Lunch Lady Suffers as Banks Prepare $2 Trillion in Lending Cuts

Date: Wednesday, March 26, 2008
Author: Peter Robison, Bloomberg

Peloton Partners LLP liquidated a $1.8 billion London hedge fund, gadget-retailer Sharper Image Corp. filed for bankruptcy -- and Monica Tomasso is paying 35 percent interest to expand her school-lunch business.

The global credit crisis is squeezing businesses from the biggest, like Peloton, whose fund collapsed this month after banks demanded repayment of loans used to bet on mortgage securities, to the smallest, such as Tomasso, 34, whose Health e-Lunch Kids Inc. sells 6,000 meals a month online to parents in Fairfax, Virginia.

Credit is drying up as lenders, staggered by losses, try to raise capital and clamp down on financing for a U.S. economy that likely is in recession, economists at Goldman Sachs Group Inc. said in a March 7 report. The supply of credit for businesses and consumers may decline $2 trillion, the report said, equivalent to 7 percent of household, corporate and government debt.

``Financial markets and banks in particular are reliant on trust and confidence,'' said Charles Bobrinskoy, vice chairman of Chicago-based Ariel Capital Management LLC, which oversees $13 billion. ``When people start to lose that trust and confidence, they stop providing liquidity to each other, and that has all kinds of negative ramifications.''

Losses on home mortgages may reach $500 billion and as much as $656 billion on commercial real estate, other business loans, credit cards and autos, the Goldman report said.

Bankruptcy Filing

San Francisco-based Sharper Image felt the effects as it filed for bankruptcy last month, partly because Wells Fargo & Co. couldn't persuade other banks to buy pieces of a $10 million loan, according to a filing.

Tomasso turned to her credit cards to help finance lunch boxes, bags, and Web site development when a dozen banks rejected her loan application. After the tab reached $100,000, she began talks with a private-equity investor who may take a stake in the business, which has annual revenue of $400,000.

``Bank of America tells you it's the bank of opportunity,'' said Tomasso, referring to an advertising slogan of one of the lenders that she says declined her application. ``That's not been proven true.''

Bank of America Corp. spokesman Scott Silvestri said the company doesn't comment on specific customers. ``We're open for business and continue to make loans across all product lines,'' he said. ``Obviously, we're being prudent in ensuring that we're taking the right risks.''

Tougher Standards

A survey conducted by the Federal Reserve in January found that one-third of domestic banks had toughened lending standards for small-business loans in the past three months. A record 80 percent made commercial-property loans harder to obtain, and a majority tightened terms on mortgages to people with good credit. The survey covered 56 domestic and 23 foreign lenders.

The tightening is apparent to Peter Djuric, a mortgage broker in Chicago who has 28 customers waiting for approvals on loans. Applications are taking a month or more for lenders to process, compared with an average of 10 days last year, he said.

``They're looking for reasons not to do loans,'' he said.

Credit losses for global banks reached $195 billion this month as Bear Stearns Cos., the 85-year-old investment bank that survived the Great Depression, sought the largest U.S. bailout ever of a securities firm. The Fed will guarantee $29 billion of Bear's assets as the firm is taken over by JPMorgan Chase & Co.

The Fed's interest-rate cuts aren't yet restarting growth as banks hoard capital.

`Extremely Focused'

Citigroup Inc. is ``extremely focused on the strength of our balance sheet,'' Chief Executive Officer Vikram Pandit told employees in a March 5 memo. A day later, the biggest U.S. bank said it would more than halve the number of new home loans in its portfolio and pare U.S. residential mortgage holdings by $45 billion, or 20 percent, over the next year.

Home prices in 20 U.S. metropolitan areas fell a record 10.7 percent in January from a year earlier, according to the S&P/Case-Shiller home-price index. The drop from peak to trough may reach 25 percent, the Goldman report said.

As home prices fall, lenders' cushion against bad loans is shrinking. Citigroup lost $9.83 billion in the fourth quarter, the most in its 196-year history. U.S. bank and thrift earnings fell 83 percent to $5.82 billion in the period, according to the Federal Deposit Insurance Corp.

At the end of 2007, the Tier 1 capital ratio of the largest banks stood at 7.3 percent, the lowest since at least 1990, according to Credit Suisse. Tier 1 capital is essentially assets minus liabilities. Banks prefer a ratio above 6 percent to avoid restrictions on dividends and deposits from regulators.

`Out of Money'

``The problem is they've run out of money they can lend, given they have to put capital in reserve against these riskier things,'' said William Dunkelberg, chief economist at the National Federation of Independent Business, a small-business trade group in Washington.

In Lima, Ohio, Tracie Sanchez said she put off plans to hire as many as eight people this year and expand a factory where she makes wooden shipping pallets for clients including Procter & Gamble Co. and General Dynamics Corp.

Sales at Lima Pallet Co. are down 2 percent from last year, said Sanchez, the firm's president. Her bigger concern is that negative talk about the economy will become self-fulfilling.

``All you hear is recession, recession, recession,'' she said. ``It's put business on hold.''

To contact the reporter on this story: Peter Robison in Seattle at robison@bloomberg.net.