Full-year earnings at the nation's smallest community banks slipped 8% in 1994 as more institutions took securities losses.

In the fourth quarter, however, return on assets jumped to 1.01% from 0.96% a year earlier, according to most recent numbers released by the Federal Deposit Insurance Corp.

Industry observers said the year-to-year drop isn't cause for concern, but they acknowledged that smaller banks face tougher times ahead as they compete with bigger institutions.

"Some of the small banks will continue to do very well, but many others might never see the opportunity to show high levels of earnings growth or even a consistency of high earnings," said Frank Barkocy, managing director of Advest Inc., a New York-based brokerage firm.

The smallest-bank group, which totaled 7,258 institutions, earned $3.5 billion for the full year. It had 530 more institutions than the prior year, and earned $3.8 billion. The group - banks with less than $100 million of assets - accounts for about 70% of all commercial banks.

The continued consolidation of the group translated into a 6% decline in assets to $316 billion, and a 6.5% drop in deposits to $295 billion.

In contrast, assets among the nation's 64 largest banks jumped to $1.9 trillion, up 19% for the group, compared with the $1.6 trillion in assets held by 55 banks a year ago. Deposits increased by 14% for the big banks.

Ross Waldrop, senior financial analyst in the FDIC's division of research and statistics, said he sees more positives than negatives in the small bank numbers.

Despite rising interest rates, the group's net interest margin has remained a healthy 4.73%, far higher than the largest banks' 3.97%. And their cost of funds was 2.90%, compared with 3.74% for the largest banks.

"I don't think there is any cause to feel pity for those guys; they look like they are doing O.K.," Mr. Waldrop said. "They are probably coping better than people would have thought in a rising rate environment."

Mr. Waldrop attributed the earnings decline to securities gains in 1993 that contributed about nine basis points to the group's 1.15% ROA. Last year, securities losses reduced the ROA by two basis points resulting in a 1.13% ROA, he said.

Mr. Barkocy, however, said overall the smallest community banks are feeling the pinch of interest margin squeezes much harder than their bigger brethren because they lack access to the noninterest income streams large banks have been building for years.

"The smaller institutions do not have the alternative sources of earnings such as fee-generating business like trust departments," he said. "And, in many cases, they simply lack the disciplines and benefits of economies of scale."

"At that size it's simply more difficult to make money, especially in a margin-squeeze environment," said Jim Marks, a bank analyst with Sutro & Co. in San Francisco.

And, though small banks in most cases are able to maintain healthy ROAs, many are laboring to increase noninterest income, said James R. Shafer, chief executive of the $29 million-asset First National Bank in Tremont, Ill.

"We haven't experienced a decline in ROA, yet," Mr. Shafer said. "Our budget is to maintain a 1.54% ROA in 1995. But we are emphasizing noninterest targets of income through the sale of insurance and a new product line we just introduced in farm and construction equipment leasing."

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