What PNC's Demchak <i>Really</i> Thinks About D.C. Policy Issues, M&amp;A

WASHINGTON — PNC Financial Services Group's Bill Demchak views his bank as something of an odd man out in the policy debates raging among regulators and lawmakers.

In a town that typically divides the industry into two groups — large, complex Wall Street behemoths and small, simpler Main Street community banks — PNC is tough to pin down. At roughly $300 billion of assets, it's the sixth-biggest bank in the country. Yet its portfolio is relatively straightforward.

"We're described in the press as a regional bank or a superregional bank… It's a lousy descriptor," Demchak says. "We are a mainstream bank. It sounds pretty simple, but we're basically a bank that takes deposits, lends money, helps their clients move money around through the payments system and helps them manage their wealth and retirement resources.

"We are not somebody that is a big proprietary trader. We are not in 56 different countries. We don't store aluminum in some unlabeled warehouse in the middle of the country. We don't have dark pools and other things that I don't even know what they are," he says. "We're a pretty basic bank."

Yet because of its size, the bank is caught up in the debate over "too big to fail," and faces enhanced regulatory scrutiny by the Federal Reserve Board and other regulators.

During a nearly hour-long discussion with reporters, Demchak tackled that subject along with a range of other hot-button policy topics, including the regulatory crackdown on indirect auto lending; the Fed's proposal to boost bank liquidity; and legislation to reform the housing finance system. He also discussed why PNC isn't interested in making more acquisitions, big or small.

His answers are refreshingly direct, with virtually no trace of the hand-wringing typical of CEOs afraid to publicly criticize their regulators. Demchak's responses are also surprisingly in the weeds, getting into precise details of various issues.

"People won't like that answer," he acknowledges at one point during a discussion of how to unwind Fannie Mae and Freddie Mac.

Following are highlights of the discussion:

Indirect Auto Lending
The Consumer Financial Protection Bureau launched a crackdown on indirect auto lenders last year, warning in a March bulletin that such firms will be on the hook for any discriminatory pricing by auto dealers. The agency has relied on a legal theory called "disparate impact," which looks for unintentional statistical discrepancies in what consumers of different races are charged.

The CFPB's effort may be futile, Demchak suggests.

"At some point, maybe we're trying to solve a problem that doesn't need to be solved," he says. "It's not at all obvious to me that in fact there is any discriminatory pricing."

Some of the differences in what indirect auto lenders charge may be due to other factors, Demchak says.

Looking "across a pool of auto dealers," he says, "while statistically it shows differences in pricing, none of that adjusts for ZIP code differential and lots of things that would be inherent in that measurement."

PNC has a good relationship with the CFPB, Demchak says, but he's unsure how the agency would correct the problem without simply stopping auto dealers from influencing the price of a loan.

"An individual dealer would have no issues but once you put the dealers together in a portfolio, you can find, through a statistical model, disparate impact," he says. "That doesn't go away, I don't think, no matter what the banks do, as long as the dealers have pricing discretion."

PNC would be willing to go to so-called "flat pricing," in which it dictates the price auto dealers could charge, he says, but it won't do so by itself.

"Unless the whole industry did it, the first guy that does it gets killed," Demchak says. "I don't know how it works unless somebody with authority — and I don't know if it's [CFPB] or not — stands up and says, 'To fix this, go to flat pricing.'"

Housing Finance Reform
Demchak did not endorse a pending Senate Banking Committee bill to create a new mortgage market, but suggested he thinks it is "headed in the right direction."

Still, he raises fairly specific concerns about one provision of the legislation by Senate Banking Committee Chairman Tim Johnson and Sen. Mike Crapo, the panel's top Republican. The bill would eliminate Fannie Mae and Freddie Mac, and replace them with a system backed by a catastrophic government guarantee.

Under the bill, firms would have to put up 10% first-loss capital and meet certain underwriting requirements for their securities to qualify for the government guarantee. Participants would be able to use approved risk-sharing mechanisms via a bond guarantor structure or capital markets executions to meet the standard.

Demchak worries that's risky. Any capital put up under the 10% risk retention requirement, he says, has to be "riskless," which he defines as cash.

"They talk about capital market alternatives, I don't know what that means," Demchak says. "Does that mean we're going to get back to the securitization of Triple-B bonds again and selling them to Icelandic banks? I think they need to get very specific about that — and I think it needs to be cash."

He acknowledges, however, that a risk retention requirement would play to PNC's strengths.

"My personal view is that risk retention of some sort is important," he says. "That obviously plays to our advantage. We are a traditional bank. We have liquidity and capital. I'm happy to own a piece of something I underwrite. I shouldn't be underwriting something unless I am. It's a very simple statement."

Any bill should be careful not to disadvantage smaller players in the market, Demchak says.

"We need to come up with something that doesn't concentrate the business into a handful of very large players because community banks and smaller banks play an important role," he says.

The Fed's Liquidity Proposal
Demchak is also lobbying the Fed to change its proposed Basel III liquidity requirement for the largest U.S. banks.

The so-called Liquidity Coverage Ratio unveiled in October would require banks to hold enough high-quality, liquid assets so they could fund themselves for at least 30 days in the event of a financial shock

The current U.S. version of the plan is more stringent than the European proposal, Demchak says. For one, the U.S. plan would not allow access to the Fed's discount window to count toward the LCR, whereas the European version would allow firms to count access to the European Central Bank's liquidity facilities.

That is particularly vexing for PNC, he says, because most of its assets are at the bank level, not the holding company, and are therefore eligible at the discount window.

"In Europe… you are allowed to rely on the ECB's liquidity facilities," he says. "In the U.S. LCR, you are not allowed at all to rely on the discount window, yet we have a balance sheet of discount-eligible assets that would easily fund at least some portion of our LCR requirement were we allowed to do it. So they are at 100% and the U.S. is at 0%.

"We've been pretty vocal about it."

Mergers and Acquisitions
Demchak makes no bones about PNC's reluctance to grow through acquisitions.

One fear is that making a large purchase could trigger more scrutiny from regulators, who are skeptical of banks that rapidly expand.

It is clear supervisors don't see PNC as being in the top tier of systemically risky institutions. The supplementary leverage ratio regulators finalized this week would not apply to the bank. Less clear is when that might change.

"When you don't know where the line is drawn, potentially buying something that triggers an invisible line -which then has the entirety of the rest of your institution fall under that line — just doesn't make a lot of sense," he says.

There are other compelling reasons not to buy. He notes the baggage that comes with purchasing an institution, such as the legacy issues PNC inherited from its acquisition of National City.

Further, making another acquisition could slow the bank's technological development.

"Every time you do an acquisition, you freeze your technology changes," he says. "Because I need to map the other bank's systems and client record to ours, which means I need to freeze our systems so I can do the integration."

He adds: If "we're to do a small deal, I'd have to freeze what I want to do in technology. And technology is going to be a big competitive advantage if you get it right."

In the big picture, acquiring another bank would also be a strategic mistake, given where banks need to pivot to next.

"In a lot of cases when you are buying smaller banks, you are kind of buying yesterday's delivery channel," he says. "I'm buying yesterday's branch design, buying employees, for the most part, who haven't been exposed to the new products and services. I might as well go build tomorrow organically versus buying it."