Bank of America's 20-year step-down step-up callable notes are aimed at income investors

By Emma Trincal

New York, Feb. 27 - Bank of America Corp.'s step-down step-up callable notes due March 12, 2032 would benefit income-seeking investors looking for the highest coupon payments at the beginning and the end of their investment but who are willing to accept some of the risks associated with the long-term maturity of the product, sources said.

The coupon will be 8% in the first year, 7% in the second year, 6% in years three and four, 5% in years five through 16, 6% in years 17 and 18, 7% in year 19 and 8% in year 20, according to a 424B2 filing with the Securities and Exchange Commission. Interest is payable semiannually.

The payout at maturity will be par.

The notes will be callable at par on any interest payment date after one year.

"Getting an 8% upfront is appealing. It reminds me of when I locked in a client in the late 1970s in an 18% CD. Fifteen years later, not a prayer of getting that kind of return off a cash-like instrument," said Carl Kunhardt, wealth adviser at Quest Capital Management.

"But the problem here is that it's pretty long-term. I don't know if I would want to be locked in for 20 years," he said.

Scott Cramer, president of Cramer & Rauchegger, Inc., said the notes will likely be called early. However, investors are still subject to the credit risk of the issuer.

"If somebody wants yield and they're willing to take on some risk and not knowing how long the duration is going to be, it's worth taking a little bit of a flyer on," Cramer said.

"My instinct tells me that this is going to end up being a short-term bond. They pay 8% on year one. Right now, Bank of America needs cash. Obviously, if their borrowing cost gets lower, they will call it.

"Clearly here, the risk is credit risk. If they have their problems and get taken over, this note would be worthless.

"If you're willing to take the credit risk, then this is a good deal."

Callable versus bullet

Kunhardt said that regardless of whether the notes are called or not, the average yield cannot be less than 5%, which, he said, is an attractive level.

But looking at secondary issues from the same issuer and of roughly the same maturity, he said that he found yields "right on par" with the step-down step-up notes.

"I could get just about the same thing on a bullet and not be locked in for 20 years. With this [step-down step-up issue] you're giving up liquidity and you're not getting anything much in return," he said.

But a market participant disagreed.

"Who says you can't sell this?" he said.

"This is a callable. And you're getting all the yield upfront. That's where you draw the line.

"You're buying an 8% upfront. Compared to a 5% bullet, you're already ahead of the game.

"And what if rates go higher? Your note will go down in price. But the bullet will go down even more."

Cramer said that lightly structured deals such as this one can easily find a market after the initial offering.

"There will be a secondary market for this. This is a bond. This is going to behave exactly like a bond."

A structurer said that 20 years is not a standard tenor in the primary market.

"You can't really compare it with a secondary piece where you don't really know how deep the market is," the structurer said.

"Right now, the benchmark would be a 10 year at 5.20% and a 30 year at 6.10%.

"In comparison, the callable step, assuming it's sold at par and held to maturity, shows a 5.74% yield. It's right in the middle. The investor has to make the decision."

Straightforward

For the market participant, the notes are fairly standard and offer attractive yields up front for income-seeking investors.

"It's not a bad structure. There's nothing wrong with it. It's a callable bond, and people like callable bonds just for that reason: they can be called before maturity."

He said that investors should refrain from guessing when and if a bond gets called.

"It's a 20-year maturity. It's not a 20-year duration. The potential duration could be less," he said.

"However, just because it could get called doesn't mean it will get called.

"People get caught up making assumptions, betting that it's going to be called on the second or the third year. You can't tell. It is what it is.

"You're getting a certain income stream. It may or may not be called. That's all you can tell people. After that, what matters is the type of income stream you're looking for and how it fits into your overall portfolio."

The notes (Cusip: 06048WKV1) are expected to settle March 12.

Bank of America Merrill Lynch is the agent.

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