BofA grabs 75% of market in heavy week; sector plays with no downside protection in favor

By Emma Trincal

New York, July 30 – The week ended Friday was especially huge for BofA Merrill Lynch, which alone printed $840 million in 25 deals, or 74.5% of the week’s volume, according to data compiled by Prospect News.

Total volume was $1.13 billion, which is not unusual for a month-end week. The current week still has four days left for July, BofA Merrill Lynch chose to bring to market the majority of its deals last week, according to an industry source, making it likely to be the heaviest week of July.

In comparison, BofA Merrill Lynch priced 62% of the volume during the final week of May and 57% at the end of June.

“I wouldn’t read too much into it. It’s a bigger share than usual, but it’s one occurrence only,” said Jim Delaney, head trader at Market Strategies Management.

Still, other agents were dwarfed by BofA Merrill Lynch. JPMorgan was No. 2 with $67 million in 18 deals accounting for about 6% of the volume. The third agent was Deutsche Bank with $65 million in six deals, according to the data.

Part of BofA Merrill Lynch’s strong ratio is that it priced all the biggest deals in the $50 million size or more, which accounted for five offerings. The agents also sold the top 12 offerings, with the smallest at $26.5 million. Finally, it priced a larger-than-usual trade at $162.57 million, which was also the No. 5 in size for the year so far.

No. 5 deal of year

HSBC USA Inc.’s $162.57 million of 0% Accelerated Return Notes due Sept. 25, 2015 linked to the S&P 500 index offer a 300% upside participation rate up to a 10% cap and no downside protection.

“High leverage but cap; short term but no protection. You’ll stop me out at 10%. I think you’re going to hit the cap, especially on three times leverage. The market is already up 7%. That would be 21% annualized. With a 10% stop, I’m losing 11%. Even if they give you triple leverage, you have to have a 3% or 4% growth before the cap makes sense,” said Delaney, who added that there is too much upside risk in the structure.

Tom May, partner at Catley Lakeman Securities, said he likes the deal.

“It’s not too bad. The market doesn’t have to go up too much for you to get a pretty nice return. A 10% in one year is very decent if the market is flat. It’s slightly more risky than a reverse convertible because they don’t give you any guarantee. Giving up the downside protection is part of the trade-off,” he said.

Besides this top deal linked to the U.S. equity market, a lot of the week’s action was around sector plays, which BofA Merrill Lynch made available to investors in one of its two best-selling structures: market-linked step-ups and three-times leveraged and capped notes. Neither structure offers any downside protection.

Oil and gas

The first notable play was on oil and gas but via an equity index.

Bank of America Corp. priced $61.43 million of 0% autocallable market-linked step-up notes due July 29, 2016 linked to the S&P Oil & Gas Exploration and Production Select Industry index. It was the No. 2 offering of the week.

The notes are callable at par plus 10% annualized if the index closes at or above initial level on July 27, 2015.

If the index finishes at or above the step-up value – 127.5% of the initial level – the payout at maturity will be par plus the index return.

If the index finishes below the step-up level but at or above the initial level, the payout will be par plus the step-up return of 27.5%.

Investors are exposed to any losses.

“This one is much more attractive to me,” Delaney said.

“You get everything on the upside, and anything south of 27% in the two years, you get 27%. It’s 13% a year. I can see why people would be attracted to that.”

May agreed, saying the structure is timely in today’s geopolitical environment. In this regard, the uncapped return is a plus.

“It’s kind of a tracker with a digital. You get either the market or the digital. With all the stuff in Russia, the sanctions and the potential impact on gas supply, all this could push prices up in this sector,” May said.

But even political tensions may not dictate prices, he noted. In such case, the return enhancement feature offered through the digital payout may come handy.

“For some reason, with all the stuff going on in the Middle East and in Russia, energy prices haven’t soared. I can’t see why there would be a reason for that. If there is not a strong rally in oil, the step-up may offer a nice bump up, but it’s still risky. There’s no buffer, and the underlying is an equity index,” he said.

Delaney offered that a play on oil and gas is a way to get indirect exposure to Europe. As a result, he does not see the necessity of downside protection, being bullish on the region.

“A lot of that is multinational. Europe is going to be accommodative longer than the U.S. That’s where your buffer is,” he said.

“On top of that, you have the Middle East. You didn’t have energy-related issues in the past couple of weeks. Here they are.”

One possible wildcard is supply, which dictates commodity prices.

“We have abundant supply of natural gas in the U.S. Also Europe and others are producing more and more natural gas. Everybody is becoming energy independent, so the impact of price shocks is much lower,” he said.

BofA Merrill Lynch offered another way to play the energy sector, this time through leverage.

Bank of America’s $55.98 million of 0% Accelerated Return Notes due Sept. 25, 2015 linked to the S&P Oil & Gas Exploration and Production Select Industry index was the No. 3 offering of the week. This product offers non-protected exposure to this index in a leveraged structure. The upside leverage factor is three, and the cap is 16.35%. No downside protection is offered.

Sector plays

Another popular sector theme was housing.

Bank of America priced $54.88 million of 0% autocallable market-linked step-up notes due July 22, 2016 linked to the PHLX Housing Sector index.

The notes are callable after one year if the index reaches its initial level. The call premium is 10%.

If the notes are not called, investors at maturity will get the index gain for any index level above the 126.05% step-up value.

If the index finishes between the initial level and the step-up level, the payout will be par plus the step-up return of 26.05%.

Again, the structure does not offer any downside protection.

“This one is a little bit more risky. If you look at the numbers, housing has kind of hit some headwinds. This is more of a domestic play while the energy business is global,” Delaney said.

Bets on a particular sector are usually done by retail investors, according to a sellsider.

“I don’t see a big institution behind it,” he said.

“You had energy, and you had housing. Maybe these are two particular sectors that are hot at this time.

“Bank of America probably has a bullish call on it. Maybe they found a lot of demand for those two sectors. There are only so many ways to structure a payoff.

“It looks like they offered the same exposure to one sector using two different types of structure. One is not better than the other. It has to do with people’s perception of the market, timing and if pricing kind of works out.”

No buffers

Regardless of the structure employed – step-up or leveraged capped note – BofA Merrill Lynch’s top deals, as it is normally the case, lacked any downside protection, sources noted.

Talking about retail investors’ appetite for risk, Delaney, who is bullish on equity said, “They start to come to my way of thinking. It’s time for me to change. You always have this knee-jerk reaction when you see retail going in one direction. It’s a contrarian indicator. My immediate response would be since retail is not worried about protection, it’s time to worry about protection,” he said.

“As we all know, it also depends on how much longer the Fed is going to keep rates low.”

The sellsider said that abandoning protection is a reflection of pricing.

“We see a lot of step-ups and leverage with no protection. It’s not really surprising. A buffer doesn’t give you that much. Sometimes they offer a 5% buffer. You might as well have nothing and get as much upside as possible. A 5% buffer, nobody cares,” this sellsider said.

Behind this is the low volatility, which still hurts the pricing of buffers or barriers given the low premium, sources said.

“Last week we had the shooting down of a Malaysian plane over Ukraine, the war in Gaza, a very unstable geopolitical picture and yet, volatility did not go up,” May said.

“In fact, Russia is up 2% this morning. Can you believe it?

“Nothing seems to be phasing the markets. The S&P 500 continues to go up. Over the past month, it hasn’t fallen by more than 1.18%. Despite a plane shot in the sky ... despite Syria and Gaza, the market is up. Go figure.”

Micron deal

Seeking higher levels of volatility, some investors are turning to single-stock deals.

An example was the No. 7 offering. It used another of BofA Merrill Lynch’s products, the STEP Income Security, which some see as the income version of the more common market-linked step-up. Instead of getting unlimited upside, investors get an additional coupon if the index finishes above the step level.

The deal was HSBC’s $42.04 million of 10% STEP Income Securities due Aug. 7, 2015 linked to Micron Technology Inc. stock.

If the stock finishes at or above the step level of $37.42, 110% of the initial price, the payout at maturity will be par plus 7.17%. If the stock finishes at or above the initial share price but below the step level, the payout will be par. Investors will lose 1% for every 1% decline in the stock.

“Usually it’s institutional investors who make those big bets on stocks,” the sellsider said.

Micron Technology is one of the core holdings of hedge fund manager David Einhorn, founder of Greenlight Capital.

“With a single stock, it’s much more important to have some downside, especially with a stock as volatile as Micron. The share price dropped 7% in the last 13 days. That’s a big move. I wouldn’t go near that,” Delaney said.

“For some reason, with all the stuff going on in the Middle East and in Russia, energy prices haven’t soared.” – Tom May, partner at Catley Lakeman Securities

“Usually it’s institutional investors who make those big bets on stocks.” –A sellsider

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