PNC Financial Services Group Inc (PNC) 2017 Q2 法說會逐字稿

Good morning.

My name is Carlos, and I will be your conference operator today.

At this time, I would like to welcome everybody to the PNC Financial Services Group earnings conference call.

(Operator Instructions) As a reminder, this call is being recorded.

I would now like to turn the call over to Director of Investor Relations, Mr. Bryan Gill.

Sir, please go ahead.

Well, thank you, and good morning.

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; and Rob Reilly, Executive Vice President and Chief Financial Officer.

Today's presentation contains forward-looking information.

Our forward-looking statements regarding PNC performance assume a continuation of the current economic trends and do not take into account the impact of potential legal and regulatory contingencies.

Actual results and future events could differ, possibly materially, from those anticipated in our statements and from historical performance due to a variety of risks and other factors.

Information about such factors, as well as GAAP reconciliations and other information on non-GAAP financial measures we discuss, is included in today's conference call, earnings release and related presentation materials and in our 10-K, 10-Q and other SEC filings and investor materials.

These are all available on our corporate website, pnc.com, under Investor Relations.

These statements speak only as of July 14, 2017, and PNC undertakes no obligation to update them.

Now I'd like turn the call over to Bill Demchak.

Thanks, Bryan, and good morning, everybody.

As you've seen this morning, PNC reported net income of $1.1 billion or $2.10 per diluted common share in the second quarter.

You likely also saw our announcement last week regarding the dividend.

Following the CCAR stress test results last month, we announced a 36% increase in our common stock dividend, raising it to an all-time high of $0.75 per common share.

In addition, we plan to repurchase up to $2.7 billion of PNC shares over the next 4 quarters, which would be a 17% increase over last year's buyback as we work to return more capital to shareholders.

Now as Rob's going to lay out in a bit more detail, this is a pretty good quarter for us.

I'm particularly pleased with our loan growth this quarter.

C&IB, in particular, grew 4% in the quarter, helped by the ENC (sic) [ECN] equipment finance acquisition and a slight uptick in utilization.

But beyond that, it was particularly impressive because it was across the board, including the traditional commercial and middle-market segments, where we really haven't seen sustained growth for several years.

Expenses were in line with our guidance, although there are certain categories in there that were a bit higher than I would've liked.

And Rob's going to give you more color on this.

But it was a bunch of give and takes, and I assure you that we remain focused here.

As you saw, credit remained benign, and fee income was up, some of it driven by seasonally higher customer activity.

Obviously, we were pleased to see another interest rate increase by the Fed in June, and NII was up on the back of higher rates and the previously mentioned loan growth.

Now on the flip side, I'd say we underperformed a bit this quarter on the home lending side.

Despite increased origination volume, gain on sales margins were down.

And I'll finish with a quick update on a couple of our strategic priorities, including our need to ramp up consumer lending and our middle-market expansion.

Now just on the consumer lending front, as you know, we have a lot of work to do, and it's going to take a while, but we are focused.

We've made some important leadership changes, and we're making progress.

As an example, we just recently launched a new Cash Rewards credit card that helped us to produce a substantial increase in volume.

In fact, June was a record month for digital card account openings.

Additionally, and we've talked about this before, we booked nearly $100 million in new loans as part of our digital consumer unsecured installment loan pilot since the fourth quarter launch.

Now within the corporate bank, we expanded our middle-market franchise into Dallas, Kansas City and Minneapolis, St.

Paul at the start of the year.

And we've been hiring or relocating top talent to each market and embedding ourselves in the communities through our traditional regional presidents model.

Now the approach we're taking in these markets is very similar to what we have done in Chicago and the Southeast.

It is a long-term play, but we're very pleased with the initial momentum of our efforts and what we're generating in all 3 markets.

We've also recently formalized plans to continue the expansion of our middle-market businesses in 3 additional markets: Denver, Houston and Nashville, in 2018.

And like Dallas, Kansas City and the Twin Cities, PNC already has a significant presence through our national businesses in each of these markets.

Now I know it's a busy day for everybody ahead, and we'd like to leave plenty of time for questions.

So I'll turn it over to Rob to run you through the results for the quarter in greater detail, and then we'll open it up for Q&A.

Rob?

Thanks, Bill, and good morning, everyone.

As Bill just mentioned, our second quarter net income was $1.1 billion or $2.10 per diluted common share.

Our balance sheet is on Slide 4 and is presented on an average basis.

Total loans grew by $4.1 billion or 2% linked quarter.

Commercial lending was up $4.4 billion from the first quarter as we saw broad-based growth in nearly every category.

This growth also reflected the impact of $1 billion loan and lease portfolio acquired as part of the ECN transaction, which closed in the early second quarter.

Consumer lending decreased by approximately $300 million linked quarter as declines in home equity and education lending were somewhat offset by increases in residential real estate, auto lending and credit card.

On a spot basis, we saw a slight increase in consumer lending, driven by growth in residential mortgage, auto and credit card loans.

Investment securities decreased by approximately $900 million linked quarter.

Maturities and payoffs outpaced net purchases as we saw fewer opportunities for reinvestment given the flat yield curve environment during much of the second quarter.

On a spot basis, investment securities were essentially flat as we increased our purchase activity toward the end of June.

Compared to the same quarter a year ago, average securities were up $5.2 billion or 7%.

Our interest-earning deposits with banks, mostly at the Federal Reserve, averaged $22.5 billion for the second quarter, down $1.6 billion from the first quarter.

On a spot basis, balances held with the Federal Reserve declined $5.4 billion, in part reflecting loan growth.

On the liability side, total deposits increased by $1.5 billion or 1% compared to the first quarter, driven by consumer deposits.

As of June 30, 2017, our fully phased-in Basel III common equity Tier 1 ratio was estimated to be 9.8%.

Our tangible book value increased $68 -- I'm sorry, increased to $68.55 per common share as of June 30.

Our return on average assets for the second quarter was 1.19%, consistent with the first quarter.

And our return on tangible common equity was 12.67%, an increase of 52 basis points.

As you can see on Slide 5, we have returned substantial capital to shareholders through a combination of share repurchases and dividends while maintaining an overall strong capital position.

In the second quarter, we fully completed the common stock repurchase programs we announced last year.

Over the last 4 quarters, we returned a total of $3.4 billion of capital to shareholders.

As Bill mentioned, following the CCAR results last month, we announced a new plan to repurchase up to $2.7 billion of shares over the next 4 quarters.

This represents a 17% increase compared to our recently completed share repurchase programs.

And importantly, the chart on the bottom of the slide shows the progression of our dividend increases.

Earlier this month, we announced a 36% increase in the quarterly dividend to an all-time high of $0.75 per share.

This will be effective with the upcoming August dividend.

As you can see on Slide 6, net income was $1.1 billion, and we continued to deliver positive operating leverage on both a linked-quarter and year-over-year basis.

Revenue was up $176 million or 5% from the first quarter, driven by growth in both net interest income and fee income.

Noninterest expense increased by $77 million or 3% compared to the first quarter, which overall, was in line with our guidance.

As a result, we delivered strong pretax pre-provision earnings.

Provision for credit losses in the second quarter was $98 million as overall credit quality remained stable.

Our effective tax rate in the second quarter was 26%.

For the full year 2017, we expect the effective tax rate to be between 25% and 26%.

Now let's discuss the key drivers of this performance in more detail.

Turning to Slide 7. Net interest income increased by $98 million or 5% linked quarter, primarily driven by higher loan yields and balances, somewhat offset by higher borrowing and deposit costs.

Additionally, the second quarter benefited from 1 additional day compared to the first quarter.

Net interest margin was 2.84%, an increase of 7 basis points compared to the first quarter, primarily due to higher interest rates.

As you can see on Slide 8, noninterest income increased by $78 million or 5% linked quarter, driven by fee income growth.

Compared to the second quarter of last year, total noninterest income was up by $76 million or 4%.

Looking at the various categories.

Asset management fees, which includes earnings from our equity investment in BlackRock, were essentially flat compared to the first quarter.

Compared to the same quarter last year, asset management fees increased by $21 million or 6%, reflecting higher equity markets and growth in assets under management.

Consumer services fees were up $28 million or 8% compared to first quarter results, reflecting seasonally higher client activity with growth in debit and credit card and increased merchant services activity.

Compared to the same quarter a year ago, consumer services fees were up 2% due to increased customer activity.

Within that, higher credit card fees were offset by elevated year-over-year rewards activity.

Corporate services fees increased by $41 million or 10% compared to the first quarter as a result of higher loan syndication and treasury management fees.

Notably, Harris Williams had another strong quarter.

Compared to the same quarter a year ago, corporate services fees were up $31 million or 8%, primarily due to higher capital markets and treasury management fees.

Residential mortgage noninterest income decreased $9 million or 8% linked quarter as servicing fees declined.

Overall, originations were up, but the mix shift from refinance to purchase volume lowered our loan sales revenue.

Compared to the same quarter a year ago, residential mortgage noninterest income decreased $61 million or 37%, primarily driven by lower loan sales revenue and lower net hedging gains on mortgage servicing rights.

Service charges on deposits increased by $9 million or 6% compared to the first quarter, driven by seasonally higher customer activity.

Other noninterest income increased $14 million linked quarter and included higher gains on an increased volume of multifamily loan sales in our commercial mortgage banking business, higher securities gains and higher operating lease income related to the ECN acquisition.

Going forward, we expect this year's quarterly run rate for other noninterest income to be in the range of $250 million to $300 million.

Turning to Slide 9. Second quarter expenses increased by $77 million or 3% linked quarter.

This reflected seasonally lower occupancy costs along with seasonally higher marketing and business activities as well as increased equipment expense.

Equipment expense in the quarter was higher primarily due to 2 factors: First, we now include the operating expenses resulting from the ECN acquisition; and second, we had elevated asset impairments and some accelerated depreciation on equipment in the quarter.

As we previously stated, our continuous improvement Program has a goal to reduce expenses by $350 million in 2017.

Based on first half results, we are on track and confident we will achieve our annual target.

As you know, this program funds a significant portion of our ongoing business and technology investments, including our retail brand strategy, enhanced digital capabilities and our home lending transformation.

These investments are multiyear efforts designed to better meet our customers' needs.

Turning to Slide 10.

Overall credit quality remained stable in the second quarter.

Total nonperforming loans were down $41 million or 2% linked quarter, and total delinquency decreased by $58 million or 4%.

Provision for credit losses was $98 million in the second quarter.

This included an initial provisional for the acquired ECN loan portfolio that was largely offset by a benefit from the performance of certain residential real estate loans and home equity lines of credit reaching draw period end dates.

Net charge-offs decreased $8 million to $110 million in the second quarter, and the annualized net charge-off ratio was 20 basis points, down 3 basis points linked quarter.

In summary, PNC posted a successful second quarter, driven by growth in loans, fee income and net interest income along with well-managed expenses.

For the remainder of the year, we expect continued steady growth in GDP and a 25 basis point increase in short-term interest rates in December.

As you can see on Slide 11, looking ahead to the third quarter of 2017 compared to the second quarter of 2017 reported results, we expect modest growth in loans.

We expect net interest income to be up in the low single digits.

We expect fee income to be stable.

We expect expenses to be stable, and we expect provision to be between $75 million and $125 million.

As a result, our full year 2017 guidance compared to 2016 full year results remains unchanged.

And with that, Bill and I are ready to take your questions.

Carlos, could you please give us the first question?

(Operator Instructions) Our first question comes from the line of John Pancari with Evercore.

Regarding the guidance, I know you just indicated that you maintained the full year '17 guidance.

Why not up, particularly the revenue guidance?

It's still at the upper end of the mid-single-digit range is what the guidance is.

But you clearly had upside to that this quarter, and just curious why not move that.

Yes.

Hey, John, it's Rob.

Well, we're pleased with our results, obviously, in the second quarter, and we're well positioned for the balance of the year.

But there's still a lot of the year to go.

So we're still comfortable with that guidance in the upper end of the mid-single-digit range that we talked about on the first quarter call, and the second quarter results play into that.

Okay.

And I guess to tie to that, the loan growth guidance, you also didn't change that.

I mean, is there an expectation that you're going to come off this high single-digit level where you're operating right now on an annualized basis from loan growth back to that mid-single-digit range?

Is that why you're not moving that?

Is that one of the drivers?

Well, we're sort of mid-single digits right now year-over-year.

So that's why we're still calling to stay in that range.

Despite the linked quarter annualized being in the high single-digit range?

Yes, that's right.

More in terms of the year in terms of the run rate.

Okay, all right.

Then lastly, the -- I just want

to get your updated thoughts around the BlackRock stake, Bill.

Just -- there's clearly, given the expectations around potential tax reform and et cetera, there's still a lot of interest in what -- or how soon you could move on that if you decide to, and what you could do with the capital.

So again, just looking to get your updated thoughts.

I don't know that I have any updated thoughts beyond what we've discussed in the past.

We'll wait and see.

Obviously, if there was some form of tax reform at the margin, that would help us should we be interested in moving the position.

But we haven't come to that conclusion.

It's been a good investment.

We get a good return on capital, and they're a great company.

So as we said before, we'll be good stewards of capital.

We'll watch what happens as it relates to regulation, capital requirements and tax policy, and make decisions, informed decisions when real things happen.

Our next question comes from the line of Betsy Graseck with Morgan Stanley.

A couple of questions.

One is on the new offices, new geographies that you're looking to expand into.

Could you give us a sense of the timing, of the size of these geographies relative to the expansion that you did a few years back in Dallas, Minneapolis and Kansas City?

I just wanted to get a sense of opportunity from these new locations versus what you've been able to deliver from the most recent expansion cities.

Well, the -- we should start back at the beginning.

We chose a year and change ago to go national with our middle-market franchise, independent of whether we had a retail presence there because we were pretty confident about our ability to succeed, given what we'd seen in the Southeast.

We then targeted markets, and we have a fairly long list of them, where we already have a national presence in some of our national businesses, so think real estate, treasury management, business credit and so forth, and then looked at just broad potential client opportunities inside of those markets.

That led us into Kansas City, Minneapolis and Dallas as a start, and the same as we go Nashville, Houston and Denver.

Those markets, as an aside, in terms of potential targets of middle-market clients, on average, are better than the markets we're in, which is what's driving us there.

So we think there's a big opportunity.

Now I would tell you, we're just recently up and running in Dallas, Minneapolis and Houston.

We've got a bit of business.

We have the teams in place.

But it's early days, and the strategy through that will be, as we did in the Southeast, we're going to be patient.

We're going to get to know the communities, become part of the communities, cover the right clients with the right products and the right people.

And through time, we've kind of proven to ourselves again and again that we will win business, but it takes time.

Okay, and then just when you say better than -- it's up "better" markets than the markets you're in, is that just the bold...

Just in terms of just simple targets.

How many companies are out there that need a -- middle-market companies, think of them, $500 million to $1 billion, that need the products and services that we offer.

When we go head to head with that type of client with any competitor in the market, we have a good chance of winning.

And when we're in the market locally, delivering products and services locally, it increases our odds.

Yes.

Hey, Betsy, this is Rob.

I can add to that.

As you know, the source of our optimism in terms of these markets comes from our success in the Southeast, where our commercial products and services have sold very well, maybe in -- maybe to a certain extent, more than we expected on relatively thin retail presence.

So based on that success, we're taking it to these other markets, where Bill -- as Bill mentioned, we have a presence, and we think we'll be able to continue to succeed on that basis.

Okay.

And then expansion into consumer from there, from these new markets, is that in the long-term plan?

Or not a part of this?

It's not a part of our current thinking.

I would tell you that as we -- as our clients increasingly become digital, there is a story line that suggests that on a digital basis, we're national today.

And those markets become relevant to us on a retail basis through digital, but not in the traditional retail sense.

Our next question comes from the line of Erika Narajian (sic) [Erika Najarian] with Bank of America.

My first question is, you're clearly continuing to outperform your peers (inaudible) your deposit cost pass-through, and I'm wondering what your thoughts are in terms of the impact of the Fed balance sheet reduction in terms of outflows for your particular deposit base and how that could shift the beta outlook?

I guess ought to -- let's just talk about what's going on with betas first, and then we'll talk about Fed balance sheet, which is a whole other question.

On the beta side, we have been effectively at 0 on the retail side.

We have seen some mix shift as customers have come out of our promo money market into our sort of relationship-based rate that we pay in our virtual wallet product.

But net-net, we've seen, what, Rob, a couple of basis points of increases...

Yes, yes, that's right.

Since the start of the increase, higher rates.

In C&IB, you have a mix, the basic, I'll call it hot money from corporates has a beta effectively of 90%.

It kind of trades right on top of government money funds.

And then there's another block of money that's compensating balances for TM that has much lower beta, and that probably continues.

I think what happens through time -- so we'll see when the Fed makes a decision to reduce its balance sheet, and they've announced that they'll do that somewhat gradually.

And through time, that will drive liquidity out of the market.

We will see the biggest impact of that, in my view, coming out of the corporate side first, which has the highest beta, therefore, has the least impact on us.

I think the consumer side's going to be driven, frankly, by continued increases in short-term rates by the Fed as opposed to the necessarily shrinking of their balance sheet, which is going to occur over the course of years the way they scheduled it out.

Got it.

And my second question is, Bill, you mentioned that you made some leadership changes in consumer lending, and you're continuing to focus on ramping it up.

And I'm wondering if you could give us just a little bit more detail on some of the change in strategy in terms of how you're approaching your market here.

Sure.

It's -- going back in history, our focus on retail was serving the client and primarily focused on getting the household DDA account as the primary product, right, as we made a lot of money on deposits when rates were higher.

And lending was treated, frankly, as an ancillary business.

It was not a focus.

And through time, we just didn't have the market share with our clients that we should in terms of penetration with consumer products.

So it's not a lot more complicated than that.

The result of that strategy led to underinvestment in technology.

We were slow in fulfillment.

We were slow in creativity of the way we offered products through digital and easy -- e-signature and all the rest.

And that's what we're working on.

So we're not jumping into -- people ask the question, "Why are you going to jump into consumer at a time when you necessarily see consumer delinquencies increasing?" We're not really changing the credit that we're going to go after.

We just need to go after the clients we already have with a competitive product and delivered in a way that is much simpler than we've done historically.

So enhancing our competency, really, rather than changing risk profile.

Our next question comes from the line of John McDonald with AB Global.

Guys, I was wondering about the competitive environment in commercial lending.

You had a nice move up in loan yields this quarter from the Fed hikes.

How have spreads been?

And what are the competitive environments on spreads?

Spreads actually increased quarter-on-quarter at the margin.

I think, Rob, across basically, all products.

Yes, yes.

Small increases, but increases.

Yes, yes.

It remains competitive.

We -- our loan growth basically comes from winning clients.

And a bit of a -- there's a bit of a mix shift.

We had, had some declines in asset-based lending, I think, as borrowers went to cash flow.

That's come back.

So we've seen growth in asset based, where we've been kind of flat to down for a couple of quarters.

In fact, we've seen, and this is a good sign, increase in utilization in asset based on the manufacturing side, which suggests maybe there's some strength behind it, which I guess we saw in industrial production today, behind the manufacturing economy.

Do you see that in the core middle market as well, Bill, the utilization increase?

Or is this still you winning business...

Yes.

No, it was up a bit in middle market as well.

And as I said in my comments, in commercial, which is the [10 to 50] think about it space, this is the second quarter in a row for us for growth, which we had been declining as,first, as we burn off balances from RBC and National City.

But that's really good news to me.

And in the middle-market space, it's as much just winning clients, but we've had 4 or 5 quarters of growth.

Five, yes, that was sustained, yes.

Middle market, itself was, I think, 4% quarter-on-quarter growth.

Yes, that's right.

Traditional, non-specialty product, basic loans.

And on the consumer side, Bill, is it too early to have an early read on the Zelle rollout?

Are the customers kind of starting to know about it and understand it and feel comfortable using it?

It's very early days.

We've been up and running here on our virtual wallet app.

We haven't yet rolled it out.

We're going to do so in a couple of weeks into our traditional online app.

I think across the market, awareness is up from 0 to, what is it, 8% or something now.

Yes, high single digits, yes.

Yes, and it'll go much higher than that as more transactions go through it.

There's been a little bit of publicity about inconsistency in performance and some other things that, frankly, doesn't surprise me given the rollout of a new product.

Fairly typical.

There's a number of banks that are trying to do it all at the same time.

But we remain really bullish, and it's kind of performing as expected at this point.

Our next question comes from the line of Matt O'Connor with Deutsche Bank.

This is Rob from Matt's team.

First, on capital markets this quarter, anything in particular that drove the strength?

And maybe your outlook for the second half.

Well, sure.

I -- in terms of this particular quarter, capital markets, at least in the way that we define it, our loan syndications and loan underwriting had a particularly good quarter.

And then as I mentioned in the opening comments, Harris Williams, our M&A advisory shop, had a very good quarter comparable to their very good quarter in the first quarter.

So not up a lot linked quarter but a lot up year-to-date.

So we feel good about that.

As far as the second half of the year, that's all baked into our guidance.

For the third quarter, we expect corporate services, of which capital markets is part of, to be down a bit.

But for the balance of the year, consistent with our guidance.

Okay, and then a similar question on treasury management.

This is a business you've highlighted you made some significant investments in.

Again, anything in particular drive the strength this quarter?

And should we think about this as being the new run rate going forward?

Yes, I think so.

I mean, in terms of our treasury management, we have been talking about it, highlighting it as our largest business inside corporate services, fits very well with our lending product.

And part of the success that we're having there is part of the increased activity, but also the investments that we're making in those products and services.

So yes, I think the run rate is good.

And we're just executing on the plan.

Yes, executing on the plan.

That's right.

Our next question comes from the line of Scott Siefers with Sandler O'Neill.

Rob, I was hoping you could spend a second talking about mortgage gain on sale margins coming under pressure for you and others, which is definitely expected at this point in the cycle.

But I guess order of magnitude might be a little more than I would have anticipated.

Could you speak a little to sort of the competitive trends you're seeing, how things are coming in versus sort of what you would have expected and sort of where we go from here?

Yes, I think if you take a look at the mortgage, the mortgage fees, it's clearly softer.

As far as the margins go, they are down a bit from what we've had.

As you know about us, our margins are typically higher because we don't do the brokered mortgage products.

So where we guide the $300 million, I think this quarter, we came at $274 million or something, which really reflects the mix shift.

Refi's way down, and purchases were actually up a bit.

So going forward, we sort of guide toward stable.

Maybe we'll see an increase in some of the refis here in Q3, which will help some of the margins.

But we're still sticking to and managing to and expecting $300 million, albeit with (inaudible).

I would tell you, though, there's an internal debate on volume versus margin here within our own team.

So we're kind of saying stable, but I think it is one of the things that we got to watch, because it clearly has become more competitive inside a market that's shrinking.

Yes, so same play, but we acknowledge the pressure.

Yes.

Yes.

Okay.

All right.

And then maybe switching gears a little.

So your balances on deposit with the Fed I think are the lowest they've been in the last few years.

Just wondering if you could talk about liquidity deploying -- sort of further liquidity deployment as you would -- opportunities as you would see it.

And how much more is there to go, so to speak?

Well, look, deployment this quarter was basically through quality loan growth.

So to the extent we continue to see that, we're happy to draw down on the balances with the Fed, and we have a lot of room to be able to do that.

Security balances, you saw, were basically flat, and yields on security balances were basically flat.

So I don't know that you'll see us race to move money into term rate markets at this point.

But to the extent we get healthy loan growth, we'll draw down on those balances.

Our next question comes from the line of Ken Usdin with Jefferies.

Just wanted to ask you a little bit.

Can you help us understand how much of the quarter was helped by the lease deal?

Do we get more of that run rating into the third quarter and trying to just understand the magnitude of benefits to the overall picture?

Yes, I -- generally speaking, Ken, for the full year, the acquisition is pretty de minimis.

Where it showed up somewhat materially is this quarter.

And most of that was in the form of the credit provision, which was the initial provision set up as part of the acquisition.

So it shows up a bit here in the second quarter, but the balance of the year, it'll fade.

Okay.

And then so expenses, obviously, Rob, you pointed to operating leverage.

You're definitely growing revenues far faster than expenses.

And this year, you did pivot a little bit away from just focusing on dollars of expenses as opposed to just the leverage and the efficiency ratio.

So I just wondered if you can kind of help us understand pacing.

Revenue is good, so expenses are higher.

But revenue growth was 5% year-over-year -- expense growth, sorry, was 5% year-over-year.

The timing of just your investments versus your saves in all those structured programs that you had walked us through in the last couple of months, can you just give us an update on that?

Yes, sure.

So I'm glad you clarified that.

Our revenues are 6.5%.

The expense growth is 5%.

I think when you take a look at the expenses, and Bill mentioned in his comments, we remain very focused on it intensely.

And that's part of our continuous improvement program, which you know funds the investments that we were making.

When you look at the quarter, the other expense of $666 million is higher than what it's been.

We guide to $625 million to $700 million.

So it's a little higher than the middle of that range, and most of that is due to timing.

So if you back off a little bit, Ken, just in the spirit of your question, and look at other expenses as a component of expense year-to-date, compare '17 compared to '16, year-to-date, it's $1.291 billion compared to last year 6 months, $1.245 billion.

That difference of $46 million is almost entirely due to the FDIC surcharge.

So everything else offsets itself except for the FDIC surcharge.

Now as you know, that was implemented in the third quarter of last year.

So when we get into the back half of the year, that comp becomes a little easier.

Our next question comes from the line of Gerard Cassidy with RBC.

Got a question on the middle-market success that you had.

I think, Bill, you mentioned that there seemed to be more lending going to asset backed from the cash flow lending.

Are you guys picking up market share in addition to showing this growth?

Is there any evidence of that?

Well, I think it's all -- I mean, beyond the increase in some utilization and the equipment finance acquisition, it's all market share.

Some of that's in ABL.

But frankly, the middle market commercial wins are basically onboarding new clients and the balances that come with them.

And similar to what we said before, it's just a function of executing our strategies in those geographies and those product areas.

I see.

And credit is obviously very strong for you and your peers.

When you talk to Hannon and others, looking at credit on a day-to-day basis, are there any issues on the horizon that they're focused on?

Again, I know it's not going to come soon, but where do they spend their time today?

I'm sorry, I'm not following.

Who are we talking about?

Our credit people (inaudible)

Yes, your credit people.

We focus on all the headline items that you read about, whether it's oil and gas or retail exposure or auto ticking up or [CART].

But none of that is kind of showing up inside of our numbers.

Because we really never changed our credit box on the -- and habit on the consumer side.

And all else equal, the consumer remains healthy, notwithstanding certain consumer products in the subprime space struggling.

We've -- the oil and gas issues appear at this point to be less than they once were.

And retail's going to play out through a lot of -- long period of time.

We're going to have to see how that plays out, given the strength of online.

But we're, by design, diversified in terms of our loan portfolio.

And each of those buckets, although we feel good about them, are small percentages of the overall portfolio.

Good.

And I assume since your Shared National Credit exam was done in the spring, your second quarter results would reflect any comments from the regulators on the SNC exam?

Yes, yes, fully represented.

Okay, yes.

Okay, good.

And then just lastly, Bill, I mean, you guys have done a phenomenal job on the acquisitions of Nat City and Riggs National and RBC.

The markets have certainly changed now, and you've been very disciplined in the way you approach acquisitions.

If you look out over the next 2 to 3 years, do you envision CCAR to CCAR banks combining?

These are banks over $50 billion in assets combining maybe with a $200 billion bank?

And what's your view on where PNC would fit into that process?

I'll just speak to our own situation, and I -- we've been pretty consistent on this.

It's really difficult to come up with a case at current valuations where we would be interested in buying a traditional bank franchise.

The business itself has changed in terms of the percentage that's going digital.

The need for branches has lessened, we don't like the balance sheets, I mean, all the issues I've gone through before.

Now having said that, across the industry, I would expect that people are subscale -- that are subscale, and you can define that however you want, are going to feel the need to merge to be able to compete with the increasing investments necessary to serve consumers.

What's going to be allowed by the regulatory regime?

I don't know.

But I don't think you're going to see us be a player inside of that consolidation.

Other than just buying, growing -- sorry, just growing share organically, which we've been successful at doing.

No doubt.

No doubt.

Just speaking of the subscale, how does technology spending, do you think, fits into your definition of subscale?

Do you think that could be a real catalyst for some banks, that they just can't afford to keep up with the technology spending, especially with the digitalization of banking that you guys have grasped effectively?

Yes, I think without question, the base cost of getting the right infrastructure and then being able to integrate that in terms of your offerings to clients is a lot of money.

You've seen us spend it, and we continue to spend.

And I -- it doesn't shrink dramatically as you reduce the size of the institution in terms of the total dollars you're spending.

I'd say it's a primary driver, really, in terms of the industry.

Yes.

Our next question comes from the line of Kevin Barker with Piper Jaffray.

Could you speak to how spreads have changed in recent months with several competitors pulling back from the auto market?

And your overall view on the competitive dynamics, given that there's been quite a shift in who's involved and who's not involved in the market at this point?

Just in auto specifically?

Auto, specifically, yes.

We haven't -- just to remind you, we're not in the lease business.

We're not in the subprime business.

I think our average FICO on that is at 740?

740, yes.

So our credit box hasn't changed, and we continue to see growth.

So we haven't pulled back.

We just have never -- we never stuck our toes over the edge of the cliff.

Yes, that's right.

Yes, we're not playing in the space that you're obviously referencing.

And just to add to that, even our tenor -- our average tenors are 71 months.

That just gives you a sense of the quality of the book.

Versus a couple of years ago, our growth has slowed, but we're still growing that book.

Yes.

And then in regards to the Check Ready product that you introduced, could you give us an update on the penetration of that?

Check Ready.

On the auto?

Yes.

It's called Check Ready.

Check Ready or mobile Check Ready, yes.

Well, yes, the Check Ready product is an important product that we have, particularly on our direct auto portfolio, which is growing as well.

So it's...

Much higher percentage.

Yes, and new volume included.

But Mobile Check Ready comes out, I mean, kind of now.

Third quarter-ish, yes.

Which gets launched, basically, and you can effectively apply and accept on your mobile app, as opposed to doing it through branch or online.

So are you seeing an increased amount of percentage in that product in the penetration of it?

Or is it still very early days before you can really see...

Well, it's growing at a much higher percentage off a smaller base.

Yes, it's a small book.

So of our $12 billion in auto loans, $2 billion is direct.

$10 billion's indirect.

Yes.

Okay.

And then to shift gears here.

On commercial deposits, you saw about a $1.1 billion decline in your noninterest-bearing commercial deposit.

And commercial deposits are roughly 10% on an annualized basis.

Could you speak to the shift that you're seeing there, given where the short end of the yield curve is now?

And what your expectations are for outflows in noninterest-bearing deposits on the commercial side?

Yes, I think most of the decline that you're referring to is on an average basis.

And most of that's seasonality.

Actually, commercial deposits on a spot basis increased in the quarter, so I'd chalk most of that up to seasonality.

And then everything going forward relates really what Bill was talking about earlier on the beta question in terms of some of the movement there.

So first and foremost, seasonality in the second quarter, going forward is part of this beta discussion and sort of the hot money, how that behaves versus the traditional relationship money.

Yes.

Our next question comes from the line of Saul Martinez with UBS.

Yes, David Eads on for Saul.

Maybe following up on just deposits.

I think in the comment earlier, it sounds like maybe we're on the early stages of seeing a little bit of competition on the consumer side as well.

And I just wanted to see if you had any -- if you're seeing anything of people kind of competing for marginal depositors or any kind of -- seeing competitors start getting promotional or -- and whether anything has shifted in your outlook for how the consumer betas might end up trajectorying from here?

We really haven't seen a shift, either in our own strategy or from our competitors.

Now there's...

On the consumer side.

On the consumer side.

There's obviously a small but growing online presence of deposit gatherers who are paying well above what a traditional bank pays.

But it's a tiny percentage of total consumer deposits.

I think we're a couple of moves away from the Fed before you'd start really seeing deposit beta shift on the consumer side.

Okay.

And then have you guys given any color on how much of the growth -- you talked about the kind of broad-based growth and taking share on the commercial lending side.

How much of that came from the new growth markets versus your legacy markets?

I know you don't traditionally give any kind of breakout there, but I was just curious if you could give any sense there.

Yes, most of that would be more in the Southeast.

As you know, with these other markets, we're new.

Legacy growth is there, but the Southeast markets are growing at a faster rate.

Yes, on a percentage basis.

On a percentage basis, yes.

Balance-wise, it's spread across all our markets.

Yes, that's right.

Our next question comes from the line of Brian Foran with Autonomous.

I was wondering if I could ask about capital, maybe longer term.

So I'd think, and correct me if I'm misstating this, but I think when you kind of talked about the big picture for you guys on capital, it's been the -- somewhere in the 8s as a CET 1 target.

But the challenge getting there has always been the CCAR, partly because of the process and partly because you have a tendency to outperform your budget or your capital plan, which we see with earnings as well.

So I realize the treasury white paper is -- it's not even really at proposal stage; it's just like a broad recommendation stage.

But just conceptually, if CCAR did change, if buybacks and balance sheet growth were less a part of the process or not a part of the process at all, I mean, you really don't lose money even in a severely adverse scenario.

So how would that change your thinking or the timing around your excess capital position?

It's an involved question.

I guess in its simplest form, and the industry has proposed this, that if CCAR got to a place where we could rely on our own models as opposed to necessarily Fed output, so we had more certainty on outcomes and what we actually believed was risk, we would be more aggressive in returning in capital then we are today.

Maybe that's the simplest answer.

Now all of that is hypothetical because, as you said, while there's comments on that inside the treasury paper, they're just comments at this point.

And we'll see what in fact happens with the CCAR process as we go forward.

Then maybe just sticking on the same theme.

As you look through all the proposals or recommendations in that paper, are there any that stand out to you as most impactful for your business or your outlook?

Well, I mean, 2 in particular.

I like the fact that they reference -- you should look at what a company actually does as to use arbitrary size thresholds in the way you set regulations.

So we have the $50 billion and the $250 billion and wherever the G-SIFIs come in.

We actually like the systemic risk indicated that they use to identify G-SIFIs as a measure to look at the riskiness of a firm.

And were they to do that, we would fall well down from some of the people we're bucketed with today on LCR.

And on LCR itself, inside of the treasury paper, they also talk about the fact that they should relook at some of the assumptions broadly for the whole market as it relates to liquidity requirements and the impact that that's having on loan growth.

So those would be our 2 biggest.

And obviously, they're related.

Regulation driven toward the complexity and the risk versus arbitrary size.

Our next question is a follow-up from Brian Klock with Keefe, Bruyette, & Woods.

So it's actually not a follow-up, but I do have a couple of just items that you guys haven't addressed yet.

Rob, earlier, you mentioned the equipment expense for the quarter included an asset impairment charge.

Do you have the amount of that asset impairment charge in the quarter?

We haven't disclosed that, Brian.

The -- but what I can tell you is that's unpredictable and lumpy.

It happened to show up in the second quarter here, so I would expect equipment expense to decline quarter-over-quarter.

Okay, so you think something that's more in line with the first quarter level?

Because the first quarter...

Yes, more in line with the first quarter level, a little above that because there is the ECN.

As I mentioned in my comments, there is the ECN component.

But with that, below second quarter levels.

Okay, and then just quickly on the ECN.

Out of the $1 billion of leases that you guys acquired on the asset side, how much of that are actually operating versus finance leases?

Actually no, well, actually, of the $1.1 billion portfolio, the majority are loans that are pulled through in terms of the industry classification.

The leases within that are about $100 million, and most of those are -- they're split.

So the answer to your question is it's more loans than leases.

Okay.

So there's no depreciation expense or maintenance or anything like that that's coming from that portfolio?

If you have anything here in equipment, it would be the facilities.

Yes, a tiny piece of it.

That's right.

Got it.

Got it.

Okay.

And just another, just a -- okay, great, great.

And just thinking about it, I know you guys haven't been giving the updated purchase accounting accretion.

I know at the end of the year, you talked aboutexpected...

You're breaking up.

I know.

Sorry about that.

But the margin's been good, even with the headwinds, where you guys have talked about the $75 million expected drop.

So just wondered, is it still on pace with what you guys had expected?

Yes, yes, exactly on pace.

The $75 million decline, we're right on track, which you would expect, because as we get to these smaller levels, the predictability is easier because the recoveries, which always added volatility to that number, are much smaller by definition because of where we are in the aging.

Got it.

Okay.

So if we're thinking that's -- of the $278 million last year, so you're in -- first half of the year, you're around $140 million, that's about?

You got it.

Well, a little less than that.

Yes, it comes down over time, but $278 million and down $75 million for the year, we'll hit that number.

Got you.

So it's probably closer to $100 million for the first half of the year.

Well, yes.

Depending on how you add that, that's right.

Full year decline.

That's right.

Our next question comes from the line of Marty Mosby with Vining Sparks.

I want to ask you a kind of bigger-picture question.

When you talked about going into markets, I mean, the Southeast was a market where you did have an acquisition and some presence.

And now you're going into markets where you don't have that.

The competition, or the competitive advantage that you bring to the table, what are a couple of those things that gives you the confidence that you can go in and win business from folks that are -- have been sitting in those markets over time?

Yes.

Well, a couple of things.

First is the markets we are going into, we have had presence, just not on the retail side.

So we've had corporate clients there from our national businesses for years, and we've had people in the markets there.

What gives us confidence is, over time, simply as we've become a larger company and a better-known company and, bluntly, a company that is known to execute well in the C&IB space, we have been able to attract outstanding employees from some of our competitors.

And as we open a market, we basically post it.

And we've been able to find lots of our internal up and comers, who want to move and grow their careers in a new market.

So we go there with great people, with great products and services.

We put product people and credit people in the market so we're local.

We go in with a regional presidents model so that we get involved with the local community.

We introduced Grow Up Great, our philanthropic effort for early childhood education.

And then we're patient.

The better clients that you want to target are already well banked.

We understand that.

You call on them for a couple of years with good ideas, and you're patient about it.

They'll come to recognize that, and you get business.

And we've just proven that over and over again, in particular in the markets that we entered in the Southeast, and we think it's going to work in these other new markets.

And then Rob, when we look at the credit, the biggest question we still pushback is we're far along in this recovery and long in the tooth.

It's been a year, so the credit cycle has to turn.

Our numbers show that when we look at the monitor, the -- our index, that we're kind of slowly kind of navigating back to neutral.

But there isn't really any pressure.

You're showing that in your credit numbers, nonperformers continuing to improve.

You're still providing less than you have in net charge-off.

So what are the tenets right now that should also give us some confidence, which we believe is there, that credit should stay stable to historically low for the next 12 to 18 months?

Well, I think we talked about it here on this call in terms of -- from the credit perspective, we feel good about all our portfolios.

The consumer is in very good shape, as you know.

And on the corporate side, everything, even in the categories that are talked about and have scrutiny in the public arena, we feel good about.

So that's the short term.

I will say, though, these are very low cost in terms of credit costs on a historical basis.

So we will see some normalization.

I can't really point to (inaudible)

So what we said -- we would've told you this time last year that a year from now we ought to be from, what, we were 20 basis points this quarter.

Yes, yes, that's right.

We're going to get to 40 and 50 through time.

You should -- you would think, you just can't put a time line on that because it's not showing up, as you said, in any of the day-to-day in the models that we run today.

And you can't really just migrate to the average.

You kind of -- even though we're kind of neutralizing, that neutralization is probably 10 to 15 to maybe even 20 basis points, but not a real a shock step-up in the sense of credit costs or provisioning, given that I think there has been constraints in the industry that have caused the books to be a little bit stronger.

Yes, I mean, look, it'll be a migration.

I can't -- I mean, I don't know what it is that would cause a shock.

But credit costs for our provision are modeled based on improvement or deterioration of the overall portfolio through a period of time.

And what we've seen, while you would -- we would expect that as we got longer in the cycle, you would see some deterioration or at least less recovery and less strength.

Normalization, right, right.

Yes.

It just hasn't shown up.

And when it does, it'll probably be at the margin and creep up and not jump to a much higher level.

And Rob, thanks for highlighting the short-term rates being higher being the benefit for margin.

A lot of misconception about what the long end does here.

But the short end's what's driving a lot of these results.

And that was good to see in your presentation.

Well, and loan growth.

Yes, yes.

Yes.

Carlos, do we have any more questioners?

No, sir, there are no further questions.

All right.

Well, thank you, everybody.

And we'll see you next quarter.

Thank you.

Thanks.

This concludes today's conference call.

You may now disconnect.