Call risk seen as top drawback in Citi’s $13 million contingent yield autocalls on S&P 500 ETF

By Emma Trincal

New York, Aug. 14 – Citigroup Global Markets Holdings Inc.’s $13 million of contingent income autocallable securities due Aug. 13, 2024 linked to the SPDR S&P 500 ETF Trust show some attractive attributes such as a short tenor, a downside buffer and a high contingent coupon with memory, all of that without resorting to a worst-of. But advisers did not adhere to the trade given the risk of getting called too early.

Investors will receive a coupon of 11.5%, paid monthly, if the underlying fund closes at or above its 90% downside threshold on the related monthly observation date, according to a 424B2 filing with the Securities and Exchange Commission. Previously unpaid coupons will also be paid.

The securities will be called automatically starting Sept. 8 at par if the price of the underlying stock is greater than or equal to its initial price on any monthly review date.

At maturity the payout will be par unless the ETF declines by more than its 10% buffer, in which case investors will lose 111.111% of the decline beyond the buffer.

Other alternatives

“I wouldn’t get excited about that. I don’t know that the risk-reward is there,” said Scott Cramer, president of Cramer & Rauchegger.

“If the market is down below 10%, it’s likely to be down much more.

“I also don’t like having a geared buffer to the downside.”

Because the tenor was short, the issuer was not in a position to offer any call protection. Cramer said that a call after just one month was a real possibility.

“If they’re going to call you right away, you’ll get one-month security with one month coupon. If I’m the issuer, I’m trying to protect myself, I get this. But I don’t think the customer is getting a whole lot of benefits if they’re called that early. For them there are more downsides than advantages,” he said.

A better alternative, he added, was to use a “risk-free Treasury yielding more than 5%.

The one-year Treasury yields 5.378%.

High-yield bonds or high-yielding securities were other valuable options.

“You can get similar returns without as much risk. I’m thinking of BDC for instance,” he said.

He gave the example of FS KKR Capital Corp., a publicly listed business development company (BDC) with a yield of 12.7%.

“They do credit lending. They’re trading at a discount to NAV.

“It has much less downside than the note. And you can get out anytime,” he said.

Agnostic case

Carl Kunhardt, wealth adviser at Quest Capital Management, found some benefits in the notes when comparing it to an outright investment in the ETF. But the automatic call was a strong deterrent.

“It’s one of those agnostic notes. I might do it. But it’s not that compelling,” he said.

One of the most attractive terms was the short tenor.

“One year is just fine. It’s not too long, not too short. If you’re investing, you shouldn’t do anything less than one year because that’s savings or money market. But you also don’t want to go too long. I like the one-year.”

The underlying ETF was also acceptable although Kunhardt said he preferred exposure to the index directly.

“You should always have the S&P in in the portfolio. So, I’m fine with the underlier. The question becomes are you better off holding it long or holding it in a note?” he said.

Kunhardt assessed other features of the product in order to answer his own question.

The coupon was attractive compared to his return expectations of 9.5% to 10% a year for the benchmark.

“Depending on what your expectations are on the S&P, an 11.5% coupon is a nice little premium,” he said.

“I also like the memory,” he added referring to the payment of previously unpaid coupons once a coupon payment is triggered.

“It’s paid on a monthly basis and if you miss one or several, you’re not missing anything because you get it later,” he said.

Finally, this adviser did not object to the buffer.

“Any buffer is better than no buffer. Yes, maybe 10% is not a big buffer, but it’s better than 0%.

“So, it’s not an ugly note. It’s not hurting you,” he said.

A call is trouble

Despite those positive features, Kunhardt said he remained “agnostic” about the note as the high likelihood of an early autocall was a real concern.

“Sure, if you get called on the first month, you’re collecting almost 1%. That’s better than sitting in cash.

“But it’s really a hassle.

“If I get called, I have to go through the desk, a commission will be involved. I have to find a replacement. I’m not sure I would want to go for the time and trouble just to get the 10% buffer, which is perhaps the main advantage you get from the note compared to holding the position long,” he said.

Overall, Kunhardt found a long position more compelling than the note.

“If I hold the index, I have no downside protection. But I’m uncapped, I have no call and I can get out any time I want,” he said.

Tiny range

Kirk Chisholm, wealth manager and principal at Innovative Advisory Group, said the notes offered limited chances to offer a positive outcome.

The optimal scenario would if the index traded between -10% and 0%, he said.

“You’re above 90% so you get the coupon. But you’re not up so you don’t get called. That’s a good place to be. But it doesn’t really fit many investment theses,” he said.

Low chances to win

Statistically, the market is below -10% or above +10% 70% of the time, he said, leaving the -10% to +10% bucket with a 30% probability of occurrence.

Without knowing the exact probability associated with the optimal scenario of a return between -10% and 0%, he said it would obviously be small and much smaller than 30%.

“Assuming it’s halfway. You have a 15% chance of getting paid without getting called. To me, that’s a low probability play,” he said.

For bulls, the coupon would cap a potentially high return.

“We’re at the top of the range in the market. The upside is limited, which doesn’t mean that you’re not going to get called. You could get called a month or two months from now and get almost nothing.

If you want to participate, you’re capped. If you don’t get called, you’re stuck in a volatile environment.

“In addition, this seems a little bit too complex for most people.

“This type of trade doesn’t appeal to me,” he said.

The notes are guaranteed by Citigroup Inc.

Citigroup Global Markets Inc. is the agent.

The notes settled on Friday.

The Cusip number is 17291Q5W0.

The fee is 0.1%.

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