Pessimism swept across the financial sector last week as investors and analysts concluded that the industry's profitability may have peaked in the first quarter.
The selloff in financial stocks was a major factor in Friday's record-setting 616.23-point plunge in the Dow Jones industrial average.
The American Banker index was off 6.04% for the week - including a 7.74% slide on Friday - despite a series of stronger than expected first-quarter earnings reports. The drop in the Dow amounted to 5.6%. The Nasdaq index dropped 9.67%. A decline in revenues from lending was a weak spot in some banks' reports, and the trading and investment banking profits that boosted first-quarter earnings are expected to dry up in the bear market for technology stocks.
"It's hard to believe that it can stay as good as it has been," said Lawrence Cohn, an analyst at Ryan, Beck & Co.
Anticipating a decline in those businesses, analyst George Bicher of Deutsche Banc Alex. Brown downgraded his recommendations for FleetBoston Financial Corp. and Chase Manhattan Corp. Friday. The party may not be over, he said, but "it's time to put down the wine and drink some water for a while."
The market downdraft caught shares of banking companies that already have reported significantly higher profits for the first quarter, including J.P. Morgan & Co., down 6.8% and FleetBoston, down 8.7%. Citigroup Inc. and Chase, both considered to be on track for similarly strong profit gains when they report this week, fell 7.9% and 6.7%, respectively.
Accelerating the banks' slide Friday was a consumer price report that reinforced expectations that the Federal Reserve will continue raising interest rates. Rising rates could hurt profitability in lending businesses, which already showed deterioration in the recent round of earnings reports.
National City Corp. chairman David A Daberko acknowledged in a statement accompanying first-quarter results that "our basic banking margins have been challenged by rapidly rising interest rates." Its profits dropped 7% from a year earlier.
Other regional banking companies earlier in the week also reported lower profits from lending, which in some cases was more than offset by strong revenues in market-related activities.
Fee income at First Union Corp. fell almost 6%, in part because of an 80% drop in fees from mortgage banking, the company said. That dragged down First Union's overall profits by 13%, to $838 million. Mortgage fees declined 41% at First Tennessee Corp., eroding its profits by 34%, to $39.5 million.
Consumer prices rose in March at the fastest rate in more than five years, the Labor Department reported. Analysts said concern is deepening that the Federal Reserve will raise rates beyond the 25-basis-point hike that was previously expected.
"Add this to three solid months of good, solid increases in average hourly earnings, and you've got a case for rate increases," said Cary Leahey, senior economist at Deutsche Bank Securities Inc. in New York. "If there is any doubt about the Fed in May, that's gone. It's one of the worst CPI reports we've seen in a long time."
Core consumer prices, which exclude volatile food and energy costs, rose 0.4% last month as costs increased for clothing, housing, medical care, and air fares. That came after a 0.2% gain in February. The overall consumer price index rose 0.7% last month after increasing 0.5% in February.
Analysts also said the blow-out profits for some big banks had been fueled by robust capital markets businesses, particularly in underwriting new stock issues and advising on deals, two activities that could be choked off if markets continue to decline. Gains from venture capital investments could also be substantially reduced.
Mr. Bicher and other analysts said the steep drop in share prices for banks, even those that reported stellar earnings, reflects the sentiment that the results are unsustainable. "The difference between the markets in the first quarter and what is going on in the second quarter is so stark," Mr. Bicher said. "Investors are looking at the future."
The pace of initial public offerings and the lucrative investment banking fees they generate already is on the decline.
Goldman Sachs Group Inc. and Morgan Stanley Dean Witter & Co., which underwrote almost half the record $22.6 billion of new IPOs in the quarter, were among firms that had planned for a booming April only to see offerings canceled or reduced.
A plunge in the Nasdaq composite index since March 10 has prompted six companies to abandon IPO plans. Of the 24 that went ahead with initial stock sales, more than half raised less than they had hoped.
"The ride could be bumpy," Salomon Smith Barney analysts Guy Moszkowski and Gabrielle Gutierrez said in a report. "The Nasdaq's recent decline clearly raises concern over the outlook for equity underwriting."
Shares of Goldman, which generated 9% of its revenue from IPOs and other stock underwriting in the past three years, and Morgan Stanley, which gets 7% of its revenue from equity underwriting, have declined sharply in recent sessions. On Friday Goldman shares fell 13.4%, and Morgan Stanley 10.4%.
Investment banks had scheduled 108 April IPOs, together worth $12.7 billion and with potential fees of as much as $89 million. They have reduced that to about 95, according to CommScan LLC.
"It would be hard for us to imagine that Wall Street has the physical capacity to drive volumes much above" first-quarter levels, Morgan Stanley analyst Henry McVey said in a report.
Some analysts said, however, that the decline in IPOs could actually help some commercial banks. Corporate clients may be forced to seek bridge or mezzanine financing from banks instead of stock underwriting services, and corporations may turn to banks for advice on restructuring. In addition, the companies that make markets in stocks or that process trades make more money in volatile markets. "It's not all bad news," said Diane Glossman, an analyst at Lehman Brothers.
Bloomberg News contributed to this report.