PNC, Covid-19 and the rise of a national champion

The scene is the home office of Bill Demchak, chief executive of PNC Financial Services, a US regional bank based in Pittsburgh, PA. The day could be one of many in April 2020. The time is 3am.

He went to bed at midnight, but Demchak is already logging on to his bank’s systems again, to help process the tens of thousands of applications that have been filed through PNC for the US government’s Paycheck Protection Program (PPP).

The support scheme, run by the Small Business Administration (SBA), helps US companies cope with the collapse of cashflow caused by the coronavirus crisis.

Demchak looks across at his Skype for Business account, at the indicators showing which of his staff are online. There are at least 500.

It’s not how Demchak expected to be spending his time. His bank headed into 2020 on the back of another good 12 months that saw revenue reach a record $17.8 billion, the result of a strategic plan that goes back more than five years.

Since 2015, revenues and pre-tax profits have each risen by about 17%. Continuing a now well-trodden path for PNC, Demchak was all set to expand into his next two new regions, Seattle and Portland.

These plans have not been abandoned but are necessarily on hold. Right now, there are long days and nights as all banks try to grapple with the new challenges thrown at them by a nationwide crisis that has touched almost every sector and client segment.

But after years of patient work, Demchak’s firm is at least in a position to think strategically.

That has been true even during the worst of the crisis.

On May 11 he announced he would sell the bank’s residual 22% stake in BlackRock, the biggest asset manager in the world, and completed the deal through an offer of common and convertible preference shares a few days later, raising some $14.4 billion and logging an after-tax gain of about $5 billion.

While done partly in response to worsening conditions in the economy, the deal was widely hailed as a now-rare example of a firm acting from a position of strength. It has certainly put PNC on a strong foundation for the risks – and opportunities – that might lie ahead.

Demchak lives about 10 minutes from PNC’s Pittsburgh headquarters, which is where he takes Euromoney’s call.

He has been going into the office every day during the crisis, despite having sent all his staff home. With his three children spending lock-down with him – one works in corporate finance, another is at university and a third in high school – his home office has been well and truly commandeered.

At least with the PNC building to himself, he can turn up in shorts and go for a run on his way home, as he likes to do.

He joined the bank in 2002 and became chief executive in 2013. On taking the top role, he set about looking for opportunities for growth against the perennial post-2008 backdrop of ever lower rates. There was barely any scope to improve in PNC’s home market, where it has a share of about 60%, he estimates.

“We put in place a strategic plan that was focused around having leading-edge technology and national expansion,” says Demchak.

The bank was early to develop its own hybrid cloud, and it poured resources into building digital tools for retail consumers and corporates alike.

He prioritized upgrading infrastructure early on, such as replacing data centres. That means the bank’s technology spending is now roughly 60% dedicated to building new things, as opposed to maintaining old ones – a ratio that Demchak reckons is higher than any competitor.

The national expansion plan was where Demchak put in place measures that were in stark contrast to how the bank had operated in the past, and which meant penetrating much more deeply into each new market than the bank’s traditional method of focusing on banking the biggest corporates.

Why that had been the previous approach is no great mystery. Historically, the earnings driver for PNC has been its corporate and institutional (C&I) division, which services companies with revenues of more than $50 million. It is a division that Demchak used to run.

C&I is still the biggest contributor of profits now. In 2019 it accounted for 35% of revenue – compared with 46% from retail banking – but 45% of profit, about double the contribution of retail.

“We do it with a mix of products that is quite sophisticated for what you might call a ‘regional’ bank,” says Demchak. “We are not big in capital markets, but we are very advanced in treasury management, generic and asset-based lending, leasing and all manner of real estate.”

And for a while, the strategy made sense. Identify a metropolitan area with potential and where there appears to be a good set of clients with the kinds of needs that PNC can service, insert some product specialists to work alongside a regional president, and get the products and services out there.

There were occasional acquisitions that helped out on the retail side. The most recent, in 2011, was Royal Bank of Canada’s US retail bank, based in North Carolina but spanning six states and adding more than 400 branches to take PNC’s total at the time to 2,870 (today it has about 2,400).

“We pursued this strategy for a while, until we came to the conclusion that what we would end up doing was having a nation-wide C&I business but trying to fund that with a regional retail footprint,” he says. “Well, that’s not going to work long-term.”

The answer was to expand the bank’s retail franchise, following in part the model used in the C&I approach, building what Demchak likes to call ‘branch-lite networks’, with ‘solution centers’ a 20-minute drive from anywhere within the relevant metropolitan area.

That’s a much leaner approach to the old PNC way of looking at retail.

“Take Houston: that’s 25 branches,” says Demchak. “Historically that might have been 100.”

It helped that technology was a key part of the strategy. The bank was able to push into new markets without a widespread branch network because it was leading with digital tools and an online high-yielding savings offer.

And by 2019, the approach was working well. Revenues were up only 4% year on year, but many peers were flat or worse.

With total year-end assets of $410 billion, the bank ranked ninth in the country, after BB&T and SunTrust merged to leapfrog PNC to eighth spot, with $473 billion. Outside the megabanks, only US Bancorp is bigger, with $495 billion.

As Demchak admits, growth in PNC’s businesses over recent years has been largely driven by client acquisition in new markets. The bank had been expanding into a couple of those each year.

At the start of his strategy, it had been in a dozen of the 40 biggest metropolitan areas in the US. Now it’s in about two dozen.

This year, it was all set to take the plunge in Seattle and Portland, even though heading into 2020 Demchak knew that things were as tough as ever on the rates front.

“Even before the crisis, we were running into an interest rate environment that was getting worse,” he says, “but you don’t change your plan as a function of what rates are doing.”

At an investor event hosted by Morgan Stanley recently, Demchak noted that while the bank could obviously just drop its deposit yields in line with rates, where it really hurt was in its book of fixed rate assets.

He elaborates on that: “Let’s say our book yields 2.5%, over time we lose 100 basis points out of that as assets run off and we replace them with new assets. On a $90 billion book that’s $900 million of pre-tax – that’s about 20% of our earnings. It hurts.”

So, what is to be done? “In the normal course of events, what we would have done is get a little tighter on expenses, more aggressive on branch closures, but otherwise continue with our strategic growth initiatives,” he says. 

“But then Covid hit. And a whole bunch of things happened.”

It was the first week of March when Demchak realised a catastrophe was on the way. He was in Washington, DC, for a round of briefings with senators in his capacity as a member of the board of the Bank Policy Institute (BPI), a lobby group that he used to chair.

“We had a set of topics we were going to talk through with them, but they had just been briefed on the virus,” he remembers. “Every one of them came into the room wide-eyed and panicked.”

On the way back to the airport Demchak phoned his chief administrative officer, Gregory Jordan, the former global managing partner of law firm Reed Smith.

“I want half our employees out of the building this week,” Demchak told him.

“He thought I was nuts, everybody thought I was nuts. I had people complaining because I was cancelling travel. But that was the thing that triggered it for me: the panic on those senators’ faces.”

Initially PNC went to an orange-team/blue-team structure, with staff alternating in the office. But soon pretty much everyone was working remotely.

“That technology investment saved us – we had zero issues with moving everyone remotely,” Demchak says. “All our apps already worked remotely. The only people we couldn’t get entirely remote were the ones in the drive-through lanes and some operational areas where a physical process is necessary.”

For PNC, that remote shift had to include the bank’s call-centre agents, a function that the firm had never off-shored. It already had in place the technology to make the operation a virtual one, with call routers that would disperse incoming enquiries to staff as they sat at home.

Demchak says productivity scores have gone up since the change.

Soon much of the US was being closed down. Once that happened, PNC was thrown into the government stimulus apparatus of the Coronavirus Aid, Relief and Economic Security Act, otherwise known as the Cares Act. Banks were suddenly engaged in a massive operation to distribute stimulus cheques, process unemployment claims and trawl through the PPP.

“We did 75,000 small business loans in a month,” says Demchak. “That’s probably the cumulative total of all SBA loans in our history.”

It all meant new technology, new portals. But it also meant a new way of looking at customers in distress. How should banks deal with negative balances?

As Demchak puts it: “You don’t want to be just capturing their cheque to pay yourself off – you don’t want to be garnering their income.”

The PPP has come in for some bad press. Banks and the SBA are accused of having prioritised the largest claimants.

Big, publicly listed companies got hundreds of millions of dollars – some later returned it, fearful of a consumer backlash. But mom-and-pop businesses left out were angry or dejected. Wasn’t this supposed to be free money from the state to those who were struggling the most?

Banks got blamed, but they were also grappling with how to help applicants against a backdrop of eligibility criteria that seemed to be constantly shifting – and all with a requirement to apply rigorous underwriting standards.

Much of the time it wasn’t at all clear whether eventual forgiveness of loans would happen, or on what basis.

Demchak makes the case for a generous verdict.

“If you consider it from 10,000 feet, the government produced a programme that distributed $400 billion through the banking system to small businesses inside of a month,” he says. “That is an unbelievable accomplishment.”

Closer to the front line, it didn’t always feel that way – as Demchak knows all too well.

“To the people that had to be involved with it, it was horrifying. Rules were being made on the fly – what even counted as income? The SBA had never done anything on this scale.”

Banks, meanwhile, just didn’t have the technology to deal with it at the start, even ones that were fairly tech-savvy, like PNC.

The SBA has been around since 1953. Conventional SBA loans were often manually entered into an old green screen SBA terminal. To use that you needed to be a licenced SBA lender. PNC had 14 of them on staff.

“So, on the day the PPP opened, I had 14 people typing in applications,” says Demchak, “and I had 60,000 applications.”

That didn’t last long.

“As time progressed, we were able to build AI-based technology to automate some of it, and batch it through to the SBA – and they were also working with Microsoft and Google to industrialise their system.”

Demchak recognises that clients whose businesses were stopped by shutdowns or shelter-in-place orders would have been terrified. The world was ending, but there was this program designed to help get the money out.

But he notes that at one point PNC had 3,000 staff working on PPP, including himself in the middle of the night.

“It was astonishing how much we got done.”

For Demchak, one of the first and most obvious effects of the coronavirus crisis taking hold was an acceleration of exactly what PNC had spent years positioning itself for: mass adoption of digital banking by consumers, albeit in a much more concentrated timeframe than he might have wished.

“As we entered the crisis, we were running at about 25% of new sales to consumers being on the digital side,” he says. “That jumped to 75% in a month. The volume of those was down, but the mix shift was huge. The cost of acquisition fell off a cliff.”

During the pandemic the bank has closed all its lobby-only branches, but has kept its drive-throughs open, operating those with half the staff it would typically use. Some branches might not re-open at all.

“What you see now is the ability to be much more aggressive on closing branches, the theory being that the shift back to physical will not happen,” adds Demchak.

In keeping with his branch-lite model, that doesn’t mean withdrawing from markets, though. But it does offer an obvious additional push to slim down.

On the corporate side, meanwhile, there was a massive shift in the area of payments, something that plays to PNC’s strengths.

Demchak argues PNC is a leader in real-time payments, an area that has become much more important as many clients abandon the physical processing of cheques.

“I would say that our treasury-management capabilities allow us to fight above our size, against the likes of Bank of America, Wells Fargo and JPMorgan,” says Demchak. “It’s been a core part of what we have invested in for years.”

Before all that upheaval emerged in March, regulatory pressures continued to bear down – although Demchak actually likes some of them.

He argues that changes in regulation since the 2008 crisis have in many ways benefited PNC, including CCAR, the annual comprehensive capital and analysis review of banks conducted by US regulators.

“That might sound strange, but we always ran the company in a slightly risk-averse way – we would underperform in good times,” he says. “What things like CCAR have done, with their increased capital and liquidity requirements, is level-set the risk profile of banks.”

Banking might be the only industry in the world where it is routinely possible to hide the truth about the health of one’s business until a crisis actually hits.

The benefit of an annual stress regime, says Demchak, is that it forces everything into the open.

“Once a year everyone has to ’fess up, which we like.”

It’s an attitude that tallies with how Demchak thinks about the business of banking – a thinking that has changed during his time in the industry.

He started out at the old Morgan Guaranty Trust, the result of the merger in 1959 between a still-small JPMorgan and the much bigger Guaranty Trust.

By 1988, the company was trading as JPMorgan. Demchak hung around for a year or so after JPM’s merger with Chase Manhattan, ending up as global head of structured finance and credit portfolio. He joined PNC as chief financial officer in 2002.

In 2005, he became head of PNC’s C&I division. He was named chief executive of the bank in 2013.

“Back in the day, I ran credit derivatives and other funky stuff, but life has changed a lot since then,” he says. “This role [at PNC] puts you right back in touch with Main Street, what real people face every day, and how you solve problems for them.”

Demchak pitches this in the context of a structural shift around the world to address the purpose of a corporation: is it to maximise profits or to serve the community? Are the two goals incompatible?

This is familiar ground for his old boss, Jamie Dimon. As head of the Business Roundtable, a Washington-based non-profit association of chief executives, the JPMorgan CEO with 180 of the Roundtable’s other members made headlines in August 2019 with the pronouncement that they were abandoning the view that company shareholder interests should take priority over all others.

“This way of thinking has accelerated over the years,” says Demchak. “You can’t be long-run successful unless you protect your brand and service your clients.”

He cites the $1 billion commitment to helping end systemic racism that PNC announced on June 18 as just the most recent example of that.

“We view this as part of our responsibility as corporate citizens,” he adds. “Even 10 years ago, I don’t know if people would have thought that.”

And he is adamant that the banking sector has seen a powerful shift in priorities since the crisis of 2008, which he says highlighted not just the leverage and housing bubbles but also a system in which banks were not putting clients first.

“Yes, we are all better capitalized and have better liquidity now,” he says. “But what has really changed is a focus on clients and a desire to support the economy.”

Even outside the context of the coronavirus crisis, PNC’s exit from BlackRock would have been a landmark for the bank. The crisis adds an extra dimension. What did it mean for Demchak, and what opportunities does it bring?

PNC acquired BlackRock in 1995, just seven years after Larry Fink had founded the asset manager from within private equity firm Blackstone. And Demchak is full of admiration for his predecessors’ decisions to invest in BlackRock and then hold onto it.

“They saw a $240 million investment grow into $15 billion over time,” he notes. “But eventually we owned that asset with no control over it.”

Increasingly there were other issues too, such as single counterparty credit limits.

That meant that even before the coronavirus crisis hit, a plan was forming to exit the stake. The crisis didn’t change that – if anything it made it all the more sensible.

“We didn’t know – and we still don’t know – the outcome of the Covid-19 crisis,” says Demchak. “But the simple thought was that in times of crisis, opportunities arise out of dislocated markets – and the person with the most capital wins.”

Now comes the question of what to do next. Demchak knows that to be successful in the US you have to be a national player. It is what has driven his strategy so far, and so geographic expansion will be the priority for any big move.

At that recent Morgan Stanley event, Demchak said he would consider an acquisition that would take PNC beyond $700 billion in assets – a notable threshold because the bank would become a Category II institution within the US prudential standards regime, imposing additional capital and other requirements.

A move of that scale would certainly allow it to accelerate its so-far patient geographic strategy. But smaller deals might also be an option.

While the Covid-19 crisis wasn’t a banking crisis, and government actions as well as post-2008 capital buffers have probably ensured that it won’t be on an industry-wide scale, that doesn’t mean that there is no crisis on the way for at least some banks.

Small institutions with loan books that are very concentrated in areas such as low-quality commercial real estate or credit-card exposure to low Fico-score clients, could struggle to stay afloat.

It’s possible, then, that many of the opportunities coming out of the crisis might be exactly these kinds of names. Many were already finding life tough going into the crisis.

Zero rates coupled with rising requirements to spend on technology mean that it is increasingly difficult for smaller institutions to earn a decent return on capital.

And, as Demchak points out, smaller is getting larger and larger every day.

Troubled firms might provide a brave buyer with an entry point into a new footprint, but Euromoney wonders if Demchak really wants to be in the business of working out a distressed asset.

He doesn’t rule it out.

“We could consider a financial transaction – if it comprised distressed assets that we knew we would be good at earning out,” he says. “We would then use the earnings from that for a more aggressive organic strategic expansion.”

But whether or not the returns are attractive is merely one part of the story.

“The other question is whether it would distract us from our ability to follow our strategy,” he adds. “You don’t want to jeopardise that by being seduced by a bargain.”