In every interest rate cycle, somebody in the corporate debt issuer market nails it. By that I mean, somebody, usually IBM (NYSE:IBM) and recently, Apple (NASDAQ:AAPL), issues debt that virtually marks the bottom in interest rates. I think we may have seen a similar event earlier this month as Bank of America (NYSE:BAC) issued its newest preferred stock, the Series V. The preferred, CUSIP 060505EG5, is a depositary share of the $25,000 per share Series V preferred stock. That doesn't make it unusual but what does make it unusual is the dividend rate.
The Series V pays an annual dividend that is fixed at $51.25 paid in quarterly installments on the $1,000 issue price. That gives the Series V a paltry dividend rate of only 5.125%. Of recent preferred issues, the Series V is by far the lowest I've seen and in particular, from an issuer the size of Bank of America. I think BAC is striking while the iron is hot and issuing preferred stock at a very cheap rate. That's great for shareholders but for investors in the Series V, not so much.
In June of 2019 the dividend goes from a fixed 5.125% to floating 3-month LIBOR plus 338.7 basis points thereafter. That means that not only is the dividend quite low right now for an income issue but it could theoretically be even lower. No one knows what 3-month LIBOR will look like in five years but it's pretty safe to say the Series V is going to offer income investors low returns for a while to come.
Anyone who reads my articles knows I'm a big bull in BAC shares and that extends to the bank's preferred shares. I believe in the business model and if common shares aren't for you, you can still gain exposure via preferred shares, collecting substantial income in the process. However, I'm doing something I've never done and that is recommending staying away from the Series V. I really think BAC is timing the bottom in preferred dividend rates and the size of the offering, $1.5 billion, speaks to the confidence that BAC has this money is going to be very cheap for a long time.
The Series V is also perpetual, as is expected for a preferred issue, but that introduces additional price volatility given that the price won't tend towards the redemption price at maturity. Bonds, no matter how cheap they become, will eventually tend towards their par value at maturity. Perpetual preferreds have no such safeguard and as such, you could end up with massive capital losses indefinitely. This is why I can't get behind the Series V; there is far too much risk involved given the extremely low dividend rate.
As an example, let's assume that the going rate for BAC preferreds demanded by market participants becomes 8%. This has happened before and it will happen again as rates eventually rise from near zero over time. If this were to occur and the Series V traded towards the market rate, the price of the Series V would need to fall to $640 in order to meet that yield. In other words, you'd be losing $360 per share if you had bought at the issue price. New owners would get the 8% yield but if you bought at the issue price, you'd be down 36% on your investment excluding dividends.
BAC has the option to call the Series V in June of 2019 but at the rate it was issued, I'd say that's a pretty long shot. Thus, holding on the hope that BAC would redeem the Series V for its full issue price would just be hoping, which is not a valid investment strategy.
BAC isn't going to default on the Series V or anything like that but given the rate you are getting, I'd wait for a much, much cheaper price. I really think BAC has nailed it in terms of the preferred market, issuing dirt cheap preferred stock in huge quantities for some sticky financing that is plenty cheap. I love this move from a shareholder perspective but owning the Series V is not something I would recommend. If you want to own a BAC preferred stock there are plenty of better options that have already be re-priced. In other words, someone else has already taken a capital loss and you can be the beneficiary. BAC's terrific timing in issuing the Series V is something you should stay away from as the bank times the bottom in the preferred market. The cards are stacked against you if you pay close to the issue price.
Disclosure: The author is long BAC. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.