Bank Of America: 6.7% Yield And Free Upside Potential

| About: Bank of (BAC)
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In the quest for yield that many of us embark upon as investors, we sometimes forget to look in the most obvious of places. Bank of America (NYSE:BAC) has a well-publicized one penny per share per quarter dividend on its common stock at present, a condition that could persist for another year or more depending on many factors. However, if you are a BAC bull but also need some income, alas, there is hope. While BAC's common shares provide virtually nothing in the way of current income, BAC has many outstanding preferred issues that could be the jolt of income your portfolio needs. One such issue is the Series L 7.25% Non-Cumulative Perpetual Convertible (BAC.L, ticker may differ depending on your broker) and it is the subject of this article.

The Series L was born during the financial crisis and has been paying steady dividends ever since. BAC actually issued many preferred series during the crisis as a way to raise capital in its time of need. However, those days are the past but these high yielding preferreds are still around for us as investors to enjoy some very generous yields without commensurately high risk. The Series L is a non-cumulative issue, meaning that if BAC were to miss a dividend payment on the Series L it is under no obligation to make up that payment. That doesn't mean it wouldn't, should that occur, but keep in mind this is a risk of owning a non-cumulative preferred stock. As I said, BAC has never missed a payment on the Series L so the outlook for that particular occurrence is bleak given BAC's constantly improving fundamentals but it is a risk worth knowing about.

In addition to that, the Series L is a convertible preferred issue. That means that holders of the shares can actually convert them into common stock at their direction at any time. The conversion ratio for this particular issue is 20 common shares per share of Series L preferred stock but with yesterday's closing price of $1,089, that isn't a particularly good idea. Right now, 20 common shares have a market value of about $281, implying a breakeven point on the conversion of Series L shares into common shares of $54.45 per common share at yesterday's Series L closing price. Obviously, $54 is a long, long way from the current price of $14 and that will be many years down the road but I like this feature in the Series L because if you hold the Series L for the long term, you could actually reap some upside on BAC common shares.

So we've established that I like the Series L's characteristics but what about the yield? The Series L pays a quarterly dividend of $18.125 per share, or $72.50 per share annually. At yesterday's closing price of $1,089, that works out to a current yield of 6.7%. With the 10 year Treasury at 2.6% and the S&P 500 (NYSEARCA:SPY) yield at 2%, 6.7% is robust to say the least. The beauty of this preferred issue is that, as long as BAC continues to make the dividend payments, if you were to hold this issue for the long term, you could potentially own it for a zero basis. At the current price of $1,089 and the dividend payment of $72.50 annually, it would take just over 15 years to fully recover the cost of your shares through dividends. While I understand that is unlikely for many investors, the idea is that this is a very strong income issue that could pay for itself in whole or in part for patient investors.

This particular preferred is a bit more volatile than I would typically like since it is essentially a debt instrument but despite that, I still like it. In the past year we've seen prices on the Series L ranging from $1,024 to $1,285. That is a pretty significant range but at $1,089, we're currently on the low end. Given the liquidation preference of $1,000 I think a pretty strong floor on the price is in place around that value. It would take a meteoric rise in interest rates for shares to fall materially below the liquidation preference and if that were to happen, it would be a tremendous opportunity to pick up more shares at an above-list dividend rate. But falling from $1,089 to $1,000 wipes out roughly five quarters' worth of dividends so be aware of that potential outcome as a risk of owning the shares. If you are a long term holder it likely wouldn't matter but if you need to get out, the risk is there that you may have to take a capital loss. The opposite is possible as well, however, as we could see $1,200+ again, providing you with income and capital gains.

In short, the Series L provides investors the opportunity to get long Bank of America's improving fundamentals for the long term while simultaneously collecting a huge amount of income. The Series L provides you with long term upside potential on the common stock as a free addition to the tremendous income it provides currently. However, if preferreds aren't your thing necessarily but you wanted to juice your BAC holdings to say, a 3% dividend level, you could offset some of your BAC common shares with some Series L preferred shares in order to have the mix reach 3%. There are many ways to take advantage of the Series L's income and if you are a long term holder, you never know, you could be sitting on free call options on BAC's common shares in addition to the income you would be collecting many years down the road.

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.