Bank of America's $10 million of 20-year step-up notes offer uncommon autocallable feature

By Emma Trincal

New York, Aug. 9 - Bank of America Corp. priced a $10 million offering of 0% step-up notes due Aug. 7, 2032 that sources said is different in that it offers an autocallable feature that makes the call strictly contingent upon the market.

"The autocall in equities is common. It's not that common in rates. It takes the issuer out of the call decision. People like it," a market participant said.

The coupon will be 4% for the first 11 years. It will step up to 5% for years 12 through 16, to 6% for year 17, to 7% for year 18, to 8% for year 19 and to 9% for year 20, according to a 424B2 filing with the Securities and Exchange Commission. Interest is payable monthly.

The notes will be called at par if the 10-year U.S. dollar Constant Maturity Swap rate is less than or equal to 2% on any interest payment date after two years.

The payout at maturity will be par.

"I haven't seen any autocallable step-ups. Did you? It's a little bit difficult to create," a sellsider said.

The 10-year dollar CMS rate measures on a daily basis the fixed rate of interest payable on a hypothetical fixed-for-floating dollar interest rate swap transaction with a maturity of 10 years.

Historically, the movements of the 10-year dollar CMS rate have been correlated to some extent to those of the 10-year Constant Maturity Treasury rate, according to the prospectus. It was not below 2% in 2007 through 2011, but it crossed that threshold this year in January, May, June and July, according to the prospectus.

Known market trigger

"For investors, there is an advantage in these autocallable step-ups besides just knowing what to expect," the market participant said.

"Suppose you have another round of [quantitative easing] because the economy is weakening. Rates are lower. That should be a factor that would incite the bank to call the notes in a normal environment. But suppose the situation is not quite normal, something else is happening, you have a flight to quality. If the U.S. is not doing well, banks aren't doing well either. The issuer's credit spreads may widen. If the call is at the option of the issuer and if the spreads are widening, the note will not be called. But here, the call is mandatory. Rates have gone down below 2%, you know you're getting called regardless of the bank's funding levels," he said.

A fixed-income structurer agreed.

"It's good logic," he said.

"The autocall gives a bit more certainty. Economically, if rates go down, it's in their favor [to call], but the credit spreads have widened and the banks want to retain their funding. They may decide to reswap it and keep the notes outstanding.

"The autocall on the other hand takes away these non-economic factors that go into calling it.

"People like it. Sure."

Pure fixed income

Many financial advisers are not familiar with step-ups or simply not interested due to the long tenors.

"In our practice, it's very challenging to commit clients' assets to a 20-year product," said Don McCoy, financial adviser at Planners Financial Services in Edina, Minn.

"We may use it for a very specific bucket. But if it happens to get called, you have to go back and find another vehicle for that portion of the portfolio.

"We prefer to look for equity exposure or higher-yield fixed-income exposure, such as high-yield bonds, emerging market bonds or new funds collecting limited partnerships. We want the possibility of getting some capital return, not just the yield."

Step-ups are for investors who really focus on yields, said Tony Romero, co-founder and managing partner of Suncoast Capital Group, a certificate of deposit brokerage.

"People who buy them want the opportunity to participate in rising interest rates," he said.

"They fear rising rates, and it's a little bit like buying a floater where your coupon rises. They're just buying protection against the risk of higher interest rates.

"Now of course interest rates when they rise may exceed the amount of coupon they get from the step-up, but at least you're getting something as opposed to a fixed rate."

Romero said that investors are not opposed to the concept of an early redemption.

"That's why you're getting a higher rate to begin with, compared to the bullet. You get compensated for that. Anything callable by definition will have a higher coupon," he said.

"It's a win-win. If you're called, you've received a higher coupon for a shorter period of time. If you're not, you still have the step-up rates. It may not be enough to offset the market rates, but that's something."

Romero compared the notes to a Goldman Sachs 20-year step-up CD callable after six months with a 2.5% rate for the first five years, 3% for the next 10 years, 3.5% for year 16 through 18, 4% for year 19 and 5% for year 20.

"The notes give you a fair compensation for not having the FDIC [insurance]," he said.

The notes (Cusip: 06048WMW7) priced on Aug. 2.

The fees were 2.85%.

Bank of America Merrill Lynch was the underwriter.

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