Dominos Falling

By: Chad Hudson | Wed, May 29, 2002
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Economists have gotten more optimistic about the prospects of the U.S. economy. The latest survey of professional forecasters published by the Federal Reserve Bank of Philadelphia found that economists have a brighter outlook on the economy than three months ago. Forecasts of 2002 GDP growth increased to 2.7%, almost twice the 1.4% growth anticipated in the February survey. Not surprising, the probability of another negative quarter of GDP growth diminished to just 13%, less than half the previously estimated chance.

Economists point to the continued purchases of big-ticket items as a sign of consumer confidence. After all who would buy expensive stuff if they thought they might get laid-off. While we agree with this premise in principle, in today's easy money environment, it might not be as accurate a gauge as in the past. Everyone already knows this recession has been atypical with consumers defying playing their regular role and curtailing spending. With spending remaining strong and employment weakening it is not surprisingly that delinquencies have been increasing as well.

When analyzing credit card debt, some of the more bullish economists argue that consumers are racking up credit card balances due to the convenience factor. There are a growing number of consumers that use credit cards for everyday purchases, and pay the bill off entirely each month. Estimates range from 40% to 50% of credit card users fall into the camp. While this would increase the total amount of credit card debt outstanding, if might actually mean more consumers are worse off. With the average household having a credit card balance of over $8,000, those who use a credit card as a convenience would pull down the average. At least, I don't know too many people that have $8,000 in monthly expenses. The increase in convenience users would also lower the number of accounts that are delinquent. Most, if not practically all, convenience users pay off the balance each month. These accounts obviously are very unlikely to be delinquent, but since they are included in the total number of accounts, they deflate the percent of accounts that are classified as delinquent.

Overall credit card debt is less telling as it has become common for consumers to take home equity loans or extract cash from a refinancing and payoff other credit balances. One indication that the refinance market is winding down is last month's earnings release from E-LOAN. E-LOAN revised its financial guidance lower based on, "substantially lower refinance demand…mortgage refinance demand dropped sharply in mid-March and has remained low…we believe that there is a reasonable probability that the boom level in refinance demand is over."

The mortgage industry has recently created interest only mortgages. These mortgages are attractive since homeowners assume a much lower monthly payment, because they only pay the interest on the mortgage for a certain number of years, usually five to fifteen. This appears to be a vehicle that allows homeowners to speculate on the housing market. Since homeowners do not build up equity, they must assume they will be able to sell or refinance the house at a later date at higher price. If not, they are upside down on their loan. There are others that like the fact that it allows them to purchase a more expensive house then they would be able to afford using a conventional mortgage.

Is this sign of speculation a sign of a top? That seems to be the million, err billion dollar question. The real estate market in California is almost reminiscent of the good old days of just a couple years ago. Besides the record median prices, The LA Times, San Francisco Gate, and numerous other California newspapers have carried dozens of stories lately about prospective homebuyers sleeping overnight to be first in line for new developments. The real estate market typically follows an orderly progression. Real estate segments fall in relation with the length between lease renewals. Hotels, with an almost daily lease renewal period, are the first to show signs of weakness. Apartments then commercial real estates follows with residential real estate declining last.

Wednesday, Hilton lowered its RevPAR (Revenue per available room) estimates for the second quarter. Hilton now expects RevPAR to decline 5% from last year's level verses the previously anticipated RevPAR decline of only 1% to 2%. Hilton said that daily room rate have not improved as much as they anticipated. Investors didn't fret since the company said it has pared down expenses enough so earnings will not be affected. The company also indicated that time-share sales have been strong. Strong time share sales should not be too surprising as it shows the continued strength of consumers, while businesses continue to cut cost.

As companies continue to pare cost, they are increasingly shedding office space. While vacancies have been falling and rents declining for several quarters, it is just now starting to hit the pocketbooks of landlords. According to the Wall Street Journal's real estate website,, average cash flow per until landlords received declined for the first time during the first quarter of 2002. This decline fits the typical progression. The lodging industry first experienced a decline in RevPAR in the second quarter of 2001. Average cash flow per unit for apartments went flat during the third quarter last year, then negative in the fourth. Now that more leases are starting to turn over, cash flow for office buildings went negative in first quarter this year. Nationally, cash flows declined 0.8%, but areas with high technology concentrations are down much more. San Francisco dropped 4%, with Dallas, Austin, Seattle, and Denver all experienced a drop of over 3%.

Richardson, a Dallas suburb, has been hit worse than any other area. Richardson is the home of Telecom Corridor, an area Richardson promoted as having "one of the largest concentrations of leading-edge telecommunications and technology-based companies in the world." Maybe just a coincidence but the website established for the Telecom Corridor by the Richardson Chamber of Commerce has a timeline that stops in 2000. The last entry features Cisco building a 1.7 million square foot, seven building campus to house 5,000 employees. Last year, Cisco halted development of the project after the fourth building was completed and the foundation for the fifth was poured. At the time, Cisco had 1,500 employees that have since been cut to 1,000. A recent Dallas Morning News article said the area sports a 46% vacancy rate and rents are about half what they were last year. Much of this space is from Nortel vacating 10 buildings in the area.

In a continuing effort to reduce cost, Nortel is cutting another 3,500 jobs and is thinking about selling its fiber-optic parts business. These latest measures will lower the quarterly revenue needed to breakeven to $3.2 billion from $3.5 billion. But, Nortel remains below the reduced breakeven mark. It forecasts second quarter revenue to be flat to down 5% from first quarter's $2.9 billion. When Nortel first started reducing costs last year, it targeted $5 billion in revenue to breakeven. Nortel also said it does not see any meaningful recovery in the long haul fiber optic market until late 2003 or 2004. Maybe Nortel should not have disclosed their forecasts until after they sold the fiber-optic parts business? The point might be moot as RBC Capital analyst, John Wilson commented, "I'd be shocked if anyone wanted to buy it."


Chad Hudson

Author: Chad Hudson

Chad Hudson
Mid-Week Analysis

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