Bank of America’s market-linked step-ups on two indexes offer ‘decent’ buffer, adviser says

By Emma Trincal

New York, April 20 – Bank of America Corp.’s market-linked step-up notes due April 2020 tied to an equally weighted basket of the Dow Jones industrial average and the Euro Stoxx 50 index offer an attractive risk-adjusted return due to the combination of a 15% buffer and longer tenor, an adviser said.

But a market participant said the five-year duration was too long to make him feel comfortable assuming the bank credit risk.

If the basket finishes above the step-up value, 122% to 128% of the initial basket level, the payout at maturity will be par plus the basket return, according to a 424B2 filing with the Securities and Exchange Commission.

If the basket stays flat or increases up to the step-up value, the payout will be par plus a return of 22% to 28%.

If the basket finishes at or above the threshold value, 85% of the initial level, the payout will be par.

Investors will be exposed to any basket decline beyond 15%.

Michael Kalscheur, financial adviser of Castle Wealth Advisors, said he liked the risk-return profile of the notes.

Good credit

“This is a really nice one,” he said.

“Bank of America as far as credit is excellent in my book. Would I rather be with a Wells Fargo? Yes. But they’re as good as the average.”

Bank of America’s five-year credit default swaps at 63 basis points are tighter than Goldman Sachs (80 bps), Morgan Stanley (73) and Citigroup (72), according to Markit. JPMorgan’s spreads at 61 bps along with HSBC (65 bps) are comparable to the notes’ issuer while Wells Fargo shows the tighter spreads at 42 bps.

Five-year tenor

The downside protection against market risk was adequate, Kalscheur said.

“It’s a buffer, not a barrier, which I like.

“It’s over a five-year period. I’m comfortable with 15%. It’s a decent size for a five-year. On a shorter term basis, I would be more concerned about the buffer amount. On a one-year, 18-month, even 24-month period you could have pretty steep losses of 20%, 25% or 30%.”

The Euro Stoxx 50 index component may pose more risks due to the current situation in Greece although the depreciation of the euro is positive for Europe, he said.

“If it was a 13-month note, I would probably pass on it. But after five years, I think most of the short-term problems with the euro zone will be worked out.”

A 15% decline in the Dow Jones industrial seemed even more unlikely.

“The chances of this happening are slim. Not none but slim,” he said.

“For this specific basket over five year the probabilities of a 15% decline are very low in my opinion.

“And even if it’s down that much, since it’s a buffer, you’ll be down significantly less.

“But if the underlying is positive you’ll be guaranteed to get 4% to 5% a year compounded.”

Conservative portfolio

Kalscheur argued that the note would be a good fit for a conservative portfolio.

“I would have no qualms recommending this to our retirees. It’s a very good option for someone in their 70s as long as it’s a small part of an overall portfolio. I wouldn’t put half of the portfolio in there of course. But from anywhere between 1%, 3% and even 5%, I would be confident to allocate those amounts.

“If you’re 70s’s your life expectation is still probably 15 years. You need to fund your retirement. In this environment where the 10-year Treasury pays 1.90% that’s not going to get the job done.

“If interest rates go up you could lose money in bonds on the short term at least.

“How do you give someone who needs to be conservative some upside potential without exposing them to an excessive amount of risk?

“This is the type of structured note that helps with this every-day challenge. I have no problem recommending this to my parents.

“It’s a high-quality issuer; the fees are low at 50 basis points a year; you have some downside protection with the buffer; the downside protection is enough to make a difference. The indexes are good. The kicker with the step-up allows you to do well in a flat market without losing on the upside if the market goes up a lot.

“Structured notes are not the panacea. They will not solve everything.

“But in a situation of very low interest rates, for people looking for future growth, this one seems to really fit the bill.”

Credit risk exposure

A market participant was more skeptical.

“To me five year is way longer than anything I would consider,” he said.

“I wouldn’t be comfortable assuming the bank credit risk over that period of time.

“I don’t know what’s going to happen in five years with the banking regulatory landscape, what the world is going to look like.

“I don’t do these notes for the sake of doing them.”

The risk-adjusted return was not attractive for this market participant.

“The 15% buffer may not be that necessary over five years. You may get this protection without really needing it while assuming the credit risk. It may make more sense to get more upside,” he said.

“And if you can’t get more upside, you should at least have more downside protection. I would want 25%.”

BofA Merrill Lynch is the underwriter.

The notes will price and settle in April.

The exact terms will be set at pricing.

© 2015 Prospect News.
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