By Steven Pearlstein
Friday, December 5, 2008

With no disrespect meant to Capital One, yesterday's sale of Chevy Chase Bank was a sad day for Washington and the Washington business community.

Over the past 30 years, Frank Saul has built Chevy Chase into what is arguably the best banking franchise in the region and the last of the major banks that is locally owned. It has led the pack on things like customer service, a convenient branch network and the use of new technology. As a private, family-owned institution unbeholden to Wall Street investors and analysts, Chevy Chase has invested heavily in building its local franchise, remaining a reliable source of capital for households, businesses and nonprofit groups in good times and bad. And like its founder, the bank has been a silent but generous patron to local charities, particularly those associated with the Catholic Church.

I realize it was probably inevitable that Chevy Chase would be sold off one day to a big, publicly held financial services behemoth -- all the big boys have been quietly courting Frank Saul for years. Surely it is better that the acquirer is Capital One, another homegrown success story, based in McLean, with a strong civic commitment. And although he's coming up on his 77th birthday, Saul will still be around and active, helping his son to shepherd his real estate empire through the coming storm in commercial real estate.

But you have to think this was not the way B. Francis Saul II -- proud, courtly and business-shrewd -- would have wanted it to end.

It was Saul's grandfather who first got into the banking business back in 1892, selling land on what was then the outskirts of the city in return for IOUs that he then sold to investors. And ever since, through various banking and real estate entities, the family has been actively involved in the growth of the Washington region. They weathered the Great Depression and the Maryland savings-and-loan debacle of the 1980s. When many local banks and developers sold out or closed during the crisis of the early 1990s, Saul stuck it out, betting everything on the belief that projects like Kentlands and Ashburn would eventually turn a profit. They did, paying off handsomely for Saul and Chevy Chase Bank.

Not long after, Chevy Chase jumped into the credit card business, building it up nicely before selling it for a bundle to Bank One. Saul invested the proceeds from the credit card sale to expand Chevy Chase's local branch network and then used the growing base of low-cost deposits to take its lending operation national, expanding into fast-growing regions of the Sun Belt. Its specialty: jumbo "option ARM" mortgage loans to high-income households, many of which it held on its own books rather than sold off in packages to investors. By the time the real estate and financial bubble hit its peak in 2006, Saul could have easily sold Chevy Chase for $2.5 billion.

Now that the bubble has burst, those billions of dollars in option ARMs in California, Nevada, Arizona and Florida are an ugly blot on Chevy Chase's balance sheet. Rather than try to ride out another cycle, Saul has decided to take his chips off the table.

By any measure, the $520 million price classifies this as a distressed sale, given that Chevy Chase's local franchise remains strong and profitable and highly sought-after by other banks looking to establish or expand a presence in Washington. Some of the buyers were said to be wary of taking on more troubled loans, while others were limited by the fact that their own stock was so badly beaten down. In the end, once a federal rescue effectively eliminated Citigroup as a potential buyer, it came down to a bidding contest between Capital One, which saw in Chevy Chase's deposit base a reliable source of low-cost funding for its credit card operation, and two New York giants, Citigroup and J.P. Morgan Chase, the latter of which has long wanted to expand its national banking franchise into the Washington region.

You could argue that, thanks to the alchemy of accounting, Capital One was able to pick up Chevy Chase virtually free. As part of the deal, Chevy Chase announced that it would immediately write down the value of those option ARMs by $1.75 billion, based on the aggressively gloomy assumptions that 75 percent of the loans would default and recover only 55 percent of what was owed. It will take years before those losses are actually realized and can be used as tax deductions by Capital One. But in the meantime, Capital One can immediately add $600 million in much needed capital to its balance sheet in anticipation of those cash savings -- a big deal at a time when bank capital has become the coin of the realm in financial services.

The Saul family is not exactly going away empty-handed. In addition to 2.5 million shares of Capital One stock, they will have $445 million in cash to plow back into the real estate business to financing ongoing projects and pick up assets at distressed prices. There's also a provision in the deal that could add up to $300 million more to the sales price if those option arms turn out to be more valuable than Capital One now assumes. Saul also gets to keep two golf courses the bank owns, along with the twin office towers in downtown Bethesda that serve as Chevy Chase's headquarters.

But it tells you everything you need to know about Frank Saul that as negotiations were reaching a conclusion, he asked for a promise from Capital One to continue making contributions to a long list of local nonprofit organizations that Chevy Chase has supported over the years. It's the kind of quiet but unshakable commitment to the civic life of the city that Washington has come to expect from this stalwart of the business community. It also tells us something important about Capital One and its founder, Richard Fairbank, that he was quick to honor Frank Saul's request.

Steven Pearlstein can be reached at pearlsteins@washpost.com.