BofA Finance’s $1 million ARNs tied to Coinbase offer highly rewarding, risky bet

By Emma Trincal

New York, Oct. 14 – BofA Finance LLC’s $1 million of 0% Accelerated Return Notes due Dec. 20, 2023 linked to the shares of Coinbase Global, Inc. provide potentially high gains due to the leverage and exceptionally high cap in addition to the volatility of the underlying stock. But the absence of any downside protection makes the notes only suitable to speculators rather than investors.

The payout at maturity will be par of $10 plus triple any stock gain, subject to a maximum payout of par plus 126.5%, according to a 424B2 filing with the Securities and Exchange Commission.

Investors will be exposed to any stock decline.

Lackluster performance

“Very interesting in many ways but this is a speculative note,” said Clemens Kownatzki, finance professor at Pepperdine University.

Coinbase is a leading U.S. cryptocurrency exchange platform. Founded in 2012, it only went public on April 14, 2021.

The stock has not performed well so far except at the end of last year, he said.

Since the company went public via a direct listing and up until the end of last year’s third quarter, the share price dropped more than 40%. From that point, it soared 62% in October 2021 when the cryptocurrency market peaked and hit a high point in early November.

“Everybody was trading. The same crowd of young men crowding platforms like Robinhood were sitting at home in front of a computer trading cryptocurrencies,” he said.

Since then, the price has plummeted, closing on Friday 83% lower than its $368.90 November peak.

“It could drop more. For some reason, when a stock is down 80% people make this naive assumption that it’s not going to drop more than 20%. It makes no sense, but our brains are wired that way. Obviously, the share price could lose 100% from where we are now,” he said.

Possible target

However, Kownatzki said the stock could surge under a plausible albeit uncertain scenario.

“Given the company’s positioning in the crypto market, the low performance of its stock and its financial condition, I would argue that Coinbase could very well be the target of an acquisition,” he said.

Mergers, consolidations, and acquisitions have always been the hallmark of the financial services industry, he noted. Recent examples include Schwab’s acquisition of TD Ameritrade and online platform E-Trade now part of Morgan Stanley.

“Coinbase is a top player in the U.S. cryptocurrency market. Their brand is well established. A brokerage or bank looking to grab market shares in this growing market may see in Coinbase an ideal candidate for a takeover,” he said.

One possible objection from investors when considering the note may be its short timeframe. But Kownatzki downplayed the argument.

“A deal could happen or be announced in the short term. It’s not impossible. You could buy the notes for that reason alone although again, doing so is highly speculative,” he said.

In a merger, the target company’s share price usually rises, paving the way to merger arbitrage.

Regulatory risks

On the negative side, Coinbase is facing a specific type of headwind, he noted.

“Will the government regulate cryptocurrencies and how far will they go if they do? More restrictive regulations would obviously negatively impact Coinbase. But I don’t think we’ll see a dramatic regulatory crackdown,” he said.

“The [Commodity Futures Trading Commission] and the [Securities and Exchange Commission] seem to be fighting with each other over who should regulate this industry. So, I don’t see any risk in the near future and certainly not over the next 14 months. Regulation of this market has a long way to go,” he said.

Fundamentally disappointing

More concerning for investors is the current value of the stock, from a fundamental standpoint, he added.

Coinbase has negative earnings, he said. Analysts expect an increase in revenues for the next couple of years but then a drop, he noted. In addition, free cash flow is slightly negative this year, should recover in 2023 but is expected to turn negative again in 2025 and 2026, he said.

“If you can’t provide free cash flow over a five-year period, it doesn’t look like a very attractive proposition.

“I’m not convinced that Coinbase in an attractive stock from a fundamentals standpoint, which doesn’t necessarily mean it’s a bad note,” he said.

That’s because such poor fundamentals could make an acquisition more attractive, he said.

“The reason you would take over a company is because you found a business that complements yours, something that’s not working properly and that you can fix. Coinbase fits that profile,” he said.

A financial institution seeking to establish footholds in the cryptocurrency market may view Coinbase as a potential source of added value, he noted.

Good underlier

“Buying the stock outright may not be a great idea. But as an underlying, Coinbase makes sense,” he said.

Kownatzki considered two possible uses of Coinbase as an underlying for a derivatives trade.

“You could look into this risky structured note. Or you could adopt a more conservative strategy with options,” he said.

Kownatzki picked a bull call spread. The not-so-bullish trade consists of buying and selling simultaneously two call options of the same underlying and same expiration date but at different strikes. The goal is to capture some gains while limiting the losses.

The call is bought at a lower strike than the short call, which generates a cost (net debit) since the short option is further out of the money.

Bull call spread

Kownatzki gave an example using the closest expiration date of Jan. 19, 2014, which is only one month longer than the maturity date of the note for which no listed contract was available.

On Friday’s midday session, Coinbase’s shares were trading at $66 (at-the-money price). The premium to purchase a call option with a strike price of 60 was $29.83. The premium received from the sale of a 70 call was $26.15. The net cost for the trade therefore amounted to $3.68.

“Selling the option is designed to cheapen the trade. But it doesn’t eliminate the cost, which remains expensive,” he said.

The net profit for that trade is the difference between the two strike prices minus the cost, which amounts to $6.32.

The maximum loss is the $3.68 cost.

The maximum return of this trade is calculated by dividing the net profit by the lower strike, which is $6.32 divided by 60 or 10.5% before transaction costs.

Two different animals

“The risk-return profile of this trade contrasts with that of the structured note. It generates a much lower potential return but creates defined maximum risk on the downside,” he said.

“For someone really bullish on the stock, the notes make sense, especially if you see Coinbase as a potential candidate for a takeover. I’ve mentioned that such scenario is plausible. But I don’t know if I would take that bet with the notes. It’s too speculative given Coinbase’s volatility, its poor financial condition, and the fact that the note offers no protection on the downside.

“But I’m sure it would be attractive to some people.”

The notes are guaranteed by Bank of America Corp.

BofA Securities, Inc. is the underwriter.

The notes settled on Wednesday.

The Cusip number is 06054B842.

The fee is 1.75%.

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