The Garrett, Watts Report (March 11, 2010 and aren’t you getting sick of Winter?)

To Our Clients, Colleagues and Friends,

• We made reference last week to Marion Berry snorting crack, and you wouldn’t believe how many people wrote us that you smoke it and don’t snort it.  One who wrote us is a major name in warehouse lending, another one a top secondary marketing executive, and one is a bank President. How do they know this sort of stuff?
• With all the moving and shifting, here are the most recent numbers on the largest banks ranked by size:

A few others you know are #12 U.S. Bancorp ($265 billion), #17 BB&T ($165 billion), #23 Fifth Third ($110 billion), #33 Comerica ($59 billion), #82 Sterling Financial, Spokane ($11.9 billion).

• A good example of how much access banks have to non-deposits funding sources is the Bank of America.  Although they have $2.52 trillion in assets, they have only $976 billion in deposits.
• The Wednesday Wall Street Journal was chockfull of items meant to assist those involved in business and finance. On page D-3 we learned that breast augmentation beat out liposuction, 311,957 to 283,735 as the most popular surgical procedure for the second year in row. Interestingly, buttock augmentations beat out buttocks lifts, 4,996 to 3,024. And no, we don’t have any idea what a buttock augmentation is or why someone would want one.
• Between the Marion Berry crack item and everything-you-never-wanted to know about buttocks augmentation, we have only one question:  Why do you read this trashy newsletter?
• Top bank research firm Keefe, Bruyette has identified 21 distinct periods of bank performance starting in the early 1960s.  Outperformance periods averaged 34 months in length, during which bank stocks outperformed the market by an average of 20.8% annualized. The under-performance cycles averaged 23 months, during which bank stocks lagged the market by 20% per year, on average. Our view is that an outperformance for small cps banks is just around the corner.
• We just looked at the schedule for the Cal football team in the Fall.   They open September 9^th against UC Davis, and all we can say is, uh oh. We predict that Cal will win by more than 50 points.

• The Mandatory/Best Efforts Spread in February averaged 38 bps with a peak of 48 bps and a low of 33 bps.  We also tracked it the last 11 days, and it was 41 bps. There are many, many companies that should stick to best efforts delivery, maybe most companies, but for those capable of hedging, tracking and of being disciplined, this pick-up can be a big contributor to earnings.
• We were looking at a Private Placement Memorandum for up-and-coming Seacoast Commercial Bank in San Diego .  One interesting piece of this turnaround situation is that they’ve sold $9.1 million of the guaranteed portion of some SBA loans and realized a gain of $780,000. That’s a nice, round 8.5 point gain. And by the way, there’s no such nonsense as giving SBA loan officers a 60-40 split like in residential. SBA lending can turbo-charge a bank’s earning faster than anything else we can think of.
  
• From 1961 through 2010 year-to-date, bank stocks rose slightly less than the S&P 500, 5.6% versus 6.2% per year based purely on stock price appreciation. Once we consider dividends, on a total return basis, large-cap bank stocks have returned 9.9% annually versus 9.6% for the S&P since 1961.
• Let’s pretend you’re a bank and you’re funding mortgages today with Fed Funds.  Fed Funds will cost you 16 bps, and let’s say you’re closing 5% loans.  Your spread while you hold them in warehouse is 4.84%, and let’s assume you’ll hold these loans for 15 days before they’re purchased.  On a $250,000 loan, that comes to $33.15 per day, which comes to $497 in net interest income for the 15 days. That’s an extra 20 bps, just from the cheaper funds. If you do $50 million a month in volume, you’ll make an extra $100,000 that month. Realistically, you’re not going to fund all your loans with Fed Funds, but you get the point.
• Let’s instead look at the same numbers above and assume you fund your mortgages with deposits costing 1.25%.  You’re picking up 15 bps during those 15 days, and on the $50 million that funds that month, you’d make an extra $77,000 by holding them 15 days.  Want to make an extra $5,000 to put to the Christmas Party?  Just ship your loans on the 16^th day instead of the 15^th day.
• We know we sound like a broken record, but don’t be fooled by how many dollars your company made last year.  Look at your pre-tax earnings and divide that by your total volume.  If you made less than 65 bps, you were below average.  If you’re okay with being average, God bless you.  If you want to do better, we can probably help.
• Have you noticed that the music on TV ads isn’t what it used to be?  We can remember the 1812 Overture for Quaker Oats Puffed Rice (the part where the cannons explode).  The Loan Ranger had The William Tell Overture,and Malto Meal had that classical piece, maybe Berlioz, with the words added about how “Winners……. wake up with Malto-Meal.”  Can anyone remember any others?
• Here are some selected prices, today and a year ago.  We don’t know if there is any deep meaning in these numbers, but it sure looks like there may be some inflation heating up.  By the way, we don’t bother to describe all the details of the type or unit of measurement.  For instance, there’s Wheat, hard, Kansas City and there’s Wheat, No. 1 soft white, Portland , Oregon .  We have no idea what this means so we just chose whatever seemed logical.  Notice how, except for wheat, everything’s really gotten more expensive.

• In the last six months we helped nine different banks start up Warehouse Lending operations.  All are extremely small banks lending only in their own back yard, but what’s really pleased us is that five of them are already funding loans and a sixth will start next week. Two are still a month or two away from going live, and one has it hold due to regulatory issues.  We can’t wait to get to see their six month numbers.  The two who’ve been doing it the longest have shown us their metrics, and they’re generating an ROA in excess of 2% so far.
• How about all those new licensing regs?  Probably a good thing to get the sleaze balls out of the industry, but it sure is bitter medicine, isn’t it?
• One of the bad things about living in or near San Francisco is that you don’t get to stay in the hotels here.  The Palace and the Ritz-Carlton are just two of many magical hotels in the City by the Bay.  Anyway, the average daily room price fell from $190.12 two years ago to $160.27.  Come on out, stay in one of the great hotels here, and we’ll take you out for a drink.

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This week’s cartoon is dedicated to all parents whose kids didn’t get into Harvard, or even apply. And doesn’t it seem like only yesterday when we’d stand there and just watch them sleep in their cribs? Crawling amazed us, and walking blew us away.  Remember when they started to talk? And then there was nursery school, elementary school, and middle school, and the start of secret crushes and dance lessons.  High school was real dances, a first date, a driver’s license and proms. And for those whose kinds were born in 1991-92, there are the letters coming in from colleges right about now.  We get excited at the acceptance letters, but we wonder what it will be like when they actually get on a plane and head off to college. They’ll get their degree and get a job, and eventually, they’ll have their own family.  Joni Mitchell called it The Circle Game:

“Sixteen springs and sixteen summers gone now. Cartwheels turn to car wheels thru the town. And they tell him, take your time, it won’t be long now, till you drag your feet to slow the circles down. And the seasons they go round and round, and the painted ponies go up and down.  We’re captive on the carousel of time.  We can’t return, we can only look, behind from where we came, and go round and round and round, in the circle game.”  The complete lyrics are attached.

We’ve also attached a lengthy but fun article for you new-comers to the Garrett, Watts Report. Page 3 has a small blurb about the time Garrett, Watts Partner Joe Garrett (that’s me!) went out with Joni Mitchell once. Sort of.

Garrett, Watts & Co.

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

• Mike McAuley   ([email protected] )
• Corky Watts      ([email protected])
• Joe Garrett      ([email protected] )