Profits are starting to cool at the nation's hottest community banks.

After surging for three years, returns on assets slipped last year at the most profitable community banks, according to an American Banker survey. And experts see tougher times ahead for virtually all small banks because of rising interest rates and shrinking margins.

"We just aren't going to be able to maintain the earnings that we have," said Ross Reid, president of First State Bank, a top performer based in Big Sandy, Tex. "The rates will hurt us."

Of course, these banks aren't exactly in trouble. The 100 most profitable large community banks - those with assets of $50 million to $1 billion - returned a hefty 2.51% on average assets last year, versus 1.21% for the banking industry as a whole. The top small community banks, meantime, notched a solid 2.40%.

Both groups, however, did fall short of their 1992 returns, and few analysts expect a rebound anytime soon.

Community banks "should continue to turn in strong profits, but I would be quite surprised to see [dramatic] increases," said Don Inscoe, associate director of research and statistics at the Federal Deposit Insurance Corp. "We might see some slight decreases."

The best-performing large community banks were selected from a group of 5,564. The best small community banks - assets up to $50 million - were picked from a total of 5,578 banks.

Kentucky Farmers Bank in Cattletsburg, Ken., captured top honors among the larger banks for the third time in five years, earning a stunning 12.16% return on its $134 million in assets.

The performance was driven mainly by the bank's securities portfolio, which exploded in value as interest rates declined.

Farmers booked $15.5 million in securities gains in 1993, up from $5.8 million in 1992 and just $69,000 in 1990.

"Even a blind hog finds an acorn now and again," said Charles Russell Jr., the bank's chief executive since 1980.

First National Bank, Keystone, W. Va., was a distant second place in the category, with a 6.7% return on assets. That was up sharply from 1.9% the prior year.

Some other large community banks also showed dramatic returns on assets. First Coleman National Bank, Coleman, Tex., weighed in with a 4.4% return, up from 0.84% the prior year. And Republic National Bank, Columbia, S.C. returned 3.5%, up from 1%.

"That kind of return is astronomical," said Mr. Inscoe about the top performers. "That is very good performance that most banks can't achieve at all."

Among the smaller banks, Community State Bank, Austin, Tex., ranked No. 1. It returning 5.4% on assets, up from 2.1% a year ago.

Community State was followed by another Texas institution, First State Bank in Big Sandy, which returned 3.96% on assets.

Mr. Russell from Kentucky agreed that the easy days are about over.

"We anticipate, given what's happened in the bond market, that we'll have very few securities gains this year," he said. "We may even elect to take some losses in that area."

Banks like Kentucky Farmers may face quite a challenge in a rising-rate environment. While securities will continue to be a significant part of its portfolio, the bank has only a 52.6% loan-to-deposit ratio.

A Mature Market

"It's grown some, and we hope it will continue to pick up," Mr. Russell said. "Unfortunately, we're in a pretty mature area, one that has been an industrial market, and a lot of industrial companies have been reducing their operations."

Dan Coughlin, an analyst at Chicago's Howe Barnes, said the best-performing community banks usually sacrifice quantity of loans for quality.

"They don't have the big [loan-to-deposit] ratios because they're more selective," he said.

Indeed, asset quality has been extremely good for the group. The top 100 midsize community banks' noncurrent loans averaged just a 0.31% of total assets. Only two of the banks had a noncurrent ration greater than 2%.

Mr. Inscoe said rising rates will force banks to lend money. And he's already seeing signs that community banks are beginning to react.

"Some of these banks are returning to the business of lending," he said. "That may be helping their profitablity."

Robert G. Hershenhorn, chairman and chief executive of First Bank and Trust Co. of Palatine, Ill., plans to hire more loan officers and boost lending.

"We're in a very fluid market in the Chicago metropolitan area that is rich with loans," said Mr. Hershenhorn, whose bank has $110 million of assets.

"And if there's not the construction taking place, there's refinancing."

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