Mellon Will Shift $1 Billion in Bad Loans : Forming Entity to Help Improve Ailing Finances

Mellon Bank Corp. said Monday that it will shift $1 billion in bad loans into a new independent bank to stabilize Mellon’s earnings and improve its recently troubled finances.

“Last June, we said we’d deal with our problems as aggressively as we could . . . that we were not going to disembowel the company in any form. This step is just a logical extension,” said Frank V. Cahouet, chairman of the bank holding company that ranked as the nation’s 16th largest at the end of 1987.

Mellon also said it would raise $525 million in new capital.

The recapitalization, arranged by Drexel Burnham Lambert Inc., a New York investment bank, is designed to strengthen Mellon, which stumbled last year under the weight of its non-performing energy and real estate loans.

Mellon will capitalize the new bank with about $130 million of its own funds, for which it will receive $100 million in preferred stock in the new bank and will pass along $30 million in common stock to Mellon’s shareholders as a dividend.

The recapitalization plan is similar to one used by banks experiencing severe financial problems, in which a portfolio of problem loans are transferred to a separate “bad bank” while a healthier parent bank retains the good loans, Cahouet said.

This is the first time, however, that the “good bank-bad bank” approach has been adopted by a relatively healthy bank, Cahouet told a news conference.

Saving a Lot of Time

Grant Street National Bank, as the new bank will be called, will not take public deposits. It will have its own own five-member board of directors, he said.

Mellon reported losing $844 million last year because of potentially bad loans in the energy-dependent Southwest and in developing countries in South America.

“We could have managed the problems over the next three, four or five years. Now at least we’re saving all that time and we can get on with developing the future of the institution,” said Mellon President Anthony Terracciano.

Standard & Poor’s Corp., a securities rating firm, said the move will bolster Mellon’s finances, help stabilize earnings and free up managers.

$200-Million Charge

The new bank, whose name reflects Mellon’s street address in Pittsburgh, will buy the bad loans for $575 million in cash and securities, a deep discount off their book value of $1 billion.

Grant Street National will sell $425 million to $450 million worth of high-yield, “junk bonds” underwritten by Drexel Burnham Lambert Inc.

Mellon will take a $200-million charge to third-quarter earnings as a result of the deal, Cahouet said.

Mellon’s exposure to risk will be limited to the $100 million in preferred shares it holds in the new bank.

Mellon’s $525 million in new capital will come from $275 million in three series of preferred shares and $250 million in equity purchase contracts from a group of investors.

The $525 million will help meet anticipated funding guidelines that bank regulators are expected to impose in 1992, Mellon officials said.

Bank officials said they expect to receive regulatory approval for the recapitalization, which should be completed in the third quarter.