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Federal Reserve Districts

Third District--Philadelphia

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The pace of business activity in the Third District was virtually steady in February, as some sectors improved slightly and others slowed. Manufacturers reported a small increase in new orders for the month compared with January, but shipments were flat and order backlogs declined. Retail sales of general merchandise and auto sales eased in February from January and from February of last year. Bank lending has been rising slowly, with most of the growth coming from consumer loans, although some banks reported recent increases in business lending. Commercial real estate market conditions have shown little change. Vacancy rates have been nearly steady, but effective rents have edged down. Residential real estate sales have been steady at a fairly brisk pace, and builders' backlogs remain high.

Looking ahead, contacts in the Third District business community expect some improvement, although they do not foresee a strengthening in growth. Manufacturers forecast some increases in shipments and orders during the next six months, but their level of optimism has waned somewhat since the start of the year. Retailers anticipate a slow improvement in sales, but they are being very conservative in their sales plans for the spring. Auto dealers expect a pickup in sales as winter comes to an end, but they do not expect to match last year's sales rate. Bankers expect slight gains in lending, but they have become increasingly concerned that loan growth could stall if the pace of business activity in the region does not improve.

Third District manufacturers reported steady shipments and slight gains in new orders, on balance, in February. However, despite the rise in new orders, order backlogs declined at area plants. Manufacturers continued to report declining inventories, and some firms characterized them as historically low. Also, some manufacturing companies indicated that their customers were maintaining very low inventories and placing orders only on an as-needed basis. By major industry sector, conditions appeared to be relatively better for makers of apparel and furniture and for some producers of industrial equipment and materials. Conditions were relatively slower among makers of paper products and fabricated metal products.

On balance, the region's manufacturers forecast improvement during the next six months, although they have not been quite as optimistic recently as they were at the start of the year. About half of the firms surveyed in February expect increases in shipments and orders by midyear, but one-fifth anticipate decreases. Area manufacturers' capital spending plans call for increases, on balance, with about one in four scheduling increased outlays and one in ten planning cuts. Most of the firms that are limiting or reducing capital spending for 2003 indicated that they are doing so because demand for their products remains weak, but a significant number mentioned geopolitical uncertainties as a negative influence on their capital spending decisions.

Third District retailers generally reported that sales in February were somewhat off compared with a year ago, and most of the stores contacted for this report indicated that sales slowed in February compared with January. Store traffic has also declined. Store executives said cold weather and winter storms have hampered shopping, but they also said that fundamental consumer demand has eased. Retailers said sales of home furnishings and electronics have been holding up, but sales of many other types of merchandise, particularly apparel and jewelry, have weakened. Some merchants also noted that there has been a sharp decline in purchases by younger consumers. Discounting continued to be extensive, with many special sales and coupon promotions being offered.

Most of the retailers contacted for this report expect sales to move up sluggishly as the year proceeds. They are being very cautious in inventory planning, and many store executives said they will be trimming promotional spending, particularly for advertising. It appears that retail companies operating in the region will also reduce capital spending this year, but most of the store executives surveyed said the cuts will not be as large as they were last year.

Auto sales in the District slipped in February from the January pace, with declines for nearly all makes. Dealers reported that sales fell as some manufacturers scaled back incentives and dropped further when snowstorms disrupted travel in the region. Dealers said the outlook is uncertain. They expect sales to rise by the spring, although they anticipate results for this year as a whole will be below last year.

Outstanding loan volume at Third District banks was rising slowly in late January and early February. Much of the growth was in consumer lending, including credit cards and other installment loans. Residential real estate lending continued to move up as well. Some banks noted recent increases in commercial and industrial lending, primarily to small and medium-sized businesses. The gains in business lending were slight, however.

Bankers generally said there has been some slippage in credit quality recently among both business and consumer borrowers. Most of the banks contacted for this report said loan delinquencies have increased, but some noted that the increase in their charge-offs has been proportionately lower than the increase in their loan portfolio's delinquency rate.

Looking ahead, bankers in the Third District expect slow growth in total lending, at best. Some expressed concern that, unless the economic recovery picks up speed, growth in business and consumer lending will stall. Furthermore, several bankers said marginal borrowers are beginning to have difficulty servicing their current debt, and they anticipate more firms and households will experience financial pressure if business activity and employment do not improve soon.

Real Estate and Construction
There has been little change in conditions in Third District commercial real estate markets in recent months. Surveys by area real estate firms indicated that overall vacancy rates have been nearly steady, with slight increases in some locations and slight decreases in others. The office vacancy rate in the Philadelphia central business district was recently estimated at around 13 percent. The vacancy rate in suburban areas varied. In markets where new buildings have been completed the rate was around 20 percent, but in other markets it was lower. Quoted rents remained fairly stable, but effective rental rates have fallen as landlords have raised tenant improvement allowances and offered rent-free periods. Leasing activity has picked up as many tenants have negotiated new or renewed leases to take advantage of landlord concessions. Although a number of new buildings have been proposed, contacts say construction activity has been easing and is likely to fall further until firms in the region add substantial numbers of new employees.

Residential real estate agents and homebuilders generally reported steady rates of sales in January and February at a fairly strong pace. Price appreciation continued to be strong in many parts of the region, although instances of multiple offers have diminished. Real estate agents expect sales of new and existing homes for the year as a whole to be a few percentage points below last year's level. Builders reported little or no decreases in backlogs, which have been kept up by strong sales while construction has been delayed by adverse weather. Residential construction contractors generally indicated that land prices continue to rise, but materials and labor costs have been mainly steady.

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Last update: March 5, 2003