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7 Bank Stocks Loved by Deutsche Bank (Update 3)

Updated with market close information.

NEW YORK ( TheStreet) -- Amid the year-to-date euphoria for bank stocks, some investors and analysts are considering the possibility of a breather, and looking further ahead to justify sector holdings.

Just this morning, Collins Stewart analyst Matthew Czepliewicz lowered his rating on Morgan Stanley (MS) to "Hold" from "Buy," following "the share price's near-60% surge since last November." Czepliewicz's $23 price target for the shares still implies 14% upside from Tuesday's closing price of $20.26. Investors yawned, pushing the shares up another 1%, to close at $20.44.

The KBW Bank Index (I:BKX) was up 15% year-to-date, through Wednesday's close at 45.23.

The star of the show has been Bank of America (BAC - Get Report), with shares rising 46% year-to-date through Tuesday's close at $8.13, after the shares declined 58% in 2011.

Looking ahead, with a mortgage foreclosure settlement expected soon between the largest loan servicers, federal regulators and most of the 50 states' attorneys general, and also with all of the large-cap banks expected to "pass" the Federal Reserve's latest round of bank stress tests in March, Deutsche Bank analyst Matt O'Connor says that the group's return of capital through dividends and share buybacks "in 2012 could be 40% plus of bank earnings and even more meaningful in 2013."

Meanwhile, "Credit costs likely to grind lower, but may be close to bottoming at some banks," net interest margins might hold up better than expected, despite the Fed's prolonged low-rate policies, and the banks could see "eventual reversal of mortgage and litigation reserves."

Bank of America, for example, ended 2011 with "$15.9 billion reserved to address potential representations and warranties mortgage repurchase claims."

On the negative side of his investment thesis, O'Connor says that if "interest rates remain low for another 2 years to 3 years, net interest margins and net interest income dollars will be pressured," loan loss reserve releases that have been padding bank earnings for several quarters "should slow" during the first half of 2012, and the group still faces "regulatory risk and overhang over mortgage litigation."

O'Connor rates Bank of America a "Hold," saying that while his "bias is to the downside for earnings expectations, estimates have come down closer to reasonable levels in our view--for the first time in several years."

The shares trade for just 7.5 times O'Connor's 2013 EPS estimate of $1.08.

On the positive side, the analyst says that "meaningful housing improvement" would "ease pressure," and that the company has "good leverage to a recovery in global capital markets (ibanking/brokerage are 20-25% of revenues)."

Negatives for Bank of America include the possibility of another common equity raise, "mortgage tail risk" that "remains outsized vs. peers," and the pressure on earnings over the short-term, from a shrinking balance sheet, market share losses and a "bloated cost structure."

The following are the seven large-cap banks still rated buy by O'Connor:
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