JPMorgan (JPM), Morgan Stanley (MS), Citigroup (C), and Wells Fargo (WFC) are scheduled to announce quarterly results on October 14. What to watch for:

BETWEEN ROCK AND HARD PLACE: In a third-quarter preview research note, Bank of America analyst Ebrahim Poonawala told investors that “mega-cap banks are stuck between a rock and a hard place,” with higher capital requirements to temper balance sheet growth for JPMorgan and Citigroup, even as AOCI hits, market volatility chips away at the common equity tier 1 capital ratio. Based on his conversations, investors are closely watching for how the mega-caps balance the need to build capital ratios versus adding to loan loss reserves. Investors also watching for any updates from the regulators that would indicate higher capital requirements. While stocks could react negatively if absolute level of capital requirement is seen as rising significantly, he noted that the actual implementation of any such rule would likely be a multi-year process. His recent expert call discussing regulatory priorities suggest that regulators are not particularly worried about the lack of capital adequacy at the big banks.

ESTIMATES ‘TOO OPTIMISTIC’: Atlantic Equities analyst John Heagerty downgraded Morgan Stanley to Neutral from Overweight with a price target of $85, down from $95. The analyst cited declining investment banking activity, falling equity markets and concern that trading estimates "remain too optimistic" for the downgrade. In addition, there are few near-term positive catalysts to improve the stock's risk/reward equation, Heagerty told investors in a research note. The analyst noted that banks typically underperform the market by 30% early in a recession before outperforming by a similar amount once the yield curve has steepened to 50 basis points. He sees the current backdrop as similar to a combination of the early 1990s and 2000s recessions, "which would provide an environment in which banks can absorb credit defaults and outperform in a relative sense while highly-priced stocks de-rate."

POSITIVE CATALYST WATCH: Early this month, Citi analyst Keith Horowitz opened a "positive catalyst watch" on shares of JPMorgan into the company's third-quarter results, while keeping a Buy rating on the shares with a $135 price target. The analyst believes a third-quarter beat on sales will lead to upward revisions on full-year guidance and imply a better run-rate into 2023.

Bearish on the stock, Morgan Stanley analyst Betsy Graseck lowered the firm's price target on JPMorgan to $126 from $127 last week, maintaining an Underweight rating on the shares. Graseck is lowering price targets across her bank coverage by a median of 3%, noting that liquidity constraints are building and that banks are having to increasingly fund loan growth with higher cost deposits, more debt, and securities portfolio runoffs. Rapidly rising and "higher for longer" rates and higher capital requirements add up to "an accelerating credit cycle," said Graseck, who suggested banks with excess capital, excess liquidity, and positive operating leverage as "where to position long."

MOVING TO THE SIDELINES: On October 3, Goldman Sachs analyst Richard Ramsden downgraded Citi to Neutral from Buy with a price target of $47, down from $54, implying 16% total return potential, inclusive of a 5% dividend yield. Although Citi's valuation still appears attractive, it needs to build more capital than peers and offers less operating leverage, Ramsden told investors in a research note. Despite "substantial progress" in the second quarter, Citi still needs to build capital, which delays the resumption of buybacks into 2023 and also potentially could impact revenue, the analyst said. He believes that in a recession scenario, Citi may also need to limit balance sheet growth more aggressively to fund reserve builds.

BULLISH ON WELLS FARGO: That same day, Goldman Sachs’ Ramsden also upgraded Wells Fargo to Buy from Neutral with a price target of $48, up from $46, implying 22% total return potential, inclusive of a 3% dividend yield. The analyst sees Wells as an "underappreciated earnings growth story," given its "best-in-class" revenue upside and efficiency improvement from interest rates and loan growth-driven net interest income. The bank also has "idiosyncratic" expense rationalization potential as it laps regulatory-related cost inflation and continues to rationalize the business footprint, Ramsden aid. Moreover, in a recessionary scenario, Wells offers less credit risk downside than peers, given its below-average loan growth in recent years and less credit card skew, the analyst wrote.

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