To Our Clients, Colleagues and Friends:

· How do Americans pay for things? According to studies, we use checks 18.9% of the time v. 18.8% with debit cards 18.4% with credit cards. The rest is a combination of cash, money orders, and prepaid cards and so on. But debit card usage surpassed credit cards for the first time this year and is expected to grow much faster in the future.

· Being curious lads, we often look at insider trading activity for financial services stocks, and boy, does Morningstar stand out.  You know them, the company that tracks and analyzes mutual funds. It seems that for the last month or so, Morningstar insiders have been selling in huge amounts, day after day after day after day.  This probably fits in the category of writing something just to fill some space, but, hey, give us a break. It’s not easy being insightful (and occasionally witty) twice a week!

· Stock transactions by insiders are replete with restrictions, but still, it always looks so much better when insiders are buying rather than when they’re selling.  Don’t you agree? But perhaps you’ve heard about a fellow named Angelo Mozilo, Countrywide’s CEO. He exercised options on 5.0 million shares of Countrywide this year and sold every one of them the same day.  He made about $120 million on the sales, getting an average price per share of $35. Not bad, considering that the price now hovers around $8.75.  SEC regulations prohibit him from buying shares within six months of selling shares, so let’s mark our calendars for June 30^th and check how many shares he bought within the preceding six months

· Want to read a good, scary book?  Read The Great Texas Banking Crash by Jody Grant. From 1982-1992, there were 506 commercial banks in Texas that failed. That’s one a week, every week, for ten long years.  Euphoric growth in the Texas energy sector led, as is happening now in the mortgage space, to a horrible morning-after hangover.

· Almost all bank failures the past decade have been smaller ones, but we’re still a nation of small banks.  We have only 88 banks with assets greater than $10 billion.  But we have over 3,200 banks with less than $100 million in assets. 

· And how about Sallie Mae Chairman Albert Lord’s recent conference call?  After a lot of hostile questions about the company’s earnings, Lord ended the call with his saying “Let’s go.  There’s no more questions, so let’s get the f___ out of here.”  Not cool. Also, bad grammar.  He should have said “There are no more questions, so let’s get the f___ out of here.”

· The storm next time?  As recently as 2002, barely $50 billion in commercial mortgage backed securities were issued. In the past three years, over $500 billion have been issued.  This is all fine, and it makes it easier to get financing on apartment buildings, offices buildings and other commercial real estate.  The problem is that these securities are now being put into Collateralized Debt Obligations (the notorious CDO), and just like what happened in the residential market, mortgage REITs have bought the riskier pieces.  Uh oh.   If Yogi Berra followed the mortgage market, wouldn’t he be wondering if this were deja vu all over again?

· And remember how just before they crashed, the residential mortgage REITs were all paying to-good-to-be-true dividends in the mid-to-high teens?  We just counted nine commercial mortgage REITs with dividend yields over 15%.  Not a good sign.

· If there was any bright spot for us in an otherwise grim year, it was helping companies become profitable again. These were companies whose owners had the willpower to make tough choices, fire friends, and treat no expense as a sacred cow. There was no secret formula,  and most of it is just being willing to cut, cut, and cut some more until expenses were less than revenue.  There’s obviously much more to it than that, but the tools we provided allowed these owners to make those tough cuts, and it really works.  Two key philosophies behind these reporting tools are (1) You can’t manage it if you can’t measure it, and (2) You need better data to make better decisions. We hear all the time that our management reporting templates have made a big difference in managing the P&L and knowing where to cut and where not to cut.

· Leo Tolstoy wrote that “Happy families are all alike; and every unhappy family is unhappy in its own way.”  Based on our clients who’ll be at our Client Appreciation Dinner, we can re-write that to say that “Profitable companies are all alike; every unprofitable company is unprofitable in its own way.”   When we look at which of our clients have survived the Massacre of 2007, there are many different models. Some are retail, some are wholesale, some are small and local, and most are larger and regional or national. But all the survivors share at least one thing in common: They refuse to lose money, believe that they must make money on every loan, and have done whatever is necessary to operate profitably each and every month.

· Did anyone notice that two Fridays ago, Standard & Poor’s downgraded 793 mortgage backed securities?  All were backed by closed-end second mortgages. And this was just two days after they downgraded 1,292 classes of 1^st lien mortgage securities. That’s a stunning 2,085 in two days.

· La plus ca change, la plus c’est la meme chose.  For those who’ve forgotten their high school French, this means that regulators haven’t changed much in 140 years. When it comes to credit quality, they were right in 1860, and they’re right today.  See the attached.

Joe Garrett and Corky Watts      Garrett, Watts & Co.    http://garrettwatts.com/