BofA’s contingent income autocallables tied to Snap have high yield for a reason, advisers say

By Emma Trincal

New York, Aug. 1 – BofA Finance LLC’s contingent income autocallable notes due Aug. 12, 2019 linked to the common stock of Snap Inc. pay a very high coupon, but the underlying stock has plummeted over a short period of time and shows no sign of turning around, which should be viewed as a red flag, buysiders said.

Each quarter, the notes will pay a contingent coupon at the rate of 18% per year if Snap stock closes at or above the barrier level, 60% of the initial share price, on the observation date for that quarter, according to a 424B2 filing with the Securities and Exchange Commission.

The notes will be automatically called at par if Snap stock closes at or above the initial share price on any quarterly observation date.

If the notes are not called, the payout at maturity will be par unless the final share price is less than the barrier level, in which case the payout will be a number of Snap shares equal to $1,000 divided by the initial share price or, at the issuer’s option, an amount in cash equal to the value of those shares.

The yield for this deal is very high because the underlying stock presents several red flags, advisers said.

Shares of Snap closed at $13.10 (NYSE: SNAP) on Tuesday, an all-time low since its initial trading price of $24.00 when the social media and video company went public in early March. In just five months, the share price has plummeted by 45.5%.

Floodgates

Since Saturday, a bearish factor put even more negative pressure on the struggling stock as the first post-IPO lockup expired. This will allow early investors and insiders to sell the stock, noted Ryan McQueeney, stock analyst at Zacks Investment Research, who draws a connection between the stock dipping more than 5% since Friday’s close and the newly available shares for sale.

In addition, the analyst said that a new supply-and-demand unbalance could drive down borrowing fees for short sellers, creating another incentive for bears to express their view.

“Of course, just because a bunch of shareholders can now sell their stock doesn’t necessarily mean that they will,” McQueeney wrote on Monday in a research note.

But more selling pressures lie ahead. Later this month, a second post-IPO lockup will expire, the analyst noted.

Too volatile

“I have no idea where the stock is going. It’s way too volatile for my clients. Even the 60% barrier is not much if it can easily blow through that,” said Tom Balcom, founder of 1650 Wealth Management.

“It’s a great coupon, but there is probably even more risk. Unless you know the company intimately, why wouldn’t you buy the stock instead? At least if it gets bought out you would perhaps benefit even more on the upside.”

A stock losing nearly half of its value in just a few months combined with a deep barrier still does not meet the definition of “safety,” he said.

“You could always say it’s been dropping like a rock, it can only go up now. ... This is so cheap. Well, it could very well be a value trap.”

Hype

Donald McCoy, financial adviser at Planners Financial Services, expressed curiosity about the yield but remained cautious.

“It’s a unique offer. It’s tied to a stock and has a hefty yield. The concern is the company, which looks like a butterfly that blossoms and dies quickly,” he said.

McCoy said he was not familiar with the stock. But he noted that before Snap, other image messaging live-streaming apps, such as MeerKAT, were highly popular.

“You first had Periscope, and it disappeared. Then MeerKAT was all the hype. Both have been kind of falling off.

“You have to wonder if Snap’s business model is not fading just the same.”

No history

McCoy said he is neither bullish nor bearish on Snap. It is simply too difficult to have a view on such a young company.

“These social media video stocks are notoriously volatile,” he said.

“What happens if it takes off? On the downside you have 40%, but who is to say the stock can’t drop even more?

“It’s a hard call.

“Such a high degree of volatility will make me stay away from that note even if I was an aggressive investor.”

When looking at the chart, McCoy said the short history of the stock is another big concern.

“You can’t really get an idea from the chart in just a few months. It’s a very speculative play. You might as well go to the race track,” he said.

Range-bound assumption

A rational bet with these notes would be to expect the stock to trade sideways with a slightly negative bias.

McCoy said he does not like the automatic call, which puts a brake on the upside too soon.

“The reason to buy this versus the stock is if you think it will stay depressed but not too depressed. If it stays down between 10% and 40%, that’s how it works. You don’t get called and you keep getting the 4.5% coupon every three months,” he said.

But this scenario is unlikely to unfold given the volatility of the stock. Besides, such a bet would involve more risk than a typical investor may want to bear, especially if the goal is income, he said.

Call

“They try to attract you with the yield. But people looking for income are going to allocate to things that produce income, and they’ll try to reduce risk as much as possible. With this note, when you lose, you lose over 40%,” he said.

“At this lower stock price, you could just as well get called in the first quarter. It’s almost a waste of time. Putting all this time and energy and all of a sudden, you’re out. Your search for income is done. That’s another kind of issue.”

More potential selling

The recent lockup expiration and the upcoming one set for Aug. 14 are unlikely to help, he said.

The notes will settle Aug. 11, according to the prospectus.

“People who are the initial investors get a lot of stock options from the onset. They may want to cash in. With big stocks there’s usually enough volume to avoid downward pressure, but this isn’t a big stock. You may run into some bearish momentum if too many people want to sell at the same time,” he said.

The deal as well as the stock present too much risk for investors, he concluded.

“When you’re reaching for an 18% yield for anything, you just have to be aware that it’s going to be risky.

“It’s unlikely you’re going to get all the coupons. You may just get only one.

“This is not like getting a 3.5% yield from GE.

“The risk-adjusted return doesn’t strike me as great.”

BofA Merrill Lynch is the agent.

The notes will be guaranteed by Bank of America Corp.

The Cusip number is 09709TAV3.

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