Thanks to three years of improvement in credit quality and earnings, Texas community banks are back on firm footing.

"California is still recovering, and the jury is still out in New England," said bank analyst Steven Didion of Hoefer & Arnett in San Francisco. "But Texas is back."

Texas community banks are topping their bigger brethren in both earnings and growth, despite relatively high overhead costs and small loan portfolios.

Meanwhile, merger and acquisition activity among Texas' community banks is at a fever pitch, as executives see a brighter future in bigger size.

There are 762 independent banks with assets under $2 billion in Texas, a field that is the biggest small-bank acquisition market in the country.

Mr. Didion added that "if the market is fight," Texas is definitely one of the most attractive community bank markets in the country.

The small banks he follows in the state are trading at about 1.5 times book value and 10.5 times earnings.

In California, by cbmparison, community banks are trading at about book value and 7.5 times earnings.

The earnings of small Texas banks have improved dramatically from just 1991, when they era-ned $187 million on $29.7 billion in total assets, for a return on assets of 0.66%.

In 1993, the group earned $471 million on $36.2 billion in assets for an ROA of 1.38%, the highest such profitability ratio of any state for community banks.

This year, Texas' small banks are on track to earn a combined 1.27% on assets-

down somewhat from 1993 but still solid.

In perhaps the clearest sign of the new stability, not a single bank has failed in Texas this year, in sharp contrast with the 1980s. (See story on facing page.)

Equity capital at the state's small banks has increased to 8.24% of assets, from 7.25% at the end of 1991.

But the biggest improvement, and the one most linked to community banks' improved earnings, is in nonperforming assets. The ratio of nonperforming assets to total loans and foreclosed real estate went from a high of 6.1% in 1991 to 2.39% in the first quarter of this year. Analysts focusing on the state believe nonperforming loans, and therefore credit costs, will continue to slide but in smaller increments.

"Their performance has been excellent, especially relative to the rest of the country," Mr. Didion said.

"They tend to have lower loan-to-deposit ratios, and efficiency ratios are geperally higher, but the decrease in credit costs that we've seen everywhere is helping people get back on their feet ."

For William Strunk, president of Houston bank consulting firm Barrett, Stmnk Associates, the reason for Texas' community bank turnaround is simple: "There's growth in Texas, something that community banks elsewhere just can't find."

Construction has been the fastest-growing sector of the economy, a particular boon to commumty banks. And, according to a DRI/McGraw Hill economic forecast for the state, Texas will continue to outperform the rest of the country throughout the 1990s.

In 1994, 256,000 jobs are expected to be created, almost as many as in California during its peak years.

The best earners in the state were in rural towns, according to figures provided by Sheshunoff Information Services.

The Bank of Robstown, a $60 million-asset bank, had a hefty 12.2% ROA in the first quarter this year due to a giant tax credit, making it the best-performing independent bank in the state. Brazoswood National Bank in Richwood also had an extraordinary gain on real estate owned, for a 7.9% ROA.

The third-most-profitable small bank in the state, State National Bank in Groom, still had an impressi_ve 3.66% return on its $14.3 million in assets.

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