BofA’s step-up autocallables tied to PHLX Housing Sector: terms are good, but sector is at risk

By Emma Trincal

New York, Jan. 10 – BofA Finance LLC’s 0% autocallable market-linked step-up notes due January 2019 linked to the PHLX Housing Sector index offer attractive features to investors, but the exposure to the U.S. housing sector means risk from a technical as well as fundamental standpoint, buysiders said.

The notes will be called at par plus a call premium of 9% if the index closes at or above its initial level on the observation date in February 2018, according to an FWP filing with the Securities and Exchange Commission.

If the notes are not called and the final index level is greater than the step-up value, 116% to 122% of the initial index level, the payout at maturity will be par plus the index return.

If the final index level is greater than or equal to the initial level but less than or equal to the step-up value, the payout will be par plus the step-up payment, 16% to 22%.

If the final index level is less than the initial level, investors will lose 1% for each 1% decline.

Soaring sector

“The terms aren’t bad. There is no cap on the upside. More notes should have no cap,” said Steven Jon Kaplan, founder and portfolio manager of TrueContrarian Investments.

“But the sector is not so good. I wouldn’t want to have exposure to this index right now.”

The index is in a bull trend. It is up 17% over the last 12 months.

Housing stocks have surged since their bottom in October 2011, he said.

“Since then, it has gone up enormously.”

The PHLX Housing Sector index, which tracks companies directly involved in the U.S. housing construction market, has tripled in price since that time.

The market bottomed in late 2011 because investors were worried about the risks of an impending recession, he explained.

“There were a lot of outflows. Now it’s the other way around. People went from very negative to very upbeat,” he said, adding that complacency prevails.

Exuberance

“I would be worried about any two-year investment in general at this point given the high valuations of the market in general,” he said.

“If the notes were linked to Mexico or Turkey, it would be something else, but this rally is overstretched.”

Kaplan is bearish on equity in general.

“Everyone is very optimistic about the Trump rally, but the elections didn’t do anything except perhaps accelerate the end of this long bull market.”

Wild card

Tom Balcom, founder of 1650 Wealth Management, said the notes are for someone who has a clear view on the sector. He said he does not.

But he cited two reasons to be cautious about the underlying exposure: interest rates and the potential for a tax reform.

“How will the new interest rate environment impact housing? I guess that’s one risk, although it’s been baked in. People expect a slow rise in interest rates,” he said.

More concerning is the impact of a tax reform on Americans’ home-buying habits.

“If Trump eliminates the mortgage interest deduction for housing, now that could have a huge impact.

“I’d be very cautious with this note. The fact that it doesn’t have any downside protection given the uncertainty regarding a likely change in the tax code ... that would make me very hesitant to buy these notes for my clients.”

The notes are guaranteed by Bank of America Corp.

BofA Merrill Lynch will be the agent.

The notes are expected to price in January and settle in February.

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