BofA’s $1 million 11.5% fixed income notes on Schwab, S&P seen as risky amid banking jitters

By Emma Trincal

New York, March 24 – BofA Finance LLC’s $1 million of 11.5% fixed income yield notes due July 18, 2025 linked to the worst performing of the S&P 500 index and the shares of Charles Schwab Corp. pose more risk than the usual worst-of on indexes given the exposure to a financial stock, advisers said.

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

The payout at maturity will be par unless either asset finishes below its 60% threshold level, in which case investors will be fully exposed to any losses of the worst performing asset.

Risk-reward

Steve Doucette, financial adviser at Proctor Financial, was not comfortable with the use of a single stock in a worst-of, especially one in the financial sector as the banking jitters have spread from regional to international banks in less than two weeks. His objection was also based on a pure risk-adjusted reward perspective.

“With a single stock you’re taking unlimited risk and you’re capping yourself on the coupon,” he said.

“Not that I have any doubt that Charles Schwab should be all right. In fact, the stock could actually go through the roof after the storm. But if it doesn’t go up, if this banking crisis continues, you’re taking too much risk for 11.5%.”

If Doucette wanted to get equity exposure, he would be long the stock outright, he said.

Using the stock and the index in a worst-of would only guarantee the worst result: missing on the gains of the stock if it outperformed the index or taking on more losses than with the index in the opposite scenario.

“I don’t want the bond exposure for 28 months, not for that type of return and certainly not in a worst-of,” he said.

Doucette was not only concerned about missing some of the potential gains. He pointed to the risks currently faced by a growing number of financial institutions.

Stress in the sector

“I’m not particularly worried about Schwab. But even Schwab is not immune to problems like exposure to bad credit, asset-liability mismatch since they carry so much cash on their balance sheet. You never know. What happened in the past two weeks could have some ramifications,” he said.

The return offered by the notes was just not sufficient.

“I’m still taking a fair amount of risk in this environment, but I’m capped. And if the stock is off to the races, I’m only getting 11%. I’m giving up a lot of potential upside while getting exposure to potentially huge losses,” he said.

The worst-of payout did not help. If the stock price of Charles Schwab outperformed the index, noteholders would not benefit from its relatively better value. If on the other hand the S&P 500 outpaced the stock, investors would be exposed to a stock that may drop more than the index given the greater volatility of single names.

“Either way, I’m not getting the exposure to the best asset. It’s a little odd to put a stock and an index together in a worst-of,” he said.

Buyer beware

Jeff Pietsch, founder of Capital Advisors 360, found some value in the note. But he said that he would be extremely cautious if he was to consider it.

“With that type of yield and given that the coupon payment is guaranteed, this is a note that could go to an alternative income strategy,” he said.

“But clients need to do their own due diligence on Schwab.”

Pietsch looked at the barrier level, which is $34.01 based on the closing price of the stock on the pricing date, which was $56.68.

On Friday, Charles Schwab closed at $53.26, or 6% off the initial price on the trade date.

“This barrier level is roughly a price we haven’t seen since the Covid lows,” he said.

Could the stock drop back to those levels? Not impossible, he said.

“It’s a single name. You always have greater risks with stocks,” he said.

Banking jitters

Pietsch pointed to some of the financial challenges faced by the brokerage firm.

“They have $11 billion in unrealized losses in their bond portfolio while the equity value is about $5 billion. That’s a $6 billion difference, which gives you an idea of the magnitude of the issues they face,” he said.

There was definitely some risk associated with the notes even if the coupon was guaranteed and the barrier seemingly deep.

If he decided to buy the notes, Pietsch said he would minimize the size of his position.

“You’d have to use the traditional concentration rules, limiting your allocation to no more than 5%,” he said.

Many complex risks have recently emerged in the financial sector as the recent run on two U.S. regional banks, the forced merger between Credit Suisse and UBS as well as renewed concerns about Deutsche Bank have illustrated over the past two weeks.

“You have liquidity risk, balance sheet risks, counterparty risk also which is huge in this business. You don’t know the trickle-down effect of all those recent events in the financial sector. There is not a lot of visibility,” he said.

“I would be extra cautious.”

The notes are guaranteed by Bank of America Corp.

BofA Securities, Inc. is the selling agent.

The notes settled on March 20.

The Cusip number is 09709VMM5.

The fee is 0.47%.

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