Citi’s callable notes on Regional Banking ETF show attractive terms due to perceived risk

By Emma Trincal

New York, May 10 – Citigroup Global Markets Holdings Inc.’s upcoming 0% callable contingent coupon equity-linked securities due May 15, 2025 linked to the SPDR S&P Regional Banking ETF offer compelling terms, which the issuer designed to attract spooked investors, wary of a sector hit by bank runs, failures and deep sell-offs.

Investors will receive a coupon of 15% paid quarterly if the ETF closes at or above its 58.45% coupon barrier on the related valuation date, according to a 424B2 filing with the Securities and Exchange Commission.

The securities may be called starting Nov. 13 at par and on any subsequent quarterly review date.

The payout at maturity will be par if the ETF ends at or above its 58.45% final barrier. Otherwise, investors will lose 1% for every 1% that the ETF declines, payable as cash or shares at the issuer’s option.

Timing

“They filed on May 5; they probably pre-hedged on May 4, which was great timing,” said Brady Beals, director, sales and product origination at Luma Financial Technologies.

The ETF tumbled to $34.52 on May 4, its lowest point since September 2020. The sell-off was in large part due to PacWest Bancorp, one of the fund’s holdings, dropping 50% on that day. The price action came three days after JPMorgan acquired the assets of First Republic, another troubled regional bank, which used to be part of the fund’s portfolio.

“KRE was down a lot, and they were able to price very attractive terms. There is a lot of volatility in the sector. They did the right thing by setting a deep barrier,” he said.

The SPDR S&P Regional Banking ETF is listed on the NYSE Arca under the ticker “KRE.”

“KRE is a very diversified fund. It has 144 holdings and not one of them has a weight of more than 5.275%. From that perspective, it’s not like buying the Nasdaq where the top five components make up more than 40% of the index,” he said.

Call or no call

A market participant said that investors should be cautious. A lesson can be learned from JPMorgan’s acquisition last week: even if a bank can be rescued, shareholders may still be “wiped out,” he said.

Indeed, First Republic, which peaked in August at $171.09, is now a penny stock trading over-the-counter under a new ticker at $0.4679 a share. Up until its failure, First Republic was one of the largest holdings of the ETF.

“The outcome is very binary. Either this note will do great or it won’t. Either it will get called or it won’t,” said a market participant.

“The terms are generous. The protection is probably pretty good. And we now know that the government is not going to let the banks fail.

“But given the backdrop of where these regional banks are you could get stuck for two years. I think that’s the main risk.”

Relief from the government

A financial adviser said the market may have overreacted when regional bank stocks plummeted last week. The sell-off was followed by a brief rally, but confidence has not been restored.

“It’s all about how you feel about regional banks. Most investors are not bullish right now. I’m not bearish,” he said.

“Regional banks are critical to our banking system. If the regional banks go under as a monolithic group, you have 2008 all over again. I don’t think we’re going there.

“For one thing, the Federal government is not going to let regional banks fail. That’s the lesson they learned from Lehman Brothers collapse.

“By protecting depositors beyond the $250,000 FDIC limit, the regulators have taken away the risk of regional banks failing. That takes care of a lot of the risk associated with this ETF.”

A few exceptions

The first regional banks to fail in March – Silicon Valley Bank and Signature Bank – had very specific and risky business models, he added.

“Those banks were not representative of how regional banks operate as a group,” he said.

“Regional banks are very diversified in their lending. They deal with small depositors and those have small deposits all covered by the FDIC.

“SVB was the poster child of a risky lending business,” he noted, adding that cash from the bank’s startup clients piled up, creating a massive amount of deposits exceeding the FDIC limit.

Signature Bank had a significant amount of crypto deposits, which generated significant risk, he noted.

“But regional banks in general are much more conservative. They have small depositors with FDIC protection. “When you’re covered by the FDIC who cares about what the market is thinking? It’s not going to have an impact.”

The notes are guaranteed by Citigroup Inc.

Citigroup Global Markets Inc. is the underwriter.

The notes will price on May 12 and settle on May 17.

The Cusip number is 17331AGP0.

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