BofA’s step-down trigger autocall on S&P, Stoxx offer “reasonable,” yet uninspiring income bet

By Emma Trincal

New York, June 27 – BofA Finance LLC’s 0% step-down trigger autocallable notes due June 30, 2027 linked to the lesser performing of the S&P 500 index and the Euro Stoxx 50 index present a “reasonable” chance to earn a double-digit return, but advisers found little to be “excited” about the product.

The notes will be called at par plus 9.3% to 10.3% annualized if each index closes at or above its initial level on any quarterly review date after one year or at or above its 70% step down threshold on the final valuation date, according to a 424B2 filing with the Securities and Exchange Commission. The exact call return rate will be set at pricing.

If all indexes close above the step-down threshold, the payout at maturity will be par plus 46.5% to 51.5%.

Otherwise, investors will lose 1% for each 1% decline of the worst performer from its initial level.

Creditworthiness

Steven Foldes, wealth manager and founder at Evensky & Katz / Foldes Wealth Management, looked at the creditworthiness of the issuer first.

“I don’t have a problem with Bank of America. Their credit spreads are fine compared to other U.S. banks.”

Bank of America’s five-year credit default swap rates are 101 basis points, according to Markit, slightly wider than Wells Fargo (97 bps) and JPMorgan (97 bps) but tighter than Morgan Stanley, Citigroup and Goldman Sachs showing spreads of 115 bps, 117 bps and 127 bps respectively.

Foldes picked a hypothetical call premium of 10%.

“I also like the fact that you’re very likely to get your 10%. The cumulative payments are also attractive.”

Fee, dividends

But Foldes mentioned a few “pretty strong negatives” as well.

The fee, disclosed in the prospectus, at 2.5% was one of them.

“It’s a little expensive especially if you get called. You get called after one year and your cost is now 2.5% per year, not 50 bps per annum. That’s a lot,” he said.

The “loss” of dividends was another issue.

“With the European index, there’s a significant opportunity cost,” he said.

The S&P 500 index yields 1.69% and the Euro Stoxx 50 index, 3.25%.

“If you average out the two yields, you’re missing about 2.5% per year.”

Worst of

The worst-of payout was not a term favorable to investors; yet it did not represent a significant shortcoming in this adviser’s view.

“Both indices have to be up and that’s a little bit of an issue but at the same time, they’re likely to be up given the current levels we’re in,” he said.

The S&P 500 index dropped 18% so far this year and the Euro Stoxx 50 index is down 22% for the period.

“It’s an attractive income play because of the high likelihood that you’re going to get paid. The cumulative payments make it more interesting. I also like the step-down of 70% at maturity. All these features give you a pretty good chance to get 10% a year. And the call protection guarantees that any return won’t be less than 10%.”

Correlations

The correlation between the two underlying indexes was another limitation.

“Usually with a worst-of you’d like to see higher correlations. I can’t say I love the correlation. I’d rather see two U.S. indexes, for instance the S&P and the Russell 2000 index or even better, the S&P and the Dow Jones industrial average, rather than one U.S. index with the European benchmark.”

The coefficient of correlation between the two underlying indexes is of 0.837.

In comparison, the Dow Jones and the S&P 500 have a 0.959 coefficient of correlation while the S&P 500 and the Russell 2000 show a correlation of 0.89.

“It’s certainly possible to have a divergence between the S&P and the Euro Stoxx. The S&P may very well recover while the Euro Stoxx could continue to fall given the major problems in Europe,” he said.

“It’s a reasonable income play but given the expenses and the dividends, it’s not something I would jump all over.”

Not exciting

Carl Kunhardt, wealth adviser at Quest Capital Management, also expressed a mixed, somewhat negative view on the deal.

“There’s nothing inherent to this note that makes me hate it or love it. It’s one of those that don’t really excite me either way. I’m not sure I would do it.”

Kunhardt in general avoids worst-of payoffs and autocallable structures.

“You have Europe and the U.S. That’s apples to oranges,” he said.

The structure was not overly complicated to understand but involved several scenarios that advisers needed to explain in detail to clients.

“At some point the clients look at you and say, ‘why are you doing this?’

The case against autocalls

“The answer is: for income. You get the income with an autocall. Unfortunately, I’m not a fan of autocalls. There are a number of things I don’t like with this type of note.”

Kunhardt began with the risk-adjusted reward of autocallable payouts.

The upside is always capped to the coupon and the downside risk becomes unlimited once the barrier is breached, he said.

Another problem in his view was the contingency of the coupon.

“Your coupon or premium is almost always at risk,” he said.

“I find it hard to use a note for income when you don’t know if you’re going to get paid. If only one index is not up, you don’t get paid.”

Finally, investors are subject to reinvestment risk.

“They give you a one-year call protection. Fine. But you still have the reinvestment risk. You get called after one year at 9.3% and now you have to reinvest the proceeds.”

Growth wanted

Worst-of payouts are another red flag for this adviser.

“You have to bet on a loser. There’s something inherently wrong to me with those bets. I know some people make money shorting. But it doesn’t seem right to me,” he said.

Overall, the note fit into a category of product Kunhardt has limited interest for.

“I want growth. If the market is up, I want to participate in the upside.

“I like traditional notes with upside participation and downside protection.”

Financial planning

Kunhardt explained the reasons for his preference. He defined his main role with his clients as building and balancing their respective portfolios.

“It all comes down to a different perspective,” he said.

“If you’re a broker – and I’m not saying that in a derogatory way – this note makes a lot of sense for investment management purposes. For a financial planner like me, it offers limited benefits. Too much uncertainty and too much risk. You can be called in 12 months. There’s no guarantee that you’ll collect any income.

“The risk is difficult to assess, especially with the worst-of.

“None of these features meet any of my needs as an asset allocator.”

UBS Financial Services Inc. and BofA Finance LLC are the agents.

A guarantee comes from Bank of America Corp.

The notes will price on June 28 and settle on June 30.

The Cusip number is 09710G452.

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