The Garrett, Watts Report (March Madness issue, March 23, 2010)

To Our Clients, Colleagues and Friends,

What’s one of the most important things to look at during Due Diligence on an acquisition target? Investor scorecards have a huge amount of information on the mortgage banks that sell them loans, and these scorecards may be the one, best way to get a quick, broad picture the company. They don’t preclude the need for full Due Diligence, but they’re a good start.
Since we started Garrett, Watts in 2003, and prior to that as bankers, we always said that you can’t manage it if you can’t measure it, and one of the many things to concentrate on this year is better reporting. It didn’t matter as much last year. Everyone made tons of money, regardless of how good or bad their reporting was. With profitability much tougher this year, now is the time to slice and dice your business in all the ways that allow you to make better decisions.

A key part of our FOCIS-plus Review is to provide companies templates of reports that allow you to understand more about your business than simply how much volume you did and how much money you made. So remember two things (1) You can’t manage it if you can’t measure it, and (2) You’ll make better decisions with better data.
What’s really frustrating for us is related to Game Theory, the academic discipline having to do with how organizations and people make decisions based on incomplete information. What really bothers us is that mortgage bankers have all the data somewhere in their systems needed to make better decisions, and very few take advantage of this. It’s all about extracting it from your systems (DataTrac, Point, Encompass, PC Lender etc.) and presenting it in a way where you can spot trends, anomalies, and red flags. The templates we mention above are one way of solving this problem.
After years of being on the Board of Directors of banks or working with them, we’re fully aware that Boards can be very much like a cat who sits on a hot stove. As Mark Twain wrote, the cat will never again sit on a hot stove, but neither will it ever sit on a cold stove again. In this vein, we spoke recently to an East Coast bank-owned mortgage company which had tried switching to mandatory, took some initial losses, and went back to best efforts. A little probing made us fairly convinced that it wasn’t bad hedging but was actually weak controls and poor pipeline management. We also got the sense that the Board’s attitude was not to investigate what happened but to take the attitude that they will never try selling mandatory ever again. Secondary marketing forensics is not easy, but it can be done, and this Board should have investigated what really happened.
A commercial banker whose bank we recently advised on setting up a Mortgage Warehouse Lending told us: “We’re sure as hell not going to do any construction lending, and my Chief Credit Officer would have a heart attack if I brought him a commercial real estate loan, I don’t care how good it is. There’s hardly any good C&I loans anymore, and if there’s some company out there making money, Wells Fargo’ll be all over them in a minute with better terms than we can ever dream about, so what am I left with? I’m left with Zip, that’s what I’m left with, and after all these years, that’s a helluva note. ”
That’s why this banker now loves Warehouse Lending: “Hell, these damn mortgage bankers are the only decent credits left for a little guy like us. They made loads of money last year, they’re flush with cash, and the damn lines are secured by loans that’ve already been sold, for Pete’s sake. I love it, I just love it, and my Board thinks I’m a damn genius.” Take a look at the attachment to learn how your bank might get into Warehouse Lending.
Grammar alert! Grammar alert! When our friendly banker said “There’s hardly any good C&I loans anymore” that was his language, not ours.
By the way, we gave out free subscription extensions on this newsletter to 26 Honorary Grammar Policepersons. The poor grammar last week was when we wrote “We were speaking to a company in the Pacific Northwest which plans to build their own software.” It should have been“…which plans to build its own software.”

Strunk & White is a book on grammar that we used in 9^th grade back in, gasp, 1963, and it’s still a great book that all writers should have. In 1967, there was even a San Francisco band named Elements of Style.
We just read on article in The Atlantic on Treasury Secretary Tim Geithner, and his background is interesting. He was born in Brooklyn, but when he was very young, his father joined the State Department and young Geithner grew up in Rhodesia (now Zimbabwe), Thailand and India. He returned to the states, went to Dartmouth (go Indians!), and got a graduate degree at Johns Hopkins.

Remember when it was called The Atlantic Monthly? They dropped the word monthly when they cut back to only ten issues a year. It’s now justThe Atlantic .
We came across the attached servicing growth announcement from 1992, and aside from 1^st California Mortgage, the Sequel, are any of these companies still in business?
We wrote last week of a Pacific Northwest company that was developing its own software, and we got this response from a mortgage industry veteran we know and respect: “I think companies who think they have to build their own software have overpowering CTOs in place who speak big and deliver slow…. and once the company has dumped millions into the software development, they can’t back out of the commitment. I’ve seen a number of companies roll out their new software only to regret it within a short period of time. Without a doubt one of the biggest wastes of time and money I have personally seen. Crazy.”
If you own stock in Raiffeisen International Bank, you just got an e-mail noting that they’re merging with another Austrian bank and that they’ve retained Deloitte Auditrei Wirtschaftsprüfung GmbH. That’s one mouthful. By the way, Raiffeisen has banks in, Romania , Bulgaria , Poland , Hungary , Czech Republic , Slovakia , Croatia , Bosnia , Ukraine , Serbia , Russia , Belarus , Moldavia , Kosovo, Slovenia and Albania . It’s a single-stock way to participate in the growth of all of Eastern Europe .

We went to their Investor Conference in Kiev a few years ago and about 20 of us had dinner with the Chairman. About every three minutes he insisted that everyone have another shot of vodka. Their website is actually pretty interesting http://www.ri.co.at/index.php?id=261&L=1 and this photo is of their executive team, with Dr. Stepic, the guy who kept pouring the vodka, 2^nd from the right.

Three things: (1) Did you notice all the women in their senior ranks, and (2) check out their suits. Doesn’t it look like most of them are wearing pants a few inches too long? And (3) Doesn’t it also look like the two guys who showed up without red ties were positioned as the bookends?

Saturday classes seem not to have been an only-at-Dartmouth barbarism, as we heard from people who remember them at Vanderbilt and Randolph Mason College . By the way, does anyone remember parietals, lock-outs, and in loco parentis ?

And what’s the deal with holiday-only foods? Why can’t we have eggnog in any month other than December? And what about yams with semi-burnt marshmallows on top? Why only on Thanksgiving, on just one day of the year? Curious minds want to know.

· Watching tiny Saint Mary’s College (28-5) knock off Big East powerhouse Villanova had us jumping up and down and shouting at the TV. Sports writers will probably make this a Cinderella story, a cute, little team that found magic and wakes up to find itself deep into the NCAA Tournament. This isn’t just luck, and Villanova coach Jay Wright said “The Gaels can play with anybody in the Big East. There’s no doubt.” The Wall Street Journal wrote that Saint Mary’s is a “….California school that has five Australians on its roster, some of whom look like they just walked out an East Village bar.” We first watched The Gaels (a Gael, is an Irish warrior) in 1958 when they had All American Tom Meschery. We were too young to know what was going on, but we’ve followed them ever since, and in some ways rooted for them more than Cal .

· Although the Jason Kidd-Lamond Murray teams were fun to watch, Cal ’s basketball teams have disappointed more often than not. Our senior year at Cal featured a team with three future NBA stars, yet they went only 14-15.
Since we’re currently all excited by Saint Mary’s College, a bit of fun trivia is that the actor who played Duke onHawaii Five-O was Herman Wedemeyer, an All- American running back at Saint Mary’s in the 1940’s. His ability to avoid tacklers earned him the nickname Squirmin’ Herman. Book’ em, Danno.

Ferris Bueller 48? Yes, Mathew Broderick turned 48 last week.

This is one of the all-time best laugh-hard, feel-good movies, and while it’s not quite a coming-of-age movie, it’s probably among the top 5-6 movies about life as an American High Schooler. French social critic Jacques Barzan once wrote that you cannot understand America unless you understand the American high school experience, and this movie capture it perfectly.

We have a great idea for someone whose son or daughter is looking for a good senior thesis. It would be to study the accuracy of Congressional Budget Office projections. A year or so ago, we read an article, possibly in Barrons, where the CBO had really missed the mark on the cost of two programs and how those programs really came in much lower. One was the Medicare program to pay for drugs, and they just really overestimated what it would cost the government. Anyway, someone could take all CBO projections from, say 1990 – 2005 and compare them to what really occurred.
Financial historians will probably debate TARP for years to come, but one positive that might have come out of it is that TARP money seemed to give investors the confidence to invest in banks. Perhaps this table demonstrates the point.

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At the beginning of this newsletter we wrote about Due Diligence and investor scorecards. We’ve done Due Diligence on very small companies being acquired where it took only one of us two days, and we’ve also done it on much bigger transactions, some of which had servicing departments, where it took three of us a full week. Not always, but usually, we uncover things that the buyer had no clue about. And when the acquiring company is a bank or thrift, we try to pay particular attention to those areas we know the regulators will look at.

Cheers!

Garrett, Watts & Co.

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