Citi’s $896,000 autocalls on indexes innovate with principal-protection, contingency of income

By Emma Trincal

New York, Sept. 1 – Citigroup Global Markets Holdings Inc.’s $896,000 of autocallable contingent coupon market-linked notes due Aug. 31, 2029 linked to the worst performing of the Russell 2000 index, the S&P 500 index and the Nasdaq-100 index introduced a slight innovation in income-product structuring. Instead of paying a fixed coupon as seen sometimes with barrier autocalls, the notes offer the opposite: contingency of the coupon and full principal protection.

The notes will pay a contingent monthly coupon at an annual rate of 5% if each index closes at or above the coupon barrier level, 80% of the initial level, on the valuation date for that period, according to a 424B2 filing with the Securities and Exchange Commission.

The notes will be automatically called at par plus the coupon if each index closes at or above its initial level on any monthly valuation date after one year.

Investors will receive par at maturity, if the notes have not been called, and any coupon due.

Time will tell

“I might see it as fixed-income replacement. The question is: with interest rates rising, do I want to settle for 5%?” said Steve Doucette, financial adviser at Proctor Financial.

“If you look at it, 5% is a pretty decent fixed-income coupon return. Rates are rising but you may get to the point in the not-so-distant future when the Fed decides to cut rates.”

In his Jackson Hole speech on Aug. 26, Federal Reserve chair Jerome Powell said he was determined to push down inflation closer to its 2% target. Recent rallies and pullbacks have been directly related to market expectations about the timeframe by which the Fed can accomplish that goal.

“It may take time, but this is a longer-dated note. If inflation goes back to normal, you might get 3% in real return,” he said.

The note however was unlikely to last seven years.

“The market is going to rally and you’re probably going to get called. Despite the one-year no-call, you’ll probably get called before rates move back lower,” he said.

Investors would have to consider that risk.

Defensive play

Adding a principal-protection component to an income-oriented structured product was the innovative part of the structure, he said.

Doucette said he wasn’t sure whether he had seen this feature in the past or not.

“For a conservative investor or someone who wants to get the principal-protection, this is a great alternative to a bond.

“You’re not investing in equities. You’re putting a different investor hat on this note. I think you’re probably going to collect most of the income,” he said.

As a result, Doucette had no hesitation as of where to allocate the notes.

“It fits right into a fixed-income portfolio,” he said.

Uncertain payments

Matt Medeiros, president and chief executive of the Institute for Wealth Management, disagreed.

“I wouldn’t consider this as income,” he said.

While principal-protection was an attribute of bond investing, collecting a fixed coupon was imperative as well, he said.

“I don’t think I would put it in the fixed-income bucket. It’s just not a fixed-income,” he said.

“There’s potential inconsistency in the way my coupon may or may not be paid. It’s going to be at random. I couldn’t count on it as income.”

Low return, no memory

A second reason was the coupon rate itself.

“5% is not high enough,” he said.

Medeiros said that when he buys autocallable contingent coupon notes, he tries to achieve a much higher return given the equity exposure. Alternatively, he seeks a memory feature, which allows him to collect later all previously unpaid coupons.

“The coupon in this note has no memory. If it did, I may have a different view,” he said.

This adviser said he would be hard-pressed to find a home for the notes, including in other portions of his portfolio.

“It’s not a cash substitute. Cash would give me 1/12th of 5% each month. That’s not the case,” he said.

“And it’s certainly not equity, not with a 5% cap.”

“I just wouldn’t know where it would fit.”

Moving parts

Inflation was another issue.

“The coupon is low, and the payment is uncertain. It’s not going to help me hedge inflation,” he said.

“You can’t get something to keep pace with inflation when inflation is increasing at this rate,” he said.

Another problem was the uncertainty around the duration of the note.

“If my coupon was guaranteed, I could tolerate the seven-year. But there are too many variables. I’m locked in for seven years. Probably there will be a call. I just don’t know when. I don’t know if I’ll get my 5%. It depends on the worst-of,” he said.

Finally, the 4.25% fee as disclosed in the prospectus was relatively high, he noted.

“You pay it upfront. If you want to put it back, you’ll take a pretty good haircut. Since you don’t know if you’ll even collect 5%, you’re mostly likely going to be under water.”

“The only attractive part of it is the 100% principal protection at maturity assuming the issuer can meet its obligations. That’s about it.”

Fat dividends lost

Noteholders may not just lose real income with inflation. As with any structured note, they are missing the dividend payments of the underlying indexes. From a bearish standpoint, the opportunity cost could be high.

“Seven years is a long time,” a financial adviser said.

“During bear markets, dividends tend to go up a lot.”

In the 1970s, the dividend yield of the S&P rose above 5% several times.

In the third quarter of 1982, toward the end of a two-year bear market, the dividend yield of the S&P 500 index reached 6.02%, he said.

“You may be earning 5% in interest payments, but you may be losing the same amount in dividends if not more,” he said.

Limited value

This adviser said the choice of the underliers did not benefit investors.

“Not only it’s based on the worst performing one, but you’re picking three highly overvalued indexes. In addition, the 80% barrier can be easily breached,” he said.

Having the one-year call protection made no difference, he said.

“The chance of being called is very small.”

“Your principal is 100% protected, which is a good thing. But the problem is the loss of income.”

“Why not buy a one-year Treasury yielding 3.5%. It’s less than 5% but it’s guaranteed.

“I can’t see any reason to buy this note,” he said.

The notes are guaranteed by Citigroup Inc.

Citigroup Global Markets Inc. is the underwriter.

The notes settled on Wednesday.

The Cusip number is 17330R2F1.

The fee is 4.25%.

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