Citigroup’s $1.62 million of callable range accrual notes on Russell put coupon at less risk

By Emma Trincal

New York, Oct. 4 – Citigroup Global Markets Holdings Inc.’s $1.62 million of callable buffer range accrual notes due Sept. 29, 2028 linked to the Russell 2000 index provide a more conservative coupon structure than a typical callable contingent coupon note with a barrier observed at separate intervals, said a market participant.

Hence the coupon is lower, he said.

The interest rate will be 7.6% per year multiplied by the proportion of days on which the index closes above the accrual barrier level, 85% of the initial index level, according to a 424B2 filing with the Securities and Exchange Commission. Interest will be payable monthly.

The notes will be callable at par on any monthly interest payment date after one year.

If the final index level is at least 85% of the initial index level, the payout at maturity will be par.

Otherwise, investors will lose 1% for every 1% that the index declines beyond 15%.

Modest coupon

“They’re not giving you that much in yield,” the market participant said.

“One way they can justify this is the 15% buffer at maturity. That’s a factor.”

Another factor was the exposure to one index rather than a worst-of, he noted.

“A single underlier is going to pay less given the lower risk. All things being equal, that’s always the case,” he said.

The monthly issuer call, however, should have “boosted” the return, he noted, even with a one-year no-call.

“I think we can credit the range accrual for the lower coupon,” he said.

Getting paid with a range accrual is a lot safer because the odds of getting your coupon are higher. Since you’re more likely to be paid more often, you should expect a lower coupon than the Phoenix,” he said.

20 Phoenix deals

Phoenix autocallable notes are the most common callable income products. The full coupon payment is paid when the price is at or above the coupon barrier.

With a Phoenix autocall, the outcome is binary.

“You either get the full coupon or you don’t,” he said.

He compared the range accrual payment to an “every day” observation.

“You have 20 trading days in a month, and so each day you don’t touch the barrier, you get a 20th of the coupon.

“It’s like 20 Phoenix deals,” he said.

Since the observation dates are closer to one another, the chances of being “right” are higher, he noted.

“Your probabilities of accumulating the coupon along the way are greater,” he said.

The risk-reward on the coupon is very different with a Phoenix, he noted.

“If you hold a Phoenix with a single observation at the end of each month, the coupon has to be higher because you take more risk. How much higher, I can’t tell you. But this difference alone may explain why the yield on this one appears to be unimpressive,” he said.

No call scenario

Those two different risk-reward profiles only relate to the interest rate.

“What the range accrual modifies is your risk around the coupon. It puts less risk on the coupon. But the risk of losing principal is not changed,” he said.

“Whether you buy a Phoenix or a range accrual like this note, your risk profile at maturity is the same. A buffer is a buffer. A five-year is a five-year. You still have your principal at risk.”

A different environment

A trader said the notes showed an outdated structure.

“I’m not excited about it,” he said.

“These types of notes were much more desirable when interest rates were lower because barriers were lower and any kind of return you got seemed attractive.

“Now with interest rates where they are, it’s not that attractive.”

This trader said that for each note he criticizes, he also suggests an alternative.

Non-inversion bet

With the yield curve beginning to flatten and heading toward a steeper shape, his best pick would be a “non-inversion note.”

“We know the Fed is going to stop raising rates. They will send the economy into a recession if they don’t stop. The curve is not as inverted as it was just a few weeks ago.

“I’d rather do a five-year note paying a fixed coupon of 7.5% per annum for the first two years. After that, I get paid the same rate semiannually if the 30 minus 2 spread is above 1 basis point. If not, I don’t get paid. Principal guaranteed at maturity. That type of product makes a lot more sense to me,” he said.

He was referring to the spread between the 30-year Treasury bond and the two-year Treasury note.

“Linking your coupon to the stock market right now is too risky. Equity markets are going to be in turmoil in the next six months.

“I wouldn’t do a note on the Russell or any equity index for that matter,” he said.

The notes are guaranteed by Citigroup Inc.

Citigroup Global Markets Inc. is the underwriter.

The notes settled on Friday.

The Cusip number is 17291QJM7.

The fee is 3.5%.

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