Citigroup's notes with 7.1%-7.3% coupon offer Brazilian real exposure, bet on global growth

By Emma Trincal

New York, Aug. 21 - Citigroup Funding Inc.'s Brazilian real-denominated notes due Sept. 12, 2016 with a 7.1% to 7.3% coupon are designed for income-seekers willing to bet on the Brazilian currency against the dollar and disposed to express a bullish view on the global economy, sources said.

The interest rate will be payable annually and will be set at pricing, according to a 424B2 filing with the Securities and Exchange Commission.

The issue price will be R$1,000 per note.

The payout at maturity will be par.

The notes are denominated in Brazilian reais, but the initial investment, all interest payments and the payment at maturity will be made in dollars. As a result, both interest payments and return of principal are subject to currency risk, according to the prospectus.

Investors are betting on a depreciation of the dollar versus the Brazilian real. The opposite scenario - a decline of the Brazilian currency versus the dollar - would be negative for the notes as investors would lose a portion of their principal or interest payments due to the conversion, the prospectus warned.

"I haven't seen that type of note before," said Dean Zayed, chief executive of Brookstone Capital Management.

"It's a bit of a play on the world's growth or lack of thereof."

Commodities

The prospectus stressed that the positive performance of the notes - that is, the relative strength of the Brazilian real - can be correlated to a bullish view on commodities.

"Brazil depends heavily on the export of commodities, and the value of the Brazilian real relative to the U.S. dollar may, therefore, exhibit a high correlation to the demand for certain commodities," the prospectus stated.

"If global growth slows, then demand for commodities will decrease, pushing down the value of the Brazilian currency. It wouldn't be a good thing for the notes," Zayed said.

"It boils down to the simple question: What's the investor's take on the global growth story?

"The U. S. looks better than other countries, but it's still not that great.

"If you think global growth is going to be anemic, this would not be an attractive play.

"We've had emerging markets leading the charge over the last decade. That seems to have slowed. China now has underperformed the U.S. this year."

Zayed said that he "wouldn't write off the emerging markets long term" but that within four years, the prediction is more difficult to make.

"It's a play on currency because it has a fixed coupon. This coupon is very solid. That would be attractive to a lot of people," he said.

Jonathan Tiemann, founder of Tiemann Investment Advisors, LLC, agreed that the notes are a currency play.

"You're betting against the dollar. That's what it really is. It's a way to get exposure to the Brazilian currency," he said.

But he added that for commodities bulls, other and perhaps better alternatives are available.

"If you want commodity exposure why not invest in Canadian or Australian equity instead? This note offers less diversification than putting your capital to work in a productive economy. You're just betting on a currency," he said.

Rich

The Brazilian currency exposure is expensive, he noted, compared to alternative ways to get better yielding instruments at equivalent levels of risk.

"It's a forward exchange rate. If you can enter a contract to pay the Brazilian real to a counterparty four years from now against the U.S. dollar at a rate you established today, you can evaluate how much you pay Citi for this note and how the credit risk is priced.

"To evaluate the pricing you need to compare the notional yield of 7.25% on this thing with the forward rate," he said, assuming a 7.25% set rate for the Citigroup notes.

Tiemann looked at the four-year Brazilian government bond. He noticed a "significant" spread between the 9% yield of the sovereign debt and the 7.25% coupon.

Both the Brazilian government and Citigroup Funding have an A- credit rating from Standard & Poor's.

"You have comparable credit, same exchange-rate risk either way, same general interest rate risk, but a much lower yield with the Citi paper than with the sovereign. If the Brazilian government defaults and Citi doesn't, you end up OK, I guess. ... Seriously, it looks like you're paying a handsome premium on this product," he said.

"Citi can easily turn around and buy the Brazilian paper at 9%. That would be the simplest way to hedge their side of the trade.

"The spread between the two yields and the underwriting fee they're charging you make this trade pretty rich. Citi is charging a fairly high premium to get access to something that may be hard to access otherwise, I don't know. I'm not saying they're robbing you, but if you're a buyer, you need to understand what you're paying for."

Citigroup Global Markets Inc. is the underwriter.

The fee is 1.75%.

The notes are expected to price Sept. 7 and settle Sept. 12.

The Cusip number is 1730T0WP0.

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