Anyone interested in high yields with little or no risk?
I know. Stupid question.
Everyone is interested in high yields with little or no risk… especially dividend investors!
But most people know better. No such thing can possibly exist, because there’s a direct correlation between risk and reward. That is, higher reward always comes at a price (i.e., higher risk).
At least, that’s what we’ve been told.
But what if there was an exception to the rule, and you could earn a 7% yield with little or no risk?
Keep reading if you’re interested. (No, it’s not too good to be true.)
You Can Bank on It
Around the time of the financial crisis, Bank of America (BAC) made a couple of purchases that are still impacting its business today – one negatively and one positively.
The purchase of Countrywide in 2007 for about $4 billion – just in time for the housing bubble to burst – was the obvious bonehead move.
So far, it’s cost Bank of America more than $50 billion in fines and restitution for claims associated with Countrywide’s mortgage operations. Not exactly a stellar return on investment!
However, the opposite is true of Bank of America’s decision to purchase the world-class brokerage firm, Merrill Lynch, in 2008. The move has been paying dividends (no pun intended) ever since. And it’s time for us to get a piece of the action with (you guessed it) little to no risk.
Energize Your Portfolio
Prior to the merger, Merrill Lynch issued trust preferred securities. Specifically, the Merrill Lynch Preferred Capital Trust IV Shares (MER-PE), which pay a fixed dividend equal to a 7.12% yield.
They were issued on a perpetual basis, too, meaning there’s no maturity date for the shares. They’re scheduled to keep paying that healthy dividend.
Think of it as Merrill’s version of the energizer bunny. They keep giving, and giving, and giving. That is, until the company decides to retire the shares – or “call” them – by returning investors’ original investments, just like companies do all the time with bonds.
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Even better, the shares are cumulative, which means in the unlikely event that a company needs to suspend dividend payments – on common and preferred shares – it has to make up all the dividend payments on the preferreds before it can resume dividend payments on the common shares.
And here’s the thing… as part of the merger, Bank of America inherited this liability. They’ve been making good on it ever since, too. And therein lies the opportunity for us…
Max Yields With Minimal Risk
The likelihood of a bank as systemically important as Bank of America missing a dividend payment is virtually nil! So the dividend paid on MER-PE couldn’t be more safe and secure.
If or when Bank of America calls the securities, shareholders will receive $25 per share.
Since MER-PE is currently trading at $25.19, our capital loss if the security is called tomorrow would be 0.76%. Of course, the security could also trade below $25. However, I believe this is an acceptable risk to bear in order to earn a perpetual yield of more than 7%.
Of course, one key question remains…
How Likely is it That Shares Will Be Called Away?
With the recent jury verdict against Bank of America, stiff headwinds against future earnings exist, making it highly unlikely that management would consider calling shares away anytime soon.
Most likely, Bank of America is going to stick with the status quo. And as long as it does, we stand to earn a super-safe and way-above-average yield.
But before you pull the trigger, please note: Merrill Lynch Preferred Capital Trust IV shares are not traditional preferreds.
In turn, they’re not eligible for favorable dividend tax treatment from the IRS. The dividends are taxed at ordinary income rates. So if you buy shares in a taxable account, your after-tax yield will be lower.
However, if you buy shares in a tax-advantaged-account, such as an IRA or 401(k), this won’t be a problem.
As always, if you have any doubts, consult a tax professional.
Safe (and high-yield) investing,