Citi’s contingent coupon autocalls tied to Wal-Mart, Costco to offer short-term income

By Emma Trincal

New York, March 16 – Citigroup Global Markets Holdings Inc.’s autocallable contingent coupon equity-linked securities due Oct. 3, 2019 linked to the worst performing of the common stocks of Wal-Mart Stores, Inc. and Costco Wholesale Corp. offer high probabilities of early call and coupon payments for short-term investors, said Suzi Hampson, structured products analyst at Future Value Consultants.

The notes will pay a contingent monthly coupon at an annualized rate of 8% to 9% if each stock closes at or above its 77.5% coupon barrier on the valuation date for that month, according to a 424B2 filing with the Securities and Exchange Commission.

The exact coupon will be set at pricing. Hampson picked the 8.5% mid-point to run her analysis.

The notes will be called at par plus the contingent coupon if each stock closes at or above its initial share price on any quarterly valuation date from June 2018 through June 2019.

The payout at maturity will be par plus the contingent coupon unless any stock finishes below its 77.5% final barrier level, in which case investors will receive a number of shares of the worst performing stock equal to the principal divided by the initial share price or, at the company’s option, the cash equivalent.

Stress tests

“Your coupon gets paid if both stocks are above the coupon barrier,” she said. “Nothing unusual here except that they’re using stocks rather than indexes, which are more common.

“The autocall is at the 100% level, which is standard. In order to get a full income stream, you need the underlying to stay between 77.5% and 100%. That’s unlikely. It’s unlikely with most autocalls. This is quite a standard construction.”

Future Value Consultants produces stress test reports for structured notes containing 29 different tests or tables.

The simulation is based on five market assumptions, including neutral or base case scenario. It reflects standard pricing based on the risk-free rate, dividends and volatility of the underlying.

Product specific

One table named “product specific tests” shows the probabilities for the various outcomes of the product based on the structure type. The outcomes for this product include barrier breach, calls on the six various dates as well as no call occurrence. Finally, the table also displays mutually exclusive probabilities of receiving one coupon payment, two, three, four, five or six.

Those probabilities are measured for all market scenarios aside from neutral, which are bull, bear, less volatile and more volatile.

Bull and less volatile

In terms of paid coupons, the most likely outcome is to get only one payment. There is a 41.66% probability assigned to this scenario, according to the table. The bull market shows the highest probability at 45.6% but the less volatile scenario is close at 43.2%.

“A non-volatile environment is almost as good as the bull scenario since you don’t need the stocks to go up. They just can’t drop below the barrier. For any autocallable, the less volatile scenario is always favorable,” she said.

As long as the stocks do not drop too much in price (bear scenario) or do not move too much in one direction or another (more volatile), investors have a very high chance of getting their first coupon, she said.

In terms of call probabilities, the most likely scenario is also the earliest one. Investors have a 37.41% chance of being called on the first call point in the neutral market scenario.

The probabilities of an autocall progressively drop with time from 12.88% at point two to 2.16% at point six, the report showed.

No call is likely

Another interesting item, she said, is the high probability (33.1% in neutral) of no call ever occurring.

“It doesn’t have to be a disastrous situation. You have the barrier there,” she said.

The barrier breach will occur 19.63% of the time, according to the simulation.

The chances of collecting all six coupon payments are slim with a probability of 8.59%.

“Still it’s not so bad. Getting the full income shouldn’t be your motivation to invest in any autocall because your odds are limited. But a 9% probability is quite high,” she said.

One of the reasons why there is almost a third of a chance that the notes will not get automatically called, she explained, is the worst-of payout.

“Both assets have to be above initial price. If it was with a single asset, this probability would be much lower.

“Also the term is very short, which is another factor. On a three-year note the odds of not calling would be very small.”

Back testing

Aside from the Monte Carlo simulation, Future Value Consultants also offers back testing analysis. The data covers the last five, 10 and 15 years.

“Back testing can be useful as long as you understand the limitations,” she said.

“Clients want to know about the performance of the stocks. It’s a natural thing. What back testing illustrates is what happens if you overlay this product on the stocks.

“This will show you how a product performs based on these underlyings. But obviously it’s based on historical data.

“If the stocks perform like they did over the last five years or 10 years, this is how you would perform with the note.

The back testing analysis showed that over the last five years, the frequency of barrier breach would be zero.

“If you looked at the past five years with a strong bull market cycle, the barrier would have never breached.

Frequency remains very minimal over the past 10 years (0.32%) and 15 years (1.88%).

“If you pick those timeframes of steady growth especially over the last five and 10 years, that’s what’s going to show up,” she said.

Short tenor

In conclusion Hampson said that the relatively short duration made the notes similar to a reverse convertible autocallable.

“It’s not your typical three- or five-year autocall on the S&P. The stocks are more volatile than indexes. It’s much shorter-term, higher risk underlying. Even though the stocks are not very volatile, they’re using the worst-of to generate a higher potential return.

“One way to look at this note is to see it as an alternative to a reverse convertible with a duration that’s likely to be short...three, six or nine months. It’s not a fixed coupon. But as long as you are aware of the risks, this note can offer quite a good chance of getting some decent income,” she said.

The notes will be guaranteed by Citigroup Inc.

Citigroup Global Markets Inc. is the agent.

The notes will price on March 28.

The Cusip is 17324XMG2.

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