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), 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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Shares of BB&T Corp. ( BBT) of Winston-Salem, N.C., closed at $29.65 Wednesday, returning 19% year-to-date. Based on a quarterly payout of 16 cents, the shares have a dividend yield of 2.16%.

The company on Friday agreed to purchase the life and P&C insurance operating divisions of Roseland, N.J.-based Crump Group from J.C. Flowers for $570 million in cash, saying the deal would "add approximately $300 million in annual revenue."

BB&T also has a deal in place to purchase BankAtlantic Bancorp's ( BBX) main thrift subsidiary for a premium of $301 million to pick up 3.3 billion in deposits, spread across 78 South Florida branches.

O'Connor's price target for BB&T is $30.00.

Among the positives he sees for BB&T, O'Connor growing its commercial and industrial loans, along with "niche areas within its specialized lending segment," while also "growing small ticket consumer, prime auto, and commercial leasing which are smaller in size, but provide more granularity/geographic diversification to its portfolio." Even without the Crump insurance business, BB&T derived "$1b or 31% of core noninterest income in 2011" from its insurance business.

O'Connor also expects BB&T's credit expenses to continue to decline, estimating 2012 earnings of $2.49 a share in 2012, followed by EPS of $2.78 in 2013.

On the negative side, risks for BB&T investors include continued pressure on the company's net interest margin, as the company "continues to run off higher-yielding Colonial assets," acquired when BB&T bought the failed Colonial Bank of Montgomery, Ala., from the Federal Deposit Insurance Corp. in September 2009.

O'Connor also thinks there "may be little upside" to BB&T's dividend this year, because of the company's preference to deploy capital through "organic growth."

Interested in more on BB&T? See TheStreet Ratings' report card for this stock.

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Shares of Citigroup ( C) closed at $34.25 Wednesday, returning 30% year-to-date.

O'Connor's price target for Citi is $36.00.

The analyst calls Citigroup "the only US bank with a meaningful presence in emerging markets (EM) in each core segment," with "total non-US revenue was over 50% of revenue at C overall."

"This is a positive," says O'Connor, "if one assumes growth in the US and developed markets in general will lag EM growth," but then again, "C is seen as more susceptible to concerns over a global slowdown and Euro zone issues (even though its exposure isn't much larger than peers BAC/JPM)."

O'Connor estimates that Citigroup will earn $3.79 a share in 2012, followed by EPS of $4.88 in 2013.

Citigroup's capital is growing, and O'Connor estimates the company will achieve a Basel III Tier 1 common equity ratio of 8.8% by the end of 2012, and that "beyond 2012, we think excess capital could build meaningfully."

The analyst also points out that Citigroup trades at a similar discount to book value as Bank of America, -- the shares of both companies traded for 0.7 times tangible book value at Tuesday's close, according to HighlineFI -- "despite higher capital and lower risk."

On the negative side, O'Connor says that Citi is "too reliant on capital markets," and that the company "has less expense flexibility in the investment bank, given recent investment spend and ongoing required investments in technology." The analyst also says that with "more moving pieces than other U.S. banks," the company is "a bit more difficult to analyze and compare vs. US peers."

Interested in more on Citigroup? See TheStreet Ratings' report card for this stock.

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Shares of JPMorgan Chase ( JPM) closed at $38.30 Wednesday, returning 16% year-to-date. Based on a 25-cent quarterly payout, the shares have a 2.61% dividend yield.

O'Connor's price target for JPMorgan is $45.00, and he estimates the company will earn $4.48 a share in 2012, followed by earnings of $5.40 a share in 2013.

The analyst says that JPMorgan's "market share gains have been impressive in capital markets and credit card," with the company remaining "#1 in global investment banking fees in 2011," while gaining 3% "of sales volume market share vs. peers over the past five years" in tis credit card business, and achieving a second-place ranking.

Looking forward to an eventual housing recovery, O'Connor says that JPM has "about $2b/qtr. of elevated mortgage servicing costs that could normalize closer to $200m/qtr," and that he expects the company to release another $10 billion to $12 billion in loan loss reserves over the next three to four years.

Among risks to JPMorgan Chase, according to O'Connor, is the company's size, making "it more challenging to grow," the industry pressure on net interest margins, and elevated regulatory risk from the Volcker Rule, as well as mortgage litigation expenses and risk from "the pending credit card interchange suit" against Visa ( V) and many of the largest U.S. banks.

Interested in more on JPMorgan Chase? See TheStreet Ratings' report card for this stock.

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Shares of KeyCorp ( KEY) of Cleveland closed at $8.16 Wednesday, returning 6% year-to-date. Based on a three-cent quarterly payout, the shares have a dividend yield of 1.47%.

O'Connor's price target for KeyCorp is $9.00, and he estimated the company will post 2012 EPS of 75 cents in 2012, followed by 80 cents in 2013.

The analyst says that "KEY seems to be well best positioned to buy back stock (when it gets regulatory approval) given Tier 1 common of 11.3% (and growing)," and "little mortgage/litigation risk." O'Connor believes that the company's management would rather buy back shares than seek a merger deal, and that KeyCorp "(in 2012) and still generate enough capital to support balance sheet growth and maintain ~11% Tier 1 common."

KeyCorp' shares traded for 0.9 times tangible book value at Tuesday's market close, according to HighlineFI.

According to O'Connor, risks for KeyCorp include a slowdown in reserve releases, as well as some "acquisition risk" over the next two years. The company just agreed to purchase 37 Upstate New York branches from First Niagara Financial Group ( FNFG), to follow that company's pending purchase of roughly 200 branches from HSBC ( HBC).

Interested in more on KeyCorp? See TheStreet Ratings' report card for this stock.

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Shares of Regions Financial ( RF) of Birmingham, Ala., closed at $5.53 Wednesday, rising 29% year-to-date.

Regions owes $3.5 billion in federal bailout money received in 2008 through the Troubled Assets Relief Program, or TARP.

The company agreed in January to sell its Morgan Keegan brokerage subsidiary to Raymond James Financial ( RJF) for "total consideration of $1.18 billion."

O'Connor's price target for Regions is $6.00, and he estimates the company will earn 48 cents a share in 2012, followed by EPS of 75 cents in 2013.

The analyst says that an "outsized capital raise for TARP repayment is unlikely given fundamental improvement," including the Morgan Keegan sale, "improvement in credit quality in 4Q and an increase in capital ratios." O'Connor expects the company's Basel I Tier 1 capital "to exceed 9% by the end of 2012."

O'Connor also points out that "unlike some regionals, RF hasn't meaningfully released Reserves," which covered 3.5% of total loans at the end of 2011.

"Tarp uncertainty" remains an obvious risk for Regions, with O'Connor estimating that the company will eventually raise $1 billion in common equity to repay the government.

Interested in more on Regions Financial? See TheStreet Ratings' report card for this stock.

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Shares of TCF Financial ( TCB) of Wayzata, Minn., closed at $10.78 Wednesday, returning 5% year-to-date. Based on a five-cent quarterly payout, the shares have a dividend yield of 1.86%.

O'Connor's price target for TCF Financial is $12.00, and he expects the company to earn 83 cents a share in 2012, followed by EPS of $1.39 in 2013.

The analyst expects TCF's net interest margin to improve, as the company has $115 million in trust-preferred shares outstanding "that are likely to be called in 2012 (adding 10bps to NIM)," and points out that the company has "$4.4b of long-term borrowing" at an "average rate of 4.3% (vs. 2.5-3.0% for peers)."

A improved funding mix, along with "the recent acquisition of Gateway and the BRP deal should add $1.3b (or 10%) of higher margin loans in 2012," according to O'Connor, leading to "solid net interest income growth in 2012/2013."

O'Connor says that TCF "has made a number of strategic changes in the past 1-2 years as it tries to reduce reliance on home equity, overdraft and debit card revenues," but that "at some point, a sale of the company can't be ruled out if either of these drags proves to be more difficult than expected to offset."

Interested in more on TCF Financial? See TheStreet Ratings' report card for this stock.

Interested in more on TCF Financial? See TheStreet Ratings' report card for this stock.

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Shares of Wells Fargo closed at $30.63 Wednesday, returning 12% year-to-date. Based on a 12-cent quarterly payout, the shares have a dividend yield of 1.57%.

The company on Feb. 1 completed its purchase of UK asset-based lender Burdale Financial Holdings and the portfolio of Burdale Capital Finance from Bank of Ireland, for undisclosed terms, in a deal negotiated by Paul Hastings LLP.

O'Connor's price target for Wells Fargo is $36.00, and he estimates the company will earn $3.16 a share in 2012, followed by EPS of $3.77 in 2013.

Wells Fargo stands out among the "big four" U.S. banks, with the strongest and most consistent earnings over the past year. The company's return on average assets has ranged between 1.11% and 1.26% over the past five quarters, according to HighlineFI.

O'Connor says that Wells Fargo is "gaining share in mortgage, card, and capital markets," and is "willing to take risks to grow." The company has "gained share in mortgages" as other companies have pulled back, and "there's still a lot of room to grow credit card by penetrating its previously-acquired Wachovia markets."

Wells Fargo acquired Wachovia at the end of 2008, more than doubling in size.

O'Connor estimates that through a "meaningful expense savings plan," Wells Fargo is seeking to cut its quarterly expenses by $1.5 billion from fourth-quarter levels, by the end of this year.

Among risks to the shares, according to the analyst, is Wells Fargo's sheer size, and "robust scale in many core businesses, making it harder to move the needle through organic growth and M&A."

Interested in more on Wells Fargo? See TheStreet Ratings' report card for this stock.

>>To see these stocks in action, visit the 7 Bank Stocks Loved by Deutsche Bank portfolio on Stockpickr.

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-- Written by Philip van Doorn in Jupiter, Fla.

To contact the writer, click here: Philip van Doorn.

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Philip W. van Doorn is a member of TheStreet's banking and finance team, commenting on industry and regulatory trends. He previously served as the senior analyst for TheStreet.com Ratings, responsible for assigning financial strength ratings to banks and savings and loan institutions. Mr. van Doorn previously served as a loan operations officer at Riverside National Bank in Fort Pierce, Fla., and as a credit analyst at the Federal Home Loan Bank of New York, where he monitored banks in New York, New Jersey and Puerto Rico. Mr. van Doorn has additional experience in the mutual fund and computer software industries. He holds a bachelor of science in business administration from Long Island University.