JPMorgan’s $1.06 million notes callable on three ETFs offer attractive valuations, contrarian says

By Emma Trincal

New York, March 21 – JPMorgan Chase Financial Co. LLC priced $1.06 million of callable contingent interest notes due Sept. 17, 2025 linked to the SPDR S&P Regional Banking ETF (“KRE”), the iShares 20+ Year Treasury Bond ETF (“TLT”) and the iShares MSCI Emerging Markets ETF (“EEM”) give investors exposure to three depressed underliers, a characteristic that reduces market risk and increases the odds of getting paid, according to a contrarian portfolio manager.

Investors will receive a coupon of 13.5%, paid monthly, if each underlying fund closes at or above its 70% coupon barrier on the related monthly observation date, according to a 424B2 filing with the Securities and Exchange Commission.

The securities may be called at par on any monthly review date starting June 17.

If the worst performing ETF finishes at or above its 65% downside threshold, the payout at maturity will be par. Otherwise, investors will lose 1% for every 1% that the worst performing ETF declines from initial level.

Regional banks

“It’s interesting. They picked three very different sectors but at least they’re all pretty undervalued, which is a very good thing,” said Steven Jon Kaplan, founder of True Contrarian Investments.

“KRE is an unloved ETF. Because of Silicon Valley and certain banks going under last year, a lot of people are scared about regional banks.”

Several regional banks failed a year ago including Silicon Valley Bank, Signature Bank and Republic Bank.

Recent turmoil at New York Community Bank has brought back the memories of this regional bank crisis.

The share price of the SPDR S&P Regional Banking ETF has rebounded since May but remains well below its pre-crisis level. It is also 35% off its all-time high of January 2022.

With last spring’s multiple bank collapses, investors have remained skittish about regional banks.

“People are still worried about the balance sheets of smaller banks. But what scares investors the most right now is the commercial real estate sector,” he said.

Regional banks have high exposure to commercial real estate loans, which drives those concerns.

As a contrarian, Kaplan believed the fear was overdone.

“Those worries are reinforced by the headlines. The narrative since Covid has been that people are now going to work from home, leaving office space vacant in big cities. It’s a well-known issue that has been well documented. The market has already priced it. Commercial real estate prices are way down. They can’t go to zero,” he said.

The real danger

A bigger threat for regional banks, he added, are residential loans.

“Residential prices are extremely overvalued. Investors should be worrying about that. But as always people are not seriously considering the risk. If prices are inflated in a sector or a stock, they buy. When prices are down, they sell or ignore the opportunity,” he said.

For lenders of residential mortgages, the risk of default and foreclosure is greater than in the commercial space where rates tend to be fixed, he noted.

Because of the overvaluation and risk associated with residential real estate, Kaplan said the regional banking ETF was probably the riskiest of the three underlying.

“It could be the worst of the three although you can’t really tell for sure,” he said.

If so, noteholders would be exposed to the SPDR S&P Regional Banking fund.

The question was whether a 30% drop from the ETF’s initial price was likely. The initial price on the trade date was of $48.83, setting the coupon barrier price at $34.181 and the downside threshold at $31.7395, according to the prospectus.

“It hasn’t crossed that price too many times. It got close in the spring of 2023, but you really have to go back to 2020 to see a price below that threshold,” he said.

Kaplan however did not completely rule out a breach of the 70% barrier.

“It could happen, but you may be lucky, and the share price could recover after that, so you would only miss a few coupons,” he said.

Deep values

The Emerging Markets fund also came with some risks but to a lesser degree.

“EEM is trading at a relatively low price. A quarter of the fund is China, which is very undervalued, so I wouldn’t be too worried about this one. I would say EEM is probably half as risky as KRE,” he said.

The Emerging Markets fund closed at $41.36 on the trade date, placing the coupon barrier level at $28.952 and the downside threshold at $26.884.

“We haven’t seen those levels since March 2020. That’s one of the reasons I don’t see a huge risk with this ETF,” he said.

The iShares 20+ Year Treasury Bond ETF was by far the safest underlying because of its depressed value.

“TLT is probably the best. In October, it has bottomed at a 20-year low. The chances of a 30% drop are virtually zero. You would need hyperinflation. It’s possible but it’s very unlikely,” he said.

“Overall KRE has a lot more risk than the two others. Of course, KRE could drop and rebound. It’s always possible especially after the Elections.”

Issuer call

From a structural standpoint, Kaplan said the 13.5% annualized coupon was “reasonable.”

“I would just have preferred to have a memory. You may miss some payments here and the memory feature would solve that problem even if it may lower the coupon a little bit,” he said.

On the other hand, the portfolio manager had no objection to the issuer call.

“To me, getting called even if it’s at the discretion of the issuer is not a bad thing because you get your money back. You also get your coupon. You come out ahead. Many times, people complain about the call. I think a call is fine because you’re no longer exposed to losses,” he said.

Principal repayment

Assessing the risk of losing principal at maturity based on the 65% barrier was difficult.

“Can one of those funds drop more than 35% in 18 months? It’s definitely possible,” he said.

“A lot will depend on the residential real estate market. It will be a function of defaults and foreclosures.”

The residential real estate market was not an isolated area, he added.

“Since the financial crisis of 2007-08 equity and real estate have become closely correlated. If the stock market falls sharply as I expect, residential real estate will be adversely affected. Obviously, all of this will have an impact on banks, especially regional banks,” he said.

A similar impact may happen with emerging markets if the U.S. stock market sells off.

“You could see the U.S. bear market spilling over emerging markets. But we just passed a point last month when emerging markets have been the most undervalued versus the U.S. in history. This means the risk is somewhat limited.”

Kaplan’s view on the notes was slightly positive but with caveats.

“I like the idea that they picked unpopular funds. This is really what drew my attention. But I would have preferred to see a coupon with memory because you are likely to miss a number of payments. How many? We don’t know. But being able to collect your interest rate later is a very good feature to have and it’s missing in this note,” he said.

The notes are guaranteed by JPMorgan Chase & Co.

J.P. Morgan Securities LLC is the agent.

The notes settled on March 15.

The Cusip number is 48134W2J5.

The fee is 0.55%.

© 2015 Prospect News.
All content on this website is protected by copyright law in the U.S. and elsewhere. For the use of the person downloading only.
Redistribution and copying are prohibited by law without written permission in advance from Prospect News.
Redistribution or copying includes e-mailing, printing multiple copies or any other form of reproduction.