Colorado Economic Forums - 1997

Economic and Banking Conditions in Colorado

William R. Keeton
Senior Economist
Federal Reserve Bank of Kansas City
May 1997

After several years of exceptionally strong growth, the Colorado economy appears to be slowing to a more sustainable pace. Some of this slowing is due to other states catching up with Colorado in economic performance, which is reducing the inflow of new residents. And some of the slowing is due to the strain the recent boom has put on Colorado's resources--its labor supply, land and housing, and infrastructure. Because Colorado still has many natural advantages, however, it is likely to remain one of the faster growing states in the nation.

Colorado banks have shared in the recent prosperity, outperforming banks nationwide by most measures. Profits have been high and stable at banks of all sizes. And while problems in the cattle industry have slowed repayments on farm loans, overall loan delinquencies remain very low. Finally, business lending has remained strong, thanks in large part to a pickup in lending to the small firms that have been providing Colorado with most of its job growth. The major challenges facing Colorado banks are to avoid easing credit standards to win business and stem the loss of deposits to mutual funds.

Let me begin by reviewing the state of the Colorado economy. Colorado's economic performance during the 1990s has been impressive. Perhaps the best overall measure of that performance is job growth (Chart 1). Strong job growth may not be a sufficient condition for prosperity--it also matters what kinds of jobs are being created and how much they pay. But strong job growth is a necessary condition for prosperity, and Colorado has had plenty of it.

Growth in nonfarm jobs has been faster in Colorado than the U.S. throughout the decade, reaching a peak of 5 percent in 1994. Growth has slowed somewhat the last couple of years. But jobs still grew 3.5 percent in 1996, much faster than in the nation. The figures in this chart are based on annual averages. The next chart plots the year-over-year change in the quarterly job numbers, which are more volatile but tell us more about turning points and current trends (Chart 2). The chart shows that in both Colorado and the U.S., job growth peaked in the first quarter of 1995 and then declined steadily over the next year. More recently, job growth appears to have turned back up in both Colorado and the U.S. The turnaround in job growth in the U.S. is one of several pieces of evidence suggesting that the national economy has heated back up in the last year, increasing inflationary pressures. In the case of Colorado, however, the rebound is much too recent (only two quarters) and much too mild (only half a percentage point) to conclude that growth is headed back up. The data do provide some hope, however, that growth has at least stabilized.

Colorado's strong job growth during the 1990s has occurred side-by-side with rapid population growth (Chart 3). From mid-1990 to mid-1996, population increased by over 500,000, with almost two-thirds of the growth coming from in-migration. This inflow of people from other states was encouraged by the state's strong economy but also gave the economy a further boost by increasing demand for locally produced goods and services. After peaking in 1994, in-migration slowed to 46,000 last year. Fewer people opted to move out of states like California as the economies of those states rebounded. And more of the people that have moved have gone to states like Utah and Arizona that are enjoying their own booms. Even at the reduced level of last year, however, in-migration remains an important stimulus to growth in Colorado.

One of the sectors that has received a boost from rapid population growth is construction (Chart 4). Colorado enjoyed double-digit growth in construction jobs in the years 1992-94. Growth slowed to a more moderate pace in 1995, appearing to respond to the falloff in population growth. But then instead of slowing still further, as many analysts predicted, growth in construction jobs actually picked up in 1996, climbing back up to 8.5 percent.

We can get a better understanding of recent changes in construction job growth by looking at contracts for the three major categories of construction (Chart 5). Nonbuilding construction, which covers projects like roads and airport runways, fell steadily after the DIA-inspired boom of the early 1990s. But residential and nonresidential construction have taken up much of the slack, keeping the construction boom going. Nonresidential construction has been strong the last two years, as declining vacancy rates have boosted construction of new office, industrial, and retail space in Denver and other cities. Residential construction was strong through 1994, reflecting the increased demand for housing by people moving to Colorado from other states, but slowed in 1995. To the surprise of many analysts, residential construction then jumped back up in 1996. It was this bounceback in homebuilding that accounted for the unexpectedly strong growth in construction jobs last year.

While most people are pleased that construction jobs have been growing, there has been concern that some segments of the real estate market may be overbuilt. For example, some analysts believe the apartment market is approaching saturation (Chart 6). This chart shows that multifamily permits have indeed been very strong, approaching 11,000 in 1996. You can also see, though, that while single-family permits have just matched the peak reached in the boom of the early 1980s, multifamily permits are still quite a bit lower than during the earlier boom. Furthermore, while vacancies for upper-end apartments appear to be rising, total apartment vacancies are still low. Thus while some segments of the real estate market bear watching, the overall picture is favorable, with little sign of the speculative excesses that have caused problems in the past.

Another sector of the Colorado economy that has directly benefited from rapid population growth is wholesale and retail trade (Chart 7). After exceeding the national average by a wide margin most of the 1990s, growth in trade jobs slowed last year to just above the national average. Retail sales actually grew several percentage points faster in 1996 than 1995, reflecting the high level of consumer confidence nationwide and the substantial increase in household wealth from the booming stock market. Despite the increase in retail sales, though, the trade sector added only half as many jobs in 1996 as 1995, contributing to the slowdown in total job growth in the state.

A sector that has not enjoyed as spectacular growth as construction and trade during the 1990s but still added many new jobs is manufacturing (Chart 8). Growth in factory jobs has been consistently stronger in Colorado than the U.S. After a very strong year in 1995, job growth slowed to 2 percent in 1996. That was still better than any other year during the 1990s, however. And it was a much better performance than in the nation, where factory jobs actually declined moderately.

Some of the growth in manufacturing jobs has been in hi-tech sectors, especially those tied to the revolution in information technology. It would be a mistake, however, to conclude that all the growth in manufacturing in Colorado has been at such high-tech firms (Chart 9). It is true, for example, that jobs have grown faster in the hi-tech sectors of computers, electronic components, and communication equipment than in nondurable goods industries like food and beverages and printing and publishing. But in the last two years, jobs have also grown slower in these hi-tech sectors than in other durable goods industries like furniture and wood products and stone, clay, and glass products. Thus, the strength in Colorado manufacturing has been broad-based and not dependent on advanced technology.

The sector of the Colorado economy that has been most responsible for the explosive job growth of the 1990s is services (Chart 10). This chart shows job growth in all service industries except wholesale and retail trade, which I have already discussed, and government. The industries covered by this chart are highly diverse--some paying relatively low wages and requiring few skills, and others paying very high wages and requiring advanced training or professional degrees. As a group, these industries have grown very fast in the both the nation and Colorado, but especially in Colorado. Job growth averaged 6 percent in Colorado in the period 1993-95, over two percentage point faster in the nation. Job growth did slow in 1996, accounting for much of the slowdown in total job growth. But at 4.5 percent, job growth in the services industries was still impressive.

Rather than discuss each of the many industries making up the service sector, I will highlight three important ones--computer services, which consists mainly of software firms; communications services, which includes both telecommunications and cable TV; and amusement and lodging, which includes services to both tourists and residents (Chart 11).

Computer services and communications services have been two of the fastest growing industries in Colorado during the 1990s, due partly to the ability of the state to attract and retain hi-tech workers and businesses from other states. The firms in these industries are concentrated almost entirely in the Front Range, where they contribute significantly to the local economy. Bucking the general trend in the Colorado economy, the computer services industry showed almost no sign of slowing in 1996, continuing to add jobs at a double-digit rate. The communications services industry was a different story. Job growth in that industry slipped to a more subdued 4 percent, reflecting industry consolidation and in the case of cable TV, competition from satellite broadcasting.

The last industry shown in the chart is one that has grown at a healthy pace throughout the 1990s but slowed somewhat recently--amusement and lodging services. From about 5 percent in 1994 and 1995, job growth in this sector slipped to 3 percent last year. This slowdown may simply reflect the effect of slower population growth on recreational spending by residents. It comes at a time, however, of increased concern about tourism.

Some people argue that due to lack of promotion and marketing by the state, Colorado is losing its edge in tourism, and that jobs in the recreation and hotel business have held up as well as they have only because increases in convention and business travel are making up for weakness in leisure travel. It may well be true that Colorado has lost some of its dominance in tourism, a phenomenon to be expected as other state promote their own attractions. It would be premature, however, to conclude that tourism is on the wane in Colorado. All indications are that the last ski season was highly successful. And while some indicators show that tourism declined after 1992, these same measures suggest tourism has rebounded more recently--a recovery that may owe something to recent increases in hotel space, the booking of major attractions, and the favorable publicity DIA has been receiving in the national press.

The last two sectors I want to discuss account for a small and diminishing number of jobs but are still important to the Colorado economy--mining and agriculture. The mining industry lost another 1,200 jobs last year, due to cutbacks in and oil and gas extraction and coal mining (Chart 12). That job loss is about equal to the average for the 1990s and continues a trend going back to the early 1980s. The natural gas industry has fared somewhat better than the rest of the industry (Chart 13). While oil production has fallen steadily, natural gas production has increased sharply, a trend reflecting both higher prices for natural gas and the building of several new pipelines that have increased access to the East and West coasts. Last winter, press reports suggested that the jump in natural gas prices to over $3.50 had revived interest in drilling in the Rockies, where reserves are a known quantity but costly to extract. Gas prices have receded since then, however, and the state rig count has remained stuck at about half of its level in the early 1990s.

In agriculture, Colorado's grain producers had a fairly good year in 1996 but cattle producers suffered further losses. Drought conditions hurt the winter wheat crop, but many wheat farmers were able to recoup some of their loses by planting sorghum and milo. The low level of wheat stocks and the poor U.S. harvest also helped push up wheat prices, more than making up for the decline in yields (Chart 14). Corn growers fared even better, enjoying the best of both worlds--yields were much higher than for wheat, and low carryover stocks had the same tendency to push up prices. Prospects for 1997 are favorable for both wheat and corn producers. Prices are expected to recede somewhat, due to weaker foreign demand and competition from other exporters like Australia and Canada. But because stocks remain low, prices should still be high. Colorado wheat growers were also fortunate to escape the freeze damage suffered last month by growers in the Southern Plains.

The Colorado cattle industry suffered its third difficult year in a row, but by the end of year conditions had begun to improve (Chart 15). Rising corn prices caused cattle feeders to suffer heavy losses early in the year, reducing their demand for feeder cattle and pushing down feeder prices. At the same time, drought conditions in the Southern Plains led to herd liquidations, putting downward pressure on the prices of both feeder and fed cattle. Cattle prices turned around in late spring. For the year as a whole, however, prices remained too low for most ranchers to turn a profit. Fortunately, the cattle industry now appears poised for a rebound. Herd liquidations appear to have come to an end, and domestic and foreign demand for beef are both projected to be strong. Thus, the average level of cattle prices is likely to be quite a bit higher this year than last, helping Colorado ranchers get back on their feet.

How will the rest of the Colorado economy perform in 1997 and 1998? We expect economic growth to remain moderate but healthy. People will continue to move to Colorado from other states, but in fewer numbers than earlier. This lower rate of in-migration will keep job growth subdued in population-sensitive sectors like housing and retail trade. And growth of other sectors will moderate as the economy bumps up against capacity constraints.

One of those constraints is a shortage of skilled and entry-level workers (Chart 16). The rapid job growth of the last several years has pushed the unemployment rate in Colorado below 4 percent, well below the average for the nation. With labor markets that tight, existing firms may have difficulty expanding and out-of-state firms may be discouraged from moving here. A recent survey of information technology firms on the Front Range, for example, found that availability of skilled workers was their number-one concern. I might add that Colorado is not the only state with this problem. The shortage of qualified workers has become a common complaint throughout much our district and in other states in the Rocky Mountains and Midwest.

A second constraint on growth is that the cost of living has been rising faster here than the rest of the nation, somewhat reducing the attractiveness of the state to out-of-state businesses and workers. Consumer prices have risen faster in Denver than the nation throughout the 1990s, though the gap narrowed a bit last year. And the cost of housing in most Colorado cities has risen from at or below the national average in mid-1990 to well above the national average in mid-1996 (Chart 17).

A third factor tending to inhibit growth is the strain the recent boom has put on public services such as transportation, public safety, and education. Experts believe all three types of services are important for economic development, and empirical studies have found an especially strong link between local economic growth and highway facilities. The strain on its infrastructure may present Colorado with a painful choice--allow infrastructure to deteriorate, or raise state and local taxes to pay for needed improvements.

The last constraint on growth is a bit more nebulous but no less important--the threat of a decline in Colorado's high quality of life. This constraint is likely to show up in two ways. In some cases, growth may be slowed directly through curbs enacted by local governments. And in other cases, growth may be slowed indirectly as increased congestion reduces the attractiveness of the state to outsiders.

While these constraints are likely to keep growth moderate, Colorado still retains many important advantages over other states, including its scenic attractions, diversified mix of industries, and highly educated work force. These advantages should help protect the state from the kind of downturn it experienced in the 1980s and ensure its place as one of the most prosperous states in the nation. The moderation in growth will be a disappointment to some. But it should benefit Colorado over the longer run by preserving the state's valuable resources and allowing the current expansion to go on longer than it otherwise might.

Let me turn now to banking conditions in the state, a topic of special interest to many in this audience. Colorado banks have both benefited from and contributed to the state's recent economic performance. Strong economic growth has increased bank profits by boosting deposits, increasing loan demand, and speeding loan repayments. But Colorado banks have also helped fuel the expansion by providing credit and other financial services to local businesses and households. This is not to say Colorado banks have no worries. Whenever lending grows as fast as it has recently be concern that some banks are easing credit excessively to win business. And as more and more investors flock to mutual funds, banks must worry whether they can keep attracting enough deposits to finance their loans. Finally, while consolidation is farther along in Colorado than other states, more changes may be in store, presenting smaller banks with both challenges and opportunities.

The next chart provides as good a picture as any of the prosperity that Colorado banks have been enjoying (Chart 18). As measured by return on assets--the ratio of after-tax profits to average assets--the profitability of Colorado banks increased sharply in the early 1990s and then stabilized at a high level. Last year, ROA averaged a little more than 1.4 percent in the state. That was more than two-tenths of a percentage point higher than in the nation, maintaining the edge that Colorado has enjoyed throughout the 1990s.

The high and stable profits of recent years have been widespread across banks (Chart 19). This chart divides all the independent banks and bank holding companies operating in Colorado into three size categories--about 120 small organizations with less than $100 million in assets, about 40 medium-size organizations with $100 million to $1 billion in assets, and 6 large organizations with more than $1 billion in assets. Of the large organizations, all but one are out-of-state companies. Last year, banks in the small and large size groups earned the highest average ROAs--1.5 percent in both cases. But banks in the medium size group were close behind with an average ROA of 1.4 percent. You can also see that profits in all three size groups were little changed from the previous year.

Besides earning high profits, Colorado banks have had little problem collecting on their loans (Chart 20). One measure of loan delinquencies is the amount of noncurrent loans, those more than 90 days overdue or in nonaccrual status. Such loans have followed the same path in Colorado as the nation in the 1990s, falling sharply in the early 1990s and remaining low the last couple of years. While noncurrent loans did edge up in Colorado in 1996, they were still only 0.6 of total loans at the end of the year, about half a percentage less than in the U.S.

Delinquencies are low not just in aggregate but for most loan categories (Chart 21). The one notable exception is farm operating loans. Last year, noncurrent loans more than doubled in this category, reflecting the problems in the cattle industry. Delinquencies remained unchanged for real estate loans, however, and increased only modestly for business loans and consumer loans. The relatively modest increase in consumer delinquencies in Colorado is in contrast to the rest of the nation, where overborrowing on credit cards has caused lenders more of a problem.

As I suggested, Colorado banks have not only benefited from the strong growth in the Colorado economy but also contributed to it. Perhaps the most important way they have done this is by lending to local businesses (Chart 22). During the credit slowdown of the early 1990s, business loans declined at Colorado banks just as they did at banks nationwide. But business lending in Colorado then rebounded sharply, growing at double digit rates. Growth in business loans slowed last year from the torrid pace of 1994 and 1995. But at 9 percent, growth in business loans was still quite strong and several percentage points faster than in the nation.

The fact that total business lending remained strong last year is encouraging. But what probably matters more for local economic growth is lending to small businesses. A recent study for the Colorado Economic Development Commission found that most of the job growth in Colorado during the 1990s has been at small firms, especially start up firms (Chart 23). According to this study, firms with less than 20 employees added 130,000 jobs during the years 1992-95, with about two-thirds of the growth coming from new firms and one-third from existing firms. At the other extreme, firms with more than 500 employees contributed a net of only 21,000 jobs.

Many of the small businesses that have contributed to Colorado growth have been able to raise long-term funds through the venture capital market, which is better developed here than in other states. But some small businesses do not have access to venture capital, and even those that do are heavily dependent on banks for their short-term credit. Thus, for small businesses to continue creating jobs, it is important that banks continue lending to them. Some people worry that banking consolidation will prevent banks from performing this role as well as they should. In particular, they fear small business lending will decline as large banks absorb smaller banks, because large banks are less able and less willing to make small business loans than the smaller banks they replace.

What does the evidence show? While we do not have data on business loans by size of borrower, banks have recently begun reporting the amounts of their business loans by size of loan (Chart 24). Most analysts working with this data approximate small business loans by loans under $1 million in size. By this definition, growth in small business lending was quite weak in Colorado in 1995, the first year for which reliable data are available. Small business loans grew only 2.5 percent at Colorado banks that year, much slower than in the nation. Last year, however, the situation changed dramatically, with growth in small business loans holding steady in the U.S. but jumping to 13 percent in Colorado.

The next chart provides some insight into both the weakness in small business lending in 1995 and the strong rebound in 1996 (Chart 25). This chart shows the growth in small business lending in each size category of banking organization. I hasten to add that the growth rates shown are averages only--within each size group, there are some organizations with faster rates of growth and some with slower rates of growth. The reason small business lending was weak in 1995 was very strong growth in the small and medium-size groups was offset by an outright decline in the large size group. And the reason small business lending improved in 1996 was that growth remained very strong in the small and medium-size groups and turned positive in the large size group. On balance, the data suggest consolidation may hurt small business lending in Colorado less than some people fear. Strong growth at smaller banks has helped offset weak growth at large banks, reflecting smaller banks' inherent advantages in making small business loans. And growth at large banks has improved in the last year, reflecting the increased effort some large banks are putting into their small business lending.

Banks in Colorado have been doing very well, but that does not mean they have no worries about the future. Whenever lending grows as fast as it has recently, there will be concern that some banks are easing credit standards excessively to win business. Anecdotal evidence indicates that competition for business loans remains intense in many parts of the country. It is reassuring in these circumstances that delinquencies remain low. But sometimes bad credit decisions can be obscured by strong growth in the economy. If the economy stumbles, losses on bad loans may begin to show up.

A second concern is whether banks can continue attracting enough deposits to meet the credit demands of businesses and households. Mutual funds have enjoyed explosive growth during the 1990s. We do not know what portion of that growth came at the expense of banks, but much of it surely did. The effects of mutual fund competition on banks have been partly obscured by a massive shift of deposits from the thrift industry to the banking industry (Chart 26). This chart shows that after adjustment for inflation, Colorado bank deposits have risen about $6 billion during the 1990s. But most of that gain came from the absorption of thrifts into the banking industry. In fact, the combined deposits of banks, thrifts, and credit unions did not increase at all in the 1990s--a surprising performance given the strong growth in the Colorado economy. Some analysts predict deposits will flow back into the banking industry if and when the stock market turns downward, but there can be no assurance that will happen.

Let me conclude by briefly summarizing my main points. After several years of exceptionally strong growth, the Colorado economy appears to be settling down to a more sustainable pace. The manufacturing and service sectors both cooled off last year, though they still grew faster than in the nation. The construction sector was an exception to the slowing trend, as nonresidential building remained strong and homebuilding heated back up. Elsewhere in the economy, mining lost more jobs, grain producers had a good year, and ranchers suffered further losses.

Looking ahead, growth is likely to remain subdued but healthy. A lower rate of in-migration will restrain growth in population-sensitive sectors like construction and retail trade. And growth of other sectors will moderate as the economy bumps up against such constraints as a shortage of skilled workers, a rising cost of living, and a deteriorating infrastructure. Farmers and ranchers have reason to be happy about 1997. Grain prices should recede only moderately from last year, and cattle prices should be quite a bit higher than last year.

Colorado banks have shared in the recent prosperity. Banks of all sizes have enjoyed high and stable profits, and loan delinquencies remain low. Growth in business loans did slow in 1996. The slowdown was from a very high base, however, and masked a sharp increase in lending to small businesses. Even with all this good news, Colorado banks still have concerns about the future. Slower economic growth may expose bad credit decisions. And if banks want to make more loans to good customers, they will need to stem the loss of deposits to mutual funds.

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