BofA’s $747,000 autocalls on Russell show insufficient protection, lengthy term, advisers say

By Emma Trincal

New York, July 5 – BofA Finance LLC’s $747,000 of market-linked securities – autocallable with fixed percentage buffered downside – due July 6, 2026 linked to the Russell 2000 index provide cumulative call premium, which advisers said was not as attractive as a pure income play. The long maturity and downside protection were also scrutinized.

The notes will be called at par plus 9.5% per year if the index closes at or above its initial level on any annual call valuation date, according to a 424B2 filing with the Securities and Exchange Commission.

The payout at maturity will be par plus 38% if the index finishes at or above its initial level.

If the final index level is less than its initial value but not by more than 10%, the payout will be par.

Otherwise, investors will be fully exposed to the decline of the index beyond the 10% buffer.

Barrier is best

Tom Balcom, founder of 1650 Wealth Management, was not sure the note provided enough downside protection.

“It’s a little bit disappointing. 10% even as a buffer is not much. I guess the higher fee dictates the terms,” he said.

The fee is 2.825%, according to the prospectus.

“It’s a little high, especially if you get called after one or two years,” he said.

While buffers are perceived as superior by many due to the guaranteed protection, the depth of a barrier can easily compete with modest buffers.

Balcom said he would rather have a 60% barrier in this case than a 10% buffer.

“The probabilities to breach that level would be much lower,” he said.

A buffer will always allow investors to outperform the price index on the downside while reducing the size of the losses by the buffer amount. But Balcom said he would rather risk greater losses if the probabilities of losing are modest.

“The chances of being down more than 40% in four years are pretty slim. Give or take, it’s probably around 5%,” he said.

“We’re already at much lower levels. You could have another drop beyond the 10% buffer. But you’re infinitely less likely to lose more than 40%.”

At pricing, the Russell 2000 index closed at 1,719.370, or nearly 25% off its January high of 2,288.30.

“Low entry points are great. But we could go down further. If we have a recession, we’ll definitely see a drop of more than 10% from the initial price,” he said.

Missing out

The upside payout was also a concern.

“Small-cap stocks deliver higher returns when the economy recovers. The Russell 2000 is usually the first index to snap back. Four years gives this market plenty of time to rebound. You don’t really want to underperform in that scenario,” he said.

The 9.5% call premium however was “fair,” he noted.

“The high volatility should give you high single-digit or low double-digit returns, and that’s what you get here.”

Asset allocation

In normal times, a 9.5% annualized return may be well-suited for an equity bucket. But the risk of underperforming the market in a recovery scenario may be too high for this type of allocation, he added.

“If I had a 60% barrier, I would put it in my fixed-income allocation. But the 10% is a bit too risky for that,” he said.

The upside risk was very much a function of Fed action.

A strong market recovery could easily happen if the Federal Reserve stopped raising rates as a result of a recession induced by excessive tightening.

“Right now, they can’t do that. Inflation is too high. But once it gets more under control, they will be less aggressive. The market, especially the Russell, which is a leading indicator or recoveries, would jump back up,” he said.

“I think a lower fee would have provided better terms, especially when volatility is so high, and rates are going up.”

Too long

Donald McCoy, financial adviser at Planners Financial Services, said he was not comfortable with the longer maturity and the notion that investors only get paid upon early redemption.

“You’re getting an interesting entry level for the Russell. It’s off from the earlier highs. It doesn’t mean it won’t fall more though,” he said.

“My main concern here is the four-year term. Your best-case scenario is to be under water for three years and get the cumulative payment at maturity. But it’s unlikely.

“What’s likely to happen is that the index at the end of the first or second year will creep back up to positive territory.”

Call premium

In the meantime, he added, investors do not collect any income as they would with a typical autocallable contingent coupon note, in which the coupon payment is triggered at a barrier level, which is situated below the initial level. Such structures are known as “Phoenix autocallable.”

Reinvestment risk was one major problem with the BofA notes.

“If you’re not called, you don’t get the return. It’s nice that the premium is cumulative. But if you do get called away, you’re not really earning income. You get paid when you’re out. You have to find something else,” he said.

Volatile underlier

Another issue was the choice of the Russell 2000 index as the reference asset.

“It’s a pretty volatile benchmark. It could go up a lot but also fall significantly. Maybe you’re not getting enough downside protection,” he said.

While stock prices have already declined significantly, no one can really identify the market bottom.

“If the market drops another 20% or 25%, we will be struggling to get back to even,” he said.

In the absence of a call, the four-year term was too long, he noted.

“People have to be really patient on a four-year scale especially if they don’t get anything during that time,” he said.

“Even if you earn the 38% at maturity, you’re getting paid for a four-year waiting time.”

In conclusion, McCoy said he preferred a pure income-generating note.

“It’s easier to get the coupon since the index can be negative. And it is real income. You can get your coupons along the way to keep you warm in the winter,” he said.

The notes are guaranteed by Bank of America Corp.

Wells Fargo Securities, LLC and BofA Securities, Inc. are the selling agents.

The notes settled on Tuesday.

The Cusip number is 09709UZ50.

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