Market cautiously hopeful on Citigroup; worries affect bank's longer-term notes more, analyst says

By Kenneth Lim

Boston, Nov. 21 - Investors remained concerned about the health of Citigroup Inc. on Friday, but market sources said the Street was not as worried about the bank as its was in other recent meltdowns.

Meanwhile, the widening of Citigroup's credit derivative spreads are likely to affect the company's longer dated structured products more than its shorter-term offerings, said structured products analyst Suzi Hampson of Future Value Consultants.

Citigroup's CDS spreads continued to widen on Friday, following Thursday's deterioration, as speculation mounted that the New York-based bank holding company could be seeking a sale of assets or other ways to raise capital amid mounting losses.

The company has repeatedly stated that it remains well capitalized.

One structured product veteran also noted the bank's stated confidence in its stability, and said that, barring more information, "we can only take their word."

The U.S. government is unlikely to allow a repeat of the Lehman Brothers collapse, and Citigroup could just be falling prey to the nervous speculation that has sent stocks on wild swings over the past few months, the veteran said.

"This is reminiscent of the spiral that we saw with Lehman," the veteran said. "It just seems like Citigroup is just a victim of the crisis."

Recent spike in Citi risk

Citigroup's CDS spreads, which are now hovering around 425 basis points, widened significantly only in the past few days, said Future Value's Hampson.

"It does seem that in the last couple of days, there was a big spike, and it jumped up, almost doubled," she said.

The change would lower the value of Citigroup-issued structured products, although there haven't been many recently, Hampson said.

One product that Future Value rated, a buffer note due 2010 linked to the S&P 500 index, actually "scored pretty well," the analyst said.

At maturity, the zero-coupon note will pay par plus at least triple any gain in the underlying index, subject to a maximum total payout of 128% to 132% of the principal. If the index is flat or falls by up to 10%, investors will receive par. Investors will lose 1% for every 1% decline in the underlying index beyond 10%.

Compared to other recent products, the Citigroup note had an average risk rating of 4.95 out of a riskiest 10, based on Future Value's assessment. The risk rating takes into account mostly the underlying risk and the structure.

The issuer's default risk mostly affects its product's value rating in Future Value's analysis, and in that respect the Citigroup note scored an above-average 8.27 out of 10. If the product were priced or reoffered today on the same terms, the value rating would decrease, Hampson said.

"The company would be issuing with a higher credit spread and would have more taken off the value score, so that's one of the biggest differences that we'll notice," she said.

Longer products affected more

The changes will have a greater impact on the longer-dated products issued by Citigroup, Hampson said.

That is largely because analyses of the products typically take away some value for every year that investors are exposed to the issuer's credit risk, she explained. The riskier the issuer, the more is deducted from the product's value. But the shorter the paper, the less exposure investors have to the issuer risk.

"The CDS rates won't be seen on shorter-dated products," she said.

CDS spreads are also not as big of a factor in products that are linked to Citigroup stock. In those cases, investors would be more concerned about the volatility of Citigroup shares, Hampson said. But a Citigroup default would still affect products linked to its stock if the stock is taken out.

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