BofA’s $15.34 million autocallable step-up notes linked to Russell fit low return expectations

By Emma Trincal

New York, Aug. 1 – BofA Finance LLC’s $15.34 million of 0% autocallable market-linked step-up notes due July 26, 2024 tied to the Russell 2000 index may prove attractive for investors with moderate performance expectations for the small-cap benchmark. But for bears, the risk is to be locked in for some time and perhaps, should the notes mature, even lose some capital despite the buffer.

The notes will be called at par of $10 plus a premium of 6.25% per year if the index's closing level is greater than or equal to the initial level on any annual observation date, according to a 424B2 filing with the Securities and Exchange Commission.

If the index finishes above the step-up value, 135% of the initial value, the payout at maturity will be par plus the index return.

If the index return is zero or positive but the index finishes at or below the step-up value, the payout will be par plus the step-up payment of 35%.

Investors will receive par if the index declines by up to 15% and will lose 1% for each 1% decline beyond 15%.

Not for income

“It comes down to your return expectations,” said Steve Doucette, financial adviser at Proctor Financial.

One thing for sure, he noted: the investment is not designed for income as the “coupon” is in fact a call premium that gets paid upon redemption, not clipped throughout the life.

“It doesn’t pay anything until the end of the note or if it’s called,” he said.

“You may be able to capture 6.25% for a few years. Or you’re long the index.”

The downside protection for this adviser presented no particular problem at first glance.

“Fifteen percent in a hard buffer is nice to have,” he said.

Uncapped on paper

Another attractive feature making the product distinct from a digital or autocallable contingent coupon deal is the fact that investors at maturity have a chance to participate in a late rally without any limit to the upside.

That in turn means that the notes did not get called on the fourth annual observation date.

“The nice thing is you’re not capped on the upside if the market is very bullish. And perhaps it will be a big run. In five years, the market could go down and go back up. But you’re limited to 6.25% a year,” he said.

“If you don’t get called and the Russell is up a lot at maturity, you’re long the index. You’re not capped. But you’re more likely to be capped at 6.25% a year.”

His rationale was that in order to be long the market above the step level, the index would have had to rise by more than 35% in the last year. Otherwise, the notes would in all likelihood have been called during the previous years.

Not for bulls

This led Doucette to conclude that for a non-bullish investor, the notes may be a good fit.

“What makes it interesting is if the market is range bound,” he said.

“Again it’s all about your expectations. If you see muted returns going forward, then 6.25% a year in a market that doesn’t do much would be a pretty good thing.

“I kind of like it.”

Taking a pass

However, Doucette said he would not consider using the notes.

“We have some leveraged notes on this index, some coming due, and I wouldn’t replace them with this one,” he said.

“I think there are better options when you want to harvest gains. When we buy notes, we want to capture excess return on both ends. That’s why we use huge barriers, like 60%.”

A bear warning

A financial adviser with a bearish outlook on U.S. markets looked at the notes with a more pessimistic angle, focusing more on the market risk.

“At least the buffer would help the downside. But it might not be enough,” he said.

The Russell 2000 peaked last summer and subsequently entered a correction in September, he noted, while the S&P 500 is near all-time highs.

“This indicates that we’re about to see the signs of a bear market soon. All serious investors should get out of the market now.”

The Russell 2000 hit an intraday high on Aug. 31 last year at 1,742.09, bottoming at 1,266.92 on Dec. 24, 2018, a 27.3% decline in just about four months.

Meanwhile, the S&P 500 pushed to a record intraday high at 3,027.98 on July 26.

Not easily called

“The question is, what will the Russell be five years from now?” he said.

In the interim, will the notes have a chance of being automatically called?

For most products of this kind, the greater probability of a call is on the first observation date.

This adviser was doubtful.

“The Russell is already in a bear cycle. We already had a big correction last year, and I expect the index to drop even more. Substantially more,” he said.

“In five years it could drop a lot and go up a lot too, but it could still be down, depending on the magnitude of the bear market.

“If it drops a lot, say by two-thirds from its current level – and I see it as very likely scenario – then it would have to triple to break even. It might not quite get back so easily.”

This is why this adviser said that he did not expect the notes to be called, even on the first year when it’s more likely.

“If we have a very severe bear market, it makes it harder to break even. My guess is that we’re not going to get any coupon.”

BofA Securities, Inc. is the underwriter.

The notes are guaranteed by Bank of America Corp.

The notes (Cusip: 097098826) settled on Thursday.

The fee is 2%.

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