BofA’s $54.88 million step-up autocallables linked to PHLX Housing index aimed at mild bulls

By Emma Trincal

New York, July 29 – Bank of America Corp.’s $54.88 million issue of 0% autocallable market-linked step-up notes due July 22, 2016 linked to the PHLX Housing Sector index was designed for investors who are only moderately bullish on the housing sector as the structure outperforms the underlying index only when the index is up within a certain range, sources said.

The notes will be called at par plus a call premium of 10% if the index closes at or above its initial level on July 27, 2015, according to a 424B2 filing with the Securities and Exchange Commission.

If the index finishes above the step-up value – 126.05% of the initial level – the payout at maturity will be par plus the index gain.

If the index finishes at or below the step-up level but at or above the initial level, the payout will be par plus the step-up return of 26.05%.

Investors will be exposed to any losses.

Digital

“As long as you want to be invested in this area, as long as you’re bullish, this note makes sense. But it’s not designed for the more bullish investor,” said Steven Foldes, vice chairman of Evensky & Katz/Foldes Financial Wealth Management.

“The idea of getting a step-up in a flat market is very attractive. If you can make 26% out of 1%, it’s great.

“Obviously above the 26%, you’re only going to get the asset class return. The note does not give you any edge once you hit the 26% threshold. This is why it’s not a good choice if you’re aggressively bullish.

“You can’t be bearish either since there is no downside protection.”

The return enhancement embedded in the structure comes from the digital payout delivered via the step payment. But the benefits of the step-up come into play only when the index appreciation is below 26%, he added, which reduces the appeal of the payout to a limited type of investor.

No leverage, no buffer

“Part of why we invest in structured notes is that we like to have our cake and eat it too,” Foldes said.

“We like to have some measure of downside protection, and we like to have the leveraged upside. For the downside protection, we like a barrier or a buffer but preferably a buffer as it gives you absolute protection.

“In this particular note, you get none of these things. There’s no buffer or barrier, and there is no leveraged upside.

“What you do get is a 26% return if the index is up between zero and 26%.

“Obviously, you don’t want to be very bullish. If you’re very bullish and expect a return higher 26%, what’s the point of investing in this product?

“Once you hit 26%, there is no leverage and therefore no return enhancement.

“If, instead of that, you had 1.5 or 2 times leverage, it’s a big win. You get the return enhancement no matter what the index does on the way up.

“This deal makes sense for an investor who wants exposure to this asset class and who expects the index to be flat or slightly up. But that’s for this type of outlook only,” he said.

The autocallable feature also illustrated how the structure would benefit a mildly bullish investor best, he said.

“This autocall giving you 10% no matter how much the index gains a year from now becomes a two-edge sword. If it is up a little, you win. If it is up a lot, you lose!” he said.

“From a client perspective you will have some unhappy clients if it is up a lot and they get ‘only’ 10%. As advisers we need to deal with the client behavioral issue as well.”

A play on the economy

Ferenc Sanderson, partner at PrevInvest, a pension and research advisory, said that a bullish outlook on housing reflects an upbeat view on the economy.

“It’s an interesting play on the state of the U.S. economy because if U.S. growth improves, if wages start to pick up, it will have a positive impact on housing,” he said.

So far the index performance has been disappointing, down a little bit more than 5% this year.

The index, which is published by Nasdaq OMX, measures the performance of the U.S. housing construction industry.

“The housing sector has been sending up very mixed messages,” Sanderson added.

“Economic growth was unexpectedly slow in the first quarter and downgraded in the U.S. At the same time, new home sales have been down. These things are a little bit worrisome.

“The market is concerned about the economy not picking up as fast as expected. Part of it is due to a job market that’s still weak. And with real wages not picking up, the incentive for people to go out and buy houses is limited.”

One driving factor for growth in the housing equity market is the Fed, he noted.

“The Fed will look at ways to make sure the U.S. economy continues to expand,” he said.

The step-up is interesting for investors looking to outperform the index.

“Getting this higher return even in a slow growth scenario is definitely attractive. That’s what makes the note interesting. However, there are usually costs embedded in these structured products. Investors need to take a look at that,” he said.

Some institutional investors may find the notes useful, he added, especially if they took strongly bullish bets on the sector before that they may want to revise.

“It’s an interesting play on the economy if you anticipate a rebound,” he said.

“It may be interesting for the small institutional investor that might have long positions in housing ETFs. If the outlook is subdued, it’s an alternative that may offer more upside if there’s only a gradual jump.”

The notes (Cusip: 06053M328) priced Thursday.

BofA Merrill Lynch was the agent.

The fee was 2%.

The index is currently composed of 19 constituents. The top holdings are Weyerhaeuser Co. with a 15.29% weight, Fidelity National Financial, Inc. with a 9.60% weight, Vulcan Materials Co. with an 8.10% weight, Masco Corp. with an 8.07% weight and D.R. Horton, Inc. with an 8.04% weight.

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