BofA’s $560,000 contingent coupon notes on indexes, ETF show deep barrier but Nasdaq a risk

By Emma Trincal

New York, Jan. 10 – BofA Finance LLC’s $560,000 of contingent income issuer callable yield notes due Jan. 10, 2028 linked to the worst performing of the Nasdaq-100 index, the Russell 2000 index and the VanEck Gold Miners ETF offer a “healthy barrier,” a financial adviser said along with an attractive entry price given the current market downturn. But barrier sizes are relative. For bears, the risk may not be worth the double-digit coupon.

The notes will pay a contingent monthly coupon at an annual rate of 11% if each underlying asset is greater than or equal to its 50% coupon barrier on that monthly observation date, according to a 424B2 filing with the Securities and Exchange Commission.

The notes are callable at par plus any coupon otherwise due on any monthly observation date starting on Jan. 10, 2024.

The payout at maturity will be par plus the final coupon unless any underlying asset finishes below its 50% threshold level, in which case investors will be fully exposed to the decline of the worst performing underlying asset from its initial level.

Entry point

Tom Balcom, founder of 1650 Wealth Management, said that it’s nearly impossible to predict which of the three underlyings will be the worst-performer at maturity if the notes do not get called.

“Anything can happen in five years...another pandemic.... a geopolitical event...”

Another factor of uncertainty was the issuer call.

“You can’t really tell if or when they will call the notes. But at least they can’t do it during the first year,” he said.

Despite the risks associated with the exposure to three relatively volatile underliers, Balcom said that the note offered a satisfying level of protection.

The three underlying assets have already declined from their peaks, he noted, with drops ranging from 20% to 30%.

“It’s not as if you were pricing this note at the top of the market,” he said.

For Balcom, the Gold Miners ETF, which has incurred smaller losses than the two other underliers, could turn out to be the worst-of.

“But it’s just a guess. Things can change in five years. The worst performer on year one and the worst performer at maturity are unlikely to be the same,” he said.

The timing of a potential call was also unpredictable, he noted. However, the call risk was limited by the one-year protection.

Risk-adjusted return

Balcom said that he evaluates the risk-adjusted return of any note he purchases by comparing its return with Treasuries.

“If you compare your 11% return with a two-year Treasury yielding 4.25%, it’s fair to say that you’re being generously compensated for the risk here,” he said.

Balcom pointed to risk mitigation factors for investors in the note.

“The 50% barrier is very healthy. It’s going to be hard to breach especially five years from now. And, we already have some built-up protection from the market pullback.

“I think the risk-adjusted return is fair.”

More to come

A market analyst had a bearish view.

“All three underlying have already retreated from their highs. But I believe there is further downside ahead of us. The Nasdaq, especially, is going to drop a lot more,” he said.

Even though the tech heavy benchmark has already shed a third of its value last year, this analyst expects the 50% barrier to be breached during the life of the notes, which would reduce the expected return for noteholders.

The greatest risk was to lose coupon payments. The risk of loss of principal at maturity was somewhat mitigated by the duration of the notes, he said.

“I wouldn’t surprise me if you only got three years’ worth of interest. That’s about 7% a year.”

This analyst compared the contingent coupon with the yield paid by government bonds.

“Today you can buy a one-year T bill and get a 4.77% guaranteed yield. The difference between the risk-free rate and 7% is not great enough to take on the extra risk. You’re not getting paid nearly enough,” he said.

This analyst said that his market viewpoint was the mere result of a close study of past bear cycles.

During the March 2000 to October 2002 bear market, the Nasdaq-100 lost 83.6%, he noted.

“My assumption is that we’ll see bigger losses this time. One, because the Nasdaq is much more in a bubble today than it was in 2000. And two, because the current bear market follows the longest bull cycle in history. The longer the bull market, the longer the following bear cycle. That too has been demonstrated by history over and over.”

Lessons from history

To estimate how much more the Nasdaq-100 may fall, he used the corresponding ETF, which is the Invesco QQQ Trust, Series 1.

He assumed the same percentage decline of 83.6% seen in 2000-02.

The QQQ ETF hit a high of $405.20 in November 2021. By extrapolation, an 83.6% drop would move the share price to a $66.45 low.

The notes priced on January 5 when the ETF closed at $261.58. From that initial level to the $66.45 hypothetical bottom, the decline would be as much as 75%.

“This may seem extreme, but it’s not. You have to look at history. The five previous bubbles since 1837 have shown price drops averaging 84%,” he said.

Coupon at risk

Those five U.S. market crashes occurred in 1837, 1873, 1929, 1973 and 2000.

“Our bear market is still very young. For the Nasdaq, the top was November 2021. We’re not anywhere near bottom yet,” he said.

“Bear markets are short. But this one should last longer. Maybe the five-year term is not enough time for the market to recover,” he said.

If the estimated 75% additional price drop in the Nasdaq is correct, the index would have to double to get back to the 50% barrier level, he noted.

“The risk of principal loss is limited over five years, but you can’t totally rule it out. The length and intensity of the market decline are key factors,” he said.

“What I’m pretty sure of is that you’re not going to get a consistent 11% a year. You’ll get much less. And that’s not just because the issuer may call the notes. A call would actually be a good thing.

“Compare this note with Treasuries, which give you guaranteed income and safety of principal. You have to ask yourself: Is it really worth taking on so much risk?”

The notes are guaranteed by Bank of America Corp.

BofA Securities, Inc. is the selling agent.

The notes settled on Tuesday.

The Cusip number is 09709VDH6.

The fee is 0.5%.

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