Alexandria, VA (July 29, 1998) --OK, we've narrowed it down to two companies, Mellon Bank (NYSE: MEL) and Norwest (NYSE: NOB). Today we'll take a look at Mellon and tomorrow, Norwest, and then Jeff and I will make a decision.
Though I picked up the coverage sort of late, I've sort of fallen for Mellon. The company's great strategy of buying money managers before the crowd started picking up that strategy has resulted in a relatively unleveraged, high asset turnover and margin sort of company. ROA of 1.95% and cash ROA of 2%+ are the result of good asset turnover without sacrificing margins. With ROA that high, a company can run a way below average leverage ratio to get ROE into the mid-20% range. In other words, these are the things we like to see in a company. On a completely cash basis (which I don't fully subscribe to because it doesn't fully reflect all the equity invested in a business), the company's ROE is above 40% and last quarter reached nearly 50%. That's big.
Further, Mellon is developing its mortgage loan stores. This allows the company to produce anything from plain vanilla Fannie Mae-conforming mortgages to "B" and "C" credit mortgages that carry interest rates above 12%. By originating the mortgage itself, its costs are lower and it can bring new customers to other Mellon services. Further, the company is a benefits consultant and is a huge trust and custody services company with around $1.5 trillion in assets under custody.
While some people will have a problem with the price/book ratio we will pay initially, that's their problem, frankly. The company generates excess capital with annuity lines of business and has a noninterest income-to-revenues ratio of 65%, which is extremely high and desirable. The businesses on which a company generates noninterest income are usually less capital intensive than lending and thus add more value to the capital to the capital in use by the company. Noninterest income-to-revenues ratios for companies in my database are (not every data point is current, but this gives you a general idea):
Merrill Lynch (NYSE: MER)....95.7%
Charles Schwab (NYSE: SCH).....83.9
American Express (NYSE: AXP).....76.7
J.P. Morgan (NYSE: JPM).....74.1
State Street Corp. (NYSE: STT).....70
Mellon Bank (NYSE: MEL).....65.3
Bank of New York (NYSE: BK).....57.3%
Chase Manhattan (NYSE: CMB).....52.
Citicorp (NYSE: CCI).....48.1
Fleet Financial (NYSE: FLT).....43.9%
NationsBank/BankAmerica (NYSE: NB).....43.3%
BankBoston (NYSE: BKB).....43
Norwest / Wells Fargo (NYSE: NOB).....40.4%
US Bancorp (NYSE: USB).....37.5
First Union (NYSE: FTU).....36.2
SunTrust (NYSE: STI).....34.1
KeyCorp (NYSE: KEY).....30.6
The companies at the top of the list are all heavily involved in the securities business. While that is true for Amex, it doesn't explain all of the company's noninterest income/revenues ratio, though. In any case, this is the sort of thing that we like to see in a company.
Mellon recently announced the acqusition of a UK-based asset management company named Newton Management Limited. That company has about $20.4 billion in assets under management and will give Mellon's Dreyfus and Founders funds another overseas distribution platform. In addition, the transaction valued Newton at 1.36% of assets under management, which is very reasonable in this industry.
On loan loss reserves, the company's reserves to nonperforming loans ratio is in-line with the industry average. As for months net charge-offs in loan loss reserves, the company is slightly below the industry average of 39.3 months. That average is very high right now as both parts of net charge offs (charge offs and recoveries) have been very favorable to the banks.
If anyone missed the numbers on the company, I included them in the column on the 22nd.