Citigroup’s barrier digital plus notes on Euro Stoxx designed for sideways markets

By Emma Trincal

New York, Nov. 19 – Citigroup Global Markets Holdings Inc.’s 0% enhanced barrier digital plus securities due Dec. 2, 2024 linked to the Euro Stoxx 50 index offer an alternative to absolute return notes by paying for a fixed coupon when the index finishes negative as long as it does not breach a barrier on the downside.

The product is especially suited to range bound markets, sources said.

If the final index level is greater than or equal to the final barrier value, 75% of the initial index level, the payout at maturity will be par plus the greater of the index return and the digital return amount, which is expected to be 26% to 28% and will be set at pricing, according to a 424B2 filing with the Securities and Exchange Commission.

If the final index level is less than the final barrier value, investors will be fully exposed to the index’s decline from its initial level.

Range bound play

“I like the concept of a digital because if the market is flat, at least you get paid something. It’s great for generating cash-flow,” said Tom Balcom, founder of 1650 Wealth Management.

“When the market is range bound, that 26% or 27% return will make up for the loss of dividends.

“And if the index is down 20%, your return is 27%. You outperform by 47 percentage points.

“Your client can buy you a nice gift for the holidays.”

Digital notes, which pay a fixed return when the index finishes above a downside barrier, have enjoyed some success so far this year.

“We’re doing a lot of these ourselves,” he said.

The five-year maturity is not ideal, he noted. But for an index such as the Euro Stoxx 50, which has not been rising much, “it’s probably OK,” he said.

“You’re probably not going to lose money over five years. But if you’re concerned about the downside risk, it provides a nice cushion in case the market does turn out.”

Better than absolute return

The structure shares a characteristic with absolute return notes: investors can get a positive return in a down market. But the benefits of the digital are more palpable, he said.

“The absolute return is based on a one-to-one inverse participation. If the index is down 2% you make 2%. With this one, you get 27% if it’s down 2%. So, it’s much more attractive, especially if the market is slightly bearish.”

He also pointed to simplicity as another advantage of those digital notes with a negative downside threshold over absolute return structures.

“You can tell a client, if the index is down 25% or less, you make 27%. If it’s up, you make 27%. It’s simple. Clients like simple,” he said.

“It’s much easier to explain than an absolute return. As long as the index is not down by more than 25%, you’re OK. You get your return.”

European value

Steven Foldes, vice-chairman at Evensky & Katz / Foldes Financial Wealth Management, was less enthusiastic about the structure.

“Having exposure to Europe makes sense. Given the terrible performance of last year and even though this year is pretty strong so far, we still see Europe as somewhat undervalued in terms of historical P/E ratio while the U.S. is overvalued,” he said.

The Euro Stoxx 50 fell by 16% in 2018. It is up nearly 23% year to date.

But in previous years, such as 2014, 2015 and 2016 the index was either negative or flat.

“We see value in international stocks. Europe is cheap. Emerging markets are very cheap. So we would be long the index,” he said.

Fee, dividends

But the note was not the ideal instrument for a bull, he said, pointing to several aspects of the structure, which he viewed as costly.

“First, we think the 3% fee is a little bit on the high side,” he said commenting on the underwriting fee disclosed in the prospectus.

“We don’t like long maturities in general. Here, given the high dividend yield of the underlying, it obviously represents a significant give-up,” he said.

The Euro Stoxx 50 index yields 3.47%.

But what was perhaps the most “expensive” feature on his list was the barrier itself.

Costly barrier

“I don’t know that the barrier is necessary. Over a five-year period, there is a high likelihood that the index will be positive,” he said.

“And obviously you’re paying for it. I’d rather take that money and use it to buy leveraged on the upside.”

If the barrier is “unlikely” to serve any purpose at the end of five years, investors are also paying a digital coupon that could have been higher if triggered above par, or better, replaced by leverage, he explained.

Leverage preferred

“You’re paying for a barrier and a digital coupon that are not adding much value. You’re getting let’s say 27% over five years. I don’t know if it’s a very good deal. The dividends alone will give you 17.35% during that time. You’re not getting paid a lot.”

Asked about the value of the uncapped upside above the digital level, he said that: “you’re still paying a high price for giving up the dividends. If you had some leverage you could offset some of that cost. Maybe the entire cost.”

The leverage made more sense as a bullish play.

“Europe hasn’t done much. I would be long this market. If you’re bullish on Europe, your best bet is to get as much leverage as possible and hopefully that would remain uncapped.”

The notes will be guaranteed by Citigroup Inc.

Citigroup Global Markets Inc. is the underwriter.

The notes will price on Nov. 26.

The Cusip number is 17327TXV3.

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