The big bank stock rally slowed Monday, as analysts began to lower their ratings on some of the sector's highest flyers.

Although analysts expect a strong third quarter, some suggested that the momentum driving the stocks to record highs could be on the wane.

"Banks have been the top-performing sector in the last nine months, but they cannot continue to outperform by the same margins," said analyst Elizabeth Summers, of Ryan, Beck & Co.

Investment ratings on a number of bank issues were cut late Friday and Monday, as stock prices neared analysts' targets. Bank stocks generally edged up on Monday, but well off the pace set Friday.

Ms. Summers downgraded First Union Corp., Fleet Financial Group, and PNC Bank Corp. to "buy" from "strong buy," noting that each had posted substantial gains since Sept. 30. First Union gained 3.4%, Fleet 3.9%, and PNC 3.7%. The Standard & Poor's 500 was up only 2.1%.

In trading Monday, First Union gained 50 cents to $69.625 and PNC 50 cents to $35.125, while Fleet lost 25 cents to $45.75.

The S&P bank index rose 0.27%, while the Dow Jones industrial average slipped 0.22%

Although she lowered her investment ratings, Ms. Summers raised her target price for all three banks. She now predicts First Union stock can reach $76, Fleet $52, and PNC $37 within 12 months.

Ms. Summers said she expects banks to bring in strong third- quarter earnings, but added that the stocks will outperform the market only if banks convince investors their business deserves a higher trading multiple.

"In order to do that they will need to demonstrate that their loan portfolios won't blow up on them during a recession," Ms. Summers said. On average, bank stocks trade for about 10 to 11 times annual earnings per share.

Analyst Merrill H. Ross at Wheat First Butcher Singer also said it "will be a strong quarter, but not a marvelous" one, in part because of the assessment on banks to shore up the Savings Association Insurance Fund.

"We'll see some loan growth, some increase in consumer losses, and margins will be strong overall," said Ms. Ross. "But when that numbers are reported, it will be unnerving."

She said Crestar Financial Corp., Richmond, Va., is expected to take a hit of 25 to 30 cents a share and First Union a one-time charge of 31 cents a share after taxes, due to the thrift fund assessment.

On Friday, Ms. Ross downgraded Mellon Bank Corp, PNC, and CoreStates saying their stocks are reaching peaks. In trading Monday, Mellon rose 12.5 cents to $64.75,; and CoreStates gained $12.5 cents to $45.125.

Nevertheless, Ms. Ross is bullish about banks: "I don't think there is any catalyst that will knock them down significantly," said Ms. Ross.

"The Fed is content and inflation is dead," she added, arguing that the Federal Reserve is unlikely to increase interest rates before next month's election.

Josephthal, Lyon & Ross Inc. removed Norwest Corp. from its "Focus List" following a 30% run-up in the Minneapolis bank's share price since July 15.

Josephthal analyst Frank Barkocy said that he is still "comfortable" with the bank's financial ratios, but said that there "could be selloff of 5% or more particularly if the market sells down a bit."

But Mr. Barkocy said the selloff could create some investment opportunities in smaller and medium sized banks and thrifts, including Hubco of Mahwah, N.J.

"Many of the larger-cap banks are getting close to their pricing targets," he said. 'But price weakness is a good way to reposition in some of the quality names."

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.