Citigroup’s $253,000 barrier notes on Stoxx 50, Stoxx Banks offer 3x leverage, no cap

By Emma Trincal

New York, Oct. 8 – Citigroup Global Markets Holdings Inc.’s $253,000 of 0% barrier securities due Oct. 6, 2025 linked to the lesser performing of the Euro Stoxx 50 index and the Euro Stoxx Banks index offer ideal terms for bullish investors. But advisers were not necessarily comfortable with the two underlying European equity indexes, especially the one tracking European banks.

If the return of each index is positive or flat, the payout at maturity will be par plus 3 times the return of the lesser-performing index, according to a 424B2 filing with the Securities and Exchange Commission.

The payout will be par if the final level of either index is less than its initial level but the final level of each index is greater than or equal to its barrier level, 70% of its initial level. If either index finishes below its barrier level, investors will be fully exposed to the decline of the lesser-performing index.

Laggards

“It’s nice to have three times leverage and no cap. The 70% barrier is nice too. But the worst-of on these two is scary,” said Steve Doucette, financial adviser at Proctor Financial.

“Do you want to lock yourself up in these indices for five years?”

European stocks have disappointed investors for a long time, he added.

For the year, the euro zone equity benchmark is down almost 8% while the comparable Dow Jones industrial average is nearly flat. In the past five years, the Euro Stoxx 50 index has posted a loss of 3.25%. During the same time, the Dow climbed 66%.

The Euro Stoxx Banks index does not have a good track record by any means. This index shed 37.15% in the last 12 months through Sept. 30, according to Morningstar. It was down 14.19% during the previous 12 months and posted another negative year from Sept. 30, 2017 to Sept. 30, 2018 with a 20.2% drop.

Value trap

“Bank stocks. Value stocks. It can also be a value trap,” he said.

“They’ve been underperforming for 10, 12 years. The gap between value and growth is the largest it’s ever been since 1999.

“You might get a pop up on theses indices, but you have to do your due diligence.

“Hopefully, you shouldn’t have to worry about the downside five years out.

“But this rally keeps going on and going on. It’s just unbelievable. There will be a pullback at some point and the question is when.”

One concern was not so much incurring steep losses a maturity but rather a muted return.

“The market could continue to run for a little while and then drop and recover some. Theoretically you could end up in five years with a weak, almost flat return.

“If the index is up 2% at maturity, who cares about getting 6%?” he said.

Investors in the notes should be bullish and expect some “reversion to the mean,” he said.

“You should probably be patient. Because so far, Europe has been lagging a lot.”

One possible benefit is time.

“Five years out, Covid and the economic recession should be behind us,” he said.

“I like the structure of the notes. It has high leverage, no cap, a 70% barrier.”

Wide CDS spreads

But he pointed to the weak aspect of the deal: the underlying.

“That’s what makes this note a little bit risky,” he said.

For one thing European banks have been under pressure for some time, he said.

Several European banks in the Euro Stoxx Banks index have wide credit default swap rates, reflecting the cost of insuring against the risk of default.

While French banks BNP Paribas SA and Societe Generale SA show tight CDS spreads (39 basis points and 40 bps, respectively, according to Markit), other banks, especially in Italy such as Intesa Sanpaolo SpA and UniCredit SpA, have a much riskier profiles, with CDS spreads at 76 bps and 85 bps, respectively.

In the U.S. CDS spreads for the big banks are tighter. Bank of America and JPMorgan both have CDS spreads of 49 bps. Morgan Stanley’s 53 bps and Citigroup’s 59 bps are also narrower than in the banking sector in Europe.

Doucette noted that almost half of the constituents of the index were concentrated in two countries where banks are under greater stress: Italy and Spain.

“You really have to do your research and take a look at these stocks. They’ve not done well for a long time. Who knows where they’re going?” he said.

Headwinds ahead

Matt Medeiros, president and chief executive officer of the Institute for Wealth Management, also expressed concerns about the underlying.

“The Euro Stoxx 50 is an important part of any asset allocation strategy. But I would prefer a buffer over a barrier.

“We are not tracking the other index. So, I wouldn’t want to opine on European banks specifically,” he said.

European stock markets are exposed to macro-economic risks in the current pandemic environment.

“There are considerable headwinds. The impact of Covid-19 on global growth remains uncertain,” he noted.

“Adverse effects could be even worse in Europe than in the U.S. because Europe is export-driven. The pandemic has hit global economies as well as international trade, and that can’t be good for the euro zone.”

As a result, Medeiros said he was only mildly bullish on Europe.

Terms

The structure was attractive from that perspective.

“I am not a bull on Europe, so the 3x leverage is appealing to me.

“I think this is really the sweetener. With low return expectations for the euro zone, the leverage is very attractive.

“I also like the five-year term. It’s a full economic cycle. It’s a good thing given that we don’t know how long it’s going to take to get the economy in full speed mode,” he said.

By the same token, the payout is a worst-of, something that always requires greater risk management especially when one of the underlying indexes is not a very well-known benchmark.

“As always, I’m much more comfortable with a hard protection on the downside.

The notes are guaranteed by Citigroup Inc.

Citigroup Global Markets Inc. is the underwriter.

The notes priced on Oct. 1 and settled on Oct. 6.

The Cusip number is 17328WN38.

The fee is 0.6%.

© 2015 Prospect News.
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