Citi, Morgan Stanley roll out Brent crude oil digital notes for high return, inflation hedge

By Emma Trincal

New York, Dec. 8 – Citigroup and Morgan Stanley priced a series of deep in-the-money digital notes on Brent crude oil with terms likely to grab the attention of investors seeking high target returns and hedges against declining oil prices or inflation, sources said.

Citigroup Global Markets Holdings Inc. priced the largest offering (Cusip: 17329UYP0) with $9.58 million of one-year contingent barrier digital notes linked to the performance of the Brent Crude Oil Futures Contracts, according to a 424B2 filing with the Securities and Exchange Commission.

If the commodity finishes at or above its 65% barrier level, the payout at maturity will be par plus 19%. Otherwise, investors will lose 1% for every 1% decline from the commodity’s initial level.

Pushing the barrier further down, Citigroup priced a second one-year deal (Cusip: 17329UR60) for $2.2 million. The 16% digital payout was triggered at or above a 55% barrier.

Price swings

“That’s an amazing coupon...and it has the feel of an absolute return with that kind of barrier,” a financial adviser said.

“But oil, especially in the past few years, has been extremely volatile. This thing could go down 45% and it has.”

The initial underlying price at pricing was $70.57, setting the barrier strike at $38.81.

“What’s the likelihood of oil going down that much, from 70 to 40? It certainly dropped below 39 in the spring and the fall of last year,” he said.

“Can you breach the barrier over one year? It’s possible. It happened. That note is not for the faint of heart.”

Outperforming, hedging

The notes may have been designed for bearish investors seeking to outperform the contracts in a down market, he noted.

“Oil is down 45% and you get 16%. That’s a nice way to hedge a sell-off.”

Bulls however may not be so attracted by the payout structure.

“If oil is at 70 and you’re a roaring bull, a 17% return would cap you at 81,” he said.

“Oil can easily go up more than that. So, this is not a bullish note on oil.”

Brent futures priced at $82.72 as recently as Oct. 1.

“I think it’s more likely that people who buy this already have an oil position, and they want to be a little bit more defensive. I don’t want to sell and get out. That’s the idea,” he said.

The most aggressive Citi product came via a third offering (Cusip: 17329URD5). The one-year notes on Brent futures sold in a $3.4 million issue. The higher barrier level at 70% commanded the highest return of par plus 21.5%.

Under-used asset class

A market participant welcomed the three trades.

“We don’t see a lot of commodities. In part it depends on issuers... whether they’re willing to issue and hedge those products,” he said.

Structured notes buyers have an equity bias, he added.

Equity underliers make for 85% of total issuance volume so far this year, according to data compiled by Prospect News.

Yet the bias could be overcome, he said.

“I don’t think investors are stuck with equity-linked notes. If the terms are appealing enough, they could look at other asset classes, including commodities. These three offerings show there are very interesting opportunities out there outside of equities,” he said.

Combating inflation

“I’m just surprised that Citi priced them all on Brent and not WTI futures since they’re selling the notes to U.S. investors. It’s probably because it priced better.”

West Texas Intermediate crude oil futures contracts, also known as Texas light sweet, trade on the New York Mercantile Exchange while Brent crude, which originates from oil fields in the North Sea between the Shetland Islands and Norway, is more of a benchmark for global oil prices.

“I think it’s no accident that we’re seeing this type of exposure to crude oil. Goldman has issued some commodities-linked notes recently. I expect to see commodities in the space because of inflation. Inflation has to be hedged and oil, gold or other commodities are a good way to do it,” he said.

One more

On Dec. 3, Morgan Stanley Finance LLC came out with its own “Brent” digital trade, pricing $3.49 million of 0% enhanced trigger jump securities due Dec. 21, 2022 linked to the Brent Crude Oil Futures Contracts, according to a 424B2 filing with the SEC.

The structure was identical to that of the Citigroup notes.

Barrier level and digital payout were set at 70% and 16.4%, respectively.

The notes (Cusip: 61773FES8) were distributed by JPMorgan.

Citigroup Global Markets Inc. is the underwriter for the Citigroup notes, which priced on Dec. 1 and will mature on Dec. 20, 2022.

The four deals carried an identical 1% fee.

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