A 6%+ Yield Offering Diversification From A World Class Financial

 |  About: Bank of America Corporation (BAC)
by: Josh Arnold

Many investors have expressed their displeasure with Bank Of America's (NYSE:BAC) lack of a common equity dividend. At one penny per share per quarter it is about as small as you can get while still paying a dividend. Of course, this condition is a relic of the financial crisis and the extraordinary stress BAC found itself in following years of bad decisions and the fallout that ensued. However, income investors can still take advantage of BAC's continued turnaround efforts and receive large amounts of income at the same time without the stock market risk inherent in owning the common. In this article, we'll take a look at the Merrill Lynch Depositor Index Plus Trust Series 2003-1 (IPB), an issue BAC inherited when it acquired Merrill, to see if it is right for your portfolio.

To begin, we'll define exactly what this security is as it is a bit of a strange one. IPB is a third party trust preferred, which means it is a preferred security that is backed by debt of some sort, rather than a true preferred which isn't really backed by anything other than the issuing company itself. IPB issued shares in order to buy the underlying issues and then funnels the interest payments to holders of IPB. You could think of IPB as a bit of a bond mutual fund with only fifteen issues; it offers tremendous diversification and no expenses associated with mutual funds or ETFs. Another important difference between third party trust preferreds and traditional preferreds is that third party trust preferreds typically have maturity dates corresponding to when the underlying debt matures; true preferreds typically have no maturity date as they are perpetual instruments.

This particular third party trust preferred is actually based on an index of fifteen publicly traded investment grade rated corporate long-term debt securities instead of a single issue, as is customary with third party trust preferreds. If you're curious which issues the trust is based on the list is on page S-21 of the prospectus linked above. These issues mature from 2029 to 2033, meaning IPB will also mature in 2033 when its underlying securities have matured. Thus, there is roughly 19 full years left for IPB making it what is essentially a long-term bond for holders of IPB.

IPB was issued in $25 increments in 2003 and pays annualized interest payments of $1.51295 in semiannual increments. At the issue price this was good for a yield of about 6.1% and with shares trading for only 10 cents more than that at present, the current yield is just over 6%.

So we know that IPB is a third party trust preferred that offers investors a chance to buy pieces of fifteen investment grade corporate bond issues and receive the interest payments twice a year; what are the risks? There are a few risks associated with IPB including some that are inherent in any interest-bearing security. The principal risk to IPB is interest rate volatility. As IPB has a stated interest rate market participants will bid it up and down depending on prevailing interest rates. Earlier this year when taper talk began from the Fed there was a nasty selloff in IPB. It subsequently recovered and was a great buying opportunity but the risk remains that this type of thing could happen again on an interest rate spike. Of course, the opposite could occur on a bond market rally and IPB could soar.

In addition the semiannual interest payments may bother some investors. Common equity dividend investors are accustomed to quarterly dividend payments and I'll admit that six months is a long time to wait for income from your securities. However, unless you are relying on the interest received from IPB to cover living expenses it likely isn't a deal breaker. But it is something to keep in mind as distributions are made only near the end of June and December each year.

Astute readers will notice I've been using the word "interest" instead of "dividend" in this article and that is because IPB funnels interest payments from the trust to holders of IPB. In other words, IPB is not eligible for the favorable tax treatment that dividends enjoy. This means that anyone holding IPB in a taxable account will be subject to a lower after-tax rate than a comparable issue that is eligible for the favorable tax treatment. In a retirement account it shouldn't matter but those holding it in taxable accounts may find the after-tax yield isn't high enough. That is something each investor must decide for themselves as IPB isn't for everyone.

Overall IPB is a very interesting issue. It pays a nice yield and if you can get over the semiannual interest payments and the fact that distributions are not eligible for the favorable dividend tax treatment, IPB could offer your portfolio a boost of income. The main benefit of IPB over other high-yielding financial issues is that IPB offers the diversification of fifteen corporate bond issues instead of being backed by one issue from the parent company, as is customary with trust preferreds. If you are looking for a lower risk way to obtain some income you can do much worse than IPB. As a point of reference the PIMCO Total Return Bond ETF (NYSEARCA:BOND) is only yielding 2.4% so if you compare IPB to funds such as this, it is a big winner.

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.