Citibank’s auto-switch CDs linked to basket of Euro Stoxx, S&P 500 offer relatively new payout

By Emma Trincal

New York, Feb. 19 – Citibank, NA’s auto-switch market-linked certificates of deposit due Feb. 29, 2024 linked to an equally weighted basket of two indexes have a relatively new structure, according to data compiled by Prospect News. Investors may either get 100% participation in the upside at maturity or a guaranteed coupon payment that is payable annually if a high-water mark condition is met. In such case, however, the upside will be capped at the coupon level.

The basket consists of the Euro Stoxx 50 index and the S&P 500 index.

An auto-switch event occurs if the basket return on any annual interim valuation date is greater than or equal to 30%, according to a term sheet.

If an auto-switch event occurs, the CDs will pay a coupon of 6% to 6.5% on each subsequent coupon payment date.

In addition, if an auto-switch event occurs on an interim valuation date other than the first one, then on the immediately following coupon payment date, the CDs will pay an amount equal to all prior coupons that would have been paid if an auto-switch event had occurred on the first interim valuation date.

If an auto-switch event has not occurred, the payout at maturity will be par plus the market-linked return, if any. The market-linked return is the basket return, subject to a floor of zero.

If an auto-switch event has occurred, the payout will be par plus the final coupon.

Unseen

This type of “auto-switch” or “autoswitchable” structured product is seemingly rare in the United States.

In 2015, Natixis Structured Issuance SA brought an autoswitchable note linked to the Euronext BeNe 40 Equal Weight Excess Return index, but the product was registered in Luxembourg. There have not been any registered notes priced in the United States using that terminology, according to the Prospect News data.

Purpose

A financial adviser who buys structured products including market-linked CDs on a regular basis was not excited about the investment.

“It feels like this product is not sure what it wants to do,” said Jerry Verseput, president of Veripax Financial Management.

“If it’s designed to give you equity exposure, there are better ways to do that.

“You can find notes that are relatively conservative and that will give you market exposure.

“If you need a modest return, just buy a traditional CD. Even money markets give you 2%. At least it’s a guaranteed income.

“Any structured product tries to solve a problem. I’m not sure what problem this one is trying to solve.”

Limits

By “locking in” the coupon if the basket is up at some point 30% from its initial level, the CD may represent an attempt at guaranteeing a 6% annual return even if a bear market eliminates all gains at some point after the “auto-switch” event, he reasoned.

“But you’d have to see the market go up 30% then collapse so you could say, I’m really glad I did that. The set of conditions to make this bet worth tying up your money for five years is so narrow, I think you’d be better off with other alternatives.”

Auto-switch

Michael Kalscheur, financial adviser at Castle Wealth Advisors, was also skeptical.

“It’s principal-protected. It’s FDIC-insured. You know you will get at least your principal. You have a 100% chance of getting 100% back,” he said.

“The most likely scenario is that you’ll hit that 30% during the five years. But there’s a catch. Say the market is up more than 30%. If you break the 30%, you end up lower. You’re capped.”

To back up his assumption that the most likely outcome is a “breach” of the 30% strike above the initial price, Kalscheur looked at the S&P 500 index performance over five-year rolling periods since 1987. He disregarded the historical performance of the Euro Stoxx 50 index, on which he has collected fewer data points.

“If anything, the Euro Stoxx would probably dilute the returns. So we’ll just run our analysis based on the S&P to get the big picture,” he said.

The chances for the S&P 500 to hit the 30% threshold over a five-year period were 63.3%.

Structured versus traditional

Kalscheur proceeded to compare the uncertain return of the structured CD with that of a plain-vanilla CD.

He found a five-year CD yielding 3.1%, which he rounded to 15% over the period, eliminating the compounding.

His historical performance data indicated that the probability of having a return in excess of 15% over a period of five years was 70%.

“If you buy the structured CD, you want to beat the 15% return. That’s all you want to do,” he said.

“Well, you have a 70% chance of doing that, which means that 30% of the time, you won’t.

“Thirty percent of the time you would be better off with the plain-vanilla CD paying 3%. Do you really want to roll the dice?

“If you tell a client, I’m putting you in a CD where you have a 30% chance of not getting what another CD would give you guaranteed, they’ll say, I’ll take my risk in the stock market.”

Better rates short-term

Another reason to prefer a regular CD was the narrow spread between two-year and five-year CD rates.

Kalscheur identified two-year plain-vanilla CDs yielding 2.8%, only 20 basis points less than the five-year rate.

“If you roll a 2.8% CD at the end of the two years, you’re close enough to 6% after only four years,” he said.

“You’re also better off staying on the short end because two years from now, interest rates will probably be higher.”

Participation

Kalscheur ran his analysis assuming an auto-switch event was the most likely and less-desirable scenario.

“If you want to participate in the market, if you need the full exposure, you can probably do that with a structured note, especially on a five-year. You could even get more than one-to-one on the upside,” he said.

Recent offerings showed leveraged notes on the Euro Stoxx 50 with full principal-protection in maturities ranging from three to three-and-a-half years. GS Finance Corp. priced at the end of January an eight-year fully protected note on the S&P 500 with 1.1 times upside leverage.

“I just can’t get really excited about this CD,” Kalscheur said.

“The reason you’re getting into a five-year CD is because you’re a conservative investor.

“A 30% chance of getting less than what another piece of paper says you’ll get ... that’s too much risk for this market.

“The structure is not the problem. It’s the target market. People who buy CDs don’t want that level of uncertainty.”

Citigroup Global Markets Inc. is the agent. Advisors Asset Management is distributor.

The CDs will price Feb. 25.

The Cusip number is 17294XNL6.

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