Advisers discuss cap, floor of BofA’s fixed-to-floating rate notes tied to CPI

By Emma Trincal

New York, June 13 – BofA Finance LLC’s fixed-to-floating rate notes due July 6, 2027 linked to the Consumer Price Index caught advisers’ attention given the high levels of inflation and clients’ increasing need to hedge it. But advisers’ views on the terms of the notes depended on their respective expectations regarding the Federal Reserve’s ability to fight off inflation.

The interest rate will be 4.5% per annum for the first year, according to a 424B2 filing with the Securities and Exchange Commission.

After that, the annualized interest rate for each monthly interest period will equal the applicable CPI inflation adjustment.

The CPI inflation adjustment will equal the percentage change in the CPI between (a) the month that is 15 months prior to the month in which the applicable interest period begins and (b) the month that is three months prior to the month in which the applicable interest period begins.

The annualized interest rate cannot be less than 0% or more than 7%.

The payout at maturity will be par plus any accrued but unpaid interest.

Good idea

Kirk Chisholm, wealth manager and principal at Innovative Advisory Group, was interested in some of the terms of the notes as well as its main rationale.

“I like the principal protection. I also like that it’s designed to protect you against inflation,” he said.

“There are a lot of appealing parts to this note. It’s one of the most interesting I have seen in a long time.”

But for this adviser, the Fed’s battle against inflation is not yet won, which means that investors may see their return limited.

On Friday, the stock market tumbled after the release of the May CPI figures coming out higher than expected at 8.6% year over year, the highest increase since 1981. The stock market sell-off was due to fears of a Fed forced to act more aggressively in hiking rates. Chisholm said the direction that the Fed will take remains uncertain, but he leaned toward a not-so-hawkish stance.

Deal breaker

“I like the idea of tracking the CPI. I like the five-year term. Three to five years is a good amount of time for inflation to rise,” he added.

“Unfortunately, the cap is a big deterrent. What if inflation goes up 15%? The CPI is already up 8.6%. You could be missing out.”

Inflation could rise even higher, he added.

“We could easily be at a double-digit rate. It wouldn’t be abnormal when you look at the rates of the 1970s, early 1980s.

The Federal Funds rate peaked at 20.61% in June 1981.

Tough medicine

“The situation today is very similar to the 1970s. You have a very high inflation that is self-reinforcing. You can’t get rid of it so easily without raising rates dramatically. No politician wants to do that. It would crush the economy. Eventually Paul Volcker put an end to the inflation of the 1970s, doing what he had to do,” he said.

Now the Fed is facing the same conundrum, he noted.

“They have to choose. Do you solve the problem now and create a recession? Or do you wait to avoid the pain? If you wait, it will be harder.

“It’s like taking a strong medication. Do you take it now or later?” he said.

Chisholm said the Fed was not likely to inflict the pain of a recession.

“So, I don’t like the 7% cap on this note,” he said.

“I can get 9.6% right now with I-bonds from the U.S. Treasury. It’s limited to $10,000 but it will continue to rise with inflation.”

Series I savings bonds are issued by the U.S. Treasury. Interests are a combination of a fixed-rate and a variable inflation rate calculated twice a year based on changes in the non-seasonally adjusted CPI for all Urban Consumers (CPI-U) for all items, including food and energy, according to the U.S. Treasury.

“It’s a good idea to issue a note on the CPI. But the cap is too strict. It needs to be higher,” he concluded.

Lower inflation

James Maher, chief executive and founder of Archford Capital Strategies, held the opposite view, expressing concerns about the 0% floor rather than the 7% cap for the annualized interest rate. He predicted a recession as a result of the Fed’s tightening.

“With the moves the Fed is about to do, inflation is going to slow, especially over a five-year period,” he said.

“From that standpoint, I don’t have a problem with the cap. The 7% cap is fair.

“The Fed has to hike rates aggressively. In doing so, the economy is going to slow down much quicker than expected.”

Higher floor needed

The 4.5% fixed rate was attractive, he noted.

“But it’s only on the first year.

“For the floating rate pegged to inflation, it would have been nice to see a 3% or 4% floor. When you’re getting a cap on the upside, you should also have a floor.

“In my opinion, we have a serious risk of a recession as a result of the Fed’s aggressive tightening. So, the enhancement should be centered on the floor, not so much on the cap,” he said.

BofA Securities, Inc. is the agent.

The notes are guaranteed by Bank of America Corp.

The notes will price on June 30 and will settle on July 6.

Fees are 0.75%.

The Cusip number is 06048WW30.

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