November 26, 2003 Federal Reserve Districts Third District--Philadelphia

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Economic conditions in the Third District were improving in November. Manufacturers reported increases in orders and shipments for the month. Retail sales of general merchandise picked up in early November after slipping in October. Auto and light truck sales also rebounded somewhat after dipping in October. Bank lending has been advancing, with gains in business and residential mortgage lending but little change in consumer loans outstanding. Commercial real estate markets in the region remain soft, with lackluster leasing activity and declining rents. Residential real estate construction and sales continued to be strong. Looking ahead, contacts in the Third District business community expect business activity to continue rising modestly. Manufacturers forecast increases in shipments and orders during the next six months. Most of the retailers surveyed in early November forecast year-over-year sales gains of a few percent for the upcoming Christmas shopping period. Bankers expect moderate growth in lending into next year. Commercial real estate companies expect the region's office markets to firm up slightly in 2004, and residential real estate agents and builders anticipate a nearly steady sales rate during the year. MANUFACTURING Reports from Third District manufacturers in early November indicated that orders and shipments were rising compared with October. Slightly more than half of the firms contacted said demand for their products was steady, but one-third said their orders were increasing, and only a few said demand for their products had eased. Although most firms said their order backlogs were steady, almost one out of five reported that their backlogs were growing. On net, order backlogs at area plants have been moving up slowly for the past several months. Business conditions were relatively stronger for firms producing electrical machinery, measuring and controlling instruments, and a variety of metal products. Conditions were relatively weaker for makers of lumber products, plastics, and transportation equipment. The region's manufacturers expect the upward trend to continue. More than two-thirds of the firms contacted for this report expect increases in shipments and orders, and only a few expect decreases during the next six months. Area manufacturing firms plan to increase production through a combination of additional work hours and added employees. More local manufacturers are scheduling increases rather than decreases in capital expenditures in the next six months. RETAIL Third District retailers generally reported that the pace of sales slipped in October compared with September and with October of last year, but was on the rise in November. Executives at department and clothing stores said unseasonably warm weather during most of October brought sales of outerwear nearly to a standstill. Many area retailers reported a drop off in store traffic in October, which they said might also have been a result of the warm weather that favored outdoor activities rather than shopping. Sales appeared to have resumed an upward trend as November began, and retailers said cold weather clothing was selling well by mid-month. Merchants said sales of home furnishings continued to be strong. Third District retailers expect sales for the Christmas shopping period to be slightly above last year's results. Their forecasted increases are in a narrow range of 3 percent to 4 percent, in current dollars. Although merchants believe consumer confidence is building, they expect sales growth to be limited because shoppers are very price conscious and there are no high-demand items to boost spending this season. Auto dealers reported a relatively sharp drop in sales in October, compared with the prior month and year, but they said sales were picking up in early November. Some dealers said an increase in manufacturers' incentives in recent weeks has helped boost the sales rate. Dealers said the outlook is uncertain, but they do not foresee a big turn to a lower or higher sales rate in the immediate future. FINANCE Outstanding loan volume at Third District banks was moving up slowly in November. Banks reported increases in commercial and industrial loans, mainly to middle market companies in a broad range of industries that are beginning to implement expansion plans. The demand for business financing has also prompted an increase in investment banking activity on behalf of firms in the region. Residential real estate lending was on the rise as banks continued to book purchase mortgages even while refinancings declined. Some banks said they have been limiting their residential real estate lending in order to prevent mortgages from becoming too large a portion of their loan portfolios. Bankers generally indicated that consumer lending has been about flat, and some reported declines in consumer loans outstanding in recent weeks. Bankers in the District expect moderate growth in lending to continue into next year. They expect business lending to rise somewhat more strongly in the new year, and they anticipate a fairly steady rate of residential lending for purchase mortgages, but they expect further declines in refinancings. Bankers believe consumer lending will rise modestly if employment gains persist, but some said that if interest rates move up consumers' ability and willingness to borrow could weaken. In general, bankers in the District indicated that credit quality for both personal and business loans has been improving. Several noted that there is strong demand in secondary markets for problem loans, and they have sold off significant amounts of troubled credits. REAL ESTATE AND CONSTRUCTION Commercial real estate firms in the Third District reported that the overall office vacancy rate rose in suburban markets in the third quarter, but was practically steady in the Philadelphia central business district. For suburban markets as a whole the vacancy rate is estimated at 25 percent, up around 3 percentage points since midyear. The increase was mainly the result of a large corporation relocating to a new building, putting its former space on the market. The vacancy rate in the Philadelphia central business district remains at nearly 13 percent. Throughout the region, average asking lease rates have edged down and effective rental rates have continued to decline as landlords offer generous tenant improvement allowances, especially for firms that lease relatively large amounts of space. Commercial real estate contacts say vacancy rates in suburban office markets will not decline in the immediate future because several large buildings currently under construction will be completed around the end of the year. For 2004, vacancy rates in the region as a whole are expected to decline slightly. Residential real estate agents and homebuilders reported that sales have been steady or rising in recent weeks. Price appreciation for both new and existing homes was said to be steady as well, and some builders indicated that the percentage of buyers who order upgraded features in new homes has been increasing. Homebuilders and real estate agents generally expect the pace of sales to continue near its current rate into next year. They believe an improving economy will support a high sales rate even if mortgage interest rates begin to move up. Return to top New York Cleveland