| |
Lost on lousy lending in the 1970s and 1980s. Found in managing money in the 1990s.
Now named Mellon Financial Corp., the venerable Pittsburgh institution has capped a decade-long transformation. It agreed this month to cast off its neighborhood bank branches to solely explore more exotic pockets of business in mutual funds, big trust accounts and financial record keeping.
Mellon announced the sale of its 345 branches here and across the mid-Atlantic region on July 17 for $2.1 billion to Citizens Financial Group, the U.S. unit of The Royal Bank of Scotland, Great Britain's second-largest bank. The deal is supposed to close by year-end.
Whether Mellon grows greener on its new turf remains to unfold.
'I can't think of another such large bank being sold off like this,' said Bert Ely, of Ely & Co. Inc., an Alexandria, Va.-based bank consultancy.
But how Mellon's bank-separation plan unfolded began with hard knocks and hard choices. The seeds of change at Mellon were planted in the 1970s - along with the bank's near-collapse.
The oil industry had been fertile lending ground for Mellon in decades past. Andrew Mellon marched Mellon loans into east Texas around 1902 and helped develop America's biggest gusher. The so-called 'Spindletop' oil field produced crude oil by the lake-full - and a world giant named Gulf Oil based in Pittsburgh.
A pair of oil shocks in the 1970s drove crude prices and industry profits through the roof. Petroleum and finance exec's figured they could produce oil and sell it for $50 or more per barrel in years to come. And Mellon money was backing plenty of rigs punching holes in the ground and on the ocean floor.
The bank during this time also loaned heavily into real estate ventures - many fed by oil riches - in Texas, Louisiana, Colorado and elsewhere.
The 1980s, however, were a different story. What nobody foresaw was a sharp drop in energy consumption, exacerbated by a nasty U.S. recession. Crude oil that had been selling for about $35 a barrel around 1980 dropped in less than two years to $12. A weakened Gulf Oil succumbed to a takeover from Chevron Corp. in 1984.
As a result, Mellon's loan portfolio blew up like a fire storm at the wellhead. And oil and gas loans weren't the only ones going south at Mellon.
| See This Related Graphic |
| Mellon's modern era (101K) A history of Mellon Bank from 1972 to present. |
Mellon had cast its eye abroad around 1965, when it established an international lending department. The idea was to run with the big dogs, such as J.P. Morgan, First Chicago, and Security Pacific.
During the 1970s, Mellon was doing just that. It floated major-league loans to governments in Latin America and the Pacific Rim, and even chartered its own bank in Frankfurt, Germany.
But those loans began to rot in the 1980s, in the wake of foreign currency crises and the sea change in energy markets. Some career bankers inside Mellon even had a running joke in those days:
'What's hurting us are the MBAs: Mexico, Brazil and Argentina,' recalled one former senior executive.
With visions of becoming a money-center bank starting to go haywire, Mellon de-emphasized lending to big corporations and foreign governments.
Instead, Mellon would grow the consumer bank. Executives lobbied the state legislature for an intra-state banking law, passed by lawmakers in 1982, which enabled banks to buy each other in contiguous counties.
Mellon - as well as PNC Financial Corp., as it was known - went shopping in Philadelphia. The first bank on Mellon's spree was the nearly 150-year-old Philadelphia institution, Girard Bank, which also had branches in Delaware.
'Philadelphia represented a good big market, and there were subsequent acquisitions that positioned Mellon throughout the rest of state,' said David Martin, a former Mellon executive who is now managing director of Sandler O'Neill & Partners' office in Coraopolis.
But the Girard purchase also proved to be Mellon's most infamous misstep. It immediately and cavalierly removed all Girard signs and replaced them with Mellon's own - causing lots of ill will in Philadelphia.
'That was one of the most disastrous mergers in banking history,' said Richard Stover, who was Mellon's senior credit officer for international lending at the time.
'I'm told there are business schools that still use Girard as a case study,' said Stover, now managing principal at Birchmere Capital, a venture capital firm based in Wexford.
That same year, Mellon acquired CCB Bancorp of State College to expand in the center of state. In 1984, Mellon expanded into Pennsylvania's northwest corner by acquiring Northwest Bank of Erie. Other in-state bank buys followed.
BOMBSHELL OF 1987
At the same time, Mellon's problem loans were still festering on several fronts. Foreign governments were going bankrupt, along with steel companies, and the oil industry was still in the tank. Ditto for commercial real estate in the boom-bust U.S. Southwest.
'Mellon was in a lot of trouble by '83-84, with the oil loans in a lot of difficulty, plus the third-world problems,' said Stover.
'None of which were enough to bring the company down,' he said. 'But in hindsight, they kind of foretold what the future might hold.'
| 'I would not have come to Mellon if I was going to sell it. That was my understanding ... with the board.' |
In April 1987 came the fallout: A $60 million loss for the first quarter - the first such loss in the institution's then 118-year history. And, despite management's assurances of a year in the black, the tide of red ink was just beginning.
What's more, the bank's board slashed the dividend in half, to 35 cents, to conserve cash.
Days later, Mellon directors met in special session and told Chairman J. David Barnes, a native of Oil City, to resign. He had been CEO since 1981 of what had once been dubbed the 'Mercedes Benz' of financial institutions.
The board installed fellow director Nathan Pearson as interim chairman and named a search committee to find a permanent replacement. The April 12 meeting took only 45 minutes.
By June 1987, the board found their next chairman and CEO: Frank Vondell Cahouet, president of Fannie Mae and former chairman of Crocker National Bank, San Francisco. When Cahouet arrived on June 22, 1987, he sensed - but did not really know - the depth of the problem.
'I took what everybody told me and multiplied by two or three,' Cahouet told the Tribune-Review in late 1998.
Meanwhile, Mellon stock in 1987 sunk as low as $8 a share, versus $70 only two years before.
BITTER PILLS
For help, Cahouet called upon a Crocker colleague, W. Keith Smith. He had been the San Francisco bank's chief financial officer and sat across the hall from Cahouet there. Dick Daniel, another Crocker alum, had already arrived at Mellon when Cahouet came aboard. Both Smith and Daniel became vice chairmen.
Some local observers were suspicious of the new management team, the first to come from outside Mellon's ranks. Doubters derided Cahouet and company as 'the Crocker crowd.' But supporters and detractors alike knew hard choices were ahead.
It's no coincidence that upon taking over, Cahouet immediately closed eight of Mellon's 12 foreign loan offices.
Another tough call was the elimination of some 2,800 Mellon jobs, or almost 15 percent of its work force. The ax included about 1,000 around Pittsburgh in Cahouet's first six months - but it also cut annual expenses by about $150 million.
Mellon hit bottom at the end of 1987 when it recorded a staggering record loss of $844 million. The bank's plight was labeled by a Fortune magazine article as 'Melloncholia,' after the word for a depressed state.
Meanwhile, Cahouet and company were spending dawn-to-nightfall days on a three-pronged strategy:
The 'good bank/bad bank' tactic was a concept Cahouet created to help turn around his former employer, Crocker. Namely, remove the earnings drag from Mellon and work off the bad loans in one place. That place was called 'Grant Street National Bank, a bank in liquidation.'
'We knew we had a tiger by the tail,' Smith told this newspaper in late 1998. He was 'the numbers guy' behind Grant Street National, having devised a similar, but smaller, workout plan with Cahouet at Crocker years before.
The local institution was capitalized first with $500 million in bonds sold by Drexel Burnham Lambert's junk-bond king, Michael Milken. Then, Mellon engaged E.M. Warburg Pincus & Co. to buy $128 million in Mellon convertible preferred stock to provide a confidence-building injection of needed capital.
Daniel was in charge of wringing as much out of the problem loans as possible. The otherwise affable executive, Daniel used to joke that an urn sitting atop his desk contained the ashes of dead-beat borrowers.
Warburg Pincus later converted its shares and remains Mellon's largest single holder today. Then, with its mission completed, Grant Street National distributed its last loan proceeds to bond holders and liquidated in July 1995.
'What should never be lost is the capitalization by Warburg Pincus. That was absolutely critical,' said Stover. 'Grant Street has been copied since then, but never really successfully.'
GROWING DIFFERENT
By 1989, Mellon was posting annual profits again. (Please see related graphic.) And more strategic changes were afoot - innovative, as well as gargantuan.
Mellon became one of the industry's first banks to enter supermarket branching when it opened one in 1990. Vice Chairman Dick Gaugh cut an exclusive agreement with Giant Eagle that eventually grew into about 100 store branches.
Boston native Cahouet's boldest move came two years later. He and Smith recognized the profit potential in the investment management and trust businesses. Cahouet announced the $1.45 billion purchase of The Boston Co., a major player in trust and money management.
The 1992 deal raised plenty of industry eyebrows, as well as the currency for Cahouet's next blockbuster, said Smith. Mellon agreed to acquire mutual fund giant Dreyfus Corp. a year later for $1.85 billion, an industry record.
The Dreyfus deal led some newspapers, including The New York Times, to nickname the Pittsburgh institution 'J.P. Mellon.' Mellon's new look - and profit stream - soon became the envy of the industry.
The tandem acquisitions produced substantial fee income for Mellon. They counter-balanced the down cycles in lending and far exceeded the returns Mellon got or would get from traditional bank business. (Please see earnings graph.)
But in early 1998, Mellon's diversified profile also produced an unwanted takeover offer. One day after Mellon's April 21, 1998, shareholders meeting, The Bank of New York unveiled a $26.9 billion bear hug.
Cahouet and his newly designated successor, Vice Chairman Martin McGuinn, immediately and firmly refused the offer. About a month later, BoNY backed off.
'I would not have come to Mellon if I was going to sell it,' said Cahouet later that year. 'That was my understanding I had at the time with the board.'
WHAT GOES AROUND ...
Ironically, Bank of New York had indicated that if it acquired Mellon, it would have divested the retail bank. Three years and three months later, that's just what Mellon management is doing.
Another irony is that Mellon, the retail bank, is being sold by its former leader, McGuinn. He was the retail bank's chief executive officer from 1993 until becoming chairman of the entire corporation in January 1999.
But by that point, the writing was already on the bank-vault wall. Mere days after ascending to chairman, McGuinn began dismantling and selling off segments of the bank. The divestitures included:
'Mellon Bank continues to be our principal subsidiary,' said McGuinn in an interview in September 1999. But in the next breath, the chairman noted Mellon's continued success 'depends in significant measure on investing in and building our high-growth, high-return businesses.'
Another sign-post that same month: Mellon dropped from its corporate tag the line, '... with a bank at its core.' It substituted: '... a global financial services company.'
Earlier this year, lease financing was sold to GE Capital and asset-based lending went to ABN AMRO N.A.
After divestitures of the past three years, left of Mellon Bank were its neighborhood branches, plus small-business lending. And rumors began swirling in late June that Mellon might sell those remaining bank pieces, too.
The legal wheels had been in motion since early spring. Attorney Thomas Todd of Reed Smith, Mellon's law firm, had been shuttling from Pittsburgh to Scotland for more than three months leading up to the seismic announcement on July 17, said one Citizens executive.
When Mellon sold its asset-based lending in May, McGuinn defended the move by noting: 'Markets change and your competition changes.'
When fellow economists lambasted John Maynard Keynes in the 1930s for shifting theories in reaction to the Depression, the British economist replied: 'When circumstances change, I change my mind. What do you do?'
