Citi's autocallables tied to Facebook show higher-than-average market risk, not enough return

By Emma Trincal

New York, Sept. 6 - Citigroup Inc.'s autocallable equity-linked securities due Sept. 11, 2014 linked to the common stock of Facebook, Inc. have a higher risk profile than average, and the issuer has not offered enough coupon to compensate investors for the risk, said Suzi Hampson, structured products analyst at Future Value Consultants.

The notes are expected to carry an 11.75% coupon. The exact coupon will be set at pricing. Interest will be payable quarterly, according to a 424B2 filing with the Securities and Exchange Commission.

"These notes are for investors looking for ways to get more income. Income is definitely why people would be drawn to this product," Hampson said.

The notes will be automatically redeemed at par of $10 if Facebook shares close at or above the initial share price on any of three quarterly observation dates.

If the notes are not called and the final share price is at least 75% of the initial share price, the payout at maturity will be par. Otherwise, the payout will be a number of Facebook shares equal to $10 divided by the initial share price or, at the issuer's option, an amount in cash equal to the value of those shares.

Hybrid

Hampson said that this type of product, which Future Value Consultants categorizes as "autocallable income product," is a hybrid between a traditional autocallable and a reverse convertible.

"It's an income payout where you can receive your coupon without being called. Your income is not contingent upon the call. In that way, it's different from the standard autocallable, in which you only get paid when your notes are called," she said.

"These autocallable income products have a lower coupon than the straight autocall because you can collect a coupon regardless of being called or not. Chances are if you still haven't been called at maturity, you may have received some income during the life of the notes. Whatever you may have collected in coupon can provide you with a little extra cushion against losses. You wouldn't have that with a straight autocallable.

"With a reverse convertible, your coupon is fixed, so you automatically get this cushion against losses at maturity. What you don't get is the flexible maturity. You don't have the autocall."

Contingent autocallable products, she said, are in high demand at this time.

"Something is making them popular because we see a lot of them. One reason may precisely be because they are a convenient hybrid. Some of their features can offset some of the negative aspects of the reverse convertible as well as some of the less desirable characteristics of a classic autocallable," she said.

"For instance, you have four opportunities to get paid a coupon with this product. With the straight autocall, you can only get your income if you're called, so you run the risk of not earning any coupon and having less protection at maturity.

"If you hypothetically compared these notes with the equivalent reverse convertible, same terms, same underlying, you would see that the reverse convertible is more risky because you don't have four opportunities to get your capital back. When an autocallable kicks out, you get your money back and the risk position ends, therefore the probabilities of losses will be lower with an autocallable."

More risk

The riskmap is Future Value Consultants' measure on a scale of zero to 10 of the risk associated with a product with 10 as the highest level of risk possible. It is the sum of two risk components: market risk and credit risk.

The 5.14 riskmap for this product is "much higher" than the 3.64 average riskmap of the same product type, she said.

The same product type in this case includes all autocallable income products, which may pay a coupon with or without a call event.

Compared to the 3.95 average riskmap of all products, the notes display an even riskier profile, she noted.

"The use of a single stock versus an index explains the higher risk," she said.

Facebook's one-year implied volatility is 45% versus 17.5% for the S&P 500.

On the credit risk scale, the notes have a 0.32 credit riskmap. The average in the category is 0.31.

"The credit risk for this product is the same as the average," she said.

"The credit risk is low because it's only one year. The creditworthiness of the issuer is not really a factor here, as Citigroup's CDS spreads are not out of range."

The five-year CDS spread for Citigroup is 106 basis points. The spread is 93 bps for JPMorgan and 145 bps for Morgan Stanley.

On the other hand, the product, with a 4.82 market riskmap, differs "a lot" from the average market riskmap of 3.32 for the same product type, she noted.

"This product has a much higher riskmap than its peers," she said.

"Since the credit risk is the same, the difference is the market risk. The gap in scores confirms that the market risk is where the risk is."

Return and price

Future Value Consultants measures the risk-adjusted return with its return score. The rating is calculated using five key market assumptions: neutral assumption, bull and bear markets and high- and low-volatility environments. A risk-adjusted average return for each assumption set is then calculated. The return score is based on the best of the five scenarios, which in this case would be the low-volatility environment.

The return score for the notes is 5.42. In comparison, the average return score for this product type is 6.14.

In addition, Future Value Consultants computes another score designed to measures the value to the investor. Based on the same scale of zero to 10, this rating, called the price score, estimates the fees taken per annum. The higher the score, the lower the fees and the greater the value offered to the investor.

The notes have a 5.04 price score versus 6.01 for the average of the same type of structure.

"The return score is pretty bad, although not as bad as the price score," she said.

"The notes are really underperforming on the price scale.

"It's somewhat easy to explain the weak return score. You have such a huge riskmap. The return score is a risk-adjusted return. If you keep the same risk level, the only way to bring the return score closer to the average would be to compensate investors more for the elevated risk. You would have to offer a very high coupon in order to do that. It looks like what they are offering is not enough based on the amount of risk investors are exposed to.

"The price score is really low. It means that the cost to the investor is high. Not much was spent on the options, which is one of the reasons the return on the investment is low.

"This type of product is quite common. Normally, the more products included in a category, the more competition for pricing and usually, the better the price score.

"But when the return is linked to a single stock, a lot depends on the underlying. It looks like this product is tied to a very volatile stock, which brings the ratings down compared to the average for this category.

"Return and price scores tend to have a correlation on the extreme side, but they don't always move together. However, if your product is poorly priced, there isn't much chance to score high on the return scale."

Overall score

Future Value Consultants offers its opinion on the quality of a deal with its overall score. The score is simply the average of the price score and the return score.

The notes have a 5.23 overall score. In comparison, the average overall score for the same product type is 6.07. It is 6.80 for all products.

"This is to be expected given the price and return scores. It's way below average," she said.

"You can see on the scatter chart that illustrates the distribution how this product compares with the rest."

The scatter chart shows product riskmaps and overall scores. The chart plots the riskmap (horizontally) against the overall score (vertically).

"The product is at the bottom right corner, which suggests the lower end of the scale. It's not the worst investment, but it doesn't compare well against the rest of the products available."

Citigroup Global Markets Inc. is the underwriter.

The notes are expected to settle Wednesday.

The Cusip number is 17321F607.

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