Bank of America's $123.88 million leveraged notes tied to S&P 500 aimed at mild bulls

By Emma Trincal

New York, Dec. 5 - Bank of America Corp.'s $123.88 million of 0% Accelerated Return Notes due Nov. 26, 2014 tied to the S&P 500 index signaled by its size that leveraged trades with full exposure to the downside have remained popular despite fiscal cliff debates and geopolitical concerns currently weighing on investors' minds, sources said.

"A $124 million deal is huge. It's pretty impressive," said Andrew Valentine Pool, main trader at Regatta Research & Money Management.

If the index return is positive, the payout at maturity will be par plus 300% of the index return, subject to a maximum payout of par plus 19.25%, according to a 424B2 filing with the Securities and Exchange Commission.

Investors will lose 1% for every 1% decline in the index.

Big deal

The offering was the sixth largest deal of the year, according to data compiled by Prospect News, which excludes exchange-traded notes and some interest-rate based products, such as step-up notes and capped floaters.

"Here are the pros: it's a simple structure to understand; it's issued by Bank of America," said Bob Lee, market participant and consultant in structured products, formerly with Charles Schwab, who added that this issuer's creditworthiness was "decent."

"The notes are probably marketed with a slightly higher cap because it's Bank of America's name," he said.

"And you have the S&P 500 index. That's a transparent underlying."

The notes are designed for investors who want to achieve higher returns when the market gains remain moderate, sources said.

"Three-times leverage on the upside is appropriate for those who believe that we'll be riding a flat market in the next two years. You can potentially get some enhanced return from the equity index," said Lee.

Flat horizon

"Apparently, investors in these notes feel pretty good about the U.S. market two years from now without being overly bullish," said Pool.

"It's a three-times leverage, not two-times. That's aimed at moderately bullish investors, people who probably have a sideways view on the market," he added.

The 19.25% cap for the period is the equivalent of about 9.5% per year. With the leverage, investors need only approximately 3% in annualized index return to hit the cap, he noted.

"They anticipate that the market will be up and not down, obviously, otherwise they would demand some form of downside protection. But they expect growth to be modest. They see a flat to slightly up market with no major downtrend," he said.

Two-year horizon

Pool said that investors in the notes make a two-year bet. The investment is not exactly short-term, which may explain that some investors felt comfortable entering the trade at this point in time amid Washington's gridlock over the Federal budget and mounting geopolitical tensions.

"We're in the middle of this fiscal cliff talk, and it looks like investors are unfazed," he said.

"We are still short over 20% of our portfolio just in case there's a major pullback. We are optimistic but we want to be prepared. Going out for two years the expectation may be different. Buyers of this product are confident that the market will be up at that point," Pool said.

Full exposure

For Lee, two year is long enough to warrant some risk mitigation feature, which he does not see in the structure.

"This deal is appealing for investors who don't know anything more than what their brokers know," Lee said.

"I don't like no downside protection. Even at 5% buffer would have been nice.

"There are several advantages in this structure, including the decent cap.

"But from my point of view, a two-year note with no downside protection is a negative. I don't think these types of products should go out any longer than 13 months to 18 months. The issuer could structure it with a lower cap and introduce some form of downside protection - a 5% buffer or a 5% European-style barrier for instance. That would be much more attractive especially given the fact that three-times leverage, while enticing, is rarely realized."

The notes (Cusip: 06053D740) priced on Nov. 29.

The fee was 2%.

Merrill Lynch & Co. was the underwriter.

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