The chairman of Perpetual Savings Bank read the words in the bank examiner's report: Unsafe. Unsound. Serious doubt about management's ability to run the savings and loan.

Thomas J. Owen thought it had to be a joke.

But there on the page was the signature of Steve Lake, field examiner for the Office of Thrift Supervision, the federal regulator for savings and loans. On a best-to-worst scale of 1 to 5, Lake rated Perpetual a 4 last spring, just one step above what could trigger an immediate takeover by the federal government.

Owen was incredulous. Perpetual Savings Bank wasn't making fraudulent land deals or lending to nonexistent borrowers. It wasn't investing depositors' money in windmill farms, billion-dollar resort hotels or any of the exotic schemes that sank other thrifts.

Owen, who resigned late last month after 13 years as chairman, had done what the federal government had encouraged him and other thrift executives to do: invest in real estate, lend to developers and diversify into corporate lending, auto leasing and insurance.

Now, having practiced what the government had preached, the Washington area's largest savings and loan suddenly found itself facing tough, new regulatory practices that were pushing it to the brink.

The rise and fall of Perpetual Savings Bank under Tommy Owen is the story of a devastating confluence of events -- a radical change in the federal government's approach to regulating the S&L industry just when the region's real estate market had nose-dived. How these factors combined to crack Perpetual's seemingly solid foundation in 1990 is based on interviews with more than a dozen past and present employees, none of whom would be quoted by name. Owen and Lake declined to comment.

Owen's departure from the S&L comes as Treasury Secretary Nicholas F. Brady and other top government policy makers question whether regulators are making a bad economic situation worse by applying overly strict standards to the banking industry.

Locally, Owen's demise rippled throughout the Washington area banking community, raising the blood pressure of S&L execu-

tives who had looked upon him as their standard-bearer. Since the Great Depression the Owen family had guided Perpetual, but it was Tommy Owen who transformed the old-fashioned family mortgage business into a profitable financial powerhouse.

"If this can happen to Perpetual, it can happen to anybody," said Henry A. Berliner, head of Second National Federal Savings of Annapolis. "When word of Perpetual's problems got out, it sent a shiver through the industry."

Moving Into the 21st Century

Most Washington-area depositors didn't understand the television commercial, which said nothing about banking.

The camera panned to a caveman sitting in front of a fire when suddenly, the fur-clad figure leaped into the future to become an astronaut.

The surreal advertisement, first aired in the mid-1980s, made all the sense in the world to Owen. Like the evolution from ape to modern man, Owen was moving Perpetual out of the 19th century and into the 21st.

When the chairman took over from his father, Thornton Owen, in February 1979, Perpetual already was one of the largest savings and loans in the nation. But for all its size, the S&L had changed little from its founding in 1881 as the outgrowth of the St. George's Society, a group of poker-playing Englishmen who pooled their resources to help members buy new homes in the nation's capital.

Perpetual had survived comfortably as a benefactor of American homeownership, living off the difference between the interest rate paid on deposits and received on loans. But just months after Owen took control, a surge in interest rates drove Perpetual's depositors to withdraw their money in favor of better earnings elsewhere.

Almost overnight, Perpetual's business prospects evaporated. And for the first time in its 98-year history, the S&L recorded a loss.

Owen scrambled to fix the business, but it took a change in the rules governing savings and loans to breathe new life into Perpetual and the rest of the nation's thrifts.

Congress decided that for S&Ls to attract savers, they needed to pay higher interest rates. But for S&Ls to afford those high rates, they needed to expand their operations and make riskier -- but potentially more profitable -- loans. This deregulation, the federal government said, would be the salve for the industry's woes.

Financial Smorgasbord

For Owen, an aggressive and tough executive who was eager to make his own mark on Perpetual, it was as if someone had let a caged bird free.

Almost immediately, Owen recruited a cadre of financial managers, all with MBA degrees or banking experience, to run his operations. He shocked the banking community with a bold move to acquire one of the largest Virginia-based savings and loans, giving Perpetual the only tri-state franchise in the area.

Shortly thereafter, Owen received permission to open a brokerage house that could buy and sell stocks and bonds -- a service banks weren't allowed to offer. It wasn't long before Perpetual added an insurance agency, an auto leasing operation, a division that specialized in loans to corporations and Owen's prized subsidiary, Perpetual's real estate investment arm.

To ensure that S&Ls were profitable, federal regulators allowed them to use their deposits to buy direct ownership stakes in real estate projects -- a privilege not accorded to banks or credit unions.

Owen, the son of a mortgage banker, had undying faith in the real estate market, according to his colleagues. And at the rate that property values were skyrocketing, he believed Perpetual's investments couldn't go wrong.

Soon, Perpetual had joined forces with dozens of developers from Florida to Maryland, building office towers, hotels, condominiums, shopping malls and housing developments. To help fund the real estate boom, Perpetual also lent hundreds of millions of dollars to developers for construction and land acquisition -- in some cases, on very liberal terms.

These real estate ventures were riskier than single-family home mortgages, but they paid high interest and generated hefty upfront fees and commissions. Besides, Perpetual executives said, Owen believed the true risk in these ventures was exaggerated. Most of the developers were friends of the S&L's board of directors, business leaders who could be trusted to know what they were doing. As long as Perpetual diversified its investments and made loans to prominent developers, real estate would be a sure-fire moneymaker, Owen told his colleagues.

By the end of 1988, Perpetual's transformation into a one-stop financial smorgasbord was complete. The S&L had more than $1 billion devoted to commercial real estate projects and operations that had nothing to do with home mortgages were generating one-third of Perpetual's pretax earnings. The seven-branch thrift with $750 million in assets had ballooned into a 70-office regional powerhouse with $5.7 billion in assets.

Owen sat high atop his mountain of accomplishments -- the envy of all.

Dealing With the S&L Crisis

It didn't last long. For hundreds of other savings and loans throughout the country, deregulation spelled disaster. The rules Owen had taken advantage of had been abused by S&Ls in Texas, California, Arizona, Oklahoma, Kansas and Florida. By the end of 1988, the industry was in ruins, the victim of fraud and gross mismanagement.

In January 1989, President Bush revealed his plan to deal with the S&L crisis. Called the Financial Institutions Reform, Recovery and Enforcement Act (FIRREA), the bill required S&Ls to increase their capital, the financial cushion that S&L operators provide to protect against losses. The Bush proposal also restricted S&Ls to home lending and set limits on how much money they could lend to one borrower.

Owen, convinced the bill would set a deathtrap for remaining healthy savings and loans, began stalking the halls of Congress trying to sell anyone who would listen on the idea that the Bush plan was punitive policy.

"If the White House wants to kill off the savings and loan industry, it's doing a great job," Owen told one House member.

The White House proposal ignored the realities of the marketplace, Owen maintained. It would be virtually impossible for the industry to raise hundreds of millions of dollars of capital while struggling to overcome a negative image, he argued. Moreover, the restrictions would make it extremely difficult for any S&L to make money.

As the FIRREA debate heated up, Perpetual's loan officers watched the once-hot local real estate market cool down. Office vacancy rates were rising, a handful of developers became delinquent on their loans, and for the first time since Perpetual plunged into commercial real estate, the S&L recognized some minimal losses.

But Owen, the mastermind behind the real estate operations, didn't have time to focus on these problems and handed them off to lesser officials.

The 55-year-old executive had become the unofficial spokesman for nearly every profitable S&L in the country, testifying at hearings and pressing for reforms on behalf of the "good guys."

It was a tough argument to make in the face of the industry's mammoth losses, which had drained the S&L fund that insured deposits up to $100,000 per account and left Americans holding a tax bill in excess of $150 billion for the industry's rescue.

So when Congress passed FIRREA on Aug. 5, 1989, Owen's pleas for special consideration for thrifts like Perpetual were ignored.

New Regulatory Environment

The ninth-floor boardroom at Perpetual's corporate headquarters fell still that August as attorneys outlined the impact of FIRREA to the thrift's 13 directors. It seemed everywhere they looked, the new law had created an obstacle.

Perpetual already had put up for sale eight of its branches, but Owen knew much more would have to be done if his S&L was going to survive the newly stringent regulatory environment.

Direct investments in real estate would have to be disposed of, the insurance subsidiary would have to be sold, loans to corporations would have to discontinued, commitments to developers would have to be canceled and -- perhaps the most daunting prospect -- Perpetual would have to find a way to raise tens of millions of dollars in fresh capital.

Although Owen and his top managers were working furiously to find solutions to the crisis, the chief executive, who had spent much of his time away from the office lobbying, once again found himself distracted; this time, by the death of his mother and marital problems.

"The timing couldn't have been more disastrous," said one Perpetual executive, a close friend of Owen's. "Suddenly, things were just falling apart. And Tommy was so depressed, he just couldn't do anything."

The situation went from bad to worse when the real estate market, which had been threatening to unravel for months, finally fell apart, something Owen thought would never happen.

The combination of the S&L bill and the slowdown in real estate hammered Perpetual's stock price down to less than $5 a share from a high of $11. The nose dive personally cost Owen more than $2 million in lost stock value, and wiped out all hope that the thrift's much-needed capital could be raised in the marketplace.

Weary, frustrated and dispirited, Owen took to sitting in his office alone at night, smoking cigarette after cigarette in the dark.

Finally, he made an anguished decision. The only way to keep Perpetual afloat and recoup his investment was to sell the 109-year-old institution to a bank holding company. After all, the thrift still boasted a tri-state franchise in a very desirable consumer market.

At the end of 1989, the board of directors hired the investment banking firm Goldman, Sachs & Co. to evaluate possible offers. Just a few weeks later, in February 1990, Steve Lake and his team of examiners from the Office of Thrift Supervision (OTS) came knocking at the door.

Criticism From the Examiners

Owen was expecting a routine examination of Perpetual's operations, colleagues recalled. But what he got was anything but routine.

The relaxed, friendly atmosphere between banker and regulator was gone, along with the sense of trust, understanding and flexibility that Owen had grown accustomed to in his years as chief executive, according to Perpetual officials.

For weeks, these OTS regulators fired question after question at management, the officials said. Their tone was accusatory, their review by the book.

They pored through Perpetual's files in search of updated real estate appraisals, proper collateral and signs of borrowers' creditworthiness. Every loan, according to the officials, was assumed to be a bad loan -- unless it could be definitively proven otherwise.

This, Owen came to understand, was the new era of S&L regulation.

The examiners' criticisms left virtually nothing untouched. Perpetual, they said, had made too many risky loans, making it vulnerable to the economic downturn. Commercial real estate loans were not well-structured and corporate loans were full of risk. Making matters worse, management had few procedures for tracking bad loans or predicting future loan problems.

The regulators concluded that Perpetual's operations were unsafe and unsound and that management's ability to run the S&L was in doubt. Perpetual was to be placed on the OTS "troubled" thrift list and given a rating of 4.

Owen, who had escaped such criticism in previous exams, couldn't believe what he was hearing, according to his colleagues. The OTS, in its zeal to ensure that the S&L debacle would not repeat itself, was completely overreacting, Owen argued. A real estate meltdown like the one that ravaged thrifts in the Southwest would never hit the Washington area, he said. Even comparing the two regions in the same breath was unthinkable.

Moreover, Owen told the regulators, if it was a thrift crisis that the OTS wanted to avoid, profitable S&Ls like Perpetual shouldn't be forced to recognize millions of dollars in losses at such a critical time.

But OTS field examiner Steve Lake saw things differently. Perpetual's management had let the developers run the store. Projects had been funded with little cash down and loan payments often weren't required for the first two or three years. Some developers didn't even pledge collateral. In a real estate downturn, the regulators said, such loans would leave Perpetual exposed to losses.

Perpetual, for example, lent more than $63 million to financially troubled real estate developer Conrad Cafritz. The developer now is working with Perpetual and other creditors to pay off his debts in an attempt to avoid bankruptcy.

According to Perpetual officials, the OTS threatened to shut Perpetual down immediately, unless Owen stepped down as chief executive and Perpetual's president, Ross Towne, was fired. Owen knew the regulators meant business; he abandoned all hope of finding a buyer.

The Owen Era Ends

Under the watchful eye of the OTS, Perpetual set aside $50 million in May 1990 to cover past and future loan losses. The S&L signed a supervisory agreement with the regulators, giving the OTS final say over all future business decisions. Perpetual promised in that agreement that it would move quickly to comply with FIRREA and dismantle all that Owen had built.

In May, Towne, who had fought the regulators' conclusions vigorously, was placed on permanent administrative leave.

One month later, Owen relinquished his title as chief executive, saying the institution needed fresh management as it recovered from a series of financial setbacks.

Last week, he resigned his post as chairman, formally ending more than 50 years of his family's control.

"I lost the fight," Owen said in June. "Now, it's time to take a fresh view and refocus ... it won't be exciting, but it's what the regulators want."

Perpetual's problems stunned the banking industry, prompting serious questions about whether the federal government's effort to clean up the savings and loan industry could be successful.

"Everyone knew Perpetual would be hurt by some real estate problems," said Bill Ferguson, a Texas-based S&L consultant. "But this was incredible."

"Owen was a man on the cutting edge," said Arnold Danielson, a bank and thrift analyst in Rockville. "He was one of the first to make his thrift a more bank-like operation. It's something I would have recommended ... but now, he's being punished for it."

What happened to Perpetual Savings Bank, most experts now say, is emblematic of the problems facing the entire saving and loan industry. Weighed down by troubled real estate loans and desperately trying to adjust to new rules governing their business, more than half the nation's 2,400 savings and loans are struggling for survival.

Industry observers agree that most of these S&Ls, regardless of the impact of FIRREA, would be suffering from loose lending practices and the real estate slowdown. But fewer, they say, would be in such desperate straits were it not for the added turmoil brought by the Bush legislation.

"If there had been no {bill}, Perpetual would still be having problems," said Alexandria-based S&L consultant Bert Ely. "But the legislation didn't help their situation, and in fact, it's really hurting them."

Within Perpetual, a debate still rages about whether the regulators' actions were necessary. Some say the OTS examination was prudent and that Perpetual -- caught up in the competitive, euphoric real estate lending that swept the area in the 1980s -- simply paid the price for playing fast and loose.

Other Perpetual employees say Lake was too harsh and that Perpetual's loans were good, solid credits until the regulators began cracking down, wreaking havoc on the S&L, on developers and ultimately on the real estate market.

OTS Director Timothy Ryan declined to discuss Perpetual's examination, citing agency policy that prohibits regulators from discussing the problems of specific institutions.

Working Closely With the OTS

Today, Perpetual is working furiously under a new leader from Maryland National Bank, John Morton, to meet the regulators' demands. With a new team of managers in place, Morton is shrinking Perpetual's size, selling off troubled assets, cutting expenses and slowly returning Perpetual to the basic business of home lending.

But the real estate market and FIRREA law continue to take their toll. Fourth-quarter and year-end results released last week show Perpetual lost $146 million in 1990 because of problem real estate loans.

Those massive losses caused the Vienna-based S&L to fall below the new federal minimum standards for capital, a serious sign of financial distress. Perpetual's stock, once traded for $11 per share, now sells for pennies.

Morton is working closely with the OTS. He even flies executives to Atlanta every other week to meet with the regulators and to give updates on Perpetual's progress.

But much of Morton's success depends on market forces beyond his control. If a continued deterioration of the region's real estate market prevents real estate assets from being sold and forces more real estate loans into default, it could be extremely difficult for Perpetual to obey the regulators' orders, the thrift has said.

What happens to Perpetual, in the end, lies with the OTS.

As Owen prophetically observed six years ago: "Commercial banks and thrift institutions are creatures which were invented by the regulators... . And what they are or what they will be, to a very great extent, will be determined by what Congress and the various {regulators} say they can do."