Citi prices $1.27 million autocallables tied to stocks with eye-catching 31% contingent coupon

By Emma Trincal

New York, April 30 – Citigroup Inc.’s $1.27 million of autocallable contingent coupon equity-linked securities due April 27, 2017 linked to the worst performing of the common stocks of Chesapeake Energy Corp., Golar LNG Ltd. and Cheniere Energy, Inc. caught advisers’ attention for its unusual 31% annualized coupon.

The notes pay each month a contingent coupon at an annualized rate of 31% if the worst-performing stock closes at or above its barrier price, 60% of its initial price, on the valuation date for that month, according to a 424B2 filing with the Securities and Exchange Commission.

The notes will be automatically called at par plus the contingent coupon if the worst-performing stock closes at or above its initial share price on any monthly valuation date.

If the final share price of the worst-performing stock is greater than or equal to its barrier price, the payout at maturity will be par plus the contingent coupon. Otherwise, investors will receive a number of shares of the worst-performing stock equal to $1,000 divided by the initial share price of that stock.

“It’s pretty amazing that you could pick up a 31% yield with a 40% barrier,” said Steve Doucette, financial adviser at Proctor Financial.

“But you really have to look at the stocks.”

Because it would take a 40% decline for any stock to eliminate the coupon for that month, Doucette ran “a scenario” in which the noteholder would be able to collect the coupon each month for the full first year.

“But at maturity, one stock could hit the barrier and you would lose at least 40% depending on how much it drops below that trigger. ... That’s the risk. You have the potential high return, but it doesn’t come without the risk. You could lose much more because you’re long the worst of.”

An investor considering the notes should not just look at the coupon.

“It depends on your forecast for the energy sector, and it also depends on your knowledge of the stocks,” he noted.

Sector matters

Looking at the chart of the three underliers, Doucette said he does not like the fact that one of the stocks has been strongly outperforming the others.

“Chesapeake has been up and down and so has Golar. But Cheniere is scary. It’s through the roof,” he said.

In the past year, Cheniere rose 34% while Golar dropped 19% and Chesapeake plunged by 46%.

“And in the past few months those two stocks continued their freefall while the other stayed positive.”

Chesapeake and Golar fell by 27% and 34%, respectively, in the past six months while Cheniere was up 2.85%.

All three companies are involved in natural gas. The price of this commodity has dropped 35% from a year ago.

“I’m a strong believer in reversion to the mean. Energy prices have been badly hit,” he said.

“When you look at those three picks, one stock has been outperforming, the others have dropped precipitously.

“If you’re comfortable with that, it might be a good bet. Otherwise, you’re taking a huge risk.

“It all comes down to doing your research on that one high-performing stock. The others are less significant. They’ve been floating along down the bottom.”

When the underliers consist of stocks not indexes, Doucette said that the assets should at least not be overvalued, adding that such is not the case in this note.

“I usually like those contingent coupon worst-of deals,” he said.

“You get paid a higher yield because the coupon is not guaranteed. The worst-of adds some risk, another reason to get more yield. The autocall boosts the premium as well. But I usually choose notes tied to broadly diversified indexes precisely because of all those risks.

“With this deal, the fact that two stocks have been hit hard is positive in a way because at least they’re not buying toppish stocks. But the other stock has been on a tear, and that’s scary. I’m just not going to do it.”

Energy turnaround

Matt Medeiros, chief executive officer of the Institute for Wealth Management, said the sector pick underlying the notes is attractive given the strong pullback in the energy sector.

“It’s very interesting. I like the underlying sector that supports the structure. I can’t speak specifically to each of the individual stocks, but the gas and oil sectors have had some significant depreciation over the last 12 months,” he said.

“I also like the idea of monthly reviews.

“It’s relatively short term, and it’s based on an asset class that I believe is going to be higher in value in two years.

“I wouldn’t call it a value play though. It would be a little bit of a stretch to say ‘value’ for energy because it’s an aggressive sector.

“Oil has lost half of its value in six months; there’s probably room for growth.”

Coupon boost

The use of fast-moving stocks in a volatile sector through a contingent autocallable worst-of structure is a sure recipe for yield enhancement, sources said.

Another example of such structure was JPMorgan Chase & Co.’s $2.07 million of autocallable contingent interest notes due May 2, 2016 linked to the least performing of the common stocks of Biogen Idec Inc., Celgene Corp. and Gilead Sciences, Inc. The payout structure, call and repayment of principal used the same worst-of conditions. The contingent coupon paid an annualized rate of 19.75%, according to a 424B2 filing with the SEC.

The observation frequency (both for coupon and call) was quarterly. The coupon barrier as well as the European barrier at maturity was 75% of the initial price.

As with energy, the biotechnology sector offered the volatility required to pay a high premium, sources observed.

Reverse convertibles

In some cases, the issuer offered less risky structures through a reverse convertible replacing the contingency with a fixed coupon.

JPMorgan in two recent offerings used the same combination of risk factors – sector pick, volatility of the stocks, automatic call and worst-of payout – but delivered the products with a guaranteed coupon.

One such deal was JPMorgan’s $3.2 million of 10% autocallable reverse exchangeable notes due Nov. 1, 2016 linked to the common stock of Twitter, Inc. and Facebook, Inc.

The review for the autocall was quarterly. Both stocks had to be at or above their initial levels on the review date.

At maturity, the barrier was set at 65% of the initial value of each stock.

Despite the fixed coupon, Doucette said he likes Citigroup’s contingent coupon notes better because of the technology sector.

“These are high-tech stocks. It’s not that interesting. They hit their peaks. Look at Nasdaq,” he said.

The Nasdaq Composite index hit an all-time high last week, beating 15 years later its peak of March 2000.

When the deal priced on April 27, Twitter closed at $51.66. The following day, the social media stock dropped 18% to $42.27 due to a leak of its earnings release.

“Those momentum stocks are overpriced. Everybody is buying them,” he said.

The second autocallable reverse convertible worst-of issued by JPMorgan was based on four insurance company stocks. The deal was $3.75 million of 9% autocallable reverse exchangeable notes due Oct. 27, 2016 linked to the least performing of the common stocks of MetLife, Inc., Aetna Inc., Cigna Corp. and Prudential Financial, Inc.

The barrier was 70% of the initial price.

The Citigroup notes (Cusip: 17298CAG3) priced on April 27. Citigroup Global Markets Inc. was the underwriter. The fee was 4.5%.

J.P. Morgan Securities LLC was the agent for the following offerings:

•∙The $2.07 million issue (Cusip: 46625HKR0). The pricing date was April 27.The fee was 1.50%;

• The $3.2 million issue (Cusip: 48127TAB9). The pricing date was April 27. The fee was 2.784%; and

•∙The $3.75 million issue (Cusip: 46625HKJ8). The pricing date was April 24. The fee was 2.75%.

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