RIAs would prefer a bet on indexes than BofA’s $3 million 9.5% autocall tied to three stocks

By Emma Trincal

New York, May 25 – BofA Finance LLC’s $3 million of 9.5% autocallable yield notes due Aug. 22, 2018 linked to the common stocks of Eli Lilly and Co., MetLife, Inc. and Tesoro Corp. offer an eye-catching fixed coupon, but advisers said they would prefer giving up this premium for an exposure to indexes given the risk that already permeates worst-of products.

Interest is payable monthly, according to a 424B2 filing with the Securities and Exchange Commission.

After six months, the notes will be called at par if each stock closes at or above its initial level on any review date.

The payout at maturity will be par unless any stock finishes below its 65% trigger level, in which case investors will be fully exposed to any losses of the worst-performing stock.

Risk premium

“You’re getting a bit of a premium by having the individual securities,” said Matt Medeiros, president and chief executive officer of the Institute for Wealth Management.

“But it’s probably not a risk I would take.”

The risk pertained to the nature of each stock, the respective sectors they belonged to and the structure of the notes itself.

“All of these individual stocks are relatively volatile and the worst-of scenario with non-correlated securities makes the risk even greater,” he said.

Principal-at-risk

The structure however offered appealing features.

“I find the fixed rate very attractive. I also like the no-call for the first six months as it guarantees a minimum return regardless of whether you get called later on,” he said.

The 65% barrier would be very attractive with one or two underlying indexes or alternatively a single stock but not as it is, he added.

“I would be concerned that one of these stocks would fall below 35% of its initial price at maturity.”

The likelihood of an autocallable event was lower with these notes, something that in itself increases the risk of losing principal at maturity, he noted.

Among the factors, which may reduce the odds of an automatic call, he mentioned the quarterly frequency of the observations, the relatively long call-protection period (40% of the term) and finally the worst-of condition, which will prevent a call from occurring if one of the three stocks falls below its initial price on the call date.

Barrier

“When you have three individual stocks especially these three, you’ll have much more volatility than with the indices,” he said.

The share price of petroleum refiner Tesoro Corp. for instance dropped 38% in just three months between November 2015 and February 2016. In just about a month between mid-April and mid-May this year, Eli Lilly dropped more than 10%.

“You can easily breach this barrier,” he said.

“Investors in search of yield don’t spend enough time understanding the underlying and the higher risk that comes with achieving the higher return.

“If the underliers were indices I would be less concerned. But since they are individual securities I probably wouldn’t be a buyer.”

Company risk

Steve Doucette, financial adviser at Proctor Financial, was also reluctant to take the risk of buying individual stocks whose values are much less predictable than indexes.

“Things happen in a corporation and it’s out of your control,” he said.

“If you get the exposure to a generic index you’re never going to get a 9.5% coupon. Here you have this very interesting note with a nice 9.5% coupon. But are you willing to take the business risk of any of those companies? That’s the scary part,” he said.

It was not clear whether the product could fit into a fixed-income bucket.

“Nine-and-a-half percent is more like an equity return,” he said.

“At the same time, most of these autocalls fall into fixed-income replacement stuff.”

But the potential for a 35% pullback was a real concern.

“It’s too easy for any of those stocks to fall through,” he said.

Sectors

The three underlying sectors – health care, financial and energy – showed little correlation between one another.

“They could move in different directions. That’s another source of risk,” he said.

In addition to uncertainties relating to each company, each sector presented its own set of risk.

Eli Lilly, for instance, could turn out to be the lesser-performing stock given the uncertainties of drug development.

“Pharma and bio is the biggest risk. Sometimes their future is based on one drug. If the drug doesn’t work out, it can cut your price in half overnight,” he said.

“Metlife, I’m not sure. It used to be a mutual company then it went public, which makes it more vulnerable.

“With Tesoro who knows where the price of oil is going to be? You run some big risk here. Will something disrupt this industry over the next 15 months? I don’t think you can say that it’s unlikely.”

If he had to restructure the notes, Doucette would use indexes, adjusting the coupon rate and barrier level accordingly.

The notes are guaranteed by Bank of America Corp.

BofA Merrill Lynch is the agent.

The notes (Cusip: 09709TAM3) settled on Monday.

© 2015 Prospect News.
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