Bank of America's $196.41 million step-up notes linked to Euro Stoxx 50 are No. 4 deal of year

By Emma Trincal

New York, Dec. 4 - Bank of America Corp. priced $196.41 million of 0% autocallable market-linked step-up notes due Nov. 25, 2016 linked to the Euro Stoxx 50 index last week, the fourth largest offering of the year.

The product geared to mildly bullish investors is attractive for its upside potential through the combination of a market-linked step-up and an autocallable provision, sources said.

"For people bullish on the Euro Stoxx, or I should say mildly bullish on the Euro Stoxx, this is a great deal," a market participant said.

The notes will be automatically called if the index closes at or above the initial index level on either of two observation dates, according to a 424B2 filing with the Securities and Exchange Commission.

The call premium is 12% if the notes are called on Dec. 5, 2014 and 24% if they are called on Nov. 20, 2015.

If the notes are not called and the final index level is greater than the step-up value, 137% of the initial level, then the payout at maturity will be par plus the index return.

If the final index level is greater than or equal to the initial level but less than or equal to the step-up value, then the payout will be par plus 37%.

Investors are fully exposed to the downside.

Bullish

"It's a pretty interesting trade. The economics sound reasonable," said Michael Davis, partner at Varick Asset Management.

"People are increasingly expressing a bullish view on Europe.

"If you're not called on those two call dates after year one and year two, you get a minimum of 37% at maturity.

"This is not for someone who would be really bullish, expecting the Euro Stoxx to be up in the 20% to 30% range after one year.

"At the same time, you're certainly not bearish since there is no downside protection."

As stated in the risk section of the prospectus, in the case of a call, investors will see their gains capped at the 12% annualized call premium.

"If you're really bullish, you shouldn't do it because you might get called," the market participant said.

"If the index is up, you get called away. But you get a 12% premium. What's wrong with that? The problem with these structures is usually when you don't get called.

"The only time you really lose is if the market is up 20% on the first year and you get called or if it's up 130% on the second call date and you get called at 124%.

"But you can't have everything in a deal."

Hybrid structure

One of the appeals of the deal, the market participant said, is that the hybrid nature of the structure offers more than just a contingent call premium. Given the step-up, investors are also able to generate gains either through a digital payout or by simply participating in the index increase without any cap under certain conditions.

"You give up the upside above 12%, but then you get it back if you receive the step-up of 37%. If the index is up, you do get the threshold at least. And above that, it's one-to-one participation, so you're not losing out anything," the market participant said.

Other similar mixed structures have priced recently. Last week, Bank of America priced autocallable step-up notes due Nov. 28, 2016 linked to the Russell 2000 index. The notes had the same structure with different terms: The annualized call premium was 9%, the step-up value was 122.25%, and investors had a 5% buffer.

"This one has no buffer. Obviously, a buffer is always good," the market participant said.

"But you can't judge a structure just because it has no buffer. A buffer has some value, but you're obviously getting something else when you don't have one. With a buffer, chances are you'll get a lower step-up and or a lower call premium. There's only so much money to go around when you price a deal. It is dictated by the investor's preferences, but you can't have it both ways."

Retail versus institutional

Sources were not clear on who may have purchased the notes last week.

"It sounds like a retail deal to me, not an institutional client. Most of the index deals are usually not institutional to begin with. And these features are usually more retail too," the market participant said.

"It's always interesting to know whether a deal is generated by one client or if they've been marketing it," Davis said.

"It could be one large client," he added.

"The investor's view is bullish, certainly, but it's kind of a volatility play. It's a reasonable view, bullish on Europe but not committed to the extent that the investor expects a huge rally. This is the theme implemented there. You can imagine a client approaching Bank of America with that view."

On the other hand, Davis said that retail investors could have just as well bought the notes simply because this kind of structure based on "contingency" or conditional terms is one that individual investors are getting increasingly more comfortable with.

"It could go one or two ways," he said.

"It could be one institutional investor who understands the contingency. Or it could be retail where investors may or may not understand the structure but are attracted by the headline rates.

"If you tell a client that they can get 12% after one year - and all the Euro Stoxx has to do is stay flat or go up - it definitely has some appeal. The other headline number is the 37% after three years, which is attractive too, obviously. The index could be up just 1% and you would be getting the 37% payout. Most people would be very happy with that.

"But a lot of investors don't understand those terms based on contingency.

"I think the notes are designed for an investor who wants to express a somewhat bullish view and who can also tolerate a certain level of uncertainty."

Davis noted that the uncertainty associated with the product is not just related to the type of payout but also to the length of the notes as the automatic call provision renders the duration of the notes uncertain.

"This note does not have a defined duration because you could get called at two different times or hold it to maturity, you just don't know in advance. It's a difficult trade if you don't know if it's going in your books for one year or for two or three," he said.

"The autocall is attractive for the issuing bank. From their perspective, it's the ideal scenario. The note is called and they can issue another deal and collect more fees."

The notes (Cusip: 06053G230) priced on Nov. 26.

The principal amount of notes sold was $196.51 million. The offering price was 99.5 for $21.3 million principal amount of notes and par for the remainder, generating $196.41 million of proceeds.

BofA Merrill Lynch was the agent.

The fee was 2%.

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