BofA’s $2.82 million 8% fixed coupon on indexes show low yield, high fee, buysider says

By Emma Trincal

New York, Dec. 6 – BofA Finance LLC’s $2.82 million of fixed income issuer callable yield notes due Dec. 3, 2024 linked to the Russell 2000 index, the Nasdaq-100 index and S&P 500 index provide a guaranteed coupon, but the risks and cost are not negligible, making the structure of the note disappointing, a buysider said. A market participant on the other hand saw the return commensurate with the level of risk.

Investors will receive a coupon of 8%, paid monthly, according to a 424B2 filing with the Securities and Exchange Commission.

The securities may be called starting May 31, 2024 on any monthly call date.

If the worst performing index gains or ends above its 70% threshold value, the payout at maturity will be par plus the contingent coupon. Investors will lose 1% for every 1% that the worst performing index declines if it finishes below its threshold value.

Low risk, low return

“It’s not high-risk. I would say it’s a moderate risk, moderate return type of profile,” a market participant said.

He pointed to the three indexes used in the worst-of.

“They’re the three major U.S. benchmarks. Historically, they are pretty correlated,” he added.

The one-year coefficient of correlation is 0.87 between the S&P 500 and the Nasdaq-100 and 0.88 between the S&P 500 and the Russell 2000 index.

The Russell and the Nasdaq display the lowest correlation with a coefficient of 0.77.

Dispersion

But the stock market this year has revealed striking differences in the performances of those three indexes, he noted.

The Nasdaq has climbed 35%, the S&P 500 has gained 18.5% and the Russell 2000 has increased by only 5%.

“The correlation is high historically. If you pick this year as your period, yes there is a risk. You’re getting the return of the least performing one. There’s always a chance to breach that 70% barrier. That’s why they’re paying you a fixed rate of 8% a year with a six-month no-call. At least, you’re guaranteed 4%,” he said.

“It’s not a very exciting return. But it’s not a very risky trade either. I understand the rationale. Would I do it is a different story. But the numbers make sense.”

High commission

A buysider noticed the 2.2% fee disclosed in the filing.

“That kind of explains the terms,” he said.

“You’re taking a number of risks and you’re not getting paid much for it.”

The note could last between six months and one year. Regardless of whether it is called or not and when, if it is, its coupon will underperform any of the T-bill yields during that stretch of time, he said.

T-bill rates range from 5.44% for the three-month to 5.1% for the one-year.

Covariance

The discretionary call added uncertainty.

“It’s issuer call. You could be called any month starting in May,” he said.

“You may also be locked in for 12 months if they don’t call. Then you have market risk exposure.”

This buysider did not minimize the worst-of risk.

“The three indices are still highly correlated, which means everything moves together either up or down. But the covariance is an issue. The spread dispersion is wider than before,” he said.

“It’s not about correlation. It’s about covariance.”

If the Russell for instance was to fall 6% during the 12-month period, and the Nasdaq to drop 36%, the barrier would be breached, he said.

“That’s the risk if we’re heading toward a recession,” he said.

Zero commission

Cost was the main problem, according to this buysider.

“For a one-year piece of paper, 2.2% is a strikingly high distribution fee,” he said.

“I’m having a hard time finding anything attractive about this note.”

He repriced the product by simply cutting the fee to 0%. He found that the fixed interest rate could be raised to 10%.

“It would be more compelling. At least, you would get twice what cash is paying,” he said.

But as currently priced, according to the filing, the payout was disappointing, he said.

“I don’t see why I would take the equity risk, the credit risk, the call risk and having to explain it when I can find better alternatives in cash or T-bills.

“It’s all about cost,” he said.

The notes are guaranteed by Bank of America Corp.

BofA Securities, Inc. is the agent.

The notes settled on Nov. 30.

The Cusip number is 09711AYZ5.

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