Citigroup’s $6.17 million trigger PLUS tied to Euro Stoxx 50 show 4X leverage for mild bulls

By Emma Trincal

New York, Nov. 13 – Citigroup Inc.’s $6.16 million of 0% trigger Performance Leveraged Upside Securities due Nov. 13, 2017 linked to the Euro Stoxx 50 index offer highly levered exposure to the European stock benchmark with some contingent downside protection. But the structure should only be used by investors who don’t anticipate much growth in the index, sources said.

If the index return is positive, the payout at maturity will be par of $10 plus 400% of the index return, subject to a maximum return of 40.25%, according to a 424B2 filing with the Securities and Exchange Commission.

Investors will receive par if the index declines by 20% or less and will be fully exposed to the index’s decline from its initial level if it falls by more than 20%.

On a compounded basis, it would take an annual growth of 3.25% for the index to enable investors to reach the cap of 12% a year.

“If you’re really bullish, I would reduce the leverage and increase the cap,” said Steve Doucette, financial adviser at Proctor Financial.

Opportunity cost

Matt Medeiros, president and chief executive of the Institute for Wealth Management, also pointed to the risk of reaching the maximum return and missing on some of the potential upside.

“There is definitely some upside risk. I’m bullish on this index. I think that because of where the euro is, the Euro Stoxx is, there are opportunities in Europe. Relative to the S&P, the opportunities are even greater. I would be a little bit apprehensive about having a cap of about 12% a year with leverage based on a benchmark I believe is going to perform at about 12% without leverage,” Medeiros said.

Trigger

The downside of the structure was a concern although Medeiros said the protection level was probably adequate.

“There is potential for volatility in Europe but there is also some good value there,” he said.

“From a structural standpoint, I prefer the buffer type though. When I look at a structured note in general, a three-year note here, since it’s a three-year commitment, I don’t really want to have to worry about the trigger being hit because when it is, you know you have no protection left. You get exposed to losses dollar for dollar. While I’m pretty confident that three years from now, the Euro Stoxx is not going to be down by 20%, I’m still not comfortable with the trigger.”

Valuation

Doucette examined the impact of the upside leverage on the value of the note on the secondary market. He concluded that leverage also has an impact on the downside.

“Let’s look at it from a valuation standpoint. Say you’re not necessarily interested in holding it to maturity, which is my investment style with structured notes. Comes two years and the market is up 20%. With four times, it’s 80%. You’re capped out. Again, if I’m really bullish, I decrease the leverage and raise the cap,” he said.

“People will tell you that the leverage is only on the upside, not on the downside. But that’s only if you choose a buy-and-hold strategy. If you intend to sell it on the secondary market, you should be concerned about the leverage because it works both ways.

“Say you’re two-thirds through the term. The market is up 10% in the first two years. You’re capped at 40%. The value of that note is less than 40% upside potential because the value of the option is not fully priced. You still have one year. You’re two years into the notes. The market could come down on the last year. I would say the valuation would probably give you 35%. Now let’s say the market starts pulling back. For each point down, it gives back 3% to 4% in return because the option has not expired yet. The four times leverage on the upside is the general concept. But when it starts pulling back and you want to redeem early, it’s four times down on a valuation basis.

“If I had to own the notes, it would make sense to me to sell it at 135%, take the money and roll it over. You’d be a fool not to take it off the table.

“But on a buy-and-hold play, this would not work. I would have to reduce the leverage and increase the cap,” he said.

The notes (Cusip: 17322X771) priced on Nov. 7.

Citigroup Global Markets Inc. was the agent. Morgan Stanley Wealth Management was a dealer.

The fee was 3%.

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