Bank of America’s $4.36 million leveraged notes tied to eight stocks offer mildly bullish bet

By Emma Trincal

New York, June 6 – Bank of America Corp.’s $4.36 million of 0% Accelerated Return Notes due July 28, 2017 linked to a basket of eight stocks were designed for moderately bullish investors who are familiar with the basket components, buysiders said.

The basket is made up of the common stocks of Anthem, Inc., AT&T Inc., Danaher Corp., McDonald's Corp., PepsiCo, Inc., Pfizer Inc., Philip Morris International Inc. and Qualcomm Inc., all equally weighted, according to a 424B2 filing with the Securities and Exchange Commission.

The payout at maturity will be par of $10 plus triple any basket gain up to a maximum return of 14.75%. Investors will be exposed to any decline in the basket.

“It’s a pretty finite view. Your basket needs to be up between 1% and 5%. The cap is pretty high, but you only need a small return to get it,” said Jerrod Dawson, director of investment research at Quest Capital Management.

“If you’re bullish, you’re not going to buy this.

“The only way you should consider it is if you had some kind of knowledge or interest in these specific stocks.”

Basket

The upside is relatively attractive for the moderately bullish investor since the cap is high and the required basket return small, he said. But the downside is more problematic as there is no buffer or barrier.

“It’s only an eight-stock portfolio. It’s hard to guess if you’re going to get this low return that you need in order to maximize that structured product.

“Meanwhile you have unlimited downside.

“If you had 500 stocks, your guess would probably be more accurate. But with eight stocks there is an idiosyncratic risk.”

Dawson said that typically protection is always a good feature to have. But his main concern regarding risk is the nature of the underlying.

“If you had the three times upside based on the S&P 500, it would change things,” he said.

Diversification

Michael Kalscheur, financial adviser of Castle Wealth Advisors, said that perhaps one of the most volatile stocks in the basket is Qualcomm.

“That stock has been a dog for the past couple of years. It went up this year, but it’s still undervalued. This is a great long-term company, but when it loses you want to run,” he said.

Bank of America’s equity research was probably behind the picks, he said.

“And that’s fine. But eight stocks is hardly enough diversification for me to get comfortable at all. I don’t care what the eight stocks are. You’re betting on these individual companies.”

The three-times leverage is “nice,” giving investors a chance to earn 14.75% in 14 months with a basket increase of only 5%.

“It’s like what, one week[’s] return for those stocks?” he said.

No protection

Unfortunately the combined benefit of leverage and high cap cannot offset the one-to-one exposure to a decline in the basket, he said.

“That’s the deal-breaker for us,” he noted.

“The reason we’re buying structured notes is to get a decent buffer or a big barrier. We’re not much interested when there is no downside protection,” he said.

Kalscheur typically buys slightly leveraged notes linked to broad-based indexes to allow for the pricing of more protection. He also favors longer durations.

“We’d rather have 1.2 leverage. It’s good. You can make up for the loss of dividends. And with a longer maturity you can have some protection. We’d rather have that than three-times with a cap and all your capital at risk,” he said.

“No one knows what the stock market is going to be in a year. You’re rolling the dice a little. You’re also replacing your own research with somebody else doing the work for you.

“That’s a trade and probably not for us.”

BofA and baskets

The deal was sold by Bank of America. It was a rare offering based on a basket of stocks coming from this agent, according to data compiled by Prospect News.

The agent has only sold $33 million of notes linked to stock baskets this year as of May 31, including this one, according to the data. That’s only 8% of the volume of equity basket-linked note issuance so far this year while Bank of America, as a top agent of equity indexes, accounts for 30% of the equity index market and for 21% of the single-stock volume, the data showed.

The notes (Cusip: 06054B156) priced on May 26.

BofA Merrill Lynch was the underwriter.

The fee was 2%.

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