Gloomy Forecast

Gloomy Forecast

By Francis X. Gilpin

Associate Editor

They don't call it the dismal science just for laughs.

Speeches by Federal Deposit Insurance Corp. economist Scott Hughes are breezy and humorous. Still, addressing Florida bank officers and directors last month in Tampa, Hughes dwelled more on potential problems facing the industry in the Sunshine State than recent successes.

Hughes leavened his dour message with a few jokes redirected at himself and his profession. "There are always upside risks," he answered one questioner, who wanted to hear something good about the future. "Being an economist, I'm always looking for the downside.

"I'm focusing on the downside risk because that's my job. That's right, doom and gloom, the dismal science."

Specifically, Hughes dislikes several trends that could adversely impact Florida banks.

The state's economy has done better than the rest of the country since the 2001 quasi-recession because homebuilding and tourism recovered nicely. A recession technically occurs only when the gross domestic product doesn't grow for two straight quarters. That failed to occur four years ago because American consumers uncharacteristically kept right on spending.

The spendthrifts aren't in a position to bail us out again, if the American economy starts to lapse into an honest-to-goodness recession. Credit cards and home-equity lines of credit are maxed out. Another income tax cut from President George W. Bush seems remote.

Besides a recession, much higher interest rates are a distinct possibility, says Hughes. That could be a double whammy for a state such as Florida.

Homebuilding usually tanks when interest rates go up. Vacationers don't need to get away from work during a recession because they don't have jobs.

Since 1970, Hughes says: "Right before every recession, we've had a spike in energy prices."

Yet isn't Florida creating more jobs faster than the rest of the nation?

Indeed, it is, especially along the Gulf Coast. Hughes says employment in and around Sarasota increased by almost 3% last year. Tampa Bay area payrolls expanded by about 2%. The annual rate nationally has struggled to stay above 1% since 2001.

But nearly half of the new jobs in Florida are administrative or temporary. Hughes says they don't pay well. Management positions grew by less than 5% and the state experienced a net loss of manufacturing jobs, according to the U.S. Bureau of Labor Statistics and economy.com.

No wonder median household income went down in 67% of Florida counties last year. Sarasota, Charlotte and Lee counties were exceptions on the Gulf Coast.

Construction employment, up about 16% last year, has been a bright spot.

There have been double-digit percentage increases in building permits for single-family homes in Florida every year since 2000, according to Hughes. The state's population growth is twice the national average. That demand for new housing is pushing up prices quicker than the national average, too.

But Hughes is among those who wonder what else may be propelling the higher prices.

"What can aggravate this price appreciation and make people start talking about bubbles, particularly in places like condo markets, is when people begin flipping contracts," Hughes told the bankers.

A state regulator at the Florida Bankers Association event later reported that one speculator recently bought every unit on one entire floor of a new high-rise condominium in Orlando.

"They aren't investors, per se," Hughes continued. "They aren't there to buy a second home. They aren't there to retire. They're there to get contracts and flip them and keep the prices increasing.

"This, long term, adds instability to the market. And that's when people start to worry about bubbles."

The Federal Reserve has observed evidence of investor flipping. "Even our friends at the Fed have said: 'You know, some markets in Florida are beginning to look a little frothy,' " says Hughes. "This can aggravate things when you have these flippers in the market. And this is happening at a time when affordability has fallen."

If Florida bankers haven't noticed, who can blame them?

Profits have been up and applicants are waiting in line to receive state bank charters.

But a closer look at the call reports shows the average return on assets for Florida community banks has been improving only gradually since 1999. Net interest margins, which generally equate to a bank's gross profit, have sunk due to Florida's competitive banking industry, says Hughes.

Mortgages have become more than 50% of the average Florida community bank's loan portfolio. Real estate lending made up only about 36% of the average portfolio in 1999.

"Bankers aren't stupid," says Hughes. "This is where the growth in the economy is occurring. Banks fund that. It makes sense."

But Hughes worries about the real estate tilt at many banks. "With that big exposure, what happens - god forbid - if long-term interest rates suddenly spike up?" asks Hughes.

The alarming proliferation of floating-rate mortgages for individual borrowers has Hughes thinking about what happens when steeper rates meet shrinking incomes.

"If we're worried about the threat, the risk of long-term interest rates going up and that happens, what's going to happen to people's debt service payment?" he asks. "Do they have a lot of income to spare?"

A state economy that is overexposed to real estate and perhaps still too dependent on tourism won't prosper in an inflationary environment.

"I can't tell you where long-term interest rates will go," says Hughes. "I can only tell you these are two risks facing the system."

Hughes concluded his remarks with a warning: "Just bear in mind, even though we've had economic growth, we're still at risk."

The applause from more than 200 bankers in a Hyatt Regency Tampa hotel ballroom was rather tepid.