Bank stocks hit the skids Monday as financial markets were shaken by the prospect that Japan might cut its enormous holdings of U.S. government bonds.

Reflecting a selloff in the bond market, the Standard & Poor's bank index dropped 14.5 points-its worst day in more than a month. It ended Monday at 545.46, down 2.60%.

In the broader market, the S&P 500 index lost 20 points, or 2.24%. The blue chip Dow Jones industrial average plummeted 192.25 points, to 7,604.26, its biggest one-day loss of the decade.

The 30-year bond's yield rose to 6.69% from 6.66%.

"There was some saber rattling by the Japanese with regard to their investment in the U.S. Treasuries," which scared investors, said Joseph Roberto, a bank analyst at Keefe, Bruyette & Woods Inc. He called the decline "unsettling" but added: "It's been so good for so long. Something like this was bound to happen."

Many large banks were hit hard. BankAmerica Corp. slid $2.87, to $64.75 a share, a decline of 4.25%. Wells Fargo & Co. fell $8.875, or 3.1%, to $276.37. Barnett Banks Inc. dropped $2.375, or 4.3%, to $53, and NationsBank Corp. slid $2.37, or 3.4%, to $66.625.

Smaller banks fared better, and some analysts said they stand to make the most out of 1997's economic good news.

"The smaller caps have done better in 1997," said Mark T. Fitzgibbon of Sandler O'Neill & Partners, New York. Shares of community banks and thrifts are catching up to the larger institutions, which had a banner 1996.

Looking beyond Monday's unnerving drop, Mr. Fitzgibbon said, "I think the prospects are bright for community banks and thrifts."

Indeed, the Nasdaq bank index, where most of the smaller issues are represented, had climbed 25.2% this year, through Friday, compared to 23.4% for the S&P bank index.

"There are hundreds of smaller institutions consolidating. That's where the lion's share" of mergers will take place, he said.

In one such case, Crestar Financial Corp. announced Monday that it would buy American National Bancorp, a Baltimore-based thrift with $505 million of assets, deposits of $330 million, and 10 branches in the Baltimore metropolitan area.

American National shareholders will receive $20.25 per share in a tax- free exchange of Crestar common stock, or cash. Crestar announced a stock buy back in connection with the acquisition. The thrift's stock price rose $3.187, to $19.31, on the news.

The Washington area market has been rapidly consolidating, said analyst Angelina Billon of Johnston, Lemon & Co., Washington. Wachovia recently announced a deal to buy Jefferson Bancshares, and Virginia First Corp. was bought out by BB&T Corp.

She noted a number of takeover targets in Washington, that she considers "attractive:" First Virginia Banks Inc., George Mason Bancshares, FMN National Corp., and Maryland Federal BancorpMeanwhile, Katrina Blecher of Gruntal & Co. upgraded Banc One Corp. to "strong buy" from "buy." She said the stock is trading at "a significant discount" at 14.5 times earnings. "When second-quarter earnings come out, investors will realize a tremendous value to the merged company." Banc One recently acquired First USA Inc., the credit card issuer.

Earlier Monday, Ms. Blecher downgraded BankAmerica Corp. to "hold" from "buy." BankAmerica "is trading at a premium to its peer group," she said. She called the company an "excellent fundamental long-term holding."

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