BofA’s $16.78 million step-up autocall tied to Russell 2000 lack protection in riskier market

By Emma Trincal

New York, April 3 – BofA Finance LLC’s $16.78 million of 0% autocallable market-linked step-up notes due March 26, 2021 linked to the Russell 2000 index offer an attractive upside payout, but the weak part of the structure is the full downside risk, especially in a market already in the red this year, advisers said.

If the index closes at or above its initial level on an annual observation date, the notes will be called at par plus a premium of 9.93% a year, according to a 424B2 filing with the Securities and Exchange Commission.

If the index finishes above the step-up level – 130% of the initial level – the payout at maturity will be par of $10 plus the index gain.

If the index gains by up to the step-up level, the payout will be par plus the step-up payment of 30%.

Investors will be exposed to any losses.

Low dividends

“In a range bound market, you’ll easily outperform with 10% annualized. If it’s up more than 30% at maturity, you’re not capped. All you lose are the dividends,” said Tom Balcom, founder of 1650 Wealth Management.

He rounded up the 9.93% call premium at 10%.

The risk of underperforming because of the non-payment of dividends was limited due to the low dividends paid by small-cap companies, he noted. The Russell 2000 index yields 1.30%.

In addition, investors buying the notes are moderately, not highly bullish on the index. In such case a 10% annualized return would probably exceed their market expectations, he said

High premium

“The only downside is if you underperform the small-cap index because of the dividends. But if you think the index will go up modestly, if you believe the market is fairly valued and hasn’t much growth looking forward, this is the place for you.

“Most people would be happy with 10% if the index is up 3%,” he said.

Defensive adjustments

The downside however was more problematic. For Balcom, the 1-to-1 downside exposure, with up to 100% of the principal at risk, was a concern.

“I prefer capital protection especially now with valuations stretched as they are,” he said.

“We’re seeing more volatility and stocks are going through a rough patch. Those recent sell-offs have led us to be more cautious.”

Balcom said that his firm is now buying notes that are more defensive, adjusting to the new market conditions.

“You want to have buffers in this riskier market environment.

“This deal is a good structure for the upside. I’d want to have downside protection too,” he said.

Mildly bullish

Donald McCoy, financial adviser at Planners Financial Services, said he could see why someone would consider the notes. But the underlying view was too narrow in his mind and the risk-adjusted return showed limited appeal.

“I can see where that product comes from. It’s for someone who has very limited expectations from equities,” he said.

If indeed the market was to rise moderately, investors would get a double-digit call premium.

“As long as it’s a little positive, you’ll get cashed out at 10%, 20% or 30%.”

Risk-adjusted return

But McCoy objected to the capped upside during the two call dates in combination with the market risk at the end.

“You can get 10% a year on the call. But if you’re not called you’re exposed to the risk of losing 100% of your principal on the downside,” he said.

“That’s not exactly a good risk-adjusted return.”

Investors had better be right in their neutral to bullish expectation.

“Any decline and you’re long the index,” he said.

Buyers of the notes also had to be confident that the market would not rise too much. While the annual call premium is 9.93%, any return in excess of it would be an opportunity cost.

“If the market is up 15% in the first year, you’re only getting 10%. You’re capped on the two calls. It’s only at maturity that the cap is removed,” he said.

No-cap reality check

He was referring to the unlimited one-to-one upside at maturity if the return is above 30%.

“The no-cap scenario at maturity is nice but not probable. It would mean that the notes have not been called two years in a row. To have gotten to that point, the index would have to remain negative on those two call dates. And then on the third year it would have to jump 30%. That can happen but it’s highly unlikely.”

For McCoy, the positive outcomes of the product were associated with a set of conditions unlikely to occur.

“You’re accepting this short-term cap and you’re accepting this full downside exposure in the hopes that the market is just sideways and that you’ll get cashed out in the first or second years,” he said.

“It’s for a very narrow view.”

“If you’re only slightly bullish, you can’t be ruling out the possibility of a significant downside and yet you’re buying a product that doesn’t offer protection against that.

“The hard part for me is that there is absolutely no downside protection,” he said.

The notes (Cusip: 097097430) will settle on Thursday.

BofA Merrill Lynch is the agent.

The notes are guaranteed by Bank of America Corp.

The fee is 2%.

© 2015 Prospect News.
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