Concerned that earnings growth may be slowing, a number of analysts are warning that bank stocks could soon lose their luster.
"On the surface, it appears that the bank sector just completed another quarter of solid relative earnings growth," said Thomas D. McCandless of Natwest Securities Corp. "In digging deeper into the financial trends, however, it is abundantly clear that earnings growth has downshifted considerably."
As a result, Mr. McCandless expects the banks stock to lag the general market through the end of the year by 5% to 10%.
"The market never pays up for a slowing rate of return," the analyst said.
Although banks have regularly outpaced other sorts of companies in terms of earnings growth over the past several years, the number of banks exceeding earnings growth expectations in the third quarter declined considerably from the second quarter, said Mr. McCandless.
Only 25% of Natwest's universe of regional banks "really beat consensus" during the third quarter, he argued.
By contrast, during the second quarter nearly 70% of banks in the Natwest banking universe exceeded expectations, he said.
Mr. McCandless said bank stocks currently owe their surging stock prices to a "roaring bull market in bonds" as well as frequent merger rumors and speculation.
But even if a strong bond market continues, "there's precious little upside in bank stocks," he said.
"Bank stocks have also done well because there are few industries right now that can deliver 12% earnings growth," Mr. McCandless noted.
Other analysts retain a more positive outlook, but are cautious nonetheless.
"Underlying trends don't portend disaster; neither do they suggest an engine for broad earnings estimate increases," said Sandra J. Flannigan and other analysts at Merrill Lynch & Co.
Even taking into account some seasonal effect, revenue growth is moderating," they said. And stock valuations "seem increasingly full," with the Merrill's regional bank universe selling at twice stated book value.
Going forward, selected banks will do well but a number of others will "likely be challenged to maintain today's return on equity - let alone raise it to the roughly 19% level that the twice book level implies," they said.
Indeed, the brokerage firm's analyst project that 40% of the regional banks they follow will post less than a 16% return on equity next year.
Mr. McCandless also frets that stock rotation trends could hurt bank stocks, regardless of whether the economy slows or regains momentum. "If the economy rebounds, technology stocks will capture investors' attention and bank stocks will suffer," he said.
While the Natwest analysts "remains negative on the group" for this year, he says investors should look to selected banking issues for 1997.
Some of his top picks include CoreStates Financial Corp, Fleet Financial Group, and Signet Banking, because their "earnings growth is so strong that you can't ignore them."
However, he emphasized that investors should not overweight their portfolios in the banking sector because, right now, "the stocks look and feel like they are ahead of themselves."
Other Wall Street analysts agree that bank earnings growth slowed in the third quarter, but they argue that banks are "right on track" and still have considerable upside in their stock.
"People should be weighted in banks," asserted analyst Denis LaPlante of Fox-Pitt Kelton Inc., New York. "We acknowledge that loan growth is decelerating, but earnings growth is still there" compared to the rest of the market.
Mr. Laplante also pointed out that banks' fee income growth exceeding expectations in the most recent quarter and that their efficiency ratios are improving.
"Bank stocks are not exceptionally expensive," he maintained. "As long as inflation stays relatively benign and interest rates stay on track, bank stocks will do well."
Industry analyst Harold Schroeder of Keefe Bruyette & Woods Inc., said banks earnings growth "may slacken a little bit" but was solid.
"The fourth quarter is a housecleaning quarter" for the banking industry, he noted.
"Banks have considerable revenue growth (and) solid, steady predictable earnings - not to mention (stock) buybacks. They will generate access capital well over what they need."
Nevertheless, analysts clearly are repositioning themselves for a slowdown in bank performance. Since the quarter began, Zach's Investment Research reports, 124 earnings estimates for bank stocks have been trimmed, while only 51 estimates have been raised.
