The Garrett, Watts Report (New and improved Jan. 27th issue)

To Our Clients, Colleagues and Friends,

• Securities firm Keefe, Bruyette has identified 393 banks with Texas ratios greater than 100%.  If we assume that 75% of them will fail (our number, not Keefe’s), that would represent $141 billion in assets, and assuming a 25% loss ratio (our number, not theirs), this would cost the FDIC $35 billion.

• In the greater scheme of things, do you really care who appears on late night TV? Still, wouldn’t you like to get fired like Conan O’Brien and get a $40 million severance package?
  

• On this day in history, January 27, 1870, the first college sorority was formed as Kappa Alpha Theta at DePauw University .  And remember how Legally Blond made fun of sororities and caused a generation of girls to swear they’d never join one?  The TV show Greek now makes sororities look cool, and a lot of those girls are changing their mind.
• If you’re worried that you’ll be required to own 5% of every loan you sell, find something else to worry about. Congress is not going to allow something that would kill the housing recovery….. and housing itself.  Even if it did get passed, we guarantee you that some Wall Street firm would figure out how to securitize the 5% pieces.  Private funds would buy them, and even if they got bought at a discount, that would just be factored into what the borrower pays.  Of all the things people could be worrying about, this should be very low on the list.

• One of the clichés of business is that if you want to be highly successful, you should only hire people from highly successful companies. When we do searches, the first thing we do is ask the client which companies they admire most.  And assuming they’re not a client, that‘s where we do our initial nosing around.  Again, you build a successful company by filling it with people who’ve worked at and learned from successful companies.  We see too many companies who hire people they’re really impressed with, but where that person never worked at a successful company.    
• It’s easy for lenders to complain that mortgage insurers aren’t paying claims, but while the MI companies look at each claim carefully, they’re still paying out tons of dollars on claims.  For the recent two quarters, MGIC wrote checks for over $930 million dollars. We call that honoring your commitments.

• Last week’s failed banks had 70.2% of their deposits in CDs as compared to the industry average of 50.2%. An over-dependence on time deposits and too few transactional ones (i.e. checking accounts) is often correlated with banks in deep trouble.

• Business Week did an analysis of how the stock market did in the first year of a President’s administration.  Here are the top six and the bottom six.

Whether this means anything is for you to decide.

• If you’re highly dependent on refinances, do you have an exit strategy? What are your plans for what you’ll do when rates go up 100-200 bps and refinances drop by 80%?  We’ve seen too many companies hang in there month after month, losing huge amounts of money because they’re waiting for the market to get better.  We like to see companies define in advance what their criteria are for shutting down the business.  (a) One would be to define what your volume must drop to for a 2-3 month period before closing shop.  (b) Another one we like is to decide how much you’re willing to lose, as in:  “I’ve built up $8 million of net worth in the company, and I‘m willing to lose $1.5 million if the market gets bad.  But the moment it hits $1.5 million, I’ll shut the place down the very next day.”   
• Two more e-mails from clients about doing things the right way:  “My wife’s brother works at the IRS as an Inspector General, and he told us that if 99.9% is good enough, 2 million docs would be lost every year by the IRS.”  Another one was “I read your article (?) about settling for less than total accuracy and my wife works in a delivery room, and she told me that if hospitals made even 1% error rate, 120 babies a day would be given to the wrong parents.”
• We wrote about prison guards in California making $100-150,000 a year, and we got this from a friend in secondary marketing:  “Why does it cost $48,000 per year to house a prisoner in California ? We have all heard of outsourcing, right? Why not outsource the prison duties to a Chinese company, ship the guys there on a container-type ship and get it done for only $2,000 per year? No visits by family members? Oh well, book a flight to a remote part in China and see your loser relative. We outsource jobs to foreign countries and we even outsource service jobs to India , so what’s wrong with outsourcing something like this?”

• We mentioned last issue that SoCal bank CVB Financial has a cost of funds of only 53 bps and that you could make good money just doing the lowest risk loans if you have cheap deposits. We looked up some Treasury yields, and while we don’t like investing short term money into long term instruments, we see that 30 year Treasuries are yielding 4.58%.  So how about a nice 4.05% net interest spread of 4.05% (4.58% – 0.53% = 4.05%) with no credit risk? Don’t want to take on any interest rate risk?  Then buy ten year TIPS at 3.92% and earn a net yield of 3.39% with no interest rate risk and no credit risk.
• We heard that one of the mortgage companies just cut off by FHA was charging $20,000 in fees on a $200,000 loan and targeting low credit borrowers, many who just walked away from their mortgages within months of closing.  Lots of complaints of bait and switch, and when the loan was closed, a $200,000 mortgage would be “Rate/Term” refinanced with a new principal balance of $220,000 with all the fees, etc. They supposedly owned the title company that handled the transactions and they charged 2 to 3 times the going rate of other title companies. This is what someone told us, but we’re not naming names because it’s just someone yapping away at this point.
• When the Berlin Wall fell, the Berlin Symphony gathered and played Beethoven’s Ode to Joy. We find it very emotional, the combination of the politics and the music:   Interestingly, this piece is now the national anthem for the European Union.  And here’s a short video from when Bulgaria was admitted to the EU.  If clicking on these doesn’t work, just cut and paste ‘em.
• · We were sorry to see that Philadelphia ’s symphony will probably file for bankruptcy.
              To be taken seriously, a city needs a decent newspaper, a major league baseball team, and a good symphony orchestra. And good Chinese restaurants.
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  We’ve written a lot lately about leakage, and we’re going to keep writing about it till everyone gets serious and starts tracking it.
  We were brought in for a FOCIS-plus by a New England company which made less than 30 bps in 2009. We looked at over 70 parts of the company, tore it apart and put it back together again.  The conclusion was staring us in the face.  They built in a very nice margin, but they just weren’t realizing it.  They had recently started using Secondary Interactive (SI), a hedging advisory service we think highly of.  In fact, the most profitable company we’ve been in all year – pretax earnings of over 120 bps – uses them for hedging.  So we flew back East and had SI’s Don Brown meet us there at the client’s offices.

The meeting took less than four hours.  We had isolated the earnings problem to leakage, and SI pointed out precisely what they needed to stop doing, and what they needed to start doing.  If this company changes absolutely nothing else about their operations, if they do just what SI told them to do, they’ll be enjoying good earnings within a month.
The patient came to see us as the General Practice doctor because they didn’t feel well.  We found out what the problem was and brought in a specialist.  We’re 95% certain these guys will be doing just fine by the end of February, and if so, this is precisely what we love most about what we do.
We got somewhat criticized for writing see you next Tuesday, so we’ll just say that we’ll see you sometime soon.

Today’s Bonus:  Private Equity Tombstone

Garrett, Watts & Co.

“Helping lenders increase revenues, control costs, and better manage risk.”

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