Shrinking interest rate margins, increased competition, and a slowing economy are likely to reduce earnings at community banks next year, according to industry consultant Alex Sheshunoff.

The president of Alex Sheshunoff Management Services Inc., Austin, Tex., also said bank prices have peaked.

There will also be fewer deals among banks with less than $100 million of assets, he said.

"We're entering a new era," Mr. Sheshunoff told 80 chief financial officers at a Bank Administration Institute conference here Tuesday.

"It's so hard to pull back when everything is going so well, but most bankers intuitively know it can't stay this good forever."

So how bad will it get? Mr. Sheshunoff predicted average interest rate spreads will shrink by 40% in 1998.

Margins will be squeezed by more competition from money-center and huge regional banks entering community bank markets via direct mail, telephone solicitations, and traveling loan officers, according to Mr. Sheshunoff.

"The big banks are getting their acts together" and are marketing their services with a more personalized approach, he said.

Mr. Sheshunoff agreed with an economic outlook presented to the group by Gary E. Wood, an economist and chief operating officer of Collins Financial Services, Austin.

Mr. Wood forecast the U.S. economy will grow 2% next year, down from the 2.7% projected for 1997. Consumers will not be as confident as they were, which may put a damper on loan demand, Mr. Wood said.

Despite the gloomier outlook, Mr. Sheshunoff said there are steps bankers can take to be competitive next year.

First, loan portfolios should be reviewed, and any investments that may not hold their value as the economy slows down should be sold.

"The time is now to start cutting back," Mr. Sheshunoff advised, noting that several community banks have already liquidated indirect auto loans.

Second, Mr. Sheshunoff suggested that the bankers should boost loan loss reserves to lessen the blow if some loans default. Several of the CFOs, including Brain M. Riley of Provident Savings Bank in Riverside, Calif., said they have already begun to edge up loan loss reserves as a means of protection.

Mr. Sheshunoff also advised the bankers to identify their most profitable customers and then plan sales strategies to retain them. Otherwise, community banks will be left with the customers the big banks don't want. "My concern is you'll end up with a core of unprofitable customers," he said.

Community bankers should also push for customers turned off by bank mergers, Mr. Sheshunoff said. "Consolidation causes customer displacement," he said. "That will be the driver for community banks for the next three to five years."

Finally, Mr. Sheshunoff warned bankers to be proactive on year-2000 issues. Do not rely, he said, on vendors' word that the banks will be protected from electronic disasters at the turn of the century.

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