Citigroup’s capped barrier notes tied to Euro Stoxx Banks fail to express a view, advisers say

By Emma Trincal

New York, June 11 – Citigroup Inc.’s capped contingent buffered equity notes due June 29, 2016 linked to the Euro Stoxx Banks index, despite having some attractive structural features, did not appeal to buysiders who said the product fails to express a clear market view and therefore is not likely to appeal to any particular type of investor.

In addition, the sector approach within a foreign equity market was an issue for those advisers who said they prefer investing in broader benchmarks.

The payout at maturity will be par plus any index gain, up to a maximum return of 18.6%, according to a 424B2 filing with the Securities and Exchange Commission.

Investors will receive par if the index falls by up to 20% and will be fully exposed to the index’s decline if it finishes below the 80% barrier level.

“If you’re going into it, you just get the index with a cap. There is a barrier, but what are you looking for? Protection or growth?” said Steve Doucette, financial adviser at Proctor Financial.

Sector bet

The European banking sector is not appealing in his opinion.

“I speak with a lot of the smartest minds. Among them, not one is telling me to buy the big European banks,” he said.

“The large European banking sector is not going to give you a good risk-reward going forward.

“Even if Europe as a whole offers good valuation compared to U.S. stocks, I wouldn’t be optimistic about European bank earnings given low interest rates, rules and regulations and capital requirements that are a drag on the sector.

“There’s nothing I like about the underlying.”

The Euro Stoxx Banks index is a sub-sector of the Euro Stoxx 600 index, which tracks the performance of the 600 largest European stocks by free float market capitalization. It represents currently 30 stocks of some of the largest banks, mainly from the 10 largest euro zone countries, according to the prospectus.

Risk versus reward

Doucette said the downside is a concern.

“If you can pull 18.6%, it would be a great return for one year. Then you have the 20% barrier. But does the barrier really help me if we get a pullback? Banks in Europe would be hit harder than other sectors, and the barrier could be easily breached,” he added.

“This is a sector with a low probability of return. At the same [time], a pullback is likely to hit your investment harder. I don’t see a great risk-reward going forward.”

Euro Stoxx 50

Doucette looked at the correlation between the underlying index and the Euro Stoxx 50 index, which tracks the top 50 large-cap stocks in the euro zone across all sectors.

“I’m stunned at the huge gap between the two indexes,” he said.

Over the past year, the Euro Stoxx Banks index has lost less than 2% while the Euro Stoxx 50 has dropped nearly 12%.

“There’s a huge discrepancy between the two,” he said.

“Do you want to get in an index that outperformed the 50 largest companies in Europe by a 10-point spread?

“I wouldn’t make that move. I’m a believer in reversion to the mean. It’s too risky.

“Right now it’s outperforming. It could continue. But how long is this trade going to last? Now you’re getting into market timing.

“You’re selling the upside to buy the protection on the downside. There may be some other combinations.

“The way the deal is structured doesn’t appeal to me much because I always look to see if I can outperform on both sides. It looks like you can only do that on the downside. That’s not a real incentive to buy.”

Nice term

Steven Foldes, vice chairman of Evensky & Katz / Foldes Financial Wealth Management, also had a negative view on the structure, except for the tenor.

“We like short notes. This one is a one-year plus just a few days more to give you the opportunity for a long-term capital gain, which is a good thing,” he said.

But other aspects of the investment are “somewhat problematic.”

The first one is the underlying itself as Foldes said his firm usually stays away from sector bets, preferring to focus on broader indexes.

Upside, downside risks

But his main criticism was that the purpose of the investment itself.

“If you’re bullish in this particular area, having a cap makes no sense,” he said.

The 18.6% cap does not compensate investors enough for the risk, in his view.

“If you’re bullish and give your client exposure to an area as volatile as the European banking sector, you want them to have full participation and be able to get a substantial gain,” he said.

The Greek debt negotiations could develop into a crisis, which would impact especially hard the European banking sector. Given their exposure to this risky sector, investors need greater protection, he reasoned.

“Having a barrier on the downside is nice. But a barrier is not a buffer. To the extent that this particular sector of European equities comes under pressure, if it falls 21%, you lose 21%.

“We don’t love barriers. We prefer buffers.”

Blind

The combination of a cap and a one-to-one exposure makes the product unappealing to most investors, he said.

“This note does not accommodate a view. It doesn’t accommodate a bullish view because of the cap.

“It doesn’t accommodate a bearish view because it’s a barrier not a buffer, and 20% in this particular sector is not huge. And it doesn’t accommodate a moderately bullish or a range-bound view because it’s not leveraged.

“It doesn’t really do anything as it relates to any kind of view you may have.”

Pricing short

Pricing a note with an 18.6% cap and a 20% contingent protection over such a short period of time must be a challenge, sources said. But the trade-off – what investors have to give up for the short maturity – is not enticing, according to them.

“I am surprised they did this product so short,” said Foldes.

“Maybe had they used an 18-month or two-year duration we would have seen a higher cap with leverage or maybe either a buffer or a bigger barrier.

“One year is a very short term. You’re sort of flipping a coin. The market seems to be moving on what’s happening in Greece. You get bad news, and it’s a sell-off. You get the good news, the market takes off.

“I would submit to the issuer to perhaps extend the term so it may at least accomplish some kind of a view.

“But right now, it doesn’t accomplish anything.”

Citigroup Global Markets Inc. is the underwriter.

The notes were expected to price June 12.

The Cusip number is 17298CCD8.

© 2015 Prospect News.
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