Bank Of America: A Safe 6.1% Yield For Your Income Portfolio

| About: Bank of (BAC)

Bank of America's (NYSE:BAC) common stock has been on a tear in recent years, rising from $5 to nearly $16 as of this writing. But the financial crisis is still rearing its ugly head for BAC common shareholders in the form of a virtually non-existent dividend. However, with the common stock at multi-year highs and no dividend to speak of there is still hope for income investors that want to capitalize on BAC's successes; trust preferred securities. In this article, we'll take a look at BAC Capital Trust VIII (BAC-Z, may differ depending on your broker) to see if it is a good fit for your portfolio.

To begin, we'll define what BAC-Z is. BAC-Z is a trust preferred security and while it is similar to a traditional preferred stock, there are a couple of important differences. First, trust preferred securities are backed by a debt issue from the parent company. Basically, BAC issued 6% Junior Subordinated Deferrable Interest debt which was then purchased by the trust, in this case the BAC Capital Trust VIII. The investor then purchases shares in the trust which then receives interest payments from BAC on the debenture and funnels them back to investors. In other words, you are essentially buying BAC debt by owning BAC-Z. This also means that, unlike traditional preferred stock, trust preferred securities have stated maturity dates. In the case of BAC-Z the maturity date is 2035, for all intents and purposes making this a long bond for holders of it today.

Second, trust preferred distributions, unlike traditional preferred stock, are classified as interest payments and not dividends, meaning they are subject to higher taxation than traditional preferred issues of like characteristics. While this doesn't matter if you hold BAC-Z in a retirement account it can make a big difference in your after-tax yield if you hold it in a taxable account. This is something to keep in mind and evaluate on a case by case basis if you are thinking of getting long BAC-Z.

BAC-Z was issued at $25 per share and pays $1.50 annually in quarterly distributions to holders of shares. This works out to a stated coupon rate of 6% and as shares are trading just below the issue price of $25, the current yield is only slightly higher at 6.1%. However, consider that yield in the context of the low interest rate environment we find ourselves in and that higher yielding issues often come with much higher risk; BAC-Z is a decent mix of risk and reward in my view.

Since 2010 BAC has had the option to redeem BAC-Z at the full $25 call price but has chosen thus far to forego that option. However, the option exists and BAC can call BAC-Z at any time between now and the maturity date for $25 plus any accrued and unpaid distributions. With the rate relatively low in the context of preferred stock I don't see BAC calling BAC-Z to save money but it doesn't mean that won't happen. It is something to keep in mind but with BAC-Z trading under the call price, even if it does get called, you'll be made whole and then some.

Interest payments on BAC-Z are deferrable by BAC for up to 20 consecutive quarters and while that would be painful, the payments are cumulative. This means that once payments were initiated again BAC would be obligated to make up all missed interest payments to BAC-Z. Thus, as long as BAC doesn't go out of business you'll receive your interest payments eventually should you hold BAC-Z. While deferred interest isn't ideal, the cumulative nature of BAC-Z is a big bonus because BAC cannot simply forego interest payments without consequence. Even if it could, if BAC ever wanted to tap the capital markets again it would do everything in its power to avoid missing payments on all of its issues, including BAC-Z. I think the risk of BAC missing interest payments on BAC-Z is as close to zero as you can get; I'm not worried about it.

Overall BAC-Z represents a low risk way to own a preferred security of a top notch payer that still offers a nice yield. You can find higher yielding preferred issues in the marketplace but you will be stepping out on the risk curve to do so. While 6.1% is certainly a great yield you can also do better if you don't mind risking loss of principal. With BAC-Z I don't see loss of principal if held to maturity as a real possibility because the payer is so strong at this point. Barring some kind of interest rate spike where shares are temporarily depressed, BAC-Z offers a very safe yield from a very strong payer that you can hold for a long time, assuming BAC doesn't call it. In short, you can get a higher yield elsewhere but BAC-Z offers a unique mix of yield and safety in my view.

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.

Additional disclosure: I may initiate a long position in BAC-Z at anytime.