JPM.PR.M: Lock-In Attractive Yields From JPM (NYSE:JPM.PR.M)

Thesis

One of the main beneficiaries of the regional banking crisis last year was JPMorgan (JPM), an international systemically important bank. JPM represents in our view one of the best run banks and is able to achieve the rare feat of paying 0.01% on their checking and savings accounts currently:

With Fed Funds above 5% and a depositor base shifting to money market accounts, many smaller banks have been forced to increase the rates they pay on savings and checking accounts, thus compressing their net income margins. Not JPMorgan.

In our opinion JPM is exactly what a large important bank should be – a cornerstone of stability and a counterparty that nobody questions in terms of long term viability and business choices.

In this article we are going to analyze one of the preferred shares issuances from JPM, and articulate why we believe the series is an appropriate instrument to take advantage of the current elevated rates environment.

Stable institutions see preferred shares follow a bond-like cycle

For banks, preferred share issuance is a form of capital, thus the non-cumulative structure followed and the classification of equity on the balance sheet. In reality, for systemically important, well-run banks, preferred equity with no Tier 1 capital triggers follow a bond-like cycle, and can be therefore priced as such.

JPM is a cornerstone of stability, and its depositor base is willing to forgo any interest in a 5% Fed Funds environment in order to bank with JPM. This writer is a customer, and JPM represents a ‘one-stop-shop’ for checking, saving and credit cards accounts, without any need to worry about solvency or the ability of the bank to exist 50 years from now.

This stability translates into preferred equity issued by JPM to be considered from a bond perspective. Even if the shares have an optional first call date in 2026, they have followed the first call date rule for most of their issuances in the past:

The shares were issued in the autumn of 2021, and thus follow the classic 5 years non-call period.

Let us have a look at a recent preferred share redemption undertaken by JPM:

In 2014 they issued a 10-year non-call preferred share series, namely the Series U. The first call date, and the date on which the interest would change, is April 30, 2024. The bank just announced the retirement of said shares on the respective first call date:

JPMorgan Chase & Co. (NYSE: JPM) (“JPMorgan Chase” or the “Firm”) has announced that on April 30, 2024 it will redeem all of the 100,000 outstanding shares of its Fixed-to-Floating Rate Non-Cumulative Preferred Stock, Series U (“Series U Preferred Stock”), and on May 1, 2024 it will redeem all of the 150,000 outstanding shares of its Fixed-to-Floating Rate Non-Cumulative Preferred Stock, Series Q (“Series Q Preferred Stock”), all of the 150,000 outstanding shares of its Fixed-to-Floating Rate Non-Cumulative Preferred Stock, Series R (“Series R Preferred Stock”) and all of the 200,000 outstanding shares of its Fixed-to-Floating Rate Non-Cumulative Preferred Stock, Series S (“Series S Preferred Stock”). Payment of the redemption price for the Series U Preferred Stock will be made on the redemption date of April 30, 2024.

A bank like JPM which is very stable from a credit standpoint will keep rotating preferred shares series as per their first call dates. However, there is no legal requirement for JPM to do so, and it can very well choose to perpetually roll the preferred shares, even after their call date if the funding rate is particularly attractive.

In our base case scenario we assume Series M to be called in September 2026.

Analytics and yields

The series currently have a 5.2% current yield, and pay 0.2625 quarterly. The shares trade at $20.16 currently, with a redemption price of $25/share. Considering the expected September 2026 maturity date we thus can obtain an implied yield to call for the series:

The yield to first call date comes to roughly 13%. Let us do a quick sanity check on this – the series are trading at roughly $20/share, thus leaving a $5 upside per share to liquidation amount. That represents a 25% upside in principal, that when divided by the remaining years to maturity of 2.5 years gives us 10% upside per year from ‘principal accretion’. The math thus checks out.

The recovery however will not be linear since preferred shares trade on current yield, thus expect the principal accretion to take place only when the Fed starts lowering rates or we are one year out from the series first call date.

If JPM chooses not to redeem the shares, then the yield to call calculation becomes mute, because there is no more defined principal paydown date. This is the main risk for the return profile of this trade, with rates staying much higher into 2026 and the bank finding the coupon for the M series attractive versus issuing new 5-year non-call debt.

Drawdown scenario

The preferred shares trade on a current yield basis, and they experienced a drawdown during the high yield wide credit spreads environment experienced in October/November 2023:

One year yields were 5.5% then, thus the shares were somewhere at 60 bps over one year risk free rates. Currently they are at 20 bps over one year yields. We feel in the next risk-off scenario the credit spread is going to widen to the same 60 bps, but the risk free rates will move lower given the signal from the Fed that its next move will be to lower rates. With a low duration of only 2.5 years, the anticipated drawdown is thus sub -5% for the preferred shares.

The only palatable true risk scenario here is another severe banking crisis that would widen spreads out even for the best institutions like JPM, or an outright troubled loan book at JPM. We believe both those scenarios are remote.

Conclusion

The high rates environment has resulted in a plethora of opportunities in fixed income. One of the pockets where the higher rates environment can be captured is the preferred shares space. JPM is one of the best banks out there, and its preferred shares can be considered ‘bond-like’ from a credit risk perspective. The bank has been very prescriptive around calling its preferred shares on the first call date, and its credit risk is minimal. As we have seen from smaller banks or regional banks, in case of a liquidity event or default, preferred shares get completely wiped out, thus the stability of the underlying bank is paramount. We find JPM to be the definition of bank stability, and like the Series M issued by the bank. The shares trade with a 5.2% current yield, but if held to their first call date can given investors a 13% yield to call assuming a base case where the shares are called on their first call date. The trade has a very shallow drawdown profile and basically represents the ‘locking-in’ of high current yields.