With his first major acquisition agreement in two years, Richard Fairbank, Capital One Financial Corp.'s chairman, unveiled a new strategy Thursday.
Its deal for Chevy Chase Bank in Maryland would let Capital One establish a branch operation in the Middle Atlantic region, something Mr. Fairbank once eschewed, though his company is headquartered in McLean, Va. Capital One would also reenter the mortgage business.
In an interview Thursday, Mr. Fairbank pointed to a vastly changed competitive landscape, one where his biggest competitors are making landmark deals that give them coast-to-coast breadth. Simply put, Mr. Fairbank said, he saw a chance to take top five market share around Washington virtually overnight, and pounced on it.
"For us, the most important thing is to have very good market positions wherever we play," he said, after agreeing to buy the $15.5 billion-asset Chevy Chase Bank for $520 million in cash and stock.
"We're not as large as the big players, so our strategy for competing against them involves having relevant scale" in select cities, he added, and "this deal is in our own backyard from a corporate perspective, so it is a natural move for us."
The deal, once it closes next quarter, would push $154.8 billion-asset Capital One from being the 13th-largest bank based on assets to No. 12.
Chevy Chase's 6.6% deposit market share in the District of Columbia and its nearly 300 branches in the Washington area were enough for Mr. Fairbank to do a deal outside the company's existing markets of New York and the Gulf Coast, though for the past two years he has said he had little interest in acquisitions between those regions. Chevy Chase also brings with it a mortgage model that had originated loans well outside of its markets, a business practice Mr. Fairbank has never trusted. Chevy Chase would deliver a loan book highly steeped in souring residential mortgages and home equity lines.On Thursday Mr. Fairbank said Capital One will look to pull back completely from out-of-market mortgage originations, though he is comfortable making such loans to Chevy Chase customers. "The day will come when the mortgage business can be attractive again on the other side of this downturn," he said. "With all of our banks we want to provide the full array of consumer products to our customers."
In addition to the $520 million cash and stock purchase price, Capital One said it would record a $1.75 billion mark-to-market adjustment against Chevy Chase's loan portfolio, which some analysts described as steep. Of this adjustment, $1.47 billion would be tied to residential mortgages and home equity lines, or 15.3% of these portfolios, which would be deeper discounts than the adjustments planned by Wells Fargo & Co. in its pending purchase of Wachovia Corp. or than those taken by JPMorgan Chase & Co. when it took over Washington Mutual Inc.
Scott Valentin, an analyst at Friedman, Billings, Ramsey & Co. Inc., said Capital One is "giving up quite a bit for this franchise," considering that the purchase price, projected writedowns, and $225 million of merger-related expenses will lead to a "big drop" in tangible common equity, which he said could fall 110 basis points, to 5.4%. Capital could come under added pressure if loss assumptions fall short. "There's a chance that they may not be able to sell the loans for what they're marked," he said.
Bruce Harting, an analyst at Barclays PLC's Barclays Capital, was also cautious, given Chevy Chase's mortgage exposure, including $4.1 billion of adjustable-rate mortgages. "While additional deposits are clearly welcome, we look to hear more details before making any conclusive judgments on the deal," he wrote in a note to clients.
Nonaccrual loans at Chevy Chase grew more than sixfold from a year earlier, to $530.3 million in the third quarter, and 89% of these involved residential mortgages. While its loan-loss provision swelled to $72 million from $5.2 million a year before, the thrift still managed to remain profitable in the third quarter, earning $5.9 million.
Any concerns over Chevy Chase's loan quality are partially offset by its deposit base, where about two-thirds of its $11.5 billion in deposits appear to be in checking and savings accounts, analysts said. They stressed the importance of having such funding as a relatively inexpensive way to replace roughly $6.4 billion of securitizations and corporate debt at Capital One that will come due next year. A need for more-diverse funding led Capital One to move aggressively into retail banking with its 2005 purchase of the former Hibernia Corp. in New Orleans and its acquisition of the former North Fork Bancorp in Melville, N.Y., a year later.
But expanding deposits has been a slow process; the deposit base at the Capital One Bank unit on Sept. 30 was just 0.7% larger than on March 31, 2007, when it added North Fork's balance sheet. And in buying a company with a 40-year heritage linked to founder B. Francis Saul 2nd, some analysts said Capital One may face challenges keeping many of those lucrative deposit relationships. Mr. Fairbank said that customers "are very loyal to Chevy Chase."
Capital One raised $750 million in capital in an October common stock offering and last month got about $3.56 billion by selling preferred stock through the Treasury Department's Capital Purchase Program. Mr. Fairbank said the common stock was sold with acquisitions in mind, though Chevy Chase became available later.