Last week, we talked about Wells Fargo's (NYSE:WFC) preferreds and came to the conclusion that the $1,000 convertible preferred WFC-L represented a bargain because it combined a relatively high yield with a low risk of being converted to common stock anytime soon.
The first five symbols are $25-par preferreds, all yielding in the 6% range. This is a higher return than the Wells Fargo preferreds because the securities have a lower credit rating (BB+ vs. BBB for Wells). Still, Bank of America seems to be doing well on its stress tests, and those yields look pretty good, right?
Nope. All of these securities are callable, and are trading above par. As shown in the yield to worst column, the returns in the worst call case ranges from a decent 5.34% to negative. BAC-D and BML-I (the ML stands for Merrill Lynch, the original issuer) have negative yield-to-calls. Investors are betting that capital-hungry banks won't call them anytime soon.
Are they right? Maybe not. Bank of America last week issued a new 6.2% preferred, so the higher-coupon preferreds appear to be in some danger of being called.
BAC-E, on the sixth row, is something different - one of several floating-rate preferreds issued by the bank. It pays interest based on the three-month LIBOR rate plus a premium, but at least a minimum rate of 4%. Unfortunately for buyers, since these securities were issued, LIBOR has gone so low (it's around 0.64%) the 4% floor now looks like a ceiling.
Not surprisingly, the price is below par, but even so, the current yield is only 4.64%. Not handsome enough to tempt me, says the proud Mr. Darcy (the other floating rate preferreds are similar).
$1,000-Par Preferred Compared
Finally, on the bottom row, we get to BAC-L. How does the $1,000-par issue compare to the $25 retail preferreds? It pays an attractive dividend of $72.50 a year, or 7.25% at par. Investors had bid the price up to $1,097 as of Friday, so the yield stands at 6.6%. Still pretty good.
But what about the conversion risk? BAC-L can be converted into 20 shares of common stock if Bank of America's common stock exceeds 130% of $50 for 20 out of 30 consecutive trading days. Doing the math, 130% times $50 times 20 is $1,300.
In other words, if the bank called away the preferred you bought at $1,100, you would get a nice capital gain. In reality, there isn't much risk that BAC common (now around $13) will get to $65 anytime soon. The 6.6% yield on cost is good for the foreseeable future. And that's better than what we see in the $25-par preferreds.
Comparison With WFC-L
Bank of America's securities are more volatile than Wells Fargo's. The recent market correction has affected BAC-L more than WFC-L, as this Google chart shows:
If you think Bank of America securities have been oversold out of unrealistic fears of another financial crisis, which has been a theme both here on Seeking Alpha and on CNBC recently, BAC-L looks like a prime candidate for a short-term bounce.
Longer term, it's different. You can get a 6.6% yield from BAC-L with about the same low conversion risk as a 6.4% yield from WFC-L. WFC preferreds are investment-grade credits, Bank of America preferreds aren't, and a 0.2% lower yield isn't enough to compensate for the reduced safety. For recently issued $25-par preferreds, Bank of America had to pay 0.5% more than Wells Fargo, a more appropriate spread.
So while BAC-L is a pretty good value and I would consider buying it for diversification, if I could only pick one, I'd stay with WFC-L.
Disclosure: I am/we are long BAC, WFC, WFC-L.
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.