Bank of America's notes linked to Euro Stoxx 50 are hybrid between autocallable, step-up

By Emma Trincal

New York, Oct. 3 - Bank of America Corp.'s 0% autocallable market-linked step-up notes due October 2016 linked to the Euro Stoxx 50 index, by combining an autocallable structure with a step-up payout, give investors several opportunities to earn a competitive return, which makes the structure attractive despite the lack of any downside protection, according to sources.

The notes have two annual call dates on the first and second anniversary of the deal. There is no observation date at the end of the term. At maturity, the structure changes into an uncapped step-up note, and the payout is no longer that of an autocallable, sources noted.

The notes will be called at par of $10 plus a premium if the index's closing level is greater than or equal to the initial level on either observation date. The premium will be 12% if the notes are called in October 2014 or 24% if the notes are called in October 2015, according to an FWP filing with the Securities and Exchange Commission.

If the notes are not called and the final index level is greater than or equal to the initial index level, the payout at maturity will be par plus the greater of the step-up payment and the index return. The step-up payment is expected to be 47% to 53% and will be set at pricing. If the final index level is less than the initial index level, investors will have 1-to-1 exposure to the decline.

'Handsome return'

"My quick take on this is I like it a lot," said Steven Foldes, president of Foldes Financial Management LLC.

"It's a rather sophisticated combination of two kinds of techniques.

"A 12% return is nice for one year. There are only two chances to get called. Assuming that you don't get called, a 1% increase in the index can give you 50% in return over the period. If the index is up 70%, you're not capped at 50%. You get 70%."

He chose a hypothetical step-up payment of 50% at the mid-point of the 47% to 53% range.

"Assuming that you get the autocall, you still have a handsome return of 12% a year and you get your money back," he said.

Foldes explained why he likes the notes: "First, for us, a structured note has to provide some kind of return opportunity. We won't buy a note with a low cap because if the asset class has some success, we don't want to penalize our clients.

"This product does not cap the return and offers several possibilities to earn a very decent return."

Several opportunities

Investors can make money in three separate ways, he said.

"The autocallable feature will give you 12% even if the index is flat. That's a very good rate of return. It can happen at the end of the first year or at the end of the second year," he said.

"Secondly, if the notes are not called, you still have opportunities to outperform the index.

"The fact that you get bumped up to 50% even if the index generates only very modest results is a great feature. A 50% return is about 16% a year. That's good by historical standards. You get this no matter what the index does as long as it doesn't end up negative at maturity.

"The icing on the cake is that if your index goes over the 50% level, you get the higher return, you are not capped out."

For Foldes, the notes offer enough appeal on the upside to offset the absence of any protective barrier or buffer.

"I know that you don't have any downside protection. I understand that," he said.

"It's a long-only exposure but one that provides significant benefits if the market trades in a modest range.

"At the same time, it doesn't cap you if the market is up a lot. It gives you a minimum of 12% a year if you get called and a minimum of 16% per year if at maturity the index is up or flat."

The duration is not an obstacle in his view.

"We see more three-years now because of the low volatility. We've seen that over the last six to 12 months, and we had to stretch our maturities. The three-year is the new two-year," he said.

The choice of the index, however, is more debatable as it may involve reviewing the deal more carefully, he said.

The index

"The only downside for me would be the underlying. The performance of the Euro Stoxx has been pretty lackluster. They may be prime for a breakout. My concern if there is a breakout would be that the autocallable could cap you at 12%," he said.

"I would be curious to see the terms you could get if you applied that same structure to the S&P 500, since we've already had the breakout in the U.S. market. You may not be able to get the same terms.

"As it is, I like the structure a lot, and perhaps the terms are really good because you're dealing with an underlying market that has been under a lot of pressure. From the investor's standpoint, though, it probably would make more sense to use it with an asset class like U.S. stocks that has already broken out. But you would have to see what terms you get as it may not be easy to replicate it with the S&P."

Bulls only

Steve Doucette, financial adviser at Proctor Financial, said he likes the deal for the ability it gives investors to generate alpha.

"If you're bullish, this is a great note because you can outperform the index. Either you get the coupon or your get the digital payment," he said referring to the step-up.

"Sixteen percent a year is not bad.

"If you're not bearish, it's a way to generate a substantial coupon if the market floats, and you lose nothing on the upside if it continues to go up."

The only caveat, he said, is that the note leaves no room for bearishness.

"You simply have to have an opinion that rules out a market downturn, at least at the end of the three years. You cannot be bearish at all. You have to be a bull and be comfortable with the fact that there is no downside protection," he said.

Doucette said that he could see why investors could be bullish on European stocks.

"Europe is interesting. It's getting a lot of activity. It's the underperforming index," he said.

The S&P 500 is up nearly 18% this year while the Euro Stoxx 50 has gained less than 12%.

"If the Euro Stoxx rallies, you'll be able to capture the return in a note under decent parameters, which isn't a bad thing," he said.

BofA Merrill Lynch is the underwriter.

The notes will price and settle in October.

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