Citigroup’s trigger PLUS tied to financial ETF show ‘fair’ terms, but rates are looming concern

By Emma Trincal

New York, July 18 – Citigroup Global Markets Holdings Inc.’s 0% trigger Performance Leveraged Upside Securities due Nov. 4, 2020 linked to the Financial Select Sector SPDR fund offer attractive terms, especially on a short duration, advisers said. However, the underlying sector and the timing gave them pause.

The payout at maturity will be par plus at least 300% of any fund gain, capped at par plus 14.9%, according to a 424B2 filing with the Securities and Exchange Commission.

If the fund falls by up to 10%, the payout will be par.

If the fund finishes below its 90% trigger level, investors will lose 1% for each 1% decline from the initial price.

Uncommon barrier

This structure has been popular for years within the Bank of America distribution channel under the Accelerated Return Notes label, noted a source. Many other dealers have followed suit.

These products are almost always the same coming with a 14- to 15-month maturity, the S&P 500 index as the underlier, a 3x leverage multiple and an aggressive cap, according to data compiled by Prospect News. But they typically don’t provide any downside protection, at least not for terms shorter than 15 months, the data showed.

“You don’t see downside protection on those high-leverage, short-duration notes even with the cap,” said Tom Balcom, founder of 1650 Wealth Management.

“A 10% barrier is not very much for a short-term note. But you can’t get a lower barrier for 15 months, so it’s still nice to have it.

“It’s also nice to see this on something other than the S&P. You don’t often see the XLF in a note.”

The underlying ETF is listed on the NYSE Arca under the ticker “XLF.”

Modestly bullish

A buyer of the notes would have to be mildly bullish on large-cap financial stocks given the leverage and cap. It only takes a 3.95% annual gain in the fund for investors to reach the cap.

On a 15-month term and with 3 times the upside up to a 14.9% cap, investors may hope to get 11.75% in annual compounded return as their maximum gain.

Sources said the cap was reasonable based on the fund’s recent performance.

While up 17.4% for the year, the ETF has been flat over the past year because it dropped 13% in 2018.

Interest rates

“I might go longer, but overall the terms are fair,” said Balcom.

“You just have to be clear that interest rate fluctuations may impact your return. It’s the risk.

“If rates go down, it’s not so good for the banks. It reduces their spreads, their profit margins.

“You have to believe that rates will be flat or rise, or you have to expect the negative impact of falling interest rates to be modest.”

Institutional trade

Jeff Pietsch, head of capital markets at the Institute for Wealth Management, expressed concerns about the sector.

“It could be a great product but probably not for a retail investor. Based on our outlook, we think the timing is not ideal,” he said.

“If I were an institutional investor with a mandate to invest in the financial sector, I would like the risk/reward profile of this note, although the fee is expensive,” he added.

The underwriting discount is 1.75%, according to the prospectus.

“But for retail investors, I’m not feeling comfortable making a bet on the financial sector. We’re already late in the economic cycle. Banks haven’t done particularly well in the last couple of years.

“If we start to see signs of more economic deterioration, banks will be vulnerable.”

A changing environment

Those signs are already visible, he said.

“The major pillars – retail sales and jobs – are very strong.

“But if you start to drill down and look at auto sales, manufacturing reports, some signs of caution are looming.”

Pietsch said a bullish bet on financial stocks makes much more sense early in the economic cycle.

After the Great Recession, the ETF price soared. It rose by 28.5% in 2012 and 35.4% in 2013, according to Morningstar.

“You want expanding liquidity and a steepening yield curve when you invest in this sector.

“Early on in the economic cycle, the environment was much more favorable.”

Red flags

Particularly worrisome is the inverted yield curve and the development of negative interest rates around the world, such as in Europe and Japan, he noted.

Short-term rates in the United States have been higher than intermediate ones since March. Inverted yield curves have often been signals of an economic slowdown.

Pietsch is not necessarily bearish on financials.

“Don’t get me wrong. I think banks are well-positioned for the next recession. It’s just not the best environment to make that trade.”

The notes will be guaranteed by Citigroup Inc.

Citigroup Global Markets Inc. is the agent with Morgan Stanley Wealth Management as dealer.

The notes will price on July 31.

The Cusip number is 17327P633.

© 2015 Prospect News.
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