Citigroup’s autocall market-linked notes on Citi Radar 5 ER index bring new index, innovation

By Emma Trincal

New York, July 3 – Citigroup Global Markets Holdings Inc.’s 0% autocallable market-linked notes due July 30, 2026 linked to the Citi Radar 5 Excess Return index present two singularities, one from the underlying, which is used for the first time in a structured note; the second from a structure that combines an autocall and full principal protection, according to sources and data compiled by Prospect News.

The notes will be automatically called at par plus an early redemption premium of 5.5% per year if the index closes at or above the applicable redemption threshold on any of the six annual determination dates, according to a 424B2 filing with the Securities and Exchange Commission.

The redemption threshold is 102% of the initial index level for the first determination date and steps up by 2% each year to a redemption threshold of 112% of the initial level for the sixth determination date.

If the notes have not been called, the payout at maturity will be par plus any index gain. If the index finishes flat or falls, the payout will be par.

First time

Launched in Feb. 20, the Citi radar 5 Excess Return index is used for the first time in a registered structured note, according to data compiled by Prospect News.

The main theme of the underlying strategy is to allocate exchange-traded funds based on the prevailing U.S. interest rate environment. The algorithm makes this determination daily and proceeds to allocate exposure to ETFs and Treasury futures according to whether the interest rate environment is “rising” or “not rising.”

For instance, in the “rising” environment, the index overweighs energy, financial and technology. Inversely, when rates are not rising, more is allocated to utilities, consumer staples and health care.

Step up

An industry source commented on the payout.

“You’re only getting paid if it gets called and your first threshold is at 102% and keeps on stepping up, making it more difficult to get your call premium,” he said.

“You might not rise enough especially if the index has a vol. target, although I haven’t looked at the index and can’t say for sure. But that’s one of your risks.”

Performance

Over the last year, the compounded return of the index was 7.2%, according to a hypothetical analysis published in the prospectus. The annualized compounded return was 6% over the last three years and 4.6% over the past five.

The rules-based index has a volatility target of 5%. The feature may reduce the index performance due to possible significant allocations to Treasury futures, according to the prospectus. For investors the tradeoff for the principal protection is to earn lower gains even if the equity markets rally.

“At first glance though you wonder: what’s my risk? I get my money back at maturity. Well, it’s a seven-year note and you may not get paid,” this source said.

Index fee

To make his point, he compared the note with the risk-free rate. The seven-year Treasury yields 1.875%.

Over the seven-year period, investors are giving up approximately 13%.

This source noted reading the prospectus that investors have to bear the cost of an index fee of 0.75% per annum.

“You have to pay this index fee over seven years, so that’s a cost of 5.25%,” he said.

The 5.25% was 40% of what an investor would earn from the risk-free rate over the period.

“40% of what you would get in Treasuries goes into that index fee. The other 60% is your risk. You take that risk so that you get the possibility of earning more.

“If you’re only risking 60% of your money in order to get a possible positive outcome and a full downside protection, it’s a pretty low risk. And when risk is low, it often means that the probabilities of winning are low as well. It actually always works that way. People don’t give away free money.

“I think you’re betting on a dark horse.”

Innovation

A market participant looked at the structure from a different angle, seeing innovation in it.

“It’s a unique way to offer principal protection. They put an autocall on it. You don’t see autocalls with 100% protection. It’s either a barrier autocall or a growth product with principal-protection,” he said.

He compared the notes with other products linked to proprietary indexes such as the J.P. Morgan Efficiente Plus DS 5 index or the GS Momentum Builder Multi-Asset 5S ER index, which provide consistent sales for their dealers.

“But the Efficiente and Momentum are more generic structures. For the most part they’re participation notes.

“This one on the other hand gives you a new choice, a different payout structure. It’s more conducive to find income,” he said.

Copycats welcome

Although the product is not purely income-oriented since investors get paid only upon the call, at least the call premium accumulates, he added.

“The step up makes it a little bit difficult to get called. But I still find it compelling.

“I wish Citi well. There’s a strong probability of getting traction, something other issuers may look at themselves. Of course, they would have to use their own prop indices.”

The notes are guaranteed by Citigroup Inc.

Citigroup Global Markets Inc. is the agent.

The notes will price on July 26.

The Cusip number is 17327TMH6.

© 2015 Prospect News.
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