Bank of America’s step-up notes on Dow Jones U.S. Real Estate offer booster, uncapped gains

By Emma Trincal

New York, July 21 – Bank of America Corp.’s 0% market-linked step up notes due July 2018 linked to the Dow Jones U.S. Real Estate index are designed for investors who are bullish on U.S. equities in the real estate sector and REITs. The structure enables investors to outperform the index in a moderate growth scenario, buysiders said.

If the index finishes above the step-up value, 117% to 123% of the initial level, the payout at maturity will be par plus the gain, according to a 424B2 filing with the Securities and Exchange Commission.

If the index finishes at or below the step-up level but at or above the initial level, the payout will be par plus the step-up payment of 17% to 23%.

Investors will be exposed to any losses.

Boost in flat market

“It’s an interesting note,” said Matt Medeiros, president and chief executive for the Institute for Wealth Management.

“We follow this asset class very closely. The underlying index is easy to track. It helps to determine how the security should be behaving.”

Medeiros however tends to prefer products, which unlike this one, offer some level of downside protection.

“But if you are optimistic on the asset class, this gives you an attractive return potential,” he said.

Assuming a step value of 120% at mid-range between 117% and 123%, the notes can deliver 10% in annualized return even if the index is flat, he noted.

Upside

The chances of outperforming the fund on the upside are fairly reasonable, he said.

“Low to mid-single-digit returns are typical in this asset class. The structure provides a great boost in such scenario. That type of return enhancement is likely to offset what you’re giving up in dividends,” he noted.

Medeiros said he may not invest in a note with no downside protection. But for investors willing to take on the risk, the product delivered attractive rewards, such as the step-up and uncapped return.

Growth

Medeiros said he had a positive outlook on the real estate sector.

“Many of these real estate companies have already refinanced at favorable rates. Both commercial and residential properties have shown margin improvements,” he said.

“Rentals are in high demand. And each time you go to different cities, you see a lot of construction going on. Demand is growing.”

Market risk

Steve Doucette, financial adviser at Proctor Financial, said the lack of downside protection was a concern.

“If the stock market goes down, REITs will go down a little bit as well. It’s a function of the economy.

There is always the possibility of some sort of financial crisis, which would directly impact real estate companies. If the global economy slows down, the stock market as a whole is going to pull back,” he said.

No cap

The appealing aspect of the structure was the step-up along with the unlimited gains if the index finished higher.

“Do I expect 10% a year? It’s a nice bump up. If the market goes up a lot, you’re long the index. If you already own real estate, there is good upside potential,” he said.

“You’re going to get 100% of the gains.”

Investors in the notes need to have a strong positive outlook on this sector or at least the conviction that a pullback is unlikely. Doucette said he prefers to be cautious.

“It’s probably a decent note when you can capture 10% a year. But I’m also concerned that there is zero percent protection,” he said.

“If things get ugly, you’re long the index.

The adviser said his firm has a small allocation to the asset class via real estate mutual funds.

“If I was to invest in a note linked to this index, I’d try to find something that can outperform in both directions,” he said.

The exact deal terms, including step level and step return, will be set at pricing.

BofA Merrill Lynch is the agent.

The notes will price in July and settle in August.

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