BofA Finance’s $10.64 million autocallables on indexes offer fixed-income, equity-like return

By Emma Trincal

New York, Nov. 5 – BofA Finance LLC’s $10.64 million of 11.85% fixed-income autocallable securities due Aug. 4, 2021 linked to the least performing of the S&P 500 index, the Russell 2000 index and Nasdaq-100 index are attractive, advisers said, as the structure pays a high and guaranteed coupon giving investors the double benefit of a fixed income and equity return.

Coupons are paid monthly, according to a 424B2 filing with the Securities and Exchange Commission.

The notes will be automatically called at par plus the most recent coupon if each underlying index closes at or above its initial level on any quarterly determination date starting in February.

If the notes are not called and each index finishes above its 70% downside threshold level, the payout at maturity will be par.

Otherwise, investors will lose 1% for each 1% decline of the least-performing index.

Equity bucket

Steve Doucette, financial adviser at Proctor Financial, said that investing in the notes required deciding on how to allocate the product. While the name of the security carries the term “fixed-income,” due to the guaranteed coupon payments, the risk-adjusted return would suggest the product is more suitable for an equity portfolio.

“It’s an equity-like return since you have to take the risk for this income,” he said.

“The question is which side of your allocation do you put that in? Equity of fixed income? With potential unlimited downside if you burst through the barrier, the equity side makes more sense as far as I’m concerned.”

While the 11.85% annual return is “decent” for an equity allocation, investors need not to be overly bullish. The notes are more suitable for mildly bullish investors.

“We’ve seen the market run up for the last three days. Can it still continue to go up and up for another nine months? If the answer is yes, you probably don’t want to cap your upside,” he said.

Nasdaq bid

Doucette said he is seeing an increasing number of equity-linked worst-of deals that are incorporating the Nasdaq-100 index. In the recent past, the most common mix was: S&P 500 index, Russell 2000 index and Dow Jones industrial average.

“We’re looking at doing a worst-of with the Nasdaq. Anytime you add the Nasdaq, it’s amazing what you can get. The parameters on the outside get stretched out ... higher coupon, lower barrier,” he said.

Up and volatile

The use of the Nasdaq-100 index as an underlier in equity-index-linked notes has nearly doubled this year.

Notes including the Nasdaq-100 as an underlying amounted to $6.14 billion this year through Oct. 31, or 16.3% of the total notional amount of equity index products sales, according to data compiled by Prospect News.

In comparison, products giving exposure to the Nasdaq-100 last year during the same time made for $2.76 billion, or 8.9% of all notes tied to equity indexes. This tally includes the use of the Nasdaq as one of the underlying indexes of a worst-of deal and, to a lesser extent, the Nasdaq as a sole underlier.

The Nasdaq-100 index has been popular in notes due to a double advantage: its robust performance and its volatility. The S&P 500 index returned 8.65% year to date through Thursday while the Nasdaq-100 rose 32.5%.

The bullish momentum comes with a high volatility, which is not always the case when asset prices rise. The tech-heavy benchmark has an implied volatility of 33%, which is superior to that of the S&P 500 index at 28%. The higher volatility helps the pricing of the notes, giving issuers more premium to raise the coupons or/and lower the barriers.

Market outlook

“If you don’t believe the market will do more, it’s a nice equity substitute,” said Doucette about the note.

“You collect your monthly coupon. It’s guaranteed. That gives you some sort of a buffer on the downside.

“It’s a nice fixed-income replacement although your payments will stop as soon as you get called. You could easily get called in three months. That’s the reinvestment risk. Then you have to find another source of income.”

The duration of the note itself was rather short. Doucette said he did not mind it.

“It’s only nine months and it’s a nice thing,” he said, adding that he is often reluctant to lock in his money for long periods of time.

“But come the summer you mature. That’s the other thing. Maybe we’re beyond the coronavirus, the market is up, and you get your money back. If not, it can get ugly. You capped your return and you’re exposed to unlimited downside. If you breach, you lose at least 30%, and that’s a minimum,” he said.

Even if the coupon is used as a cushion, the minimum loss if the 70% barrier is breached will be close to 20% at 18.15%.

Investing in the notes was a matter of having a clear market expectation.

“If you believe the market won’t go up that much, that’s a decent deal. If not, then you should move on. When you cap yourself at 12% with unlimited risk, you should expect a market that’s not going to move much one way or the other.”

Short term

Matt Medeiros, president and chief executive of the Institute for Wealth Management, said he liked the notes.

“It’s interesting that it would be such a short-term note. I don’t know what the thought was behind that. But I like the nine-month term,” he said.

“These underlying securities are relatively highly correlated so I don’t presume that the worst of the three indices would pierce the barrier in nine months.”

Cautiously optimistic

The market however could be volatile in that time horizon, and Medeiros did not rule out the possibility of a pullback.

“But I think you have enough protection given the current market environment. A pullback is possible, but we think such scenario is less likely within a short period of time. The economy is looking much better,” he said.

“We have uncertainty obviously in the government, but I don’t think the result [of the presidential elections] will impact the market negatively or substantially negatively in this short period of time.”

1% a month

As the votes were being counted and the presidential elections results were too close to call, the market rallied on Thursday for a fourth consecutive session.

A continued rally raises the likelihood of an automatic call, which could occur as early as in February.

Medeiros did not see such outcome as a drawback with a monthly coupon payment of 0.9875%.

“In three months, you get just about 3%. That’s pretty good compared to what’s available out there.

“It’s a good trade.”

The notes are guaranteed by Bank of America Corp.

BofA Securities, Inc. is the agent.

The notes settled on Wednesday.

The Cusip number is 09709TY96

The fee is 0.25%.

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