BofA Finance introduces two offerings with rare 'American-style' barriers

By Emma Trincal

New York, April 26 – BofA Finance LLC used the uncommon “American-style” option for the pricing of two autocallable note offerings last week with varying rates of success.

To determine the principal repayment at maturity, most barriers are observed point-to-point, using a so-called “European” barrier option. Less common, the principal repayment barrier can be knocked out at any time during the life of the notes, introducing more risk but also more pricing power.

It’s what BofA did last week with two autocallable yield note offerings.

American barrier, gold

The first deal, which priced at $3.5 million consisted of 12-month contingent income autocallable yield notes linked to the Nasdaq-100 index, Russell 2000 index and VanEck Gold Miners ETF, according to a 424B2 filing with the Securities and Exchange Commission.

Investors will receive a coupon of 19.35%, paid monthly, if each underlier closes at or above its 65% coupon barrier on the related monthly observation date.

The securities will be called automatically after six months at par on any quarterly call determination date if each asset closes at or above 105% of its initial level.

If none of the assets closes below the 65% threshold value during the life of the notes or if all three assets finish above their initial levels, the payout at maturity will be par plus the contingent coupon. Otherwise, investors will lose 1% for every 1% that the worst performing asset declines.

“That’s very risky. We never do American barriers. Since the underlier can knock the barrier any day you’re more likely to lose money,” said Mark Dueholm, chief fixed-income trader at Landolt Securities.

“I can see why you’re getting such a high coupon. Those barrier options are much cheaper. But you’re really gambling, especially with gold.”

Having the call threshold at 105% also brought extra risk, he noted.

“You’re less likely to get called, which means you’re more likely to breach the barrier. The longer you hold the notes, the greater the chance of falling below 65%, especially if it can happen any time.”

American barrier, three indexes

The second offering, which priced for $36.16 million, also adopted an American-style barrier option but some risk mitigation factors were included in the package.

The term was shortened to 12 months. The underliers were almost identical with the VanEck Gold Miners ETF [Ticker: GDX] replaced by the S&P 500 index. The coupon, payable monthly at a rate of 13.55%, was guaranteed, not conditional. The six-month call protection was maintained but the autocall frequency was monthly rather than quarterly with a call threshold back to the normal 100% level. However, the contingent protection was slightly reduced from 35% to 30%.

“That one remains very risky since the barrier is still observed daily,” said Dueholm.

“But it’s a little less crazy because they got rid of the GDX. Even though gold has been a little bit more stable lately it’s still very volatile.”

The call trigger at par also helped reduce the risk, increasing the odds of an early redemption, he said.

“You take less risk therefore your coupon is lower. But it’s a fixed coupon, which makes it significantly more appealing than the other. Despite the barrier, I can see how they were able to raise much more money on this one.”

Bespoke offering

A market participant reached similar conclusions in comparing the two notes although he downplayed some of the risk introduced by the American barrier.

“The first deal seems like a customized offering. Someone was looking for a huge coupon – almost 20% -and was willing to take the risk for that,” he said.

“The adviser probably had to go for an American barrier to get that kind of coupon.”

This market participant said that he did not expect this type of barrier to become “mainstream.”

While some investors have been willing to put their coupon at risk with American barriers, the use of such barriers is rare when it comes to putting one’s principal at risk, he noted.

“I don’t think many people would be willing to use those barriers. I think it’s a one-off.”

This market participant agreed that the second offering was less risky, hence the lower coupon of 13.55% versus 19.35% in the first one.

“The second note is much more mainstream with the exposure to the three common indices. You see those deals all the time. People can understand the risk much better,” he said.

“What’s much less common is the American barrier. I guess the fixed coupon, the autocallable trigger at par, which increases the probability of getting called and the use of conventional underliers helped offset some of the risk attached to the American barrier,” he said.

All about gold

But what really decreased the risk of losses was the elimination of one of the underliers seen in the first deal, he added.

“The barrier with daily monitoring increases the risk but not substantially so. Statistically, if GDX is down below 65% anytime during the life, it’s likely that it would also be down over the 15-month mark. The conditional probability is not that different between the two barrier types,” he said.

“The main risk factor is GDX due to its extremely high volatility.”

What about the dispersion risk? Did the Gold Miners ETF in the worst-of contribute to the high premium given the ETF’s low correlation with the equity indexes? The market participant downplayed this assumption, again insisting on the volatility factor.

“There might be a low correlation between the ETF and the indices and to a lesser extent between the Russell and the Nasdaq. But the correlation is not a big driver, here. If the market drops, correlations will go up. What really drives pricing is the fact that GDX is extremely volatile.

“By removing it in the second deal, you’re creating a much more balanced risk-reward profile.”

And the winner is...

Playing with these different variables, BofA Finance last week introduced a third deal, which turned out to be the winner in size. The issuer priced $93.39 million of 11.01% fixed-income autocallable yield notes due April 24, 2024 linked to the worst performing of the Russell 2000 index, the Nasdaq-100 index and the S&P 500 index. The issuer offered a 70% barrier, European-style, eliminating the daily monitoring.

“It’s the same as the second deal except that you’re back to the conventional European barrier. Without the GDX and the American barrier, you’re getting the lowest coupon of the three,” he said.

“But it was also the biggest deal.”

BofA Securities, Inc. was the agent on the three deals, which settled on Monday.

The $3.5 million deal (Cusip: 09709VS98) carried a 1% fee.

The fee for the two other notes was 0.25%.

The Cusip number for the $36.16 million deal is 09709VEG7.

The Cusip number for the $93.39 million offering is 09709VMX1.

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