Capital One Awoke To Its Dream Deal
For $520 Million, the Credit Card Giant Brings Home a Local Banking Icon

By Zachary A. Goldfarb and Michael S. Rosenwald
Washington Post Staff Writers
Friday, December 5, 2008

The vision of buying Chevy Chase Bank came to Richard Fairbank six weeks ago in a dream.

For years, the chief executive of Capital One had looked out from his 14th-floor office in McLean toward a tower on the horizon, desirous of the landmark Washington bank, but he thought the privately held company was out of reach. Then, just a day after telling his business associates about what he had dreamed, Fairbank learned that a New York investment banker had called with news: Chevy Chase was on the block.

"I was a bit spooked by that prophesy that this might be possible," Fairbank said, recalling the episode.

The possibility became reality yesterday when Capital One announced that it was acquiring Chevy Chase for $520 million in cash and stock. Under a new Treasury Department regulation meant to spur strong banks to buy weaker ones, Capital One stands to record tax relief of up to $607 million over time -- more than what it is paying for the bank. Capital One said tax savings was not a big driver and that it raised private capital for the deal.

The deal stands to change the Washington banking landscape, with Capital One, a credit card company that has recently been buying regional banks, gaining a firm hold in its home region. Capitol One has hundreds of bank branches in New York and Louisiana and now adds Bethesda-based Chevy Chase's 244 local branches.

Capital One said it doesn't have plans to lay off employees or change how Chevy Chase branches operate. In a letter to employees, B.F. Saul, 76, the discreet local businessman who started Chevy Chase Bank 39 years ago, wrote that "while this represents the end of one chapter in the highly successful Chevy Chase Bank story, it also marks the beginning of another as the bank we have built joins with one of the leading brands in the financial services industry."

The deal is subject to regulatory approval and is expected to close by the end of March.

Some customers expressed consternation yesterday about the loss of their local bank. At a Chevy Chase branch in Rockville, Joe Lamari, 53, remembered the days when local banks provided such personal service that if your account was overdrawn, someone from the local branch called. "Everything has gotten bigger," he said. "You miss the teller that knows you. It's all computers now."

At Chevy Chase, the decision to seek potential buyers came about three months ago. The bank had a well-known brand in a wealthy area and $11 billion in cash deposits. At a time when banks were struggling to raise funding, "it would be a time to take advantage of [the fact that] a deposit-taking franchise would be very valuable to people," said Thomas McCormick, the bank's general counsel and Saul's right-hand man.

But the bank was also running into mounting problems. Into the middle of 2007, later than most, Chevy Chase had been selling a risky type of mortgage in parts of the country such as California and Florida. The adjustable-rate mortgages, known as an option ARM, allowed a borrower to defer part of the required monthly payment for several years. As payments came due, many borrowers defaulted.

Chevy Chase's distressed assets tripled to $490 million from September 2007 to June. This was reflected in the sale price. Capital One is spending about a quarter of the average price paid in recent years for banks of its size.

Yesterday, Capital One said it was assuming that $1.75 billion of Chevy Chase's portfolio of loans would go bad in coming years. Most of that loss was associated with the option-ARM portfolio. The calculation suggests that 75 percent of borrowers with option-ARMs will fail to pay off their mortgages.

During negotiations and as dozens of Capital One employees and outside accountants pored through Chevy Chase's books, the two companies disputed the severity of the challenges facing Chevy Chase.

Although Capital One concluded that Chevy Chase had made fewer loans than other troubled banks in parts of the country hardest hit by the housing downturn, it also became clear that Chevy Chase had continued making loans even as the market was getting worse in 2007 and held more of these risky mortgages than many other banks, according to Capitol One executives. Capital One also calculated the effect of a sharp recession. That pushed down the value of Chevy Chase's portfolio and, consequently, the value of the company.

Chevy Chase disagreed.

To resolve the issue, the companies agreed that the Saul family would be compensated if it turns out Capital One had underestimated the value of Chevy Chase's portfolio. As much as an additional $300 million could flow to the Saul family. "The owners of Chevy Chase will share in that benefit," said Fairbank, 57.

Chevy Chase had a number of initial bidders. McCormick described Capital One's $520 million figure as an "attractive price." He said: "Capital One doesn't have a bank in this area. It was a nice opportunity for employees here to continue to be employed and operate things under the Capital One umbrella."

Sources familiar with the sale said federal banking regulators played no role in the deal. McCormick said the bank would have "absolutely" survived without being bought.

Capital One had been taking steps to ensure that it had the money to put down on a bank. It raised $700 million in private capital in October and received $3.56 billion from the Treasury as part of the government's emergency $700 billion initiative to stabilize the financial system.

Chevy Chase's deposits would add to Capital One's deposit base, which helps it fund its huge credit card business as the downturn in financial markets limits access to other sources of funding.

The deal has another significance for Fairbank. "To be able to start with something like this in our hometown is a transformational event for Capital One," he said. "Far bigger than the numbers associated with the deal."

On Wednesday night, as the deal neared, Fairbank worked from a conference room next to his office in McLean and Saul from his office in Bethesda. Saul held a board meeting to complete the deal. Fairbank signed the final paperwork, using special Waterman and Cross pens embossed with the Capital One logo. The two men talked on the phone.

"I expressed to Frank . . . that I know there are mixed emotions in selling his beloved institution and that I hoped that he shared our view that we would be the very best partners," Fairbank said.

Today, Fairbank will go to Chevy Chase's headquarters to meet with top employees and dine privately with Saul.

Staff writer Binyamin Appelbaum contributed to this report.