Citigroup’s variable coupon market-linked notes on S&P seen as conservative play

By Emma Trincal

New York, April 11 – Citigroup Global Markets Holdings Inc. plans to price variable coupon market-linked notes due April 27, 2027 linked to the S&P 500 index, according to a 424B2 filing with the Securities and Exchange Commission.

The notes will pay a coupon of at least 5% per year if the index closes at or above its initial level on an annual observation date. If on this date the index is less than its initial level, the annual rate will be 1%. The exact higher coupon rate will be set at pricing.

At maturity, investors will receive par plus the applicable coupon payment.

Allocation in the portfolio

“It’s a super interesting note,” said Carl Kunhardt, wealth adviser at Quest Capital Management.

“Five year is not that short, but for a principal-protected note, it is sort of short.

“Worst-case scenario: I get my money back with 1% a year. It’s money market basically. Best case scenario, I get my principal back with 5%.

“I would do it in a heartbeat.”

The principal-protected bullet note with variable coupon presents hybrid characteristics, which would require one to think carefully about how to best allocate the securities in the portfolio, he said.

“You get single-digit return. It’s hard to say it’s for growth. You collect a guaranteed coupon, but you only get paid on an annual basis, so it’s hard to describe it as income.

“But if you’re not too bullish and if you look for a conservative alternative to fixed-income, I think it fits into both buckets. I would do it for both growth and income,” he said.

Equity substitute

The case for using the note as equity replacement is all the more relevant for investors with modest return expectations.

“More and more people are saying that the U.S. is poised to get into a recessionary period. If that’s the case, the note is stellar,” he said.

The worst outcome, he noted, would be to underperform the market.

“If the market is on a tear, of course you’ll underperform, but nobody is going to complain because you are buying a safe asset. This is the safe money. Your return expectations can’t be too high. You may not get a high return, but if volatility is high, you are protected,” he said.

Buyers of the notes were unlikely to be disappointed.

“Anyone expecting a bull market like the one we’ve had for nearly 15 years would not buy a note with principal protection like this one. Also, they would not cap their return at 5%,” he said.

Advisers just had to explain to their clients the tradeoff.

“You get the principal-protection, but there is no free lunch. Your upside has to be capped if you want to remove your exposure to a pullback or a bear market,” he said.

Rates

Another possible risk would be if the interest rates were to move much higher than the 5% coupon over the next five years. Kunhardt ruled out the possibility.

“I don’t think rates are an issue,” he said.

“I don’t think the Fed is going to start increasing rates to such a degree that they’re going to throw the market into a huge correction.

“What’s driving rates higher right now is the Fed reaction to inflation. They’re trying to control it. I don’t see rates jumping to 5% during that five-year period.

“It’s a very interesting note. Other than having to tie up your money for five years, I can’t see anything wrong about it.”

Beating a down market

Kirk Chisholm, wealth manager and principal at Innovative Advisory Group, also saw some benefits in the note.

“It’s fine for conservative investors. It’s one of the most interesting notes you can find out there,” he said.

This adviser said he liked the full principal protection in the current market environment.

“The probabilities for the market to be down in five years are extremely high in my view given inflation, the risk of a recession and several other issues.

“So, getting 5% or even 1% with principal protection is better than anything you can find out there if you think the market will end up below par at maturity.

“Other than credit risk, you are not subject to any risk. You get full downside protection in a bear market or during a correction.

“To me, it sounds like a really good investment trading strategy.”

Deja vu

Citigroup’s variable coupon market-linked note is not a new structure. But the concept has not been deployed in recent times.

Similar deals based on the two types of coupons were seen five and six years ago, according to data compiled by Prospect News. Issuers such as Credit Suisse AG, London Branch and Barclays Bank plc, in particular, used to offer what they then called “high/low coupon” notes.

Those products however did not offer the full principal protection. Instead, they came out in callable formats with a knock-in level used to determine the size (high or low) of the paid coupons during the life as well as the amount of principal repaid at maturity.

The notes are guaranteed by Citigroup Inc.

Citigroup Global Markets Inc. is the underwriter.

The notes will price on April 22 and settle on April 27.

The Cusip number is 17330FGN5.

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