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San Francisco Regional Outlook - Fourth Quarter 1997
San Francisco Region's Large Metropolitan Areas Experience a Wide Range of Conditions and Risks
San Francisco Region Includes Both Fast- and Slow-Growing Large Metropolitan AreasWhile the San Francisco Region leads the nation in economic growth and includes some of the nation's fastest-growing metropolitan areas, it also includes several underperforming areas. However, as the Region's economies differ, so do the economic and banking risks these areas face. Both groups of large metropolitan areas are subject to national economic risks, such as recessions. Other risks are regional. In some faster-growing areas, the economic risks center on demographics, specifically slower population growth that might dampen their booming real estate markets and economies. The group of weaker economies risks being left out of a sustained period of national economic growth. Moreover, some metropolitan areas in each group may be emerging as areas of special interest because of their heavy bank exposure to commercial real estate and construction lending (see Regional Banking Conditions).
Of particular interest are the metropolitan statistical areas (MSAs) within each group where the local economy is very dependent on highly cyclical construction activity and where the local banks have a heavy exposure to construction and commercial real estate lending. Two faster-growing areas, Las Vegas and Portland, and one slower-growing area, Tucson, fall into this category. Fresno also may bear closer examination even though its economy is not highly dependent on construction. The overall weakness in Fresno's economy and real estate markets, coupled with its banks' heavy construction lending exposure, should be carefully observed.
Large Metropolitan Areas outside California Continue Their Robust GrowthThe four fastest-growing large MSAs (those with employment greater than 250,000) in the Region are Las Vegas, Phoenix, Seattle, and Portland. These MSAs continue to be among the fastest growing in the nation, and all are reporting strength in services and construction. Each of these MSAs reported robust growth over the 12 months ending in July 1997 (see Chart 1). These MSAs added jobs at a 4.3 percent pace or better, compared with 3.1 percent and 2.3 percent, respectively, for the Region and the nation.
The service sector, which accounts for three of every ten jobs in the Region, continues to set the pace for expansion in the fast-growing MSAs. Each of these MSAs reported growth rates in service jobs equaled or exceeded the Region's 4.4 percent rate over the 12 months ending in July. All four also reported very strong growth in manufacturing jobs, well above the Region's 3 percent rate. With the exception of Seattle, each of the MSAs also added construction jobs at robust rates of 7.3 percent or better.
Despite the continued strong growth in these fast-growing MSAs, three grew at a slower pace in 1997 than in 1996. Seattle, which is experiencing an aerospace boom, was the only one of the four MSAs where employment growth accelerated over the past 12 months. However, Chart 1 also illustrates that the rapid growth of these MSAs over the past two years continues to easily outpace the Region, even with their slightly slower rate of growth in 1997.
Demographic Forces May Slow GrowthThe Region's four fast-growing large MSAs are all located outside California and could be subject to demographic shifts within the Region. Such shifts might slow population growth and adversely affect both real estate markets and financial institutions in those MSAs with heavy commercial real estate and construction loan exposures.
The influx of new residents, many arriving from California, was a strong factor in the expansion of the Region outside of California during the 1990s. States and metropolitan areas with strong economies and more favorable employment market conditions generally experienced accelerated population growth, while California suffered large job losses, high levels of unemployment, and an unprecedented net outflow of residents.
Recent population figures, however, suggest that the outflow from California may be slowing or even reversing as the state's overall economy picks up and job opportunities improve. Chart 2 shows that California's population growth was higher in 1996, compared with the prior three-year period. In contrast, population growth rates for all of the other states in the Region were slower in 1996 compared to the earlier period.
Rapid population growth in the 1990s spurred the construction sector in these metropolitan areas and most of them became much more dependent on construction sector jobs than the Region as a whole. For example, as of July 1997 construction accounted for only 4.9 percent of all nonfarm jobs in the nation and 5.1 percent in the Region. Nevertheless, as is shown in Chart 3, as of July 1997 construction accounted for 10.3 percent of all jobs in Las Vegas, 7.1 percent in Phoenix, and 6.2 percent in Portland.
The dependence of these MSAs on construction activity is reflected in the June 1997 banking industry statistics. Community banks (those with less than $1 billion in total assets, excluding specialty credit card banks) in three of these MSAs have a much larger share of their loan portfolio in construction loans than banks of similar size elsewhere in the Region. In Las Vegas, construction loans made up 17.3 percent of total loans, while Portland and Seattle report 15.9 percent and 14 percent, respectively. The comparable figures for their peers in the Region and for all community banks in the nation are only 8.2 percent and 4.8 percent, respectively. Finally, to give some historical perspective to the degree of exposure for community banks in these MSAs, at year end 1990, before the Los Angeles real estate markets tumbled, construction loans at Los Angeles-area community banks accounted for 15.4 percent of total loans.
Dependence on the Construction Industry Exposes These Areas to Weakness in the Event of a SlowdownAmid a background of renewed strength in the real estate sector nationally, several fast-growing MSAs are reporting potential signs of softening in some real estate and construction indicators. Moreover, some softening is consistent with the slowdown in migration to these MSAs. Second quarter 1997 metropolitan office vacancy rates for Las Vegas rose to 3.6 percentage points above the third quarter 1996 vacancy rate as the supply of new facilities has outstripped demand. The area's vacancy rate of 13.2 percent is noticeably above the national average of 11.2 percent. In the first and second quarters of 1997, industrial vacancy rates rose slightly in Portland. Finally, nonresidential construction contracts fell modestly in both Portland and Seattle in 1996, and more recently Las Vegas, Phoenix, and Seattle all reported declines in the first quarter of 1997 compared with the same period in 1996.
Residential real estate markets in much of the Region outside of California also appear to be showing signs of cooling off, such as smaller price increases. At midyear 1997, total single-family residential building permits for the Region were down slightly relative to the same period a year earlier. Except for Seattle, where real estate markets are picking up with the economy, the other three fast-growing areas all are reporting noteworthy declines in 1997 compared with 1996 for both single-family and multifamily permits. Total permits, usually an indicator of future residential construction activity, are below last year's pace in Phoenix (-10 percent), Portland (-9 percent), and Las Vegas (-7 percent). Conversely, California, where housing sales and prices are exhibiting renewed strength, especially in the Bay Area, is showing a sizable increase in 1997 permits authorized.
The simultaneous softening of many real estate market indicators in these fast-growing MSAs, following the slowdown in migration to these areas, may be an early warning of deteriorating real estate market conditions and reduced construction activity. This is important, since the construction industry is one of the most volatile sectors of the economy and its boom and bust periods often lead the overall business cycle. Chart 4 shows the extent of these wide swings in construction for the fast-growing MSAs. The annual growth rate of construction-sector employment varied about four times as much over the past 20 years as the growth rate of total employment excluding construction jobs.
Implications: While the outlook for the fast-growing MSAs is positive, the effects of potential demographic changes on their booming real-estate-based sectors and the heavy exposure of real estate lenders in the construction and commercial real estate areas should be carefully monitored. Most economists expect these areas to continue to expand rapidly, although probably at somewhat reduced growth rates. For example, DRI/McGraw-Hill recently projected that Las Vegas (ranked first), Phoenix (seventh), and Portland (twelfth) would be among the top 20 large MSAs in the nation in employment growth over the five-year period ending in 2002. In spite of this optimism, slower growth and reduced immigration could have adverse impacts on these areas. Las Vegas in particular has been singled out for concern by some economists because of its heavy dependence on the robust performance of its highly cyclical construction industry.
Warning Signs in Fresno and TucsonThe strength of the four metropolitan areas described above contrasts sharply with the performance of the three slowest-growing large metropolitan areas in the Region. These areas fall into two groups. The first includes Honolulu, which remains an established area of concern because of its lingering recession. The second group includes MSAs that are still expanding but also are experiencing signs of deterioration, such as a slowdown in employment growth or softening real estate markets. Fresno, in California's Central Valley, has recorded job growth of less than 1.5 percent for the past two years, and its unemployment rate of 12.1 percent is almost twice the rate for the state. Tucson's economy also has slowed noticeably from just two years ago, when it was one of the Region's fastest-growing MSAs.
Fresno's Economy Is Slow Compared with the Region, and Its Real Estate Markets Are SofteningFresno is emerging as an area of concern because of its slow economy, erratic growth pattern, and softening real estate market conditions. The Fresno area reported only 1.4 percent growth in employment over the 12 months ending in July 1997, less than half the growth rate for the Region. Many sectors of the economy, including construction, finance, and wholesale and retail trade, are weak. Demographics also may be playing a role in the Fresno market. A sharp downturn in residential real estate markets may reflect a reduced inflow of residents from the Los Angeles Basin as the southern California economy improves. The weak economy and high and rising metropolitan office vacancy rates (14.4 percent for the second quarter of 1997) are important because community banks in the Fresno area have a relatively heavy exposure to both construction (16.1 percent of total loans) and commercial real estate loans (24.9 percent). This concern is underscored by a significant increase over the past year in the ratio of past-due and nonaccrual construction loans to total loans. For construction loans, the ratio soared from 5.6 percent to 10.7 percent (see Regional Banking Conditions).
Tucson's Economy Has Slipped over the Past Two YearsIn recent months, Tucson's economy has grown slowly compared with the Region. It also has experienced some signs of deterioration in real estate markets. Despite the slowdown over the past year, Tucson remains at full employment. In July 1997, Tucson's 3.3 percent unemployment rate was well below the national average of 4.8 percent.
Tucson's reported employment growth rate dropped below 1 percent over the 12 months ended in July 1997; a year earlier it added jobs at twice that rate. Two key reasons for the slower growth were a loss of government jobs and a loss of construction jobs. In addition, there was a sharp slowdown in job creation by the service sector in general and business services in particular. While health care services picked up somewhat, the change was not enough to offset weakness elsewhere in the service sector. Despite the apparent weakness in Tucson's local economy, activities more dependent on the health of the national economy, such as tourist-related services and manufacturing, continue to do well.
The decline in Tucson's construction employment is consistent with the signs of weakness in some sectors of the area's real estate markets. The softness is important because construction accounts for 6.4 percent of Tucson's jobs, well above the 5.1 percent share for the Region. Weakness is most evident in vacancy rates for industrial properties, where the second quarter 1997 vacancy rate of 13.1 percent is 5 percentage points higher than the national average. Tucson's metropolitan office vacancy rate rose from 8.5 percent in the first quarter to 9.0 percent in the second quarter. Within the Tucson area, however, while the downtown office vacancy rate remains very high (almost 22 percent), suburban office markets are very tight and vacancy rates are under 5 percent.
Not only have some segments of the commercial real estate market softened, but residential housing permits for the Tucson metropolitan area for June 1997 also fell almost 8 percent from a year earlier. The decline was most dramatic in multifamily housing permits, but single-family permits also fell. The weakness also could be influenced by slower in-migration. These twin developments, a slowing in the economy and signs of deterioration in some real estate indicators, are of particular interest in Tucson. Banks in Tucson, especially larger institutions, are heavily engaged in real estate lending. Commercial real estate loans make up almost 27 percent of total loans at banks in Tucson; construction loans account for another 15 percent of total loans. Exposure to both loan types is high relative to other metropolitan areas in the Region.
Lingering RisksFinally, Honolulu continues to suffer from a lingering recession, and current indicators do not foretell a quick turnaround. Commercial office vacancy rates remained close to 15 percent in the second quarter of 1997, among the highest in the nation. Housing prices continue on a steep decline, and building permits are far below pre-recession levels. International forces have buffeted real estate investment and tourism; the soft Japanese economy and the stronger dollar have caused many foreign visitors to reduce their spending or shorten their visits.
Implications: Weak economic conditions in these three MSAs warrant additional monitoring, although the risks vary somewhat across these MSAs. For example, while the Tucson area has slowed recently, its long-term prospects are generally considered sound. DRI/McGraw-Hill recently ranked Tucson fifteenth among the top 20 MSAs in expected growth over the next five years. Still, community banks in the Fresno area and larger banks in the Tucson area have relatively high exposures to both commercial real estate and construction lending. Because of their high degree of exposure in these loan categories, which have created problems for the banking industry following slowdowns in other parts of the Region, the slower growth rate of these communities bears closer monitoring.
Gary C. Zimmerman, Regional Economist
For More InformationGabriel, Stuart A., and Joe P. Mattey. "The Slowing Exodus from California." Economic Letter, Federal Reserve Bank of San Francisco, Number 96-38; December 27, 1996.
Zimmerman, Gary C. "California's Community Banks in the 1990s." Economic Letter, Federal Reserve Bank of San Francisco, Number 96-04; January 26, 1996.
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