Bank of America’s $58.36 million autocall step-ups tied to Euro Stoxx 50 were top deal of week

By Emma Trincal

New York, July 2 – Bank of America Corp.’s $58.36 million of 0% autocallable market-linked step-up notes due June 23, 2017 linked to the Euro Stoxx 50 index was the best-selling offering last week. It appealed to moderately bullish investors who are more eager to capture extra returns in a toppish market than protecting the downside, sources said.

The notes have an autocallable feature with two annual observation dates after the first year and the second year. The call is triggered on the call date if the index closes at or above its initial level. The call premium is 10.5% on June 26, 2015 and 21% on June 17, 2016, according to a 424B2 filing with the Securities and Exchange Commission.

If the notes are not called, investors will be paid either a digital return or get one-to-one participation in the upside with no cap, depending on where the index finishes in relation to the step-up value set at 133% of the initial level.

If the final index level is greater than the step-up value, the payout will be par plus the index return. If the index finishes between the initial level and the step-up value, the payout will be par plus 33%. If the final index level is less than the initial index level, investors have one-to-one exposure to its decline.

No cap sells well

An industry source said the step-up structure contributed to the strong bid.

“These types of notes are getting more and more popular,” he said.

“People want the unlimited upside. For many, it’s better to get better terms on the upside than protection on the downside.

“Buffers look always better, but they’re not necessarily valuable anymore. A buffer in this market is not even a cushion. It’s a pillow. It gives you a sense of comfort.

“For this particular kind of step-up, you also have the autocall. It’s only at maturity that your upside is unlimited. But if you’re called along the way, then the unlimited upside is gone. Your call premium becomes your cap.”

The notes were particularly appealing to investors who expect subdued returns in the next three years.

“If the index growth is very small, if it’s even flat, then you’ll be glad if you’re called. That would be a good thing.

“And if your index is up in the single digits on an annualized basis, the step-up at maturity is also a good thing.

“This note is a good choice for a moderately bullish investor.”

Digital return

A market participant agreed.

“It’s a great structure. I’m glad they had a good size for it. The digital is good,” he said.

With this type of product, investors have no particular interest in protecting their investment from a pullback, he said.

“The concern is not the downside. The concern is to generate returns if the rally loses its momentum,” he said.

“With markets hitting new highs, some investors are beginning to think that the current run may not keep going much higher. That’s when a structure like this one can be really attractive. It’s a digital payout. The autocall is a form of digital. If the market stays flat during the term, you get called and you still make 11% for the year or 21% in two years. And if the index finishes flat or up by less than 10% a year, you have an edge with the 33% digital payout.

“There is no downside protection because the notes are designed to address the risk on the upside. If you’re still bullish, you can capture all of the upside. If you’re bullish but wonder if there is still gas in this market, the digital offers a valuable solution.”

However, the full downside exposure is not acceptable for some investors, such as Clemens Kownatzki, an independent currency and options trader.

“It looks interesting because you can capture the upside and get a nice bump up anywhere from zero to 33%. If the index rises by 5% at the end of the three years, getting 33% is very, very attractive,” Kownatzki said.

“What’s not attractive in this market environment is that there is absolutely no downside protection. It’s a bit of a concern. You’re locked in in a three-year cycle with no buffer or barrier. And the market is at all-time highs.”

Autocall is no protection

The autocallable feature is not a substitute for a barrier or buffer, he said, because the call may or may not be triggered.

“Who’s to say you’re going to get called? It’s not a protection. You’re just speculating that at a particular date the index is supposed to be above par. But what if it’s not? Some people view an autocall as a form of protection. They assume the call will be triggered and the duration shortened. But nothing guarantees that. If the index price is not above 100 on one particular day a year, I’m still in and the principal is still not protected,” he said.

Kownatzki said that having no risk-mitigation feature in the notes is even more of a concern when valuations are as high as they are now.

1990s memories

“I am currently reducing my long positions a little bit. It’s getting a little bit scary. Look at last week’s IPO. GoPro shares doubled in just a few days,” he said.

The shares of GoPro, Inc. began trading on the Nasdaq on June 26 at a price to the public of $24.00 per share. The stock closed at $48.80 on Tuesday, up 103% in just four trading sessions. By Wednesday’s close though, the stock had fallen by nearly 14% from the previous trading day.

“These types of things, those hot IPOs remind me a little bit too much of the speculative market of the 1990s,” he said.

“Technically, I don’t have a problem with the notes, but I have a problem with an equity bullish note for three years with no downside protection.”

ETF for liquidity

One alternative for investors would be to buy the SPDR Euro Stoxx 50 exchange-traded fund, which is listed on the NYSE Arca under the ticker “FEZ,” he said.

“You can sell it at any time. That’s the main advantage,” he said.

Another advantage is that ETF investors, unlike the noteholders, receive the 2.67% dividend yield of the index.

“But I don’t take that into account because not getting dividends is implied in the structure. The notes give you other things, the autocall and the digital, which you won’t get with the fund. Investors in the notes get the optionality but not the dividends. That’s the cost of putting together the product. The investment bank has to find a way to price it, and that they use dividends to cover the cost of the options. I’m fine with that,” he said.

Overpriced market

“My concern again is the downside. You have no protection. You are locked in for three years. And you are dealing with an index that has the potential to drop quite a lot,” he said.

During the last bear market, from August 2008 to March 2008, the S&P 500 index fell by 36.7% while the Euro Stoxx 50 lost 46.4%, he noted. To be sure, the Euro Stoxx 50 significantly outperformed the U.S. benchmark from 2004 to 2008. Since 2011, the S&P 500 is outperforming the euro zone index, he noted.

“Still, both indexes are very high compared to the lows of March 2009. We’re fairly high up in this bullish cycle from the lows of March 2009. All equity indexes are fairly high up in this bullish cycle. If we get a correction and I’m in the notes, I can’t get out. I have no downside protection. Not a good place to be,” he said.

The notes (Cusip: 06053M237) priced June 26.

BofA Merrill Lynch was the agent.

The fee was 2%.

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