Bank of America's $33.25 million capped notes tied to CMS rates seen as offering value, access

By Emma Trincal

New York, July 17 - Bank of America Corp.'s $33.25 million of capped notes due July 11, 2033 linked to the 30-year Constant Maturity Swap rate and the two-year CMS rate was well-priced and offered the advantage of not being callable, which is somewhat unusual for these kinds of structures, sellside sources said.

The offering was last week's largest deal, according to data compiled by Prospect News.

The initial interest rate is 10.25%, according to a 424B2 filing with the Securities and Exchange Commission.

Beginning July 11, 2014, the interest rate will be (a) four times (b) the 30-year CMS rate minus the two-year CMS rate minus 10 basis points, subject to a maximum rate of 10.25% per year and a minimum rate of zero. Interest is payable quarterly.

The payout at maturity will be par.

Tightly priced

"The deal priced well. It was priced tightly," a sellsider said.

"Investors recognized the value. A $33.25 [million] deal is a decent size for this type of paper."

Most steepeners are callable, he noted. The notes were not.

"It was probably the first time to my knowledge that I've seen a bullet on a 20-year steepener."

The non-callability of the notes may have driven demand, a market participant said.

"There aren't a lot of bullets out there, and some people are definitely looking for that type of paper," he said.

Steeper curve

Jim Delaney, portfolio manager with Market Strategies Management, said that the deal made sense for retail investors who wanted to bet on the steepening of the part of the curve comprised between the two-year and the 30-year rates.

"You get four times the difference. Right now the two-year swap is 0.4692% and the 30-year is 3.5430%. The difference is 3.0738%. You multiply that by four and you get a rate of 12.3%. Since you're capped at 10.25%, you're giving up 200 basis points," Delaney said.

"All I have is my cap, so it doesn't help me if the curve steepens more. I'm already giving up 2%. And the curve isn't even as steep as it was a week ago. So that's the downside.

"But for retail investors to actually make that trade on their own is not that easy. They can't get involved in the rate swap market.

"This note has a 20-year tenor. The 20-year swap is currently at 3.406%. If my bet on the steepening of the curve is right, this note is paying me 10.25%. So even though I'm giving up 200 basis points because of my cap, I'm outperforming the 20-year swap by 685 basis points. Not bad."

Access

"For a retail investor, this type of product offers a way to bet on the shape of the curve. It gives you access to this strategy. It's a good deal if you believe, as I do, that rates are going to rise and that the curve will steepen. Even if the curve stays as steep as it is, it's a sure way to get 10.25%. By buying this piece of paper, you're outperforming quite a lot the rate you would get on the swap," he said.

As stated in the prospectus, investors should consider the risk of not earning any interest after the first year, a structurer said.

"These deals are for retail investors. As retail investors, they have no way to figure what the rates are going to be in the future. But if you can get 10.25% in this environment, it seems like a decent bet," he said.

"The problem of course is that you don't know what the spread in the future is going to be, and if you have an inverted curve, eventually the investor will get less or even zero. That's the risk."

The notes (Cusip: 06048WNZ9) priced on July 8.

BofA Merrill Lynch was the agent.

The purchase price for the agent was 97.54.

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