Apr 14, 2016
Executives
Brian Gill - Director of Investor Relations Bill Demchak - Chairman of the Board, President, Chief Executive Officer Rob Reilly - Chief Financial Officer, Executive Vice President
Analysts
Betsy Graseck - Morgan Stanley Gerard Cassidy - RBC Scott Siefers - Sandler O'Neill Paul Miller - FBR &Co. John Pancari - Evercore ISI Rob Placet - Deutsche Bank Ken Usdin - Jefferies Erika Najarian - Bank of America Kevin Barker - Piper Jaffray Matt Burnell - Wells Fargo Securities Bill Carcache - Nomura Securities
Operator
Good morning. My name is Emma and I will be your conference operator today.
At this time, I would like to welcome everyone to the PNC Financial Services Group earnings conference call. All lines have been placed on mute to prevent any background noise.
After the speakers' remarks, there will be a question-and-answer session. [Operator Instructions].
As a reminder, this call is being recorded. I will now turn the call over to the Director of Investor Relations, Mr.
Brian Gill. Sir, please go ahead.
Brian Gill
Thank you operator and good morning. Welcome to today's conference call for the PNC Financial Services Group.
Participating on this call are PNC's Chairman, President and Chief Executive Officer, Bill Demchak and Rob Reilly, Executive Vice President and Chief Financial Officer. Today's presentation contains forward-looking information.
Our forward-looking statements regarding PNC performance assume a continuation of the current economic trends and do not take into account the impact of potential legal and regulatory contingencies. Actual results and future events could differ, possibly materially from those anticipated in our statements and from historical performance due to a variety of risks and other factors.
Information about such factors, as well as GAAP reconciliations and other information on non-GAAP financial measures we discuss is included in today's conference call, earnings release and related presentation materials and in our 10-K and various other SEC filings and investor materials. These are all available on our corporate website, pnc.com, under Investor Relations.
These statements speak only as of April 14, 2016 and PNC undertakes no obligation to update them. Now I would like to turn the call over to Bill Demchak.
Bill Demchak
Thanks Brian and good morning everybody. As you have all seen this morning, PNC reported net income of $943 million or $1.68 per diluted common share in the first quarter.
Now that was down linked quarter and year-over-year as our results were impacted by weaker equity markets and lower capital markets activity which impacted our fee revenues as well as continued pressures across the energy industry which resulted in higher than expected loan loss provision. In addition to normal seasonality, the weaker equity markets impacted the equity earnings that we received from our investment in BlackRock whose results you likely have already seen today.
And while our overall asset quality remained relatively stable, our loan loss provision did increase $78 million to $152 million this quarter. Now this increase is primarily related to reserves for our oil and gas and coal exposure.
In spite of these factors, it was a pretty solid quarter for PNC as we continue to focus on the execution of our strategic priorities. We grew loans and deposits on a spot basis this quarter.
You saw that net interest income increased linked quarter, driven by growth in core NII and importantly, noninterest expenses were down about 5% due to seasonally lower business activity but also our ongoing focus on disciplined expense management. We also saw good momentum in some of our businesses.
In the corporate and institutional bank, we saw continued year-over-year growth in treasury management as we benefit from new customer wins, strong growth trends in corporate payments and repricing activities. We also maintained momentum in our underpenetrated markets, particularly across the Southeast in Chicago where we are building high-quality customer driven franchises.
Wins in the core middle-market and cross sell demonstrate the efficacy of our model. Now within our retail bank, we saw good year-over-year and linked quarter growth in earnings and we continue to see improved efficiency within the business as we execute our ongoing strategy to reinvent the retail banking experience with more customers migrating to nonbranch channels for most of their transactions and the expansion over universal branch model.
It was a decent quarter for our asset management group also. Inside this business, fee income was down just 4% linked quarter and 2% year-over-year, despite the weakness in the equity markets during the quarter.
Meanwhile, AUA actually ticked up during the quarter as we continued to see positive flows. At the same time however, despite an increase in NII this quarter, we continue to be impacted by interest rates that remain near all-time lows and we have had to adjust to the reality of at least one less rate hike in 2016 than we previously forecast.
Now, Rob will have more to say about that in a few minutes. But on the whole, although this quarter will be reported as a miss, we were solid in terms of our execution against the things that are in our power to control.
Despite the hit to provision this quarter, beyond the energy book and certain exposures in the steel industry, we don't see negative trends in other areas of credit. In fact, our total nonperforming assets have declined by about $200 million year-over-year.
And our core business has performed well, relative to market conditions in the ongoing interest rate environment. Now Rob will speak to the details of our guidance, but I would say as we look out at the landscape, the condition supporter view that the fundamentals remain solid in the U.S.
economy. The labor market continues to improve and the tight job market is going to eventually lead businesses to raise wages, which should in turn support consumer spending.
Also, we see housing and commercial construction offsetting drag from trade and the downturn in energy production. Within our businesses, we continue to make progress against each of our strategic priorities.
We are working hard to continuously improve the customer experience across our lines of business and I am confident in our long-term ability to continue to create value for our shareholders. And with that I will turn it over to Rob for a closer look at our first quarter results and then we will take your questions.
Rob Reilly
Thanks, Bill and good morning everyone. PNC's first quarter net income was $943 million or $1.68 per diluted common share.
First quarter results reflected the expected seasonal declines in business activity. However, as Bill mentioned, results were also adversely affected by weaker equity markets, lower capital markets activity and energy portfolio pressures.
Offsetting these items were growth in net interest income and strong expense management. Our balance sheet is on slide four and is presented on an average basis.
Commercial lending was up $2 billion or 2% from the fourth quarter primarily reflecting growth in commercial real estate along with increases in large corporate loans. Average consumer lending declined by $865 million or 1% linked quarter, in part due to the year-end derecognition of purchased impaired loans as well as decreases in home equity and education loans.
Investment securities were up $2.4 billion or 4% linked quarter and increased $13.1 billion or 23% compared to the same quarter a year ago. Portfolio purchases were comprised primarily of agency residential mortgage-backed securities and other liquid data and asset backed securities.
Our interest-earning deposits with the Federal Reserve averaged $25.5 billion for the quarter, down $6 billion from the fourth quarter as we shifted some Fed deposits to higher yielding assets. On the liability side, total deposits declined by $803 million or less than 1% when compared to the fourth quarter as growth in consumer deposits was more than offset by seasonally lower commercial deposits.
Of note, consumer savings deposits increased by $5.5 billion linked quarter reflecting our strategy towards relationship based savings products. Total equity remained stable in the first quarter compared to the fourth quarter.
Retained earnings and higher AOCI were essentially offset by common share repurchases. Turning to capital.
As of March 31, 2016, our pro forma Basel III common equity Tier 1 capital ratio fully phased-in and using the standardized approach was estimated to be 10.1%, essentially flat link quarter as we continue to return capital to shareholders through our dividends and share buybacks. During the first quarter, we repurchased 5.9 million common shares for approximately $500 million.
As a result, period-end common shares outstanding were 499 million, down 21 million or 4% compared to the same time a year ago. For the fourth quarter period that ended March 31, 2016, our total payout ratio, including dividends and buybacks under the current share repurchase program was 85%.
Finally, our tangible book value reached $65.15 per common share as of March 31, a 6% increase compared to the same time a year ago. As you can see on slide five, net income was $943 million.
Highlights include the following. Net interest income increased by $6 million linked quarter despite a lower day count driven by growth of $10 million in core net interest income.
Noninterest income was $1.6 billion, a decrease of $194 million or 11% linked quarter. This decline was primarily driven by weaker equity markets and lower capital markets activity, along with seasonally lower client revenue.
Noninterest expense decreased by $115 million, or 5% compared to the fourth quarter. Expenses continue to be well managed, due in part to our continuous improvement program.
However, expenses also declined as a result of lower business activity. Provision expense in the first quarter was $152 million, an increase of $78 million compared with the fourth quarter due to certain energy related loans, which I will discuss in more detail in a few minutes.
Finally, our effective tax rate in the first quarter was 23.5%, down from the 26.1% rate in the fourth quarter. For the full year 2016, we continue to expect the effective tax rate to be approximately 25%.
Now, let's discuss the key drivers of this performance in more detail. Turning to net interest income on slide six.
Core net interest income increased by $10 million linked quarter primarily driven by higher loan and securities balances and higher loan yields, partially offset by the impact of the consistently low interest rates and one less day in the quarter. Purchase accounting accretion declined by $4 million linked quarter.
For 2016, we continue to expect purchase accounting accretion to be down approximately $175 million compared to 2015. Net interest margin was 2.75%, an increase of five basis points compared to the fourth quarter.
This was primarily due to the impact of lower Fed deposits and higher loan balances and yields. Turning to noninterest income on slide seven.
In addition to normal seasonality, which typically impacts the first quarter, weaker equity markets and lower capital markets activity contributed further to the linked quarter decline of $194 million. Asset management fees, which includes earnings from our equity investment in BlackRock were down $58 million or 15% on a linked quarter basis.
Of that amount, PNC's asset management group represents $8 million of the decline. Despite the decline in the equity markets, discretionary client assets under management increased by $1 billion linked quarter to $135 billion, reflecting solid net flows.
Consumer services fees and deposit services charges were both lower compared to fourth quarter results reflecting seasonally lower client activity. Within consumer services, brokerage fees increased 4% linked quarter, driven by account activity and growth.
Compared to the first quarter of last year, consumer services fees grew by $26 million or 8%, with growth in all categories. Highlights include increased debit and credit card activity along with higher brokerage income, all consistent with our efforts to meet the broad financial needs of our customers.
Service charges on deposits increased by $5 million or 3% compared to the same period a year ago, driven by higher customer activity. Corporate services fees declined by $69 million or 18% compared to fourth quarter results, which are typically strong.
However, beyond seasonality this category was also affected by lower activity levels in the broader capital markets. As a result, first quarter results were also lower year-over-year.
On the positive side, we saw good trends in our treasury management business on a year-over-year basis and we expect that to continue, driven by strong customer relationships in new products. Residential mortgage noninterest income declined by $13 million or 12% linked quarter.
Most of the decrease was driven by our hedging results. Mortgage originations were down compared to the fourth quarter, due in part to closing delays resulting from the implementation of new disclosure requirements.
However, servicing fees increased both linked quarter and compared to the same quarter a year ago. Other noninterest income decreased by $30 million or 9% linked quarter, primarily due to lower gains on asset dispositions.
We also had slightly lower gain from the sale of VISA stock. Going forward, we would expect this year's quarterly run rate for other noninterest income to be in the range of $225 million to $275 million, excluding net securities and VISA gains.
In summary, despite weaker equity markets and lower capital markets activity in the first quarter, we continue to believe that our underlying transfer fee income are favorable and we expect that to continue due to a strong new business pipeline. Turning to expenses on slide eight.
First quarter levels decreased by $115 million or 5%, reflecting our continued focus on disciplined expense management along with both seasonal and lower market related business activities. The decline in linked quarter was primarily due to lower variable compensation and employee benefits.
As we have previously stated, our continuous improvement program has a goal to reduce costs by $400 million in 2016. We are one quarter of the way through the year and we have already completed actions to capture more than one-third of our annual goal.
We remain confident we will achieve our full-year target. Through this program, we intend to help fund the significant investments we are continuing to make in our technology and business infrastructure throughout the year.
As a result, we continue to expect that our full-year 2016 expenses will remain stable to 2015 levels. Turning to slide nine.
Overall, we view our firm-wide credit quality as relatively stable compared to the fourth quarter as improvements in our consumer loans and commercial real estate portfolios were offset by deterioration in our energy portfolio. Total delinquencies, including the impact of energy loans continue to decline on both a year-over-year and linked quarter basis.
In addition, it's important to note that many of our customers benefit from lower energy prices. What the graph on slide nine depict is the impact on our credit metrics of both energy-related loans as well as our nonenergy related portfolio.
Nonperforming loans increased by $155 million or 7% linked quarter, as $259 million of new nonperforming energy loans were partially offset by $104 million net reduction in nonenergy related commercial and consumer portfolios. On a year-over-year basis, nonperforming loans decreased by $124 million or 5% even with the impact of the energy nonperforming loans.
Provision for credit losses increased by $78 million linked quarter and totaled $152 million, over half of which was energy related. Nonenergy provision increased by $21 million, reflecting the continuing normalization over the historically and in our view unsustainably low levels we experienced throughout 2015.
Net charge-offs increased to $149 million in the quarter, resulting in a net charge-off ratio of 29 basis points. Energy related charge-offs represented approximately 17% of losses and the remainder was due to consistent levels of charge-offs for home equity, credit card and other commercial loans in the linked quarter comparison.
Now let's take a deeper look at our energy book. We view our energy portfolio, which represents 1.6% of our total outstanding loans as well defined and properly reserved.
As you can see on slide 10, at the end of the first quarter we had total outstandings of $2.7 billion in oil and gas and $535 million in coal. Total outstandings in our oil and gas portfolio are up 4% on a linked quarter basis, but down 5% compared to the first quarter of last year.
Breaking down the portfolio, we have approximately $800 million in outstandings to upstream exploration and production companies, $1 billion to midstream and downstream companies and $900 million to oilfield services. We believe this mix is favorable relative to others in the industry.
As you know, our focus remains on the services book and while we have seen some pressure on this portfolio, approximately $700 million or almost 80% of the $900 million is asset based, which by definition is collateralized. As of March 31, 2016, our loan loss reserves for oil and gas represented 5% of outstanding in this portfolio.
These reserves include the impact of the recently completed Shared National Credit exam. Utilization levels for oil and gas have remained fairly constant.
They were at 34% as of March 31 of this year, essentially unchanged from the prior quarter and the same time a year ago. Total unused commitments were $5.4 billion as of March 31 of this year.
Redetermination of the borrowing bases for E&P loans is ongoing and we would expect to see continued reductions in lines as a result. Approximately 38% of our oil and gas loans are criticized up from 28% linked quarter.
Turning to coal. Our portfolios significantly contributed to our provision this quarter.
Going forward, however, while coal prices remain under pressure, our overall portfolio is small and our remaining risk is concentrated in a handful of specific credits. Our reserve against this portfolio is 15% and criticized balances represent approximately 37% of outstandings, up from 27% linked quarter.
Lastly, in regard to our overall energy portfolio, we continue to monitor market conditions as well as consequential impact to other businesses. If energy prices remain pressured, this will continue to affect our provision.
In summary, PNC posted a solid first quarter driven by higher net interest income and strong expense management. Offsetting this were weaker equity markets, lower capital markets activity, energy pressures and seasonality.
Looking ahead, we believe the economy will continue to grow at a steady pace based on an improving labor market and solid overall economic trends. Because of this, our current forecast anticipates that the Federal Reserve will raise short-term interest rates in both June and December with each increase being 25 basis points.
Our full-year 2015 guidance continues to call for modest growth in revenue and stable expenses which by definition positions us to deliver positive operating leverage. Looking ahead at the second quarter of 2016 compared to the first quarter reported results, we expect modest growth in loans, we expect modest increases in net interest income, we expect fee income to be at 10% to 12%, reflecting the higher anticipated business levels in the second quarter, we expect expenses to be up in the mid-single digits, primarily as a result of the higher anticipated business activity as well as seasonality and we expect provision to be between $125 million and $175 million, which reflects our view of continued near-term energy pressures.
And with that, Bill and I are ready to take your questions.
Operator
[Operator Instructions]. Your first question comes from the line of Betsy Graseck with Morgan Stanley.
Please proceed with your question.
Betsy Graseck
Hi. It's Betsy.
Can you hear me?
Bill Demchak
Yes.
Betsy Graseck
Hi. Yes.
I just wanted to get a sense. You did obviously put or move significant amount or not significant, but a part of your investments with the Fed into other parts of the portfolio.
So I just want to get a sense where you have changed? It looks like you have accelerated a little bit this quarter.
Is that accurate? And is there more to do that would potentially help support the NIM as we move forward here?
Bill Demchak
The bulk of what you saw in terms of growth in securities actually came from TBAs that we bought in the fourth quarter when rates were a bit higher and settled into this quarter. So we kind of took advantage of when rates were at that point the tenure was well above two.
Now that they have rallied back, we are kind of holding portfolio pretty constant. And if they stay where they are, through time it would actually cause that securities book yield to decline as opposed to see the growth you saw in the first quarter.
Betsy Graseck
Okay. And then the second question was just on the case of NPLs.
And the reason I asked the question is, a lot of us came into the quarter expecting that we would see an uptick in NPLs, part of it this SNC related reviews and some investors are asking, okay, well if this look at prior cycles, is this the beginning of an uptick that's going to last several more quarters or a year plus or are we behaving a little bit differently and trying to get ahead of the deterioration that we are seeing in the oil space, et cetera?
Rob Reilly
Yes. This is Rob.
See, obviously, the biggest impact to NPLs is the change in the energy portfolio, which we highlight in the slides. Underlying that, it's still pretty benign.
When we take a look at the improvements on the consumer portfolios and in some parts of the commercial portfolios offsetting that. So that's why you are seeing sort of stable levels.
Bill Demchak
But if your question is, have we seen the end of NPLs coming from energy, the answer to that is no. Even inside of our ABL book where we might have very small charge-offs, because it's secured, we expect that we are going to have a number of credits that we are going to have to liquidate inside of that book, particularly in the services sector, which is what they bank.
So you will see NPLs continue, I think, on the energy book. To the best of our ability and consistent with the SNC review, we are fully reserved for what we know today.
Betsy Graseck
Right. So pace of change, can you just give us a sense on that as we sit here?
Bill Demchak
Look, one thing I would say about this quarter was, there was a couple of lumpy credits that you would like to think aren't going to come through like that again. But I can't promise that.
I would expect that this will play out through time. This quarter we had a couple of lumpy ones that --
Rob Reilly
All in energy.
Bill Demchak
Yes, all in energy.
Betsy Graseck
Got it. Okay.
That's helpful. Thank you.
Bill Demchak
Yes. That's the biggest point.
We dig through all related areas and reserve for those two, but beyond what we are seeing in energy and as I mentioned in my comments, some of the specialty steel guys that supply the energy sector, there just really isn't credit pressure showing up in the C&I space or real estate and certainly in the consumer space. Consumers are really strong.
Rob Reilly
And ex-energy, why you see the NPLs going down.
Betsy Graseck
So there is opportunity to in fact potentially increase the loan growth rate, given the fact that you have got a pretty modest outlook for credit at this stage, especially since some players have been exiting?
Bill Demchak
Well, you are not going to see us grow the loan book inside the energy space anytime soon, I don't think. And we have been focused on dropping and we continue to focus on specifically dropping our coal book.
But beyond that, we are seeing pickup, for example, in our ABL book as there is pressures in other areas of leverage lending just on ability for people to get deals done. We have seen more and more deals commendatory ABL book.
If you dug into that, you would see the spreads in that book are up pretty substantially quarter-on-quarter, as we are getting pricing power back. Pricing power in growth in the generic C&I space, we will continue to win customers, but it is very competitive.
And as you know, we don't really change a credit box and we remain focused on the right return on the capital we deploy. So that will display out through time.
Betsy Graseck
Got it. Okay.
Thank you very much.
Brian Gill
Next question, please.
Operator
Our next question comes from the line of Gerard Cassidy with RBC. Please proceed with your question.
Gerard Cassidy
Thank you. Good morning.
Bill and good morning, Rob. Can you guys give us any color, obviously, the CCAR was pushed back a quarter and the curveball this year was the negative rate environment, could you share with us how it went in your preparation for that in terms of the handling of the negative rate environment from a systems standpoint.
Rob Reilly
Yes. Hi, Gerard.
Good morning. It's Rob.
So we did submit our capital plan and as you know, in the one scenario around negative interest rates, we had buildout a plan for that. To your question around operating capabilities, we believe that we can do that.
It would require some manual workarounds. But part of the drill was to be able to show that we could handle it.
That doesn't mean that we anticipate it, but generally speaking, if that were to occur, we think we have got the manual workarounds to be able to support it.
Gerard Cassidy
Great. And then Bill, in the past on these calls, you have talked about ideal fully phased-in Basel II Tier 1 common ratio below 10% or below 10.1% where you are today.
What do you think is going to take for PNC to able to, because currently now you are paying out close to earnings in your combined ratio of dividends and buybacks, what do you think it is going to be able to take for you guys to go over that 100% level, not to say that you asked for it this year, but what's going to be able to get you to do that?
Bill Demchak
There are so many factors in that question. One is, we have to ask for it, as you mentioned.
In fact, that's the most important. But the other thing, just to remind you, we focus on the end result of the stress not the starting point.
So in a benign environment, with the consistence Fed stress, we had said that we could operate below the 10% which is what you are referring to, but we got there by looking at the results post stress. I am not going to comment on this year's CCAR.
We submitted it. We will wait and see what they say.
But through time and the right environment, we ought to be able to drive that ratio down and the way we would do it is by going beyond the 100% in ask and again I say that through time. Fed has been pretty explicit that there isn't a hard boundary at 100% payout.
So it's a question of having the right environment and asking for it.
Gerard Cassidy
And regarding the post-stress capital ratio, which I think currently is 4.5%, last year you guys obviously were well above that. Do you have a comfort level?
Or do you want to be 200 to 300 basis points above whatever the post-stress requirement is after you go through CCAR?
Bill Demchak
We obviously have a buffer built into our capital policy beyond the minimum of the 4.5%. I remind you, last year in the published results and correct me if I am wrong here, Rob, but while we were well above that minimum that had the phase-ins.
Rob Reilly
That's right. The transitional.
Bill Demchak
Transitional calculations and of course we are always thinking towards the fully implemented when we actually run our capital plan.
Gerard Cassidy
Sure. And then just lastly, coming back to the energy portfolio, could you share with us what percentage of the portfolio is participations in syndicated credits?
And second, of the increase in the provision, how much of it was due to the syndicated portion of that portfolio?
Rob Reilly
Yes. I don't have that offhand.
Bill Demchak
I think generically what you would find is the midstream and services are more direct and since we were never into the reserve based stuff, probably more of that is participations. But we would have to dig that out.
Gerard Cassidy
Okay. Great.
I appreciate it. Thank you.
Brian Gill
Next question, please.
Operator
Our next question comes from the line of Scott Siefers with Sandler O'Neill. Please proceed with your question.
Scott Siefers
Good morning, guys. Rob, I was hoping you could talk a little bit about the expected makeup of the provision guidance, the $125 million to $175 million.
I guess as I look at things, the cross currents seem to be the non-energy portfolio is behaving great but the provision is starting to creep up and then obviously the smaller portion of the portfolio that is energy has understandably much higher credit costs associated. So as you look at that $125 million to $175 million, how much would be your best guess for how much is energy related versus non-energy, to the extent you can talk about it?
Rob Reilly
Yes. Well, I can give you some direction in terms of the way that, at least that we think about it.
You are right. At a base level, energy aside, at a base level, we have said for some time, we would expect credit cost to normalize off the very, very low levels that we experienced in 2015, that I mentioned in my opening comments, but not at a rapid rate.
I think when you take a look at the second quarter, most of the variance will be driven by what results from the energy portfolio. And that's why we built that into our guidance.
And inside of that, particularly as it relates to our coal portfolio, it's a specific handful of credits and how some of those might behave, the lumpiness of that is where you are going to see the variance.
Bill Demchak
One of the things where we struggle with is, as provision has generally been so low that single credit can double provision, just because we are operating off such a low base. So it gives us some pause, frankly, as we think out and put guidance on what provision will be a quarter out.
Obviously we jumped that range from where we were a quarter ago because we were surprised by a couple of credits and thought it made sense to bring it up a little bit and widen the variance up a little bit.
Scott Siefers
Okay. All right.
That's perfect. Thank you.
And then just one quick follow-up. Rob, could you offer maybe a little more color as to kind of the activities or market assumptions that you have embedded into the fee guidance in the second quarter?
Rob Reilly
Yes. Sure, that's a good question.
So our guidance is up about 10% to 12%. And if you just sort break the components down, I will help you with that math.
Asset management, as you know, is comprised of both our equity investment in BlackRock as well as our own asset management group. The BlackRock piece, as you head this morning, BlackRock had an episodic oriented first quarter.
They do expect some tailwinds going into the second quarter that if go back into the normal range of what they had which they expect, you get to a 10% kind of number, maybe a little better. Our asset management business is probably in the mid to high single digits based on the pipeline.
So asset management because it's weighted more toward BlackRock in terms of the second quarter in that range. Secondly, the corporate services probably growing double digit, if you take a look into that, our M&A business are markets related were down.
Business pipelines are very strong there. So we would expect that to grow within the guidance range.
Consumer services, which has been growing year-over-year, we expect that to continue probably in the mid to high single digits that we have experienced. And then residential mortgage which is small, coming off a seasonally low quarter, we would expect production gains, although small in absolute dollar sense to be in comfortably in the guidance percent range.
So that's the math.
Scott Siefers
Okay. Perfect.
That's great. Thank you very much.
Bill Demchak
Sure.
Brian Gill
Next question, please.
Operator
[Operator Instructions]. Our next question comes from the line of Paul Miller with FBR &Co.
Please proceed with your question.
Paul Miller
Yes. Thank you very much.
I have been jumping all over the place today, so I don't know if you answered this question or not. I know you guys did a really good job talking about your energy exposure, but what about the second derivative, especially in parts of the Ohio Valley and Western Pennsylvania where I think it's more energy related than anything else?
Are you seeing any material weakness in some other commercial credits outside of energy and especially CRE?
Bill Demchak
No, we are not. And you know, the one place and I already mentioned it where we are seeing contagion and we have thought about this and sort of counted as part of our exposure in some cases is inside the metal space.
So the suppliers to energy obviously get impacted. And that's included in some of our reserve build and frankly some of our charge-offs.
We are watching, just as an aside and inside our local economy, Ohio, Pennsylvania, it's quite strong. So notwithstanding the pullback in shale and the investment, there is no particular weaknesses in the local surrounding region.
We are obviously watching CRE in certain markets. You think about exposures that would be down in Texas.
We have some real estate exposures down there that we are watching carefully. But thus far real estate continues to behave very well.
Paul Miller
And then, I think I caught the tail-end of the comments, because I had to jump around on some calls, but are you still in your guidance expecting some rate hikes in 2016?
Bill Demchak
Yes. We still have two in there.
It's a practical matter, only one matters because you the second would be, at the end of the year it would impact 2017 as opposed to what we do this year, but that is in there.
Paul Miller
Okay. Hey, guys, thank you for picking up.
Bill Demchak
Sure.
Brian Gill
Next question, please.
Operator
Our next question comes from the line of John Pancari with Evercore ISI. Please proceed.
John Pancari
Good morning.
Bill Demchak
Good morning, John.
Rob Reilly
Good morning, John.
John Pancari
A couple of things on energy. How much of the first quarter provision was related to coal versus energy?
Do you have that? Or coal versus oil and gas?
Rob Reilly
Yes. About half, John.
Bill Demchak
Half of the 80%.
Rob Reilly
Yes. That's right.
John Pancari
Okay. Got it.
And then separately, also on the energy front, do you have the energy NPL or the NPL ratio that is for coal and then for oil and gas?
Rob Reilly
Well, we have the criticized that we talk about, which in both cases is about 37%.
John Pancari
Okay. But the actual amount that's on non-accrual, do you have that?
Rob Reilly
I don't have that as broken out.
Bill Demchak
We didn't break that out in the disclosure, John.
John Pancari
Okay. All right.
That's fine.
Rob Reilly
Of the total energy, you can extrapolate that, the total energy nonperforming loans, it has been roughly in the first quarter about half.
John Pancari
Got it. Okay.
All right. And then the efficiency ratio held relatively stable this quarter and generally in line with what we were expecting.
Can you just give us your updated thoughts on the efficiency ratio trajectory over time through the back half of this year and possibly some color into 2017, how we could think about it?
Rob Reilly
Well, sure. So we don't manage the efficiency ratio.
We are sort of more geared toward trying to deliver positive operating leverage, which we are still positioned to be able to do. Expenses, in general, we had a good quarter.
Our continuous improvement program which is designed to generate expense reductions is running a little bit ahead of where we expected to be. So that's helping out in the first quarter.
But we are still guiding because of the seasonal factors and investments that we plan to make and hopefully what we anticipate in terms of higher expenses around greater levels of business for expenses to be stable in 2015 and in-line with the positive operating leverage that we anticipate.
John Pancari
Okay. Stable expenses in 2016 versus 2015?
Rob Reilly
Yes. Stable 2016 compared to 2015.
John Pancari
Got it. Okay.
That's it for me. Thank you.
Bill Demchak
Sure.
Brian Gill
Next question, please.
Operator
Our next question comes from the line of Matt O'Connor with Deutsche Bank. Please proceed with your question.
Rob Placet
Hi. Good morning.
This is Rob Placet from Matt's team. Just on your outlook for 2Q net interest income, I was just curious how much of an increase you would consider modest this quarter?
Rob Reilly
Yes. Well, so our guidance was for modest increase here in the first quarter, which was $6 million.
So that's one data point.
Rob Placet
Okay. So similar increase?
Rob Reilly
Yes. I think that's right.
Rob Placet
Okay. And then on your energy exposure, total exposure of $8.1 billion, I was curious how big of a risk you view line drawdowns in your portfolio and have you seen any of this behavior to-date?
Rob Reilly
Well, in terms of the $8.1 billion, you need to break it down, obviously in the components I talked about in my opening comments. We watch utilization rates and they have been remarkably steady.
So we are at roughly 35% in terms of utilization. That's where we were in the fourth quarter.
And that's where we were a year ago. So we don't see any big change there.
We would expect over time for some of that exposure to come down because with the redetermination that I talked about in E&P and just some of the general contraction, the utilization rates could change.
Bill Demchak
Yes. One of the issues, it's kind of a misleading number, particularly for the asset based book because the fact there is a borrowing base that they can borrow against and only up to that amount, independent of what the original line was, so while much of the DHE in the asset based book, the dry rates or whatever they are, their ability to actually draw to that amount would be entirely dependent on having valuable collateral to back that loan.
So I think we are going to see as a practical matter, the outstandings, as values fall and the asset based book fall and we will see the lines fall and perhaps outstandings inside as we go through the reserved determination in the E&P book.
Rob Placet
Okay. Thanks very much.
Bill Demchak
Yes.
Brian Gill
Can we have the next question, please.
Operator
Our next question comes from the line of Ken Usdin with Jefferies. Please proceed.
Ken Usdin
Hi. Thanks a lot.
Just a follow-up on the balance sheet mix and composition. Bill, to your point earlier about the TBAs that closed in the first quarter and led to a bigger portfolio, just with rates having moved down on the long-end, I just wanted to get your updated thoughts on using cash from here, what you are doing with securities portfolio run-off and how you want to try to balance that mix right now?
Bill Demchak
Yes. We are basically treading water here.
So we grew when we saw the first bump in the backend, late in the fourth quarter and as things have rallied, we have effectively been replacing run-off with that and we will continue to do so until we see some opportunity here.
Ken Usdin
Okay. And then as far as just your loan outlook, loan growth has been pretty good and it looks like it has still been pretty diverse.
You had taken a little bit of a pause prior just given that we were seeing some competition and we were kind of long in the cycle. How do you just look at the competitive landscape in terms of pricing and where you are seeing growth in the commercial side of the loan portfolio as far as your expectations going forward?
Bill Demchak
Yes. It really hasn't changed.
The specialty segments continue to grow. Generic middle-market commercial is a tough fight.
So you see growth and we would expect it to accelerate in our asset base book, perhaps in equipment finance. Obviously inside of the real estate space, we had strong year-on-year and quarterly growth, principally as a result of changing the mix from new project loans to permanent financing term loans.
As your aware, that the disruption in the CMBS market and the risk retention rules coming online, have driven a lot of that product at good pricing structure towards the bank. So we would expect to see that to continue.
Rob Reilly
Yes. And Ken, just in addition to that, in the large corporate loan book, we have seen progress.
Ken Usdin
Okay. Got it.
Thanks a lot, guys.
Brian Gill
Next question, please.
Operator
Our next question comes from the line of Erika Najarian with Bank of America. Please proceed.
Erika Najarian
Hi. Good morning.
Bill Demchak
Hi Erika.
Erika Najarian
Just a quick follow-up question. Bill, could you remind us where you are on your systems upgrade project, please?
Bill Demchak
Everybody always want to know what inning we are in, but rather than talk about this, I will talk about what we have accomplished. We have one new data center up and running.
We have got the second one basically turned on and are starting to plan out migration activities to that. We are largely through the upgrades to applications so that they can run in a virtual environment.
We have done the bulk of our investments in cyber and fraud. So we are pretty far along and making good progress.
I think in dollars, Rob, if you want to comment, last year was our biggest.
Rob Reilly
That's right. Our biggest spend, yes.
So in terms of dollars in the innings, we are getting to the later innings. Of course, will pick up some of the depreciation that goes along the ways, but we are on our way and by the end of this year, Bill, that second data center will be up and running.
Erika Najarian
Got it. And just as a follow-up to that, thank you for giving the color on where you are on the spend.
The reason I ask is, it seems like investors are not just interested in that question not just because of how they are thinking about the incremental spend from here, but also I am fielding questions on whether or not being done or mostly done with the project changes the way you are thinking about your M&A strategy. And so, Bill, I would appreciate your thoughts on that.
Bill Demchak
It's probably a year ago I made the comment and I wish I didn't, but I made the comment that we would have the technical ability in terms of having the systems ready to do an integration if we wanted to do that. But we don't want to do that.
So our attitude on M&A in terms of buying other banks remains the same and that we are basically out of the market. I don't see value there.
I think there is many other things that we can spend our capital on to offer better return to shareholders. Just as an aside, one of the things that I think people miss as it relates to a lot of the work we are doing in the core infrastructure is what it ultimately allows us to do with customers in terms of product offerings and customer services.
We actually had an API test internally here last week where we had employees form teams and opened up all the API for our online mobile and online banking capabilities and turn them loose to create new service apps for customers, all of which is fantastic, but none of which works unless you have an environment that allows you to quickly deploy these new products. And that's what we are building and that's where I think the big benefit ultimately comes from, for all the money we spent inside the technology space.
Erika Najarian
Got it. Thank you.
Brian Gill
Next question, please.
Operator
[Operator Instructions]. Our next question comes from the line of Kevin Barker with Piper Jaffray.
Please go ahead.
Kevin Barker
Good morning. Thanks for taking my questions.
I noticed in the auto portfolio you were fairly aggressive in growing that portfolio in 2012 and into 2013 but have since pulled back and have seen very little growth compared to the rest of the industry in the last couple of years. Obviously your FICO score is very high, near over 750 on average.
Could you just give us a feel for what you are seeing in the industry and what are the reasons why you are not as aggressive as you were in the past?
Bill Demchak
Well, we are exactly where we were in the past. We are just not growing at the same pace.
We haven't changed our credit box and everybody else has. By the way, that's a pretty consistent practice for us across all of our lending type.
So we have tried to hold true to where we see real economic return in the auto book and you have seen other people, as you know, drop into the subprime space and go increasing into leasing where we don't play. But one thing that has grown for us this quarter inside of auto was actually the direct book where we have something called a check ready product, where customers, in effect, get the car loan without going through the dealer.
That continues to grow at a very healthy clip. But beyond that, we see other people lengthening tenure, going subprime in terms of FICO, higher advance rates.
Rob Reilly
Taking risk we don't want to take.
Bill Demchak
Yes. And you see the delinquencies tick up across the industry as a result.
Kevin Barker
Is this something you are seeing particularly from the nonbanks? Or are you also seeing several large banks that are competing in the market?
Bill Demchak
You know the answer to that question. So I am not going to answer it.
Kevin Barker
Well, I appreciate the color. Thank you very much.
Brian Gill
Next question, please.
Operator
Our next question comes from the line of Matt Burnell with Wells Fargo Securities. Please proceed.
Matt Burnell
Good morning. Thanks for taking my question, guys.
Just a question on the consumer growth. That's been much lower than what you have seen on the commercial side despite what appears to be a bit more demand on the consumer side.
So I guess I am curious, maybe Rob, can you give us a little more color as to what's going on specifically within the consumer portfolio and why it appears you all are growing that portfolio a little bit slower than peers? And I am wondering if there's a decline in the government insured portfolio within other consumer that's maybe hiding some of the core growth there?
Bill Demchak
Well, that true in the student loan book that continues to run off, but there is two big run off in education lending as we run off the old government guaranteed book and continued declines inside of the home equity space. Largely while we continue to originate there at a healthy clip, just the size of the book that came with a combination of PNC and National City, remember they had a large national business, our production isn't keeping up with the maturities.
So it's dropping as they hit maturities. We have seen drops in small business lending and largely that's around our ability bluntly to make money against some of the loans we see being made.
It's a tough business to get a good return on without a lot of cross sell and a lot of that business has become loan only going to the small banks and our books declined as a result.
Rob Reilly
And then just the other two categories, auto we just talked about, which is risk management and then credit card, although it's relatively small for us, the growth has been pretty good year-over-year and we would expect that to continue.
Bill Demchak
Yes. The file one thing is, as you know, while we have grown some residential mortgage loans on balance sheet, we haven't been balance sheeting a lot and our production isn't that much.
So a lot of the consumer growth you are getting, when you look at other banks is actually coming from simply retaining self originating mortgages.
Matt Burnell
Sure. That's fair.
And then if I can just as a follow-up, Bill, I think you mentioned earlier in your comments about a repricing across some of the commercial areas which I took to mean an upward repricing. Can you give us a little more color on that and how those repricing efforts are being responded to by clients?
Bill Demchak
So I was specifically referring to what's going on inside of the asset based lending space. Most of the rest of C&I, frankly, somewhat illogically has held pretty constant notwithstanding what we have seen credit spreads do in the capital markets.
But inside of ABL, as credits either move from being a cash flow credit get refinanced in ABL or people start to get into trouble and trip a covenant or trip something. Our ability to charge fees and ratchet spread is pretty aggressive.
It's part of the original loan terms. As a fact of the matter, clients who use that product knows how it works.
So I suspect they don't particularly like it. Nobody like to pay more, but that's the environment.
And by the way, it is entirely consistent with many cycles we have been through in the past. ABL does really well when credit conditions get tight.
That's what we are seeing.
Matt Burnell
Right. And then just to tag onto that, in terms of the energy portfolio, how do you manage the overall exposure relative to your loan agreements and when customers want to tap those unused lines, your being able to control that in terms of the covenants that you have that you have in your documents?
Bill Demchak
You almost have to go sector-by-sector and credit-by-credits. So there is high-grade energy credits inside of that services book that basically can draw when they want.
There is asset based credits inside of the services book and midstream who have to have collateral value to allow the draw to occur, independent of what the line is. So simplest form in asset base, I can give you $20 million line, but if you have $10 million of collateral, we probably let you draw $8 million.
And of course, in the reserve based stuff, it's a function of the forward, in effect projected value of the reserves coming out of the ground that give rise to that borrowing base. So it's across-the-board dependent on credit structure and ultimately whether, as is with some of those credits, whether they are really high investment-grade.
Matt Burnell
Okay. Thanks very much.
Brian Gill
Next question, please.
Operator
Our next question comes from the line of Bill Carcache with Nomura Securities. Please proceed.
Bill Carcache
Thank you. Good morning, guys.
Bill, can you broadly discuss the clearXchange opportunity? And in particular, do you envision the existing ACH system remaining in place and clearXchange basically just being a superior real-time P2P money transfer offering that would exist above and beyond that?
Or is the vision that ACH would eventually go away and be replaced by clearXchange?
Bill Demchak
I don't know if I can do it briefly. First off, what is going on with the merger of EWS and clearXchange, there is six banks plus ourselves who collectively purchase this, we are creating a real-time P2P payment network that's going to be ubiquitous offering that we would like to get out into every banks' hands in the country, such that whether you are a PNC client or a Bank of America client, or a Fifth Third client, you have the same app that is pre-populated with information in a secure way to allow you to make payments person-to-person.
Entirely different than what we are doing at the clearinghouse as it relates to real-time payments in the potential down the road substitutability of ACH. So ACH is now gone.
There is now same day ACH. You will have seen, the clearinghouse announced the build of a real-time payment system that today we envision certain use cases for, you might see it for payroll, you might see it simply when somebody wants to make a payment they don't want to wait a day on.
Whether or not that takes some or all of the volume off of ACH through time, we will wait and see. But today, those are two very different things.
One thing focused on consumer payments, P2P make it really easy for consumers in a secure way to move money around, the other one mostly focused sort of an institutional payments.
Bill Carcache
Understood. Thank you.
That's very helpful. And a separate follow-up question, Rob, for you.
In response to the response that you gave to the earlier question about utilization and line draw-downs, can you discuss how you guys factor in the probability of utilization rates rising as we move deeper into the credit cycle?
Rob Reilly
We haven't focused a whole lot on that. Obviously we take a look at utilization for trends in terms of where they are.
The percentage itself is something that you want to monitor. But again, if exposure comes down and percentage goes up, that's different than if it's the other way around.
Bill Demchak
To be very clear, in a generic credit book, we on a portfolio basis, assume as part of our reserve an amount to withdraw diversified across a credit book. As it relates specifically to energy, we are obviously looking credit-by-credit, what might be drawn, what the reserve redetermination is going to do on all of the above.
But remember inside of the generic reserving process, we have a factor as does everybody else that assumes some amount of draw and it's a function of type of client collateral, a whole bunch of different factors that go into the modeling for that.
Rob Reilly
Yes. I think that's a good way to put it, that it is done on an individual basis and reserved in energy and reserved appropriately.
Bill Carcache
That's very helpful. Thanks guys.
That's all I had.
Brian Gill
Next question, please.
Operator
There are no further questions on the phone lines, sir.
Brian Gill
Great. Thank you, operator and thank you all very much for joining us on this quarter's conference call.
Bill Demchak
Thanks a lot, everybody.
Rob Reilly
Thank you.
Operator
This concludes today's conference call. You may now disconnect your lines.