TEXT: Beige Book

Third District--Philadelphia

Business activity appeared to be weakening slightly in the Third District in February. Manufacturers, on balance, reported declines in new orders and shipments. Retailers generally reported small year-over-year decreases, and auto sales continued to fall. Overall bank lending has been rising slowly, although some banks reported drops in commercial and industrial lending. Residential real estate sales and construction remained well below the year-ago pace. Commercial construction has eased. Reports of increases in input costs and output prices were somewhat less prevalent in February than they were in January, although reports of rising import prices have become more widespread. Wage increases were reported to be moderate. Several firms in the District noted that they had implemented hiring freezes.

The outlook among Third District business contacts has become less positive. Manufacturers, on balance, expect decreases in new orders during the next six months, although they expect a rise in shipments. Retailers have generally revised their 2008 forecasts down and now expect only slight gains, if any, in sales. Auto dealers expect sales in 2008 to be below sales in 2007. Bankers anticipate very slow expansion in overall lending. Residential real estate agents expect sales to continue to be slow, but they expect to see some signs that the fall in sales might reach a bottom this year. Contacts in commercial real estate anticipate slower leasing activity this year compared with last year. Nevertheless, they expect rental rates, which rose last year, to show little change in 2008.

Manufacturing
Third District manufacturers, on balance, reported falling shipments and new orders in February compared with January. Around one-fourth of the manufacturers surveyed noted increases and around one-third noted decreases. Manufacturers also reported a drop in order backlogs, on balance. Increased demand for their products was reported by makers of apparel and by some producers of industrial materials and equipment. Decreased demand was noted by producers of lumber products, furniture, construction materials, and metals. Several manufacturers noted that their business was being adversely affected by declining residential construction activity. They reported that demand for their products from the "housing and housing-related market, including home improvement is slow," with substantial declines from last year.

The outlook in the Third District manufacturing sector is not strong. On balance, manufacturers polled in February expect a further decline in new orders during the next six months, although they predict shipments will edge up. However, they expect order backlogs to fall further. Capital spending plans at area manufacturing firms have been cut back, on balance, since the start of the year. In contrast to a net increase in spending among firms surveyed in January, firms contacted in February indicated that their capital spending will be only steady, on balance, during the next six months.

Retail
Retailers in the Third District generally reported slight year-to-year decreases in sales for February. Most store executives attributed slow sales in all lines of merchandise to a decline in consumer confidence. Some also noted that sales of winter apparel were especially weak due to unseasonably mild weather. Retailers are limiting inventories in response to the slow pace of sales. Store officials said they have revised down their sales forecasts for 2008; they expect results for this year to show minimal improvement over last year, at best. Several noted that expansion and renovation plans for this year have been cancelled. One chain store indicated that its corporate capital spending plans have been "drastically reduced" and another said it has implemented a "company-wide belt tightening."

Auto dealers in the region generally reported slow sales in February, with most indicating that sales were below the year-ago rate. Dealers in the region expect sales to edge up later this year, but they do not expect sales for the year as a whole to match last year's sales.

Finance
Total outstanding loans at Third District banks were rising slowly in February. Most of the commercial bank lending officers contacted for this report indicated that loan volume outstanding has been rising modestly for all categories of credit; however, some noted that commercial and industrial lending has eased. Most bank contacts indicated that asset quality overall continued to weaken somewhat. All of the banks contacted for this report noted that they were "tightening credit standards across the board" and some indicated that they had ceased lending to lower-rated borrowers completely. Bankers reported that attracting deposits is "a struggle," with strong competition among banks in the District. Some said they have made increased use of purchased funds and Federal Home Loan Bank advances. Looking ahead, bankers generally foresee slow growth in overall lending. They expect earnings to be under pressure during the year as charge-offs increase, unless funding costs decline.

Real Estate and Construction
Residential real estate activity in February remained significantly below the year-ago pace. Residential real estate agents said buyers were deferring purchases in anticipation of further price declines, and sellers were deferring putting their homes on the market because they perceive demand to be weak. In general, residential real estate agents said downward pressure on prices persists. The forecast of one contact--that there will be "no appreciation for quite some time"--was representative of the consensus in the region. Home builders also reported a very slow rate of sales, despite increased incentives. Looking ahead, residential real estate agents and home builders believe there might be some "stabilization" in the lower to mid-price range, but they expect demand for homes in higher price ranges to remain weak, due in part to the reduction in financing for nonconforming mortgages.

Commercial real estate firms reported that office vacancy rates in most markets in the region have continued to decline over the past several months, and rental rates have increased. However, they noted that office vacancy rates have risen in some markets where financial services firms have reduced or ceased occupancy. Construction has eased in most office markets in the region. Industrial real estate firms reported that overall demand for industrial space remained firm, although increased supply has kept rental rates in check. Looking ahead, most contacts in the commercial real estate sector expect leasing activity to be slower in 2008 than in 2007, although they generally expect rental rates to be about level through the year in most markets.

Prices and Wages
Reports of increases in input costs and output prices from Third District business contacts were somewhat less prevalent in February than they were in January, although there has been an increase in the number of businesses noting increased prices for imported goods. Firms in the region noted increases in prices of textiles, food products, chemicals, industrial materials, metals, and machinery. They also reported rising costs for transportation and shipping and for electricity. Most of the firms reporting on employment costs in February indicated that wage increases remained moderate. Several firms noted that they had instituted hiring freezes in response to slowing business activity and rising general operating costs.

CONTINUED

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