Bank of America’s 7%-9% autocallables linked to Disney are unusual type of reverse convertible

By Emma Trincal

New York, Oct. 22 – Bank of America Corp.’s 7% to 9% autocallable coupon-bearing notes due November 2016 linked to Walt Disney Co. shares present all the characteristics of a reverse convertible except one, sources noted. It offers no barrier.

The product’s interest is paid quarterly, according to a 424B2 filing with the Securities and Exchange Commission. The exact rate will be set at pricing, at the end of the month.

The payout at maturity will be par of $10 unless Disney shares finish below the initial level, in which case investors will be exposed to the decline.

Conversion

The structure is in essence a reverse convertible, a market participant said, in that the investor sells the issuer the right to sell the stock to the noteholder at a predefined strike price if the stock finishes at or below the strike. For taking that risk, the investor gets paid a guaranteed coupon, which would be the equivalent of receiving a premium on a short put trade, he explained.

“And yet, I wouldn’t call it a reverse convertible because a reverse convertible would have to have a knock-in or some sort of contingent protection,” he said.

The term reverse convertible is not used in the prospectus.

Range bound

Steve Doucette, financial adviser at Proctor Financial, said the notes express a range-bound view, but he found little appeal in the risk-adjusted return.

“If you’re bullish on the stock, why are you going to give up the upside for a 7% or 9% return? You have a 9% cap and an unlimited downside. Why would you invest in this?

“You really have to believe the stock is going to be up but not up by more than 9% after a year. You’re making that bet just to collect the coupon.”

Doucette said he prefers to get exposure to benchmarks.

“We’re more of an asset allocator. We don’t pick individual stocks.

“We prefer to take on market risk than business risk. You eliminate the business risk by diversifying.”

An investor would have to be very eager to capture yield in order to put his entire principal at risk, he said.

“I guess it’s like selling a put. I wonder what’s the craziest thing: this note or a put?

“You probably get a juicier yield for selling the option, but you also risk more capital.

“One contract forces you to buy a hundred shares of the stock if you’re wrong. Disney is now trading at $113. That’s an $11,300 liability. With the note, you can keep your risk down to a $1,000 investment. Less risk, less return. So yes, I guess the put sale is a little crazier.”

Doucette commented on the 1.25% fee, saying that it has an impact but only if the stock drops.

“You get called: you get your principal back and the coupon. ... Same thing at maturity, assuming the stock is up. It’s when it’s down that the fee has an impact because then you are one and a quarter behind the market.”

Liquidity premium

Matt Medeiros, president and chief executive of the Institute for Wealth Management, expressed concern as well about the full downside exposure.

“Walt Disney is an interesting company, but it’s vulnerable to the potential of unbundling of programming” he said.

“The economics of the sector are changing with fewer consumers subscribing to cable TV as they prefer a-la-carte programing and reject the bundle concept.

“So you have some risk here associated with the sector.”

The notes are designed for income, he noted.

“It would be somebody who is looking for the yield because of the current low-yield environment,” he said.

“Giving up the dividends is not a huge sacrifice. Disney pays a 1.2% dividend.”

“However, without having a barrier you bear the risk of lack of liquidity if the stock trends down.

“What I mean is that most structured notes offer a trade-off. You sacrifice liquidity because you get a barrier or a buffer.

“In this case with no downside protection, having no liquidity becomes an issue. You’re boxed in for a year, something you wouldn’t mind doing if you had protection.

“But here you’re long the stock on the downside. It changes everything.”

BofA Merrill Lynch is the agent.

The notes will settle in November.

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