Bank Of America: 6.5% Yield For Income Investors

| About: Bank of (BAC)

Bank Of America's (NYSE:BAC) epic turnaround from the depths of the financial crisis has caused a meteoric rise in its common shares. While patient investors have been rewarded with large gains off the bottom the common share dividend is still stuck at what is essentially zero. BAC had a pressing need to preserve capital and preserve capital it did, slashing the dividend years ago to only one penny per share per quarter. This has left income investors out in the cold when it comes to playing BAC's rebirth as a healthier bank but there is hope. In this article, we'll take a look at the company's Series D Preferred Stock (BAC-D, may differ depending on your broker) to see if it could be a fit for your income portfolio.

To start, we'll define exactly what the Series D is. The Series D is a true preferred stock issue. The reason I specify a true preferred stock issue is because many securities, like exchange traded debt and trust preferred securities, look like traditional preferreds but aren't. The distinction is, among other things, that true preferreds are eligible for the favorable 15% dividend tax treatment whereas interest received from exchange traded debt, for instance, is not. In a retirement account this probably doesn't matter but if you hold the Series D in a taxable account, it is a very large tailwind on the after-tax return of the issue.

Since it is a true preferred, the Series D is also, unfortunately, non-cumulative. This means that BAC can choose whether or not to pay the dividends on the Series D and if it chooses not to make payments, it is under no obligation to make up the missed dividends. Of course, doing so would be a last resort for BAC since, if it ever wanted to access the capital markets again, it would need to inspire investor confidence. Choosing to forgo dividends is a last ditch effort to save money and we wouldn't see such an eventuality unless BAC was on the brink of financial ruin anyway, in which case you probably don't want to own anything associated with the bank. Given that BAC is very profitable at this point and that it has plenty of capital being generated the idea of missed dividend payments is almost laughable. However, it is definitely something to keep in mind because that clause does exist if things get ugly.

Also, as the Series D is a true preferred it is also perpetual. This means that there is no stated maturity date on this security and, apart from BAC calling it, it will persist forever. Speaking of BAC calling this issue, since September of 2011 BAC has had the option to call this preferred at any time. While this has not happened and, given the relatively low coupon on this issue in the realm of preferreds, likely won't be as long as BAC has higher coupon issues still outstanding, it could be called at any time given that it is trading past its call date. Again, it's just something to keep in mind.

Up to this point we've defined the Series D but we haven't looked at its price or yield so we'll do that now. As of yesterday the Series D was trading at a decent discount to its call price of $25 at $23.99. Essentially, you can buy this preferred at a 4% discount right now and in the event BAC calls the issue, as we just discussed, you'll not only receive the dividends you're entitled to, assuming BAC pays them out, but also a nice 4%+ capital gain on your position. This is one very nice effect of buying a preferred at a discount but the other is that the current yield is higher than the coupon on the preferred. The coupon on the Series D is $1.551 per share annually paid out quarterly, good for a stated yield of 6.2%. However, with the discount we currently find on shares the current yield is actually higher than that at 6.5%. Thus, with the Series D trading at a moderate discount to its issue price you get not only a chance at a capital gain in the event the issue is called but also a higher current yield on your shares.

Overall, the Series D is a nice preferred issue to generate some income. With BAC's common shares paying virtually nothing in the way of dividends income investors can still take advantage of BAC's improving fundamentals by owning the Series D. The Series D offers a very nice 6.5% current yield and a chance to receive a small capital gain in the event of BAC calling the issue. It also has the added advantage of the payer strengthening quarter by quarter, decreasing the likelihood of missed dividend payments. If you can look past the non-cumulative nature of the issue, which is admittedly a large negative, the ample yield and favorable tax treatment could mean the Series D is a great addition to your income portfolio.

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.