Deutsche Bank strikes it big with oil-linked notes

The structured notes allow investors to take the view that the price of the nearby month’s crude oil futures contract will not decline by more than 10-20%

Sales of Deutsche's crude oil futures notes peaked last month

Deutsche Bank sold more structured products linked to crude oil futures contracts in August than in any other month in 2014, despite paying lower coupons than similar notes issued earlier this year.

The bank sold 21 notes linked to crude oil futures in August, the highest number of any month this year, according to Sorin Ionescu, head of commodities structuring at Deutsche Bank in London. The notes allow investors to take the view that the price of the nearby month's crude oil futures contract will not decline by more than 10-20%. If prices remain stable or increase, the notes pay an annualised coupon of between 8% and 12%.

"A year or two ago, investors were buying similar products with a barrier of 70–75%, but now you have to set the barrier closer to 80–85% of the initial level to get similar coupon levels," says Ionescu. "I think the decline [in crude oil prices] in July partly explains the increased interest. Maybe clients have felt a little more comfortable with the higher barrier levels after the July correction."

The spot price of WTI crude plummeted in July and continued to fall in August, touching a bottom on August 22. The World Bank predicts that oil prices will continue to decline in 2015, according to its commodity markets outlook report for July.

The Deutsche notes, sold in Europe, the US and Asia, carry maturities between six and 18 months. Notes issued on April 25 paid an annualised interest rate of 11.625% and had a knock-in barrier set at 80%. In contrast, a note issued four months later on August 22 paid a lower interest rate of 11% and carried a higher knock-in barrier at 90% of the starting level. Barrier levels reflect the limit beyond which investors start to participate in price declines of the underlying asset.

The reason for the change in terms is down to volatility and the shape of the crude oil futures curve, says Ionescu. "What's happened over the past two years is that volatility has become much lower and there's less backwardation in the curve." In backwardation, longer-dated futures contracts trade at higher prices than nearer-term contracts.

Notes issued by Credit Suisse displayed a similar trend. A note tracking WTI crude oil futures and gold mining stocks paid 11% annualised interest and carried a knock-in barrier of 60% when it was issued on March 31. A similar note issued on July 8, which was also linked to the Russell 2000 index, paid 8% annualised interest and featured a barrier of 64% of the initial level.

Dan Scharlach of Innovative Wealth Partners in Angola, Indiana says he has bought the Credit Suisse notes in the past but declined to buy them recently. "At 12% [coupon], it is kind of a 'wow' without some volatility on the way, [but] at 8%, I think I would rather just buy the [underlying] exchange-traded fund and call it a day," he says.