Bank of America’s step-up autocallable notes linked to PHLX Housing Sector index offer access

By Emma Trincal

New York, May 11 – Bank of America Corp.’s 0% autocallable market-linked step-up notes due May 2017 tied to the PHLX Housing Sector index offer investors exposure to a hard-to-access index and the potential to outperform in a mildly bullish environment, sources said.

The notes will be called at par of $10 plus an annualized call premium of 9% if the index closes at or above the initial level on the call observation date in June 2016, according to a 424B2 filing with the Securities and Exchange Commission.

If the index finishes above the step-up level – 114% to 120% of the initial value – the payout at maturity will be par plus the index return.

If the index gains by up to the step-up level, the payout will be par plus the step-up payment of 14% to 20%.

Otherwise, investors will be fully exposed to any losses.

The exact step-up level and step-up level payment will be set at pricing.

Access

“I find it interesting because there are a very few ways to play the housing sector. Getting access to this index is appealing in its own right,” said Kirk Chisholm, wealth manager and principal at Innovative Advisory Group.

The index is currently comprised of 19 stocks of companies in the building and prefabrication of residential homes, mortgage insurers and suppliers of building materials.

There is no exchange-traded note or exchange-traded fund listed in the United States that tracks the index, according to a spokesperson at Nasdaq OMX, the index sponsor.

Likely call

“The upside to this is certainly attractive as you can get almost 10% automatically in just one year if the index is just flat or up,” he added.

“You’d have to be negative on the first year to really benefit from the bump-up offered by the step payment. If you look at the past return, the index was up 15% in the past 12 months. It’s more likely that you’re going to get 9% after the first year. In the past five years, the index has gained more than 112%. For a few years it has been moving at a good clip.”

The step-up payment is not the most probable outcome in his view.

“It’s highly unlikely that you’ll collect the 20% bonus at the end because that would mean the index was negative on the first year and then up. However, if it happens, if the index is down in a year and then just moves up a little bit, you could make 20%. So that’s a nice component. Both the autocall and the step-up are attractive.

“Even if all you get is the 9% on the autocall after one year, it’s still a pretty decent return.

“So based on those probabilities, it’s a good note.”

Not too bullish

The note is not a good option for bearish or very bullish investors, however.

“I don’t see a huge growth in this market in the next few years, so that makes the notes even more attractive, at least from that standpoint,” he said.

“If you envision a very bullish scenario, if you expect growth to be over 20%, the notes offer no advantage: you’re long the index and you don’t get the dividends. But for someone who expects modest or flattish returns, it’s quite appealing. Unless things turn down pretty sharply, we can pretty much predict the outcome. The autocall will kick in, delivering a 9% return in just one year.”

The less attractive aspect of the deal, not receiving cash distributions paid on stocks, is common to most structured notes.

“It’s a stock index, and you’re not getting the dividends,” he said.

On a weighted average basis, the yield for the index is 1.29%, according to the weightings listed in the prospectus.

“But even if you’re not getting the dividends, I think 9% based on the risk-return is still decent. You’re potentially giving up some of the upside, but it’s still a reasonable note if you’re positive on the index,” he said.

Hedging interest rates risk

Jerrod Dawson, director of investment research at Quest Capital Management, said that he likes the risk-return profile of the notes in both the autocall and step-up scenarios.

“For someone looking to get exposure to the housing space, this note offers a pretty good way to do it by adding after two years some potential alpha with the kicker,” he said.

“If investors get called automatically, it’s a good outcome too. Most people would be happy with a 9% return. You are capped, but it’s a pretty reasonable risk-return in this interest rate environment where interest rate risk is increasing.

“The prospect of higher rates is real with the Fed articulating that it is willing to raise rates. That wouldn’t be good for a portfolio of housing stocks,” he noted.

He does not see the lack of any buffer or barrier as a drawback.

“There is no downside protection, but you’re not giving up anything. You’re not getting protection, but you wouldn’t have it anyway if you owned the shares,” he said.

“Someone who thinks there is a strong upside potential for housing stocks would not want to be invested in the notes. They would risk being capped out.

“But someone who is moderately bullish in the sector would be an ideal buyer.”

As of April 30, the top three holdings in the index were Weyerhaeuser Co. with a 14.09% weighting, Vulcan Materials Co. with an 11.24% weighting and Masco Corp. with an 8.47% weighting.

BofA Merrill Lynch is the underwriter.

The notes will price in May and settle in June.

© 2015 Prospect News.
All content on this website is protected by copyright law in the U.S. and elsewhere. For the use of the person downloading only.
Redistribution and copying are prohibited by law without written permission in advance from Prospect News.
Redistribution or copying includes e-mailing, printing multiple copies or any other form of reproduction.