July 29, 2009 Federal Reserve Districts First District--Boston

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Business activity in the First District continues to be slow. Most retail contacts are optimistic that they are past the bottom, while manufacturers consider business to be bouncing along it, at best. While activity at consulting and advertising firms seems to be leveling out, commercial real estate has weakened further, reflecting continuing cuts in office employment, among other factors; residential real estate markets remain weak. Many respondents continue to reduce headcount and cut benefits, if not pay. Price changes are varied. Few contacts expect business to pick up before 2010. Retail Contacted retailers in the First District report mixed sales results for the early summer months, although the majority of respondents report less negative or more positive year-over-year sales changes than in recent reports. Family restaurants are said to be an exception, with some deterioration in sales. Retailers continue to manage inventory levels carefully. Capital spending is varied, with some contacts looking for or taking advantage of expansion opportunities. The majority of contacted retailers say their headcounts are currently stable, although several mention picking up talent when possible, as other firms shed workers. Selling prices are mostly stable, but a few retailers report that they are starting to observe some vendor price increases. Overall, most First District retailers expect sales growth to remain modest, but many say they are cautiously optimistic about being "past the bottom." Manufacturing and Related Services Almost all manufacturing and related services contacts headquartered in the First District report that business remained weak in the second quarter. Many customers were said to be delaying or even canceling their orders for equipment and instruments, causing sales of nondefense capital goods to fall at double-digit rates from year-earlier. A few contacts had rising equipment sales to the military or to parts of the residential construction market year-over-year. Biopharmaceutical and other selected healthcare niches were the only additional bright spots mentioned. Respondents indicate that foreign sales varied by geography but were mostly weak or down, and that currency movements depressed dollar-denominated revenues. Some contacts detected order or sales upticks for selected products in the second quarter, but the consensus appears to be that volumes remain low, business is merely "bouncing along the bottom," and "no sustainable green shoots" have emerged. Still, a few express relief that the economy is no longer in a "free fall" and customers are "getting their bearings." Manufacturers say that materials costs are flat to down compared to a year ago. However, costs for petroleum derivatives and some steel products are beginning to creep up. With the exception of biopharmaceuticals, most contacts cite downward pressure on selling prices, but the extent to which this is translating into actual reductions varies. For example, some companies that increased prices 2 percent to 3 percent in early 2009 indicate that the higher prices are sticking. Others are giving concessions to their major customers or are dropping prices for non-specialty products. About one-quarter of the contacted manufacturers and related services providers are holding their domestic headcounts steady. Most of the remaining firms continue to cut U.S. employment, either selectively or through layoffs and facility closures. Nonetheless, several respondents mention that they are actively hiring specialized scientific and engineering personnel. About two-thirds of the firms have raised employee pay this year, usually in the range of 2.5 percent to 3.5 percent. In some cases, however, these firms have also reduced benefits, frozen pay for selected business units, or announced that they will be deferring future pay increases. The remaining one-third or so have reduced and/or frozen employee pay, and/or have enacted temporary shutdowns or unpaid vacations. The majority of responding firms have cut capital spending from last year's levels, in some cases dramatically. Some companies are holding expenditures steady because of commitments to restructuring- or technology-related projects. Relatively few respondents are increasing production capacity. Capital spending plans generally center on new product development, technology upgrades, or cost reduction. Some contacts add that while bank credit remains expensive, financial market conditions have improved. Most manufacturers and related services providers appear resigned to slower growth or outright declines in revenues year-over-year through late 2009. While many respondents look forward to slowly improving business in 2010, some mention that factors such as structural shifts in the automotive and financial services industries are likely to delay a full recovery in business until sometime after next year. Selected Business Services Most First District advertising and consulting contacts report stable or slightly higher demand in the second quarter of 2009 compared to the first quarter but year-over-year declines from 8 percent to 42 percent. Losses associated with mergers or acquisitions of large clients seen in the beginning of the year have not been offset with new demand. Demand from the healthcare sector is weakening, chiefly due to uncertainty about the upcoming healthcare reform. All contacted advertising and consulting firms report price pressure and some are facing "extremely aggressive" price-cutting strategies from competitors. Some firms have offered 15 percent to 20 percent discounts to core clients. Several respondents have reduced personnel costs, cutting bonuses up to 50 percent, deferring compensation, or laying off workers. By contrast, a few companies increased compensation by 2 percent to 3 percent in April 2009. Although wages and salaries will be held stable, a couple of respondents expect to increase total compensation somewhat in the second half of the year. Headcounts in most contacted firms were stable in the second quarter, although a few companies laid off from 10 percent to 25 percent of their workforce. Several contacted firms will reduce employment in the second half of the year either through layoffs or attrition. Most respondents expect the third quarter to be similar to the second. Demand in 2009 is projected to decline about 4 percent to 10 percent, and sales should start to increase in 2010. Major risks to this outlook are healthcare reform, the state of the regional economy, and higher jobless rates. Commercial Real Estate Sentiment is mostly negative among commercial real estate contacts this period. Throughout the region, vacancy rates rose again across all commercial property types as sublease supply continues to expand. In Boston, office vacancy downtown is estimated at roughly 15 percent. While this figure is the same as that reported last time, the perception is that the number is on the rise. The suburban vacancy rate is reportedly higher, but estimates range from the upper teens to as high as 24 percent (the figure reported last time). In downtown Providence, office vacancy stands at roughly 18 percent, and suburban office vacancy climbed from 19 percent in December to close to 22 percent currently. The industrial market in Rhode Island continued to perform relatively well, with vacancy rates still below 10 percent. Office vacancy also rose in Hartford. Rents are said to be falling dramatically in Greater Boston. One Boston contact estimates that asking rents for office space in June 2009 fell 30 percent to 40 percent on a year-over-year basis. Retail rents in Greater Boston were also "clobbered," with exact figures not cited. Year-over-year rent declines have been less steep in Rhode Island, about 6 percent, with all of the declines occurring in the past six months. In Greater Hartford, rents are reportedly holding steady, but landlords are offering significant leasing concessions. Across the board, leasing volume remains very low, as tenants refrain from making commitments beyond a one-month horizon. Sales transaction volume remained very light across all markets, as large gaps persisted between bid and ask prices and credit remains tight. While underwriting standards are still quite stringent, commercial real estate financing continues to be available from small and medium-sized banks with healthy balance sheets, and through the public equity (REIT) market, which has seen increased activity in recent months. Two contacts noted the rising tide of loan delinquencies and maturities on properties that are "underwater." One contact reports that special servicers for securitized commercial loans are overwhelmed by the volume of problem loans, the result being that de facto loan extensions are being granted. Across all types of lenders, including commercial banks, loan extensions of one to three years have become increasingly common, as lenders hope that equity positions will improve over that horizon. Other lenders are restructuring debt at deep discounts, forestalling steeper losses. Ideally, lenders would prefer that borrowers put in additional equity, but most are short on cash. Contacts expect fundamentals to continue to deteriorate for at least one more quarter, but expectations for the timing of the recovery vary from three to twelve months. Consistent with recent developments, future declines in rents and property values are expected to be greatest for Boston and less severe in other markets that saw smaller run-ups in prices during the boom. The pace of write-downs by commercial lenders is expected to accelerate over the next twelve months. Residential Real Estate Residential real estate markets in New England remained sluggish in May and into June, although contacts cite some positive signs. Massachusetts and Connecticut saw May home sales drops of 15 percent and 19 percent, respectively, from May 2008. Rhode Island and Maine had more moderate single-digit year-over-year home sales declines in May. In June, Boston area home sales declined only 5 percent year-over-year. In New Hampshire, home sales were flat in June compared to the year before. Condo sales were still far below 2008 levels in Massachusetts, Rhode Island, and Connecticut. The median home price fell about 12 percent year-over-year for most states in the region, but dropped 25 percent in Rhode Island in May from a year earlier. Another exception was the Greater Boston area, where the median home price decreased only 2 percent year-over-year in June. Distressed properties make up a much larger share of the homes being sold this year than last, especially in Rhode Island, with negative effects on median prices. However, inventory continues to decline in some areas, reducing excess supply. Several contacts complained about the Home Valuation Code of Conduct, which they argue is leading to under-appraisals by appraisal management companies lacking sufficient experience in local housing markets. Return to top Summary New York