Citigroup’s $1.16 million callable notes on ETFs show 18% yield based on sector bets

By Emma Trincal

New York, Feb. 15 – Citigroup Global Markets Holdings Inc. priced an 18% contingent coupon using three different sector ETFs in an autocallable income play. Some further research on the potential risk induced by high volatilities and low correlations between the underliers was necessary to make a decision, according to an adviser.

A trader said he did not need an in-depth analysis to rule out the trade as too risky.

Citigroup Global Markets Holdings priced $1.16 million of callable contingent coupon equity-linked securities due Feb. 12, 2027 linked to the worst performing of the SPDR S&P Regional Banking ETF, the Utilities Select Sector SPDR fund and the VanEck Vectors Gold Miners ETF, according to a 424B2 filing with the Securities and Exchange Commission.

Investors will receive a coupon of 18.15% paid monthly if the worst performing ETF closes at or above its 70% coupon barrier on the related valuation date.

The securities may be called after three months on any subsequent monthly review date.

The payout at maturity will be par if the worst performing ETF ends at or above its 60% final barrier. Otherwise, investors will lose 1% for every 1% that the worst performing ETF declines.

Due diligence

“You could be called in May. While you would get a 4.5% return in three months, that may still be the downside of this note. You get the reinvestment risk and that’s a big deal when you have to give up an 18% coupon,” said Steve Doucette, financial adviser at Proctor Financial.

“That would be pretty unpleasant.”

While “unpleasant,” the chance of being called should not dissuade an income investor, he said.

“You have to look at the risk-reward. Here is a great yield. But it’s three different sectors. I would have to do some due diligence on the underliers,” he said.

Floating around

“The regional banking one has been hit hard. But on the long-term chart it’s been pretty flat. Utilities are a value play. The gold miners also have come down quite a bit. The price looks attractive,” he said.

Valuations were an important factor when buying a note, he said.

“Here you’re not really buying anything at the peak,” he added.

Doucette said the three sector ETFs contrasted with the usual underliers used in the typical callable structures, such as the Russell 2000, the Nasdaq-100 and the S&P 500 indexes.

“It’s an odd mix of underliers. I would have to do some research and find out what are the odds of collecting 18%. Some of these ETFs are a little volatile but they’re kind of floating around, which is what you want in an income note. You don’t want the price to jump or plunge,” he said.

Volatility

Doucette conceded that some of the ETFs were volatile.

The SPDR S&P Regional Banking ETF for instance has an implied volatility of 31.33%. Just below, the VanEck Vectors Gold Miners ETF showed an implied volatility of 29.55%. The less volatile of the three was the Utilities Select Sector SPDR fund with an 18.41% implied volatility.

“There is potential volatility in any of those three, especially with the regional banks. But the entry points are not bad right now,” he said.

Looking at a long-term chart, he noted that the SPDR Regional Banking ETF had endured three major sell-offs, one during the financial crisis, another during the onset of the Covid pandemic and the last one a year ago.

In March, a regional banking crisis erupted with the closure of Silicon Valley Bank and Signature Bank, precipitating a deep decline in the ETF price.

“I don’t know if the banks are going to drop 40% in three years. But we’re not far from the lows of 2008 and 2020. This regional banks ETF may be scary for some people, but it surely looks undervalued to me,” he said.

The price-per-earnings of the SPDR Regional Banking ETF is 9.6.

“Is there too much risk in these three industries to capture an 18% coupon? I think it’s reasonable.

“You could use this as equity substitute with a potential 18% annual return,” he said.

Something new

Doucette said that he liked the use of less common underliers in the note.

“They got creative. That’s one of the things that makes the note interesting. That and the 18% coupon,” he said.

When trying to build a note based on certain criteria, Doucette said he noticed the significant differences in return when using different underliers.

“When we model our notes on the Halo platform, we’re always amazed at the huge swings in coupons as soon as you go from one underlier to another,” he said.

The three traditional broad-based U.S. indexes tend to give yields below 10%, he said.

“It’s nice to see issuers getting a little bit more creative.”

Correlations

Another factor behind the high-yielding rate was the low correlations between the three ETFs.

As stated in the prospectus, lower correlations between the underliers may result in a higher coupon but also in a higher risk of loss at maturity.

On a scale of 0 to 1, with 1 being a perfect correlation, the coefficients of correlation between the ETFs are close to zero or even slightly negative.

“There is a lot of due diligence that needs to be done,” he said.

“I like the note. But I’m not going to jump on it because I need to do more research on these three ETFs.”

Dicey

Mark Dueholm, chief fixed-income trader at Landolt Securities, said the notes were overly speculative.

“That’s a gamble. You’re playing with fire.

“One ETF gives you exposure to the regional banks. They were in crisis last year and recovered a bit. But those banks are very sensitive to commercial real estate. They have a high exposure to those risky loans.

“Gold miners are also very volatile because the price of gold is volatile and can go all over the place.

“These sectors are extremely risky and you’re going to get the worst of the three,” he said.

“The 18% coupon is not worth taking so much risk.”

The notes are guaranteed by Citigroup Inc.

Citigroup Global Markets Inc. is the agent.

The notes settled on Wednesday.

The Cusip number is 17291L2S3.

The fee is 0.65%.

© 2015 Prospect News.
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