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Regional Outlook

Regional Perspectives The San Francisco Region's job growth rate slowed during the first seven months of 1999 compared with the year-ago period. Nevertheless, jobs were created in the Region at a rate that exceeded the national average. The Region's financial institutions reported healthy conditions; weakness was noted, however, in institutions in Hawaii and Montana. Mortgage and agricultural lenders in the Region reported performance declines, while some smaller commercial lenders increased holdings of traditionally riskier assets. Low commodity prices and resulting declines in farm income negatively affected asset quality of the Region's agricultural banks, particularly in Montana and Washington. Economic and Banking Conditions The San Francisco Region's Economy Continues to Outpace That of the Nation Despite slowing since 1998, the San Francisco Region's economy is generally healthy. Total nonfarm job creation continued to exceed the national average, but slowed to an average year-over-year growth rate of 2.9 percent in July 1999 (see Chart 1). Strength in the services and construction sectors offset softness in the manufacturing, aerospace, energy, and agricultural sectors. In particular, rural areas of Montana, Wyoming, Idaho, Utah, Oregon, Washington, and California have been negatively affected by dependence on the agricultural sector during a period of sustained low commodity prices. Chart 1 As expected within such a large and diverse Region, job growth rates differed greatly during the first seven months of 1999. Five of the Region's eleven states-Nevada, Arizona, Idaho, California, and Utah-outpaced the nation in job growth during this period because of a strong services sector. Washington and Oregon experienced some weakening in job growth because of reliance on the weaker manufacturing and agriculture sectors. Alaska, Montana, and Wyoming were among the slower growing states in the Region because of lower commodity prices, and Hawaii grew more slowly than the nation because of its depressed tourism sector. The Services and Construction Sectors Drove Growth in the Region's Best Performing States-Nevada, Arizona, Idaho, California, and Utah These states' job growth rates outperformed the nation's during the first half of 1999 because of strong growth in the services and construction sectors. Rapid growth in Nevada's hotel and amusement sector boosted the state's overall job growth and accounted for nearly 40 percent of the jobs added in the state since January 1999. Specifically, recent openings of 3,000 rooms at the Paris Las Vegas hotel and nearly another 3,000 at the Venetian1 hotel fueled Nevada's robust service-sector expansion. Visitor volume in Las Vegas was expected to grow by roughly 3.1 percent through 1999 because of the addition of the new resorts and interest stimulated by the upcoming New Year's celebration. Like Nevada, California experienced fast growth in its services sector, particularly in Southern California's hotel and amusement and motion picture industries. In addition, the September 1999 UCLA Anderson Forecast noted that growth in software and Internet business services is expected to accelerate, reaching as much as 9 percent in 1999. Idaho, Utah, and Arizona continued to experience strength in the services sector; Utah and Idaho exceeded the national growth rate in the sector. 1 According to the Las Vegas Convention and Visitors Authority, construction of the Venetian will take place in two phases. Three thousand rooms were completed in May 1999 during Phase One while another 3,000 are expected to be created during Phase Two. A date for the completion of the second phase has not been reported. The Region's top-performing states experienced improved growth in the construction industry and outpaced the national average during the first seven months of 1999. Arizona and California saw the Region's fastest year-over-year growth in the construction sector-10 and 9.7 percent, respectively. Both states also experienced double-digit growth in total residential building permits during the first two quarters of 1999, likely because of strong population growth. Washington and Oregon Experienced Some Weakening in the Manufacturing and Agriculture Sectors Washington and Oregon, states that had performed well in the past, experienced a slight weakening during the first half of 1999 because of dependence on the manufacturing sector and, to a lesser extent, the agricultural sector. Washington's economy slowed earlier in the year as Boeing, the state's largest employer and a major past contributor to job growth, laid off 17,400 employees in the 12-month period ending June 1999. In Oregon, manufacturing job losses began in the third quarter of 1998 and continued through the second quarter of 1999. Oregon's manufacturing slump has been attributed primarily to slowdowns in the durable goods manufacturing sector, which includes information technology manufacturing. In addition, Oregon is the only state in the Region in which the number of business bankruptcies increased in the second quarter of 1999. Furthermore, rural areas in Washington and Oregon are exposed to deterioration in the agricultural sector, primarily related to weakness in wheat and apple prices. A more in-depth discussion follows in the section entitled "Low Commodity Prices Pressure Some Farmers in the San Francisco Region," below. Lower Commodity Prices and Weak Eastbound Tourist Volume Hurt Some States in the Region Alaska, Montana, and Wyoming remained among the Region's poorest performers at midyear 1999, partially because of low energy and agricultural prices. Alaska's economy was affected by weak oil prices from late 1996 through year-end 1998, resulting in a 10 percent year-over-year decline in mining employment for the first seven months of 1999. Nearly 7 percent of Wyoming's total employment is in the mining sector, compared with less than 1 percent for the Region and nation. More than half of these jobs are in the oil and gas industry, making the state's mining sector vulnerable to weakness caused by low oil prices. Wyoming experienced a 0.9 percent job increase through July 1999, but the mining sector experienced losses of 2.3 percent during the same period. Montana experienced weakness in the agricultural sector during the first half of 1999. Although the state saw total nonfarm employment growth keep pace with the Region, weakness in the farm sector will likely depress farm employment, given the low commodity prices experienced since 1997. These three states have government sectors much larger than the Region's average, and these sectors are funded, in part, by the mining industry. Therefore, weakness in the mining industry could affect many more workers than those directly employed in mining. Hawaii's economy remained weak during the first half of 1999, affected primarily by the declining number of eastbound tourists. Although the hotel and lodging sector has not added jobs since mid-1997, the increase in the number of westbound visitors to the islands offset some of the negative affects caused by a slowdown in eastbound visitors. However, the Hawaii Visitors and Convention Bureau estimates that eastbound visitors spend significantly more money per day than westbound visitors, indicating that Hawaii may not recover quickly from its economic slowdown. The San Francisco Region's Banking Conditions Remain Strong Despite slowing in the Region's economic growth, its insured financial institutions reported generally strong earnings as of June 30, 1999. Insured institutions posted 1.33 percent aggregate return on average assets (ROA) through second-quarter 1999, unchanged from the level reported one year ago. While net interest margins (NIMs) have continued to fall from a year ago, ongoing reductions in overhead and provision expenses have offset these declines. Strong and improving asset quality in most of the Region's institutions has reduced provision expenses. Reported past-due loans, currently at a low 1.59 percent of total loans for the Region's insured institutions, remained below the 1.98 percent reported for the nation. Even though strength in earnings and asset quality was reported for the Region, institutions located in states with weak economies, such as Hawaii and Montana, underperformed peer institutions in the Region and the nation. The performance of Hawaii's 14 financial institutions, with total assets of almost $30 billion, continued to be hampered by the effects of the turmoil in Asia, which has contributed to the state's lingering economic weakness and weak real estate markets. In addition, Montana's 93 financial institutions, with over $11 billion in total assets, reported generally poorer asset quality than the Region and nation primarily because of the great number of institutions concentrated in agricultural lending. Macroeconomic developments also have negatively affected the financial performance of some institutions concentrating in mortgages. The Region's 57 mortgage lenders2 reported declines in NIMs and lower gains on securities and loan sales, likely as a result of the increase in interest rates and a steepening in the yield curve. The changes in the yield curve slowed fixed-rate mortgage origination, reducing mortgage banking revenue and increasing depreciation in available-for-sale securities in many of these institutions, most of which are located in California and Washington. 2 Mortgage lenders have single-family mortgage loans and mortgage-backed securities greater than 50 percent of total assets. The Region's economic strength has contributed to the strong reported asset quality of its commercial lenders,3 which account for over 31 percent of the Region's assets. These institutions, however, experienced declining NIMs and lower ROA. As a result, some commercial lenders increased higher-yielding and traditionally higher-risk assets such as commercial real estate, construction, and multifamily residential loans. The growing concentration in higher-yielding assets is particularly notable for commercial lenders with assets less than $1 billion located in Arizona, Nevada, Oregon, and Utah (see Table 1). As a result, these institutions reported higher NIMs and higher ROA figures than the Region and nation did. However, higher concentrations in these potentially higher-risk areas raise concerns, particularly in Oregon and Nevada, where these institutions are reporting increases in past-due loan levels. Hawaii is the only other state in the Region where small commercial lenders reported an upswing in past-due loans. 3 Commercial lenders have commercial real estate, construction, multifamily, and commercial and industrial loans greater than 25 percent of total assets. Finally, stress in the agricultural sector has resulted in lower earnings, falling NIMs, and rising reported past-due loan ratios in the Region's 93 agricultural banks,4 primarily located in California, Montana, Washington, and Wyoming. The discussion that follows focuses on deterioration in the Region's farm sector. 4 Agricultural banks have 25 percent of their loans in agricultural production and real estate loans. Low Commodity Prices Pressure Some Farmers in the San Francisco Region Low commodity prices, which have persisted since 1997 for some of the Region's agricultural products, have adversely affected the Region's farm sector. Deterioration in the agricultural industry is a concern in the San Francisco Region because of the size of the industry and the number of insured institutions lending to the sector. The Region's agricultural cash receipts represent over 20 percent of the nation's total, and California accounts for over half the Region's total. Although California produces the majority of the Region's agricultural crops, all 11 states are involved in agricultural production. Consequently, agricultural lending exposure is widespread; over 50 percent of the Region's 852 insured institutions have extended agricultural loans. Unlike other areas of the country, in the San Francisco Region the size of agricultural lenders varies significantly, reflecting differences in the size of farm revenues. Average annual cash receipts range from a high of near $311,000 for farms in California to less than $100,000 for farms in Montana, Utah, Oregon, and Wyoming. California is home to three of the nation's largest agricultural lenders.5 However, because of large institutions' product and geographic diversification, these institutions' relative risk exposure is not as high as that of the Region's agricultural banks. The Region has numerous smaller institutions with loan portfolios concentrated in the agricultural sector. Although these institutions range in size from $215 million in assets in California to $57 million in Montana, they all are more vulnerable than larger institutions to deterioration in agricultural portfolios because of a lack of product and geographic diversification. (For more information about the San Francisco Region's agricultural sector and agricultural banks, see the San Francisco Regional Outlook, second quarter 1998.) 5 Agricultural lenders are institutions that make agricultural loans. However, these institutions are not necessarily agricultural banks because some do not have 25 percent of loans in agricultural production and real estate loans. Unlike many of the Region's metropolitan areas that have enjoyed strong economic growth through midyear 1999, many rural areas have experienced economic slowdowns, particularly in the agricultural sector. Declines in agricultural commodity prices appear to be the primary cause for the persisting weakness in the Region's farm sector since 1997, and, as a result, farm incomes in parts of the Region have declined. In addition, many insured institutions lending to agricultural borrowers have reported rising past-due ratios on agricultural portfolios, indicating that weakness in commodity prices and farm incomes in the Region is beginning to adversely affect agricultural borrowers' repayment ability. Commodity Prices and Export Markets Appear Stressed Among the variety of agricultural products produced in the San Francisco Region, the commodity groups that have recently experienced price declines are wheat, cattle, and vegetables and fruits (primarily apples). Domestic overproduction as a result of improved technology and low incidence of crop diseases is often cited as the primary reason for these declines. Farmers' response to the Federal Agriculture Improvement and Reform Act of 1996 (FAIR) also led to oversupply problems in the farm sector. When production restrictions were lifted, farmers began planting land that they had previously left fallow. Recent agricultural exports also have declined because of high worldwide production, reduced foreign demand, and a strong U.S. dollar. Severe price declines in wheat, which ranks6 among the top ten commodities for eight of the Region's eleven states (shown in Map 1), concern analysts because of the adverse effects observed in many of the Region's rural areas where the crop is grown. The price of wheat fell from $4.30 per bushel in 1996-1997 to $2.65 for the 1998-1999 marketing year, largely because of strong foreign and domestic production. In 1996, when FAIR was enacted, U.S. wheat supply growth began to outstrip increases in demand, not only because of domestic overplanting but also because of favorable growing conditions and low incidence of wheat diseases. As a result, the beginning stock of wheat7 began to rise while the price continued to fall (see Chart 2). Map 1 Chart 2 6 Rankings are measured by total state agricultural cash receipts unless otherwise stated. 7 The beginning stock is defined as the excess supply of a commodity not sold in a certain marketing year, causing it to carry over into the following year's supply. In addition, major wheat-exporting countries have large supplies of the commodity, and the U.S. dollar is relatively strong. China, the world's largest wheat producer, reported record production of the commodity in the 1997-1998 marketing year, with 1996-1997 production and projections for 1998-1999 only slightly lower. Domestic wheat producers' competitiveness may be further diminished if China devalues the renminbi and the U.S. dollar remains strong. Cattle, which ranks among the top five cash-producing agricultural products in each of the Region's states except Alaska and Hawaii (see Map 2), have also been negatively affected by falling prices during the past decade (see Chart 3). Although prices edged up in late 1998 and early 1999, the sector remains weak because of farmers' decisions to sell animals for slaughter at already low market prices rather than retaining them for breeding. While such action likely will put upward pressure on cattle prices, those farmers who sold heifers at low prices will have to pay higher prices to rebuild their herds. Map 2 Chart 3 Apple prices have been under pressure since 1998, as shown in Chart 4. Apples are particularly important to the Washington economy, as well as to the economies of parts of Oregon and California (see Map 3). Specifically, an increase in Chinese apple exports and a decrease in Japanese demand for the commodity have hurt apple prices. In 1998, China brought 2 million more acres of apples into production. At the same time, the Chinese renminbi depreciated against the U.S. dollar, making Chinese apple exports more competitive in the U.S. market. In addition, China's increased apple production and exports to the U.S. market has negatively affected the price of apple juice concentrate in this country. Juice apple prices fell to $10 per ton in 1998 from $50 per ton in 1997 and $180 per ton in 1995. In addition, because of Japan's economic downturn and the fact that apples are considered a luxury there, that country's demand for apples has declined since 1997. Chart 4 Map 3 1998 Farm Incomes Are Weak in California, Montana, and Washington In 1998, low commodity prices resulted in declining farm incomes, particularly in California, Montana, and Washington. However, in many states, weakness in crop or livestock revenue has been masked by large increases in government payments8 to farmers, particularly in 1998. In addition, the existence of shared appreciation agreements (SAAs)9 may increase individual farmers' debt burdens at a time when farm incomes are weakening. 8 Direct government payments are cash payments made directly to farmers and include Production Flexibility Contracts; Loan Deficiency Payments; payments made under the Conservation Reserve, Agricultural Conservation, Emergency Conservation, and the Great Plains Programs; and other miscellaneous payments. 9 In the mid-1980s farm income, farmland values, and the ability of many farmers to service their outstanding debt deteriorated significantly. During this troubled period, the Farm Service Agency (FSA), formerly the Farmer's Home Administration and the Agricultural Stabilization and Conservation Service, agreed to forgive some of the farmers' debts. However, after 1988, the FSA required farm program borrowers applying for a debt writedown to sign a shared appreciation agreement (SAA). SAAs allow for the recapture of a portion of farmland appreciation for ten years following the signing of the agreement. The amount of the recaptured debt is limited by the amount of the original writedown. California's net farm income experienced the largest decline in the Region during 1998, dropping over 16 percent from peak levels in 1997 to near the state's 1990 to 1997 average (see Chart 5). The largest declines were evident in cotton, almond, and grape crops, which had particularly strong yields in 1997 but fell to average levels in 1998. Montana's net farm income increased slightly in 1998 but remained at only 70 percent of the 1990 to 1997 average, primarily because of a decrease in the value of harvested food grains. Washington reported a decline in value of the state's important fruit and tree nut crop for the second straight year. This sector contributes nearly 20 percent of the state's total agricultural revenue. Chart 5 However, high direct government payments and low feed and input costs mitigated weakness in farm income in the San Francisco Region. In 1998, Congress approved a $6 billion aid package to help farmers offset some of the effects of commodity price declines; a larger aid package of $8.7 billion was signed into law in October 1999. Consequently, in 1998 direct government payments to several of the Region's states rose substantially, in most cases to record levels (see Chart 6). In addition, grain prices were low, which resulted in reduced feed costs for the livestock sector in 1998. Chart 6 The existence of SAAs in certain states may result in larger debt burdens in 1999 for some of the Region's farmers as the first group of SAAs reaches the ten-year recapture date. Table 2 outlines the Region's SAA exposures. Idaho, which has the Region's greatest number of farmers holding the instruments, and Montana, which issued the Region's largest dollar value of agreements, have the greatest exposure to these agreements. Although this exposure is limited,10 it may negatively affect some farmers, perhaps unexpectedly, by increasing debt levels and hindering their repayment ability. 10 The Region's $182 million in SAAs account for only 11.8 percent of the total SAAs in the nation. Agricultural Banking Conditions Analysts' concern about the Region's agricultural banks, which hold about $7.5 billion of the Region's assets, increased in 1999 because of deterioration reported in these institutions' agricultural loan portfolios. While earnings and capital levels declined slightly through the second quarter of 1999, asset quality at the Region's 93 agricultural banks has deteriorated noticeably compared with previous years. Insured institutions in Montana experienced the most severe past-due agricultural loan problems in the Region during the first half of 1999. As a result, the total past-due loan ratio for agricultural loans in the state was one of the highest in the Region (see Map 4). Farm banks in Idaho, California, and Washington are also seeing deterioration in asset quality. While government programs guarantee some of these institutions' loans, many loans are not guaranteed, leaving lenders at risk of default if commodity prices continue to fall. Map 4 As of second quarter 1999, ROA at the Region's agricultural banks was 1.25 percent, noticeably lower than a year ago, but higher than the national average for agricultural banks. However, the strength in the Region's ROA may be somewhat distorted because of the existence of 13 Subchapter S agricultural banks in Montana, Wyoming, and California; these institutions tend to have a higher ROA because of their tax-advantaged status. Furthermore, the Region's Tier One leverage capital ratio of 9.91 percent for the second quarter of 1999 was at its lowest second-quarter level in the past five years. Despite slightly lower earnings and capital levels, weakened asset quality is the most serious problem facing the Region's agricultural banks in 1999. This situation may be exacerbated if commodity prices or farm income levels continue to weaken. The Region reported a past-due agricultural loan ratio of 2.78 percent in the second quarter of 1999, which is near the national average for the period. It is the Region's highest level for that period during the past five years, suggesting that low commodity prices are beginning to negatively affect agricultural borrowers. Montana, Washington, and Wyoming, home to 73 of the Region's agricultural banks, reported increasing levels of past-due loans (as shown in Chart 7). While Montana is the only state with a past-due loan ratio exceeding the national level, Wyoming and Washington reported increases compared with the past five years. This upswing in the Region's total past-due agricultural loans is attributed to increases in agricultural production and real estate past-due loans. In addition to declines in asset quality, Montana and Washington have experienced marked deterioration in coverage ratios11 because provision expenses have not kept pace with large increases in noncurrent loans. Chart 7 11 Coverage ratio is defined as the allowance for loan and lease losses divided by noncurrent loans and leases. Because some of the loans are guaranteed by government programs, it may appear that high past-due loan ratios in the Region's banks are not a serious concern. However, the level of guaranteed past-due loans in the Region is very small. Chart 8 shows the structure of the Region's past-due loans, assuming that all past-due guaranteed loans are agricultural loans. Even from this conservative perspective, the volume of past-due agricultural loans remains a concern. Montana appears to be most at risk because, even with the guaranteed portion of the portfolio excluded, the state exceeded the Region's average as of June 30, 1999. Chart 8 Implications for the Region's Agricultural Banks The San Francisco Region has significant exposure to the agricultural sector, given the volume of agricultural products produced in the Region and the number of insured institutions involved in farm lending. The Region's weakness is concentrated in agricultural banks, particularly those in Montana and Washington. These states have large wheat crops, and Washington is also exposed to the decline in apple prices, which has persisted since 1997. While most states have yet to experience significant declines in net farm income, crop income has fallen. However, this decline has been mitigated by the increase in direct government payments to farmers. Conditions at the Region's agricultural banks reflect the stress experienced in the agricultural sector since 1997. While earnings and capital levels weakened slightly in the second quarter of 1999, analysts are primarily concerned about the asset quality deterioration experienced at these institutions. Past-due agricultural loan ratios are high in Montana and have risen in Wyoming and Washington in the second quarter of 1999, compared with 1998 and 1997 levels. This trend suggests that farmers have been negatively affected by low commodity prices and, as a result, could experience repayment problems. San Francisco Region Staff Regional Outlook Information Return to Regional Outlook main page