A New Course for Mellon

Turning a company’s strategic direction on a dime is never easy. For an institution with as venerable a reputation as the old Mellon Bank, the task has tested the board’s ability to quickly digest a new management-driven modus operandi.

In its previous life as a corporate lender, the Pittsburgh-based company bankrolled the development of America’s steel industry and played a hand in the founding of such Rust Belt icons as Alcoa and Westinghouse. Today, Mellon Financial, as the company is now called, is no longer much of a bank. Its credit card, mortgage, and retail banking businesses are gone, while its $8 billion loan portfolio would hardly qualify it as a mid-tier player in the industry.

But Mellon is no less of a powerhouse, having bought its way into being a top-10 global player in businesses such as private banking, cash management, shareholder services, and human resources consulting and No. 11 in asset management. Its highest-profile business? Probably Dreyfus, the big mutual fund company.

Is the transformation paying off? It’s debatable. Earnings slid in 2002 to $682 million, or $1.55 per share, down sharply from the $1.32 billion reported in 2001. Moving into asset management at a time of declining equity values definitely hurt. Yet, return on equity was 19.9% and fee income jumped 32% for the year, reflecting a vision of a leaner company capable of producing more stable revenues.

Shareholders may not yet be convinced that Chairman and CEO Martin McGuinn, 59, is on the right course. Mellon’s stock has dropped 40% over the past year, and was recently trading at $21. Even with the lower earnings, the P/E ratio of 13 is significantly less than the 16 times earnings fetched by shares of key rival Northern Trust Corp. But you won’t find any doubters on the 15-person board, a sophisticated and conservative bunch that includes a number of longtime directors, among them 30-year board veteran Seward Prosser Mellon, 60, a scion of the founding family and CEO of the investment firm Richard K. Mellon & Sons.

Even before McGuinn officially moved to the top job in 1999 from his position as Mellon’s vice chairman, he recognized that remaking the company depended on getting his board to embrace and support some controversial moves, most notably the 2001 sale of Mellon’s flagship retail bank, which raised the ire of Pittsburgh localsu00e2u20ac”and put some directors on the hot seat. “I didn’t want them reacting,” he says. “I needed them to be very involved from the start.”

To make this happen, McGuinn launched his version of a director education program that continues today. The schooling includes off-site strategic retreats with big-name speakers, top managers who are always available to answer questions over the phone, and a nonstop flowu00e2u20ac”make that a torrentu00e2u20ac”of information. Directors get regular packets of financial data and reports on how the bank is doing, along with assorted press clippings, analyst reports, and internal memos, all culled by staff, but previewed and reviewed by McGuinn. The material is e-mailed to directors two or three times a month. Hard copies, sent by snail mail, quickly follow. “I want them to understand what our competitors are doing, what customers are asking for, and the trends,” McGuinn says. “In order to be effective, they really have to understand the context we’re operating under.”

To hear various board members tell it, the information flow has helped the board and management think more or less as one. The two groups examine the same issues through the same strategic prism and, during interviews, use the same catch phrases to talk about the makeover. “We have a very strong partnership,” says Wesley von Schack, CEO of Albany, New York-based Energy East Corp. and a Mellon director since 1989. “We don’t necessarily agree on everything, but we’re pretty much on the same page.”

McGuinn’s openness doesn’t hurt. He doesn’t hesitate to let directors know what’s on his mind strategically, contacting them individually or in group e-mails and cutting them in on his communications to employees. “Marty does a very good job of keeping directors informed about what’s on his mind, and what’s going on in the industry,” says Ira Gumberg, CEO of J. J. Gumberg Inc., a Pittsburgh real estate management firm, who is a 14-year veteran of the Mellon board and chairman of its audit committee. “The result is very much a ‘no surprises’ environment.”

McGuinn, a mild-mannered former general counsel, is also ready to call upon individual board members for advice.

Soon after becoming CEO, for example, he wanted to tie more of his executives’ compensation to company performance and telephoned Charles Corry, a retired chairman and CEO of steel maker USX Corp., to see what he thought. Corry, who has since retired from the board, tempered McGuinn’s enthusiasm. It was a good idea, he said, but only up to a point. Basing too much pay on performance could penalize good employees during a broad economic slowdown, and that would hurt morale. Says McGuinn, who toned down his plans accordingly: “Getting that kind of counsel from someone who had lived through different cycles was invaluable in getting the right balance into our incentive comp program.”

Laying the foundation

Mellon’s transformation actually began before McGuinn, a 20-year company veteran, took the reins in 1999. In the mid-1990s, it acquired mutual fund giant Dreyfus and The Boston Co., a large asset management firm. But clients and investors alike were confused by the company’s later efforts to acquire traditional banking rivals CoreStates Financial Corp. and the old BankBoston Corp. By 1998, the board was fending off a hostile takeover attempt by Bank of New York.

McGuinn got the job on a platform of extending “what had already been done to reposition the company.” That, of course, meant getting directors on the same page. As CEO, one of McGuinn’s first moves was to turn what had been primarily a casual golf gathering for directors into a more-intense, annual retreat. For three days each June, directors gather at a Mellon-related siteu00e2u20ac”last year’s meeting was just outside of Pittsburgh; 2001’s at the headquarters of The Boston Co.u00e2u20ac”to deliberate the company’s long-term objectives. “Our strategy is always evolving,” McGuinn says, “and we need to have a dialogue with the board that goes beyond what can be accomplished at a regular, one-day meeting.”

The sessions begin on Sunday afternoons, with golf for those directors who care to partake. an An informal dinneru00e2u20ac”last year, it was a steak roast by the poolu00e2u20ac”kicks off the event. Monday is a full working day, when board members meet with senior executives, investment bankers, and outside attorneys. Among the regulars: Rodgin Cohen, a longtime M&A adviser and the influential chairman of the New York law firm Sullivan & Cromwell.

Last year’s meeting focused heavily on corporate governance. Thomas Todd, another Mellon adviser and a partner with the local law firm Reed Smith, talked about regulatory proposals made by the New York Stock Exchange and Mellon’s own proactive steps toward better governance. The company announced that it would report all insider trades by the second business day of the week following a transactionu00e2u20ac”before such requirements were codified by new law,u00e2u20ac”and later opted to expense stock options.

Monday nights are typically more formal. Last year’s session included a suit-and-tie cocktail reception at Prosser Mellon’s home, followed by dinner at a local country club.

Tuesdays feature a full board meeting and what, for many directors, has become a highlight of the retreatsu00e2u20ac”a high-profile speaker whose assignment is often to help directors think through the strategic issues that Mellon faces.The first year’s featured guest was Cisco Systems CEO John Chambers, who, in the midst of the dot-com boom, discussed “how the Internet had already changed business and how he thought it would continue to,” McGuinn recalls. “We had, frankly, a couple of directors from old-line manufacturing companies who were saying, ‘What’s this e-commerce stuff? Why should we spend shareholder money on that?’” McGuinn says Chambers’ talk played a key role in convincing the board to spend more than $30 million on building a uniform Web architecture across its business lines.

Such epiphanies are common. Other guests have included former IBM CEO Louis Gerstner and AT&T chief Michael Armstrong, and sometimes the subject matter is more theoretical. One CEO speaker, for example, talked about the difficulties of introducing new ideas into existing lines of business. “As he put it, ‘The white cells would surround it and kill it,’” recalls Allan Woods, Mellon’s chief information officer. “Most of the directors sitting around the table were saying, ‘Boy, do I have that issue,’” Woods says. That CEO’s solution: establish independent groups to launch the idea, then co-opt one business line to adopt it.

While the discussions usually carry broad themes, “I always ask them to conclude by talking about what it means to Mellon,” says Woods, who recruits many of the speakers.

When they’re finished, the speaker and his entourageu00e2u20ac”most bring along a handful of corporate lieutenantsu00e2u20ac”scatter among the tables for informal chats with directors over meals and drinks. The speakers “really get you thinking,” von Schack says, adding that, “Invariably, they touch on something that has relevance to my own day job.”

McGuinn’s remaking of Mellon took the form of a dizzying spate of sales, shutdowns, and acquisitions. Almost immediately after taking over, McGuinn dumped Mellon’s credit card, mortgage, and ATM-processing operations, among others. He followed those moves by acquiring several regional asset managers; bolstering Mellon’s human resources consulting subsidiary, Buck Consultants; and taking full control of a shareholder services’ joint venture.

The board has been involved in every move. Before signing off on a deal, directors push management about the strategic fit and conduct a “very rigorous financial analysis” of the proposed transaction, says von Schack. Directors are particularly concerned about culture and the acquiree’s management team. “We want to know they’ll fit in and that they’re committed to helping us grow the business,” von Schack adds. Sometimes, directors lend a hand by talking with directors of prospective acquirees, “just to make sure everyone is comfortable with the fit,” McGuinn says.

Directors say there are rarely serious disagreements about specific deals. “We’ve already discussed the strategy so much that when specific opportunities come along, everyone understands how they fit,” McGuinn says.

The $2 billion sale of the retail banking franchise to Citizens Financial Group, a U.S. subsidiary of the Royal Bank of Scotland, was probably the biggest test of directors’ faith in McGuinn. But again, some aggressive education helped shape the board’s thinking. When he took the job, McGuinn broke down the Mellon empire into two simple groups: units that could increase earnings-per-share by 14% annually and generate returns on equity of 22%, and those that couldn’t. He’d keep the first group and unload the second, he said, creating a somewhat smaller company that was capable of faster growth.

While wealth-management and technology-based outsourcing services made the cut, it was clear from the numbers that the retail bank, which provided nearly 25% of earnings but was growing at just 4% a year, would be a goner. “We realized over time that the retail bank was a no-growth area for us,” von Schack says.

Even so, the final decision didn’t come easily. Mellon has been a Pittsburgh fixture for 134 years. It’s difficult to walk more than a few blocks without finding a street, sports arena, or other landmark bearing the Mellon name. Early on, directors worried about the sale’s impact on the city, and what would happen to branches and employees. Would the Mellon brandu00e2u20ac”and their own personal reputationsu00e2u20ac”be damaged by a deal?

“There were a lot of questions: ‘Is now the right time? Is this the right purchaser?’” McGuinn recalls. Some directors were more pointed: “Why does this work for Citizens and not for us?” Gumberg, a Pittsburgh native, remembers hearing. The final decision to sell, Gumberg adds, “was emotionally difficult. …We were giving up so much of what Mellon had been for so long. A big part of our heritage was in the retail business.”

In the weeks after the deal was announced, such concerns were validated. The locals howled over the ostensible betrayal, while the state of Pennsylvania pulled Mellon’s contract to manage its 529 college savings plans on the grounds that Mellon now lacked the physical offices to service accounts. That hullabaloo has quieted, as Royal Bank has stayed true to its pledge to support Mellon’s heritage. At Mellon’s annual meeting last year, not one attendee publicly said anything about the deal.

Looking ahead

With Mellon’s makeover mostly complete, the board’s emphasis is now on growing the new stable of businesses. Risks exist. The move into asset management, for instance, could prove hazardous if the slump in global markets continues. Some pundits have even speculated that Mellon, with its attractive mix of businesses, could wind up as acquisition bait itself if its stock price continues to falter.

The board, meanwhile, seems committed to staying the course. “We’ve already done the most important thing a board can do: Define what the company wants to be,” von Schack says. McGuinn’s education and communication efforts have provided the foundation for such confidence. Continued schooling should ensure that, no matter what happens to Mellon, the board won’t be surprised.