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Bank of America Corp. (NYSE:BAC) will no longer lay claim as the U.S.'s largest employer in banking sector as it announced cost cutting initiatives that include slashing 16,000 jobs, or 6% of its workforce, by the end of the year. The job cut is part of the program called Project New BAC under which 30,000 people will be laid off and $5 billion in annual expenses will be saved by the end of 2013. In the second phase starting after 2013, the cuts will be less drastic with an objective of cutting another $3 billion in one-and-a-half years. The job cuts were expected although not in 2012. After 2013, both JPMorgan Chase (NYSE:JPM) and Wells Fargo (NYSE:WFC) will have a larger workforce unless something changes between now and then.

CEO Brian Moynihan known he needs to streamline operations, reduce investment risks and increase revenues while cutting cost. More branches will be closed this year in addition to the 163 shut down in 2011, and the business will step away from mortgages and other unnecessary supplementary areas such as international credit cards and insurance. Cutting to grow is not a path to investor happiness without a commensurate reduction in the stock's float.

Fun with Numbers

In Q2, BAC's revenues contracted at a much slower rate than in previous quarters. Its operating income has jumped sequentially from $759 million in Q1 to $3.1 billion Q2, though off by 69% YoY. The continuous decrease in loan loss provisions have been good for the stated bottom line; coming down from $3.2 billion a year ago to $1.7 billion. By booking phantom revenue in this way, BAC is attempting to sell investors that their loan portfolio has improved. If that was not the case, then the Fed would not have announced a doubling of Mortgage-backed-security purchases under QEIII. Still, that is the purpose of QEIII, ultimately to underwrite the risk that the banks take in lending at obscenely low interest rates. This process of substitution is what allows banks to report Tier I capital asset gains while not having materially improved their lending practices.

This type of behavior is endemic to the banking sector in 2012. This is the reason why they can report profits knowing full well that it is all based on manipulation of the accounting rules. A company that earns $3.1 billion in a quarter does not excise 30,000 jobs unless their actual business, i.e. traditional fee-based banking and lending was in trouble. Look for BAC and the rest of the sector to continue lowering their loan loss provisions in the coming quarters now that QE for them is a multi-national safety net. Net non-operating losses have also slid from $2.8 billion in Q2 2011 to just $6 million in Q2 2012.

In a zero-interest-rate environment, the banks cannot make money via traditional lending as savers have no incentive to put their money in the bank. BAC's net interest income dropped along with deposits YoY in Q2 and this trend will continue for as long as the Fed continues its current policy, currently stated through 2015. Income from Consumer and Business banking declined YoY from $1.3 billion in Q2 2011 to $1.2 billion in Q2 2012. On an alarming note, interest income has decreased by $376 million sequentially and $845 million YoY to $4.7 billion. The return on average economic capital has fallen sequentially from 26.2% in Q1 2012 and annually from 45.9% in Q1 2011 to 20.3% in Q2 2012.

The Global banking unit is struggling due to falling revenues on account of the Eurozone debt crisis and weakening economies, while trading volumes are declining as this unit's income fell by $336 million sequentially and $449 million YoY to $462 million. Sales and trading revenues dropped $542 million YoY to $3.2 billion, or 14.4%.

Excisions, Decisions and Revisions

The cost cutting initiatives, even with falling revenues, can result in higher profits. Investors seem to have approved these moves by Moynihan who has delivered on all the promises he made when he faced the tough questioning from shareholders after the stock plummeted by 20% in 2010. And, while BAC is up 65% on the year, it is still down more than 40% since Brian Moynihan became CEO.

The bank is not going to raise new capital anytime soon, as promised by Moynihan. It has a strong balance sheet with $641 billion cash and short-term investments. So far, it has sold 46 non-core assets as part of the transformation process and more sales are likely in the future. If BAC is so operationally healthy, shareholders will want an increase in dividends or share buybacks to reward their patience. But for now, BAC is facing the latest round of the Fed's stress tests, along with everyone else. The management will wait on any dividend hike until after the stress test results are released.

The recent settlement for $2.43 billion in damages over the acquisition of Merrill Lynch should clear away another storm cloud from BAC's future. While stiff, the penalty is now known, the same with the $25 billion robo-signing deal agreed to last year with the U.S. State Attorney Generals. But, as one of the three U.S. banks involved in setting LIBOR, along with JPMorgan and Citigroup, and directly implicated in any potential litigation stemming from it, BAC is not out of hot water yet.

Irrepressible Zombies

As mentioned above, BAC is up 65% in 2012, while JPMorgan and Wells Fargo are far behind with 22.8% and 26.7%, respectively. BAC was the most beaten up during 2011, so any good news, even in the form of large monetary settlements, will be seen as a positive to the stock as known liabilities beat potential liabilities in the minds of investors. Financials have been good this year, in spite of JPM's struggles due to the London Whale fiasco which cost it $6 billion in Q2. Their performance has been one of the main reasons for the SPDR S&P500 ETF (NYSEARCA:SPY) increasing 16.5% year to date.

In the current global economic environment and falling domestic interest rates, it would be a miracle if BAC could sustain even current revenue levels of these units. Hence the cuts in staff and branch offices and the entire austerity plan Moynihan has put in place. Structurally, it seems dubious to invest for the long term in businesses that are only still functional because of central bank largesse. To understand the U.S. banking sector at this point is to simply look east to Japan and back in time. Would you have bought Japanese banks after the boom turned to bust and the Bank of Japan turned them into zombies?

While there will be massive short-term rallies and fades, fundamentals eventually win out in the end, and right now the fundamentals of western banks are terrible.

Source: Why Settle For An American Zombie Bank?