BofA Finance’s step-up autocallables linked to Hang Seng China Enterprises seen as too risky

By Emma Trincal

New York, June 11 – BofA Finance LLC’s three-year 0% autocallable market-linked step-up notes linked to the Hang Seng China Enterprises index are designed for a range-bound market, sources said. But this structure type is not ideal with an underlying index as volatile as the Hang Seng China Enterprises, they added.

The notes will be called at an annual call premium of 12% if the index closes at or above its initial level on any annual call date, one and two years after the pricing date, according to a 424B2 filing with the Securities and Exchange Commission.

If the index finishes at or above the step-up value – 128% to 134% of the initial level – the payout at maturity will be par of $10 plus the index gain. The step-up value will be set at pricing.

If the index is unchanged or gains by up to the step-up level, the payout will be par plus the step-up payment of 28% to 34%, which will be set at pricing.

Investors will be exposed to any losses.

Wild swings

“I don’t think you get to maturity. I’m ready to bet there is more than a 50/50 chance you get called on the first year,” a market participant said.

“So your upside is limited to 12%. On the downside, you’re one-to-one.”

He pointed to the volatility of the Hang Seng China Enterprises index.

“In less than three years it declined by 30%,” he said, looking back on the chart from a high of 10,718 in September 2013 to a low of 7,505 in February 2016.

But the index is also volatile on the upside.

From the February 2016 low, it climbed to a new peak of 13,724 in January 2018, an 83% increase in less than two years.

“This thing can definitely move around,” he said.

“Based on that, you have to figure out a few things.

“There is no downside protection. If things go down, you get hurt pretty substantially.

“If things go up, you don’t get a chance to participate because you’re going to get called immediately.

“It doesn’t work in the investor’s favor.”

Upside risk

Looking back at the 83% index gain in two years, he said that in comparison, an investor in the notes would be called at a premium of 24% if called at that time.

“If I assume I can make 83% in two years – as we know it can happen – and if the notes get called at 24%, I’m leaving almost 60% on the table.

“On the downside, if it’s down 30% – and it can be down 30% – I’m in a lot of trouble.

“A range-bound trade on a very volatile asset is kind of strange.”

Trade tensions

Meanwhile, the U.S./China trade war has yet to be resolved, he noted.

“It’s almost why I don’t want to invest at that point of time.

“If things get settled in a positive way, China will rally as well as the U.S. because they’re two giant trade partners. You’d be missing a whole lot of upside with this note.

“If things don’t get resolved, you get hit.

“This is not an attractive trade. With that type of volatility, your risk exposure is too high.”

Risk-adjusted return

Tom Balcom, founder of 1650 Wealth Management, shared the same view.

“I would want downside protection on that. If you’re bullish, it’s not for you since you’re capped with the call,” he said.

“Even if you think the market will trade sideways, you still need the downside protection, otherwise the risk/reward is not appealing,” he said.

Balcom pointed to another price move in the index: a 50% drop from May 2015 to February 2016.

“There’s no protection there, and a volatile index like this one can swing pretty dramatically.”

Unlike other notes, this one failed to offer a compelling alternative to a direct investment in the index, he added.

“If you’re bullish, you want to be long-only. You don’t want your exposure to be limited,” he said.

“In any case, if you’re not getting a buffer or even a barrier, you’re better of being long so you can get out if it goes wrong.

“I would caution any investor seeking exposure to the Chinese equity market to think first and foremost about defense before thinking about offense.”

The notes are guaranteed by Bank of America Corp.

BofA Merrill Lynch is the agent.

The notes will price in June and settle in July.

© 2015 Prospect News.
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