Banking has evolved dramatically in the past 28 years. In the autumn of 1979 the Fed dramatically raised interest rates, and it changed the way banks did business; the days of the 3-6-3 rule are ancient history. Globalization of our markets has impacted regional banks as much as it has money center banks. Today, asset-liability management and fee-based income are the name of the game. (To learn more about common bank fees, read The Ins And Outs Of Bank Fees.)

Another Marriage
The consolidation of banks continues with the merger of Mellon Financial (NYSE: MEL) and Bank of New York (NYSE: BK). The combined bank, to be known as Bank of New York Mellon Corporation will have a market capitalization of roughly $48 billion, revenue over $12 billion and will save approximately $700 million in cost saving synergies. This combined operation will be the leading global custodian and one of the world's largest asset managers with about $1.1 trillion in assets under management.

Prior to this merger both banks were considered regional banks, neither concentrated on retail banking. In fact, Mellon got out of retail banking in 2001. The merger will bring synergy and allow the cross-selling of custody services along with asset management services to all the combined customers.

While competitors such as State Street (NYSE: STT) and Northern Trust (Nasdaq: NTRS) should be justifiably concerned, Mellon's loan portfolio might hedge this fear as the partnership is now saddled with write-offs in telecom and aircraft leasing loans. Since the bank's custodial fees are based on market value of the assets, markdowns in equities or debt are a possibility and could hurt revenue from this source.

When is a Bank not a Bank?
PNC Financial Services Group (NYSE: PNC) has come a long way since the days when it was just Pittsburgh National Bank. PNC is another bank that derives the majority (63%) of its revenue from non-interest income sources. To be fair, PNC does have a retail banking operation and those deposits generate 30% of the bank's revenue. PNC's recent acquisition of Yardville National Bank (Nasdaq: YANB) gives it an additional avenue into deposit-rich New Jersey and metro Washington, D.C.

PNC's 34% stake in BlackRock (NYSE: BLK) contributes roughly half to its bottom line. It realized a $1.3 billion gain when Merrill Lynch (NYSE: MER) bought the other 66%. The bank also has a capital-markets business that contributes fee income for the bank.

Going forward, PNC is focusing on its lending business, building better credit quality into its portfolio and has initiated a cost-cutting scheme. The scheme has already cost 3,000 people their jobs and saved the bank about $400 million annually.

Don't Bank On Community Banking
Cleveland-based KeyCorp (NYSE: KEY) has had a rough go of it these past few years. Deposits have remained flat, growth in its loan portfolio is almost nonexistent at 2.3% and net interest margins are squeezed - for a bank that is the 15th largest, as ranked by deposits, one has to wonder, why the trouble?

KeyCorp's fundamental business is traditional banking, taking in deposits and making loans. The bank also has businesses in capital markets, insurance and asset management that produce a steady stream of income. KEY divested its retail brokerage and subprime mortgage business.

The bank has adopted a "community banking" model, hoping to build stronger customer relationships while being more conservative in its credit underwriting and asset/liability management. While this may lend some comfort to a local board of directors, it does little to impress the real world. Unfortunately, it also has a high cost structure and is located in a declining population center. Perhaps KEY should look for answers elsewhere.

It is easy to blame the flat yield curve and compressing credit spreads on a lack of creativity or poor performance. Banking is not the staid business it once was; it is now as dynamic a business as you can find, and in a dynamic market place, you either change and grow or watch as others pass you buy.

To keep reading on this subject, see Analyzing A Bank's Financial Statements.

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