PNC Financial Services Group Inc (PNC) 2018 Q3 法說會逐字稿

Good morning.

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

At this time, I'd like to welcome everyone to The PNC Financial Services Group Earnings Conference Call.

(Operator Instructions).

As a reminder, this call is being recorded.

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

Sir, please go ahead.

Well, thank you, 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 measures are included in today's earnings release materials as well as our SEC filings and other investor materials.

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

These statements speak only as of October 12, 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.

This morning, you would have seen PNC reported third quarter net income of $1.4 billion or $2.82 per diluted common share.

Overall, I thought we delivered another really solid quarter, highlighted by continued progress on our strategic priorities and our key financial metrics all moving in the right direction.

We grew average loans and deposits and we continued to add new clients, net interest income increased, NIM expanded and fee income grew.

In fact, we hit a record high for fee income through 9 months with increases in basically every category other than residential mortgage.

We continue to manage expenses well with the small increase this quarter reflecting higher business activity.

Credit quality also remains strong with nonperformers and net charge-offs down and our tangible book value per share grew again, and we raised the quarterly dividend to $0.95 in August.

I do want to touch on loan growth for a second because I know it's something you are all watching closely.

And while we did see modest growth in the quarter consistent with industry data, our corporate loan growth came in below our own expectations.

We attribute the shortfall to a combination of several factors, including elevated competition, meaningfully higher payoffs this quarter and pay downs and overall lower line utilization.

The higher payoffs and pay downs appear to be driven by competition from non-bank lenders, excess corporate cash, and attractive opportunities for our clients in the bond markets.

Interestingly our secured lending businesses, excluding real estate, which collectively comprise roughly 1/3 of our book and face less competition, they grew at almost 3% this quarter.

Now while we recognize these challenges, we can't impact all of them directly.

What we can and are doing is executing upon our Main Street model providing value-added solutions and world-class service.

We continue to add new customers and deepen relationships that meet our risk-adjusted returns.

On the consumer side, I was pleased to see loan growth again this quarter.

And while our outlook for fourth quarter loan growth is up modestly, as Rob's going to review with you a bit later, the economy is really strong.

Consumers are in great financial shape and companies are optimistic and growing.

In addition, recent market disruption may help to alleviate some of the challenges that I outlined a moment ago.

So we expect to see continued opportunities for loan growth moving forward.

To that end, we're experiencing success in our national initiative to expand our middle market corporate banking franchise and faster-growing markets.

And we also recently launched our national retail digital strategy, leading with a high-yield savings account and offering our virtual wallet checking account, which will be supported by an ultra-thin retail network.

In fact, we just opened our first out-of-footprint retail location in Kansas City earlier this week.

As we work to expand the reach of our brand, we're excited about how we're positioned to drive growth and efficiency through time.

And before I hand it over to Rob, I just want to thank our employees for their continued hard work as well as our clients for their trust in us.

With that, over to you, Rob.

Great.

Thanks, Bill, and good morning, everyone.

As you've seen by now, we've reported net income of $1.4 billion or $2.82 per diluted common share.

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

Total loans grew approximately $700 million linked quarter and $4.1 billion compared to the same quarter a year ago.

Investment securities of $80.8 billion increased $3.3 billion or 4% linked quarter.

Purchases were primarily agency residential mortgage-backed securities and U.S. Treasury.

Our cash balances at the Fed averaged $18.8 billion for the third quarter, down $1.9 billion linked quarter and $4.6 billion year-over-year.

Deposits were up 1% on both the linked-quarter and year-over-year basis.

As of September 30, 2018, our Basel III common equity Tier 1 ratio was estimated to be 9.3%, down from 9.5% as of June 30, 2018, reflecting continued capital return to shareholders and a decline in accumulated other comprehensive income.

Importantly, we maintained strong capital ratios even as we returned $914 million of capital to shareholders.

We repurchased 3.3 million common shares for $469 million and paid dividends of $445 million.

Our return on average assets for the third quarter was 1.47%.

Our return on average common equity was 12.32% and our return on tangible common equity was 15.75%.

Our tangible book value was $73.11 per common share as of September 30, an increase of 5% compared to a year ago.

Turning to Slide 5. Average loans were up approximately $700 million linked quarter and $4.1 billion or 2% compared to the same quarter last year.

Commercial lending balances increased approximately $200 million compared to the second quarter.

As Bill mentioned, our pipelines were strong throughout much of the quarter, but payoffs and pay downs were substantial.

Compared to the same quarter a year ago, total commercial lending increased $3 billion and growth was broad based with the exception of real estate, which declined by $1 billion.

Importantly, we're seeing momentum in consumer lending.

Balances increased by approximately $500 million linked quarter and $1.1 billion year-over-year.

We had growth in our auto, residential mortgage, credit card and unsecured installment loan portfolios, while home equity and education lending continued to decline.

Deposits increased by $3 billion or 1% compared to the same period a year ago.

On a linked-quarter basis, deposits increased $1.5 billion, driven by seasonal growth in commercial deposits.

During the quarter, consumer demand deposits decreased somewhat reflecting seasonal consumer spending, however, our time deposits increased reflecting higher rates.

As the slide shows, our overall cumulative deposit beta increased in the third quarter to 29%, driven by both commercial and consumer.

Within that number, the cumulative commercial beta is near our stated level, however, our cumulative consumer beta is only 15% compared to a stated level of 37%.

Increases in our overall betas, which we expect to continue, will primarily be driven by the consumer side going forward.

As you can see on Slide 6, net income in the third quarter was $1.4 billion.

Revenue was up 1% linked quarter, driven by growth in both net interest income and fee income.

Noninterest expense increased 1% compared to the second quarter, reflecting higher business activity.

Provision for credit losses in the third quarter increased slightly to $88 million as overall credit quality remained strong.

Our effective tax rate in the third quarter was 15.7% and this was the result of the timing of certain tax benefits that this year mostly occurred in the third quarter.

You'll recall our tax rate in the second quarter was somewhat elevated at 18.3%, so when combined and viewed on a year-to-date basis, our effective tax rate year-to-date was 17%, consistent with our guidance and expectations for full year 2018.

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

Turning to Slide 7. Total revenue grew 1% linked quarter and 6% year-over-year.

Net interest income increased $53 million or 2% linked quarter and $121 million or 5% compared to the same period last year as higher earning asset yields and balances were partially offset by higher funding costs.

The linked-quarter comparison also benefited from an additional day in the third quarter.

Net interest margin was 2.99%, an increase of 3 basis points compared to the second quarter.

Noninterest income decreased 1% linked quarter and increased 6% year-over-year.

Importantly, fee income grew 1% linked quarter and 8% compared to the same quarter last year.

It's also worth noting that our fee income on a year-to-date basis was a record-setting $4.7 billion, with increases in every category except for residential mortgage.

The main drivers of the linked-quarter fee increases were asset management fees, which include our earnings from our equity investment in BlackRock, increased $30 million or 7%, reflecting higher average equity markets.

Discretionary assets under management increased $10 billion in the quarter.

Service charges on deposits increased $17 million or 10% reflecting a seasonal increase in consumer spending.

Corporate services fees declined $22 million primarily due to a lower benefit from commercial mortgage servicing rights and lower loan syndication fees, partially offset by higher M&A advisory fees.

Notably, Harris Williams had another record quarter.

Finally, other noninterest income of $301 million, decreased $33 million linked quarter.

Visa derivative fair value adjustments were negative in the third quarter and positive in the second quarter, resulting in a change of $59 million.

This was partially offset by higher private equity investments.

Going forward, we continue to expect the quarterly run rate for other noninterest income to be in the range of $225 million and $275 million, excluding net securities and Visa activity.

Turning to Slide 8. Third quarter expenses increased by $24 million or 1% linked quarter.

Personnel expense increased $57 million linked quarter, largely as a result of incentive compensation expenses related to business activities and an additional day in the quarter.

Importantly, every other expense category declined quarter-over-quarter.

Compared to the same period a year ago, expenses increased to $152 million.

Personnel expense grew $127 million year-over-year, reflecting revenue growth, higher staffing levels to support business investments and the increase in the minimum hourly wage commitments we made to our employees at the beginning of the year.

Additionally, marketing expense increased to support business growth, including our digital expansion efforts.

Our efficiency ratio was 60% in the third quarter, unchanged on both a linked-quarter and a year-over-year basis.

As you know, we have a goal to reduce costs by $250 million in 2018 through our continuous improvement program, and we are confident we will fully achieve our full-year target.

Our credit quality metrics are presented on Slide 9 and remained strong.

Compared to the second quarter, total nonperforming loans were down $25 million or 1%.

Total delinquencies were up $67 million or 5%, and included higher auto loan delinquencies in the 30- to 59-day bucket related to the impact of Hurricane Florence.

Provision for credit losses of $88 million increased by $8 million linked quarter, reflecting a higher consumer provision primarily due to credit card and auto loan growth.

Net charge-offs decreased $18 million compared to the second quarter.

In the third quarter, the annualized net charge-off ratio was 16 basis points, down 4 basis points linked quarter.

In summary, PNC posted strong third quarter results.

During the fourth quarter, we expect continued steady growth in GDP, and we expect one more 25 basis point increase in short-term interest rates in December.

Looking ahead to fourth quarter 2018 compared to third quarter 2018 reported results, we expect loans to be up modestly, we expect both total net interest income and fee income to be up low single digits, we expect other noninterest income to be in the $225 million to $275 million range, we expect expenses to be up low single digits, and we expect provision to be between $100 million and $150 million.

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

(Operator Instructions) Our first question on the phone lines comes from the line of Scott Siefers with Sandler O'Neill.

Okay.

First question just on loan growth, the guide for the fourth quarter is consistent with the guide for the third quarter.

Just curious if you could give a sense for overall trajectory?

Should we be expecting it to be same level, maybe a little better, and why?

And then, I guess, Bill, just as you look at the numerous factors that seem to be impacting growth for you guys in the industry.

Given where we are in the cycle, what would it take for loan growth at banks like PNC to be able to reaccelerate towards something that you would expect would be more normal given the strength of the economy?

All good questions.

So our guidance for the fourth quarter, we're saying up modestly.

I would tell you that our forecast as it sits today is up a little bit over the growth rate that we had in the third quarter, so a little bit better.

But I would also say that we were surprised by the third quarter.

Our actual production and new clients were pretty good.

We saw -- against that though, we saw this broad-based utilization drop and we saw a lot of pay downs that we hadn't expected.

So I don't know how to forecast for that.

I look at some of this disruption and some of the value lost in corporate bond funds and I think, well, maybe that'll slow some of that down.

But I don't know, which is why we put the forecast out that we did.

As I think forward, and you say, what should trigger growth here?

As we talk to companies, they are really bullish and they are investing.

And we see CapEx expenditures going up and so you would think it would follow through in loan growth.

Against that, we've seen a preponderance -- I've seen all these charts of just the volume of noninvestment grade borrowing and even the volume of BBB inside of investment grade and then the size of the corporate bond markets, all of which are playing against banks as sort of the shadow banking system has taken a lot of volume.

So I'd like to think that it would change for the better, but we have some structural changes in the market I think that we saw play out in the third quarter that at least in the near term are impacting us.

Okay.

All right, I appreciate that color.

And then, Rob, if I could switch for 1 second to the deposit side.

Total deposit growth still fine, but a little bit of a mix shift as you would expect in a rising rate environment.

I think in your prepared comments, you had made some note about demand deposits being down seasonally.

What would be your best guess for how the mix of the overall deposit book trajects here as we go forward?

I would expect -- you mean between the interest bearing and noninterest bearing?

Yes.

I think -- sorry, I thought your comment was on demand deposits, but I could be wrong though.

Yes.

Well, I just -- that's just the way I do it, and then you tell me if this answers your question in terms of just the consumer and the commercial side.

On the consumer side, we're seeing a shift to savings, which we've seen for some time.

And now the beginnings of time deposits, which is natural and what you would expect.

And then, on the commercial side, we are seeing somewhat of a shift from noninterest bearing to interest bearing.

Again, all reflective of a higher rate environment.

Our next question comes from the line of John Pancari with Evercore ISI.

On the expense side, just given the -- some of the pressures on balance sheet trends, particularly on the loan side that you just discussed, any thought, as you're looking at the expense side of the equation, to get more constructive on the CIP goals as you -- particularly, as you look through the rest of this year, and more importantly, into '19?

John, this is Rob.

So on expenses in the quarter -- in the linked quarter, we did well.

Virtually, all of the increase in the linked quarter was in personnel and all of that was essentially incentive compensation related to the higher business activity levels.

Every other category went down linked quarter.

And part of that reflects our CIP effort.

When you drop back and take a look at our expenses year-to-date, that tells sort of the broader story.

And if you look at our expenses year-to-date, we're up $382 million so far this year over '17.

And of that $382 million, 80% of that or $300 million of that is in personnel.

So if you -- the other categories are good.

Occupancy is down, equipment expense, all other are in line and marketing expense is up, part of our investments, but that's a smaller number.

But back to that personnel number, that $300 million, about half of that in a typical year is what you'd expect to see, half of that is merit and promotion as well as incentive compensation, which as I pointed out earlier, it's a little higher this year, which is a good thing.

The other half of that, that other $150 million, really reflects investments that we've made that -- we make investments every year, but in 2018, they're particularly strong.

And they represent higher headcount to support our technology build out, our geographic -- physical geographic expansion in corporate banking and our digital expansion in consumer banking.

As well as the commitment we made to raise the minimum wage to $15 an hour -- minimum pay to $15 an hour.

So that part, that $150 million of the $300 million reflects investments.

And like all investments, where we front-end that and we expect to see return on that through time.

Obviously, the technology investments, we'll talk about a little bit more.

On the raise to the $15 an hour, we're already seeing lower attrition rates that we would expect will continue.

So that's all deliberate and all factored in.

And our expense discipline and our program is on track.

I mean, the quick answer, John, we focus on expenses every day and try to find ways to knock them down.

At the same time, as you look at the changes that are happening in the banking industry as kind of digital takes over and the need to produce product and serve clients in that space, it would be a real mistake in my view to slow down and stop our investments.

I like the idea of self-funding them, which we've largely been able to do.

But I don't want to cap off our growth rate because we see 1 quarter of slower loan growth, that's not the right answer.

Got it.

All right.

And then separately on the capital side, you're sitting here at about a combined payout ratio of about 75%.

You've alluded to the potential to increase that given you might have been a bit too conservative as we look to this past CCAR.

Can you give us your updated thoughts there?

And your peers are around a 115% combined payout, how do you -- where do you think you could go here as you look forward?

Well, without getting specifically into payout, as I said at a recent conference, we did realize we went in a little bit light.

There are a couple of reasons why it made sense for us to go back to the Fed and resubmit.

We are in conversations with the Fed at this point.

Beyond that I don't have any more detail to give.

On a longer term, I like the idea of 100% payout.

We, on our base case CCAR, always tend to kind of get there.

And then, we tend to out-earn our CCAR case largely because of some of the assumptions you have to put in on loan loss provision and some other things.

So we always struggle with this notion that we try to get 100%, maybe we have to budget for over 100% to solve back to 100%.

But we're not holding back from capital return at this point and our goal wouldn't be to.

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

Rob, I was wondering based on the -- some of the recent regulatory dialogue, it seems that you could potentially see a benefit from easier liquidity rules.

Just if that happened, could you remind us how mechanically an easier LCR rule would allow you to perhaps do some things in the balance sheet you can't do now?

And is there any way for us to think about the magnitude of that benefit?

Yes.

John, we've spoken about this all year, and we are optimistic that something favorable will occur.

The -- I think the easiest way -- there's a lot of options.

The easiest way, obviously, would be take a look at the $19 billion that we have on deposit at the Fed.

We would, in simple terms, be able to pay down debt or liabilities.

In other instances, we'd be able to redeploy in the higher yield securities.

So I think that the conservative route would be to establish what level of liquidity you need and then just reduce the debt -- short-term debt accordingly.

Okay.

And I guess in this environment you wish you had more things to do with your current liquidity.

So it'd just kind of add, I guess, to more of that?

Yes.

That's right.

Okay.

And you guys have, obviously, talked about different ways you're taking PNC on the road into new markets.

Wanted to kind of ask the opposite question.

When a big player like Bank of America comes into your hometown, how you think about incremental competitive threats and ensure that you're maintaining your position and branding as market leader?

And with digital and mobile, are you able to compete a little more on nonprice factors these days?

Well, that's -- so that's the dynamic that's playing out.

This is Rob, Bill may want to add some color.

This -- that's the dynamic that's playing out.

We're excited about the initiatives that we have going, the amount of footprint on the digitally led offering, which we can talk a little bit more about.

In regard to other providers coming into our sort of legacy markets, we fully expect that, that will occur.

We can't control that.

We compete with them everywhere already other than maybe Pittsburgh.

And I would tell you in our own experience where we go into a market dominated by somebody else and we are the underdog, the growth rate always tends to surprise me, largely I think because there's some percentage of the population for whatever reason that wants to try a different bank.

And I suspect if somebody comes into Pittsburgh, they'll pick up some amount of that.

We have 60% market share or something in Pittsburgh and there's 40% left to go around without really major bank presence sitting here.

So I suspect they'll do fine.

But not necessarily with our consumers, yes.

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

Two questions.

One -- just one more on expenses, so up a little bit this quarter, partly a function of the marketing.

And the investments that you're doing, I think it's related to the digital banking.

I was just wondering how much of that persists from here because you've got the startup costs and then you've got the ongoing marketing.

So should we expect that some of that fades as the startup is done or maybe you could talk through that a little bit?

You're going to have some offsetting things.

We didn't kick off the digital program until late in the third quarter.

Having said that, the third quarter, I think, was probably the first full quarter we had the total impact of the $15 raise increase.

So there's a whole bunch of moving pieces in there between personnel and what we'll do in marketing, and all of that's embedded in Rob's [comment].

Yes, I think -- and for the fourth quarter guidance, Betsy, that's it.

The most notable item is that our marketing expense will increase in the fourth quarter.

Typically, that hasn't happened, and that marketing is largely directed toward the digital initiatives.

And then could you talk a little bit about the branch rationalization that you're doing in your core -- your legacy markets, is there run rate?

Is that run rate going to persist at current kind of levels?

Or is there more to do there or are you almost done?

Just give us a sense on that side of the equation.

Yes.

No, we're pretty steady there, Betsy.

And on our plan for the year, we've been averaging about 100 consolidations a year.

And this year, we're on track to do a comparable number.

So that's the current path and I'd expect that to continue.

Yes.

But part of the issue with accelerating that is the amount of time and effort we put into preparing customers for a branch to close.

So what's very important is that we retain the balances and the customers as we consolidate a branch, so we spend a lot of time on that.

And I'm not sure as a practical matter that we could actually do more or substantially more than the 100 a year we're currently doing.

And we'll continue to go kind of at that run rate until and if the market tells us based on client attrition that we need to slow down.

Got it.

Okay, no, that's helpful.

And then just lastly on the mortgage side, I know you did a lot in improving the efficiency of that platform over the last couple years.

Could you just tell us strategically, how you're positioned?

And is there -- have you created some operating leverage for yourself as you build out into some of these new markets?

Well, we're finally seeing the costs come down in terms of sort of duplicative personnel as we were running 2 systems.

We still have the last leg of bringing home equity origination onto that platform.

With that, we will have in effect digital origination capability and closing capability with home equity in our out-of-footprint markets should we choose to offer that.

I'm not exactly sure where we are on that yet.

But that's a dramatic improvement from where we are today, where, believe it or not, to close a home equity loan at PNC today, you've got to go into a branch.

So all of this system change sort of puts home equity mortgage on the same front end, same servicing platform.

And independent of volumes, which we hope would increase, you'll see cost continuing to bleed out of that system.

Our next question comes from the line of Erika Najarian from Bank of America.

Could I ask a little bit, Bill, about the tenor of competition from nonbank?

And I'm really most curious about more on the competition with regards to structure.

And what you're observing in terms of competition from private, direct, middle market lenders?

And then sort of as a follow-up to that, you mentioned structural changes in the market, which I agree with, but I wonder as the Fed continues to drain liquidity out of the system, how much of the opportunity can go back to banks over time?

Yes.

Again, all good questions.

And I guess, what I would say is, we continue to think that the leveraged loan market is overheated.

I continue to think that as rates rise, it's going to put real pressure on those credits that were originated in a lower rate environment, and necessarily hedged against LIBOR going up as much as it does.

Eventually that turns.

Now as it relates to kind of our near-term flow, we don't really play in the leveraged loan market, but that market being as open as it is has caused a number of our private middle market companies that we historically have banked to go to private equity.

And while we might keep them as a transaction client, TM and so forth, we don't participate in the financing of that.

So that M&A wave is kind of pulling loan demand off and out of the banking system by levering it and putting it into CLOs and so forth.

And I do think there will be a crack in that at some point as rates continue to rise.

And I think when that happens, you'll see probably more traditional flows back into the banks, but I just don't know the time line in that.

Our next question comes from the line of Mike Mayo with Wells Fargo.

Well, thanks for your honesty, Bill, in terms of what's happening with your loan growth that is tough to forecast.

So when you go back to your team at PNC, what kind of message do you want to send?

I mean, you could send all sorts of messages.

You could be angry, you could be happy, you could acceptance -- accept what's taking place or you could pause.

So let me just -- you could be angry because you say, "Hey, we're not executing as well as we need to, do better." Or you could be happy and say, "You know what, you've seen these cycles before, you see the crazies out there.

We're going to stick to what we do and that's fine." Or you could accept what's taking place and say, "It's not going to get better," and have a new expense program or something.

Or you could be -- or you could pause and say, "You know what, this is just weird, and we're just going to see what happens over the next couple quarters." So what message will you be sending to your team?

I don't, I don't -- Mike, I don't really have to do any of the above in the following sense.

We have, since I've been at PNC, followed the same model, the same credit box, the same clients we want to bank are the ones that we bank.

And for risk, as outside of our box, we just don't do it and we can't control the market.

Now what was weird about the third quarter was, we actually originated a lot of business.

So I'm actually pleased with the activity of our bankers and the number of new clients that we brought on board.

I'm disappointed by the environment in the sense that utilization went down and we had pay downs, but there's nothing I can do about that.

And as a practical matter, we will never be the bank -- and by the way, we could be very easily -- that simply says, go get loan growth.

I can make loan growth whatever you want for the next 6 months or a year or until the cycle cracks.

And we just don't do that, and we don't need to do it given our ability to grow fee income and our plan to just -- banking is 3 years and a cloud of dust and you do it consistently forever and you produce a good franchise.

And that's what we're after.

Your question on expenses, I get back to this now.

So we're fighting every day to drop expenses.

But having said that, again, we could choose to simply curtail investment in digital.

We could choose to curtail investment in cyber.

We could choose to not have active, active data centers in terms of resiliency of our client-facing applications.

And in the near term that would make our expenses look great, and in the long term, it would kill us.

And I think a lot of our competitors are choosing to do that on expenses and choosing to do that on loans.

And that's just -- that's not who we are.

So let me see if I have this straight.

So I mean, what I think I hear you saying, you're going to barrel through with your strategy that's worked for the last several years and the environment will eventually come your way since you're looking through an entire cycle.

Is that paraphrasing it correctly?

Well, on credit, yes, right?

So you can't figure out who's lying or not with respect to loan growth until you have a credit crunch.

And you've heard me say forever that banks are the only industry in the world where you can lie about your cost of goods sold until there's a downturn.

And I always want to be the bank that outperforms in that environment.

And if that means that we have to at the margin slow top line growth by not chasing deals that just don't hit our return metrics, then so be it.

All right.

And then lastly, the line utilization, is that from some of the borrowers going elsewhere or what else?

That's just the corporate...

You know what I think that is, is simply corporates are flush.

The lower tax rate is basically increased cash flow in companies, and all else equal, they're not spending the incremental difference in totality on CapEx.

And so they're dropping their line utilization.

I think that...

Mike, this is Rob.

I can jump in on that.

That's exactly right.

And Bill referenced this in his opening comments.

If you take a look at our commercial loans, where the pressure that we're talking about as most pressing is in that general corporate book.

And the 2 headwinds are cash flush borrowers, which is dropping utilization and that's a function of lower tax rates, repatriation, all the things you read about, and these pay downs and payoffs.

Those 2 items are the headwinds.

To the extent that they abate, which we expect that they might at some point, that's the issue.

Yes.

And by the way, Mike, our pipeline as it sits today in the forward months, looks great.

It looks stronger than it's looked in the last 6 months I think, I'm looking to Rob to nod, but yes, it does.

And so our only hesitation on this stuff is the...

[The settling.]

Out of our -- we can get lots of deals that meet our risk criteria in this environment and we're winning them.

What ends up happening is our existing book of business is borrowing less and/or disappearing through pay downs, either public market or pay downs because they were taken private.

That's out of our...

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

Can you talk a little bit about the noninterest-bearing deposits?

When you look at your levels, which represent about 31% of total interest-bearing liabilities, what do you think in a rising rate environment, that's going to settle out at?

When you think back at PNC, maybe prior to the financial crisis where those levels were, do we have just as a risk for everybody in a rising-rate environment, those deposits tend to fall?

Yes, Gerard, I can answer that.

I mean, obviously, that's out there.

We watch it all the time.

I would expect the continued shift that's occurring, that will occur.

I don't -- we haven't really handicapped where it's going to stop or where it's going to be because there's obviously a lot of variables involved there.

But we manage this way, we've managed this way before, it'll be fine either way.

I see, okay.

And then coming back to the competition on commercial lending that you've already addressed, have you sensed that other competitors with the lower tax rate are maybe competing away some of the lower tax rate?

Is there any way of seeing if that's happening?

For all the talk around that, we actually haven't seen it.

There was some talk early on that we heard from some clients that competitors were maybe doing that at the margin, but, practically, that isn't really what we're seeing.

We're seeing competition on structure, we're seeing deals that should be ABL going cash flow, those kinds of things.

But I don't see people outright sort of restating tax reform.

I see.

And then just finally, in this whole commercial competitive area that you've referenced, is it primarily in the legacy PNC footprint or are you also seeing it in your newer markets that you've been expanding into?

It's everywhere.

And by the way, it's intuitive, right?

If what you're offering is a commodity, which is money, there's no special skill involved, there's no special secured financing or technology, then you're offering a commodity.

And in this market, there's a lot of competition for that commodity.

No doubt.

If part of your question though is in our expansion and growth markets, we do see better growth dynamics just because it's off a smaller base, even though those factors are in place there.

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

Recently, there has been some talk, talking about banks of your size and the potential, maybe helpers on the regulatory front from either capital or liquidity?

I know you've talked -- discussed this in the past.

But I'm just wondering just where that conversation sits in your mind?

And what you're, at this point, hoping for directionally?

Well, I think in Governor Quarles last testimony, he spoke to this and talked about...

Large non-G-SIBs.

Yes, the large non-G-SIBs and having something out in the market before the end of the year, and that's consistent with my own dialogue with the Fed.

I'm not exactly sure of what they're going to do.

I think they're thinking about the notion.

And we would like to see the notion that you get rid of the step function of 250.

Not only as it relates to LCR, but, frankly, as it relates to some of the relief you see on capital to the groups below 250, the change in the [syn] bucket items...

AOCI.

Yes, AOCI and some other things.

So we'll have to see.

But I think there is an inclination amongst the regulators to put more finesse on allowing regulation to fit the size and risk of the firm as opposed to doing a step function off of an asset value that they came up with 15 years ago.

Which they call tailoring, Ken.

Yes, okay.

Got it.

So a little wait and see on that.

And then just a follow-up on the choices that you have on the mix of the excess cash.

Just in -- what are you doing right now in terms of just the investment portfolio, obviously, it was up at period end, but in terms of the types of new rates you're seeing versus what's rolling off the back book is in the securities book?

Yes.

So just a couple of things.

The securities balances were up quarter-to-quarter, but our actual duration dollars were flat because we unwound or reduced received fixed swap positions.

So it looks like we put a lot of money to work in the third quarter and we didn't really, we just moved from synthetic to cash.

That said, particularly with the rate environment where it's been for the last couple of weeks, the yield that we're seeing on incoming securities that at this point are largely mortgage-backs and treasuries are in excess of the portfolio that's running off.

There is clear benefit from this going forward.

Yes.

And, Bill, one just follow-up on that.

Will you continue to move that synthetic to cash just at this point of the rate cycle?

How do you balance just where you stand on asset sensitivity versus starting to kind of mortgage it a little bit?

Well, we're still asset sensitive.

So we're nowhere near done here.

The move from synthetic to cash is simply a value trade.

Swaps and we put them on, offered a lot more value than they did.

So we unwound those and went into securities.

And we'll do that opportunistically.

We go back the other way if things change.

So that was just the value trade.

I think going forward, we will be investing into this market.

You've heard us say, forever, we're not going to bet on red in one big swoop, but we'll increment our way into it.

And our patience, thus far, looks like it's going to pay dividends.

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

I just wanted to follow-up on some of the deposit conversations and questions.

We've seen the period-end noninterest-bearing deposits drop significantly.

And you mentioned, part of that was due to the business customers.

Was there any shift also from the consumer side?

And do you expect the rate of change between noninterest-bearing deposit growth and interest-bearing deposit growth to remain the same going into the fourth and first quarters?

Kevin, it's Rob.

To answer your first part of your question, firstly, all the movement we saw was on the commercial side, so not much in terms of the consumer side.

If anything on the consumer side, as I said earlier, is more a migration to savings and time deposits but from already interest-bearing accounts.

Going forward, we'll just have to monitor it.

I don't see anything in terms of a radical step change.

Well, the one thing that will happen over time is we do accelerate our digital expansion as the bulk of those new moneys will come in the form of interest bearing.

Yes.

And that's growth.

Yes, but it's growth in interest bearing that would largely outpace because we're not bringing in a proportional amount of noninterest bearing at the same time.

So it could cause our mix to shift over time.

Right.

Over time, but not necessarily in the short term.

Yes.

Great.

So when I think about the shift to digital, I mean, you already have plenty of liquidity.

You're meeting your LCR ratio, you're loan to deposit ratio is running in the mid-80s, much better than most of your peers.

When I look at the digital offering, are you going to continue to be -- are you going to be a price leader here in the beginning just to show that you can grow the deposits and then slow it down?

You have to compare it to the alternative and the ultimate today is wholesale funding.

So it's a lot cheaper than what we pay on wholesale funding.

Even with LCR, if they make LCR changes, our ability to mix shift some of our more expensive wholesale funding into retail, which is beneficial to us.

So we'll continue to be competitive on our digital offering.

We have no real cost structure other than advertising behind it.

So the margin to it is actually pretty good.

And there's a -- as you know, there's a big qualitative element to it.

This is an experiment in terms of the future of banking.

So it's largely that versus a need for the deposits.

Yes.

The one thing I would say, and it's really early days and what we're doing in digital is.

So we have been pleasantly surprised by the number of clients who choose to open the virtual wallet account, which is a full-service account versus just open a high-yield savings account, which is obviously our dream scenario.

We want full-service clients and we have a large percentage of the people out of the gate choosing to be that.

My own assumption going in was that, that would take longer, frankly, to convert these clients and so that's a good thing.

Do you see that starting to generate higher loan growth on the consumer side, particularly in card and auto because of that shift?

It's too early, it's too early.

I mean, it's anomalous.

It's something we're going to track and we're going to have to figure out the right metrics to show you guys, which we will.

Our next question comes from the line of Brian Klock with Keefe, Bruyette, & Woods.

Rob, I was wondering if you could follow-up a little bit, and I apologize if you answered this already, but on the expense guidance for the fourth quarter, I think you did talk a little bit about having some of the seasonal marketing expenses that would be in that guidance for the fourth quarter.

But are you assuming that the FDIC surcharge is still in that expense for the fourth quarter?

Yes.

So in our guidance, we assume no change in the surcharge amount.

So there's the potential that we don't have that expense.

And if that's the case, that would be a good thing, but it's not part of our guidance.

And if I understand correctly, I mean, even if it's still there for the fourth quarter, one way or the other, it's not going to be in 2019, right?

So there'll be some sort of settlement.

That's the FDIC's expectation.

And it's a matter of hitting the -- their threshold on the DIF fund.

That's right.

That's right.

So if anything the fourth quarter guidance you're giving is not an expectation of a normalized expense level.

I know you're not giving '19 guidance yet, but maybe just say it's a seasonal item.

No, we're not giving '19.

I mean, the only other thing I would say, Brian, is, the seasonal aspect of marketing, it's not that.

Typically in years past, our marketing expense actually declined in the fourth quarter.

This quarter it's going up because of the digital investments that we're making.

So the investment component of that, it's not seasonal, it's deliberate.

Okay.

Okay.

So will that digital investment be something that stays into the expense base going forward?

I guess, is that -- what will be different?

Well, we'll get into that.

We'll get into 2019 when we get on later in the year.

It appears that there are no further questions on the phone lines at this time.

Okay.

Well, I'd like to thank all of you for joining us for this quarterly call.

Thanks, everybody.

Thank you.

Thank you.

Ladies and gentlemen, that does conclude the conference call for today.

We thank you for your participation and ask that you please disconnect your lines.

Thank you, and have a good day.