Net earnings at community banks have increased, on average, 8% per year since 1992-almost three times the growth rate of community banks during the 1980s. Higher profits, in part, were bolstered by lower efficiency ratios.

But Hovde Financial Inc. concluded in a report released last month that only 10% to 15% of the community banks with assets of $100 million to $3 billion will continue to generate significant earnings growth. The rest of the roughly 3,000 banks in that asset range will grow far more slowly over the next three years, the Washington investment banking firm predicted.

"We just want to sound an alarm," said Jeff Warlick, senior vice president at Hovde Financial. "Community banks will face more of a challenge, and they need to ask themselves some serious questions."

Hovde Financial also doubts whether many community banks can find ways to further cut costs. The report said that "most banks will find further improvement unattainable."

Net interest margins are at their lowest levels in five years. At banks with assets of $500 million to $1 billion, average interest margins were 4.7% in 1993. But by yearend 1998, the average had fallen to 4.47%

Meanwhile, opportunities for fee income are diminishing, provisions for loan losses are increasing, and the trend in mortgage refinancing-a key source of fee income for community banks-is expected to slow down, Hovde Financial said.

With reduced trading multiples of community bank stocks and an anticipated 10% to 15% drop in acquisition prices, Hovde Financial said some community banks may lose up to 30% of their value over the next three years.

Banks that do prosper will either offer niche products, be based in fast-growing markets, or pursue acquisitions in order to cut costs through size, the firm said.

Despite the less-than-cheery outlook, Eric D. Hovde, the company's president and chief executive, stressed that community banks are not bad investments. As a group, he said that community banks are "overly discounted," trading at 12 times earnings.

"Some individual banks will be able to achieve growth and some remain attractive from an acquisition standpoint," Mr. Hovde added.

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