JPI: The Storm Has Passed For This Bank Preferred Equity CEF (NYSE:JPI)

Thesis

The Nuveen Preferred & Income Term Fund (NYSE:JPI) is a bank preferred equity CEF. The vehicle runs a high leverage ratio of 40% and has been negatively affected by the regional banks crisis. The turmoil has seen the fund lose -15% in the past month, a deep and sudden drawdown. From a price perspective the CEF is now below its October 2022 lows.

Nobody was expecting a banking crisis, especially after all the regulatory initiatives that followed the ’08-’09 Great Financial Crisis. However, the roll-back of certain stress-tests and requirements for U.S. regional banks in 2018 seems to have played a large role in asset/liability mis-management for certain banks.

In a normalized economic environment, bank preferred equity is a rates play. Well capitalized, investment grade banks, usually just have to ensure growing profitability to grow the price of their common equity, while preferred capital is not caught up in net debt tests but constitutes a form of perpetual capital. Everything is upended in a crisis. In a crisis all investments in a bank’s capital structure become virtually fungible – we have seen this for SVB and Signature, where the common and preferred equity were wiped out, and the senior unsecured bonds are now trading at cents on the dollar.

JPI is a diversified, leveraged take on preferred equity, and it will take deep nose-dives in a situation like the one we are facing today. While granular and not heavily affected by the actual bankruptcies, the fund collateral has experienced a massive spread widening, especially for CoCo bonds:

Contingent convertibles (CoCos) are debt instruments primarily issued by European financial institutions. Contingent convertibles work in a fashion similar to traditional convertible bonds. They have a specific strike price that, once breached, can convert the bond into equity or stock. The primary investors for CoCos are individual investors in Europe and Asia and private banks.1

CoCos are high-yield, high-risk products popular in European investing. Another name for these investments is an enhanced capital note (ECN). The hybrid debt securities carry specialized options that help the issuing financial institution absorb a capital loss.

The fund has a high concentration to CoCo securities:

As Credit Suisse wrote down the entire AT1 securities it had issued as part of the UBS takeover, the market re-priced wider the entire spectrum. That was the reason behind the violent fall in price for this CEF.

We feel most of the storm has passed, and while the regional banks issues are not fully solved, the market is coming to some sort of consensus regarding institutions which are going to make it, and banks which are not. Banks that fail are not a problem, mass hysteria on the other hand is an issue. We feel market participants are now moving from a state of shock and fear where any bank is shunned, to a more tiered environment where certain institutions are priced to possibly be wiped out, where the others are seeing their spreads normalize.

JPI is still a cyclical, high risk investment, but we feel most of the storm has passed at this stage.

Analytics

• AUM: $0.37 billion.
• Sharpe Ratio: 0.07 (3Y).
• Std. Deviation: 19 (3Y).
• Yield: 8.5%
• Premium/Discount to NAV: -6%
• Z-Stat: -1.45
• Leverage Ratio: 40%
• Effective Duration: 3.55 years

Performance

The CEF is down over -12% year to date on a total return basis:

We can see how the unleveraged (PFF) fund is fairly flat, as is the big banks ETF (XLF), while the preferred bank CEFs (JPI) and (JPS) are down around -10% to -12%. The worst performer is the regional banks equity ETF (KRE). This makes sense since the common equity slice has been the hardest hit in this crisis.

The cyclical nature of this CEF is illustrated in its 5-year performance graph:

The fund has now negated five years of total returns.

Holdings

The CEF holds a portfolio of financial services companies preferred equity:

We can see that none of the banks in the news is in the top holdings here:

The portfolio is very granular, with over 200 names in the holdings. Granularity is very important during a bank crisis, because it ensures the fund does not take concentration risk via large slices in individual names.

Premium/Discount to NAV

The fund’s discount to NAV has trended down, but not significantly:

We can see this CEF with a -2.47% discount to NAV. It is surprising how resilient the market price versus NAV has been. During the latest drawdown we would have expected a wider discount. This speaks well to the fund, and the market perception of the manager and overall quality.

Conclusion

JPI is a bank preferred securities CEF. The fund runs a high leverage ratio and has been negatively impacted by the current banking crisis. With a -15% price performance in the past month, the CEF has experienced a deep drawdown, and is now exhibiting a flat total return on a 5-year time-frame. Bank preferred equity CEFs are deeply cyclical vehicles that can wipe out many years of gains. We are encouraged by the performance of the fund’s discount to NAV, which has not widened very substantially. The fund is very granular, and it will not take large hits, even if banks do default. We feel most of the spread widening shock is now behind us, and JPI can become an interesting play for investors with a longer time horizon. Do not expect a smooth ride though since volatility is here to stay for the next six months.