A weak economy has increased the pressure on Mellon Financial Corp. to prove that its new fee-driven business model is working as it marks its first anniversary without a retail business.
Mellon has spent the past year whittling down its loan portfolio, which at the end of September stood at $9.4 billion and implementing an efficiency program that has produced more than $300 million of cost savings and pretax revenue.
But the company still has some wood to chop. Third-quarter profits of $191 million were flat from a year earlier, and the benefits from its cost-cutting program, dubbed Leap, for "Lift Earnings and Performance," which began in the second half of last year, will not be fully felt until the first quarter.
Meanwhile, to adjust for sluggish revenue growth, Mellon has another 1,000 or so jobs slated to be cut between the fourth and the first quarters, on top of the 1,900 that have been eliminated or earmarked for elimination as a result of the Leap program. An employee benefits outsourcing business, Mellon HR Solutions, is just getting off the ground, as is a major marketing push for new customers.
The Pittsburgh company completed its most significant divestiture - the sale of its retail and branch operations to Citizens Financial Group of Providence, R.I. - in December 2001. Through a series of portfolio and business sales, targeted acquisitions, and joint ventures over the last three years, it has steered its business mix away from traditional commercial banking and toward an almost entirely fee-driven model based on asset management and corporate services.
Mellon executives and Wall Street observers say that the right pieces are in place but that the anticipated boost in revenue growth has proven elusive because of the prolonged market downturn. Its assets under management have slipped about 5% from the beginning of the year, to $563 billion at the end of the third quarter.
"I'm excited about the mix of businesses we built, the team of people we have making them work, and the potential we have, particularly once the environment improves," Martin G. McGuinn, the company's chairman and chief executive officer, said in an interview with American Banker this month. However, "we expected the economy to be a little stronger this year and the markets to be better."
Wall Street analysts said they will be patient.
"The positive results they expected have not materialized" because of the markets, said Gerard Cassidy, an analyst at Royal Bank of Canada's RBC Capital Markets. "The timing of selling their retail business may have been early, but I think it will prove them right in the long run."
The retail sale resulted in a smaller balance sheet, and Mellon, which has sworn off corporate lending as a core activity, continues to reduce its credit exposures. It has exited international lending, leveraged finance, and project finance.
At the end of September it had $9.4 billion of outstanding loans, down from $32 billion in 1998. Of its remaining exposure, $2.5 billion is in large corporate loans, with the rest in jumbo mortgages, private wealth loans, commercial real estate, insurance premium financing, and large-ticket leases, the company said.
Corporate lending was a major headache for the company this year. In June it found itself holding a $100 million loan to WorldCom after the telecommunications firm disclosed it had improperly booked $3.9 billion of expenses and filed for bankruptcy protection. WorldCom is the successor company to a longtime Mellon client, MCI Corp., but the experience affirmed Mr. McGuinn's decision to stop lending for lending's sake.
The WorldCom situation "wasn't necessarily poor underwriting," he said. "It was a fraud accounting situation," but "that kind of loan with our reduced balance sheet and strategy is just not a risk we can take."
Mellon has said that - with some exceptions - it will not lend to new clients but will continue to give credit to existing customers. "We don't want to just leave [existing clients] in the cold, and we'll work with them over time, but we have to bring the exposures down," Mr. McGuinn said.
In addition to reducing its credit portfolio, the company has been looking for ways to improve efficiency and boost revenues. The Leap program is scheduled to end at the close of the first quarter.
"I'd never want to go through it again, because it was very intense and very consuming," Mr. McGuinn said.
But through the process, the company discovered and corrected inefficiencies. "We weren't doing enough things on a centralized basis, because we had acquired companies and we didn't bring them into the corporate approach," he said.
Mellon centralized functions such as purchasing computers and making travel arrangements, Mr. McGuinn said. "This was a chance to step back and say: 'Wait a second. We want everybody to do this, because we can get tremendous savings and you'll still get the best of what you need.' "
Though Leap will not be officially renewed, the program has changed Mellon's culture such that in certain businesses, employees continue to generate ideas, he said.
Over the last year and a half the company has reduced its head count by around 7% to 9%. "As some revenues in some businesses have slowed down we've had to eliminate some more positions in addition to the 1,900" cuts produced by Leap, Mr. McGuinn said. The company plans to make another 500 to 600 reductions this quarter and possibly 500 in the first quarter, he said.
Mr. McGuinn said he has no regrets about getting out of retail, though it was banking's hottest trend this year. The sale to Citizens, a unit of Royal Bank of Scotland Group PLC, has gone "exceedingly well," he said, with customer retention rates on both sides reaching nearly 100%. After the sale, Mellon added 20 wealth management offices and combined its private asset management, private mortgage, and private banking businesses to form a private wealth management unit.
He said he still believes that the Citizens transaction will make Mellon less vulnerable to acquisition, because its long-term growth rate is higher. Compared with mutual fund processing and pension fund administration, retail was a slow-growth business at the company. Though those two businesses are not enjoying the same high growth rates they were in the late 1990s, a market turnaround would boost returns.
"I think our board feels more strongly than ever that we are executing a right strategy," Mr. McGuinn said. At this point, "they would be less inclined to sell to somebody who would be trying to take away that value on the cheap."
Brock Vandervliet, an analyst at Lehman Brothers, said Mellon has "a good fundamental business structure at this point, so much of the heavy lifting is complete," and no major pieces need to be added or removed.
But, barring a major lift in the market, Mellon's earnings will not increase dramatically in the near term, in part because of poor margins from Mellon HR Solutions, Mr. Vandervliet said. The unit generates 25% of the company's revenue but only 5% of its net income, he said.
Mellon needs to consolidate the platform of services, and such an effort could take until this time next year, he said.
Mr. McGuinn said that the next focus will be gathering new customers.
To accomplish this, the company set out a year and a half ago to establish a marketing plan it calls marketing coverage and sales effectiveness. The marketing sales forces are separated into sectors - asset management, treasury, human resources services, and asset servicing - and then split into three categories of customers - financial institutions, large public companies, and not-for-profits and governments, he said.
Mellon has just begun to implement the marketing plan, which will officially kick off on the first day of next year, when many staff assignments and incentive programs will change, Mr. McGuinn said.
