Community banks in the Northeast are reporting another quarter of strong earnings, but analysts are raising a red flag over tighter interest margins that could take a toll on bottom lines.

With pressure mounting on banks to raise deposit rates to keep them more in line with last year's interest rate hikes - most institutions have delayed raising rates - banks are paying more for their funds. That's tightened the spread between the interest banks earn on loans and the yields they pay out on deposits, which is reflected in lower interest income.

"The banks are finally running into margin problems," said Gerard Cassidy, bank analyst at Tucker Anthony's Hancock Institutional Equity Services. "Their spreads are narrowing because the deposit rates that they're paying are increasing at a time when their asset yields are flattening out and have started to decline."

The result is either an actual drop or slower growth in net interest income at some institutions, though net income is still increasing.

"The profit picture is up but at a declining rate because of the margin squeezes that are beginning to be felt," said John Carusone, president of the Bank Analysis Center in Hartford, Conn.

At Greater New York Savings Bank, for example, the net interest margin dropped to 2.93% for the second quarter of 1995 from 3.23% for the same period last year. That led to a decline in net interest income, to $18 million in the second quarter from $19 million in the second quarter of 1994.

Grove Bank in Boston also reported that its net interest margin had dropped, to 2.62% in the second quarter from 3.05% the year before, though net interest income grew to $4.1 million, from $3.6 million.

And some analysts expect the trend to continue. That's because in the last couple of years many institutions have been relying on lower expenses and loan-loss provisions to boost earnings to record levels, though interest revenue has been flat, Mr. Cassidy said.

But with operating expenses and loan-loss reserves about as low as they can go and earnings growth slowing despite some lending growth, comparisons of future earnings to current figures will be "terrible" if "we don't see a pickup in revenue growth in the next six months," Mr. Cassidy explained.

"Those engines are not going to be driving earnings going forward," he said. "We need top-line revenue growth, which we don't have."

But Salvatore J. DiMartino, bank and thrift analyst at Advest Inc. in New York, doesn't expect margins to shrink any more than they already have.

"The most positive thing that I've seen so far is that margins at most of the banks that we follow have held up very well in the second quarter," he said. "The compression in the margin over the past three or four quarters has run its course."

Mr. DiMartino said margins have bottomed out at about 3% for smaller community banks and 4.25% to 4.5% for community banks with $1 billion to $5 billion of assets. Queens County Bancorp, for example, reported a net interest margin of 4.55%, down from last June's level of 5.44%.

Margins should at least stabilize but may increase during the rest of the year, he said.

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