Citigroup's 5.75%-6.25% coupon notes linked to S&P 500: too much risk for too little yield

By Emma Trincal

New York, June 18 - Citigroup Funding Inc.'s 5.75% to 6.25% market-linked coupon notes due July 23, 2015 linked to the S&P 500 index offer a disappointing risk-adjusted return for bulls and income-seekers alike, sources said.

The exact coupon will be set at pricing. Interest will be payable quarterly, according to a 424B2 filing with the Securities and Exchange Commission.

If the final index level is greater than 60% of the initial index level, the payout at maturity will be par. Otherwise, investors will be fully exposed to losses from the initial level.

Too little upside

Carl Kunhardt, wealth adviser at Quest Capital Management, said that being bullish on the S&P 500, he would not see the point of capping his return at a 5.75% to 6.25% annual rate.

"You get a coupon guaranteed at 6%, but that's all you get," he said.

"You're giving up all your return above 6% just to get that 40% protection on the downside. I wouldn't do it.

"I'm more bullish on the S&P than that over the course of three years."

Kunhardt said that the market has been trading range bound for a while because "no one knows what the rules are."

"After the elections, once we know who is in the White House, regardless of who wins, those headwinds on the S&P 500 will go away. The economy is going to improve, or it's going to go down. I don't see it muddling along like this," he said.

"This deal is for someone who expects the market to continue to go nowhere for three years. I just don't see that. We could still be range bound for a while, but not three years from now.

"I like the 6% return, but I don't like the full exposure to the downside once you breach that barrier.

"The risk is not exorbitant on that note. But if I'm taking the risk, I want the return."

Kunhardt looked at three-year corporate bonds issued by Citigroup maturing May 7, 2015 with a 4.8% coupon. Trading at a 103 premium, the bonds had a yield to maturity of 3.7%. Those bonds offer two important advantages when compared to the structured notes, he said: better liquidity and the absence of exposure to the equity market risk.

Too much risk

Michael Kalscheur, financial adviser at Castle Wealth Advisors, said that the notes are designed for income seekers but do not fit the low risk profile of those types of investors.

Because investors in the notes do not receive dividends on the underlying index - the S&P 500's dividend yield is about 2% - they really are collecting less than the stated coupon compared to an equivalent equity investment, he noted.

"Even if I was looking just for yield, I wouldn't do that because net of dividend yield, I am only getting a coupon of 4%. It's not enough based on the risk," Kalscheur said.

"The S&P 500 is not going to zero. But you could have easily a 40% hit. It happened four years ago. We know it is certainly possible. It's a small risk, but it's a real risk.

"Why would you want to take that huge downside risk on a minimum upside potential?"

Market risk is not Kalscheur's only concern.

"Your biggest worry is not going to be 'Is the S&P going to zero?' It's going to be 'Is Citi going to zero?' That's the big consideration with all structured notes. You're not just betting on the underlying. You're betting on the issuer.

"In the case of Citigroup, they're not AAA, they're not AA. They're the bare minimum credit rating I would consider as an investment option."

Citigroup Funding is rated A- minus by Standard & Poor's.

"If Wells Fargo had come up with a product like this one, same 6% coupon, I wouldn't be surprised about it. I wouldn't be excited, but I wouldn't be surprised. It's more of a surprise with Citi. You would think they could have come up with a more compelling yield than 6%," he said.

Kalscheur said that if he were looking for yield, he would invest in high-yield bonds, floating-rate notes, bank loans and international bonds or simply in real estate investment trusts and dividend stocks.

He mentioned Deutsche Telekom AG, whose American Depositary Receipts offer a nearly 9% yield, as well as France Telecom SA with a 12.5% yield.

The notes (Cusip: 1730T0YA1) are expected to price July 18 and settle three days later.

Citigroup Global Markets Inc. is the underwriter.

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