Investment Road Test: Citi SFIs

PORTFOLIO POINT: Citibank’s self-funding instalment warrants access to a wide range of shares at less than full price.

In the wake of the GFC many instalment issuers ceased business or dramatically changed their terms. At one stage the scenario looked very gloomy indeed (see It's RIP for SFIs).

But times change: Citibank has continued to issue instalments and offers a range of “self-funding” instalments (SFIs), which are tailor-made for investors looking at accessing coming stockmarket growth. The Citi SFIs have some benefits compared to other instalment issuers, but to fully appreciate their utility, we need to appraise the risks of this type of geared investing.

The current Citi series of SFIs is available for investment via a product disclosure statement (as a “primary issue”) or through the market that Citi make on the ASX. The PDS is clear and very simple. The issuer is Citigroup Markets Australia Limited, which is fully guaranteed by Citibank.

There is a large list of ASX shares to choose from. Like normal instalments, you make an initial payment, which comprises pre-paid interest for the term remaining to the next interest payment (each year, in late June) as well as an initial capital contribution. Depending on the share price when you invest, the Citi range offers gearing levels about 50%, so along with your initial payment (including some capital), Citi lends you the balance of the purchase price. At each interest payment date, interest is capitalised (it’s added to the underlying loan).

The loan that Citi extends is the key feature of this product: it is “limited recourse”, which means you don’t have to repay it '¦ although you can do so if you wish. If you walk away from the instalment, Citi takes over the underlying shares, which are held by a security trustee until the instalment matures, and which Citi has security over until you repay the loan or exit.

If you walk away you have nothing further to pay. Like all instalments you are entitled to receive all dividends and franking credits and there is no CGT unless you sell the instalment. Since you have paid less than full price for the underlying shares, your yield is enhanced compared to owning shares outright.

SFIs automatically reinvest dividends to reduce the loan outstanding. Citi SFIs have a term of five years and, using conservative dividend growth assumptions, in normal situations the loan will be substantially paid off by the end of the term. The risk is that interest rates rise by more than the dividends during the term of the SFI.

You should carefully focus on the earnings growth prospects for the companies that you invest in, as well as understanding that interest rates are tipped to rise over time (although current five-year interest rates have already risen strongly in anticipation of these rate rises). You need to calculate the real interest rate on the instalment as well.

The magic of SFIs is that they allow for investment strategies that recognise that one way to value shares is to assess their “payback” period; that is, by collecting dividends, how long does it take for the share to pay for itself. Once a share is paid for, the investor has a free carry over the cash flow and growth on the share. This is another way of using the “P/E” multiple to value shares.

Using conservative gearing like SFIs effectively allows for payback periods to be reduced, as well as generating tax deductions for interest payments, and the only legal mechanism for gearing into self-managed superannuation funds. The Citi SFIs avoid the problems that some other issuer’s products experience (where the gearing becomes automatically repayable if the share price falls by 40% or more) in which case the instalments from those other issuers requires the underlying shares to be sold out to repay the loan.

Investors burnt by margin calls in the GFC will recognise this auto sale process as akin to a margin call sale, where stock is sold at dreadful prices to the detriment of the investor. Thankfully, Citi’s SFIs don’t succumb to this problem.

The score: Four stars
1 Ease of understanding/transparency
0.5 Fees
0.5 Performance/durability/volatility/relevance of underlying asset
1 Regulatory profile/risks
1 Innovation

Tony Rumble is the founder of the ASX-listed products course LPAC Online, a provider of investment training to financial services professionals. He is a customer of Citibank but does not own, trade in or sell any Citi Instalments.