Seeking Value in Unconventional Spaces
While I don’t typically gravitate towards non-cumulative preferred shares, every once in a while, an offering comes along that’s just too intriguing to ignore. In a previous piece, I delved into the “busted” preferred shares issued by Wells Fargo (WFC), and now, let’s turn our attention to the Series L preferred shares from Bank of America Corporation (NYSE:BAC). Sporting a tantalizing 6.4% yield, these securities appear to be an interesting play on potential rate cuts in 2024. With Fed Chair Powell signaling a shift in policy may be on the horizon, betting on lower rates might just pay off handsomely.
Risk Assessment: Are Dividends Secure?
When considering an investment in preferred shares, the foremost concern is whether the company can comfortably sustain the preferred dividends. Though Bank of America is a stalwart in the financial world, it’s prudent to keep close tabs on the bank’s financial health to ensure peace of mind.
In the third quarter, Bank of America witnessed an uptick in interest income, albeit accompanied by a rise in interest expenses. This resulted in a net interest income of $14.4B, marking an increase of roughly $600M over the same period last year.
Additionally, the bank reported a total non-interest income of $10.8B alongside non-interest expenses of $15.8B, culminating in a net non-interest expense of approximately $5B. This translated to a pre-tax and pre-loan loss provision income of around $9.3B. After factoring in a $1.23B loan loss provision, the pre-tax income stood at $8.1B, with net income settling at $7.8B.
Covering the preferred dividend payments required roughly $532M, leaving a net income attributable to common shareholders at approximately $7.27B or $0.91 per share.
For the first nine months of the year, the total net profit came in at $23.4B, including around $3.3B in loan loss provisions. To cover the preferred dividend payments, BAC needed approximately 5.7% of its 9M 2023 net income, a figure that ticked up to 6.8% in the third quarter. This means the bank could sustain the preferred dividends even if loan loss provisions multiplied fivefold to $6B per quarter.
Furthermore, the evolution of Bank of America Corporation’s Common Equity Tier 1 capital position is reassuring. The CET1 capital climbed from $176B to $194B in the past four quarters, propelling the CET1 ratio from 11% to 11.9% – a robust position that bodes well for the company. Notably, the “net income” mentioned refers to the net income prior to preferred dividend payments, as denoted in the image below.
Unveiling a Promising Investment Opportunity
The Series L preferred shares, trading under the ticker symbol NYSE:BAC.PR.L, fall into the category of “busted” preferreds with no call option for Bank of America. Shareholders have the prerogative to convert their shares into 20 common shares, and given that the common shares are trading at just over $30, the likelihood of a forced conversion in the near term is minimal. Moreover, even in the improbable scenario of a forced conversion, holders of the preferred shares would stand to receive at least $1,300 in common shares (20 times $65), heralding an immediate 15% capital gain based on the prevailing share price of approximately $1125.
Simultaneously, these preferred shares offer a 7.25% preferred dividend based on the $1,000 principal value of the security. At the current share price of $1,125, this equates to a yielding potential of 6.40%. Although not the loftiest yield available, the appeal lies in the fact that this preferred share isn’t easily callable, and the odds of a forced conversion into common shares are remote.
Final Verdict: A Calculated Position
In my prior analysis of Bank of America’s Series L preferred shares, I opted to invest in similar insulated preferred shares issued by Wells Fargo due to their intriguing attributes. With a substantial cash inflow from bond maturities recently, I’m actively scouting for fresh income-generating opportunities to deploy these proceeds. Despite the non-cumulative nature of Bank of America’s preferred shares, I am leaning towards establishing an initial long position in the foreseeable future. The 6.4% yield is within an acceptable range for me, and if rate cuts do materialize in 2024, the price of these preferred shares is likely to ascend.
Currently, I hold no position, but it’s highly probable that I’ll initiate a long position in the imminent future.