BofA’s $33.89 million 16.12% fixed-income autocalls on indexes use riskier barrier type

By Emma Trincal

New York, Nov. 2 – BofA Finance LLC priced an issue of short-term autocallable notes with a high double-digit and guaranteed coupon. The payout was made possible by the use of a so-called American barrier at maturity. American barriers are observed during the life of a note while the commonly used European barriers are only monitored at maturity.

BofA’s $33.89 million of 16.12% fixed-income autocallable yield notes due Oct. 26, 2023 are linked to the worst performing of the Russell 2000 index, the Nasdaq-100 index and the S&P 500 index, according to a 424B2 filing with the Securities and Exchange Commission.

Interest is payable monthly.

The notes will be called at par if each index closes above its initial level on any monthly determination date after six months.

The payout at maturity will be par if no index closes below its 70% threshold level during the life of the notes or if all three indexes close above their initial levels. Otherwise, investors will be fully exposed to any losses of the worst-performing index.

Three short puts

“The American barrier is inevitable,” a market participant said.

“In order to price the terms that you have – a guaranteed 16% rate – you need enough premium. In this case you get it by increasing the odds of losing some of your principal. Once you breach – and it can happen on any trading day – you’re long the worst-of on the downside.”

He explained how the notes were structured.

“The barrier basically knocks in the short position of the worst of three puts. For each put, the strike is at 100 and the knock-in at 70. You knock in when the worst-of drops below 70 at any time. But you’re short the worst-of put at the money. If the worst-of knocks in during the term and you finish at 80, you’ll lose 20 because the short put strike is at the money,” he said.

The term at-the-money refers to the initial level of the underlying, or 100 for the notes.

A put sale is a bet that the underlying will stay above the strike price. If it doesn’t, the put writer is “assigned” to buy the underlying at the strike price, which naturally has become higher. Therefore, even if the price finishes above the 70% barrier, the barrier has “knocked in” and investors are fully exposed to losses from the initial (at-the-money) level.

Tradeoff

“Technically there’s nothing new in using American barriers. It’s just that it’s usually done on the coupon. Typically, the barrier at maturity is not an American option. It’s a European option,” he said.

“Here they observe it every day to increase the value of the short put.”

Investors buying those riskier products should understand the tradeoff, he said.

“Something has to give. You are not going to get a 16% fixed rate for nothing There’s much more risk with an American barrier, but you also get a lot more value, which you can spend on many different things,” he said.

Among those, he cited a lower barrier, a higher coupon and/or a guaranteed coupon as well as a shorter tenor.

Point-to-point

A sellsider was intrigued by the use of a daily observation barrier for the principal repayment.

“They used to be a lot more common. Six or seven years ago there were plenty of them, especially when volatility was higher,” he said.

“We’ve never really done American barriers either on the coupon or at maturity.

“Doing it on the coupon doesn’t have a big impact. But an American barrier at maturity can significantly enhance the return.”

A single breach of the 70% barrier at any time and investors lose all downside protection when the notes mature, he said.

“You can incur big losses while if you breach the coupon barrier, it only limits the number of coupons you will receive. It’s a much more limited risk since it only impacts your payout, not your principal,” he said.

Suitability

This sellsider saw value in the structure. But the sale of those products required extra due diligence.

“You have to be careful with those barriers. It enhances the yield so much that people become very greedy.

“In a way it makes sense. Getting a 17% coupon versus 11% or 12% on the vanilla version is really tempting.

“Personally, with the S&P already down 20% and based on historically back-tested performance, I don’t see a ton of downside risk with this 70% American barrier.

“You have to walk a fine line between giving investors what they want without taking undue risks.

“I don’t think this deal is crazy. But it’s probably not a good fit for conservative investors,” he said.

The notes are guaranteed by Bank of America Corp.

BofA Securities, Inc. is the selling agent.

The notes settled on Oct. 26.

The Cusip number is 09709V4M5.

The fee is 0.25%.

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