Though community banks in Texas are coming off two extremely profitable years, a new report suggests the future will be tougher.

Eroding net interest margins, the strength of credit unions, and the traditionally weak efficiency ratio of community banks in Texas will force boards of directors to take a hard look at their core business and likely seek mergers as a way to grow the bottom line, according to Barrett, Strunk & Associates, a Houston consulting firm.

"Net interest margin will likely continue to be compressed and profits will have to come from either balance sheet growth, without equal growth in noninterest expenses, or by being as efficient as possible in the bank's existing core business operating environment," said William Strunk, the report's author.

There are more than 400 community banks in Texas, and save for several metropolitan areas it is one of the most unconsolidated banking markets in the country. Despite the presence of virtually every major banking company in the nation, community banks hold 43% of the state's deposits.

Community banks have been merging at an accelerating pace in Texas in recent years. The report's statistics show that the reasons for merging are increasing.

One of the main reasons is that internal growth, irrespective of loan demand, is becoming tougher. The report shows empirically what bankers have said is increasingly the case: Credit unions are cleaning their clocks.

For the period betwen 1990 and 1994, Texas bank deposits were down 3.91%. During the same period, Texas credit union deposits were up a whopping 68%.

The lament of James Cox, chief executive of the $152 million-asset Security National Bank of San Antonio, is familiar.

"San Antonio is a very strong credit union town," he said. "What they have in the form of subsidized earnings and no taxation is difficult to compete against."

Mr. Strunk said the trend is troubling because community banks need to grow to justify their historically high operating expenses. Further, what internal growth has been attainable by community banks in Texas has not been accompanied by controlled expenses.

The average efficiency ratio of Texas' independent banks was 65.6% in 1994, lower than 1993 but still higher than that of their larger brethren in the state. Fifty-five percent is considered an excellent ratio.

Finally, net interest margins have shrunk and will likely shrink further. Mr. Strunk said most banker estimates of margin squeeze are conservatively set at 50 basis points in 1995. The net interest margin in 1994 for Texas independents was 4.49%, a decrease of 12 basis points.

Mr. Cox said Security National's margin has been squeezed 10 basis points in the last nine months. And though he doesn't expect a further squeeze, he wants to build up the bank's noninterest-income businesses.

He added that the balance sheet and competitive pressures alone aren't enough to force a community bank board to decide to sell.

"Most every community bank I know can justify itself by the service it gives its customers," Mr. Cox said. "The key indicator of whether a bank sells or not is going to be price. What is going to drive it is how aggressive the acquiring institutions are, especially the large, out-of- state institutions."

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