Mellon Finished
Dale wraps up an epic study!
by Dale Wettlaufer (DaleW@fool.com)


ALEXANDRIA, VA (Sept. 14, 1998) --Mellon Corp. (NYSE: MEL), come on down, you're the next contestant on "The DRIP is Right!"

That's what we're playing for here (the right price), though this isn't a game. This could mean the difference between our kids going to college or living under a bridge. It could mean the difference between our living well in retirement or living in a van down by the river. Well, maybe that's putting too much pressure on Mellon right now. We don't want to give it performance anxiety before we've even made a commitment. But we do like Mellon enough to contemplate a commitment very seriously.

Even more so than rival finalist Norwest (NYSE: NOB)/Wells Fargo (NYSE: WFC), Mellon is a diversified, profitable company. First, let's look at diversity of its business lines. From the third quarter 10-Q, versus $371 million in net interest income, the company reported $712 million in noninterest income:

 
 Fee revenue (in millions): 
 Trust and investment revenue: 
    Investment management:   
      Mutual fund................$120 
      Private asset................54 
      Institutional asset..........53     
 ------------------------------------     
        Total investment management 
          revenue.................227     
    Administration/custody/consulting: 
      Mutual fund..................34     
      Private asset.................5     
      Institutional trust..........98     
      Benefits consulting..........54     
 ------------------------------------     
        Total administration/custody/ 
         consulting revenue.......191  
 ------------------------------------ 
        Total trust and investment 
          fee revenue.............418 
 Cash management and deposit    
   transaction charges.............65 
 Mortgage servicing fees...........53 
 Foreign currency and securities   
   trading revenue.................38 
 Credit card fees..................23 
 Other............................115 
 ------------------------------------     
        Total fee revenue......$712

This is a very granular revenue base that is derived, in part, by an increasing asset base from equity mutual funds. While Dreyfus is known as a large fixed income money manager, Mellon has set about diversifying its money management business, adding small fund groups to the fold along the way. This spring, the company acquired Founders Asset Management, with $7 billion in mainly equity mutual funds. In July, the company announced an agreement to acquire 75% of Newton Management Ltd., a U.K.-based investment manager with $20 billion in assets under management. The company will probably get a lot more bang for its buck here, because the price was in all likelihood lower than what U.S.-based asset managers are going for right now, and the intrinsic growth rate of qualified investment plan participation in the U.K. over the next ten years will probably be higher in the U.K. than in the U.S.

Since last year, assets under management have grown at a 22% rate, some of which comes from market appreciation, some from net inflows of cash from clients, and some from acquisition (AOL users, please maximize window for viewing):

 
                       Q298   Q198   Q497  Q397  Q297     
 Total market value of assets     
 under management.....$350....$328....$305..$299...$286     
      
      
Revenues are also derived from Mellon's custody and administration business that takes care of nearly $1.8 trillion in assets, up from $1.5 trillion at the beginning of the year. In addition to asset management, the company has other diverse noninterest income business lines, which we looked at earlier this year. These include its benefits consulting company, Buck Consultants, and newer acquisitions, such as insurance agency Clair Odell Group in Flourtown, Pennsylvania.

As for lending, the company's business here is spread out among retail and commercial lending lines. In addition to numerous specialty lending lines, such as its insurance premiums finance line, the company does a number of things from plain vanilla to more specialized. For instance, the company has a larger exposure to jumbo mortgages, which are larger mortgages for private residences. These are occasionally more risky than conforming mortgage exposure, because the risk is more concentrated and the market for the collateral can slip very quickly, but in general, these are lower loan-to-value mortgages that have enough personal collateral and real estate equity behind them. The company's loan portfolio as of last quarter looks like this:

 
                                JUNE 30,     
 (in millions)                    1998     
 DOMESTIC LOANS     
    Commercial and financial.....$11,283 
    Commercial real estate.........2,134 
    Consumer credit:     
      Consumer mortgage............8,506 
      Credit card....................830 
      Other consumer credit........3,582   
 ---------------------------------------- 
          Total consumer credit...12,918     
    Lease finance assets...........2,570     
 ---------------------------------------- 
          Total domestic loans....28,905     
 INTERNATIONAL LOANS...............1,749     
 ---------------------------------------- 
     Total loans,      
     net of unearned discount....$30,654     
 -----------------------------------------

The portfolio is well-diversified in terms of credit risk, maturities, and yields. As for geographic risk, that's tough to get your hands around from the company's federal filings. On loan credit loss reserves, the company's 35.6 months of net charge-offs in reserves is right where the industry is while its nonperforming assets-to-total assets ratio is about half that of its peers. With 1.62% of gross loans in credit loss reserves, the company is also within the bounds of its peers that don't specialize in credit cards.

As for profitability, the company turns its assets quickly, at almost a 10% clip per year. This is excellent for the banking business and shows the lighter business model of Mellon. Combined with a net margin before goodwill amortization of 21.1%, the company's ROA of 2.03% is super-attractive. Admittedly, the company is leveraged on a tangible assets to tangible equity ratio, but a big part of that is due to acquisitions of companies that are not asset-intensive. You simply do not need that much tangible equity to support the operations of an asset management company. The company has an ROE2 (earnings before goodwill amortization divided by average shareholders' equity) of nearly 23% and return on tangible common equity is above 40% -- 50% (annualized) last quarter. These are all excellent numbers in the banking industry and point both to a good business model and a well-run company.

Given the company's high profitability, we don't think that Mellon is overvalued even if its valuation is in the higher end of the banking universe. We wouldn't feel uncomfortable starting an investment plan in the company and believe the company's business model gives us both growth and good return on capital. Mellon is becoming less and less a traditional bank and more of a well-rounded financial services company. It has also adopted some of the retail strategies that we like so much about Norwest. In short, while I've told Jeff that I like Norwest and Mellon equally, if pressed, I think I lean towards Mellon.

Here are the company's numbers:

(NYSE: MEL)

 
 Price/Valuation     
      
 Share Price...$57  7/8     
 Market Cap...$15,385.95     
 Price/Book...3.63     
 Price/ Tangible Book...7.40 
 BVPS...$15.93     
 Price/Assets...32.43%     
 Price/Net Loans...51.02%     
 Price/Deposits...46.35%     
 Price/Tangible Assets...33.97% 
 Price/Revenues...3.65     
      
 P/E...19.85     
 Amortization-Adjusted P/E...17.27 
 Discount/Premium to Group...22.1% 
 EPS...$2.92     
 Cash EPS...$3.35     
 Diluted Sharecount...265.85     
 1998 EPS Estimate...$3.24     
 1999 EPS Estimate...$3.63     
 Multiple on 1998 Est....17.86     
 Multiple on 1999 Est....15.94     
 Amort-Adjusted Multiple on 1999...14.23 
 Discount/Premium to Group...15.0% 
      
 Capital Productivity/Efficiency 
      
 Asset Turnover2...9.60%     
 Asset Turnover...9.25%     
 ROE2...22.84%     
 ROE...19.86%     
 Amortization Adjusted ROE...40.04% 
 ROA...1.95%     
 ROA2...2.030%     
 Net margin2...21.13%     
 Net Margi...18.38%     
 Efficiency Ratio...64.92%     
 Interest In...come/AEA...6.94%     
 Interest Expense/AEA...3.00%     
 Net Interest Margin...3.93%     
 Net Share Buybacks (Including preferred)...$305.0 
 Dividends on Common...$347.0     
 Preferred Dividends     
 Retention Rate...61.06%     
 Payout Ratio on Amort. Adjusted Earnings...38.94% 
 Internal Capital Generation Rate...24.45%  
 Owners' Yield...4.24%  
 Insider %...0.99%  
      
 Balance Sheet  
      
 Cash & Nonearning Assets...$5,708.0 
 Cash & Nonearning Last Year...$5,225.0 
 Long Term Debt...$3,994.0     
 Shareholder's Equity...$4,234.0 
 Last Year Equity...$3,570.0     
 Tangible Equity...$2,078.0   
 Last Year Tangible Equity...$2,373.0 
 Tangible Assets...$45,292.0     
 Last Year Tangible Assets...$42,515.00 
 Total Assets...$47,448.0     
 Earning Assets...$41,740.0     
 Last Year Earning Assets...$38,487.0 
 Last Year Assets...$43,712.0     
 Total Liabilities...$42,223.0   
 Goodwill...$2,156.0     
 Last Year's Goodwill...$1,197.0  
 Gross Loans...$30,654.0     
 Loan Loss Reserves...$498.00     
 Loan Loss Reserves %...1.62%     
      
 Leverage     
      
 Equity/Tangible Assets...9.35%  
 Average Equity/Average Assets...8.56%  
 Average Equity/Average Assets (Tangible)...5.07% 
 Assets/Equity...11.68     
 Avg. Assets/Avg. Equity (Tangible)...19.73 
 Loans to Deposits...92.34%     
 LT Debt/Equity...94.33%     
 Leveraged Capital Ratio...6.70%     
 Tier 1 Capital Ratio...6.50%     
 Total Risk Based Capital Ratio...10.80% 
      
 Income Statement     
      
 Revenues...$4,216.00     
 Interest Income (TTM)...$2,782.0 
 Interest Expense (TTM)...$1,319.0  
 Net Interest Income...$1,463.0   
 Provision for Loan Losses...$128.00 
 Noninterest Income (TTM)...$2,753.00 
 Noninterest Expense (TTM)...$2,853.00 
 Net Income for Common (TTM)...$775.05 
 Amortization Adjusted Earnings...$891.05 
 Noninterest income/interest income...99.0% 
 Noninterest income/revenues...65.30%     
 Noninterest income/NII...188.17%     
 Amort. Adjusted Net/Revs....21.13%     
 Amortization of Goodwill...$116.00      
      
 Credit Quality     
      
 Nonperforming Loans...$107.00     
 Nonperforming Assets...$170.0     
 Loan Loss Provision/Net Interest Income...8.75% 
 Loan Loss Provision/Gross Loans...0.42%     
 Net Charge Offs...$168.00     
 Nonperforming Assets Ratio...0.55%     
 Reserves/Nonperforming Loans...465.42%     
 Months Net Charge-Offs in Reserves35.6     
 Months Charge-Offs in Reserves...32.0     
 Loan Loss Provision/Net Charge Offs...76.19%     
      
 Deposits     
      
 Deposits...$33,197.0     
 Noninterest bearing deposits...$8,880     
 Noninterest bearing deposits last year...$$9,483 
 Noninterest deposits/deposits...26.75%     
 Deposits/Liabilities78.62%     
 Core Deposit Percentage NA     
 Non Jumbo/Jumbo CDs...2.4 
     

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9/14 Close

Stock Close Change CPB $51 11/16 +1 1/4 INTC $85 13/16 + 7/8 JNJ $79 +2 5/8
Day Month Year History Drip 1.76% 12.59% 12.93% (3.83%) S&P 500 2.05% 7.54% 6.11% 8.24% Nasdaq 1.47% 11.11% 6.08% 4.51% Last Rec'd Total # Security In At Current 09/02/98 8.027 CPB $52.867 $51.688 07/01/98 9.724 INTC $80.239 $85.813 08/07/98 6.543 JNJ $70.138 $79.000 Last Rec'd Total # Security In At Value Change 09/02/98 8.027 CPB $424.36 $414.90 ($9.46) 07/01/98 9.724 INTC $780.21 $834.40 $54.19 08/07/98 6.543 JNJ $458.92 $516.90 $57.98 Base: $1900.00 Cash: $186.05** Total: $1952.24

The Drip Portfolio has been divided into 81.201 shares with an average purchase price of $23.399 per share.

The portfolio began with $500 on July 28, 1997, adds $100 on the 1st of every month, and the goal is to have $150,000 in stock by August of the year 2017.

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