To Our Clients, Colleagues and Friends:.

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· We were just reading the Wells Fargo presentation from the Dec. 12 Goldman Sachs Financials Services CEO conference.  Here’s one tidbit we found of great interest.  Of the $71.5 billion in HELLOCS they plan to hold in portfolio, a full $11.5 billion (16%) are HELOCS in first lien position.  If you’re ever stuck sitting next to us on a long flight, ask us why we think a 1^st lien HELOC is the ideal mortgage for almost all borrowers.

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· Listed below are the biggest European banks by market cap in dollars.

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$203   HSBC  ( U.K. )

$96    Royal Bank of Scotland

$133   Santander ( Spain )

$95    UBS

$113   Unicredito Italiano

$91    BBVA  ( Portugal )

$ 99   BNP Paribas (France)

$82    Barclays  ( U.K. )

$ 98   Intesa  Saopaolo  ( Italy )

$81    Societe Generale (France)

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We were a bit surprised to not see Deutshce Bank ($61 billion) on the list. We thought they were bigger. And by comparison, Citigroup has a market cap of $151 billion and the Bank of America is at $186 billion.

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· And how about City Bank in the Seattle area?  Are there any banks with more impressive numbers? (a) A net interest margin of 7.56%, (b) an efficiency ratio of 22.4%, (c) a return on average equity of 20%, and (d) a jaw-dropping 3.74% return on assets over the past 12 months.  The only reason their ROE isn’t much higher is that they generate capital faster than they can pay out dividends, buy back stock or grow assets. They do pay out absurdly high dividends, and last year the yield on the regular and special dividends was about 11%.  If you’re not familiar with banking metrics, here’s a baseball analogy: City Bank’s performance is the equivalent of batting .400, hitting 40 home runs, driving in 240 in runs, and then pitching every 5^th day and winning 20 games. If you know your banking and your baseball, you know we’re being very accurate here.

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· First Horizon seems to be preparing investors for a decline in the value of their mortgage servicing portfolio.  Huh?  Isn’t the value supposed to go up in an environment like this with slowing prepayments?  Some smart people we know think that what they’re really saying is that higher costs associated with increased delinquencies and foreclosures are much greater than any pick-up from slower prepayments.  Ouch.

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· We just read that bond insurer MBIA revealed exposure to $8.1 billion in CDO’s backed by other CDO’s. To see how leveraged and complex this all is, let’s follow the money trail: (1)  A mortgage backed security is a security backed by a pool of loans.  (2)  A tranche is a slice of that MBS.  (3) A Collateralized Debt Obligation (CDO) is a security backed by various tranches. So now you have (4) a CDO backed by various other CDO’s.  Following this trail, it’s possible that the cash flow from a single loan could go to as many as four different security holders. No wonder the lawyers are getting rich trying to figure out who gets what as borrowers default and these CDO’s fall apart and have to be unwound.

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· Do you remember Ross Perot?  When he was running for President, he famously said that if NAFTA were passed, it would create “.. a giant sucking sound as jobs and investment capital head across the border into Mexico .”  Well, it’s been 14 years since NAFTA was passed, and a good ten years since it was fully implemented.  And how has it affected us? First, free trade does cause certain jobs and companies to vanish, but it also creates new opportunities, and new companies that entrepreneurs invest in. Since it passed,  (a) Our economy has 16.5 million more people with jobs today than ten years ago, (b) average real compensation per hour has increased 22% over the past ten years, and (c) the net loss in this decade of 3.3 million manufacturing jobs has been surpassed by 11.6 million new jobs in sectors where the average wage is higher than in manufacturing.   Perot was an entertaining (and sometimes irritating) candidate, but he was absolutely wrong about NAFTA and free trade!

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· Sometime a year ago or so, we made some reference to Flagstar Bank as sleepy, boring, and stuck in the past.  Boy, did we blow that one!   Our clients now all ask us about getting a warehouse line and a correspondent relationship going with Flagstar.  Funny how there’s a buzz about a company we referred to as stuck in the past.  Our hats off to the people at Flagstar who knew that subprime was a good product to avoid and that doing FNMA and Freddie Mac loans was still a good business.  We just thought of corporate motto for them:  Flagstar Bank… using common sense since 1987.  Or how about  Flagstar Bank… built for comfort, not for speed.  Sometimes, boring is better.

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Instead of sending out Christmas cards or gifts to clients, we have made a donation to Wounded Warriors, a non-profit organization that helps the young men and women veterans of the Iraqi war. It works with those missing limbs and other new disabilities with rehabilitation skills so they can get their lives back.   While we like getting Christmas cards and boxes of chocolates, helping these young patriots just seemed a bit more in the true spirit of Christmas.   Merry Christmas to everyone.

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Joe Garrett and Corky Watts

Garrett, Watts & Co.

http://garrettwatts.com/