BofA notes linked to real estate index compete with peers, but pricing slightly disappoints

By Emma Trincal

New York, April 1 – Bank of America Corp.’s 0% Capped Leveraged Index Return Notes due April 2018 linked to the Dow Jones U.S. Real Estate index offer “decent” terms for mildly bullish investors seeking exposure to real estate investment trusts, especially if they want to mitigate risk, said Tim Vile, structured products analyst at Future Value Consultants.

But the value of the notes is slightly below average, he noted.

The payout at maturity will be par plus twice any index gain, capped at 21% to 25%. The exact maximum will be set at pricing, according to a 424B2 filing with the Securities and Exchange Commission.

Investors will receive par if the index falls by up to 10% and will lose 1% for every 1% decline beyond 10%.

Real estate

“This is a sector-based play for investors looking to invest in real estate investment trusts. They should be careful though and not be misguided. It’s not an investment in real estate but in companies that generate revenues from real estate. There is a difference,” he said.

“It’s not a bad product. The two-year term is not too long. For people who are not extremely bullish, the leverage helps you gain a decent return.”

In his report, Vile chose a 23% cap, which is at the mid-point of the 21% to 25% cap range.

A 23% return would give investors a 10.9% annualized compounded return based on the leverage factor and term, he noted. Such performance could be achieved if the index grew as little as 5.6% per year on a compounded basis.

“You don’t have to be too bullish to make that assumption. If you’re right, you can get 11% a year in return, which I don’t think many people would complain about,” he said.

In its research, Future Value Consultants assesses risk, return and price using a variety of proprietary scores in order to compare a product with others.

Each product is compared against a list of recently rated notes within the same structure type – leveraged return in this case – as well as with all products.

Risk

For the risk, Future Value Consultants produces its own metric, the riskmap, which measures the risk on a scale of zero to 10 with 10 as the highest level of risk possible. This measure of risk is the sum of two riskmap components – market risk and credit risk, both calculated on the same scale.

The market riskmap is 2.74 versus an average of 4.17 for the product type, according to Future Value Consultants’ research report.

“It’s pretty low. The 10% buffer really helps, obviously, especially on a two-year,” he said.

“Also it’s not the most volatile underlying.”

The Dow Jones U.S. Real Estate index has an implied volatility of 15.5% versus 12.5% for the S&P 500 index.

The credit risk is more elevated at 0.57, compared with an average of 0.49 for the leveraged return category, the report showed.

“Perhaps the credit spreads of the issuer are a little bit higher,” he said.

The result is a 3.31 riskmap versus a 4.67 average for the product type when adding the two risk components.

“It’s decent. The low market risk is the main factor. The relatively high credit riskmap has less of an impact given how we measure risk,” he explained.

“A default is the worst-case scenario. It’s something you have to factor in. But the odds are so small that we give more weight to the market riskmap.”

Return score

In order to assess the risk-adjusted return of a product versus its peers and the market, Future Value Consultants produces a return score using five market scenarios. The most favorable scenario is used to compute the return score, which in this case would be bullish. The score measures the risk-adjusted return on a scale of zero to 10 with 10 being the best possible result.

At 7.20, the return score happens to be the same as the average for the product type.

“It’s nice and neat but at the same time almost annoying when you want to make an investment decision,” he said.

“At first it’s surprising not to see a better-than-average score. The riskmap is low. It should help. The cap is a good cap. It still holds the product back, but it’s not a detrimental cap.

“I guess the explanation is that you’re competing with uncapped leveraged returns. Some of them are longer-dated uncapped leveraged notes and generate stronger returns under the bullish assumption.”

Price score

For each product, Future Value Consultants computes a price score that measures the value to the investor on a scale of zero to 10. This rating estimates the fees taken per annum. The higher the fees, the lower the score and the lower the value offered to the investor. The score improves as the duration increases since the fees are calculated on an annualized basis.

The notes have a 6.81 price score, and the average for the product type is 7.51.

“It’s not impressive, but it’s not too bad. Anything over 6 is not bad.

“This result may be due to the fact that two years is shorter in time than the average. Longer notes price better because the cost is spread over more years.

“The cap perhaps could have been a little bit higher.

“More likely the reason lies in the fees.”

Overall

The overall score measures Future Value Consultants’ general opinion on the quality of a deal. The score is the average of the price score and the return score.

The overall score is 7.01 versus an average of 7.36 for the product type.

“Despite a disappointing pricing, we have a fairly decent note for the right investor. You get a 10% buffer over two years and a reasonable cap with a potential of 11% a year.

“For someone looking to invest in this asset class, the terms remain fairly attractive.”

BofA Merrill Lynch is the agent.

The notes will price in April and settle in May.

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