Bank of America’s $168.52 million leveraged notes linked to S&P 500 seen as short and sweet

By Emma Trincal

New York, Aug. 5 – Bank of America Corp.’s $168.52 million issue of 0% Accelerated Return Notes due Sept. 30, 2016 linked to the S&P 500 index is the latest of the firm’s giant month-end deals. The deal priced July 30 and ranks No. 7 for the year so far, according to data compiled by Prospect News.

If the index return is positive, the payout at maturity will be par of $10 plus 300% of the index return, subject to a maximum return of 10.41%, according to a 424B2 filing with the Securities and Exchange Commission.

If the index return is negative, investors will be fully exposed to the decline.

Short is good

Despite having 100% of their money at risk, investors apparently were drawn to the structure given the deal size. A market participant explained why: “Merrill has really been specializing in these short-dated leveraged deals. They’ve done really well with them.

“The S&P is the most broadly used index. Whenever you have the S&P in a shorter-dated maturity, it’s always interesting.”

As investors grow less bullish about the market, the appeal of the three-times leverage multiple makes sense.

“People anticipate moderate returns going forward like 5%, 6% or 7% a year. Whenever you get that leverage on the upside in a very short-term note, clients like it,” he said.

“They don’t perceive too much risk short term. Volatility is still very low.

“Shorter is better. They’re happy to get these returns.”

Risk-reward

Leverage in a structured note, such as this one, offers benefits versus a long-only investment, sources noted.

“Compare it with an ETF where you get one side up and one side down,” said an industry source.

The lack of downside protection is the result of the issuer’s focus on return enhancement.

“They give you the ability to get more upside. You can’t get those terms on a one-year or 14-month with a barrier or a buffer,” he said.

“It’s a short maturity. It’s a good deal.”

But investors have to be cautious.

“It’s a good potential return, but you’re getting some risk too. In my opinion it’s more risk on the downside than on the upside,” this source said.

Notes versus ETFs

Paul Weisbruch, vice president of options sales trading at Street One Financial, said the leveraged notes offer two benefits compared to a leveraged ETF.

“You don’t have the leverage on the downside. That’s a plus,” he said.

“Also, the point-to-point makes a huge difference. A three-times levered ETF with a daily reset would eat alive your performance.

“Here, you no longer have to worry about the short-term volatility.”

Seesaw market

Despite those advantages, investors in the notes incur credit risk exposure, unlike equity investors, while lacking the liquidity of an ETF.

“I don’t think I would look into it. I’m leaning more on the bearish side. I’m more of a bear than a bull at these levels,” he said.

“But I can see why people would be tempted to be bullish. The market is very choppy. It keeps on going up and down and up. After a short selloff, people buy on the dips and the market keeps rallying. This cycle doesn’t seem to end.”

However, at some point it may end. One year or 14 months would be enough to change the complacent pattern of today’s market, he said, leaving investors in the notes at risk of losing principal.

“The one-year [term] would be concerning to me because there are imminent rates rises. It does put you in a situation where with the no-protection, you’re making a gamble one year out,” he said.

“One year out, the environment unquestionably will be different. A lot will depend on how the Fed raises rates and also on how portfolio managers react to the hike, if they sell out or decide to rebalance their positions.”

The notes (Cusip: 06053W490) priced on July 30.

BofA Merrill Lynch was the underwriter.

The fee was 2%.

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