Citigroup’s contingent coupon autocalls on Halliburton show high chances of modest gains

By Emma Trincal

New York, Feb. 23 – Citigroup Global Markets Holdings Inc.’s plans to price autocallable contingent coupon equity-linked securities due Feb. 27, 2019 linked to the common stock of Halliburton Co. provide an alternative to equity investing by offering potential income with risk-reducing features. But the chances of an early redemption after only three months are high, making the return likely but small in size, said Suzi Hampson, structured products analyst at Future Value Consultants.

Each quarter, the notes will pay a contingent coupon at an annualized rate of 8% to 9% if Halliburton stock closes at or above the coupon barrier price, 80% of the initial price, on the valuation date for that quarter, according to a 424B2 filing with the Securities and Exchange Commission.

The notes will be automatically called at par of $1,000 plus the contingent coupon if Halliburton shares close at or above the initial share price on any quarterly valuation date.

If the final share price is greater than or equal to the 80% final barrier price, the payout at maturity will be par plus the contingent coupon. Otherwise, investors receive a number of Halliburton shares equal to $1,000 divided by the initial share price or, at the company’s option, the cash equivalent.

Single underlying

Amid a large supply of worst-of income-generating products, this note is tied to a single stock, Hampson noted.

“You need to have some volatility to pay for the coupon and the barrier when you’re not using a worst-of.

At 29%, the implied volatility of the underlying stock is greater than that of an index. The S&P 500 index’s implied volatility is 16% in comparison.

“Still, it’s not hugely volatile if you compare it to other stocks.”

Without necessarily being “stock-pickers” investors in the notes should be familiar with the name and the sector of the underlying, she noted.

“It’s an alternative to a direct investment in the shares,” she said.

“Rather than investing in the stock itself, the structure allows you to modify the risk-reward profile: the contingent coupon limits your upside; but you have a barrier on the downside. It’s a different way of getting exposure to the stock while reducing your risk.”

Call, market risk

The automatic call also contributes to mitigate the risk.

“Having three calls during the term is having three opportunities to get your money back. It’s a risk-reducing factor,” she said.

At the same time, the autocall feature comes with some characteristics investors should always consider as they may add risk.

Those include the reinvestment risk when the notes are automatically called, the uncertainty around the duration of the notes, the contingency of the coupon and the capping of the upside with potential unlimited downside.

“Any investor needs to be familiar with these issues, which are always there in any autocall,” she said.

“But it’s a tradeoff. You just have to be aware of it.

“In this trade for instance, you just can’t assume you’ll be holding the notes for one year. Chances are it will be more like three or six months.”

Staying the course

The best-case scenario is when investors receive their full income stream due to a stock not moving much on the downside and not being up on any call date.

“You collected your coupon during the whole life and you get your money back at maturity. That’s the best possible outcome. It’s also the less probable,” she said.

The most likely scenario is the automatic call.

“If the stock goes up or even stays flat, you will kick out and you would get your last coupon,” she said.

Finally, the negative outcome is the one in which the stock finishes below the barrier level, causing investors to lose some of their capital.

Product specific tests

Future Value Consultants generates stress testing reports on structured notes. The report organized around 29 tests or tables is designed to allow users to choose the sets of statistics that they like.

A simulated analysis displays the different outcomes for each product, which depends on the structure type. A probability of occurrence is assigned to each outcome.

One table, the “product specific tests,” displays different probabilities of outcomes. Those include for this note the probabilities of barrier breach, of calls at various dates and of coupon payments.

The test illustrates something common to all autocallable notes: the highest chance of a call is on the first call date. For this note, investors have a 50% chance of getting called after only three months, which is the first call point.

“The high probability of calling on the first call point is verified across all scenarios,” she said.

She referred to the five different market scenarios, which are the basis of the stress testing analysis.

The neutral scenario, which is the base-case used in all tables, reflects standard pricing based on the risk-free rate, dividends and volatility of the underlying. The four other market assumptions are bull, bear, less volatile, more volatile. They are also calculated based on growth rate and volatility assumptions for the underlying.

An automatic call on the first call date shows a relatively tight distribution of probabilities from 46.3% in the bear market to 54% in the bull scenario.

“We’re looking at a one-year note. The first call point is after three months. An investor has to be prepared to hold the notes for only a very short time,” she said.

Barrier value

In the base-case scenario, the absence of a call (“no-call” outcome) occurs 28% of the time. By definition, this is the result of the decline of the stock below its initial price but not necessarily underneath the barrier threshold.

Only the barrier breach scenario, which happens 17% of the time, will generate a loss of principal, she explained.

By subtracting the barrier breach probability (17%) from the no-call probability (28%), one can measure the usefulness of the barrier, which will effectively protect the investor 11% of the time, she said.

“Each time the price finishes between 80 and 100, the barrier accomplishes something.”

Income payment

The same table identifies the probabilities and frequency of coupon payments.

In 57% of the time, investors will receive only one coupon.

“You have a high chance of getting a decent return but in almost 60% of the time it’s just going to be for a three-month period. As long as it’s part of your expectation, it’s fine,” she said.

To generate the report, Hampson used the midpoint of the coupon range, or 8.5%. After three months, investors will then receive 2.125%.

“No one should look at this as a form of income replacement. You don’t have a fixed coupon and you don’t know how long you will be invested,” she said.

The table illustrates the point revealing a 7.72% probability of receiving all four quarterly interest payments.

“There’s only a small chance of getting your last coupon.”

Gains versus losses

Another table in the report called “capital performance tests” shows that the probability of getting “more than capital” is 83% versus a 17% chance of losing money. There is zero probability of getting just 100% of principal because the coupon barrier and principal repayment barrier are set at the same level.

“You’ll always get some income if you get your capital back,” she explained.

From a risk-adjusted standpoint these types of notes provide investors with high chances of gains but the gains are small in size, she said.

The chances of winning at 83% are nearly five-fold those of losing, she noted. However, the average payoff is only 103.6%, according to the capital performance tests table.

“That’s what autocalls tend to do. They reduce the risk and increase the odds of getting a positive return. But the payout is not necessarily high and your reinvestment risk is something you should always keep in mind.”

Citigroup Global Markets Inc. is the underwriter.

Citigroup Inc. is the guarantor.

The notes will settle on Tuesday.

The Cusip number is 17324XMM9.

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