BofA's leveraged notes tied to real estate have good terms, but asset class still precarious

By Emma Trincal

New York, Dec. 21 - Market participants said they find the structure of Bank of America Corp.'s planned leveraged two-year notes linked to a domestic housing sector index attractive. Yet the uncertain outlook for real estate makes some sources hesitant to say they would buy the notes as the housing recovery has not completely materialized despite some recent improvements.

Bank of America plans to price 0% Capped Leveraged Index Return Notes due January 2012 linked to the Dow Jones U.S. Real Estate index, according to an FWP filing with the Securities and Exchange Commission.

The payout at maturity will be par of $10 plus double any index gain, up to a maximum return of 34% to 38%. The exact cap will be set at pricing.

Investors will receive par if the index falls by up to 20% and will be exposed to declines beyond 20%.

The notes are expected to price in January and settle in February.

A REIT index

The Dow Jones U.S. Real Estate index is a float-adjusted capitalization-weighted, real-time index that provides a broad measure of the U.S. real estate securities market.

The index consists primarily of real estate investment trusts but also includes other companies that invest directly or indirectly in real estate through development, management or ownership, including property agencies.

The index is a subset of the Dow Jones U.S. index, a broad-based measure of the U.S. stock market, which aims to represent the top 95% of U.S. traded companies based on float-adjusted market capitalization, excluding the smallest and least-liquid stocks.

Legitimate asset class

"We believe the U.S. real estate market is a legitimate asset class," said Frederick Wright, partner and chief investment officer at Smith & Howard Wealth Management in Atlanta. "This product is a good way to move into real estate because you have the buffer. I really like the structure. Two times leverage with a high cap is pretty attractive especially with a 20% downside protection," he said.

Wright said that his firm was invested in real estate in 2004 but that "we got out" the following year.

"It's something we are thinking of, and if we had conviction we would get exposure to this asset class again," Wright said.

"The only question is: Is the timing right to make a move into real estate? ... There are a lot of uncertainties about this asset class, in particular about the refinancing that needs to be done and the soft economy."

Notable growth

Commenting on the growth of the underlying index, which is up about 23% so far this year, Wright said that the sector "got deeply sold at the end of 2008, early 2009 and probably oversold. By the spring it started to pick up, and we've seen a nice snap back."

The index move reflects a drop in price by half since the highs of several years ago, Wright noted, adding that since last spring, valuations have "probably come back by 100%."

Timing versus structure

"The timing makes me cautious but I really like the structure," Wright said. "If banks were lending more and if it was easier for redevelopers to renegotiate their debt, that would make us more comfortable."

Cautiously optimistic outlook

Tom Lydon, president of Global Trends Investments, an investment advisory firm specializing in the creation of customized portfolios for high-net worth individuals, said that he believes that the outlook for U.S. real estate has improved as well. But Lydon remains cautious because "there are still a lot of foreclosures."

One positive trend, Lydon noted, is that "we're starting to see new home sales," even if "the average American family that buys new homes buys smaller" homes. "It's still good news for the builders as it brings a different type of demand," he said.

Lydon predicted "much better numbers" in real estate by the second half of 2010, "if banks manage to clean up their books" and "if the economy turns."

"The next six months are going to be critical," he said.

Merrill Lynch, Pierce, Fenner & Smith Inc. and First Republic Securities Co., LLC are the agents.

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