Citigroup’s notes linked to S&P 500 target mild bulls seeking alternative market exposure

By Emma Trincal

New York, July 22 – Citigroup Global Markets Holdings Inc.’s 0% buffered securities due in 25 to 28 months linked to the S&P 500 index are designed for investors who expect little price appreciation over the next two years and want to use leverage to beat the benchmark, said Time Vile, structured products analyst at Future Value Consultants.

The notes will be guaranteed by Citigroup Inc., according to a 424B2 filing with the Securities and Exchange Commission.

The payout at maturity will be par plus double any index gain, up to a maximum return of 18% to 21%. The exact cap will be set at pricing.

Investors will receive par if the index falls by up to 10% and will lose 1.1111% for each 1% decline beyond 10%.

“The S&P 500 has recently hit new highs, and a growing number of investors who remain bullish expect limited returns in the next coming years,” said Vile.

“This note uses leverage for return enhancement. It’s not a very high cap, but for a moderately bullish investor, it should be enough to outperform the benchmark.”

Terms

Vile ran a research report on the notes based on his firm’s methodology. The model evaluates risk, return and price using a variety of proprietary scores in order to compare the product with others, including its peers and all products.

In this case, the “same product type” is leveraged return, one of the most widely used structures.

To compute the scores, Vile had to make some assumptions since some of the terms were disclosed in ranges. He used a hypothetical cap of 19.5%, which is at the mid-point, and a maturity of 25 months, which is on the shortest end of the range. Both choices are part of the firm’s conventions when assigning scores.

Based on those hypothetical terms, investors are expected to earn a maximum return of 8.95% per annum on a compounded basis. Reaching the cap would only necessitate a 4.55% index return per year.

“It’s not too ambitious. If the market slows down, you get a nice enhanced return after two years. It’s a decent cap but only to the extent that you can outperform the index. And that means the market is not going to go up much,” he said.

On the downside, the gearing allowed the issuer to increase the cap, but investors may lose up to their entire capital.

“That’s how you’re not getting a bad cap. The gearing can eventually take your principal down to zero, but that’s in an extreme price decline scenario. Overall, it’s still better than a direct investment in the index fund,” he said.

Risk

The research report showed a higher-than-average market risk, which Vile said was “a little bit surprising.”

Future Value Consultants calculates the market risk and the credit risk and adds the two components to generate the “riskmap,” which measures on a scale of zero to 10 the risk associated with a product with 10 as the highest level of risk possible.

The notes have a 2.22 market riskmap versus an average of 1.75 for leveraged return products, according to the firm’s research report.

“It’s not really a high market riskmap. ... It may be that some of the recent deals we priced had a low risk profile,” he said.

“The gearing obviously doesn’t help compared with a straight buffer,” he added.

The credit riskmap is 0.59, slightly more than the 0.46 average for the product type.

Vile did not attribute this result to the issuer’s creditworthiness. At 76 basis points, Citigroup’s credit default swap rates tend to be tighter than other large U.S. banks. Morgan Stanley and Goldman Sachs for instance show spreads of 90 bps, according to Markit.

“I think the main factor here is the two-year [term]. We get a lot of shorter-term products. We may have more one-year notes, and that’s an extra year,” he said.

Credit risk increases with time. The longer the term, the greater the exposure to the risk of the issuer defaulting.

Adding the market riskmap and credit riskmap generates a 2.81 riskmap, which is higher than the average for similar products of 2.21, according to the report.

Return score

Future Value Consultants measures the risk-adjusted return of a note with its return score. The score is established based on the best among five market scenarios. In this case, the bullish market scenario is the one retained in the model.

The return score is 7.35 versus an average of 7.45 for similar products and 7.14 for all products, according to the report.

“The cap brings it down. It’s a reasonable cap, but you still get punished. Also the riskmap is higher than average, which doesn’t help,” he said.

Value, overall

For each product, Future Value Consultants computes a price score that measures the value to the investor on a scale of zero to 10.

This rating estimates the fees taken per annum. The higher the score, the lower the fees and the greater the value offered to the investor.

The price score is 8.06, compared with the 8.76 average for the same product type.

“This is a pretty good price score. You have products that show average return scores while delivering good value. This is the case with this one,” he said.

“The issuer spent some decent amount of money on the options. You have a buffer, two-times gearing. The cap is not super high but still reasonable. It’s got a little bit of everything.”

The options on the S&P are also very liquid, which makes pricing more competitive, he added.

“That helps too.”

Overall

The overall score measures Future Value Consultants’ general opinion on the quality of a deal. The score is the average of the price score and the return score.

The notes have an overall score of 7.71 versus 8.11 for the average leveraged return note and 7.73 for all products, according to the report.

“This is OK. For an investor who is not overly bullish, for someone who expects the S&P to grow 4% or 5% a year and wants to do better than that, this product is a decent alternative to the index fund,” he said.

“Plus, you get this 10% buffer, which makes it more compelling than a long-only investment.”

Citigroup Global Markets Inc. is the underwriter.

The notes priced on Friday.

The Cusip number is 17324C6Y7.

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