The Garrett, Watts Report (January 25, 2009)

To Our Clients, Colleagues and Friends,

• From a client who’s a very senior officer at a community bank:  “Examiners are hammering everyone about loans with ridiculous standards, i.e. if it is weak it is bad, if it is OK it is bad, if it is good we must be missing something because it has to be bad.  If you don’t have an appraisal that was done one week ago, it is too old and they discount it.  If you have a current appraisal, it must be based on unrealistic comps.” The banker who wrote this is very smart, very experienced, and very much on target.
• We just finished Jesus of Nazareth,  a 1925 book by Jewish scholar Joseph Klaussner. Toward the end, he writes “If we omitted the miracles and preserved only the moral precepts and parables, the Gospels would count as one of the most wonderful collections of ethical teachings in the world. If ever a day should come and this mythical code be stripped of its wrappings of miracles and mysticism, the Book of the Ethics of Jesus will be one of the choicest treasures in the literature of Israel for all time.”  We agree.  But what Klaussner apparently didn’t know is that Thomas Jefferson had already done it.  We read Jefferson’s Bible a few months back and Jefferson had done precisely what Klaussner wrote about 125 years later.

• We’ve been critical of Boards of Directors for approving management plans to go into subprime lending, but we’d like to make one thing clear.   We don’t really fault these Directors for deciding to allow management to move into subprime lending.  Directors are human, and people often make decisions that look foolish only in hindsight.  So we don’t fault them for the decision per se.  What we’re concerned about is whether they did proper due diligence and analysis before making the decision.  We’re less concerned with bad decisions and more concerned with how they made that decision. Bad decisions can be excused, but not bad decision-making practices.   Does that make sense?

• With all the discussion about doing away with or merging regulatory bodies, how about this:  Instead of one regulator for national banks, one for state banks and one for thrifts, how about three regulatory bodies based on the size of the bank?  It doesn’t make sense for the OCC to regulate $2 trillion Bank of America as well as a $200 million community bank, just because the smaller one happens to have a national bank charter.  How about one regulator for all banks under $500 million in size, a second regulator for all banks between $500 million and $5 billion, and a third regulator for all banks over $5 billion?

• Do you like Neil Young’s music? One scientist liked him so much that when he discovered a new species of spider recently, he named it Myrmekiaphila neilyoungi.

• What’s a sudden?  When someone says, “All of a sudden, the Examiner-in-Charge decided to give us a Cease and Desist” we know generally what he means, but do we really know what that noun sudden  means?  Isn’t all of a sudden kind of a weird phrase?  What’s wrong with just saying “Suddenly, the Examiner-in-Charge decided to give us a Cease & Desist”?   Actually, the proper English is “All of a sudden, the sunuvabitch decided to give us a Cease & Desist.”

• There’s a proposal in California to re-write the state’s unwieldy constitution, and one of the many components of the plan is to require drug testing for all members of the state legislature.  Isn’t that hilarious?  Don’t you love it when hypocrites can be uncovered.
• Speaking of  California , prison guards here can retire at 50 with a pension equal to 90% of their final years pay. There are hundreds of prison guards who make well over $100,000 a year, many who make over $150,000 with overtime. We wrote Arnold and asked how many made six figures, but we never heard back.
• We just read that Mary Travers of Peter, Paul and Mary died sometime last year. If you’re seeing this for the first time, doesn’t it kind of make you feel like a part of an era has passed?

• Cal professor Jack Gallant can literally read your mind.  He shows thousands of images to people while they’re in an MRI machine that reads brain patterns, and he measures and records the brains response to each image.  Later, he can ask you to think of something, and by measuring your brain waves through MRI’s, he can know with complete accuracy what you’re thinking about by matching brain wave patterns. While fascinating, it’s also scary.  You can only imagine what this could be used for 10-20 years from now.  On the other hand, you don’t need all this hi-tech science if you have teen aged boys. You already know what they’re thinking about, or you can at least narrow it down to 2-3 things. Maybe 1-2.
• Remember we quoted Fred Jackson that “If you get your deposit pricing right, you’ll find lots of good loans to make”?” meaning you won’t have to chase higher risk loans for their yield.  At the old Chino Valley Bank in Southern California , now CVB Financial, the cost of their deposits was 53 basis points last quarter. When your deposits only cost you 53 bps, you can make lots of money making only the safest loans.

• For all of you who are starting to plan for your June wedding, yes, getting married on a beach in Hawaii sounds romantic, but as the photograph shows, you might want to consider a church.
  

On the other hand, getting married in a Church doesn’t necessarily mean that everything will be perfect.  See http://www.youtube.com/watch?v=BLUYo-Nc4zg&feature=related It’s short and funny.· The photo above is interesting. The bride looks full of hope and love, but what’s going through his mind? (1) He might have just spotted the topless person to his  right and is wondering if it’s a he or a she, (2) he’s wondering when his wife will discover that his FICO score is on the wrong side of 500, (3) he’s a bank CEO who’s wondering how he’ll tell his Board he just got a CAMELS-5 or (4) he could be looking at his wife’s sister in the front row, wondering what she looks like naked. · Plans for our East Coast Client Appreciation Dinner are coming along. We’re looking at locations in Washington D.C. and Baltimore.  We’ll keep you posted. · And can we talk about John Edward’s love child for a moment? Was it the New York Times that broke the story? The Washington Post?  Heck no.  The National Enquirer has been writing abut this for months, and if you think newspapers are no longer relevant, look no further than this.  No industry that could break a story of such national importance will ever die.  Put another way, is this a great country, or what?

• To prove that  we’re serious lads here at Garrett, Watts , we  list the names of some famous people – and what their names were before they changed them.

It seems that many of the original names were just fine, and doesn’t Dino Crocetti sound so much better than Dean Martin? On the other hand, can you really fault Ralph Lipschitz?  High school must have been really hard for him. 

• Exactly two years ago, January 2008, California had 16.6 months inventory of unsold homes.  Today, it’s down to only 3.8 months of unsold homes.  This is the sort of thing that is an absolute sign that housing prices have bottomed out.  With such low inventory, people have already started over-bidding, and if you believe California is  a bell-weather for the rest of the nation, better times are around the corner.
• We were pretty disgusted when Goldman Sachs became a bank holding company just to get their hands on TARP money.  They somehow nabbed $36 billion in deposits, we suspect almost all are non-core deposits.  Their lack of loyalty to the banking industry was never in doubt, and with the new banking regs on the horizon, it wouldn’t surprise us to see them dump their bank charter pretty quickly.
• We have an idea.  Eliminate or sell FNMA Freddie Mac, and GNMA. They performed the job they were meant to do, which was to provide the liquidity needed to make home ownership more available. They  did the job well for decades, and recently they did it too well, buying or insuring loans of people desperately unqualified.  Instead, how about a GSE of some sort to do for infrastructure what FNMA did for housing?  It could buy or insure bonds or loans to finance the rebuilding of bridges, freeways, power grids,  windmill farms, and whatever other infrastructure our country needs.  It’s just an idea.
• Some of you sent you examples of people tolerating mediocrity.  One commercial banker wrote that “If 99.9% is good enough, then 22,000 checks will be deducted from the wrong checking account in the next hour.” A powerful message.

We’ve talked to many, many clients recently about tracking secondary market leakage.  Some can track it loan by loan, and others look at it on a 2-3 month rolling basis it.   Unfortunately, too many have never really thought about it.  But however you look at it, you need to be aware of it, watch it, and think about it.  It’s one of the 3-4 most important things you can focus on. See you later in the week.Special Bonus: How To Use Return on CapitalGarrett, Watts & Co.“Helping mortgage lenders increase revenues, control costs, and better manage risk.”

• Joe Garrett      (510-469-8633)
• Corky Watts      (408-395-5504)
• Mike McAuley   (281-250-2536)