Bank Stocks Signal Breather

A run in the financials seems to have crested, some say.
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Bank stocks could be signaling that the broader market is ready to take a breather.

The Dow Jones Industrials has been setting record highs, led in part by a sharp rally in the financial sector. Shares in

Merrill Lynch

(MER)

,

Bank of New York

(BK) - Get Report

,

Citigroup

(C) - Get Report

and

JPMorgan Chase

(JPM) - Get Report

all rose last quarter, with Merrill putting in a 25% gain and JPMorgan up 15%.

But this week, the group's earnings have been only so-so. As a result, the group's run has halted -- which could undermine advances in other sectors even as stock market bulls mull over the latest new high.

"I do think we are at a point where we could see a correction," says Tim Ghriskey, chief investment officer for Solaris Asset Management. "We don't think it's a major market decline. But generally you need financial leadership for a market rally."

The problem for bank investors is that the lenders really haven't impressed much and revenue growth often has been soft. And, for the first time, a number of banks are showing signs of trouble with consumer borrowing, an uptick in problem loans and weakness in investment banking work -- especially stock underwriting.

To be sure, the roof isn't falling in on the banking sector. But traders are coming to believe the big bull run in financials may be over. Solaris, which is long shares of

Bank of America

(BAC) - Get Report

, recently reduced its exposure to financial stocks, says Ghriskey.

A mixed quarterly report from Citigroup, the financial-services behemoth, set the tone Thursday. The nation's biggest bank reported a 23% decline in third-quarter profit on flat revenue. Even on an operating basis, earnings rose just 6% from a year ago to $5.3 billion, or $1.06 a share.

International consumer banking performed well, but domestic retail banking was weak. Revenue at the bank's U.S.-based consumer group rose a mere 1% to $7.8 billion. More disturbing, Citigroup's investment bank posted a 6% revenue decline to $6 billion. Fees from stock underwriting tumbled 32%. The saving grace was deal advisory work, which generated a 7% rise in M&A-related fees.

Another ho-hum investment banking performance came at Merrill. There, revenue from investment banking work declined 3% from a year ago to $857 million. While fees from advising on corporate mergers were up 63% from a year ago, revenue from stock and bond underwriting fell 17% to $596 million.

Bank of America

(BAC) - Get Report

, which also reported earnings Thursday, did much better than Citigroup. The nation's second-largest bank reported a 41% gain in third-quarter earnings, generating 5.42 billion, or $1.18 a share in profit. But a good chunk of that gain stemmed from its acquisition earlier this year of credit-card giant MBNA.

And like Citigroup, BofA also had trouble at its investment bank. Excluding the gain from the sale of its Brazilian operation, net income from the investment banking group at BofA declined by 4% and investment banking revenue would have risen a mere 1%.

Officials with all the banks are pooh-poohing the weak investment banking numbers, blaming it on a combination of the summer doldrums and a rough August patch for IPOs. Everyone is saying the pipeline for future corporate deals is full, and they expect a robust fourth quarter.

Even so, other troubles still loom. Lenders, such as

Commerce Bancorp

(CHB)

,

Fifth Third

(FITB) - Get Report

and

BB&T

(BBT) - Get Report

, continue to report trouble navigating a tricky interest rate environment, which has made it difficult for banks to borrow money on the cheap and reinvest their deposits at higher rates. The nation's lenders continue to grapple with a stubbornly flat yield curve -- the narrowing spread between short- and long-term rates.

Then there's the issue of the health of the residential and commercial loan portfolios at the nation's banks. Over the past two years, banks have been able to routinely reduce the money set aside each quarter for bad loans in their portfolios, as borrowers had had few problems making payments. But there

are signs that's beginning to change after 17 interest rate hikes by the Federal Reserve.

It's hardly doom-and-gloom time at the nation's banks. But you won't find many bankers donning Dow 12,000 caps anytime soon.