BofA’s leveraged buffered notes linked to S&P 500 designed for short-term mildly bullish play

By Emma Trincal

New York, June 20 – BofA Finance LLC’s 0% leveraged buffered notes due in 13 to 15 months linked to the S&P 500 index offer investors a double-digit potential gain with hard protection over a relatively short period of time.

The structure is likely to appeal to short-term investors expecting more market upside but also concerned about a possible pullback.

The trade-off however is the downside leverage applied beyond the buffer, which for some is a deal-breaker.

If the index return is positive, the payout at maturity will be par plus 150% of the index return, capped at between 11.97% and 14.04%, according to a 424B2 filing with the Securities and Exchange Commission.

Investors will receive par if the index declines by 10% or less and will lose 1.1111% for every 1% that it declines beyond 10%.

Simplicity

“This is the kind of simple note I like because chances are you will outperform in either direction unless you pass the cap. But what are the odds that the market will surpass 11% a year? We just broke another record,” said Steve Doucette, financial adviser at Proctor Financial.

On Thursday morning, the S&P 500 hit an intraday all-time high of 2,956.20.

Doucette based his comments on a hypothetical tenor of 14 month with a cap of 13%, which both consist of the mid-points for the tenor and cap ranges, respectively.

Upside

On a 14-month duration and with 1.5 times upside leverage, investors could get as much as 11% per annum on a compounded basis.

Doucette downplayed the risk of being “capped out,” as valuations are high in U.S. equity markets.

“I can’t envision the market going up at this current pace for the next 14 months. You still have the economists predicting that we’re heading toward a recession. Whether it will turn out to be true or not, no one knows right now. In theory the market could continue to go up quite a bit, but you’re still locking in 11% per year. That’s a pretty decent return on the upside,” he said.

Gearing

The 10% buffer was very attractive as well, he said, in spite of the gearing.

“You’re ahead 10% even if it’s being fractionally reduced as you go down. It takes a long way down to really feel the impact of the gearing,” he said.

Taking an extreme bear-market scenario, a 40% decline in the index, investors in the notes would lose 33.33% of their principal.

“The market is down 40%. You’re still ahead by 6.7%, and that’s a severe bear market.

“Is 6% or 7% a big deal? Not really. But how likely is it that the market will drop 40%?”

Even though it is possible, what is more likely is a pullback or a bear market but perhaps not one as severe, he said.

When stock prices fall by a less drastic amount, the impact of the gearing on investors’ bottom line becomes less of an issue.

A 20% bear market for instance would imply a 10% loss with a traditional 10% buffer versus an 11.11% loss with the geared buffer used in the notes.

“Unless the market crashes heavily you’re still outperforming quite a bit. By how much? It will depend on how much the market goes down,” he said.

Good overall

In conclusion, this adviser had a positive view of the product.

“The only risk is you might be capped out if the market continues to be up,” he said.

“If I were a bull, I’d say no because of the cap.

“But it’s hard to be a bull when the market just peaked and economists keep on predicting a recession.

“I like it. It’s a simple note. It’s likely to outperform on either direction, which is why I buy structured notes in the first place.”

Beware the gearing

Jeff Pietsch, head of capital markets at the Institute for Wealth Management, had a different view. The buffer was the weak spot in the structure while the cap was acceptable in his view.

“This note fits within our capital market assumptions of moderate equity gains in the near-term set against the intermediate possibility of a mild recession,” he said.

“However, I have a concern that the geared buffer mechanism may be difficult to explain to a retail client.”

The gearing may also set the wrong expectations for investors.

“The results may be different from what clients may have anticipated. Fourteen months go by, and the outcome is not what they expected. After the facts, you have to explain it again.

“It’s a personal concern, as an adviser.”

Thin protection

The size of the buffer itself, independently of its gearing, was also a negative.

“If we hit a recession in the next 14 months, a mere 10% buffer is not going to be enough,” he said.

A traditional buffer would have been preferable.

“It’s easier to explain. It’s more likely to cover the possibility of a sharp market decline if we hit a recession.”

On the other hand, Pietsch did not object to the cap.

“The cap is fine, especially as the market is at all-time highs. As valuations are rich, we’re looking at single-digit returns in the near future. The cap as it is with the leveraged participation would satisfy our capital market outlook and also would compensate for the loss of dividends.”

The notes are guaranteed by Bank of America Corp.

BofA Securities, Inc. is the underwriter.

The Cusip number is 09709TSH5.

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