BofA’s market-linked step-up notes on Euro Stoxx 50 to outperform in moderate growth

By Emma Trincal

New York, Oct. 7 – BofA Finance LLC’s 0% market-linked step-up notes due April 2026 tied to the Euro Stoxx 50 index may outperform the euro zone benchmark in a modest growth scenario without penalizing bullish investors much.

If the index finishes flat or up, investors will get at least the step-up value, 140% to 146% of the initial level and will get the index gain if it finishes at or above the step-up level, according to a 424B2 filing with the Securities and Exchange Commission.

Investors will be fully exposed to any index decline.

BofA Securities, Inc. is the agent.

The notes will price and settle in October.

The exact step-up value will be set at pricing.

Bull-friendly

“If you’re bullish on Europe, it seems like a great note. You have the minimum return. No cap on the upside. I just don’t like the no downside protection. But over a four-and-a-half year, it shouldn’t be an issue,” said Steve Doucette, financial adviser at Proctor Financial.

The long tenor does not eliminate the risk, however.

“You can never tell. It could be up for the next three years and then drop big time in a bear market four years from now.

“Just because the probabilities of finishing down over a longer period are lower doesn’t mean I wouldn’t prefer having a barrier,” he said.

Laggard

Doucette tend to be bullish on the Euro Stoxx 50.

“It has been lagging the U.S. for a long time. I believe in reversion to the mean,” he said.

The Euro Stoxx 50 index, which tracks mega-cap stocks of companies in the euro zone, has shown lackluster returns compared to the United States, although the gap has narrowed this year.

Some of the contributing factors, according to Morningstar analyst Ryan Jackson, are the excessive concentration of the portfolio around 50 stocks, which adds volatility, the avoidance of smaller stocks, which generate higher returns, as well as the index ‘exposure to Italian and Spanish stocks, which have underperformed the stocks of other euro zone countries.

Value

The Euro Stoxx 50 underweights the technology sector, which makes for 17% of the portfolio. In comparison, the allocation to technology is 28% in the S&P 500 index.

“That’s a plus as far as I’m concerned,” he said.

“Tech stocks are running through the roof. Remember AOL in 2000? It was supposed to be the biggest thing. It doesn’t exist anymore,” he said.

No dividend, fee

One problem with longer maturities is the non-payment of dividends over longer periods of time, he noted.

The Euro Stoxx 50 index has a dividend yield of 2.34% compared to 1.39% for the S&P 500 index.

“The dividend is a huge component of the index return. But the minimum return more than compensates you for that. You have to decide if you like the tradeoff. I guess it depends on your view,” he said.

On the other hand, Doucette said the cost of the notes was too high.

The underwriting discount is 2.5% in addition to a 0.75% hedging-related charge, according to the prospectus.

“It’s rich,” he said.

“We custom-tailor our deals. We do $4 million to $22 million deals. If we do $20 million, 2.5% is a lot of change.”

Big agent, small issuer

BofA Securities is an active agent. But it diversifies its offerings across a wide-open platform of issuers. As a result, BofA Finance LLC is among the less active issuers compared to top players such as Barclays Bank plc, GS Finance Corp. and UBS AG, London Branch.

The credit diversification and creditworthiness offered by Bank of America were advantageous, he said.

“Bank of America has a good credit,” he said.

Bank of America’s five-year credit default swap rate is 49 basis points, just behind JPMorgan Chase, which shows a spread of 47 bps, according to Markit. Wells Fargo is also among the banks with the tightest spread at 51 bps. In comparison, Citigroup’s spreads are 55 bps, Morgan Stanley, 58 bps and Goldman Sachs, 60 bps.

“We don’t have much of their paper. In fact, I don’t think we have any. They go through their own shop, Merrill Lynch. They don’t focus on [registered investment advisers]. We get sales calls from JPMorgan, HSBC and Citi all the time. But not from them,” he said.

Low return expectations

Matt Medeiros, president and chief executive of the Institute for Wealth Management, said he would need to compare the note with a long position in the index.

“I’m not sure why you would pay a fee and tie up your money for more than four years versus buying the index fund,” he said.

“Why would I do a note if it doesn’t have downside protection or leverage? That’s my first take on it,” he said.

The note however offered something different – the step payment, which gives investors an opportunity to outperform the index.

“This minimum return is a form or return enhancement. It’s interesting. It’s a plus in a low return environment, which we could see for some time,” he said.

“We would have to do our own research to determine what our outlook is for that asset class.”

The only chance to outperform the index is if the return is positive and below the step level, he said.

“Your decision is going to depend entirely on your return expectation. If you expect low returns going forward, then I’m not opposed to the idea.”

But without any protection on the downside, more research would have to be done on the asset class.

“We would have to take a look at potential headwinds in Europe. There are many, from elections to economic slowdown,” he said.

One bullet a month

BofA Securities constantly sells market-linked step-up notes through its franchise. However, this one, which is a bullet is different from the standard version – the autocallable market-linked step-up, which BofA has sold in 124 deals this year for a total of $2.38 billion, according to data compiled by Prospect News.

The bullet version is less common and perhaps less popular since income, call premium and early redemption opportunities are in high demand.

Investors receive no payment during the life of the notes and lack the benefit of protection. The step-payout however remains structured the same way: long exposure above the step level and below initial price; bump up if the index rises up to the step.

According to data compiled by Prospect News, BofA Securities is pricing a bullet version of its market-linked step-up notes at least once a month. Deal sizes tend to be lower than with those with an autocall feature except for the last one, issued by BofA Finance for $39.41 million on Sept. 23. This two-year note, also linked to the Euro Stoxx 50 index, showed a 118.16% step-up.

Two other similar deals on the Euro Stoxx came in before. In August, HSBC USA Inc. priced $5.59 million of two-and-a-half year market-linked step-up notes with a 22.7% step-up; in July, Bank of Nova Scotia issued $7.07 million of two-year notes with a 117.2% step-up.

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