Citi’s autocalls on S&P 500 offer memory payout, deep barrier on single asset in risky market

By Emma Trincal

New York, March 14 – Citigroup Global Markets Holdings Inc.’s 0% autocallable securities due March 14, 2025 tied to the S&P 500 index offer an example of new pricing standards made possible by the market pullback, according to an adviser.

If the index closes at or above its initial level on any annual valuation date, the notes will be called at par plus an annualized call premium of 11% per year, according to a 424B2 filing with the Securities and Exchange Commission.

If the index finishes at or above its initial level, the payout at maturity will be par plus 33%.

If the index falls but finishes at or above the 60% barrier level, the payout will be par. Otherwise, investors will lose 1% for each 1% decline of the index from its initial level.

The double-digit cumulative call premium, a single-index exposure, a deep barrier over an intermediate tenor were some of the terms Tom Balcom, founder of 1650 Wealth Management, requested from issuers in a reverse inquiry leading to the offering.

Volatility

“Volatility definitely helps. We locked the terms on Tuesday before pricing the deal on Friday,” he said.

The pricing of the notes allowed for an initial level of 4,204.31, which is 12.75% lower than the S&P 500 index’s all-time high of Jan. 4.

The current market pushed the VIX index to 33, or about twice its 16 level at the beginning of the year.

“You get better terms all across the board. We approached other banks and they were very close. It was very tight. We wanted to diversify our credit risk exposure, so we chose Citi,” he said.

Correlations

The correction also improved the pricing of notes in general by modifying the correlations between indexes, he noted.

“Just a little while ago, you couldn’t do anything worthwhile without using a worst-of, but now you see more deals on just one index like this one.

“With the sell-off, correlations have increased. You don’t get much more for having multiple indices,” he said.

Asset returns tend to be more correlated than usual when stock prices are falling.

When correlations are low or negative, worst-of structures can provide higher payouts as more premium is available from the dispersion risk.

Rising correlations have the opposite effect, making the use of worst-of marginally less effective.

“The combination of higher volatility and higher correlations is bringing back deals on the S&P only. Worst-of continue to be very common but they’re becoming slightly less relevant. Since clients prefer to see one index, it’s a win at least from a pricing standpoint,” he said.

Another factor “helping the terms” was the modest fee, which, according to the prospectus was set at 0.10%.

“It’s just a custodial fee. The deal is for advisers; it’s fee-only, so you don’t have the brokerage commission,” he noted.

Memory, barrier

Balcom said he uses the notes as fixed-income replacement.

“The memory feature is very helpful. If you don’t get your 11% on the first year, you can have it later without losing any income.

“You may lose time value for two or three years. But you would lose more with a fixed-income instrument due to rising interest rates,” he said.

The 11% annualized premium could in theory justify allocating the notes to an equity bucket. But Balcom said he prefers to use the notes as a bond substitute.

“To me, it’s fixed-income replacement mostly because of the deep barrier over three years. That’s pretty conservative,” he said.

The adviser said he ran back-testing simulations on the S&P 500 index since 1999.

The probability of breaching the barrier over a three-year rolling period during the 23-year period was less than 2%, he said.

Kirk Chisholm, wealth manager and principal at Innovative Advisory Group, was not confident the barrier size would be conservative enough.

Risks ahead

“I think it’s an interesting note. As long as you expect the market to stay reasonably flat with a reasonable range of volatility, it’s fine,” he said.

But this adviser said he is not optimistic about the current environment.

“The biggest risk is obviously what’s going on in Ukraine alongside of the high inflation, which both could lead to stagflation. That’s really the risk. I don’t see a lot of upside in this market from here. You also have this Fed removing liquidity. Rising rates are going to hurt earnings. There is a number of serious issues,” he said.

“Most likely, what’s going on in Europe is going to cause economic harm across the world.”

In those conditions, investors may not even be in a position to collect their premium.

“The market would have to be at least flat. I find it hard to imagine it’s not going to drop given all the major risks we’re facing.”

“40% might be enough. But we’re talking about a potential global war. If it was a buffer, it would be different.”

Similar offering

And yet, the size of the buffer would matter.

On March 7, Citigroup priced a comparable deal (Cusip: 17330AQW5) for $1.95 million paying a 11.25% annualized premium. The structure offered a 20% buffer instead of the 60% barrier but a longer tenor of five years versus three years.

“I don’t think the longer term is going to make it more attractive in this other deal,” he said.

“We had lost decades in the past. I think we may be heading in that direction again.

“In a normal environment a 20% buffer would be great, but we’re not in a normal environment; so, I’m not sure 20% would cut it.”

Bearish outlook

Going back to last week’s offering, Chisholm said the 11% call premium would be attractive if the market was to be flat or slightly up.

“I don’t really expect the market to stay flat, certainly not as long as we have this global conflict going on,” he said.

Even if the crisis found a resolution before the end of the term, Chisholm said the S&P 500 index is more likely to move downward than upward.

“I don’t see this market going from being one of the most overpriced ever to one that’s even more overpriced,” he said.

“There’s very little room for upside with the deterioration of the global economy we’re facing. Central banks are tightening, inflation is skyrocketing, interest rates are rising. There is a war in Europe is raging. It’s hard to imagine that the market is going to do well in this environment.”

The notes will be guaranteed by Citigroup Inc.

Citigroup Global Markets Inc. is the underwriter.

The notes priced on March 11 and will settle on March 16.

The Cusip number is 17330ATZ5.

The fee is 0.1%.

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