Bill Demchak, Chairman, President, and CEO of The PNC Financial Services Group offered his insights on this week's Walker Webcast.
A few highlights from the discussion include:
Willy Walker is Chairman and Chief Executive Officer of Walker & Dunlop. Under Mr. Walker’s leadership, Walker & Dunlop has grown from a small, family-owned business to become one of the largest commercial real estate finance companies in the United States. With a $32B transaction volume in 2019, Walker & Dunlop is ranked top three with Fannie Mae, Freddie Mac, and HUD.
Bill Demchak is chairman, president and chief executive officer of The PNC Financial Services Group, one of the largest diversified financial services companies in the United States. Demchak joined PNC in 2002 as chief financial officer. In July 2005, he was named head of PNC's Corporate & Institutional Banking responsible for PNC's middle market and large corporate businesses, as well as capital markets, real estate finance, equity management and leasing. Demchak was promoted to senior vice chairman in 2009 and named head of PNC businesses in August 2010. He was elected president in April 2012, chief executive officer in April 2013 and chairman in April 2014.
If you have any comments or questions about the evolving economic landscape and how it is impacting the CRE space, our experts are available to help. Additionally, if you have topics you would like covered during one of our future Wednesday webcasts, we would be happy to take your suggestions.
WW: Thank you Susan and thank you everyone for joining us today. If it's Wednesday, it's the Walker Webcast. I'm really pleased to have my friend, my banker, fellow CEO, and fellow exercise fanatic Bill Demchak with us today. I'm really looking forward to Bill's perspectives on the banking sector and the overall economy.
Many of you who joined us last week heard Leslie Hale, CEO of RLJ Lodging Trust talk about inclusion and how to promote more diversity in corporate America. Leslie was quoted quite widely in the media after that discussion saying “I'm not a unicorn” and I would strongly encourage any of you listening today who didn't see my interview with Leslie last week who are interested in how to build diversity inside your companies to listen to that discussion with Leslie if you missed it.
Before I dive into my discussion with Bill I want to talk for a moment about the current state of the virus and economy. As many of you know I had Governor Jared Polis from Colorado on the webcast about a month and a half ago and as all of us see these numbers as it relates to the virus continuing to spread across the country I thought I'd go back and look at the Colorado numbers to give some perspective on a state that has really dealt with this virus very well but then also to make sure that we're all looking at the appropriate numbers and not necessarily just the headlines as it relates to the spreading of the coronavirus.
If you look at Colorado on April 25 that was the peak day for cases in Colorado and there were 726 cases reported that day. Yesterday there were 211 cases reported in the state of Colorado. Interestingly, the peak deaths in Colorado were actually on April 13 at 39 deaths, two weeks before the peak in cases. One of the big things that everyone's trying to work with right now is we're seeing a peak in cases and thinking that we have a peak in death toll that comes after it. If you look at Colorado it was actually the opposite, peak deaths came actually before you got to peak incidences.
If you look at who has actually gotten the virus in Colorado, there have been 2,073 cases of COVID in Colorado in people over 70 years old and of those 2,073 cases 1,070 of those people have been hospitalized. A 52 percent hospitalization rate for people over 70 and of those 1,296 have died. The death rate for known cases of COVID in Colorado is 62.5 percent for people in their 70’s and in their 80’s, so if you're over 70 you’ve got to take this thing super seriously.
Then lets go to the cohort of people who are between 20 and 40 years old in the state of Colorado. There are 10,833 reported cases so five times the number of cases as in the 70 plus cohort. Of those, 805 people had been hospitalized so a 7 percent hospitalization rate and of those people 20 have died. That's 18.5 basis points or less than one quarter of one percent of people who have gotten COVID, known cases in Colorado, between 20 and 40 years old have died. So, you have many more incidents in that lower cohort, you have a much lower hospitalization rate and you have an infinitesimally smaller death rate. And so I just think it's important to realize that as the incident number spreads across the country, and it's scary to see this thing go, the actual impact on hospitalization rates as well as death rates if Colorado is an example we should look at, we shouldn't get too freaked out by the spreading of the virus and we should really be focusing on hospitalization rates and death rates.
Back in early April as well as it relates to testing, the state of Colorado was testing between one and 2,000 people per day and the infection rate was between 15 and 25 percent. Today the state is doing between six and 8,000 tests per day and the infection rate has been holding steady at about three percent.
If you think about what Colorado has done, the Governor has led quite honestly by wearing a mask on a very consistent basis, people in the state of Colorado are wearing masks in public spaces. The state has been expert at isolating hot spots in senior housing communities, in jails and other places where the virus has cropped up. And I would also say that one of the other things to keep in mind is that the weather in the state of Colorado over the last month has been fantastic. People have been able to go outside, it hasn't been too hot, and so people can recreate outdoors. In some of the states where we're seeing this virus spread very rapidly right now - Florida, Texas, Arizona - the weather is already really hot and so people are being forced to recreate indoors and so without proper protection, and being indoors, we're clearly seeing the case counts accelerate.
Let me go for a moment before I go to Bill back to the April 1st webcast that I did with Dr. Nancy Kane from the Harvard Business School because that was three months ago today. That was the first day of Q2 and I went back and looked at it and listened to where I was, and where Nancy was, back then as sort of, you know, what's happened over that period of time, and I very much look forward to hearing Bill's perspectives on where he was and where PNC was on April 1 versus where the bank is on July 1. But I mentioned in my opening remarks some comments that Saint Louis Fed President James Bullard had made the day before on Squawk Box, where Bullard had said what we're doing right now by shutting down the economy is that we are investing in the health and well-being of the American population and I thought it was a really fantastic way of framing what we were doing. We weren't in some type of crisis that we weren't controlling, we were actually taking measures to control it. Some of you may have seen Barry Sternlicht who was also on the Walker Webcast back in April talk yesterday on Squawk Box about his big push to reopen and get going. One of the things that I would put forth on Barry’s comments is just that until people believe it's safe to go to restaurants, or fly on an airplane, they won't, and so everything that we can do as citizens to put confidence in our behavior, and confidence in our economy, is only going to help us make sure that the investment we made to shut down our economy, and to invest in the health and well-being of the American population, are not squandered.
My final point would be this. As I think back on my perspective on the markets in the beginning of Q2, we didn't know how bad it was going to be. We didn't know how quickly the virus would spread, how deadly it was going to be, how much damage it would be to our health, to our economy and to our society. And as everyone saw markets don't like doubt, they don't like not knowing, and so as a result of that the markets, the equity markets sold off by about 38 percent in those final two weeks of March. Well over the last quarter, as we all know, the markets have basically added back that entire 38 percent almost to the penny. And, so you sit there, and you just sort of say so what's that mean going forward? First, the markets think we know enough about this virus, its impact, and the damage it will wreak on our health and economy to not present future surprises. I seriously hope and pray that that's a proper read on where we sit today. Second, the federal government and businesses reacted to the original crisis effectively and are not going to be surprised going forward. I'm looking forward to Bill sort of either reiterating that view or saying that he's got some questions about the future.
And then, finally, there's a big question mark about the next stimulus bill and how big it is going to be and what area of the economy it targets. But there's a general sense that there is the time and information to make the right decisions. We've had a lot of forbearance during the second quarter. The U.S. government and financial services institutions like PNC, put enough liquidity into the market and postponed enough payments through forbearance on mortgages and car payments and credit cards and rents and student loans and everything else, to allow the U.S. consumer to survive and for the markets to continue to function. But Q3 is when the rubber will really hit the road. Q3 and Q4 is when forbearance plans come to an end and lenders like PNC are going to ask people to get back and get current and it's that reality without another $6 trillion of federal stimulus that might make it so that we actually see the real impacts of COVID and the shutdown on the economy.
So, with that, let me turn to my guest. Bill is Chairman, President and CEO of the PNC Financial Services Group. He joined PNC in 2002 as the Chief Financial Officer, then ran their Corporate and Institutional Banking which included commercial real estate lending, and was then elected President of PNC in 2012, CEO in 2013 and Chairman in 2014. That's quite the run on titles Bill. Before I jump into my questions for Bill, I'd like to say that PNC has been an amazing partner and competitor of Walker & Dunlop for many, many years. PNC is one of the largest commercial real estate lenders in the United States and Bill and I will discuss PNC’s current exposure to commercial real estate in a little bit. They’re also one of the largest and best construction lenders in the country, a very significant agency lender with Fannie Mae, Freddie Mac and HUD, including a very significant tax credit syndication business. And finally, PNC owns Midland Loan Servicing, the largest commercial loan servicer in the country with over $700 billion in loans.
So, Bill, you grew up in Pittsburgh and went to Allegheny College. Then you got your MBA from Michigan. It's my assumption there weren't a ton of Allegheny college grads when you were working your way up in the ranks of JP Morgan, all the way to having a seat on the capital and the risk committees. So how did being the only Allegheny college grad in the room with a bunch of Ivy leaguers impact your career?
BD: So first off you're wrong about Allegheny. I actually showed up in the training program at JP Morgan and a guy named Dag Skattum who was a fraternity brother from Allegheny showed up next to me, that was pre cell phone and e-mail so nobody knew who was going to show up where. He went on to be the Vice Chairman of M&A or Vice Chairman in Europe for JP Morgan and he now works for BlackRock. And Bruce Thompson from Bank of America, who you probably know, was also a fraternity brother from Allegheny. And, finally, Marty Pfinsgraff when I got to Wall Street was the chair of Prudential Securities, so don't count out Allegheny College.
But I would tell you my upbringing and my interests weren't traditional for Wall Street; it was a bit different. I wasn't and I'm still not a guy who wants to spend their life finding the next cool restaurant to go to or discover the next new red wine or play golf at country clubs, so that took a little bit of getting used to. I'm happy to say that I'm not sure I ever did and I'm more back to my old life than I was before.
WW: Given that Bill, as you built up PNC what have you looked for in the people who have helped you so successfully build and grow PNC as it relates to either their background or their work experience?
BD: First and foremost, I look for people who want to work as a team, work with people who have positive energy. I always tell our employees you think about the person who even when times are tough they don't coat over the bad stuff but they think about what the solution will be, as opposed to gripe about what the problem is. I think our leadership team is all of that -they're smart, they're engaged, they share each other's burden, so we declare victory as a team, as opposed to individual solos. If you can work in that environment, you excel at PNC. If you want to be a solo player, you're going to struggle.
WW: You gave the commencement speech at the Tepper School of Business at Carnegie Mellon a couple years ago, and in that speech you said what is legal, what is ethical, and what is right, are not always the same. You also said that most ethical breaches are usually made without the person knowing they have an ethical decision to make. How do you manage your executive team and yourself between what is legal, what is ethical and what is right?
BD: That's a good question. Legal is legal so you don't break the law, so assume that's table stakes in whatever you do. But we run it, we have a saying inside - what would my mother think if she read about what I did in the newspaper. Would she be proud of me or would she be disappointed? By the way, that's a real thing, I don't want to disappoint mom. When we think about how we treat clients, how we work inside the community, the decisions we make in terms of our advocacy, it's always through a lens of what is right and sometimes that's a gut feeling. We're guided by the values we hold as a company. I know that sounds corny, but it isn't, we have things that we hold dear inside of the company that we stand for and we kind of measure ourselves against those values.
WW: In that address you went on to say it's increasingly likely that people inform opinions without all the facts. And this was back in 2014 and you were basically taking a dig at social media and the fact that people were making opinions about the world we live in with sort of sound bites from Facebook, if you will, or from Twitter and not really understanding the issues. As the CEO of a major public company, how do you go about communicating both internally as well as externally with clients and coworkers and investors and so many communities where PNC has a major stake, to make sure that people understand the facts and not only having half the story?
BD: Well we are sometimes successful at that, sometimes we're not. I think we always strive to tell the truth. We are very open with our employees. We communicate endlessly with our employees and our clients as it relates to what we're doing. Banks are, for whatever reason, probably going back to the financial crisis, always somebody to be blamed for something and we struggle against that as an industry independent of what the real facts are. But ultimately I think we are known for what we do, our reputation is a function of how we treat our clients and what they think of us and over time, particularly with PNC, we've come a long way from kind of the thoughts people had about banks during the financial crisis. The basic issue of learn the facts before you form an opinion, I have that conversation with my kids all the time because they get the news and sound bites and the world is this more complicated than sound bites. I encourage them to read and research and debate and figure things out for themselves rather than kind of accept as a truth whatever it is that rolls across a Twitter and an Instagram feed.
WW: Has this crisis changed the way that you communicate either internally or externally at PNC given that you're not able to sort of get out and see people and interact with your team face to face?
BD: If anything, we've increased the level of communication because of it so I do a lot of internal podcasts or video casts. As you can imagine when this first came on just the logistics around what we were going to do vis-à-vis work from home, treatment of clients as we went into forbearance across many products, all that stuff took massive communication across 52,000 people, and of course I did that, but importantly everybody in our executive team was doing that as well with their teams throughout the bank.
WW: I know a bunch of people on your team and you're sort of famous for asking why, sitting around a meeting and someone says we ought to do this and you ask why. And to exactly your point about telling your kids to research before they make an opinion on something you seem to always probe for why and why and why so let me turn your “why” back on you and ask why. After making an over 7,000 percent return on PNC’s investment in BlackRock did PNC end up selling its finding of 22 percent stake in May for something around $14 billion?
BD: So why did we do that? First of all, I can't take any credit for that investment. Two Chairmen before me, a guy named Tom O'Brien, had the foresight to invest $240 million into an entity that today their market caps probably $70 billion plus or minus. We knew through time that BlackRock was becoming more of an investment as opposed to part of the company. We started owning 100 percent of it. We took it public. With their public currency they bought State Street, then they bought Merrill Lynch, and then ultimately VGI, and we were diluted down to a 22 percent stake I think we had when we sold them. An issue for us was they were sort of a, call it an uncontrolled massive investment that was a big part of our market cap. They were also collectively, we and they, were getting squeezed by regulators and accountants as it relates to capital intensity of holding that investment in various forums and, in their instance, being controlled by a bank that limits some of what they could do as an investment company. We knew over time that we were going to have to sell it. There's never a good time to sell a great investment, you always wish you can get the exact day that they're going to be at their absolute high. But, in any event, we knew this was coming and as we got into this crisis one thing that has been true over and over and over again, is in periods of uncertainty there is market disruption that typically present massive opportunity, and the firm, the bank with the most capital in that environment wins. And we, notwithstanding some green shoots that we can perhaps argue about, I continue to think that we're going to be into a disrupted market here, and we're going to have an opportunity to deploy the capital we created in a way that's very beneficial for our shareholders.
WW: On that, you were on CNBC a couple weeks ago and you said when asked, how you're going to deploy the capital or what you were going to go buy, you said we’re going to hang around the hoop. And so, in hanging around the hoop I guess my question would be who do you need to block out? So to stick with the analogy that opportunity is going to fall off the rim, is it a JP Morgan or a State Street, a Goldman Sachs, or an Apple, in the sense of as you think about the competitive landscape that PNC is in today is it more coming from your big money center bank competitors or is it from the acid aggregators such as a State Street or a BlackRock or is it from the tech world of the Apples and the Googles of this world?
BD: Well in the basic world of banking, forget about how we might deploy the capital, our real competitors and what we do, and if you think about what we do as a bank, we lend money, we help people save and invest and we help people manage their money and move it around. It's a pretty basic business. We're not huge in capital markets, although we support our clients and we're largely in the U.S. We compete head-to-head over and over again with the JP Morgan and BofA’s of the world, Wells Fargo perhaps less frequently lately, and then you kind of fall off a cliff. Truist is going to be a competitor. USB shows up every once in a while, but basically, it's the big banks that we compete with. Do I worry about tech getting involved in banking? Yes, but they're not the people that we are having fights with today.
As it relates to deploying capital, we're in a pretty interesting spot Willy. We’re the sixth or seventh largest in the bank but the guys who are up in the G-SIFI land (Global Systemically Important Financial Institutions) are four and five times larger than us, and basically because of their status as G-SIFI’s it's highly unlikely that they could buy another depository institution. So, you go through that math and you say well who could actually buy if there's a distressed asset out there. It's kind of ourselves and maybe USB, although we have a big capital advantage now. Truist just did a deal so they're still putting SunTrust and BB&T together, so we’re in a fairly unique place to be able to take advantage of some dislocations here.
WW: You talked about technology. If you wind the clock back Bill to when you joined PNC and over the 18 years subsequently every - you know I’ve been pitched on crowdfunding, and how crowdfunding was going to displace all of the major capital sources in the commercial real estate space, and fortunately we didn't buy that pitch, and fortunately we haven't moved into the crowdfunding space, and fortunately crowdfunding has ended up where I thought it would, which is really a very minor source of capital in the commercial real estate space. You've seen all sorts of things coming in and out of the banking sector from a technology standpoint. What's worked and what's been sort of that sounds like a really cool idea like crowdfunding in commercial real estate but is just not going to take hold because of the way that the banking system is set up and because of quite honestly the branch networks that you and many other big banks have established?
BD: I think what has worked and what some of the tech companies have shown us is largely in the fulfillment space, ease of use, customer ease. They came at old problems with newer technology and friendlier technology and in doing so they proved that there's actually elasticity in pricing in certain instances particularly with consumers for ease of use. We spend a billion plus a year in technology so nothing that these tech companies were doing we couldn't recreate in a week. So they had a lot of good ideas and we would kind of recreate and adapt and we've changed all of our internal systems to be much more - I'll use the word agile as a buzzword - to be able to adapt and take advantage of these.
But what hasn't worked - all of the things that were going to change lending - there's no new way to lend money. You can do it online, you can do it through crowdfunding, you can do it through peer to peer, you can do whatever it is, the losses are always the losses. There's no new answer to lending in scale. We've seen that now with the online lenders all struggling through time either because of funding or losses beyond what they expected and so forth. So, don't confuse the technology and ease of use which is good necessarily with the product offered which can sometimes be bad.
WW: At the core of all that, to your point lending is lending, what about just the physicality of your branch network, PNC has an extensive branch network. Clearly Apple did the total counterintuitive thing where everyone thought all computer sales would be online and, then, all of a sudden Apple decides to go put stores in and the next thing you know we're all walking into an Apple store. Talk for a moment about your thoughts as it relates to the branch network as far as the deployment of that capital in the future versus more online and technologically driven.
BD: Branches matter. As you know we're pursuing a national expansion, have been for a while, where we're building what we call a branch thin network in major MSAs around the country, so think Houston and Dallas and Denver and so forth. But whereas historically we might have needed 100 branches in a location, today we might need fifteen, and the reason for that is the digital capabilities that we offer to our consumers and small business and corporates, such that they need the branch for perhaps more complex conversations, or more complex product offerings, but frankly they need it and want it a little bit for security. Money's different, they want to see that there's physically something there, they want to know that they can go into a building when they have a problem, when they're subject to a fraud or something and actually talk to a real human being and resolve the problem. So, I don't think branches go away, I think we will actually see an acceleration of the trend we've seen over the last five years with branch count in the U.S. declining. With COVID what's happened because we're all forced to basically close the branches for the most part - we left drive-through lines open – but we saw a massive jump in our digital usage. Pre-COVID we would get 25 plus or minus percent of our new sales digitally and that's over 75 percent today, so we sort of forced adoption in effect of people who use online banking and mobile banking to do their financial transactions, and my suspicion is that many of those people won't go back to the physical channels.
WW: So that's a really good transition to COVID. I know you have been quoted as saying that - the analogy you've used has been that COVID is like a category five hurricane sitting off of the coast of Florida and we've sort of got the windows boarded up and the real question is, does it come and have a direct hit on downtown Miami and take out lots of structures or does it sort of turn and graze the coast. Given we’re now three months into it, what's your view as it relates to landfall on that category five storm that we know is coming and how we're going to weather it come Q3 and Q4 of this year?
BD: I guess my own thought is – unfortunately, I think it's going to kind of hang off the coast for a while and pelt us with the rain. We've adapted our way of life in a way that we can clearly make our way through this crisis yet the notion that there's going to be some fourth quarter vaccine that's going to fix all this, the notion that there isn't going to be a second wave, maybe we're still on the first wave. I think this is with us. We're going to see case spikes, hopefully it's concentrated in younger people, and as you mentioned that the death rate stays low. But I think that's going to be out there for a while and I think that uncertainty in turn is going to cause our ability to bring the economy back to full employment is going to be really tough. I think you've seen it in payroll numbers today. ADP came out and printed a disappointing number versus what expectations were and we see as they go through second rounds of shut offs that people who were rehired, particularly in restaurants and so on and so forth, have been let go again as they’re closing businesses down. So I don't know that it's going to devastate us but I just think it's going to put us into a period of really slow growth and in the process of that unfortunately hurt the parts of the economy that are least able to deal with it. Our lower paid workers are the ones who are who are suffering most with this.
WW: If it is a rainstorm, one of the things that’s allowed people to get through it has been forbearance and PNC has extended forbearance across business lines over the last three months. It's my assumption at some point there are discussions as it relates to the ending of forbearance and people kind of catching up and getting back to being current. What's your thought as it relates to both the consumer and businesses being able to catch back up?
BD: I think for PNC that period of time started June 15th, so it's a bit early to be able to draw conclusions from the data we've seen. But on the consumer side - a couple of sound bites. Our lower balance accounts, so think of a checking account that might have $500 bucks in it on average through the course of the year, those accounts on average today are maybe $1,200 dollars. So a combination of - if it's unemployment, kind of the excess unemployment, combination of the stimulus check and then not having to pay income taxes, the land income taxes - so consumers are somewhat flush at least currently and also the combination of the fact they haven't had to pay any bills because we tell them they don't have to pay if they call.
Now that it’s turning around, the stimulus has largely until they renew it run out, PPP is kind of out there and used, stimulus checks went out and so on and so forth and I'm really concerned about it. What we're going to end up doing without question is taking the payments that were missed and sort of tack them on to the end of whatever the loan is, if it's an auto loan or a mortgage. On a credit card balance where they haven't been making minimum payments, you're going to have to set up a schedule over the course of the next 4, 6, 9, 12 months, whatever it is, where they pay down those balances and I think that's going to put a big drag on consumer spending and I think we're going to have some defaults.
The commercial, where we see it in size as well at least equal to what we see with consumers, is on the small business commercial side and inside of the commercial space as you can imagine, heavy concentrations in real estate. And I don't know how that plays out because retail is driving a lot of this and retail’s not paying their rent, so the underlying properties aren't paying their mortgage, so that flows through to us. I think it's going to be a struggle. I think you're going to see a lot of defaults in small business and in smaller commercial entities as we try to bring them back current and or just extend them out further because it's the next best alternative to foreclosure.
WW: So on that, my assumption would be that, I mean you don't want to own these assets?
WW: I don't think you want to have a big group running around trying to do these workouts and so I guess this crisis seems to be a little bit different from past in the sense that we know kind of what's coming. I guess the first question would be, have you tried to off load, and can you off load any of the risk that you might see coming down the road? And then the second thing about it is, given how well capitalized PNC is, and how well capitalized the overall banking sector is, how long can you go sort of continuing to work with borrowers before all of a sudden you say parties up, we’ve got to kind of move forward? Because I remember very distinctly Bill, during the Great Financial Crisis, when you are faced with defaults, when you were faced with problems, you had to go face them, there was no ability because the capitalization levels weren't as high, the crisis was happening and unfolding every single second and you just sort of had to deal with the issue. This seems a little bit more like you can set up a plan, but the question would be how long can you continue to provide that forbearance and flexibility to the market?
BD: Well it depends on the underlying asset, but real estate perhaps is the best example. There's not a bid out there for real estate right now and the reason for that is the unknown. It's not something you can model at this point because we're still trying to figure out what's going to happen to office, are hotels going to go back and so on and so forth. So, some notion that you would grow around that collateral and try to wholesale it becomes a pretty unappealing notion, I guess depending on whatever you think your loan to value is. In practice, if we have good operators, history has shown us that having patience through a crisis, to your point assuming you have the capital to be able to hold on to assets and work with good operators is always the best outcome on our recovery value.
Now other types of loans that effectively are cash flow loans and don't have particular collateral behind them are perhaps a different outcome. One of the real challenges with small business and smaller commercial entities - and this is why it's important that the government keeps supporting them – first, they don't have access to capital markets in effect the Fed put on liquidity, they're not public entities and, secondly, they don't necessarily have enterprise value, they are worth the production of whatever their employees produce, and so if you shut them down you're effectively putting a whole bunch of people into unemployment and not recovering anything.
So that always weighs into how we make decisions. We ultimately want to try to support clients. We want to make the right economic decision for PNC. We have the patience and capital to make that right economic decision, on a case by case basis. But this is a weird environment, there's a lot of capital on the sidelines, particularly in real estate. If you think about the people who buy B-pieces in CMBS, Willy, a lot of capital on the sidelines that isn't really stepping into this yet. In theory they’re the smart money saying we haven't even seen the bottom here.
WW: Bill on that, as you sort of segment out between the various business lines that PNC is in, one of the big concerns that I've had is consumer finance having significant problems in, for instance, the cards business which then kind of falls into the auto loan and the student loan and the mortgage space on the consumer side, which then pinches financial services institutions like PNC and then causes a more, if you will, conservative stance on extending credit to both companies as well as real estate which are both as you just said better capitalized, a lot of money sitting on the sidelines.
As I look through the Fed stress test, which I would say in reading it PNC without a doubt - first of all I don't do that very often, I did that in preparation for talking to you so I got a little geeky on that, I know you know the numbers in there better than almost anybody - but as I looked into it consumer finance and particularly cards, is the one area where default rates under the big stress scenario get up into the high teens and low 20 percentages. And then you look at everything else where whether it's in first trust mortgages on single family homes, whether it's HELOC’s (home equity line of credit), whether it's C&I loans (commercial and industrial loan), whether it's commercial real estate, none of those get close to that kind of a default rate. Just size for me and for those listening, could that consumer finance problem in cards kind of flow through the system in such a dramatic way that it could really put pressure on financial services institutions or relatively speaking is it a small enough component part of lending that it will have pretty high default rates but it's not something that's going to materially impact the capitalization of the U.S. banking system?
BD: So, first a little technical bit. That 18 to 19 percent default rates in card, those are actually the loss rates, not the default rates. In C&I where they might have a five percent number against PNC for C&I rate, those are our loss rates. Inside of that, if you assume we recover 75 cents on the dollar - pick a number - the default rate’s actually much higher than that. First point. Second point is, one of the reasons PNC does well inside of those stresses is we have a fairly diversified book of business, we're not concentrated in card. Now there's a few credit card monoline companies out there that of course if you hit that type of loss rate in card are really going to struggle notwithstanding they're much better capitalized this time around than the financial crisis.
One of the things that, just as an aside, all the equity analysts are playing with this - they're trying to figure out is this a C&I real estate recession. The financial crisis was a consumer recession largely because of the bubble in residential housing and so they’re saying is this going to be a C&I problem not a consumer problem. Of course, if it's a C&I problem, it becomes a consumer problem because unemployment spikes if companies are going out of business. So in the end a general slowdown in the economy is going to hit all of these things one way or the other and I think the most exposed areas at the moment are in retail, hotels, restaurants and then somewhat related to COVID is oil and gas.
WW: As you think about having just divested from your BlackRock investment which was viewed as, if you will, really sticky capital, long term revenue streams, you do own Midland which is the largest commercial loan servicer in the country with over $700 billion in loans. I would assume that you like the dynamics of the commercial loan servicing industry and the size and scale that Midland has there. Any comments on either the continued growth of PNC as far as being the largest commercial loan servicer and then anything specifically in the markets today that you're seeing through Midland as it relates to your comments on retail or on hotels?
BD: Midland’s been with us for a bunch of years, as you know, and it's a great business and it is an expertise that we have. Midland services for third party - CMBS deals are sometimes just portfolios and we're both master and special on some of these things. But what it gives us, Willy, is in an environment like this, it allows us to play offense in that space. For example, go back to the financial crisis, when we bought National City, who was heavily exposed to real estate, bringing the army in from Midland to be able to help us evaluate that risk was enormously valuable, and that still exists. Today, I would tell you three months into this thing we have basically half of the balances already in special servicing that we had during the entire financial crisis. We've been rolling a billion and a half plus or minus a month into special servicing. They expect that by the end of this year we're going to have as much as 20 percent of the entire portfolio in special servicing, of the assets that remain special, and no surprise that the concentration inside of that is retail and hotels.
WW: Have you seen anything Bill as it relates to whether in your C&I business, or potentially in the real estate business, but I don't think so, but have you seen any new capital requirements or capital needs in the economy as people have transitioned to sort of a, I don't want to say post-COVID because COVID’s going to be here for a while, but you made the point about your shift from branch to online, but behind all that online there are clearly companies that are emerging whether it's the hiring that a Walmart or an Amazon is doing. Have you seen anything there that says there is a green shoot over there as it relates to someone investing in a new way of doing business that's requiring capital from PNC?
BD: The one that comes to mind and they have plenty of access in public markets, but technology has been booming. You think about all the connectivity that we're using now through Zoom or WebEx or Skype or whichever your video channel of choice is and then the cameras that have to be purchased to do that. And if you're on VPN - so I'm on PNC’s network right now sitting in my house so I have to be on VPN and my VPN network needs to support 52,000 people - all of that spend adds up and that's why you've seen the tech sector rally the way you've seen in the equity markets. I think that's real.
The other interesting question obviously comes back to real estate itself and office space. Today we basically have everybody working from home other than certain of our operation centers and certain of our branch employees. Some of those people will never come back into the building. We have found, for example, our care center agents that can work from home virtually are actually more productive and much happier working from a home environment that we kit out for them with technology. So, we're making our entire Pittsburgh care center virtual which just opened up, I don't know how many square feet that is, but measured in hundreds of thousands that we're likely to use for our technology employees. But all of that's going on right now as people are trying to figure out who's going to come back and when.
WW: Do you think you repurpose that space and keep it inside of PNC or do you turn it back to the landlord?
BD: Well, we are the landlord.
WW: That helps.
BD: That particular building was actually the original headquarters of Mellon Bank which, back in the day, was just a giant, giant branch, think like 23 Wall Street, it's kind of one of those big old marble buildings. But we're going to put technology employees in there. One of the things that we've been doing through time as we build out our tech capability is we've been using less and less third party contractors and more and more direct employees so we've had expansion in that space and we'll be able to use it there.
By the way, the offset to that whole thing, again I'll go to technology, our tech tower is set up so that you literally come in and sign in as to what desk you want that day depending on which agile team you're going to work with. You have a locker, there's literally a locker that's your locker on the floor, but the desks are all plug and play, your phone is your computer if you’re sitting with a group you're going to be working with that day.
Now imagine that in an environment where we're trying to do social distancing. I don't know. We've all built our office towers to get rid of all the cubicles in the offices and all of a sudden our facilities guys are telling us I’ve got to put Plexiglas up all over the place, so maybe that causes us to need more square footage.
WW: Yeah, without a doubt. Let's shift in the time we have remaining Bill a little bit to racial and social justice because this is a topic that PNC has been a long standing leader on and so I'd love your perspective on it given the issues in the United States today.
PNC has gotten an outstanding rating under the Community Reinvestment Act for the last 40 years. You launched back, way back in 2004 something called Grow Up Great which works with kids between zero and five to make sure that they're getting the start in life that they need to be able to get the education and be successful. And just last year, PNC was awarded something called the Higginbotham Corporate Leadership Award by the Civil Rights Under Law Commission, and when you went to receive that award Bill you said, “While this award is a wonderful recognition for everyone at PNC for their diversity and inclusion efforts, I always find it a bit strange when we are given an award for something we do because it is so clearly good for our shareholders, employees, customers, and communities. We are basically being given an award for doing our job.” So, first of all, congratulations on winning that award and being such a leader in this space, but I guess second, if you're just doing your job why hasn't the rest of corporate America been doing theirs?
BD: There's a million-dollar question. Willy, first off, we've been working on diversity for a long period of time, and corporate America has as well, and we've all sort of followed the same playbook with different levels of intensity perhaps where we value diversity of thought, we measure diversity across many spectrums, we measure leaders, and promotion rates, and recruiting and all the above, and we've had a fair amount of success in that effort.
But what's happened inside of that is our success with African Americans, with our black colleagues, has been less. So we’ll quote great numbers in people of color but when you actually break down and say what is happening with our African American colleagues, are we recruiting, retaining, promoting at a level that's ultimately going to allow PNC to be a fully diverse company. The answer was sometimes, and I would suspect that we are much better than most at doing this. So one of the big things that has happened because of the recent tensions, and I don't know exactly why this has happened, but it has caused conversations amongst our employees, with our black colleagues, that have been much more intense and direct than we've ever had before. So being able to understand life experiences and how they impact coming to work, obstacles that they faced at work, all sorts of things that, frankly, in normal times gets sort of hidden behind the veneer of the face of somebody who's just trying to come to work and succeed but doesn't really let their guard down.
We need to use that, and double down, not just on diversity broadly but specifically inside of that we need to do better with the African American community. And I think part of that, at least for PNC, is a recognition of – when I talk internally, I talk about recognition for all employees of understanding the burden that people come to work with, whatever your particular burden is, we have to know each other as human beings.
We have a senior African American who you probably know, pay him a lot of money, to this day, when he goes home in his BMW, he takes his wallet out of his suit and sets it on the dashboard of his car for fear of being pulled over and having to reach into his jacket to get his wallet. That's a burden. That's something that we need to understand and share with our other employees that we haven't done as well as we could.
I don't know, Willy, people have to be committed to this. This is America's problem at this point, this isn't somebody else's problem. This isn't something that the African American community can solve for themselves. This is America's problem. We're under producing as a nation because we're disadvantaging and not investing in a massive subset of our population and we’ve got to change it.
WW: So along those lines, my team at Walker & Dunlop has interfaced with your team at PNC as it relates to gender diversity and your program at PNC to both recruit and promote women and one of the things that I thought was quite unique about what PNC is doing is that you've created an entire sort of partnership-mentorship program where men at PNC are working with women at PNC to help promote them. Is there a model there that is applicable - because you've been clearly very successful as it relates to gender diversity at PNC - is there a model there that can sort of enlist the support of other employees at PNC or at companies like Walker & Dunlop to follow that kind of a model of getting that buy-in? Anything along those lines because I think that getting men to buy-in, not just sort of having a women at PNC movement, and led by women and women for women, if you will, I found it to be very interesting that PNC has really brought men into that to provide leadership to that initiative.
BD: Yeah, Men as Allies. We need to do much more in the form of mentorships, particularly for our younger employees. There's a thing called “code switching” where they - in many instances for all our employees this is their first professional job - they come into the training program, they behave how they think they're supposed to behave within a group of people, and for some of our black employees they come in, and they'll tell you this, they're behaving how they think they're supposed to behave around white guys, and it's exhausting, because they go home with their friends and they change their face, they lighten up, they get to be themselves, they get to go home and be themselves. Imagine coming to work every day, it just has to be exhausting, where you're effectively pretending to be somebody else. And one of the things that we're going to put in place, we'll call it mentorships, but we need to have outlets for employees such that work feels safe for them, so people can come to work and be themselves. We want to measure, think about what we want out of an employee, I don't care how people necessarily get something done, I want them to be productive. They don't have to do it all the same way. That's a long-winded answer to your question and I wish I had the answers, but we've got to get people involved, we’ve got to get people to understand and open up. We've got to get our senior African Americans to recognize that they are actually part of the solution for our junior turnover, and take some ownership of that as well.
WW: That's a super important issue and I'm appreciative of both the leadership role you’ve played and then also I know that PNC will continue to lead on this particularly after your billion dollar commitment to investing in communities and to making a real difference on these issues in America. We've only got a couple minutes left and so I want to turn to my final question to you. You have a very big job, you're an extremely busy person and at the same time if somebody Google's you, one of the first images that will come up is you winning some triathlon, finishing a marathon with a bunch of fellow PNC’ers. How do you find time to do the amount of training and to stay in the physical shape that you do and how does that impact your ability to lead PNC?
BD: Well with respect to finding time it's just something I've always done my whole life so not doing it feels stranger than doing it. The people who say they can't find time is just garbage. I don't play golf and I don't watch a lot of meaningless TV and, there, I’ve got all the time I want, it kind of comes down as simple as that. Leading PNC - exercise as you know gives you time to think, you can get lost in your thoughts and think through and focus on problems you're trying to solve. It actually gives me a way, we have a PNC run club, we sponsor lots of different types of races around the country and I try to go to participate in a lot of them. It gives me a way to get to know employees without their work face on. There's nothing like a run where they run up a hill and just about puke to figure out what their made of. And by the way, I'm the old man so they do that to me these days. I don't know, it's part of life, you get up in the morning and you do something and maybe do something again at the end of the day.
WW: I will say that two of my deepest friendships in the commercial real estate and lending space are with two PNC’ers, Jeff Johnson and Mike Lyons, both of whom are fantastic athletes and we have spent more time talking about what PNC and Walker & Dunlop do together while exercising than probably in the corporate boardroom and I think it's benefited both of our companies over the years.
Bill, it's a real pleasure to have you with me. I greatly appreciate you spending the time to give us some perspectives on what's up at PNC, what's up in the banking sector and your view on the overall economy. I wish you and your family health and safety and thanks again for joining us today.
WW: To everybody else who has joined me, thank you very much for joining us today.
Next week the President of Howard University, Dr. Wayne Frederick, will be with us to talk about going back to school in the fall as well as to talk about the COVID crisis. Dr. Frederick is a physician by training so knows a heck of a lot more about the medicine behind a cure than I do. And he will also talk about how to recruit and train and retain minorities into corporate America so looking forward to having Dr. Frederick with us next week.
I wish everyone a very happy Fourth of July and once again, Bill, thanks again for joining me today.
BD: Thanks for having me. Really appreciate it.