Bank Of America's Earning Power Suppressed

Oct.16.12 | About: Bank of (BAC)

Bank of America (NYSE:BAC) recently had its price target increased from $8.50 to $10.00 by Citigroup. A price target of $10.00 would give Bank of America about a 10% upside from its current price. While this move shows optimism that the housing market might be strengthening, I remain partial and would avoid BAC for the time being for multiple reasons.

BAC recently announced that it plans to cut 16,000 jobs by the end of this year to try to counteract declining revenues. The plan is to eliminate $5 billion in annual expenses and cut as many as 30,000 jobs by 2013. These moves do not signify strength; rather, I see these moves as a company making financial decisions in an uncertain global economy.

No one knows how the upcoming election is going to pan out. From an economic perspective, both the Romney and Obama campaigns have completely opposite views on the economy. I think this is causing a lot of reluctance in companies to hire employees simply because they don't know what kind of laws will be put in place and what will happen with America's corporate tax rate. Low interest rates put on by the Federal Reserve also make it nearly impossible for banks like BAC, Citigroup (NYSE:C), and JPMorgan Chase (NYSE:JPM) to make any real money off of loans. Until the interest market gets steeper, I see the banks' earning powers being severely limited.

As of now, the interest rates aren't set to increase until 2014-15. Which means corporate and commercial banking makes up approximately 30% of BAC's total revenue. During Q2 this year, BAC saw its corporate and commercial banking division revenue decline about 15% from the previous year. That's a huge decline for the companies largest profit division. BAC simply can not manage to flourish if it's largest profit division is being restricted so tightly by Ben Bernanke and the Federal Reserve. It would be like PepsiCo (NYSE:PEP) trying to succeed without its soda division -- the company might be able to get by, but would you really want to own shares in the company? Probably not.

The following is a chart that shows that while interest rates were higher, banks were lending out more money for mortgage loans. The reason for the decline is that the banks have tighter restrictions on who they lend money to. Banks have to be pickier because they're lending mortgage money with high risk and low reward on interest. This has forced companies like BAC to have to make money using less traditional methods, such as cutting expenses and reducing unnecessary spending. Sure, BAC can make money, but it's a much longer process.

BAC is falling victim to the federal government. While there are optimistic people out there saying that BAC will soon increase its dividend to pre-recession levels, the cold hard facts are that, no, BAC probably won't be increasing its dividend or performing a share buyback anytime soon. What money does BAC have to pay back to the share holders? BAC is in debt and its major source of revenue (interest off of loans) is suppressed for the time being. Now, with the company trimming its workforce who knows what impact that will have on revenue numbers. With BAC, I would wait to see what this next round of job cuts does for the company's revenue.

Optimism about the share price of the banks is nice, but I would avoid this mess all together. The earnings rewards and dividend payments just aren't worth the frustration when dealing with bank stocks. BAC is no exception here either, and regardless of what analysts say, I'm staying far away for BAC for a while.

Disclosure: I am long PEP. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.