Bank stocks outperformed the Dow Jones industrials last week, though the blue-chip average hit record highs.

In a turnaround from the previous week, banking issues improved 1.63% in the five trading days ending last Thursday, besting the 1% gain in the Dow during the same period.

Three of the stronger performers in the period were Signet Banking Corp., up 6.3%; Mellon Bank Corp.. up 4%; and BayBanks Inc., up 3.1%. Late Friday, Signet shares were at $33, Mellon's at $57.75, and BayBanks' at $49.75.

Bank stocks were down on Friday in line with the broad market in sluggish late-summer trading.

Commenting on the gain for the week. Lawrence R. Vitale of Bear, Stearns & Co. said: "As the long bond kept falling and people decided the stock market would probably keep going up, the banks started to look like bargains again."

Despite their strength over the past two years, almost all banking shares still trade at a discount to stocks in general on a price-to-earnings basis.

When the latest downdraft in interest rates began three weeks ago, banking stocks initially weakened on investor fears about the impact on earnings. But they were later pulled along by a strong overall market and now seem to have resumed a market leadership position.

|We've Been Very Busy'

"There's a lot of interest and we've been very busy" with clients. Mr. Vitale said. "You would think people would be on vacation, but our morning meetings have been full."

Another analyst, Gerard S. Cassidy of Tucker Anthony Inc., said bank earnings appear secure in contrast with profits at technology and pharmaceutical companies.

"In talking with institutional investors, they say they are comfortable with their holdings of bank stocks and view them as a safe haven," he said.

Coming Employment Report

But Mr. Cassidy said these investors are not adding to positions, except during periods like the recent price weakness.

This week, stock trading will be dominated by anticipation of the government's August employment report, due Friday, which will be a fresh indicator of the economy's strength and direction.

Despite their rebound last week, bank stocks still face dangers ahead if rates remain low and the economy stays weak, Mr. Cassidy said.

"I think the political risk factor is rising," said the analyst. "How long is it going to escape attention that the banks' rate is still 6% when you have the 30-year [U.S. Treasury] bond rate nearly at that level?

Pressure on Loan Rates

"And look at the prime rate in relation to the federal funds rate," he said.

"Historically, the spread between those rates is 175 basis points, but it is now 300 basis point," he said. The Federal Reserve's target for the fund rate is currently 3%.

Banks have not cut the prime rate because previous cuts did not spur fresh loan demand, he said. But they can probably expect jawboning from the Federal Reserve and others for another prime-rate cut soon, he said.

A prime-rate cut would accelerate a downward repricing of bank assets.

For the past two years, banks have thrived in an environment in which their liabilities were repricing downward.

Banks' cost of funds, especially for deposits, has fallen far faster than returns on their assets. That trend caused net interest margins to widen to highly profitable levels.

The wide margins, together with falling costs for problem loans, have been the impetus behind record earnings and surging stock prices for banks over the past two years.

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