Weekly Market Update - May 8, 2014

Federal Reserve Senior Loan Officer Survey of bank lending practices. Q2 2014: The April 2014 survey is based on the responses from 74 domestic banks and 23 U.S. branches and agencies of foreign banks. Of particular interest to us are the results for construction and land development loans and what this data tells us about the outlook for non-residential starts. A majority of banks are reporting a strong increase in demand for construction and land development loans, but lending standards have been becoming less easy for four quarters culminating on Q2 2014 at only a net 4.1% reporting an easing of standards, (Fig. 1). What this means is that the number of banks reporting an easing of standards was 4.1% higher than the proportion reporting a tightening of standards. In Q2 last year, 22.4% of banks reported easing standards. This data doesn’t seem to support the McGraw Hill / Dodge data on non-residential construction starts. Banks have become less enthusiastic about construction and land development loans but are still on net not tightening and according to the loan survey, demand is strong. Other highlights from the Federal Reserve survey are that demand for commercial and industrial (C&I) loans from large firms was little changed but declined for small, (< $50MM revenue) firms. Banks kept lending standards to both large and small firms little changed with a net 11.1% reporting easing to large firms and 7.1% easing to small firms. The bad news in this report continues to be that more than a net 25% of banks reported a decrease in demand for prime mortgage loans.

Fig 1

Nonresidential construction starts (Source McGraw Hill Dodge): In three months through March the square footage of nonresidential starts contracted by 4.7% year over year with a negative momentum of 11.8%, (Table 1). There were some bright spots, hotels / motels and offices / banks continued to have very strong growth on both 3 and 12 month basses. As we have seen in other data sources, apartment construction is slowing but still grew at a 7.6% rate in the first quarter y/y. Overall the current results were impacted strongly by the high volume sectors of education and retail which both have double digit contraction and negative momentum. March was the fourth consecutive month of contraction of the rolling 12 month total of starts, (Fig. 2). No doubt the extreme winter weather played a part but another issue that is looming is the availability of skilled labor which is becoming a constraint on the construction recovery. This is particularly true of buildings. On Saturday Reuters reported. “The construction industry was obliterated in the wake of the housing crash. Of the 8.2 million jobs lost during the Great Recession, 2.3 million were in construction, according to the U.S. Bureau of Labor Statistics. The demand in construction jobs is not just being met by former workers returning to the fold, according to company bosses and industry analysts. Many of these former workers have been lost forever, forcing companies to hire and train new, inexperienced employees.” The contraction of starts has not yet been mirrored by the volume of ongoing construction as measured by the Commerce Department Construction Put in Place, (CPIP) report. In Q1 2014, nonresidential CPIP grew at a 5.1% rate y/y.

Table 1

Industrial Construction Starts were down 3.2% y/y and 19.3%, 3 months y/y ending April, 2014 and while this sounds bad, as (Fig. 3) illustrates the expenditures in the industrial sector remain strong (albeit volatile) when compared to history. Power projects, the largest dollar spend project category accounting for 23.3% of the total 12 month spending ending April, was down 34.5% vs a year ago. Since power projects can run in the multi-billions of dollars, a few starts (Start Definition: the entire project expenditure is counted in the month when the “field work” commences) over a month or two can skew the data. To put this into perspective, if we take the data presented in Fig. 3 (rolling 12 months data) and present it as rolling 3 month data, the result exhibits extreme volatility as illustrated in (Fig. 4). Examining the data regionally reveals that 33.8% of the project starts were in the Southwest ($39.4 BN of $116.4 BN) over the past year. Starts in the Southwest continue to surge ahead, up 42.3% y/y. The gulf coast region is the primary beneficiary of these construction dollars. The main project types capturing the dollars in the Southwest include: Power, production oil & gas, transmission oil & gas and chemical processing. The next strongest region of the country at $13.4 BN of starts (11.5% of the total), over 12 months was the Midwest, followed closely by the West Coast at $12.9 BN, (Table 2).

Fig 3

Portland Cement Shipments: On a national basis cement shipments increased by 4.0%, 3 months y/y ending February. However there were large regional variances. The Pacific West saw the largest percentage increase, surging 17.4% y/y, followed by the West South Central which posted a 9.8% y/y increase. The nations Midwest and North-Atlantic regions posted declines ranging as much as -15.9% y/y in the Middle Atlantic. Undoubtedly the severe winter had a major impact on the shipment values in these regions, (Fig. 5). Fig. 6 presents the regional data by shipment volume and compares the relative trajectory of growth. The West South Central reveals the greatest volume and strongest “climb”. After taking the broadest plunge from its pre-recession highs, the South Atlantic is staging a modest recovery, as is the Pacific West. The East South Central and Northeast have yet to show signs of recovery.

Fig 5

Commercial Property Price Index: The Moody’s/Real Capital Analytics national all property CPPI posted 15.3% y/y gains and the trajectory suggests continued solid growth. Sales in the first quarter totaled $87.0 billion up from $75.7 billion in Q1, 2013. The index has now surpassed its pre-recession peak for 8 months in a row, (Fig. 7). Looking at the sub-components, the largest price index gain, 25%, y/y was in the commercial business district (CBD), office market. The smallest gain was for apartments, 10.9% y/y. In volume terms, the clear winner was apartments with overall volume up 147%. A stable interest rate environment and an increasingly competitive financing market contributed to the positive trends in Q1. Fig. 8 charts each of the sub-sectors as percentage change y/y, the black dashed line represents the national CPPI. Positive results were recorded in most markets. Philadelphia, New York City Burroughs and Tampa were the top volume producers in Q1, however, Manhattan, and Los Angeles continue to be the number 1 and 2 hottest markets. A few markets posted y/y declines, including Boston, D.C., Seattle and Phoenix. According to Moody’s, loan underwriting standards have been relaxed, contain more generous loan terms and are readily available. This seems to contradict the loan survey results discussed above.

Fig 7

U.S. Industrial Production measures the monthly output from four industries: mining, manufacturing, gas, and electric. Its baseline is 2002 = 100. The seasonally adjusted figure reached another all-time high in March of 103.24. The Index rose 4.2% on a y/y basis and increased for the fourth straight month. The three month moving average is 102.34, the highest figure on record. March’s reading is up 24% since June 2009, the lowest measure during the Great Recession. As industrial production has recovered and seeing all-time highs, total steel supply has only made a partial comeback from the depths of the recession, still well below the monthly averages seen well before the recession. It is probable that as the construction and manufacturing industries continue to expand throughout 2014, total steel supply will follow suit. Historically there has been a 70% correlation between the two data sets, (Fig. 9).

Fig 9

Manufacturing Cap Utilization rose for the third straight month in March to 76.7%. March’s rate is up 0.80% on a y/y basis. The ideal capacity utilization range is 75%-85%. Manufacturing capacity utilization has remained in this range since the beginning of 2012, albeit on the lower side; however, this figure hasn’t been north of 80% since early 2000, (Fig. 10). The Manufacturing PMI Index has recovered from the abnormally harsh winter and rose to 54.9 in April, up 1.2 points from March, and is trending up as spring and summer arrive. The latest National Association of Manufacturers survey showed that optimism is the highest since 2012, as 86.1% of respondents were positive about their company’s outlook. Partial optimism is due to the federal budget being passed without a possibility of a shutdown for at least two years. Survey respondents noted pessimism regarding regulatory issues and uncertainty due to the Affordable Care Act.

Fig 10

Contributors this week include; Brian Drozdowski, Peter Wright and Steve Murphy