The Garrett, Watts Report (March 26, 2010)

To Our Clients, Colleagues and Friends,

Attached is a very interesting Interagency Policy Statement on Funding and Liquidity Risk Management. Interagency means it’s issued by the OTS, the OCC, the Federal Reserve, the FDIC, and the National Credit Union Administration. Skip all the boring stuff at the beginning and go right to page 19. Although the document is a “guidance”, it doesn’t mean you might want to maybe think about it. We always took guidance to mean we’d damn well better do it. Either that or get slammed in the next Safety & Soundness Exam.
We got a great suggestion regarding this photo. This contest is to come up with a thought bubble to be the caption for this photo. Come up with a good line for what Geithner is thinking, and we’ll enter you into a sweepstakes, one in which the winner just might have Ed McMahon knocking on your door with a prize. By the way, is Ed McMahon even alive?

And does anyone know what ever happened to Ed McMahon’s home? A year or so ago he was being foreclosed on.
We ran a little item on the book Elements of Style last week, and we were really surprised at how many people wrote in about it. About 25-30 of you wrote us how much they loved the book. Same here.
From an article in the Rocky Mountain News. “For customers, Wells Fargo would be able to attend to their business to the ends of the earth if required.” That’s from an 1866 issue of the paper. If you think about it, the Wells Fargo brand and reputation have been in the making for almost 150 years.

It’s kind of faint, but the sign on the top of the building says Wells Fargo & Co.
By the way, isn’t there an argument to be made that Wells Fargo no longer exists? Legally, Norwest bought Wells but then kept the name. Does it even matter?
One of the items that resonated during the final weeks of the fight over Health Reform was when Anthem Blue Cross raised their premiums by 39%. Great timing there, Blue Cross. In the history of corporate public relations, has there ever been worse timing?
Many of you remember Lauren McSorley from her days at WAMU’s warehouse lending group, and Lauren wrote us that “I am raising my daughter Madden (19 months old now) and I’m 7 months pregnant with baby girl #2!!!” She adds that “I have never had a job that required more patience on a daily basis but I love every second of it.” Hmmm. We don’t recall her ever being that enthusiastic about the warehouse lending business!
We must have been bored, but we actually read the annual report on the Schwab Cash Reserves money market fund. Lots of their holdings were recognizable (Federal Home Loan Bank, Deutsche Bank, Chase, etc.) but there was a lot of stuff with names like Falcon Asset Securitization Corp., Starbird Funding Corp., and Tulip Funding. We’re sure they’re fine, but remember how mortgage securities would get generic, meaningless names like these? Maybe we’ll call them and ask. By the way, this $31 billion fund is yielding 0.07% (as in seven bps), after Schwab pays itself 47 bps.
In 2004, Iranian President Rafsanjani bragged that an Iranian nuclear attack on Israel would kill 5 million Jews. He estimated that if Israel retaliated with nuclear weapons, Iran would lose 15 million people, and he went on to say that this would be a small “sacrifice.” Even if a nuclear Iran doesn’t bomb Israel , it would alter everything by their simply and repeatedly threatening to launch a nuclear attack.
And isn’t he referred to as a moderate Iranian? What’s wrong with the leadership there? Under the Shah, Iran had very good relations with Israel .

San Francisco mayor Gavin Newsom pushed through a law a few years back to encourage taxi cabs into using hybrid engines or other less-polluting fuel. We just read that 57% of all cabs in the City by the Bay are now green. Very cool.

And doesn’t our Mayor have the kind of hair even Mitt Romney would be jealous of?
A year or two ago, 90% of our FOCIS-plus Reviews were for mortgage companies or their Warehouse Lenders. Interestingly, it’s about 50-50 now between those two v. banks and thrifts that have mortgage banking operations.
The Temporary Liquidity Guarantee Program (TLGP) turned out to be pretty huge. Under TLGP, the FDIC insures non-interest-bearing accounts above the $250,000 limit. We just read in the FDIC Quarterly that this program has brought in $834 billion in non-interest-bearing transaction accounts. Banks can make a lot of money when given deposits for which they pay zero interest.
We’re in Seattle 15-20 times a year, but we practically never cross the lake over to Bellevue . We were there last week, and hey, when did all those big buildings go up? It seems like only yesterday none of them were there.
There‘s some talk about doubling the number of teams in the NCAA basketball play- offs, and does that really make sense? There are 347 NCAA Division 1 teams and if they go from inviting 64 teams up to 128, it would mean that 37% of all teams would go. Wouldn’t that make it all kind of meaningless?
Here’s a very interesting research article titled “Troubled Banks: Why Don’t They All Fail? Skip all the statistical mumbo jumbo (“Predictions of Unordered Multistate and Bivariate Models”, whatever the heck that means) and go right to the graphs at the end. It’s easy to assume that most CAMELS 4 & 5 banks will fail, but there are some interesting events that can occur among these troubled banks that correlate with non-failure.
Now that no one trusts airlines with their luggage, it takes forever when people try to board the plane and try jamming their suitcases into the overhead bins. We have a solution!! The people without carry-ons get on and off first! Simple, brilliant, elegant. This should speed things up a ton. We think this is so brilliant that we just might nominate ourselves for a Nobel Prize of some sort.
Have you ever wondered how much Hollywood spends on those scenes where about ten cars get smashed up in a chase scene? Well, we’ll tell you. The first SBA loan we did at Sequoia National Bank 10 years ago was to San Francisco ’s 2^nd or 3^rdbiggest taxi cab company, and they told us what they did with cabs that got too old to operate. They’d sell them to movie companies for $25 each where they’d get re-painted colors other than yellow, and these would be the cars used in crash scenes.
We also remember something else from doing that loan. It was a big loan, right around $1 million, and we sold the guaranteed piece for 110. That’s ten points! Not ten basis points but ten points. The loan officer got a half point commission, we netted something like $80,000, and we kept the servicing, which threw off 50 bps of annual cash flow. We also got the company’s non-interest bearing checking accounts. Is this a great country, or what?
There are completely legitimate arguments on both sides of the health care debate, but what we find intellectually disingenuous is people who say that any government involvement in health care will be a disaster that will only hurt the patients. Wait a minute. What about VA hospitals? What about Medicare? Haven’t these been monster success stories? If people think these programs are so horrible, they should publicly declare that they will not sign up for Medicare when they turn 65 and that they’ll have their parents immediately cancel their Medicare coverage.

And what about those lawsuits asking the courts to declare the new legislation unconstitutional because it is “an unprecedented encroachment” on the rights of individuals? Well, here in California it’s illegal to ride a motorcycle without a helmet, and everyone who drives a car is legally forced to have auto insurance. Are these encroachments on certain rights? Yes, absolutely, but somehow life goes on. Maybe, just maybe, for the better.

We did some work for Firstrust Bank last year, and the history of this bank is a testament to the tradition of great family-owned banks. In 1934, on New Years Day before you could spend the whole day watching football, Samuel Green founded the bank in South Philadelphia . His son, Daniel Green, took it over in 1970, and for the last 15 years, his grandson, Richard Green, has run it. Family-owned banks have a deep sense of dedication to the community they serve, and they’re a rich part of the American banking landscape.

This photo is of Samuel Green, the banks founder, and his son Daniel. Firstrust today has over $2.3 billion in assets!

· We hate to sound like a nag, but what are you doing to track your leakage? If you’re building in a profit of, say, 150 bps on FHA loans, are you realizing those 150 bps when the loan is purchased? We see companies that will build in 150 bps, and on average only realize 70-80. The reasons are varied, but not getting the margins you build into your pricing is almost always one of the biggest reasons for a company that’s doing poorly. We do a lot of detective work on this issue, trying to figure out what causes this leakage, and lately we’re seeing credit overlays as a big source.
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From a loan a mortgage banker we know: “It’s interesting that the Garrett, Watts Report mentioned parietals, in loco parentis and lock-outs! Freshman year at Temple we had curfews and at the end of the year for the first time had a weekend when they had open visiting hours and female students could visit a male student in their room for one hour with the door open! There was a rule about one foot on the floor if sitting on the bed as well. My roommate that year had been expelled from another college the prior year for not making curfew and had to start all over again at my school as a freshman. We even had drills in the middle of the night where attendance was taken!”
Our freshman year at Dartmouth was filled with stories of students expelled – not suspended by expelled – for having women in their rooms. After transferring to Berkeley , the walls started crumbling fast. Parietals were the complex set of rules of behavior for when male and female students visited each other, and Lock-outs meant that if that a coed didn’t make it back to the dorm by curfew, she was locked out and couldn’t sleep there. Was this stupid or what? As guys, we were always trying to bring our dates home late. If our date were locked out, heck, well, gee, I guess you’ll have to spend the night at my place.
In the dorms (where we lived for one quarter), they tried an experiment. On the last Sunday of each month, girls could be in the boys’ rooms from 3:00 to 5:00. The door had to be open the width of a book, which we always defined as the width of a match book. And yes, they literarily required that at least one foot per person had to be on the floor (as opposed to the bed) at all times.
This lasted a month or two till someone burned down the school’s Naval Architecture building as a means of ending the war in Vietnam . Riots and tear gas were the daily norm, and the school decided the hell with trying to enforce parietals, curfew and the number of feet on the floor.
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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.
See you guys soon. And remember to always keep at least one foot on the floor.

Garrett, Watts & Co.
Helping lenders increase revenues, control costs, and better manage risk.