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For Some Bank Investors, Riskier May Be Better

JPMorgan Chase and Wells Fargo kick off bank earnings season on Friday. While industry profits should continue to improve, banks with exposure to trading activity and advisory services may see uneven results, say analysts.

"Certainly the big capital markets banks, they have some struggles against fourth-quarter results," Gerard Cassidy, an analyst at RBC Capital Markets, told CNBC. "But on a year-over-year basis, the industry should report positive earnings comparisons due to the improvement in credit quality."

And while Cassidy expects the group to continue to run—given that bank stocks remain cheap and earnings can continue to improve—it's the "risk on" banks still recovering from the financial crisis that may have the most upside, he says.

Earnings Watch

Cassidy said he'll be watching Wells Fargo results to see how residential mortgage production is faring at the country's largest home lender, particularly as overall origination is forecast to decline after a strong 2012.

The Mortgage Bankers Association forecasts that total U.S. mortgage origination activity in the first quarter will fall about 6 percent from last quarter.

For JPMorgan, which also boasts a residential mortgage business, their capital markets performance—which offers a glimpse into deal-making and trading activity—may be a bigger focus, Cassidy said.

According to a research note from Evercore Partners, JPMorgan is the most leveraged to capital markets activity among the big banks, with about 30 percent of total revenues coming from investment banking and trading versus only 20 to 25 percent for Citigroup and Bank of America and 5 percent for Wells Fargo.

Evercore analysts estimate that trading will be down nearly a fifth at JPMorgan this year.

Banks also collected fewer fees on investment banking advisory services in the first quarter than they did in the fourth. Fees totaled $19.8 billion during the first quarter of 2013, a 6 percent year-over-year increase, but down 11 percent from the fourth quarter, according to data from Thomson Reuters.

In the M&A market, the dollar value of mergers was up 10 percent from last year, but the number of deals dropped 16 percent, marking the slowest start to the year in a decade, Thomson Reuters' Matthew Toole told CNBC.

(Read More: 'Greece-Like Risk' for Financials: McDonald)

JPMorgan Catches an Upgrade

But even with potentially choppy capital markets results, Evercore is turning more bullish on JPMorgan, upgrading the stock to "overweight."

Evercore wrote that other fundamentals remain healthy with solid loan growth, deposit inflows and the least net interest margin risk among peers.

The analysts expect core earnings per share of $1.43 for the first quarter, above the Street consensus of $1.38.

The stock is also cheaper than other large-cap banks, trading on 8.6 times Evercore's 2013 estimates versus 10.2 times for its peers. Evercore's $55 price target on JPMorgan shares implies 17 percent upside.

Evercore also has an "overweight" on Bank of America with a $13 price target but "equalweight" ratings on Wells Fargo and Citigroup.

Shifting to Neutral on Investment Banks

But while analysts still see upside in some of the diversified big banks, it may be time to invest more selectively among the broker-dealers.

Last week, Bank of America Merrill Lynch downgraded Goldman Sachs to "neutral" and Credit Suisse cut Morgan Stanley to "neutral." Both firms cited the run up in the stocks over the past few months.

"While we still expect Goldman Sachs to be one of the leaders within the sector in terms of navigating a dynamic backdrop and producing premium returns, given that that stock now trades in line with our target valuation relative to our expected returns, we see more limited upside," BofA analysts wrote in a research note.

(Read More: Goldman Sachs and the Next New Thing on Wall Street)

Meanwhile, Credit Suisse sees little change to its long-term outlook on Morgan Stanley, but advocates a "neutral stance today absent a further pickup in the operating environment, meaningful operating leverage and/or faster excess capital returns."

Both Morgan Stanley and Goldman have run up about 10 percent so far this year. JPMorgan and Wells Fargo are up 7 percent — nearly in line with the S&P 500 that has gained 8 percent.

(Read More: 20 Stocks With the Potential to Pop)

Going for 'Risk On'

RBC's Cassidy, meanwhile, sees little reason why the broader banking group can't continue to race higher.

"As the economy improves, housing especially is going to drive not only loan demand but an improvement in credit quality," he said. "So the profitability for the sector should improve throughout the year. And with the valuations where they are there's still meaningful upside for the sector."

Richard Madigan of JPMorgan Private Bank also told CNBC, "We think financials have a huge ramp up in front of them."

Cassidy expects the "risk on" banks to do better than "safer banks" from here.

He points to Citigroup and Bank of America among the large banks and regional banks like SunTrust and Regions Financial, which are still recovering from the financial crisis, and can post big earnings improvements over the next two years.

"If you look at them on price/book basis, the stocks are still very cheap," Cassidy said of the sector. "We anticipate that normalized earnings for the industry will materialize at some time next year."

It's the stocks of safer banks that may struggle. Cassidy said US Bancorp is one of the best banks in the U.S. and because of that its shares may continue to underperform.

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Disclosures:

Credit Suisse provided both investment banking and non-investment banking services to Morgan Stanley within the past 12 months. Bank of America Merrill Lynch makes a market in shares of Goldman Sachs, and provided investment banking services to Goldman in the past 12 months. The firm also owns on percent or more of the common stock of Goldman Sachs. Evercore has a client relationship with JPMorgan, or received revenues from JPMorgan in the past 12 months and expects to receive or seek investment banking services from this company.

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