BofA’s $6.24 million autocalls on bank stocks raise concerns over sector, high correlations

By Emma Trincal

New York, Nov. 30 – BofA Finance LLC’s $6.24 million of 0% autocallable market-linked step-up notes due Dec. 1, 2025 linked to an equally weighted basket of bank stocks offer a competitive call premium, but a buysider raised the issue of recession risk associated with current changes in the financial system, which could negatively impact banks’ profitability.

The basket consists of the stocks of Goldman Sachs Group, Inc. with a 33.34% weight, JPMorgan Chase & Co. with a 33.33% weight and Morgan Stanley with a 33.33% weight, according to a 424B2 filing with the Securities and Exchange Commission.

The notes will be automatically called at par plus a 20% annual call premium if the basket closes at or above its initial level on any annual observation date.

If the basket finishes above the step-up level, 145% of the initial level, the payout at maturity will be par plus the basket gain.

If the basket finishes flat or gains up to the step-up level, the payout will be par plus the step-up payment of 45%.

Investors will be fully exposed to any basket decline.

All stocks are up

Andrew Valentine Pool, main trader at Regatta Research & Money Management, liked the potential return but not the risk associated with bank stocks.

“Interesting. At least one of them is not Credit Suisse because I would take a pass immediately,” he said.

He compared each stock’s current price with their respective average price between 2018 and 2020.

“Goldman Sachs is a lot higher. It went from an average price of $225 during that two-year window to $386 now,” he said.

Morgan Stanley’s price had increased the most.

“The stock is way up. Its average price then was $50. It’s now trading at $93.”

Only the appreciation of JPMorgan’s stock price had been more moderate from a $120 average during the 2018-20 period to $138 today.

“Two thirds of this basket is way up,” he said.

Uncertain profitability

But valuations differ from price.

One issue with the notes, he said, was that bank stocks are hard to value especially in the current market environment marked by a dramatic monetary policy shift.

“When Covid hit, the Fed floated money into the system. It was a heck of a lot easier for people, banks included to make money then,” he said.

“Now that tightening is happening, it’s a different story. Rates may be higher, but will banks be able to make enough profit when demand for loans plummets?”

Higher rates, especially mortgage rates, have a negative impact on the economy, affecting a number of sectors including housing, equipment leasing and car sales, he noted.

JPMorgan for instance has been building up reserves this year to protect against possible loan losses.

“Rates may be higher, but you also have less demand for loans. So, I’m not sure what the outcome is going to be for banks over the three-year period,” he said.

Deal-breaker

In a slow-growth environment, the structure may be adequate since investors get paid even if the price of the underlying basket remains flat as long as it is not negative on the call date.

“This is a really good call premium, but I don’t think I would want to buy this note. I don’t like the lack of downside protection. I would need some form of buffer to consider this for my clients,” he said.

High correlations

A market participant explained how the issuer had been able to structure the call premium.

“This 20% call premium looks high but there are reasons for that,” he said.

Compared to contingent coupons paid on a Phoenix autocall, 20% appears high, but Phoenix autocalls are based on indices, he said.

“This deal is linked to three stocks. Stocks are much more volatile than indices,” he said.

Although investors are not exposed to a worst-of but to a weighted basket, the choices of the basket components added some risk.

“They picked three big bank stocks: Morgan Stanley, JPMorgan and Goldman Sachs...You can’t find anything more correlated,” he said.

High correlations between worst-of components dampen the risk of losses but have the opposite effect on weighted average baskets.

“You want more diversification in a note like this, not more correlation. Correlations are too high in this basket. “You don’t get the benefit of diversification,” he said.

Higher rates

What helped pricing the most was the current level of interest rates.

He noted that the three-year Treasury yielded 1% at the beginning of the year. The yield six months later rose to 3.5% and is now over 4%.

“There’s been this massive jump in interest rates, which can give you much higher levels on conditional coupons,” he said.

“The higher rates is what has the biggest impact on pricing.”

Another important factor behind the pricing of a 20% premium was the lack of any downside protection.

“That’s going to help a lot. Obviously if you don’t spend the money in a barrier or a buffer, you can significantly boost the coupon,” he said.

“If the basket is down, you get all the downside, you don’t get any dividends.

“All of these factors especially higher interest rates help explain how they could give investors a 20% premium.”

The notes are guaranteed by Bank of America Corp.

BofA Securities, Inc. is the agent.

The notes settled on Wednesday.

The Cusip number is 06054E127.

The fee is 2%.

© 2015 Prospect News.
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