Bank of America's $50.29 million 9.5% STEP Income notes linked to Goodyear aimed at bulls

By Emma Trincal

New York, June 15 - Bank of America Corp.'s $50.29 million of 9.5% STEP Income Securities due June 25, 2012 linked to the common stock of Goodyear Tire & Rubber Co. were designed for investors who are more bullish than the traditional buyer of reverse convertible notes, sources said.

The deal was also the largest to price last week. It ranks among the top 20 single-stock deals priced so far this year, according to data compiled by Prospect News.

"It's a good structure," a market participant said.

"It's a more bullish trade than a traditional reverse convertible, and it's a good way to express a more bullish opinion on the stock."

If the final price of Goodyear stock is greater than or equal to the step level - 109.5% of the initial share price - the payout at maturity will be par of $10 plus a step payment of 7.25%, according to a 424B2 filing with the Securities and Exchange Commission.

If the final share price is greater than or equal to the threshold value - 95% of the initial share price - but is less than the step level, the payout will be par.

Investors will lose 1% for every 1% that the share price declines below the threshold value.

Just like in a reverse convertible structure, investors receive the 9.5% coupon regardless of the performance of the stock.

The difference is that investors have a chance to collect an additional payment at maturity, which is the 7.25% step payment, sources noted, adding that it is not a guarantee as it is contingent upon the stock's final performance.

If the stock price ends at or above the step level, investors will pocket a total return of 16.75%, which is the sum of the 9.5% coupon and the 7.25% step payment, said a sellsider.

"But 16.75% is also like a cap. You can't make more than that," he said.

Bullish play

The market participant underlined the main difference between the notes and a classic reverse convertible.

"Even though there is a buffer, it's slightly more bullish than a traditional reverse convertible," the market participant said.

"You expect the stock price to end above the step level in order to maximize your return.

"The 5% protection is smaller. You're less concerned with the downside.

"You expect the stock to perform higher, so you want to be paid a higher coupon."

Investors in reverse convertibles are slightly less bullish, he noted.

"They expect the stock to trade sideways. With this deal, they tweak the structure to make it more bullish with less protection."

But there is a limit to investors' expectations on how much the stock price may rise given the 16.75% maximum return.

"Of course, if you think the stock can go up 30%, then it's not for you. The very bullish investor will be better off with the stock itself," the market participant said.

The sellsider agreed that investors have to have an outlook that is bullish on the stock but is capped to the sum of the coupon and step payment.

"It's probably sold to reverse convertible buyers. But they are slightly more bullish," he said.

"You're going to outperform the stock if the performance is above 9.5% and under 16.75%.

"But if the stock finishes higher than 16.75%, then you'll underperform."

Trade-off

This sellsider said that investors in the notes are willing to accept some level of uncertainty in exchange for a potential higher upside.

"You have the 9.5% [coupon], but the 7.25% step is not a guarantee. It's a contingent return that depends on the stock's performance," he said.

"Here, you're willing to put some of the fixed payment at risk for the extra payment," he said.

Investors may also be willing to sacrifice some of the downside protection that they may get with a traditional reverse convertible for the potential step payment paid in addition to the coupon, the market participant said.

"You're willing to have less protection for the extra step payment. Again, that's because you are less concerned with the downside. This is a more bullish trade than the reverse convertible trade, and that's why," he said.

Big deal

Looking at the size of the offering, the sellsider said that he does not think the sale went to an institution.

"This is distributed internally. It was a big size, but it was probably sold to high-net-worth clients, not to an institution, I don't think," he said.

"I also think they were successful because Goodyear is a household name.

"There's probably some internal research outlining a bullish view on the stock.

"I think they market the name. I don't think they market the structure."

Bank of America Merrill Lynch is the agent. The fees are 1.75%.

In March, Merrill Lynch sold another STEP Income deal on the behalf of AB Svensk Exportkredit.

The $185.75 million issue of 9.75% STEP Income Securities due March 23, 2012 linked to the common stock of Ford Motor Co. was the biggest stock deal so far this year.

The Goodyear STEP Income notes sold last week ranked No. 17 among the biggest single-stock offerings of the year, according to data compiled by Prospect News.

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