The Garrett, Watts Report (February 25, 2010)

To Our Clients, Colleagues and Friends,

Corky and I were Compass Analytics users for years back when it was called Tuttle & Co., and as great a hedging advisor as it was then, it may even be better today. One of the many things they track for clients is the spread between best efforts and mandatory pricing, and we recently looked at their numbers for all of 2009. The spread was as follows:

2009	High – Low	Average Differential
1^st quarter	160 – 62	117
2^nd quarter	72 – 60	65
3^rd quarter	55- 45	50
4^th quarter	43 – 41	42

The first quarter for 2009 was crazy insane, and many of our clients made as much money selling on a mandatory basis in the first quarter as they did the rest of the year.

If you were a Compass user back in the early 90’s, you probably remember Art Yend, Ray Knapp, Lenny Auerbach, Rob Chrisman, and, of course, Paul Tuttle. Last week we stated that one way to measure a company’s greatness is to see how many industry leaders came from its ranks. By this measure, Tuttle/Compass was an amazing success, with the hedging and secondary world being populated with tons of ex-Tuttle employees.
We remember one Safety & Soundness Exam years ago where the Examiner-in-Charge was going through our hedging techniques. We were a Compass user, and their reports were detailed, comprehensive and easy to follow. We spent an hour with the EIC going over how we hedged, and after listening patiently, she started flipping through her notes and asked, “Um, yeah, like back at the beginning you used the term ‘being short” and then you said something about “being long.” I’m not familiar with those terms, so like, can you can explain them to me.” Uh oh.
Do you ever write to politicians? If you do, don’t use e-mail. Ask their staff members and they’ll tell you that almost no e-mail is actually read. If you want your letter read by a decision-maker, do it on hard copy and send it by mail.

The San Francisco Bay Bridge was damaged in the 1989 earthquake, and they’re still rebuilding it 21 long years later. We were throwing out some old papers and came across an article with the headline “Red Tapes Holds up New Span of Bay Bridge.” Doesn’t that strike you as funny, as if it’s being held together by some sort of red-colored tape? If you care about good syntax, you can drive yourself batty with all the poor writing out there.
Remember last week our writing about Bank of Commerce that got a CAMEL 1 but with a 2 rating for management? Here’s an e-mail from their CEO Pete Davis: “Hey, that was us!! Actually the regulators wanted to give the bank a CAMEL 2. This was after years as a 3 and even a 4 — so they thought they were doing us a favor. When they finished going over the report with us, they asked if we had any questions and I said “What’s the appeal process?” They were shocked as was Gary (the CFO). They said they’d get back to us, and when they did, the bank had an overall CAMEL #1, but management a #2. When Gary asked about this they said it was because Management was not receptive to regulatory counsel. The Bank sold for 5 times book less then a year later, so fighting this was moot. Besides we had gotten the Camel #1.” Is this a great story, or what?
We just read that the University of Oregon women’s basketball team is being coached by Paul Westhead, and we wish we knew earlier so we could watch them. He’s coached men’s college teams as well as winning championship in the NBA, and his up-tempo, run-and-gun teams are always great fun to watch. His philosophy is simple: (1) Forget about defense. If you take more shots than the other team, you’ll win, and (2) if you’re in better condition than the other team, you can run them till their exhausted. When he coached men’s basketball at Loyola Marymount in Los Angeles , his 1989-90 team went 27-3 and averaged 122 points per game! They scored over 140 points in eight games, beating Michigan 149-115, Saint Mary’s 150-119, and the University of San Francisco 157-115. He had a rule that the offense only had seven seconds to get the ball up court and get a shot off. Here he is in his Oregon t-shirt.
There’s a company that helps lenders fight investor re-purchase demands. It’s Resolution Portfolio Management & Oversight in Boca Raton , Florida (866-661-4776). We don’t know anything about them, so if anyone out there has used them, please let us know what you think.
We found this funny, the part about gay termite control experts: “We need knowledgeable, professional gay or gay-friendly real estate agents, brokers, mortgage lenders, home appraisers, insurance agents, home inspectors, pest and termite control experts, professional painters……and so much more, who would look forward to serving our gay community.” http:///www.gayrealestatedirectory.com Gay termite control experts just strikes us as funny.
We’re endlessly fascinated by the role the bank Directors should play, and our latest thoughts are how Director education can be such a tricky area. There are some areas that are so complex that there’s no way a Director can be expected to learn them. Think about all the financial engineering of the past few years, the derivatives, the derivates of derivatives, the swaps, the options, the swaps on options (they’re actually called swaptions) , the CDO’s and the CMO’s and on and on. If you have the President of a manufacturing company on your Board, or perhaps the head of a community based non-profit, can they really be expected to ever understand this? Of course not. Some of these instruments may be inappropriate for your bank, but some serve a legitimate purpose, so how can your Directors know which is which? The answer is multi-sided, but this is an example of things that Board members simply aren’t going to ever really understand, no mater how good your Director Education might be.
So what should they be doing? We think they should look at the overall risk in the bank, and one such example is one of the basics of risk, this being leverage. Our recollection is that when Lehman fell, they had leveraged their capital 32-to-1, while most other Wall Street firms were leveraged around 15-to-1. Were Lehman’s Directors aware of this? Above all else, they should have been aware. This could be a perfect example of a broad policy where the Board sets the maximum leverage ratio and where this might take care of their not understanding many of the truly complex details of the banks operations. They may not understand Inverse Floating Collateralized Mortgage Obligations, but they can certainly under the maximum leverage that management is allowed. The key is to find the limited number of metrics that (a) are critical to directing the bank and (b) that can be understood easily by your Board members.
Banks and thrifts reported an aggregate profit of $914 million in the fourth quarter of 2009, a teeny, tiny amount but a huge improvement from the $37.8 billion loss the industry suffered in the fourth quarter of 2008.
More than half of all institutions (50.3%) reported year-over-year improvements in their quarterly net income. Almost one-third of all institutions (32.7%) reported net losses for the quarter, down from 34.6% a year earlier. All this data is from the FDIC Quarterly Banking profile, a copy of which is attached.
The FDIC’s liquid resources (cash and marketable securities) increased to $66 billion at year-end, up from $23 billion at the end of September. That might not be enough if some really big banks fail, but it should be enough if most bank failures continue to be the smaller institutors.
With Opening Day not too far away, we get to delight our clients who are baseball fans and bore the rest of you, so here’s a good one. Q: What pitcher holds the record for striking out ten consecutive batters? A: It was Tom Seaver who struck out 19 Padres in a 1970 game, ten of them in a row. Can you imagine how exciting that must have been if you were in the crowd?
This week’s cartoon is dedicated to all those who bought their homes near the top and who think it might still fetch an okay price.

· Movie critic Pauline Kael once wrote of Cary Grant: “We smile when we see him. We laugh before he does anything. It makes us happy just to look at him.” We were watching the Dave Chapelle show the other night, and we thought you could say the exact same thing about him. He may have the most engaging smile of anyone on this planet, and his humor is original and brilliant. This photo doesn’t do him justice, but when he walks on stage, don’t you feel like you and he could be great pals?

When people talk about the Third World , we know this means developing nations or emerging markets, (they used to be called under-developed nations but that was considered insulting). Anyway, the poor countries were the Third World, the West (The U.S., England etc.) was the First World and the Commies were considered the Second World . Foreign policy expert Leslie Gelb has come up with a new hierarchy he calls the Pyramid of Power with the U.S. alone on the top. The second tier contains Eight Principals: China , Japan , India Russia, the U.K. France, Germany and “just barely” Brazil . Below them are the Oil and Gas Pumpers. In the fourth tier are Regional Players like Mexico , South Africa , and South Korea . Next are the Harmless Responsibles (i.e. Switzerland , Singapore , and Norway ) and finally, in the 6^th tier are the Bottom Dwellers, like Zimbabwe , Sudan and the like. A good way for ordering the world.
For those of you haven’t gotten around to calculating your break-even, wasn’t January a sort of a proxy of a breakeven analysis? With volumes down 30-50%, many clients came face-to-face with what their earnings looked like when volume drops dramatically. It was a real wake up call for a lot of people we know.
Bernie Madoff’s daughter-in-law, Stephanie Madoff, has petitioned the court to change her last name to Morgan. She explained to the judge how difficult it was having the name Madoff. No kidding!
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Not much traveling the next week for us, so we’ll see you soon. We like staying in touch this way.

Garrett, Watts & Co.

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