PNC Financial Services Group Inc

NYSE:PNC

Earnings Call Analysis

Strong Q3 results with positive outlook for loan growth and NII

In the third quarter, PNC Financial Services achieved impressive results, generating $1.5 billion in net income, or $3.49 per share. Net interest income (NII) grew by 3%, targeting record levels in 2025. Fee income increased by 10%, notably boosted by capital markets. The retail expansion strategy is yielding results, particularly in the Southwest. While credit quality remains stable, expectations for charge-offs exist in the commercial real estate sector. Looking ahead, PNC anticipates stable loans with approximately 1% growth in NII next quarter. The Federal Reserve is expected to cut rates twice more in 2024, potentially enhancing loan demand.

Strong Financial Performance in Q3 2024

PNC Financial Services Group reported solid results for the third quarter of 2024, with net income reaching $1.5 billion, translating to $3.49 per share. This marks a notable performance, driven by a $21 million increase in total revenue, amounting to $5.4 billion. Key components of this growth included a 3% rise in net interest income and a significant 10% increase in fee income, which reflects solid momentum across various business lines.

Growth in Net Interest Income and Fee Income

The growth in net interest income was primarily supported by higher yields on interest-earning assets, with net interest income recorded at $3.4 billion, an increase of $108 million. Meanwhile, fee income surged to $2 billion, bolstered by notable increases in capital markets and advisory fees, which rose approximately 36%. This diversified income stream contributes to PNC's overall financial health and positions the bank for future growth.

Cost Management and Operating Leverage

PNC demonstrated effective cost management with a decrease of 1% in noninterest expenses, totaling $3.3 billion. The decrease was attributed to stable or declining expenses across several categories, which allowed for positive operating leverage for the third consecutive quarter. Year-to-date, PNC has increased its continuous improvement target from $425 million to $450 million for 2024, emphasizing a commitment to efficiency and cost control.

Stable Loan Portfolio and Commercial Lending Outlook

PNC's loan portfolio remained stable at $320 billion, with a yield on total loans increasing to 6.13%. Despite subdued loan utilization rates, PNC management expressed confidence that demand for commercial loans is likely to rebound, particularly following anticipated interest rate cuts from the Federal Reserve. Loan commitments have increased quarter-over-quarter, indicating a positive sentiment among commercial clients in preparation for future borrowing.

Future Forecasts and Market Expectations

Looking ahead, PNC anticipates stable average loans and projects net interest income to increase by approximately 1% in the fourth quarter. However, the bank expects a decline of 5% to 7% in fee income due to elevated capital market conditions. Notably, PNC forecasts the Federal Reserve to cut rates by 25 basis points in both November and December 2024, which the bank envisions will further stimulate loan growth and financial activity.

Strong Credit Quality Amidst Economic Uncertainty

PNC's credit quality remains stable, with nonperforming loans increasing mildly due to the commercial real estate (CRE) office segment. The bank has maintained adequate reserves to manage risks in this area. As the economic landscape remains uncertain, PNC continues to prioritize careful risk management, positioning itself as a robust player in the market.

Building Capital and Shareholder Returns

The bank has worked on strengthening its capital position, with tangible book value per share increasing by 9% to approximately $97. With a Common Equity Tier 1 (CET1) ratio of 10.3%, PNC is well-capitalized. The firm returned approximately $800 million to shareholders over the quarter through dividends and share repurchases, reflecting a solid commitment to enhancing shareholder value.

Investment in Growth and Future Opportunities

Management highlighted their focus on expanding their branch network and investing in high-growth markets, particularly in the Southwest region. As they continue to enhance their consumer offerings, including a new credit card, PNC aims to capture greater market share in consumer lending, reflecting confidence in the growth potential of their various business segments.

Earnings Call Transcript 2024-Q3

[Operator]

Greetings. Welcome to the PNC Financial Services Group Q3 2024 Earnings Conference Call. [Operator Instructions] Please note that this conference is being recorded. I will now turn the conference over to Bryan Gill, Executive Vice President and Director of Investor Relations. Thank you, you may begin.

[Bryan Gill, executive]

Well, good morning. Welcome to today's conference call for the PNC Financial Services Group. I am Bryan Gill, the Director of Investor Relations for PNC and participating on this call are PNC's Chairman 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 are all available on our corporate website, pnc.com, under Investor Relations. These statements speak only as of October 15, 2024, and PNC undertakes no obligation to update them.

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

[William Demchak, executive]

Thank you, Brian, and good morning, everyone. As you've seen, we had a very good third quarter. We executed well and saw strong momentum across our franchise. We generated $1.5 billion in net income or $3.49 diluted earnings per share. Rob will take you through the details shortly, but I wanted to highlight a few points. First, we generated positive operating leverage for the third consecutive quarter. And as an aside, our strong performance has positioned us to deliver positive operating leverage for the full year of 2024.

Inside of the third quarter performance, NII grew 3% as we continue our growth trajectory towards expected record NII in 2025. Our fee income grew 10% with a very strong quarter in capital markets and we remain disciplined on the expense front. Second, we continue to see strong growth and activity across our franchise. C&IB continues to have great momentum as new loan production and commitments increased this quarter while overall loan utilization has remained soft, the recent Fed actions to lower interest rates and the expectation of further cuts is likely to spur greater demand as we move ahead.

Importantly, we are well positioned to serve our customers on loan growth returns. Within retail, we continue to invest heavily in our branch network to build density in our most attractive growth markets, and we are seeing success. We continue to grow customer households and checking accounts with the highest customer growth being realized in the Southwest markets. AMG is accelerating growth in high opportunity markets and benefiting from favorable equity markets. Third, our overall credit quality remains relatively stable, reflecting our thoughtful approach to managing risk, customer selection, and long-term relationship development. While we expect additional charge-offs in the CRE office segment were adequately reserved.

Lastly, we continued to strengthen our capital levels during the quarter. And with the ongoing improvement in AOCI, our tangible book value per share increased 9%. In summary, we delivered strong results in the quarter, and we remain well positioned to continue our momentum. In fact, we're in the middle of our strategic planning process, and I can't recall a time when our organic growth opportunities have ever more attractive.

Now before I turn it over to Rob for more detail on the financial results and outlook, I'd like to say thank you to our employees for everything that they do for our customers and our company. And with that, I'll turn it over to Rob to take you through the quarter. Rob?

[Robert Reilly, executive]

Thanks, Bill, and good morning, everyone. Our balance sheet is on Slide 4 and is presented on an average linked quarter basis. Loans of $320 billion were stable. Investment securities increased slightly by $1 billion or 1%. And our cash balances at the Federal Reserve were $45 billion, an increase of $4 billion or 10%. Deposit balances grew $5 billion or 1%, an average $422 billion. Borrowed funds decreased $1 billion or 2%, primarily due to the maturity of FHLB advances, partially offset by parent company debt issuances. At quarter end, AOCI was negative $5.1 billion, an improvement of $2.4 billion or 32% compared with June 30.

Our tangible book value increased to approximately $97 per common share, which was a 9% increase linked quarter and a 24% increase compared to the same period a year ago. We remain well capitalized and our estimated CET1 ratio increased to 10.3% as of September 30. Regarding the Basel III endgame, while certain aspects of the proposed rules are likely to change, we estimate our revised standardized ratio, which includes AOCI to be 9.2% at quarter end.

We continue to be well positioned with capital flexibility and we returned roughly $800 million of capital to shareholders during the quarter through common dividends and share repurchases. Slide 5 shows our loans in more detail. Average loan balances of $320 billion were flat compared to the second quarter as well as the same period a year ago. And the yield on total loans increased 8 basis points to 6.13% in the third quarter. Commercial loans were stable at $219 billion linked quarter as utilization rates remained low and well below the historical average of roughly 55%.

We continue to have confidence that commercial loan demand will return in the coming quarters as our loan commitments continue to increase, and we expect business investment to return to historical levels. Consumer loans averaged $101 billion and were stable with the second quarter as growth in auto loans was mostly offset by a decline in residential real estate balances. Slide 6 details our investment security and swap portfolios. Average investment securities of $142 billion increased $1 billion or 1%. The securities portfolio yield increased 24 basis points to 3.08%, driven by higher rates on new purchases and the full quarter impact of the securities repositioning.

As of September 30, our securities portfolio duration was approximately 3.3 years. Our active received fixed rate swaps pointed to the commercial loan book totaled $33 billion on September 30. And the weighted average rate increased 58 basis points to 3.08%. Our forward starting swaps were $15 billion with a weighted average receive rate of 4.26%. Importantly, with our forward starting swaps, we've locked in the replacement yield on the majority of our 2025 swap maturities at levels higher than existing swaps and current market rates.

Turning to Slide 7. We expect considerable runoff of lower-yielding securities and swaps, which will allow us to continue to reinvest into higher-yielding assets over the next couple of years. Accumulated other comprehensive income improved by approximately $2.4 billion or 32% to negative $5.1 billion on September 30 compared to negative $7.4 billion on June 30. The linked quarter improvement in AOCI was primarily due to lower rates, which benefited our swap and available-for-sale portfolio valuations. Going forward, AOCI related to these securities and swaps as well as our held-to-maturity portfolio will accrete back as they mature and prepay, resulting in further growth to tangible book value.

Slide 8 covers our deposit balances in more detail. Average deposits increased $5 billion or 1%, reflecting an increase in interest-bearing commercial balances as well as higher time deposits. Regarding mix, noninterest-bearing deposits were stable at $96 billion and remained at 23% of total average deposits. Our rate paid on interest-bearing deposits increased 11 basis points during the third quarter to 2.72%, reflecting growth in commercial interest-bearing deposits. We believe our total rate paid on deposits has reached its peak level and with the 50 basis point cut in September, we've already begun to reduce deposit pricing.

Looking forward, we expect the Federal Reserve to cut the benchmark rate by 25 basis points at both the November and December meetings, which will accelerate deposit repricing, particularly within our high beta commercial interest-bearing deposits.

Turning to Slide 9. We highlight our income statement trends. Third quarter net income was $1.5 billion or $3.49 per share. Comparing the third quarter to the second quarter, Total revenue of $5.4 billion increased $21 million. Net interest income grew by $108 million or 3%, and our net interest margin was 2.64%, an increase of 4 basis points. Fee income increased $176 million or 10%. Other noninterest income was $69 million and included negative $128 million of Visa-related activity. Noninterest expense of $3.3 billion decreased $30 million or 1%. As a result, PPNR grew 2% linked quarter, and we generated positive operating leverage for the third consecutive quarter. Provision was $243 million, reflecting portfolio activity, and our effective tax rate was 19.2%.

Turning to Slide 10. We highlight our revenue trends. Third quarter revenue increased $21 million, driven by higher fee and net interest income, partially offset by lower other noninterest income. Other noninterest income included negative $128 million of Visa-related activity. Net interest income of $3.4 billion increased $108 million or 3%, driven by higher yields on interest-earning assets. Fee income was $2 billion and increased $176 million or 10% linked quarter. Looking at the detail, asset management and brokerage income grew $19 million or 5%, reflecting favorable equity and fixed income market performance. Capital Markets and advisory fees increased approximately $100 million or 36%, driven by higher M&A advisory activity as well as broad growth across most categories.

Card and Cash Management decreased $8 million or 1% as higher treasury management revenue was more than offset by credit card origination incentives. Lending and deposit revenue grew $16 million or 5% due to increased customer activity. Mortgage revenue was up $50 million linked quarter, driven by a $59 million increase in the valuation of net mortgage servicing rights. Other noninterest income of $69 million included Visa derivative fair value adjustments of negative $128 million, primarily related to Visa September announcement of a $1.5 billion litigation escrow funding. Notably, we continue to see strong momentum across our lines of business and throughout our markets. And year-to-date, noninterest income of $6 billion grew approximately $400 million or 7% compared to the same period last year.

Turning to Slide 11. Our noninterest expense of $3.3 billion declined $30 million or 1%. Excluding the second quarter, $120 million contribution expense to the PNC Foundation, noninterest expense increased $90 million or 3% linked quarter. Personnel expense increased $87 million or 5%, reflecting higher incentive compensation related to increased business activity. Importantly, all other categories declined or remained stable. Year-to-date noninterest expense has increased by $80 million or 1%. Excluding the $130 million FDIC special assessment and $120 million foundation contribution expense in 2024. Noninterest expense is down 2% compared to the same period a year ago.

We remain diligent in our continuous improvement efforts. We increased our CIP goal last quarter from $425 million to $450 million and we're on track to achieve that goal in 2024. As you know, this program funds a significant portion of our ongoing business and technology investments. Our credit metrics are presented on Slide 12. Nonperforming loans increased $75 million or 3% linked quarter, primarily driven by an increase in CRE office loans. Total delinquencies of $1.3 billion were stable with June 30. Net loan charge-offs were $286 million. The $24 million linked quarter increase was driven primarily by lower commercial recoveries. And our annualized net charge-offs to average loans ratio was 36 basis points. Our allowance for credit losses totaled $5.3 billion or 1.7% of total loans on September 30, stable with June 30.

Slide 13 provides more detail on our CRE office credit metrics. We continue to see stress in the office portfolio given the challenges inherent in this book and the lack of demand for office properties. CRE office criticized loans were essentially stable linked quarter, but NPLs increased due to the migration of criticized loans to nonperforming status. Net loan charge-offs within the CRE office portfolio were down slightly. However, going forward, we expect additional charge-offs on this book, the size of which will vary quarter-to-quarter given the nature of the loans.

As of September 30, our reserves on the overall office portfolio were 11.3% and inside of that 16% on the multi-tenant portfolio, both up slightly from prior quarter. The modest increase in reserves reflect the continued valuation adjustments across the portfolio and specific reserves for certain credits. Furthermore, CRE office balances declined 4% or approximately $270 million linked quarter as we continue to manage our exposure down. Accordingly, we believe we are adequately reserved.

In summary, PNC reported a solid third quarter. Regarding our view of the overall economy, we're expecting continued economic growth in the fourth quarter, resulting in real GDP growth of approximately 2% in 2024 and unemployment to remain slightly above 4% through year-end. We expect the Fed to cut rates 2 additional times in 2024 with a 25 basis point decrease in November and another in December. Looking at the fourth quarter of 2024 compared to the third quarter of 2024. We expect average loans to be stable, net interest income to be up approximately 1%, fee income to be down 5% to 7% due to the elevated third quarter capital markets and MSR levels. Other noninterest income to be in the range of $150 million and $200 million, excluding Visa activity.

Taking the component pieces of revenue together, we expect total revenue to be stable. We expect total noninterest expense to be up 2% to 3%, and we expect fourth quarter net charge-offs to be approximately $300 million. Importantly, considering our year-to-date results and fourth quarter expectations, we're on track to generate full year positive operating leverage.

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

[Operator]

[Operator Instructions] Our first questions come from the line of Erika Najarian with UBS.

[L. Erika Penala, analyst]

Rob, if we can just [indiscernible] little bit of the commentary you made on the swaps. So I guess, first part of this question is, I noticed that the received fixed rate on our asset on your active swaps went up quite a bit quarter-to-quarter, implying that what's rolling off is well sub 1. You went from [ 250 to 308 ]. So I'm wondering if you could confirm that. And looking forward, I think you said something in your prepared remarks about replacing expiring 25 swaps at a higher fixed rate received fixed rate than you thought to maybe just clarify that statement as well.

[Robert Reilly, executive]

Sure. So yes, you're right. And again, all of this in terms of your question points to what is occurring, which is that our repricing of our fixed rate assets, including our securities loans and swaps is occurring at higher rates. So that's all of what we've been talking about for a while. True in terms of the swaps, new swaps are at the higher rate than the old swaps and then as you recall, back in the spring, we did execute some forward swaps that locked in rates for maturing assets in '25 that contribute to our statement, which we might as well confirm upfront, our NII being at record levels in 2025. We're sticking to it.

[L. Erika Penala, analyst]

Got it. Okay. And just the second part of my question, that's the mechanical side now on the strategic side, Bill, it's been such a long time since the market has seen a neutral rate of not zero. Everybody has talked about deposit betas. But as we think about what the natural deposit cost is for PNC, how should we think about what the spread is, let's say, we settle at 2.75%, 3% in terms of Fed funds. What's the spread in terms of Fed funds versus your funding costs naturally.

And additionally, just as a quick follow-up to Rob as we're on the liability side of the balance sheet. Is there -- what drove the strength in deposits? And was that mostly corporate? And is that permanent balances? Or is that sort of some corporate balances just parked for now, given the uncertainty in the market .

[William Demchak, executive]

I can't give a specific answer to where we might end up. If rates front rates kind of hold it pre and change, which I expect they will. Practically, you can do most of that yourself, right? So the 0 cost deposits are obviously worth a lot more if there's any steepness to the curve, we get that benefit with our fixed rate assets. So maybe inside of your question is, all else equal, if we end up in an environment where front rates are pretty unchanged and back rates are somewhat higher than that. That's the really attractive environment for banks, ourselves included.

[Robert Reilly, executive]

Yes. And then the second part of that, Erika, was the outperformance in our deposit balances came on the commercial interest-bearing side. As commercial clients continue to build cash on their balance sheet. Our expectation is that will hold for the most part through the end of the year. .

[Operator]

Our next questions come from the line of John Pancari with Evercore. Good morning.

[John Pancari, analyst]

On the loan side, still -- balances are clearly still pressured and you flagged by utilization down a bit to 50.7 and below your historical. Can you maybe talk about the demand -- the underlying demand trends that you are seeing? And what do you think is going to be the biggest catalyst to get borrowers off the sidelines and borrowing? Is it continued rate cuts confidence in that front? Is it the election? If you could just maybe give us some thoughts there? And what do you think a growth rate is reasonable as you enter 2025.

[Robert Reilly, executive]

John, it's Rob. So yes, all year, we've yet to deliver the loan growth that we thought was coming at some future point. And for all the obvious reasons that you've seen utilization is low. And there is a bit of a pause feeling, obviously, with the election coming up and the rate environment. What we point to in terms of the constructive front is we do continue to add customers. We do continue to add loan commitments quarter-over-quarter. So our commercial clients are putting those lines in place with the anticipation of borrowing. So that's a constructive sign. And then you've seen the lower inventory levels, the low CapEx to sales levels. So it does feel as though we're at the point of the cycle to where loan growth is not too far off.

[John Pancari, analyst]

Okay. Got it. And then separately, capital markets clearly has been a point of strength. Can you maybe just provide us a little bit of color on the pipeline there? And do you expect a pullback in the fourth quarter off these high levels? Just how should we think about that?

[Michael Rose, analyst]

Yes, yes, we do. I'll expand that a little bit in terms of our fee guidance for the fourth quarter. So we're pointing to down 5% to 7%. And all of that decline is being driven by the elevated MSR levels and the elevated capital markets levels that we achieved in the third quarter. So for the fourth quarter, the MSRs is pretty straightforward. We don't expect to have those levels in the fourth quarter. And then on the capital markets side, the short answer is we probably pulled a little bit of the fourth quarter activity into the third quarter. A lot of that is in our Harris Williams M&A advisory businesses had a really strong third quarter as well as some of the other broader capital markets story. So it's a little bit lumpy. The pipelines that are strong. The momentum is strong. Capital markets year-over-year is up north of 23%, the back half of '24, including our capital markets guidance for the fourth quarter is up 20% over the first half. So the momentum is there, it's just not necessarily going to fall linearly quarter-to-quarter.

[Operator]

Our next questions come from the line of Scott Siefers with Piper Sandler.

[Robert Siefers, analyst]

I guess, I wanted to follow up just a little bit on sort of the lending and deposit discussion. I guess, first, just kind of qualitatively, do you have a sense for what a lending recovery might look like when it does come back. And I guess the context of that is I recall at a time when the bank loans used to grow at a multiple of GDP, but it's been quite a while since we've seen that. So maybe just some some top-level thoughts there? And then on the other side of the balance sheet, just maybe your sense for how deposit costs behave if lending does come back better. You all and I think a lot of the industry are great from a liquidity perspective. So curious how much competition factors into your thinking as well.

[William Demchak, executive]

We can come up with 10 different theories on why loan growth hasn't been there and why it might come back, but all of them are making up series. It's been below trend on utilization. There's a bunch of uncertainty, not the least of which is the election and rates and all the other things that may impact it. But it's one of the reasons why we kind of said, look, we'll produce growth for our shareholders without having to rely on some made-up story as to why there might be loan growth. If there is, it's terrific, and at some point, it will come back. But given I'm trying to forecast it personally.

On the funding side, we are very liquid. So we have an opportunity should it arise. We have a lot of capital and cash, and that would be a great thing for us [indiscernible] balance at the Fed [indiscernible].

[Robert Reilly, executive]

35 spot, 45 average, so a lot.

[William Demchak, executive]

Yes. So I don't know that it's going to impact our funding costs whatsoever.

[Operator]

Our next questions come from the line of Matt O'Connor with Deutsche Bank.

[Matthew O'Connor, analyst]

Any updated thoughts on where you think your net interest margin normalizes? I think I had one point a couple of months ago, you said it could approach 3%. I think it was by the end of next year. But updated thoughts on that, given the forward curve and your outlook for the mix of balance sheet.

[Robert Reilly, executive]

Matt, it's Rob. I do recall you asking the question before. And the answer is going to be the same, which is our NIM is increasing. We don't manage to NIM. It's an outcome. We've operated close to 3. My expectation is that we'll approach those levels. I don't remember saying by the end of '25, but maybe that's something that you added in, but we're on our way up and 3 is reasonable through time.

[Matthew O'Connor, analyst]

Okay. And actually, maybe it's by the end of '26. I had [indiscernible] to read. And then just separately, you've always been very strong in commercial lending and some of the few businesses that come from that the consumer side has always been a little bit less of a focus, but I think you've been leading in comparatives like credit card around the edges and -- just any updated thoughts in terms of what could be growth drivers as we think about consumer lending, consumer fees the next couple of years?

[William Demchak, executive]

Look, we've -- historically, we have underinvested in and we -- we are underpenetrated with our existing clients.

[Robert Reilly, executive]

And consumer.

[William Demchak, executive]

And consumer, Yes. And that's our opportunity set. I don't know that we need to be heroic and we go beyond that, but we ought to have the same penetration rate that our peers do with respect to our consumer lending. And there's a fairly material upside if we can pull that off, and we're investing to be able to do so.

[Robert Reilly, executive]

And we've introduced a new credit card and plans to continue to do that along those lines.

[Matthew O'Connor, analyst]

Okay. And when do you think you'll start -- we'll start seeing some of those efforts kick in? I mean we are seeing pretty good credit card volume growth for the industry and at most peers. And obviously, there's a little bit of a lag, but what do you think some of those efforts will be a little bit more evident.

[William Demchak, executive]

I don't know that I have a time line on it. I would tell you that we're investing in people. We're investing in our credit management capabilities in our marketing and our product delivery, all of the above that will, hopefully, through time, allow us to get the penetration we should have -- I don't know what the time line is on that, but I know it's a journey, and I know we need to start it.

[Robert Reilly, executive]

And we're beginning now.

[Operator]

Our next questions come from the line of Bill Carcache with Wolfe Research.

[Bill Carcache, analyst]

Following up on your loan growth commentary. You've had a lot of success over the years and taking share within C&I. If we do get a reacceleration in loan growth over, say, the next year or so, how does that influence your ability to continue to take share and perhaps outpace industry growth, recognizing your competitors are obviously not willingly ceding share.

[William Demchak, executive]

Well, I think that will show up. We are growing DHE and winning new clients at a record pace, I think. So when utilization comes back, to be honest, as we have in the past, my best guess is we would outperform.

[Robert Reilly, executive]

Well, TH is our loan commitments. They're unfound at the moment, but they've been put in place. And I think the most of the momentum that we see is in our Southwest markets, where we are achieving record levels and would expect to be above average, if it all plays out as we expect.

[Bill Carcache, analyst]

That's helpful. And then separately on noninterest-bearing deposits, do you expect rates on your interest-bearing deposits to decline starting next quarter, but how long before you'd expect to see the effect of lower rates relating to compensating balances?

[Robert Reilly, executive]

Yes, I don't know. That's a tough one to answer. I mean, what we're encouraged about is we've clearly stabilized now. for a couple of quarters at the levels that we are following several quarters of pretty substantial decline. So we've stabilized. There's a lot of theories in terms of what sort of the magic short-term rate is that picks that up. But no one has a definitive answer.

[Bill Carcache, analyst]

Right. But is the credit that you give customers on compensating balances to sort of lever that you'd expect to use or be willing to use as you look to grow noninterest-bearing deposits? Just trying to think through whether that's a potential something that could spur growth? .

[William Demchak, executive]

You should assume that crediting rate is below market versus open deposit rate. And so it's not going to have a moving beta for some period of time relative to rate cuts coming down.

[Robert Reilly, executive]

It's relatively constant, and we're fine with that.

[Bill Carcache, analyst]

Okay. Great. And if I could squeeze in one last one. If the NII trajectory that you laid out for 2025 plays out as anticipated. Is there any reason why the positive operating leverage commentary that you laid out is very helpful. But any reason why the efficiency ratio wouldn't get down into sort of that high 50% range. It seems like the math would suggest that, that could get there, but I would appreciate your thoughts.

[Robert Reilly, executive]

We'll have to see. Bill, we're in the process of doing our budgeting for next year right now. So we'll have more for on that in our January call. .

[Operator]

Our next questions come from the line of Mike Mayo with Wells Fargo.

[Michael Mayo, analyst]

I think, Bill, your prior comment that you expect record NII in 2025. Do you feel more, less or just as confident as before? And what sort of loan growth do you kind of assume for next year?

[William Demchak, executive]

We wouldn't have said it if we didn't feel confident to begin with. So I don't know levels of confidence, but we feel pretty good that.

[Robert Reilly, executive]

That's [indiscernible].

[William Demchak, executive]

And we don't have any loan growth in there whatsoever to get to that number.

[Michael Mayo, analyst]

So no loan growth for next year.

[William Demchak, executive]

We have something, but it's...

[Robert Reilly, executive]

Well, we will have something, but the record NII level is not reliant.

[William Demchak, executive]

Yes, it's not dependent on loan growth.

[Michael Mayo, analyst]

Okay. And then back -- I know -- I think last quarter, you used the word befuddled as to why loan growth wasn't coming back. I guess, number one, could be the election. Number 2 would be private credit. Number three, it could be disintermediation in capital markets. Number four, companies could just be managed differently today or number five, you could have a weaker economy or it could be all of the above. Just give us your best stab at why loan growth remains just so weak in the economy that's still growing?

[William Demchak, executive]

I think all of your reasons other than 3 and 4. I don't think private is causing utilization rate on middle market companies to remain low for the businesses we play in. And I'm not sure. I mean the margin public markets being wide open has caused some of our larger clients that pay down outstanding balances and hit the capital markets. So that's probably true at the margin. But this basic notion of people just aren't using working capital the way they used to. And maybe that's the way they run the company post COVID, maybe that's the uncertainty, it's going to play out over time, and we can all guess about it. I just don't know the answer, so I'm still be funneled.

[Michael Mayo, analyst]

Okay. And then lastly, your reserves on office CRE, we're taking even higher, especially multi-tenant last quarter, you said the industry is in the first inning. I think a lot of people disagree with that. I'm not saying -- yes, I'm not sure -- we're 2 years into this, at least. And it's still a big question mark, I think, in a lot of people's mind. So when you said the industry in the first inning, and clearly, your reserves are higher than others. What's -- why do you say it's only the first inning? What's your reasoning?

[William Demchak, executive]

I think we're just now starting to clear buildings in sales, right? We've had some extensions. We've had maturities hitting. We have a whole slew of term loans in the CMBS market and with small banks that will be out there 3, 4, 5, 6 years. So I just think this plays out through over a long period of time. Office vacancies pick your market are quite high, and we're just now realizing the mark-to-market value of that as we resolve our properties. That's why we're reserved where we are, and that's why I'm not worried about it per se from a PNC standpoint, but no, it's going to be noisy for a while.

[Robert Reilly, executive]

Early innings -- it's really early innings. .

[William Demchak, executive]

But we're not -- I mean we're not in early innings with respect to how we're reserved. Yes. I mean [indiscernible], but to the best of our ability, we've taken all that upfront.

[Michael Mayo, analyst]

And then sneaking one more, last one. As far as acquisitions, I know you'd like to buy them on the cheap. I mean, National City, you go down the list. It's getting tougher for you to buy things on the treat. Maybe if you -- a bank does have an office or CRE problem that you swoop in there. But Am I right in thinking it's a lot less likely you do an acquisition now that some of these stocks have come back or what you're thinking?

[William Demchak, executive]

Yes. You're right. We don't see value in an acquisition at the moment.

[Operator]

[Operator Instructions] Our next questions come from the line of Ebrahim Poonawala with Bank of America.

[Ebrahim Poonawala, analyst]

I guess just one, Rob, for you as a follow-up on deposit pricing. I think a fair amount of uncertainty around how much banks will be able to flex deposit costs lower. We got the September cut. Remind us, one, around your beta expectations? And any early proof points on how customers and especially commercial customers have received the lower rates over the last few weeks?

[Robert Reilly, executive]

Sure. So we're early on just a couple of weeks out from the rate. But now we're in a down beta cycle. We've said that we think that our terminal beta will be approximately 50%. And we will reduce rates paid through the balance of this year and maybe we get a little bit less than half of the way there by the end of '24, but that's going to play out. It's early, but that's sort of our thinking. So rate paid will be coming down, particularly in the higher interest-bearing commercial deposits, some wealth deposits, and that's underway and we expect that to continue.

[Ebrahim Poonawala, analyst]

Got it. And on commercial clients. So heard you around loan growth and all the reasons why loan growth may or may not pick up. If you don't mind just speaking to the health of the commercial customer base, and whether like some of the macro data on jobs could be a bit misleading. Like when you talk to your C&I customers, are they -- like are the balance sheet healthy, -- like do they -- if the Fed were to pause rate cuts after a cut does that increase the risk for these customers and how they might approach investing, hiring, et cetera? Would love any color you can share?

[William Demchak, executive]

I guess maybe -- and it varies by industry, but a simple notion is companies at the margin are losing margin, right? They have an end -- they can't pass on prices, the [indiscernible] could. They're not making it up in volume. So the discussion of how do I cut cost as at least entered the dialogue, but we haven't seen that show up in layoffs, right? The data remains strong as long as the data is strong, consumers are spending and the economy is strong. So everybody's staring and watching and looking and there's margin pressure on corporates. But there's no -- we don't see in conversations, some pending big layoff spike hitting the U.S. economy. There are specific industries that are in slumps, whether it's transportation, health care, struggling consumers at the margin, but it's just at the margin.

[Robert Reilly, executive]

Nothing new.

[William Demchak, executive]

Yes.

[Ebrahim Poonawala, analyst]

Got it. And one last one, just following up on Mike's question on M&A. Bank transactions usually stock for stock. What -- I mean your stock has done well. Why would a deal given your history and track record on deal integration, like is it just completely ruled out at this point? Is there a willing seller acquiring a good franchise? Does it no longer make sense just because of pricing?

[William Demchak, executive]

Yes. It's, I mean, the fact that we have a multiple advantage, our stock is worth the money it trades at. I'm not sure our other stocks are. So straight up financial math saying it works, doesn't mean it's a good deal. And when we look at potential targets, it would be interesting from certain geographies and so forth. They just don't pencil out when you look at their balance sheet and the amount of investment we have to put in the franchise and just the time sync it takes to do it. So -- and by the way, we look at everything. I don't think the market is anywhere close where we'd find something attractive.

[Robert Reilly, executive]

Or pay a premium on top of what you think already a premium and price gain.

[William Demchak, executive]

Yes.

[Operator]

Our next questions come from the line of Betsy Graseck with Morgan Stanley.

[Betsy Graseck, analyst]

Okay. Great. Just to follow up on the last question. So right doesn't make sense, M&A right now in this environment given well, whatever I won't go there. But just the underlying question is organic growth. How do you see your organic growth progressing over the medium term? Are there legs to acceleration? Or are we -- what we're seeing today is a good run rate?

[William Demchak, executive]

No, there's legs on acceleration certainly in C&I as we continue to build out these new markets. What you're going to see us do is more aggressively invest into our retail distribution franchise, very targeted and high-volume branch builds in particular markets. At the moment, go back to somebody's question of, hey, what if rates are 3.25% at the front end and what do you earn on deposits, the breakeven on a branch has become a lot easier to achieve. And my historical comments on the need for scale are still true. It just looks like the way we're going to have to get there at least in the near term is through investment in organic growth, and we're good at it. We've been executing on it, and we'll just continue on.

[Robert Reilly, executive]

Particularly in the Southwest markets where the momentum is very strong across all our businesses, C&IB, retail and the private bank.

[Operator]

Our next questions come from the line of Gerard Cassidy with RBC Capital Markets.

[Gerard Cassidy, analyst]

You guys have done a very good job in managing credit over the years, and it shows up again this quarter. Can we take a look at -- in the C&I portfolio, what are the trends that you guys might be seeing in your -- the SNC portfolio or the asset-backed portfolio or the leverage portfolio. The trends pretty benign? Or what are you guys seeing there?

[William Demchak, executive]

Not much. At the margin, we still have more downgrades and upgrades, very simple ratio across that whole book. Much of that is driven by margin compression as opposed to anything fundamental with the underlying company. But now the economy is healthy and company and our portfolio is healthy. We'll have lumpy one-offs. There's always some story that happens, and we had one of those this quarter actually, but overall, the portfolio feels pretty strong.

[Robert Reilly, executive]

Yes, they're still very acceptable bookable credits. They're just not as strong as the ultra strong they were the last time I raised them.

[Gerard Cassidy, analyst]

Got it. And I know you touched on this on commercial loan growth about companies might be stronger. Have you seen any evidence that because of the pandemic, because of what companies went through, your longtime customers that you've talked to for years, do you actually see them better manage or stronger because of what would happen during the pandemic?

[William Demchak, executive]

I think that almost has to be true. And certainly, part of the answer to the utilization question, by the way, has to be the notion that basically, working capital was free for a bunch of years, and all of a sudden, got expensive. So you're looking at places where you can improve margin and you're trying to cut your borrowings and be more efficient at what you're running in inventory and investments.

So companies did without a lot of stuff during the pandemic, and you learn from that and you try to keep to it. So we'll see. But on our broader message is the economy is fine companies are fine. Labor still feels strong. A lot of things in the geopolitical horizons that could disrupt that, but those are exogenous variables to the basic economy we operate in.

[Gerard Cassidy, analyst]

Great. And then just a final follow-up. You gave us some good data, of course, on the commercial real estate office portfolio. What kind of impact or I guess, if the cap rates start to come down, when do you start to see that be beneficial for the commercial -- I mean, where it could really help you -- help the values of those properties. I know each property is different vacancy rates are critical. But is there any kind of point that you guys look at -- the cap rates fell 100 basis points or 150 that would help the valuation process?

[William Demchak, executive]

Look lower cap rate at the margin is to help. I think what you're running into, though, is you'll have office buildings that if they're 50% vacant, they'll hit the market. And the question will be, can they ever get to normal occupancy through historical absorption rates. And if the answer to that is no, the value of that building, we just saw 1 in New York is next to 0. If there's a tail on absorption where, yes, I think I can rehab it and I get this thing back to my normal 90%, 95%, then it has value as [indiscernible] concern, and it's worth something. The cap rate almost is irrelevant in those 2 scenarios. If the thing is never going to be occupied, it doesn't matter what the cap rates were if it's worth land.

[Gerard Cassidy, analyst]

Very good insights. Thank you. .

[Operator]

Thank you. We have reached the end of our question-and-answer session. I would now like to hand the call back over to Bryan Gill for any closing comments.

[Bryan Gill, executive]

Okay. Well, thank you all for participating on the call this quarter. And feel free to reach out to the IR team if you have any follow-up questions. .

[William Demchak, executive]

Thanks a lot, everybody.

[Robert Reilly, executive]

Thank you.

[Operator]

Thank you. This does conclude today's teleconference. We appreciate your participation. You may disconnect your lines at this time, and enjoy the rest of your day.