Bank stocks fell again Monday on continued worries that a surprisingly strong economy would cause interest rates to surge, sapping bank profits.

The Standard & Poor's index of major banks tumbled 2.01% Monday, after diving 3.08% Friday as the government released a trio of unexpectedly vigorous employment reports. By contrast, the overall S&P fell only 3.09% in those two days.

Despite the large bank stock selloff, many Wall Street observers cautioned against panic.

They argued a better economy could help prevent further deterioration in consumer credit quality, the bugaboo of the past few months. In addition, they said many banks have positioned their balance sheets to be immune to volatile changes in interest rates.

But one prominent analyst downgraded the stocks of five major banks Monday, saying profits are imperiled.

"Over the past few months, we had assumed the economy would slow on its own, providing bank stocks with a reasonably favorable environment of slow growth, low interest rates, and an accommodative yield curve," said Judah S. Kraushaar, of Merrill Lynch & Co.

But now, prospects that the Federal Reserve may tighten rates "makes us considerably more concerned that bank stocks may be in for some rougher sledding in the short term," he said.

Mr. Kraushaar cut his near-term rating to "neutral" from "accumulate" on both BankAmerica Corp. and NationsBank Corp., and lowered ratings to "accumulate" from "buy" on Chase Manhattan Corp. and Republic New York Corp. He also lowered his near-term rating to "reduce" from "neutral" on Signet Banking Corp.

On Friday, the government said the nation added 239,000 jobs in June, 82,000 more than expected. Also, unemployment dipped to 5.3%, a six-year low, and hourly wages had the largest jump on record - all likely precursors to inflation in Wall Street's view.

The yield on the government's 30-year bond surged to 7.18% Friday, and on Monday hit 7.24%, before settling back down to 7.19% in late-afternoon trading.

Rising rates can hurt banks since rates on liabilities can rise faster than those on assets, and loan growth can be stunted. But many analysts think banks' effort to manage their interest-rate sensitivity should limit the damage.

"I am not changing any of my ratings. I still like the group," said Dennis Shea of Morgan Stanley & Co. "While rate-sensitive, bank stocks can withstand the pressure of rising rates and can even do better in this environment."

Indeed, Carole Berger of Salomon Brothers on Monday upgraded BankAmerica to "buy," citing the company's earnings prospects.

And Michael Stead, a portfolio manager with SIFE Trust Fund, said the selloff represented a buying opportunity.

Bank earnings should rise, and consumer credit quality should be less of a problem in a growing economy, he said. In the last few months, rising consumer debt problems, especially credit cards, have sent shock waves through the financial services sector.

But Mr. Kraushaar is not sure the healthy job figures mean that consumer credit problems are now solved. "Given the persuasive signs of consumer credit distress even with the strong employment levels, we increasingly worry that writeoff rates may go to historical highs and that consumer credit demand may dry up quickly."

Lawrence Vitale of Bear, Stearns & Co. argued that rising rates will likely hurt bank stocks, despite the sector's efforts to be rate-neutral.

Banks get a significant chunk of revenues from noninterest income, he said, and many of these businesses like investment banking and money management firms are interest-rate sensitive.

Subscribe Now

Access to authoritative analysis and perspective and our data-driven report series.

14-Day Free Trial

No credit card required. Complete access to articles, breaking news and industry data.