BofA’s $5.34 million 10.4% contingent yield notes on Apple to reward investors with early call

By Emma Trincal

New York, Sept. 15 – BofA Finance LLC’s $5.34 million of contingent income autocallable securities due Sept. 11, 2026 linked to the common stock of Apple Inc. may offer a better risk-adjusted return if called early than if the notes were to be held at maturity given how richly valued the share price of the tech behemoth is, said Clemens Kownatzki, finance professor at Pepperdine University.

Investors will receive a coupon of 10.4%, paid quarterly, if the underlying stock closes at or above its 80% downside threshold on the related quarterly observation date, according to a 424B2 filing with the Securities and Exchange Commission.

The securities will be called automatically starting Dec. 8 at par if the price of the underlying stock is greater than or equal to its initial price on any quarterly call determination date.

At maturity the payout will be par unless the stock closes below its 80% downside threshold level, in which case investors will be fully exposed to the decline of the stock.

High valuation

“The price of Apple has gained more than 50% this year through the high of late July. For a $3 trillion company to go up 50% in about half a year is remarkable,” said Kownatzki.

“It suggests that Apple is richly priced. Can we really say that the stock is worth 50% more in July than it was in the beginning of the year based on the fundamentals?”

The price-per-earnings ratio of Apple was high, too, he noted at 29.3.

“It has been higher before, at 35. But during the previous decade it was in the mid to high teens,” he said.

Apple’s P/E is in line with the Nasdaq, which has a P/E of 30, he added.

“The Nasdaq is also very richly valued but there’s a logic behind it: its top holdings are AI stocks, which are inflated at the moment,” he said.

Short-term income

From a risk perspective, the barrier may not be very strong, he added.

The share price closed at $178 when the notes priced, setting the 80% barrier at $142. Apple hit that price earlier this year, he said.

“Over the next three years, the probabilities of dropping below that level are pretty high,” he noted.

But the most likely scenario would be an early call on the first observation date in December.

“Apple could certainly be higher in three months than it is now. This gives you an opportunity for an early redemption in December, which would be a positive given the rate of return you would get,” he said.

The quarterly coupon rate is 2.6%.

“From that perspective, if the timing is right and if you can get that kind of return in three months, the note is relatively attractive.”

Chinese ban

Kownatzki brought up another consideration for the trade, pointing to recent headline news.

“The China story had a huge market impact. But it should be put into perspective,” he said.

On Sept. 6, the Wall Street Journal reported that the Chinese government was banning the iPhone and other foreign-branded devices from use by workers at central government agencies.

“The news was a shock. In two days, Apple shares dropped 6%. That’s a $200 billion loss in market capitalization as a result of the headlines. Was the reaction warranted?” he said.

Kownatzki did not think so.

“There’s a disconnect between the market reaction and what China’s iPhone sales represent in reality. The share price drop was not reflective of the revenues Apple gets from China,” he said.

In fiscal 2022, China accounted for 18.8% of Apple’s total revenues, or $74 billion.

“Meanwhile China has denied the ban following the news. It’s confusing.”

The market’s “knee-jerk” reaction if anything was evidence that Apple shares are “overpriced” and vulnerable to big price moves, he said.

Market timing

“There’s definitely some risk holding the notes for three years with a protection of only 20% on the downside. It’s especially risky with a barrier, which puts you in a long position if it gets knocked out.

“The valuation today is pretty high. Apple is an expensive stock. This note is not a very conservative trade.

“Also, the 10.4% coupon you’re getting to get exposed to such a highly valued stock is not much.

“Both the barrier and the yield are pretty skinny,” he said.

Such should be the reasoning of a long-term investor holding the note for three years, he said.

But from a trading standpoint, Kownatzki’s view was quite different.

“The stock has dropped and there’s an opportunity to get called in three months. You get your principal back in December with an annualized return of 10.4%. That’s not bad at all.

“Over a three-year period, I wouldn’t risk it. But the first call is coming soon enough. You have a pretty good chance of getting out of this trade quickly with a decent, short-term profit,” he said.

The notes are guaranteed by Bank of America Corp.

BofA Securities, Inc. is the agent. Morgan Stanley will act as distributor.

The notes settled on Sept. 13.

The Cusip number is 09711AM96.

The fee is 2.25%.

© 2015 Prospect News.
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