Citigroup notes tied to Euro Stoxx combine unlimited upside participation with digital payout

By Emma Trincal

New York, Feb. 25 - Citigroup Funding Inc.'s 0% buffered digital plus securities due March 30, 2017 linked to the Euro Stoxx 50 index combine a digital payout with an uncapped upside while offering a 10% buffer on the downside, an attractive set of features, according to financial advisers.

"It's a great trade," said Scott Cramer, president of Cramer & Rauchegger, Inc.

If the final index level is greater than or equal to the initial level, the payout at maturity will be par plus the greater of the fixed return amount and the index return. The fixed return amount is expected to be 35% to 40% and will be set at pricing, according to a 424B2 filing with the Securities and Exchange Commission.

Investors will receive par if the index declines by 10% or less and will lose 1% for every 1% that it declines beyond 10%.

Simultaneously, Citigroup is planning another offering with the same terms except for the underlying index and the fixed return amount.

The second deal is linked to the Dow Jones industrial average. Its fixed return amount is expected to be 20% to 25% and will be set at pricing.

Simplicity

"I like them both," said Carl Kunhardt, wealth adviser at Quest Capital Management.

"They have all the features that I look for in a structured note. It's simple; I can explain it to clients in 30 seconds. They get it. There are not a lot of bells and whistles.

"It's very similar to two that I use from HSBC but they are S&P and Euro Stoxx deals.

"This one, I like more because it's the greater-of type of payout while the other is just a digital."

Risk versus reward

"It's rare to have that kind of digital structure," Kunhardt said.

"The upside is uncapped so you can participate in the index growth, plus you have the 10% buffer on the downside. I like the buffer obviously. I always prefer bigger, but 10% is better than nothing and it's certainly better than a barrier. It's a true buffer.

"The fixed annual returns are also both reasonable," he said.

Cramer noted the appeal of the point-to-point payout as well as the overall risk-return profile of the notes.

"This is a great deal for somebody who is bullish on the market over four years. What happens in between doesn't matter even if we have a meltdown. And you have a 10% buffer," Cramer said.

"You get the full upside participation in the index and you get the downside protection. You get the 35% regardless of how much the index increases.

"This is a very good deal."

Fixed income

For Kunhardt, the notes would be useful to advisers looking for fixed income substitutes.

"If I think to what I want to do with structured products, which is to replace a little bit of the fixed income allocation, because fixed income doesn't look like it's going to do well looking forward, if I'm not necessarily looking for a shoot-the-moon return, this one totally fits the bill," Kunhardt said.

"There's very little volatility. What I care about is the end point; what matters is what the index does in the end.

"I'm basically replacing fixed income with reasonably creditworthy issuers and at the same time I get potential for equity returns."

Citigroup's senior debt is rated Baa2 by Moody's and A+ by Standard & Poor's.

"I'm still OK with Citigroup's credit. That's quite low on the credit scale, but I don't see them falling apart in four years. The government would likely bail them out as they bailed them out before," Kunhardt said.

"With a senior note, you're pretty high up there on the credit hierarchy. You're second in line after senior secured notes," Cramer said.

Equity alternative

For Cramer, the risk-return profile of the notes made the product possibly more compelling than a direct investment in the underlying index itself, at least for someone willing to get credit risk exposure.

"Clearly if you specialize in preservation, the 10% buffer is reasonable for the type of upside you're getting because if it's up slightly, by just one point from the initiation point, you're getting a relatively big coupon. Therefore it's very much worth the liquidity risk if you believe that Citi is not going to go bust, which I do believe," Cramer said.

"It actually makes it a better risk than the security itself. With the security, you've got to go up as much as 35% to 40% to get that return. With this, all you need is to go up.

"If I was interested in getting exposure to the Euro Stoxx index, I'd be really tempted to take this over the security.

"The upside is the same above the fixed return, and in the meantime, the intermediate upside is enhanced with the digital, plus you have protection on the downside."

Cramer said that the pricing of the structure was revealing of how the options market viewed the index.

"They're buying options to structure this product. It shows you how poor the options are worth on the Euro Stoxx, how bearish the options are.

"These are options that you're buying from somebody. Somebody is selling you an option that enables you to capture a 35% return from one basis point of index move. That should tell you how scared the institutional people writing this are," he said.

Both offerings are expected to price March 27 and settle three business days later.

Citigroup Global Markets Inc. is the underwriter for both products.

The Cusip number for the notes linked to the Euro Stoxx 50 is 1730T0SA8.

The Cusip number for the notes linked to the Dow is 1730T0RY7.

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