Citi’s $14.88 million callable contingent yield notes on indexes offer double-digit return

By Emma Trincal

New York, Aug. 21 – Citigroup Global Markets Holdings Inc.’s $14.88 million of trigger callable contingent yield notes with daily coupon observation due Aug. 19, 2022 linked to the least performing of the S&P 500 index, the Russell 2000 index and the Nasdaq-100 index offer an above-average yield for an index-linked note. The issuer used several yield-enhancement features, which sources said were reasonable and added value to the trade.

Each quarter, the notes pay a contingent coupon if each index closes at or above its coupon barrier, 70% of its initial level, on each day that quarter, according to a 424B2 filing with the Securities and Exchange Commission. The contingent coupon rate is 11.3% per year.

The notes are callable at par of $10 on each quarterly observation date.

If the notes are not called and each index finishes at or above its 65% downside threshold, the payout at maturity will be par.

Otherwise, investors will lose 1% for every 1% that the least-performing index’s final level is below its initial level.

Objections

At first glance, the structure may discourage investors seeking a steady stream of income due to at least three features that suggest coupon payments may not last or be easy to get. The issuer call is one of them; the number of underlying is another factor; finally, the daily observation (American barrier) for the coupon is the last one.

More typical contingent coupon notes would have two underlying indexes, an automatic instead of a discretionary call, sometimes six months of no-call if the observation is conducted on a quarterly basis while this note has no call protection. Finally, the coupon barrier is almost always “European,” which means that it’s based on a point-to-point observation, according to data compiled by Prospect News.

The decent size of the deal came as a surprise to a buysider, who thought the terms were not favorable to investors.

But two sources felt otherwise arguing that the notes offered value.

Tailoring the deal

“It boils down to a client asking: give me 10%+ in yield and a good barrier. I think the 70% coupon barrier is appropriate. The 65% barrier at maturity is pretty good. And 11.3% is significantly high for a coupon,” an industry source said.

“Then, the question is: how do you get that? That’s when you need the additional features. The issuer call, the American barrier.

“Of course, people would rather have a European barrier. But a European barrier is not going to give you a double-digit coupon on indices,” the source said.

Issuer calls

Issuer calls, also known as discretionary calls, are less and less common, he noted.

“People don’t like them too much because of the uncertainty that comes with it. You don’t really know if and when you’re going to get called,” he said.

“It’s easier to explain an autocall to a client.”

Some issuers have come up with compromises to enhance the yield. Instead of a straight autocall threshold, they have included elevated autocall levels, named “step up.” Conversely, some structures are based on declining call thresholds, called “step down,” he explained.

“But issuer calls are valuable when you want to boost the coupon. Compared to an autocall...you can capture an additional 100 basis points,” he said.

Not about numbers

Addressing the issue of having a worst-of payout based on three indices, his response was that correlation was the most important factor to take into account when assessing dispersion risk.

“I’d much rather see high correlation between three U.S. indices as opposed to the traditional S&P, Russell and Euro Stoxx. Even though the Euro Stoxx gives you a lot of funds to buy the option because of its dividends, it’s been such a laggard, it probably hurts your call probability.”

Just more opaque

A market participant agreed with this assessment.

“The correlation between the three indices is very high. It’s in the 90% level. From that perspective, it’s rather good. You have a worst-of of three things that are almost the same,” he said.

He also agreed that the issuer call gave more value to the coupon. “They’re less common than autocalls. But you can really get much higher coupons,” he said.

“The only thing is that it’s less transparent. It makes it more difficult for investors to understand when they’re going to get called.

“But think about it this way: when you get called, it’s a great thing. You get your coupon and your money back.

“I don’t see the discretionary call as such a negative. It just brings more opacity.”

Volatility is king

For this market participant, the surge in volatility last week when the deal priced was probably one of the most important drivers.

“The reason for the higher coupon is the volatility, which climbed last week. On Wednesday the Dow dropped 800 points. I’m not sure you could price the same deal today. Volatility has come down a lot this week,” he said.

The notes priced on Friday. On that day, the CBOE VIX index was over 20. It is now at 15.71.

The American barrier also helped pricing, he said. But it only applied to the coupon, not to the 65% repayment barrier at maturity.

“What really makes a difference is the volatility,” he said.

The 70% coupon barrier with an 11.3% yield was mostly the result of selling volatility at a high.

“Overall I don’t see those terms as detrimental to the investor. It looks like a pretty good deal to me.”

The notes are guaranteed by Citigroup Inc.

UBS Financial Services Inc. and Citigroup Global Markets Inc. are the agents.

The Cusip is 17327P658.

The fee is 1.25%.

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