BofA’s $5.29 million 6.5% callable notes on value ETFs seen as large vs. small-cap arbitrage

By Emma Trincal

New York, Feb. 8 – BofA Finance LLC’s $5.29 million of 6.5% trigger callable yield notes due May 5, 2023 linked to the performance of the iShares Russell 2000 Value ETF and the iShares S&P 500 Value ETF offer a neutral bet on value stocks with investors favoring one of the two market capitalization segments in the U.S. equity market – large versus small – buysiders said.

Interest is payable monthly, according to a 424B2 filing with the Securities and Exchange Commission.

The notes are callable at par on any monthly coupon payment date after three months.

The payout at maturity will be par of $10 unless any ETF finishes below its 60% downside threshold level, in which case investors will lose 1% for each 1% decline of the worst performer from its initial level.

Income substitute

“There is a well-defined market view here,” said Tom Balcom, founder of 1650 Wealth Management.

“You’re playing value, which has been out of favor, and you’re betting that it will be back in favor.

Balcom said he liked the guaranteed coupon as opposed to the common contingency.

“It’s definitely an income play.

“You get a nice coupon and it’s a fixed rate. That’s one of the reasons it could easily be used as fixed-income replacement. The other reason is the 60% barrier. 60% is a pretty steep barrier especially on indices.”

Looking for the worst

The iShares S&P 500 Value ETF represents undervalued large-cap stocks. The iShares Russell 2000 Value fund tracks undervalued small-cap equity within the Russell 2000 index.

“The S&P Value is the less likely to be the worst-of,” he said.

“The large-cap value has outperformed the small-cap over the past one, five and 10 years. Small-cap stocks are more volatile. That’s one factor,” he said.

Looking forward, Balcom said the large-cap ETF should continue to beat its small-cap counterpart.

“Rates are going up. Small companies are less insulated from rising rates than larger ones.

“So, my guess is that the underperformer will probably continue to be the Russell Value ETF,” he said.

Valuations

Steven Jon Kaplan, founder and portfolio manager of True Contrarian Investments, took a different approach based on valuations.

“The large-cap one has the most risk because large-cap stocks are more overvalued,” he said.

“I’m not a huge fan of either. Both ETFs trade at high P/Es although the small-cap value one is cheaper.”

The price-per-earnings ratio of the iShares Russell 2000 Value ETF is 13.16 versus 20.20 for the iShares S&P 500 Value fund.

“As a value investor I want to see P/Es below 10. But the Russell Value is much cheaper. There’s a big difference between 13 and above 20,” he noted.

“I would think the worst-of would be the S&P Value one. These are very large-cap stocks that tend to be overpriced,” he added.

Berkshire Hathaway Inc., Johnson & Johnson, Procter & Gamble, Exxon Mobil Corp. and Chevron Corp. are the fund’s top five holdings.

Among the top constituents of the iShares Russell 2000 Value fund: oil company Ovintic Inc., Macys Inc. and Avis Budget Group Inc.

Terms

Kaplan said he liked the barrier size.

“60% might be large enough to at least get you to receive your money back at maturity with your coupon,” he said.

“The Nasdaq can drop 40%. But those two funds are not nearly as overpriced.”

Kaplan pointed to the so-called reinvestment risk associated with the monthly issuer call.

“It’s not a significant risk. You have no call for the first three months. And if you get called, it’s not necessarily a bad thing. It eliminates the end-risk.”

The notes are guaranteed by Bank of America Corp.

BofA Securities, Inc. and UBS Financial Services Inc. are the agents.

The notes priced on Feb. 2 and settled on Feb. 7.

The Cusip number is 09710E234.

The fee is 0%.

Same-day deal

On the same trade date, BofA Finance priced another deal (Cusip: 09710E226) showing identical terms except for the price ($10.2 million), coupon rate (4.5% per annum) and cost (1% fee).

The underlying ETFs, monthly observations, discretionary calls, three-month call protection, barrier level, maturity date and distribution were identical.

“One has a 1% fee over 15 months, the other has no fee. That’s the difference in terms. You have an RIA deal versus brokerage distribution,” said Balcom.

“The lower the fee, the greater the chances to get better terms. You have more money to buy the options.

“Obviously, I prefer the first one. A 2% difference in the coupon is significant.”

Spotting the best value at the best price is an essential aspect of investing, said Kaplan.

“The difference between the two deals highlights the importance of shopping around,” he said.

“Buyer beware.”

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