KRE - JPS: High Concentration To Regional Bank Preferred Securities

2023-03-11 00:22:50 ET

Summary

• JPS is a fixed income closed end fund from the Nuveen family.
• The CEF has a high concentration to national and regional banks' preferred equities.
• The CEF runs a high leverage ratio of 38% which will magnify any potential losses.
• With Silvergate folding and SIVB collapsing, common and preferred equities in the banking space are under pressure.
• JPS is simply a leveraged take on banking preferred shares, and it will be under pressure from a pricing perspective until the market gets comfortable with regional banks' balance sheets.

Thesis

The Nuveen Preferred & Income Securities Fund (JPS) is a closed end fund from Nuveen that focuses on preferred shares and contingent capital securities. The fund has current income as its primary objective with capital preservation ranking second.

This CEF has come to our attention due to its high concentration in regional banks preferred securities:

Regional banks are under tremendous pressure, with SVB Financial (SIVB) collapsing yesterday on the back of a capital raise announcement. The common shares plunged over -60% while the preferred shares gapped-down by more than -20%. Contagion risk is the talk of the town, with the SPDR S&P Regional Banking ETF ( KRE ) down over -8% yesterday, its biggest gap down since the torrid Covid days of 2020.

JPS mainly financial services preferred equity (thus not diversified across other industries such as energy, mining, etc.) and is fairly levered on top of that (current leverage tallies out at 38%). Leverage magnifies the downside, and we are of the opinion that the market will sell now and ask questions later. We do not believe market participants were aware of the available for sale securities impact, and the fact that SIVB brought that to light spells trouble for a lot of regional banks.

Poor communication and management decisions continue, with Republic First Bancorp ( FRBK ) announcing today that it is raising equity as well. Banking works on faith, since by its structure a bank will never be able to pay all depositors tomorrow if they chose to claim their money back. A traditional commercial bank lends long term (1 to 5 years) while its depositor base can take out their cash at any point in time. This maturity mis-match makes a bank susceptible to bank runs.

We feel the large U.S. banks are in great shape and not in any fundamental danger, while the regional banks will see tremendous pressure on their common and preferred equity until the market gets a better comfort with their AFS portfolios and depositor 'stickiness'.

It all started with Silvergate Capital ( SI ) and is now continuing with SIVB. We see weakness in JPS due to its leveraged exposure to regional banks and a -10% potential down move. A retail investor would be best suited to reduce exposure here.

Analytics

• AUM: $1.4 billion.
• Sharpe Ratio: 0.01 (3Y).
• Std. Deviation: 17.6 (3Y).
• Yield: 6.9%
• Premium/Discount to NAV: -12%
• Z-Stat: -1.37
• Leverage Ratio: 38%
• Duration: 4 years

Holdings

The CEF holds financial services companies preferred equity:

Its top holdings are all banks:

Its portfolio is overwhelmingly investment grade, but kindly keep in mind that Silicon Valley Bank is rated investment grade as well:

Premium/Discount to NAV

The fund usually trades at a discount to net asset value:

We can see the CEF moving towards the bottom of the range for its discount to NAV. We think the CEF will move down another -3% to around -14% to -15% discount to NAV.

Available for Sale ((AFS)) Securities for Banks

The concern right now with many regional banks is around their available for sale portfolios and the extent of 'hidden' mark to market losses:

Available-for-sale ((AFS)) is an accounting term used to describe and classify financial assets. It is a debt or equity security not classified as a held-for-trading or held-to-maturity security-the two other kinds of financial assets

A mark to market asset is priced daily and goes through the profit and loss. Held to maturity refers to bonds a bank will hold until they mature, hence an accrual profit and loss method. In between one finds AFS, where the losses do not hit earnings, but a line item called OCI (other comprehensive loss).

SVB made the mistake to realize the AFS losses via an outright sale of all its portfolio (mainly MBS and Treasuries). By actually selling the securities the bank crystalized the losses, thus moving them from OCI to income and hitting its capital ratios. That is why SVB was forced to raise capital - in order to keep its Tier 1 ratios intact.

This AFS issue is a very pervasive one in the U.S., with research indicating there are over $600 billion of unrealized AFS losses sitting in OCI lines:

The market is going to sell now and ask questions later. It will take a bit for market participants to get their head around this accounting concept, and until they do so we will see more pressure on bank common and preferred shares.

Conclusion

JPS is a fixed income closed end fund from the Nuveen family. The CEF has a high concentration to U.S. regional banks which are currently in the eye of the storm. The market is rattled by Silvergate Capital folding and SVB Financial raising capital after selling their AFS portfolio for a nearly $2 billion loss. The market is now realizing the issues embedded in banks' portfolios via AFS holdings, and the possibility of loss crystallization if depositors flee. This problem is more pronounced for regional banks. The SPDR S&P Regional Banking ETF was down over -8% yesterday, its biggest gap down since the torrid Covid days of 2020. Both common and preferred equity are under pressure, which is set to continue. JPS via its high leverage is just magnifying this down move. We feel a retail investor is best suited to cut exposure here until the storm passes.

For further details see: