.5%, down from 9.6% as of March 31, 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 30, an increase of 5% compared to a year ago. Turning to Slide 5, 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 and 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 and pay-offs 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 $2.8 billion or 4% linked quarter. Purchases were primarily agency residential mortgage-backed securities and US 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 6, 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 7, 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 pretax earnings. For the full year 2018, we continue to expect the effective tax rate to be approximately 17%. Now let’s assess the key drivers of this performance in more details. Turning to Slide 8, 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 5 basis points compared to the first quarter. Non-interest income increased 9% linked quarter and 6% year-over-year, as we remained focused on growing fee-based revenues. 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 cards. 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 pay-off 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 margins. 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 the quarterly runrate for other non-interest income to be in the range of $225 million to $275 million excluding that security and Visa activity. Turning to Slide 9, 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 10 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 1 basis point linked quarter. So 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 of 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 to $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 a 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. So 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, and importantly, we remain positioned to deliver positive operating leverage in 2018. And with that, Bill and I are ready to take your questions.

[Operator Instructions] Your first question comes from the line of John Pancari with Evercore Partners. The line is open. Please go ahead with your question.

Good morning.

Hey, John.

Hey, John.

On the revenue growth outlook that you just mentioned, your rational in pushing at higher – is – I get the first part of the year so far in the, particularly the second quarter come in 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 are factoring in now?

I’d say, John, this is Rob. Good morning. I’d say, it’s all of the above. I mean, 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. And then, separately, on the loan demand side, just want to see if you can talk a little bit about what you are seeing. I know you indicated that, paydowns are still elevated in commercial real estate. Wondering what you are seeing in terms of demand on the commercial side and do you expect any impact related to the trade wars and presenting your loan growth outlook was unchanged despite any maybe underlying improvement we are seeing in CapEx for example? Thanks.

Yes, I’d say – I’d say that, when we look at the second half of the year, as I mentioned, the pipelines for loan and C&IB credits is healthy. I think the big change and nothing due this quarter, but the big change over the last couple of years has been the CRE component which is on slot. But corporate banking or middle market, the pipeline is healthy, our business credit secured businesses, specialty businesses all look pretty good. Large corporate, not as strong as it was and we think in part that’s due to some of the cash repatriation and some of the tax reforms. But I’d say generally speaking, it looks healthy.

And notwithstanding all the 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 is obviously a handful who are impacted maybe more than that, but as subtracting that 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 the rates in the curve, the bank stock 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. So I am kind of wondering where is the curve relevant for you and where is it not relevant, kind of 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 and we benefit from floating rate loans as LIBOR goes up but our yield on invested securities to the extent the ten year keeps trading inside of three years, it suffers. We did increased securities this year, but 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. But I, at the end of the day, if we hang around some range bound around 3% on the ten year, we are 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.

Good morning.

The one question I’ve gotten to most from your investors recently is, on the buybacks. I think everybody got the message, Bill and Rob that you wanted to focus on the dividend, but I guess, they are wondering would 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…

Oh sorry, 25 basis points.

Saying, yes.

25 basis points. So not 25%. So just dialing that down.

Look, at this point, we just got done on the CCAR process. So we will take a look at it, of course if they also put in a commentary that you can resubmit if you want it. And we’ll watch our play through the course of the year. The one thing I would say on the buybacks, the other question you guys have relayed to us is, are we saving capital for some sort of acquisition, and the answer to that is no. So 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 vesting in our business. It’s a good thing. And we have a lot of – you’ve heard us talk about growth opportunities inside the company itself. So, we’ll look at it as the year goes on as to whether we resubmit our use of de minimis and the other stuff, but in the mean time we are not going to do anything silly with your capital.

And we do see the current share price as attractive.

Yes, yes.

Our next question comes from the line of Scott Siefers with Sandler O'Neill & Partners. Please go ahead with your question.

Good morning guys. Just I was hoping you could touch a bit on the provision in guidance and I guess we are sort of getting back into that phenomenon where even though $100 million to $150 million range looks – starts to look kind of conservative. Just, I mean, how strong the trends are so. I was hoping you could 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 are printing is it’s so low now that single credits can impact it. So, we could have a blip on a few credits go in a quarter and put us back in that range pretty easily. And even that range that we are guiding to right now is below what you would expect sort of on average through the cycle. So we are just at really low levels and maybe we are conservative in saying we’ll be a little higher and it keeps surprising ourselves. And it takes a tiny blip to move us.

Yes, that’s right. Scott, this is Rob. We are just working of such at low absolute levels that literally, particularly in the commercial portfolio, literally a deal or two moving in either direction can affect the range. And so, that’s a good thing and a good place to be, but it does – that makes the guidance…

Around a low number.

That’s right. 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.

Hey, Betsy.

Question on just – as we are thinking about NIM outlook and trajectory, I know we talked about the deposit beta side and asset yields, could you give us a little color on how you are thinking about the non-deposit funding and 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 and then maybe there is an opportunity there to restructure that and flow the uptick in cost of funds on that side of the balance sheet?

I am not sure I follow, I mean, the cost of funds increase is just to related to the increase in LIBOR as much as anything else as we swap effectively our wholesale borrowings back into floating. So it hasn’t gone up on sort of a relative cost basis other than the impact on interest rates and of course net-net we benefit from that increase in rates on our floating rate loan portfolio. So now I don’t see us to get and see any opportunity.

Or need to shift trends.

Yes.

Okay, and like on – just the mix between sub debt or senior debt or FHLB or other borrowed, there is no need to mix that up at all?

We are in a pretty good place.

Okay. Just to follow-up on the digital banking strategy, I know you have – you are rolling that out. Could you give us a sense as to where you are really pushing that more than others, because it feels like, as you roll that out it’s a marketing push and I am just worrying you are really doing it on a nation-wide basis or is it specific MSAs that you are focused on for us?

Well, it will be enabled as a function of specific geographies and zip codes, both the ability to find it and search and then ultimately to open an account and move money. We do that purposely, so we don’t in effect could contagion bank 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, that will be obvious to you when we do it. So it will be available basically on a national basis, but we’ll focus 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.

Yes.

Got it. And so that would include Boston and Phoenix that you announced that you are going to…

Eventually, they will be our…

Okay.

Early ones.

Got it.

It will be available there day one, you won’t see billboards and branches.

It’s in physical.

Now in the Fed.

And then 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 are doing is chasing deposits with a low and effect marginal cost to them, because we don’t have a big physical plan cost associated with the deposits come in. So, it doesn’t take much to offset the cost of what we’ll deploy in marketing in the small branch build and I would think, given the offering we’ll have the simplicity at 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, and the pricing on the deposits?

It’s going to be competitive.

Okay.

And we are looking to learn.

Okay.

Looking.

I mean, I think part of – 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 that the actual at which this is going to grow and when and if you get a convergence between digital deposit pricing and what we pay in core accounts is within the rest of the network. So, we are going to kind of test and learn and by the way we will do it somewhat differently in each market as it relates to the way we spend marketing dollars and we’ll see what happens and we’ll report back as we learn.

And the competitive is competitive versus the online deposit gatherers?

Yes.

Yes, okay. All right. That’s helpful. Thanks.

Yes.

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, maybe one-time in nature?

Yes, 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 CDA. So in this quarter, as we mentioned, private equity had a very strong performance and then on top of that, we had the Visa valuation adjustment. So, those were the really the two big drivers. We guide to 225 to 275, because that’s where it tends to be on average, but because of the lumpiness of that category can be higher in one quarter and lower in the next and this quarter it was just higher.

I see. Thank you. And then, in the 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 on – through the digital channel, but 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 and we believe as evidenced by the fact, we are going to go in and build this branch to network that we will have some amount of success with that. But that’s what we are going to have to figure out. The research basically says, if there is in 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 screen that something – screen to somebody if we guess something wrong. But we are going to, we’ve set it up to the best of our ability. We are going to test and learn and we’ll see through times. My own belief is that over time, we will see that exceeds. I just don’t know how long it’s going to take and you are actually correct that thus far people haven’t been able to do that to a much extent.

Great. Thank you very much.

Yes.

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, I 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 your new money yield is coming on at and how much more remix into securities out of cash? Do you still have the ability to do especially with –a still quite attractive loan-to-deposit ratio? Thanks.

Sure, Ken. In regard to the securities book in terms of what we are purchasing you can see is, 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 $20 billion, approximately $20 billion or so with the Federal which could be moved into by definition into high quality level 1 securities. So, we still have a lot of flexibility. We will continue to deploy more money on a tactical basis.

Okay, great. And then, one question on just the regulatory outlook. The great bill didn’t have a lot to offer banks of your size, any incremental hopes of what might come down in the pike that you might see some benefits from down the road or hopes that you might see?

Yes, Governor – 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 thin bucket items. So 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 at 70 and a 100, they would instead sort of scale that number as a function of asset size and other measures of complexity rather than have a binary trigger to certain dollar amount and all the body language out of the Fed suggested they are going to something like that.

And obviously, we are receptive to that the more the tailoring approach versus the - a sheer simple asset size.

Next question please?

Our next question comes from Kevin Barker with Piper Jaffray. Your line is open. Please go ahead.

Good morning.

Hey, Kevin.

Hey, Kevin.

And Rob, you made a mention that the consumer – I mean, 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%. So you have made this.

Yes.

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?

Yes, I think, catch-up is probably a good word and that’s why we’ve put that chart, we break that chart in between current betas and cumulative betas. So, what changed this quarter was across commercial and consumer and a result total, our current betas went above our stated betas. But you can see on the cumulative beta we are still lagging. So, I do see – I 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. And then, given the outlook for rates in the back half of this year and given your revenue guidance, it implies that 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, that’s 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.

And so, I want to follow-up a little bit on the deposit side, not the beta question, but just overall balances and looking at the end of period spots balances. So it looks like the DDA balances have been declining since the third quarter of 2016 roughly and were over $82 billion at the end of the third quarter 2016, now it’s $79 billion and then down about 1% year-over-year. So, Bill, are you seeing commercial companies shifting into – they try to get some rate, I mean, I guess, is there conversations of customers about earnings credit or some of those deposits actually going out of the system and being used.

I mean, I guess a couple things. Look, the net liquidity into this system from QE has been gradually dropping, but I don’t think that’s impacting us. What you are seeing is in shift, both on the consumer and the corporate side, the interest-bearing where they can get it. So lazy money is moving and that’s not really a surprise to anybody.

Got you. And then, do you have the mix – the interest-bearing deposit growth kind of help to move total deposit growth? And do you have the mix of how much of that’s in the CDs versus the money market accounts?

It’s still predominantly money market. We’ve – I think just last quarter, Rob, started getting a little more aggressive, sort of 18 months to two year CDs.

But it’s a still small but active and contrast to what it’s been the last handful of years.

Yes.

Got it. Okay, thanks. And then, I guess, just as a follow-up, on the expense guide, it seems like the fourth quarter guidance, if I plug a number, maybe it’s down 10 million or 15 million from what you are guiding for the third quarter and it seems like the FDIC surcharge, and we took an estimate of something in the neighborhood of 30% to 40% that could be benefiting your fourth quarter. So do you guys – are you including a potential for that surcharge to go way in the fourth quarter in your guidance or I guess, what are your thoughts if you are including and 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 and we estimate a handicap. Events that might occur including a FDIC relief which isn’t assured and then we blend that all into – we blend that into our estimates.

You are giving us a way too much credit for being exact.

We have 60 items - see different things – there is a lot going on.

Trying to give you our best shot.

Lot going on within approximate $10 billion spend.

That’s a fair play. Thank you guys. Thanks for your time.

Sure.

Our next question comes from the line of Matt O'Connor with Deutsche Bank. Your line is open. Please go ahead with your question.

Yes, hi. This is Rob from Matt’s team. Treasury matters have seemed especially strong this quarter. I know this is a business you’ve been pretty positive on and have highlighted in prior presentations, but any color you can provide on the strength this quarter? And then maybe just the outlook for that business going forward?

I mean, nothing unusual, it’s just working. If anything you are probably seeing an acceleration as we cross-sell into the 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, but the offering is the offering. We continue invest pretty heavily in technology-based solutions for our clients and it’s working.

Okay. And then separately, you borrowing costs were up meaningfully again this quarter, presumably on the widening on the day LIBOR spread on an average basis. That said, that spread has come in bit more recently, given that, should we expect that to be benefit in 3Q or have you guys start to swap that out at all? I know you have mentioned on the last call.

I mean, the borrowing cost again are up largely because of LIBOR broadly to find rates up and we did in fact, hedge out a fair chunk in a basis between threes ones over the course of the last four, five months I guess. So I don’t know that you’d see any impact going into the third quarter beyond whatever.

I can jump in there to – so we pointed that out in the first earnings call that mostly just – not because just its size relative to our total NII, it’s just that it was a bit of a surprise and 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 second quarter that Bill mentioned, we were able to move on a tactical basis to some one month index and then also to your point it did – the gap narrowed and it narrowed in a good way with one month LIBOR going up, three months LIBOR seeing relatively flat, because we benefit from that from our loan book. That whole issue bottom-line subsided substantially quarter-over-quarter.

Got it. Thanks for the color.

Sure.

Our next question comes from the line of Chris Kotowski from Oppenheimer & Company. Your line is open. Please go ahead.

Yes, good morning. I guess, looking at the trading action in your stock and mostly other banks, it seems to me everyone is concerned about the rising deposit betas and the flattening yield curve, but I guess when I stand back and look at a big picture, I see 2.9% year-over-year loan growth and 6.9% net interest income growth. And so, clearly you are still getting a very significant benefit and I assume most of that is coming from the free funds, the demand deposits, equity and other float and I guess, what needs to – when does a further Fed rate increase not become a benefit? I mean, it just seems to me, you’d have to have an extreme view of deposit betas or curve in order for a further Fed increase – 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 and the Fed goes by another 25 basis points, we get 12.5 basis points.

Yes.

Every time, so, on top of what we are carrying into it with a cumulative beta of wherever we are at this point. So, I don’t particularly understand that logic of course, betas were going to accelerate in a simple notion that you build a gap between what you are paying and where the Fed is. And 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 are not an NII shop. We like it when rates go up and we make more money, but we continue to grow fees at a pace that has an opportunity at least as great as what we do in NII through time and it’s less volatile and less dependent on the environment. So, I – the market will do what it will do.

We tend to agree with you.

Yes. I mean, just it’s still a benefit, right. It’s all still – and I mean, I guess, I think it seems to me most bank kind of business models were kind of calibrated in an environment where in short rates were like between 3% and 6%, I mean, that was kind of historically the normal range and we are still below that. I mean, would you say?

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 mortgage is quick prepaying and so forth that you just lose carry-on. Right, so 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.

All right. Thank you. That’s it for me.

Sure.

And our next question comes from the line of Marty Mosby with Vining Sparks. Your line is open. Please go ahead.

Thank you. Bill, I want to ask you about the loan growth. Given the competition that we are seeing in pricing and maybe some underwriting loosening, are you really kind of, Bill, 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 is growing is probably the right position to be in?

We don’t purposely throttle our growth one way or the other. We maintain the credit box that we always have. So, if a deal works for us, it works for us. We’ll compete on the 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. So we are not necessarily tightening credit and we are 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. But that’s most apparent in CRE where we coming out of the crisis, we had quite strong growth that it’s tapered off over time as that market in our view has gotten overheated.

And then Rob, I got two questions for you. If you look at where the yield curve kind of lays out right now, the flatness between the two and ten, 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, one or two years, you don't have to take much duration and you get all the benefit. Is that part of why you began to deploy some of that liquidity, because it almost becomes a no brainer to create something with that much cash flow that shorter duration and get that much benefit? And then, lastly, when the mortgage fees start to work again? I mean, we watch this whole cycle waiting on that business to kind of kick in and we just haven’t gotten yet.

I would just comment on the rates. I mean, your comment is exactly right. You go twos, tens, you get an extra twenty basis points. You’d have to really buy into a big curve inversion with 10-year rallying from here to want to do that. So, and that’s part of what we are doing.

That’s right.

On mortgages, look, volume is down, where our purchase volume versus refi is north of 60%, 70%,

30%, 70%, yes, yes, in the purchasing.

And so, with that much capacity in the market, you are basically relying on purchase volume you are going to see margin squeezed.

Do you hope that the mortgage activity kind of kicks in as we get home formation picking up again?

It is always a hope.

Yes.

I mean, beyond our – 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 on what the market itself does. But we are in a fairly tough market for mortgages and you are seeing that in everybody’s results.

And perhaps, Marty, you are right. Mortgage is obviously a smaller component and it’s a strategic product need for us. We want to be able to do it for our customers. So, I think the Refi wait is over for a while, so 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. So, did I hear you right you are creating a national digital bank, you are going to really focus on a few select markets and in those few select markets you’ll eventually be opening up bank branches?

Yes, in fact, it’s pretty much concurrent with the launch, we’ll open a handful of branches. I mean, it will be a very, very thin network, it won’t look like any of our traditional retail markets. But we think you get – you have the potential for a much broader set of consumers to the extent you have physical presence in brand and the trust that comes with that as you launch digital.

And I think this is the first time PNC has ever expanded retail de novo to new markets and I am just wondering what gives you extra confidence at this stage of the corporate lifecycle to do that and I am also noticing your marketing spend was up one-third quarter-over-quarter, does that increase your marketing spend related to the new expansion?

Somewhat related to the new expansion. Look, we are – banking has changed. The ability to go de novo into a new market, you are right, I don’t think we’ve ever done it, but the way we’ve never really done it on the C&IB side either and that’s going game busters and then trailing that with the digital retail offering on the back of the brand presence that will 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 available twenty years ago.

So, should we think of – well, first, I guess, you didn’t identify the cities, I am going to guess it’s – it might be Dallas, Kansas City, Minneapolis, Denver, Houston, Nashville. In other words, does it make sense?

[A fewer throw and odd, sets riding.]

Okay. So it’s kind of like, Goldman Sachs markets, but with branches or?

Yes, that’s right.

Yes, that’s right, because we are – so, 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. So long, long-term we have been in balance there. Right, so, simply to high yield savings product is a good way for us to grow some stable deposits through time. But 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 spend a lot of time building the technology that’s going to make it very simple for somebody to convert those accounts. And that the handful of branches that we might have in a market, just is kind of the tipping stone to give somebody comfort that they are not dealing with the person behind the curtain here that there is actually a presence of go and talk to somebody if they need to.

Last follow-up. I can see why you’d have an advantage to stay against some fin tech firm in Silicon valley, I mean, you have the expertise with consumer banking. On the other hand, I mean, 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. So we are going to offer into that market including the customers that convert to a full relationship, a full digital price. Right, so the yield that we offer on savings products in these markets will be as high as than any of the online banks today and we will have with that, we’ll augment that with a handful of branches. So, when they convert to virtual wallet, that savings product inside a virtual wallet will offer this online rate. So in a world where rates are no longer zero, and that makes it a big difference to be.

All right, we’ll keep a close watch. Thank you.

So will we.

And there are no further questions.

Okay, well, thank you very much for participating on the call.

Thanks everybody.

Thank you.

And this concludes today's conference call. You may now disconnect.