Good news, bad news: What to make of analysts' mixed reviews of our bank stocks

Published Wed, Oct 5 20224:59 PM EDTUpdated Wed, Oct 5 20225:05 PM EDT

Wells Fargo (WFC) and Morgan Stanley (MS) got mixed reviews in separate analyst notes on Wednesday ahead of their earnings releases next week. As long-term shareholders of both, we believe they're well positioned in their sector to weather the economic storm. Morgan Stanley Atlantic Equities downgraded Morgan Stanley to neutral from overweight (hold from buy). It also cut its price target on the stock to $85 per share from $95. Analysts cited declining investment banking activity, falling equity markets, and concerns that trading estimates are overly optimistic given this rough macro environment. A meaningful drop in investment banking activity, which accounts for 17% of Morgan Stanley's total revenue, could dent the bank's earnings, Atlantic Equities wrote. By comparison, investment banking at the major U.S. banks overall only accounts for 10% of total revenues, the analysts added. In addition to investment banking — which includes putting together mergers and acquisitions and initial public offerings — Morgan Stanley also focuses on trading and has a wealth management division. That's why Atlantic Equities thinks the continued decline in the stock market could also hurt Morgan Stanley's upcoming third-quarter results. "On a combined basis, IB (investment bank) and trading account for 50% (of revenues) for Morgan Stanley (likely 45% in FY22) compared to 30% for the money-centre [center] banks, leaving the IBs much more exposed to a pronounced downturn in activity," the research note said. Bank stocks are down this year, but not quite as much as the broader market. Atlantic's research said there's more room for bank shares to fall in the event of a harsh recession. Conversely, it also notes that during the recovery phase, banks tend to outperform. "Banks typically underperform the market by 30% early in a recession. On the positive side, banks' share price performance for the 18 months following the inflection point is 48% and the relative outperformance of the sector is 26%," analysts explained. Despite the Morgan Stanley downgrade, Atlantic Equities kept its overweight (buy) rating on Wells Fargo on the expectation that it will benefit from rising interest rates. Overall, Atlantic acknowledges that banks today are in "much better" financial positioning than they were in 2007 during the financial crisis. Analysts explain that the "main threat" banks face is not so much from a possible hit to earnings rather than the gloomy backdrop of a recession that can leave multiples well below "rational" levels. We currently have a 1 rating on Morgan Stanley, meaning we would buy shares right here . In other words, we believe the risk/reward is attractive at the current price and we would look to add to our position when it makes sense with our average cost basis and current size. Wells Fargo Morgan Stanley's research side of the business lowered Wells Fargo's price target to $59 per share from $62 but kept its overweight (buy) rating and top pick label. Analysts there cited excess capital, strong liquidity, and positive operating leverage as reasons for why they like Wells Fargo. Morgan Stanley broke down why they're taking a long position on Wells Fargo into several points. Due to the Federal Reserve-mandated asset cap, which keeps the bank's assets below $1.95 trillion, Wells Fargo has not grown loans as quickly as its peers, which means it has less exposure to credit losses in the event of an economic downturn, the note said. Given that Wells Fargo has been increasing its net interest income due to higher rates, the analysts anticipate an increase from the bank's full-year 2022 net interest income guidance, especially if interest rates continue to climb. Morgan Stanley currently forecasts WFC net interest income to be up about 21% year over year compared to management's guide of 20% growth. The analysts expect higher rates to further weigh on WFC's mortgage business, which was down about 80% year over year in the second quarter due to low refinance activity. Earlier this week , Goldman Sachs analysts struck a similar tone regarding Wells Fargo, issuing an upgrade on the stock in a research note on Monday. The Club also rates Wells Fargo as 1, meaning we consider it a buy. (Jim Cramer's Charitable Trust is long MS and WFC. See here for a full list of the stocks.) As a subscriber to the CNBC Investing Club with Jim Cramer, you will receive a trade alert before Jim makes a trade. Jim waits 45 minutes after sending a trade alert before buying or selling a stock in his charitable trust's portfolio. If Jim has talked about a stock on CNBC TV, he waits 72 hours after issuing the trade alert before executing the trade. 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A screen displays the trading information for Morgan Stanley on the floor of the New York Stock Exchange (NYSE), January 19, 2022.

Brendan McDermid | Reuters