BofA’s $2.23 million autocallable leveraged notes on Russell add one call to regular catapult

By Emma Trincal

New York, March 6 – BofA Finance LLC’s $2.23 million of buffered autocallable enhanced return notes due March 1, 2027 linked to the Russell 2000 index showed a hybrid structure borrowing some of the terms of so-called “catapults” and others from snowballs, sources said.

The notes will be called at par plus 10% per year if the index closes at or above its initial level on either annual review date, according to a 424B2 filing with the Securities and Exchange Commission.

The payout at maturity will be par plus 200% of any gain in the index.

If the index finishes below its initial level but no lower than its buffer level, 85% of its initial level, the payout will be par.

Otherwise, investors will be exposed to the decline of the index beyond 15%.

A mix

The notes would be a snowball if the call premium accumulated each year, effectively capping the upside to 30% without any participation at maturity.

A so-called catapult would be similar to the note as it is now but with an important difference: there would be only one automatic call and not two. Moreover, the one-time autocall would be set up early enough to give the index enough time to grow before maturity.

Bridges and seagulls

“The reason why the call feature makes the uncapped leverage at maturity possible is because you may not get to maturity,” a market participant said.

“By introducing the second call, you’re even less likely to get the uncapped leveraged exposure at the end.”

To make his point he used a figure of speech.

“Your performance is like the flight of a seagull over the ocean. It’s flying up all the way and you’re putting a bridge right in front of the bird. The seagull has to tuck under the bridge before taking off. They force the seagull not to fly too fast and not too high. If it does, it hits the bridge. That’s the idea of the call,” he said.

The call at the end of the first year is what makes the option cheaper, allowing the issuer to price the leverage at maturity, he said.

“That’s how they can do it,” he said.

Disrupted flight

But in practice, most similar structures dubbed “catapults” feature only one call, which is triggered early on, usually after one year.

Adding a second call limits the value of the leverage, hence cheapens the price of the option even further, he said.

“Now the seagull has to face not one bridge but two. It has been flying down or horizontally to avoid both bridges and now it has to take off. A bird doesn’t fly like that,” he said.

For this market participant, investors are unlikely to hold the notes throughout the entire three-year period.

“Chances are you’re not going to participate in the index’s performance. The probabilities of a call are much greater.

“This note is more like a snowball. If you make any money, it will be 10% or 20%.

“You’re hoping to get 2x with no cap, but chances are you won’t,” he said.

The structure of the note may have been the result of a discussion between the client and the bank.

“If the client really wants 2x uncapped and if putting a second call in there is the only way to price it, then that’s how you get the deal done,” he said.

Due diligence

But a buysider said that brokers had to be extremely careful when explaining the payout to prospective buyers.

“The chances of getting the leverage are very small, which is why they can offer it,” he said.

“Don’t get me wrong: 10% a year is not so bad. But whoever sells the notes needs to explain what’s the most probable outcome. Don’t sell this as a growth note with 2x no cap; otherwise, the product will end up blowing in the face of the issuer.”

This buysider stressed how challenging it has become for issuers to generate premium.

“We’re at the end of a bull market. Volatility is low. Interest rates have come down from their highs. How do you juice a payout? You don’t juice it with marketing.

“You have to manage expectations. Otherwise, it’s just a gimmick,” he said.

The notes are guaranteed by Bank of America Corp.

BofA Securities, Inc. is the selling agent.

The notes settled on Friday.

The Cusip number is 09710PWC6.

The fee is 2.5%.

© 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.