Citi’s $7.35 million trigger autocalls on two ETFs offer defensive play, analyst says

By Emma Trincal

New York, March 12 – Citigroup Global Markets Holdings Inc.’s $7.35 million of trigger autocallable contingent yield notes due March 6, 2026 linked to the SPDR S&P Regional Banking ETF and the SPDR S&P 500 ETF trust provide a reasonable risk-adjusted return for conservative investors seeking income, said Suzi Hampson, head of research at Future Value Consultants.

Each quarter, the notes will pay a contingent coupon at an annualized rate of 9.9% if each fund closes at or above its coupon barrier, 70% of its initial value, on the observation date for that quarter, according to a 424B2 filing with the Securities and Exchange Commission.

The notes will be redeemed at par of $10 plus the coupon if both ETFs close at or above their initial values on any quarterly observation date after six months.

The payout at maturity will be par plus the coupon unless either underlier finishes below the 50% downside threshold, in which case investors will lose 1% for each 1% decline of the worst performing underlier from its initial value.

Subset

The SPDR S&P 500 ETF trust replicates the S&P Regional Banks Select Industry index, which itself tracks the regional banks segment of the S&P Total Market index.

“By choosing a sector ETF that’s a segment of a broader index, the issuer is increasing the correlation between the two underlying. This lowers some of the risk,” said Suzi Hampson, head of research at Future Value Consultants.

The correlation between the two underlying assets is 0.89.

“It’s quite high. Maybe not as high as the correlation between the Dow and the S&P, but still high,” she said.

The most volatile of the two underlying is the regional banking ETF.

“That’s to be expected. It’s a smaller universe,” she said. The implied volatility of this underlier is 31.65% versus 21.83% for the S&P 500 index.

Double exposure

Investors considering this product (or any other worst-of) need to remember that they are not gaining exposure to one of the two underlying but to the relationship between the two, she said.

“If you want exposure to regional banks, the worst-of structure is not the right format. Your return may not be tied to this ETF. Your payout depends on the worst of two underlying. What you want is pick up a coupon and see if the barrier offers enough protection based on a number of factors, such as volatility and correlation.

“You want to make sure the coupon is sufficient for the kind of risk you’re taking.”

The art of pricing

Hampson pointed to the difficulty issuers face in pricing attractive coupons.

“This one pays just under 10%. The dividends on these two indices aren’t high,” she said.

The SPDR S&P 500 ETF trust yields 1.23% and the SPDR S&P Regional Banking ETF, 2.19%.

“On the volatility side, even the regional banking ETF is not extremely volatile. So, it’s hard to price that type of product. You’re hardly getting a 10% return even with a worst-of. It gives you an idea of how challenging pricing can be in this environment,” she said.

And yet, the notes offer an attractive risk-adjusted return, she noted.

“They set the final barrier at 50%, which is quite a defensive level,” she said.

“It’s still a worst-of, but the underlying are stable, the correlation is high and the barrier level, generous.

“You’re not getting the highest coupon, but it’s still a decent one for that type of risk.”

Autocallable outcome

Another risk-reducing feature is the automatic call.

Future Value Consultants offers stress-testing analysis of structured notes encompassing a Monte Carlo simulation and back-testing analysis. Hampson generated a report for this product, which analyzes the various probabilities of outcomes.

The probability of a call at point one, six months after issuance, is 42.4%, according to the report.

“As ever, the probability of calling is the highest on the first call. The probabilities drop rapidly after that,” she said.

For instance, the chances of a call at point two, which is nine months into the note, drops to 8.56% and after one year it is only 5.34%, the report showed.

The probability of a call at point one is always lower with a worst-of than with a single-asset note, she said.

But in this case, the worst-of held on well.

“42% is not bad for a worst-of,” she said.

“It’s usually 40% or lower.”

Loss scenario

Another important outcome – the loss scenario when the barrier is breached – had a low probability of 18.22%.

“This of course is the result of the deep barrier at maturity,” she said.

In the event of a loss of principal, the average loss would be around 65%, according to the model.

“You know you’re going to lose at least 50% since you’ll breach the barrier,” she said.

A sum of coupon payments could have in theory limited the average loss size near that point, she explained.

But the simulation rules out this scenario.

“It’s unlikely that your coupon payments are going to offset the final loss amount. That’s just because the chances of getting many coupons and finishing down more than 50% are quite low in the simulation,” she said.

Looking back

The back testing offered a much brighter picture.

Over the past five years, the frequency of capital losses is zero. The notes get called 100% of the time, with a probability of 63% on the first call date.

“It looks very good historically and that’s always the case with back-testing analysis,” she said.

“Past performance can be helpful. But as we all know, it’s never a guarantee of future results.”

Protective strategy

In conclusion, Hampson said the notes were aimed at cautious investors.

“It’s a worst-of. It’s an at-risk product. But the 50% barrier is quite deep,” she said.

“This is not the type of product a bullish or speculative investor would have in mind. It’s designed for the more conservative investor.

“What you are looking for is a steady performance for the next six, nine or 12 months, so you can kick out and get your 10% coupon.

“That is by far the best outcome.”

The notes are guaranteed by Citigroup Inc.

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

The notes settled on March 8.

The Cusip number is 17329B707.

The fee is 0%.

© 2015 Prospect News.
All content on this website is protected by copyright law in the U.S. and elsewhere. For the use of the person downloading only.
Redistribution and copying are prohibited by law without written permission in advance from Prospect News.
Redistribution or copying includes e-mailing, printing multiple copies or any other form of reproduction.