Deutsche Bank released a comprehensive report covering the large bank and regional bank sector. While I can’t cover all of the topics in the report, I’m going to say that the worst case scenario is already priced into the stocks, and I believe a compelling buy opportunity among the higher quality names is starting to emerge. Now of the banks that I do cover, the two that stick out the most are JPMorgan Chase and Bank of America. Now, my stance is a little subjective, but seems somewhat in-line with the commentary provided by other analysts. Here’s what Deutsche Bank stated on its stress-test scenario (i.e. recession scenario):In total, we estimate a severe commercial credit cycle could reduce EPS by 25%. A material short fall in capital markets could reduce EPS by another 15-20% at BAC, C and JPM—implying total potential downside of 40-45%. In this scenario, we find 50% downside at GS and MS. Large regional banks could be 30-35% once we factor in other drivers. We view these as a very stressed EPS downside scenario, rather than a base case or a mild downside scenario (which we also discuss in this note). But with stocks down 25%, we’re trying to figure out what’s being priced in/feared. Yeah, so basically there’s not a very compelling reason to bet against banks unless you anticipate a recession over the next 12-months. Banks are heavily linked to economic cyclicality, but from my perspective I find it extremely improbable that we’re entering into a recession until the Fed maxes out its interest rate policy to 3% to 4%. Furthermore, the Federal Reserve is heavily data dependent, which implies that rates will only increase assuming broader macro trends remain intact. Now, what’s funny here is that even Deutsche Bank doesn’t know what the market is fearing, and their downside scenario is modestly more upbeat than the stressed scenario provided by Credit Suisse last week. I think CS had something in the range of 50% to 55% negative EPS impact from a recession, which will correspondingly drive higher net charge offs, debt value adjustments, weakness to trading revenue, narrowing of net interest margins and so forth. Basically, the recession probabilities aren’t all that great, and Morgan Stanley recently released a report indicating a 20% probability of a recession (pretty low probability). So that should only capture about 10% downside to EPS when based on Deutsche Bank’s stressed scenario. Again, I’m not saying that a recession is impossible, but it seems fairly improbable. Of the banking names I cover, I really like Bank of America. BAC has some of the lowest energy exposure and has a consistent path to widening its net interest margin and lowering its operating costs when compared to other banks. Deutsche Bank iterates on the credit risk in their banking note:BAC shares have declined as much as peers both vs. July highs and YTD. We believe this reflects a combination of selling related to dampened macro/rate hopes as well as concern that BAC is under reserved for its energy exposure. However, as we’ve discussed before (and recap below), BAC has only a modest amount of non-investment grade exposure. And while we estimate reserves on this are just 4-6%, to increase it from 4% to 10% (to be more in line with our estimate of cumulative losses), this would reduce EPS by just $0.03 or 2% of our 2016e. Again, the impact is fairly minuscule, so even as we roll through the year and defaults continue to tick higher. The bank that seems least exposed among the major universal banks is Bank of America. Therefore, from a risk standpoint, Bank of America seems relatively well positioned. But, what about JPMorgan Chase? Well, this bank is pretty unique because their asset management and investment banking have done pretty darn good in this environment. Furthermore, the consumer credit is what separates the bank from the pack, and every incremental bit of deposit growth adds to JPM’s lending capacity as they’ve met fully phased in CET 1 requirement inclusive of the G-SIFI buffer. Now, if that sounds like archaic stuff, it just means that JPM’s lending capacity will likely increase and they can potentially move down the credit tiers assuming the Federal Reserve revises lower the G-SIFI buffer. If that occurs, banks will likely move as a group, but of those banks, JPMorgan is positioned better than the rest given the heightened customer sat scores and expansion of the branch network within denser markets. Deutsche Bank’s take on JPMorgan more or less echoes my sentiment:High quality banks (JPM, MTB, PNC, USB and WFC) have outperformed the BKX by 670bps since the July 22nd highs (with JPM outperforming market sensitive peers by 12% over this period). Despite this strong relative performance, we stick with our overweight quality bank call that we made in early September given our more cautious macro view. Loan growth continues to be driven largely by C&I. Average loan growth was strongest at MTB (+23.3% y/y, mostly reflecting the HCBK deal), JPM (+10.2%) and WFC (+7.4%). While I’m not as familiar with the other banks Deutsche Bank refers to. I like JPM’s exposure to commercial and industrial (excluding energy and exploration). The bank continues to generate loan growth at the fastest pace among its large bank peer group. While top line growth metrics remained intact relative to its environment, the increasing net interest margins, and back-half recovery in investment banking keep me upbeat. The earnings and sales big banks generate are heavily dependent on the equity, fixed income, and commodities market. Assuming a path to normalization in commodities and fixed income with upwards momentum to stock prices, the banks will rapidly recover. The asset management, trading, and investment banking component tend to perform much better in a rising equity environment. In other words, bank fundamentals are heavily tied to broad market sentiment, and if sentiment continues to weaken the damper on earnings and sales worsens. Hence, banks tend to exhibit more beta volatility to the market. If the market does great, so will the segments tied to equity performance. There’s a high correlation to this, which is why major stock market corrections have so much impact on big bank valuations. I think a recovery in stock indices remains highly probable, which is why investors can ride the banks that much higher once we reach that key inflection point I’m pounding the table on JPMorgan Chase and Bank of America. Not only are they cheap, the risk to reward is very compelling. Both banks are high conviction buys.