USB: Over the years, Mellon has been moving toward greater reliance on fee income, but why did you move so dramatically and in one swoop?
McGuinn: It was the next logical step in the evolution of Mellon as we've sharpened our strategic focus. We had been selling off some of those mass-market consumer banking branches for some time. What convinced us to do the sale at this time was that, as we talked with Citizens, we realized they had a different strategy. They really focus on the mass-market consumer, whereas our focus has been more on our fee businesses. And this gave us an opportunity to take that next logical step in repositioning Mellon in a way that really was a win/win. They were willing to buy basically all of our branches, take all of our employees. We thought that would serve our customers and employees as well as it would serve us. And Citizens was willing to pay a fair price. It was the most effective course for all involved.
USB: Did Citizens approach you or did you approach them? Or was there an intermediary?
McGuinn: I've known Larry Fish [Citizen's CEO] for several years, and as we've talked from time to time he observed that our strategies were different but complementary, and that at the appropriate time we ought to talk. So this seemed to be the appropriate time and we began our discussions. We decided to proceed on an exclusive basis.
USB: Were you so determined to get rid of your retail operation that you would have done it at any price?
McGuinn: No, not at all. While we thought the price was fair, that was not the driving factor. This was much more of a strategic move.
USB: Might it have been wise to go to a Morgan Stanley or Goldman Sachs and say, Look, we want to sell our whole retail business, why don't you shop around and see who might meet our objectives and get the highest price?'
McGuinn: I don't think so. Because when we began the discussions with Larry Fish and Citizens, I explicitly said to him we were willing to proceed on an exclusive basis if he would buy the whole package, take all of our employees and pay a fair price. We did look at comparable sales and we did engage an investment bank to advise us on what would be a fair price. In fact, several investment banks over the last couple of years came to us, advising us to do it, and they went so far as to give us what they thought were comparables. So we had a very good sense of what the right price should be.
We also thought this was the best transaction for our customers and employees and communities, and we thought it was a lot easier to execute one transaction rather than trying to do several.
USB: Was saving the jobs of your retail employees an important factor?
McGuinn: Everything we do is for our customers and everything we do is through our employees. So having and keeping and motivating and rewarding the best talent is absolutely key. I used to have responsibility for our retail bank, and I know a lot of these people and we wanted to be fair to them because it's the right thing to do. But, frankly, that's part of our reputation and our culture, so it was important that the entire organization believed that we were proceeding fairly here.
USB: My perception is that the economy and the stock market may be in for very hard times. It seems that now a very big part of your business will depend on the well-being of the stock market. Do you think you may be putting too many eggs in one basket?
McGuinn: No, and that's something that we have thought about very specifically in terms of both developing our strategy and executing it. I share your concerns about the economy and even the stock market over the short term. But in the long-term, I would expect the equity markets to perform very well.
An important part of our strategy is to have an attractive mix of businesses. Our businesses already are well diversified. Within wealth management, for example, we have the private client business, including private asset management and private banking, and then our mutual fund business and our institutional asset management business. That's about half our revenues and income. And even within that mix, equities are less than 50%.
The other half of our business is what we call processing and corporate services, and those are not tied to the stock marketor even to the economy, for that matter. We have a nice mix of businesses from cash management to investor services, to trust and custody, to employee benefit administration, to our Buck Consultants unit. USB: Skipping to another subject, last year you had 10% growth in earnings and your return on equity was 25.8%. Can those numbers be sustained?
McGuinn: Our objective is to be the best-performing financial services company. The emphasis is really on the word "performing," because we think that performance can be quantified and measured. Certainly our growth rate in terms of earnings per share is an important measure, which drives stock price.
If you look at Mellon last year or even today, we have been among the best-performing. And certainly our returns on both assets and equity have been at the very top, and our earnings growth has also been among the very best. What we're trying to do now is take the company to the next level of success, to be the very best. So, I can't say in absolute terms that our return on equity is going to stay at 26%, but on a relative basis we think we will be at the very best levels.
USB: What do you think is a realistic ROE over the next two or three years?
McGuinn: That's a tough question. We expect that we will be above 22%, I think that is realistic. And also I think we have the momentum to continue that. Now, obviously, the external environment is a major factor. But we also think that our growthwhich has been in the 12%-14% range, and even higher if you look at our core businessescan be in excess of 14%, again taking into account economic and market cycles that may cause some distortion.
USB: Do you think the divestiture will help your price-to-earnings ratio?
McGuinn: Yes. Our P/E over the last several years has been much higher than what I'd call "traditional" banks' or regional banks'. It has not been as high as what we call the trust banks', such as State Street and Northern Trust. And we've seen that as a valuation gap. One of the reasons we wanted to narrow our strategic focus was to close that gap.
USB: To what degree did the P/E drive your decision?
McGuinn: Well, it was a factoralthough we thought even on the then-existing mix of businesses that we deserved a higher P/E. But obviously P/E in large part is driven by your earnings growth rate. And the retail bank, because we were not investing in it to the same extent as others were, really wasn't growing as quickly as some other businesses in which we have been investing more. To that extent it was holding us back a little bit. So we think that the divestiture really should help us accelerate our growth rate and therefore drive a higher P/E.
USB: Do you feel at all uncomfortable about reducing your capital base as you buy back stock?
McGuinn: The amount of capital needed for some of our businesses is less than what might be needed for other businesses. I think of capital in three ways: one is to reinvest in our businesses; second is to use it to make acquisitions; third is to return some of it to our shareholders by share repurchases. Or we can do a combination of all three. We're continually looking at what would be the best use of capital at a particular time.
In the last couple of years, we have bought back a lot of stock because we didn't find acquisitions that we thought fit our strategy and that were appropriately priced.
As frustrated as that made me feel at certain times, I look at all the failed acquisitions made by other banks, and take some solace from the fact that we didn't overreach.
Because we had good organic growth and momentum, we didn't have to overreach. Even if we buy back stock with these proceeds, we can always issue new stock to make acquisitions. We are going to be more aggressively looking for acquisitions because in this environment there may be more opportunities than there have been in the recent past.
USB: Do you have any idea at this point how much stock you might buy back with the $900 million you expect to clear?
McGuinn: No, except that it's likely we will use the large majority of it for buy-backsunless we can find the right acquisitions. We're looking at possibilities literally every day.
USB: Can you be specific about the kind of companies you'd like?
McGuinn: Oh, absolutelyones consistent with our strategy, which is to focus on our fee-based businesses. It would be an asset management company, a processing company, a consulting company in the benefits and human resources consulting areas.
USB: What likelihood is it that you will be going overseas for these acquisitions?
McGuinn: The real priority overseas would be the U.K. and the Continent. We're interested secondarily in Japan, although at the moment I'm not that high on Japan. Expanding overseas is a very high priority.
USB: Do you have any qualms about giving up your base of retail deposits and the impact it might have on liquidity?
McGuinn: No. Clearly, a retail franchise does bring in relatively low-cost deposits, but we have a number of businessessuch as our cash management and our trust and custody which also bring in billions of dollars of deposits. Liquidity is not a concern for us.
I'd like to stress that I don't believe a retail or a mass-market consumer banking strategy is necessarily a bad strategy. For other organizations that have the necessary scale and the right products and services, it can be a fine strategy. Mellon, as a traditional bank, was only about 20th largest, and so trying to invest in and expand that business was not as appealing to us as building on businesses where we had tremendous strengths and position. In the asset management business, we're 11th largest in the worldand that's not just compared with banks, that's compared with Fidelity, Merrill Lynch, whomever. And in trust and custody we're one of the largest in the world.
USB: Last year I interviewed PNC CEO Jim Rohr and it seems they've been becoming more like you. How will the divestiture of your retail business impact your competition with them?
McGuinn: PNC is a very successful organization and a very strong com petitor. I really make it a personal policy not to comment on specific competitors. We have done a lot of the same things in terms of divesting our credit card and mortgage businesses. They have been competing very hard for our retail customers, so presumably they think that's a very important business for them. But I don't really know, nor would I speculate, about what I think they'll do going forward.
USB: What about Bank of New York?
McGuinn: Prior to this transaction, because we both had significant corporate banking and retail banking businesses, the comparison with Bank of New York was understandable. But after the Citizens transaction, I think the comparisons with State Street and Northern Trust are much more appropriate.
USB: Last year, when I interviewed Tom Renyi, Bank of New York's CEO, he stressed that an important part of what Bank of New York does centers on its commercial banking business. Would you say that's true here also?
McGuinn: Clearly, corporations and institutions are more than half of our business, and now will probably be even a larger percentage. And we are very focused on building relationships. So if you're talking about lending to corporations, that is still a core business for us and will continue to be, but we want to lend as part of a broader relationship.
Many of our competitors for large corporate business are out selling investment banking services, which are much more transactional in nature, or capital market types of products and services. Mellon, in contrast, is aligned very well to serve large corporations and institutions because our products and services are much more relationship-oriented such as pension management, custody, cash managementand they're all very performance-measurable.
The relationships we build really fit the products and services we sell, and we think help us compete against these much larger companies which are really leading frequently with credit.
USB: So, Mellon doesn't want to be in investment banking?
McGuinn: We are definitely not trying to be an investment bank.
USB: What are your strengths versus State Street and Northern Trust?
McGuinn: Our strengths are that we have more diversification in our mix of businesses. For example, in terms of trust fees to total revenues, we are the largest in the country. If you look at our growth rate and our return rates, we compare very favorablyin some instances, are even better.
USB: I understand Northern Trust has been particularly successful in private banking and has been growing that business more quickly than yours.
McGuinn: Northern Trust has a very strong private bank. Private banking has been one of our strengths. That's why we kept the private bank. It will be combined with our private asset management, our private client services area. With that focus, we'll be able to accelerate the growth of that business.
USB: How do you define private banking?
McGuinn: We define private banking as serving individuals who have a million dollars or more of investable assets, and/or who would contribute $250,000 or more in terms of business with us, whether it be borrowings, mutual funds, asset management, deposits...
USB: $250,000you don't mean $250,000 in Dreyfus?
McGuinn: Yes, it could be that, sure.
USB: That's not very much.
McGuinn: We have a structure where we can serve them very wellthrough mutual funds or whatever.
USB: But then how do you distinguish yourself from Citizens?
McGuinn: Citizens will be dealing with the mass market. I don't know what their minimum deposit levels will be, but I'm sure they'll be below $250,000. They'll also have a distribution system that's aimed much more at the mass market, which we will not. So, in fact, we'll be more like Northern Trust. We've kept 19 locations in our more affluent areas.
USB: Changing subjects, how quickly do you think you'll be able to reinvest your capital to end the dilution?
McGuinn: We'll be investing it as fast as we can. We had meetings with two investment bankers yesterday, and one the day before.
USB: They must love it.
McGuinn: Oh, sure, they all are looking at our sale proceeds. Of course, we won't have them till November or so.
USB: Have you seen anything that might fit the bill? Anything really big?
McGuinn: Oh, yes, there are several possibilities, some of which are large, that are very attractive. But the question becomes: can you find the right cultural fit, the right price and so forth.
USB: Can you be more specific about what you want?
McGuinn: In domestic asset management, we don't have a hole. We would like to continue to add on to what we have, especially in getting quality asset managersand especially to expand our distribution. Asset management is only part of what we're looking at. We're looking at processing as well. I don't want to name any specific companies.
USB: Do you think manufacturing and distribution go together in the asset management world?
McGuinn: Not necessarily. We have very strong manufacturing capability; we also have good distribution capability. But distribution is an area where we would particularly like to expand.
USB: When I interviewed Tom Renyi of Bank of New York, he played down his mutual fund business, saying he doesn't want to compete with his customers.
McGuinn: Well, I don't ... we have ...
USB: Don't be too diplomatic.
McGuinn: We have one of the largest capabilities in asset management in the world, and in mutual funds, so our situation is very different from others who don't have that.
USB: Do you find that having your own vast mutual fund business hurts you at all in doing business for other mutual fund companies?
McGuinn: Not at all. In fact, we're finding more and more that some of our biggest customers are also our biggest competitors. We've just won the outsourcing business for Trust Company of the West, one of the biggest asset managers in the country. I mention that only because it's been made public. So we compete in a way, but we are going to be their back office. I could go on and on with examples of where we compete with people but we do their custody or their cash management business.
USB: With the huge amount of disposable capital you'll have, why did you find it necessary to cut the dividend?
McGuinn: Yes, we do have a significant amount of capital, but we're also giving up a fair amount of earnings here. And we want to be able to make more acquisitions, so that capital is very important to us.
Mellon's payout rate was relatively high. If you look at Mellon more as a trust company and more as a growth company, then you have to look at our payout ratio compared to that category of companies. In that respect, it really was appropriate to cut our dividend level because that's what brings us into a growth company category and a trust company category.
USB: And what was shareholder reaction?
McGuinn: There are some shareholdersand certain mutual fundsthat are very much aimed at investing in companies with high dividend levels. We expect, without knowing for sure, that some of those investors will move out of our stock. But we also think that other investors who are looking for growth companies will be moving in.
Frankly, one of our dilemmas in the pastand I think it's why we had that valuation gapis we have been seen as a bit in between. We weren't a regional bank, but maybe we weren't a growth company or trust company. What the divestiture does, and the dividend is part of it, is reposition us as a growth company. So we think we'll have a different shareholder base.
USB: Were you at all surprised about the initial reaction on the stock market?
McGuinn: I was disappointed. But the day before, Bank of New York had made an announcement with their earnings report, saying they expected their growth to slow. That was not well-received, and might have rubbed off on us, as well as on all other trust companies and processors. Also our financials are somewhat complex at the moment because we have continuing operations and discontinued operations, and I think that clouded the picture.
But I think as our shareholder base readjusts, as our story is better understood, and as we continue to implement and show the terrific momentum we have in our core businesses, then I think the market will understand that and our price will reflect it.
USB: My final question is: are you still a bank?
McGuinn: Yes, we are a bank, in part. There is a Mellon Bank, and we'll be dealing with a very important customer base through our private bank. We will be lending money to corporate relationships. We will have a cash management business, so we're a very important part of the payments system. We have a trust and custody business, again, which ties to being a bank.
In a way, we're really returning to our roots of 130 years agowe are more of a private bank for affluent individuals, but also a very important bank for corporations and institutions. So, we're building on what has made Mellon very unique in the past.
