The Drip Portfolio
In past Drip Port columns, we outlined the most important factors that we consider in each of Mellon's quarterly reports. We'll harvest those numbers again, for quarter three of 1999.
With Mellon, we're most interested in results regarding noninterest revenue, also called fee revenue. This number accounts for revenue dollars coming from the high-returning trust, investment management, and administration and custody businesses at Mellon. These results are increasingly important as Mellon refocuses its business and sheds some interest-bearing assets such as its credit card line.
Mellon has high noninterest revenue as a percentage of total sales compared to other "banks," reminding us that Mellon is a financial services and financial management organization first and foremost. We like this. A high percentage of noninterest revenue helps raise Mellon's return on tangible assets (ROA) to a higher level than your average banking organization.
Excluding the effect of acquisitions and divestitures, third quarter fee revenue increased 9% compared with the same quarter of 1998, primarily due to a 12% increase in trust and investment fee revenue. Mellon's second quarter fee revenue was $787 million, up 10.5% from a year prior, so this quarter's gain of 9% was considerably less on a percentage basis. This is apparently due to lower securities lending revenue, lower brokerage fees, and lower foreign currency and securities trading revenue. Some of this may relate to July and August being slower months for investment activities. Either way, for the trailing nine-month period, almost all of Mellon's fee revenue figures have grown impressively, so Mellon's fee-based revenue business lines appear to be on track.
The less important net interest revenue figure at Mellon was $352 million in quarter three, down $24 million from last year and down $11 million from the second quarter of this year. The decline is primarily due to the sale of Mellon's credit card business.
The 9% net gain in Mellon's fee revenue may not merit a celebratory dinner tonight with your significant other at the most expensive restaurant in town, but when you consider how small Mellon's coinciding expense increase was, you might at least regain a hearty appetite for the business.
Excluding the effect of acquisitions, divestitures, and nonrecurring expenses, operating expenses at Mellon were unchanged compared with the third quarter of 1998 and decreased 2% compared with the second quarter of 1999. Mellon kept operating costs down as it grew its earnings per share (EPS) by double-digits this quarter. This is a reflection of the company's focus on expense management. Well done.
Profits and Profitability
Low costs helped Mellon achieve operating earnings per share growth, before goodwill amortization, of 12% over last year, with EPS chiming in at $0.46. Meanwhile, return on annualized equity (ROE) was 43.7% -- record strong and well above the 40% level that we desire.
That all-important number, return on tangible assets, was 2.25% excluding a one-time net loss from divestitures. Last year this quarter, this return on assets measure amounted to only 2.13%, while it was only 2.05% the prior year. ROA (return on assets) is more meaningful than ROE (return on equity) with a financial management company such as Mellon, so this steady and significant increase in ROA is encouraging.
In case you want to quiz your friends, Spanky the Wonder Pooch reminded us how ROA is determined: Return on assets equals asset turnover multiplied by net margin. Asset turnover is represented by total revenues divided by total tangible assets. See How to Value Stocks for much more. Woof.
There are two more numbers that we especially care about: Mellon's credit quality expense was $5 million this quarter, compared to $12 million last year and $5 million in quarter two. The favorable lower expense resulted from a lower provision for credit losses following the sale of the credit card business, as well as higher net revenue from acquired property.
Finally, nonperforming assets at Mellon totaled $169 million on September 30, 1999, compared with $142 million on June 30, 1999, $161 million on March 31, 1999, and $140 million on September 30, 1998. The ratio of nonperforming assets to total loans and net acquired property at Mellon was 0.58% on September 30, 1999, compared to 0.46%, 0.53%, and 0.45% in each time period, respectively, that was just described in the preceding sentence. We'll keep an eye on the 0.58% number, hoping for a downtick. The 0.45% results of one year ago were a record low for Mellon -- we liked that.
Wrap It Up, We'll Take It
In its third quarter of 1998, Mellon grew tangible EPS 16%. In comparison, this year's 12% gain is less inspiring, but it is still admirable. If Mellon can manage its business to consistently crank out comparable results, on average, over the years, we'll be cookin' with oil.
Mellon stock (at $32 3/4) trades at 17.9 times consensus 1999 EPS estimates, and at 16.0 times year 2000 estimates. It yields 2.4%.
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