JPMorgan: Strong Results Make 6% Preferred Shares Still Appealing
Summary:
- JPMorgan remains highly profitable, with strong net interest income and a robust CET1 ratio of 15.3%, despite increased loan loss provisions.
- Preferred shares offer a steady income stream, with a 6% fixed dividend yield, making them attractive for income-focused investors.
- The Series EE preferred shares are appealing, but currently slightly above my buying range; I would consider buying at $25/share.
- I hold a small position in JPMorgan common shares but haven’t increased it due to the stock’s rise beyond my limit price (and I haven’t chased it).
Introduction
JPMorgan (NYSE:JPM) is a US-based financial conglomerate with a worldwide name and brand recognition. The bank’s share price has done very well in the past few years. But as interest rates on the financial years started to move down, I became increasingly interested in the preferred shares issued by JPMorgan. While the preferred shares don’t really offer any exposure to capital gains, they can be a useful security to focus on a steady and reliable stream of income. You can read all my older articles on JPMorgan here.
JPMorgan remains very profitable
Before going into more detail on a specific series of the preferred shares, I wanted to establish how well the preferred dividends are covered. As JPMorgan recently published its Q3 results, we have access to a fresh set of financial details.
As the income statement of JPM below shows, it reported total net interest income of $23.4B, which is an increase of almost 3% compared to the third quarter of last year. On top of that, the total non-interest revenue increased from $17.15B to $19.25B, and that $2.1B increase only had an increase of the non-interest expenses to the tune of just around $800M associated with it.
It goes without saying the combination of a higher net interest income as well as a lower net non-interest expense had a very positive impact on the underlying profitability of the bank. The pre-tax income before loan loss provisions jumped to $20.1B. And despite a sharp increase in the loan loss provisions, which jumped from less than $1.4B in Q3 2023 to just over $3.1B in the third quarter of this year, the pre-tax income increased by a few hundred million dollars.
That ultimately resulted in a net income of $12.9B of which $12.54B was attributable to the common shareholders of JPMorgan, translating into an EPS of $4.38. While that was slightly lower than in the third quarter of last year, mainly due to a higher tax expense, the EPS increased by approximately 1% thanks to the reduced share count.
And although the total amount of loan loss provisions increased to $3.1B, the bank is still doing fine. After all, the cost of risk will fluctuate throughout the cycle and will be lower in good economic years and higher in weaker years. I think it’s fair to say 2024 is a weaker year, but as the income statement shows, the bank can still easily handle the higher loan loss provisions.
In fact, based on the Q3 financial results, JPMorgan can handle $20B per year in loan loss provisions before reporting a loss. Some authors have been focusing hard on the safety of the banks and were warning for higher loan loss provisions. And while that was a fair thing to warn for (and no one can say higher loan loss provisions are a surprising element to see), the larger US banks can still easily deal with these higher provisions. In fact, JPMorgan’s CET1 ratio of 15.3% is a ratio quite a few other banks would be jealous about.
With $273B in Common Equity Tier 1 capital and the current earnings profile of generating $80B per year on a pre-tax and pre loan loss provision basis, JPMorgan appears to be in a good position to immediately deal with any potential fall-out from a deteriorating loan book or higher risk market positions.
And to state the obvious: The bank needed less than 5% of its after-tax profit to cover the preferred dividends, so I’m satisfied from a preferred dividend coverage perspective.
The Series EE preferred shares: attractive on a small pullback
As explained in a previous article, there are 185,000 shares of $10,000/share outstanding, but the depository shares, trading as (NYSE:JPM.PR.C) represent 1/400 th as the principal amount of the depository share is $25. This means the total size of this issue is $1.85B. These preferred shares pay a 6% fixed preferred dividend yield and the annual preferred dividend of $1.50 is payable in four equal quarterly tranches of $0.375.
While writing this article, the share price moved up to $25.60, likely as the increasing interest rates on the financial markets are reducing the call risk.
After all, in the past few months the five-year US Treasury rate increased from 3.5% to approximately 4.2% and this 70 bps increase obviously also has an impact on the interest-dependent securities. REITs have been suffering and preferred shares for sure have been impacted as well. This means that the cost of the preferred equity of 6% is just 180 bps above the perceived five-year risk-free interest rate and less than 170 bps above the 10-year Treasury yield, which currently stands at 4.31%.
Investment thesis
I would only be willing to pay the $25 principal plus one quarterly dividend payment per preferred share so the Series EE preferred shares are just outside of my buying range, but should it drop back toward $25/share, I could potentially be a buyer again as this security would be a useful diversification for my fixed income portion of the portfolio.
I have a small long position in the common shares of JPMorgan as well, and the sole reason why I don’t have a larger position is because the stock started to run away from my limit price and I haven’t chased it yet.
Analyst’s Disclosure: I/we have a beneficial long position in the shares of JPM either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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