BofA Finance’s two bear note issues tied respectively to S&P, Russell 2000 may be a tough sale

By Emma Trincal

New York, April 26 – Bank of America announced the pricing of two bear notes offerings, a surprising move for a firm that has branded Merrill Lynch, its wealth management arm, as the bull of Wall Street.

Bear notes are notoriously difficult to market, sellsiders said. With the S&P 500 index already up nearly 7% this year, bear notes may find their place in a portfolio for the purpose of hedging. They may also be used as a bearish play for those who believe that the more than eight-year long bull market is nearing its end, they noted.

Two deals

The first notes offer a digital payout; the second ones are autocallables that pay a call premium upon the early redemption if any.

BofA Finance LLC plans to price 0% bear notes due April 2019 linked to the S&P 500 index, according to a 424B2 filing with the Securities and Exchange Commission.

The payout at maturity will be par of $10 plus a conditional payment of 18% to 24% if the index finishes at or below its initial level. Investors will lose 1% for each 1% index gain.

In addition, BofA Finance announced the pricing of 0% bear Strategic Accelerated Redemption Securities due April 2019 linked to the Russell 2000 index, according to a 424B2 filing with the SEC.

The note s will be called at par plus a premium of 10% to 12% if the index closes at or below its initial level on any annual call date.

If the notes are not called, investors will lose 1% for every 1% index gain.

Imperfect hedge

“You may think you can use these notes as a hedge for a long-only portfolio. But I don’t know if I would do that,” a buysider said.

“For one thing, your downside is unlimited. If the market is up you can lose 100% of your investment.

“I think you’re much better off with a put option or the short S&P ETF.”

He was referring the ProShares Short S&P exchange-traded fund, which provides the inverse return of the equity benchmark.

The put offered the advantage of limiting the downside risk since the maximum loss is limited to the amount of premium paid to purchase the option. The ETF presents the advantage of being liquid, allowing investors to exit the trade any time.

Shorting the market with a structured note was an exercise in timing, he added.

“The two-year term is too long. To be short, you have to be right right away. You can’t afford to be wrong for a year and a half... After that if you have a sell-off it’s already too late.”

Hard to market

A market participant agreed. He said that bear notes are not sought after by investors partly because the success of the investment requires timing the market over a short period of time.

“We’ve always found bear notes hard to sell,” this market participant said.

“From time to time we have clients who like them, so you can see some demand. But by and large the popularity of those products is very limited.”

The strategy however can be successful in some cases.

“We had a bearish housing product just before the housing bubble burst. This was the only time we had a good success with it,” he said.

If bear notes may work in some circumstances, as a rule investors show little appetite for them.

Execution

“People are less likely to be successful timing a bear market than a bull market. That’s why bear notes are a little scary,” he said.

“Those products may look like a good strategy to express a bearish view...But bear markets are very short-lived and timing is the key.

“If the market is down 10% the selling is already well under way. People think they’ve missed it. The market usually recovers quickly. Unlike a rally that can last for a while, stocks in a bear market go down bigger, faster than they go up...and they go down in big, big drops.

“That’s why a bear note may not be the best trading tool for a bearish investor.”

The notes will be guaranteed by Bank of America Corp.

BofA Merrill Lynch is the agent on both deals.

The notes are expected to price in April and settle in May.

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