REM Slashes Dividend - Exactly As I Predicted

Jun.25.14 | About: iShares Mortgage (REM)


Many investors appear to have been surprised by the reduction in REM's dividend to about $0.30.

As I explained earlier there was nothing improper about REM's higher dividends but the factors that had caused them are over.

REM should not fall precipitously because of the dividend cut, since shares can be redeemed by professionals at net asset value, in lots of 50,000.

As I predicted, iShares Mortgage Real Estate Capped ETF (NYSEARCA:REM) has declared a quarterly dividend of $0.291714 with an ex-date of June 24, 2014, with a pay date of June 30. This is sharply below previous levels, and is the lowest quarterly dividend since December 28, 2011.

This sharply lower dividend may have been a surprise for some. However, readers of my recent article How Does REM Pay That 15% Dividend?, may not have been surprised since that article contained: "My calculation indicates that the next quarterly REM dividend, that will be announced soon, should be about $0.30, a sharp reduction from the $0.5067 paid on March 31, 2014 and the $0.4767 paid on December 30, 2103." With the REM price of $12.48 (ex-dividend) the annualized yield based on the most recent dividend is 9.3% The procedure I used for calculating the dividends is explained in: Projected June Dividend For CEFL Will Bring Yield To 18.1%.

Some Seeking Alpha contributors and commenters were somewhat skeptical of my prediction that the next REM would be about $0.30. I read that a comment to my above mentioned REM article by an SA contributor said "Having said this, I do agree that REM's dividend is likely to drop somewhat, perhaps to 12-14% yield (at current price)."

My article specifically stated that there was nothing improper about REM's accounting or procedures. That the previous high dividends were not due to any return of capital or similar tactics. However one Seeking Alpha commenter to the above mentioned REM article still said "If REM only collects enough dividends from all of it's components TODAY to pay out only $0.30 per share, where the heck has the money been coming from to allow REM to pay out way over this amount every quarter for the past 4 years?"

Some Seeking Alpha commenters to the news of the REM dividend announcement either did not read my article or had not believed it. They were quite unhappy. A Seeking Alpha commenter said "Surprised at such a sharp reduction over previous since sector seems to have stabilized and most are maintaining divs."

Some were more emphatic. A Seeking Alpha commenter said "Totally illegal since they are still getting the full divs amount from their holdings. Time for a lawsuit." I don't think he had read my article.

I am fairly certain that the Seeking Alpha commenter who said: "This doesn't make sense to me. I would have thought that the dividend would have been higher. Does anyone have an explanation for the reduction?" did not read my article.

It appears that the REM dividend news had some negative effect of the mREIT sector. However, since REM shares can be created or redeemed (in lots of at least 50,000), there is not much risk that there will be a sharp sell-off in REM prompted by the dividend returning to the level I forecast. Any downward pressure on REM would result in arbitrage in which REM shares were bought to be redeemed if the net asset value was significantly above the market price. Since REM is relatively large, with over $1.3 billion in assets, it is theoretically possible that selling pressure in REM could put downward pressure on the mREITs in the index. However, REM is still small compared to the total capitalization of the mREITs that comprise the index. Annaly Capital (NYSE:NLY) alone has a capitalization of more than $11 billion. This would make the "tail wagging the dog" scenario of REM sharply pulling down the prices of the components less likely.

In summary, aside from me getting to say I told you so, REM is still a good way to collect high yields, if you are comfortable with the interest rate risks associated with mREITs. With 36 different components, REM is better diversified than most other mREIT funds and ETNs.

While 90% of REM's portfolio is in agency mREITs, the other 10% is in other types of REITS, such as commercial mortgage financing, industrial and office REITs. The agency mREITs are primarily dependent on the continuation of low interest rates to maintain their dividends. Thus, weaker economic activity is good for the agency mREITs. Some of the agency mREITs do contain some non-agency mortgages, which entails some credit risk. Mortgages that do have credit risk benefit from stronger economic activity and generally suffer from weaker economic conditions. Thus, at least 10% of REM's portfolio will do better in periods of increased economic activity, which provides some diversification for the risks that agency mREITs will suffer when economic activity increases.

It has been said that the purpose of financial markets is to punish the majority opinion. Thus, mREITs are out of favor now and have very high yields. My view is that interest rates will stay lower for longer than many people think. See: A Depression With Benefits: The Macro Case For mREITs.

Disclosure: The author is long REM. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.