BofA’s $33.91 million contingent yield deal on indexes boosts coupon via call, barrier options

By Emma Trincal

New York, July 1 – When a worst of three broad equity indexes is not enough to generate the yield investors are looking for, issuers use new tools. One increasingly seen of late is the discretionary call in place of the autocall. Another lesser known one is the use of an “American” barrier for the coupon.

BofA Finance LLC’s $33.91 million of trigger callable contingent yield notes with daily coupon observation due June 30, 2022 linked to the least performing of the Euro Stoxx 50 index, the Russell 2000 index and the S&P 500 index combined both options.

The deal priced last week.

Each quarter, the notes pay a contingent coupon at a rate of 13.3% per year if each index closes at or above its coupon barrier, 65% of its initial level, on every day that quarter, according to a 424B2 filing with the Securities and Exchange Commission.

Barriers with this “any day” observation are called “American” after the name of the option they are built upon. The commonly used “European” barrier is observed point to point.

The notes are callable at par of $10 plus any coupon due on any quarterly coupon payment date.

If the notes are not called and each index finishes at or above its downside threshold, 55% of its initial level, the payout at maturity will be par. Otherwise, investors will lose 1% for every 1% that the least-performing index’s final level is below its initial level.

American option

“The American barrier is a modification they put there to make the coupon higher,” a market participant said.

“If the barrier is observed any day, it’s more likely to be breached. That’s more risk, and therefore you get more premium from the option.”

The issuer call is another feature included in the structure. It replaced the typical automatic call.

“Now the issuer can call the note whenever it’s favorable to them to call. You don’t know when or if they will. This type of option has more value. It’s more risk to the investor, and you get a higher coupon in return,” he said.

Issuer call

The prospectus stated that the issuer is more likely to call if the coupon payable on the notes is greater than comparable rates in the market.

But the market price of the underlying indexes plays a role as well, the market participant said. The further the underlying price is to the barrier, the more likely the issuer is to call the notes.

“They will call if the stock goes up or if interest rates have come down. But you can’t tell when. That’s how you’re getting paid 13.3%,” he said.

It is impossible to tell which of the two features – the American barrier or the issuer call – contributes the most to the higher coupon.

“You would have to price the whole thing. But they both add value,” he said.

Comfort zone

Issuer calls are not yet popular among registered advisers, who routinely purchase equity-linked notes for the purpose of getting income.

“It’s a balancing act between the coupon you want to get and the risk you’re willing to take. If advisers are familiar with a certain coupon level from autocalls, if they feel comfortable with the barrier, they’re probably not going to want to get out of their comfort zone just to stretch for yield. They may prefer to feel in control,” he said.

Heavy bid

The size of the deal was relatively high.

“It is a big deal. But it’s not that surprising. Worst-of on broad-based indexes or ETFs are very popular,” a source said.

However, some buysiders are still reluctant to get exposure of the least performing of several assets even if the underliers are diversified groups of stocks, not single names.

“We generally don’t like doing worst-of because you don’t really get a diversified exposure,” an adviser said.

“Your return is tied to the worst of two or three assets. Instead, we would use three ETFs – the Euro Stoxx ETF, the Russell 2000 ETF and one of the S&P ETFs. Then you have a strategy in place that’s a fit for our model.

“If two indexes do poorly and the third one is up a lot, you end up with the worst-performing one. That’s a lot of explaining to do with clients.”

Open architecture

The market participant noticed that the agent for the deal was UBS.

“It’s interesting that UBS distributed a note issued by BofA. Merrill has their own distribution platform. Somehow, they did it together,” he said.

“But that’s what wealth management firms should do. They are neutral on the issuer. Bank of America had the best price and UBS, the distribution. That’s how it’s supposed to be.”

The notes are guaranteed by Bank of America Corp.

The notes settled June 30.

The Cusip number is 05591G587.

The fee is 1.25%.

© 2015 Prospect News.
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