Bank of America's $5.09 million notes on S&P 500 offer 9X leverage but full downside risk

By Emma Trincal

New York, Sept. 20 - The Bank of America Corp.'s $5.09 million of 0% Accelerated Return Notes due Sept. 25, 2020 linked to the S&P 500 index are "attractive" for the return potential offered through an "unusually high" leverage factor of nine, advisers said.

But the long-term maturity and the lack of downside protection make the product "unsuitable" for a large number of investors, they noted.

The payout at maturity will be par of $10 plus nine times any index gain, subject to a maximum return of 220.59%, according to a 424B2 filing with the Securities and Exchange Commission. Investors will be fully exposed to any index decline.

According to the prospectus, the notes are designed for investors who believe that over a 10-year period, the index will increase only "moderately."

Yet, sources said that investors need to have a high appetite for risk in order to make the "moderately" bullish bet.

High-octane product

"This is mainly an enhanced return product, as there's obviously no protection," said Carl Kunhardt, director of investment management and research at Quest Capital Management.

"It looks like a high-octane return with nine times the benchmark return. It's more appropriate for younger, more aggressive investors who don't need the liquidity," he added.

While nine times leverage is both unusual and attractive, several factors limit the appeal of the product, sources said.

No protection

The first one is the lack of downside protection, which "makes the product unsuitable for conservative investors," said Pran Tiku, president of Peak Financial Management, Inc.

But the product may not be appropriate for bulls either, he reasoned.

"If you're bullish on the market, you're likely going to be a global investor and you're not going to be confined to the S&P 500," he said.

Some advisers simply prefer a different risk/return profile for their clients.

"I don't know if I would be attracted to this deal in this day and age. I'm looking for more protection rather than more returns," said Kunhardt.

Watch that cap

Another drawback is the 220.59% cap that limits return at the end of the 10-year term, which is the equivalent of an 8.2% annualized compounded return, said Tiku.

"On the face of it, it sounds like a reasonable return," he said. "But you have no downside protection and no liquidity."

The "lack of liquidity," he explained, is the combined result of a long-term maturity and the low liquidity of structured notes in general. "You can't count on getting a higher price if you sell prior to maturity," he said.

Looking at the upside potential, sources said that returns may be limited either by the cap or by the market itself.

Even if the S&P 500 performs range bound, as the notes have been designed for, investors are not necessarily going to fully benefit from the high leverage factor, said Kunhardt.

"The bank is not taking it out unhedged. It's very unlikely that they will pay you nine times the return because you're going to hit the cap," he said.

Tiku said that "returns are likely to be cyclical" over the next decade.

"You're not going to have a huge return every single year. You're going to have a year with good returns, a year flat, a year with bad returns, etc," he said.

But overall, moderate bulls are the ones who will like the notes the most, sources said, because the most favorable outcome would be the index grows enough to hit the cap but not beyond that.

Merrill Lynch, Pierce, Fenner & Smith Inc. is the underwriter.

The fees are 2.5%.

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