Citigroup's trigger PLUS tied to iShares MSCI EM ETF offer leverage with reduced protection

By Emma Trincal

New York, May 27 - Citigroup Funding Inc.'s upcoming 0% trigger Performance Leveraged Upside Securities due June 27, 2013 linked to the iShares MSCI Emerging Markets index fund grant protection through a barrier - protection that is limited compared to the type investors would get with the more typical buffer found in most enhanced growth products, said structured products analyst Suzi Hampson.

The payout at maturity will be par of $10.00 plus double any increase in the index fund's share price, subject to a maximum payment of $12.30 to $12.60 per note that will be set at pricing, according to an FWP filing with the Securities and Exchange Commission.

If the final share price is greater than 85% of the initial price and less than or equal to the initial price, the payout will be par.

If the final share price is 85% of the initial price or less, the payout will be par plus the fund return.

Moderate growth

"This product is designed for investors who are only moderately bullish on emerging markets," said Hampson. "If they were very bullish, they would not need the leverage and they would not want a cap."

Investors can capture two times the performance of the underlying fund up to a limit, which will be at best 26% for the two-year term, according to the prospectus.

Investors in the notes would outperform the underlying if the fund's performance did not exceed the 26% cap, she said.

In addition, investors get some protection with the barrier, she noted.

"The barrier gives you a basic protection. It's not as great as a buffer, but it's slightly better than investing directly in the fund," she said.

Barrier versus buffer

With a 15% buffer, the first 15% losses are protected if the underlying declines below the trigger price. As a result, investors cannot lose more than 85% of their initial investment, Hampson explained.

In contrast, the barrier option at maturity will not provide investors with a cushion protecting them against the first 15% losses if the fund hits the trigger. Any decline beyond the trigger price translates into the same level of loss as the fund's decline, and investors may lose 100% of their principal.

Hampson gave an example: If the underlying fund was to decline by 20%, investors with a 15% buffered note would only lose 5% while holders of this product would lose 20% of their capital.

"A barrier is not as good as a buffer," she said.

"The barrier will increase your amount of losses compared to a buffer. Naturally, it will translate into more risk."

Riskmap

Riskmap is Future Value Consultants' measure of the risk associated with the product. The higher the riskmap, the higher the risk on a scale of zero to 10.

This product has a riskmap of 6.24, which is much higher than the average riskmap for similar products, 3.79.

"Most enhanced growth products we see have buffers, not barriers, which reduces the risk a lot," said Hampson.

"This product has some similarities with a reverse convertible: a risky structure also built around barriers.

"The difference is that barriers in a reverse convertible note can be triggered anytime during the life of the notes while this one is a final-day barrier. It's a little bit less risky when the barrier can only be breached on the final day as opposed to any day.

"But still, having a buffer remains the best form of partial protection."

Market and credit risk

The riskmap is the sum of two risk components: market risk and credit risk. Market risk with this product at 5.38 is greater than the average leveraged note at 3.16.

"This has to do with the underlying. Many similar notes are linked to the S&P 500. This one, tied to an emerging market fund, is much more volatile," she said.

"If the fund declines below the trigger, the losses will be higher than the average product with a buffer. That's another reason."

Future Value Consultants considers the credit quality of the issuer as the other side of risk, which it rates as credit risk, the other component of riskmap. This product has a rating twice as high as the average structured product but only a little bit higher than products with a similar structure.

Citigroup has a credit default spread of 128 basis points, said Hampson. Its spread is wider than Deutsche Bank at 96 bps but tighter than Goldman Sachs at 150 bps.

The higher the CDS spread, the greater the credit risk because the spread is the amount of return an investor should get in order to be compensated for the credit risk taken on.

Losing big

The return score of 4.88 is impacted by the high level of risk. The higher the risk, the lower the return score.

The return score is Future Value Consultants' indicator on a scale of zero to 10 of the risk-adjusted return of the notes.

In comparison, similarly structured products have a greater return score of 7.18. The average for all structured products is also higher at 6.14.

"The probability of losing 15% or more of principal is high just because of the nature of the barrier," Hampson said.

"With a volatile underlying, the chances of higher losses are greater."

Future Value Consultants calculates the probability tables of return outcomes using a Monte Carlo simulation that inputs volatility, dividends and interest rates.

With these notes, investors have a roughly 22% chance of losing money versus a 78% probability of generating a positive return. But within those categories, the probability of losing more than 15% is the greatest on the loss side (220.4%), while investors have a very high probability of generating gains in the highest return bucket: a 53% chance of a 10% to 15% gain per year.

"When you lose, it's very likely that you'll lose a lot, at least 15% or more. And when you score a gain, your return will be capped," said Hampson.

The notes received an average price score of 6.17. Based on a scale of zero to 10, the score represents the real value to the investor after deducting the costs the issuer charges in fees and commissions on an annualized basis and profit margins on the underlying derivative.

Looking at the big picture, these notes were below average, noted Hampson, pointing to the overall score.

The overall score is Future Value Consultants' opinion on the quality of a deal based on the average of the price score and the return score.

The notes received a 5.52 overall score, which was below the average for all products (6.11) and the average for similar products (7.78).

The notes (Cusip: 17317U881) will price June 24 and June 29.

Citigroup Global Markets Inc. is the agent.

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