Citi’s callable CMS spread range accrual notes on S&P offer long teaser period, high rate

By Emma Trincal

New York, Nov. 23 – Citigroup Global Markets Holdings Inc.’s $3.72 million of callable fixed-to-floating SOFR CMS spread range accrual securities due Nov. 17, 2042 linked to the S&P 500 index caught market participants’ attention for a number of compelling terms, such as a guaranteed coupon over a multi-year period.

The interest rate is 11% for the first four years, payable quarterly, according to a 424B2 filing with the Securities and Exchange Commission.

After that, the coupon rate is 50 times the 30-year U.S. dollar SOFR ICE swap rate minus the two-year U.S. dollar SOFR ICE swap rate for each day the index closes at or above 50% of its initial level, subject to a maximum rate of 14.5% and a floor of zero.

The notes will be callable at par on any quarterly redemption date after one year.

The payout at maturity will be par plus any coupon due.

Compelling terms

“We did this 20-year Citi note. You get a fixed coupon of 11% for four years. Four years is a long time for a teaser rate,” said Jerry Verseput, president of Veripax Wealth Management.

“Then the rate becomes contingent with an accrual based on the S&P. The interest barrier is 50%. Clearly, that means the rate is practically not contingent.”

The S&P 500 index would have to drop approximately below 2,000 based on the S&P 500 index’s initial price of 3,991.73 on the trade date. Such level has not been seen in the past seven years.

Even if the barrier is breached, the coupon payment is not compromised as it is based on an accrual formula, he noted.

“After four years they pay you the variable rate of 50 times the 30’s minus the 2’s. 50 times leverage. That’s a lot of leverage. The only reason Citi can offer that note is because the yield curve is inverted,” he added.

“They can also offer it because it’s callable after a year. Citi will call it. Fine you’ll get 11% in one year. I don’t have a problem with that.”

Steepening ahead

A bond trader agreed.

“It’s a very attractive structure. Only the coupon is at risk, but you have this 50% barrier. If it gets called after one year, you get 11%, or 600 bps over Treasuries. That clears that up,” he said.

“If you don’t get called, it’s still very enticing because in 18 months to two years, the curve will start to be flat to slightly positively sloped. Being in positive territory should give you a very good coupon with the 50x leverage.”

For this trader, the curve should steepen because the Federal Reserve can only raise short term interest rates for so long.

“We’re already well into a recession, no matter how you call it. In the first half of the year, the Fed should be backing off a little bit on the aggressiveness of its tightening policy.”

Having a “teaser rate” for four years was unusual, he added. Typically, the “teaser rate” on steepeners is paid over a one- to two-year period.

Call premium, cap

“You get a guaranteed rate of 11% for the first four years. If you’re not called, that’s 44%, close to half of your money before the formula.”

The probability for the issuer to call the notes after one year was high, he noted.

“It’s likely to happen. But if they call, I don’t care. I get an 11% coupon and I don’t have to worry about a 20- year maturity.”

In the event of no call, this trader said he liked the 14.5% cap on the variable rate.

“That’s a high cap. Interest rates are nowhere near that. Whether you get the 11% or the 14.5% maximum return, you’re way ahead of the game.

“Another thing: usually when you have contingency of the coupon with an equity component, you also have contingency at maturity. But that’s not the case here. Your principal is protected at maturity. That’s unusual.

“That’s a very attractive bond for someone to buy,” he said.

Not a done deal

A market participant stressed the risks incurred by investors betting on a steeper curve.

The yield curve between the 30 and two years is “extremely” inverted, he said at minus 150 basis points.

“It’s an all-time low. There have been very few times this part of the curve has been inverted at all. Right now, it’s the most inverted it has ever been. You have to expect that at some point it will normalize, but when? That’s why they’re giving these incredible-looking terms,” he said.

In order to earn any kind of coupon from the floater, the curve needs to steepen, he said.

“Having 50x leverage looks nice, but what are you leveraging up? It’s not going to do anything if the spread is zero or negative because it’s so inverted. The most recent peak was in March 2021 at 180 basis points. Now it has to go back up. You do need the curve to normalize. It may be zero for quite some time,” he noted.

The best outcome will come from the issuer if it decides to exercise its call option.

“A call at an annualized rate of 11% ... no one should be disappointed with that. That’s probably the best outcome for the investor.”

The notes are guaranteed by Citigroup Inc.

Citigroup Global Markets Inc. is the underwriter.

The notes settled on Nov. 17.

The Cusip number is 17330YCM0.

The fee is 5%.

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