Citigroup’s contingent coupon autocalls tied to Micron, MetLife show lower chances of autocall

By Emma Trincal

New York, May 10 – Citigroup Global Markets Holdings Inc.’s contingent coupon autocallable notes due May 14, 2020 linked to the least performing of the common stocks of Micron Technology, Inc. and MetLife, Inc. are less likely to be automatically called compared to a single-asset equivalent product, said Suzi Hampson, head of research at Future Value Consultants.

The notes will pay a contingent quarterly coupon, plus any previously unpaid coupons, at an annual rate of 15% if each underlying stock closes at or above its 60% coupon barrier on the observation date for that period, according to a 424B2 filing with the Securities and Exchange Commission.

Starting in August, the notes will be called at par if each stock closes at or above its initial level on any quarterly observation date.

The payout at maturity will be par unless either stock closes below its 60% barrier level, in which case investors will receive a number of shares equal to $1,000 divided by the initial share price or, at the issuer’s option, the cash equivalent.

No-call test

One of the immediate effects of a worst-of payout is to reduce the likelihood of the autocall event, Hampson said.

This can be demonstrated from one of the 29 probability tables, which are the core of Future Value Consultants’ research reports. The firm provides stress testing analysis on structured notes allowing investors to review probabilities of occurrence of outcomes pertaining to a specific structure type.

The Citigroup notes are a classic example of a so-called Phoenix autocallable note in which a contingent coupon may be paid independently even when the notes are not called since the coupon barrier is below the call trigger level.

The non-occurrence of an autocall had a 41.7% probability associated with it, according to the “product specific tests” table of Future Value Consultants’ report. The other tests in this table include probability of barrier breach, probabilities of calls at the various “call points” (call dates) as well as coupon paid at various payment dates.

Market-dependent

The 41.7% probability of a “no-call” outcome is observed under the neutral scenario. Future Value Consultants’ simulation model presents four other market scenarios, which are bullish, bearish, more volatile and less volatile.

The likelihood of the notes never being called is naturally the greatest under the bear market assumption (47.74%) while it bottoms in a bull market with a 36.11% probability, according to the table.

“You see variations based on the market type. But if you were to compare this product with another Phoenix tied to a single underlying, you would see a big gap in probabilities. The call is much more likely in a single-asset type of autocall,” she said.

The worst-of factor

The neutral scenario is the basis of the simulation in all reports. It reflects standard pricing based on the risk-free rate, dividends and volatility of the underlying.

“But it doesn’t mean anything in terms of market projections. We use it for consistency and comparison between products. When clients want to make market assumptions, we determine other market scenarios based on various growth assumptions in the underlying,” she explained.

This is what allowed the analyst to point to the less-likely occurrence of the autocall associated with this note.

“Under the neutral assumption, we can make comparisons and verify that the probability for a ‘no-call’ outcome is much higher when you have two or several underliers rather than just one,” she said.

“It seems obvious intuitively since both stocks have to be above their initial price. But the difference in probabilities is quite big.”

Correlation, volatility

Correlations between the two underlying stocks has to be taken into account. In this product, MetLife and Micron belong to two distinct sectors – financials and technology, respectively – and their coefficient of correlation is only 0.72. A coefficient of 1 would be perfect correlation.

“It’s not like a 0.8 or 0.9 coefficient we get for big indices,” she said.

“One of the stocks could go up while the other goes down. The relatively low correlation reduces the chances of both rising above their initial price. Naturally, it’s going to have an effect on the probability of calling.”

Another factor making the call less likely is the short duration.

“It’s only a one-year. You only have three call points. The more call points you have, the more chance of it happening,” she said.

Volatility

The volatility of each stock also impacts the probabilities of call, coupon payments and losses. But its role is more indirect in a worst-of since the volatility is tied into the correlation, she said.

“The more volatile one is the one where you’re most likely to incur losses,” she said.

Not surprisingly, Micron, a semiconductor stock, displays the highest implied volatility at 39.7% versus 22.9% for MetLife, she noted.

However, volatility can be associated with a sharp price rise as well.

“The volatility itself doesn’t give you a way to know where the stock is going,” she said.

Gauging the defense

Assessing the protective value of a barrier is a challenge in itself for investors looking at underliers they are not familiar with unlike the S&P 500 index, whose omnipresence in the market facilitates “at-a-glance” comparisons.

The “barrier breached” test in the table offered an answer.

Under the neutral scenario, the barrier at maturity will be breached 13.06% of the time.

“You can’t look at a 60% barrier and say: it’s a low risk product. Too many factors are at play,” she said.

A good place to start is to see how often the barrier is likely to be breached, she added.

“The 13% probability seem reasonably low to me,” she said.

Unknown exposure

The structure at first sight shows risky features, she noted.

“You have two stocks starting by the letter ‘M.’ I don’t know what other similarities they have,” she said.

The worst-of payout is also difficult to predict.

“The worst-of is not a tangible asset. This is not something people would have a view on.”

Having more than one underlying as mentioned before also reduces the likelihood of a call. Along with that, the probabilities of a call occurring on the first observation date are lower than with a single-asset autocall.

A call occurring at point 1 (on the first quarterly observation) has only a 38.69% chance of happening, according to the table.

“Usually on the neutral scenario, the call at point 1 happens 50% of the time when it’s not a worst-of. Will the stock be lower or higher than its initial price? That’s kind of a 50/50 probability,” she said.

The worst-of changes the distribution, making it more likely for investors to be called at a later date or even not called at all.

Mitigating risk

But the issuer introduced in the product some risk-reducing features as well.

“The autocall for one will reduce your risk. Sixty percent of the time, you will kick out, and that means you’ll get your principal back with your coupon,” she said.

The 60% probability of an autocall was the rounded number for 58.3%, or 100% minus the 41.7% probability of the no-call outcome.

The call may happen less frequently with a worst-of, but it still mitigates the risk of losing principal at maturity.

“Risk is off the table once the notes are called. That’s true for any autocall, including this one,” she said.

The barrier level was another risk-reducing element.

“As we’ve seen before, you will lose money only 13% of the time because the barrier is quite deep. The downside of a low barrier of course is that your losses will be big if you do breach. You know you will lose at least 40% of your money.

“But the probability of this happening is quite small.”

The use of two stocks with little correlation to one another helped the issuer provide the 15%.

“It’s a double-digit return with a relatively low barrier. It gives the product a decent risk-adjusted return profile, which reduces some of the risks associated with the worst-of,” she said.

Defined outcome

Overall the notes can be used as an equity substitute.

“If you’re comfortable with those stocks, rather than investing in them directly, you could take the exposure to the worst-of and cap your return in order to reduce your risk. You’re getting a limited return but you’ll be more likely to get something. It’s an alternative to a long exposure, which offers the whole spectrum of returns available to you but at a much higher risk,” she said.

The notes are guaranteed by Citigroup Inc.

Citigroup Global Markets Inc. is the underwriter.

The notes will settle on Tuesday.

The Cusip number is 17324XPT1.

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