Bank Of America: 7.2% Yield And Principal Protection

| About: Bank of (BAC)

With Bank of America (NYSE:BAC) common shares still producing just one penny per quarter in dividends, income investors may have been turned off to the idea of taking advantage of BAC's tremendous fundamental improvements over the past few years. However, income investors can still gain exposure to the banking giant through a preferred issue known as the Merrill Lynch Preferred Capital Trust V (MER.PRF, may differ depending on your broker); the prospectus can be seen here.

This security is one where the operating subsidiary, the Trust, purchases debentures from the parent company, which is now part of BAC, and then funnels the interest payments to preferred shareholders as dividend payments. With the preferred's liquidation preference of $25 and a coupon rate of 7.28%, the shares pay out a robust $1.82 per share annually. As shares are currently trading at a very slight premium to liquidation preference at $25.38, the current yield is still very strong at 7.18%.

It is important to note that these shares are trading past their call date and can be redeemed by BAC at any time. If you were to get long these shares at current levels you would be subject to a ~1.5% capital loss if shares were redeemed by BAC at $25. This is less than one quarterly dividend payment but it is a small risk that investors should keep in mind as shares are trading for a premium at present. Apart from BAC's right to redeem these shares, they are perpetual so if BAC chooses not to redeem the shares, they will persist as long as BAC is a functioning entity.

The Trust can defer dividend payments for up to six consecutive quarters but as these shares are cumulative, you are entitled to any missed dividend payments. Thus, these preferred shares come with comparatively less risk than some others that are non-cumulative since BAC is obligated to make up the lost dividend payments should they ever be deferred. However, it would take a gargantuan series of negative events for a large bank like BAC to consider missing preferred dividend payments so I believe the risk is low. However, there is always the chance it could happen and you'd have to wait to receive your dividend payments.

The Trust offers a tremendous opportunity for income investors that are looking to get into a bank preferred issue. BAC has made tremendous strides in recent years in improving its business but income investors have been left out in the cold in terms of the common stock. However, this preferred offers investors the opportunity to get some exposure to BAC's improving fundamentals without having to wait for the common dividend to return.

In addition, current BAC shareholders could exchange some of their common shares for some of these preferred shares as a way to increase the yield on their BAC position. If, for instance, you wanted your BAC position to yield 3% you could exchange 40% of your current BAC common position for MER.PRF shares in order for your entire position to yield the desired amount. Just an example but the point is that this issue can replace the lack of a common dividend from BAC shares at present.

Whether you're a current BAC shareholder, someone looking to get exposure to BAC or an income investor, the MER.PK preferred issue offers you decent principal protection along with a terrific yield paid in quarterly installments. In addition to the shares' great yield the dividends are cumulative, offering you peace of mind as you know that your dividends, even if payments are missed, are safe and obligated to be paid.

Disclosure: I am long BAC. 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.