MORL Dividend Yield Still High At 22.5%



Even after the price rebounds in MORL and MRRL from the January 2016 lows, the yields are still relatively large.

The lower interest rates for longer scenario still makes sense.

The automatic increase in the leveraged ETN dividends due to the higher indicative value offsets the higher market price to keep the yields relatively steady.

Only the two components that have ex-dates in May 2016 will contribute to the June UBS ETRACS Monthly Pay 2X Leveraged Mortgage REIT ETN (NYSEARCA: MORL) 2016 dividend. The table below shows the weight, ex-date, dividend amount and dividend frequency of each of the mREITs that now comprise the index upon which MORL and its essentially identical twin UBS ETRACS Monthly Pay 2X Leveraged Mortgage REIT ETN Series B (NYSEARCA:MRRL) are based. For the two components that will contribute to the June 2016 dividend, the price and the contribution to the dividend are also shown.

Last month, in MORL: Dividend Yield Of 22.4% Makes It Still Interesting, my projection was significantly lower than the actual $0.1293 May 2016 MORL dividend. Two months ago in MORL: Dividend Yield Of 27.4% Makes It Still Compelling, my projection was significantly higher than the actual $0.5583 April 2016 MORL dividend. I have attempted to determine the source of the errors. So far my requests to UBS and U.S. Bank Trust National Association, the Trustee specified in the MORL indenture, have not resulted in my obtaining a list of the contributions by components for the April and May 2016 dividends. In the past UBS has sent me the spreadsheet of the contributions by components for some of the UBS ETRACS Monthly Pay 2X Leveraged ETNs. Without the spreadsheets of the contributions by components we can only speculate as to the source of the errors. One possibility is that one the contributions in my table showing the contributions by components should not have been included in calculating the April dividend but was then included in the May Dividend.

My projection for the June 2016 dividend for MORL and MRRL is $0.0345. The projection for the dividend is calculated using the contribution by component method. The Market Vectors Mortgage REIT Income ETF (NYSEARCA:MORT) is a fund that is based on the same index as MORL and MRRL. However, MORT is a fund rather than a note and thus does not employ the 2X leverage that MORL and MRRL do. MORT also pays dividends quarterly rather than monthly.

In the table below I have included the ex-dates and dividends for all of the components that contributed the MORL dividends. If the ex-date or dividend amount was incorrect, the dividend calculation would also be wrong. As long as the ex-date was for the correct month that would not impact the calculation, only if it indicated an ex-date in the wrong month would it matter. Generally, whenever I have had an incorrect ex-date or dividend amount, readers have indicated so in comments, usually within hours of the article being published. So far no such corrections have been suggested. I have included all the ex-dates and dividends again in the table below, so there is still some possibility that someone might spot an error.

Most of the MORL components pay dividends quarterly. Only two of the MORL components: American Capital Agency Corp. (NASDAQ: AGNC) and ARMOUR Residential REIT Inc. (NYSE: ARR) pay dividends monthly. The January, April, October and July "big month" MORL dividends are much larger than the "small month" dividends paid in the other months since most of the portfolio components pay quarterly, typically with ex-dates in the last month of the quarter and payment dates in the first month of the next quarter. ARR has reduced its' monthly dividend again to $0.22 from the previous $0.27. AGNC has maintained its' monthly dividend at $0.20. Their contributions are shown in the table below.

There was also an increase in the net asset or indicative value of MORL from $13.1352 at the end of April 2016 to $14.1303 on May 13, 2016. As the value of the closed-end funds in the portfolio increase, portfolio assets must be increased to maintain the leverage level. This increases the dividend, separate from any changes in the dividends paid by the mREITs in the portfolio. The relationship between the net asset value of a 2X leveraged ETN and the dividend is explained more fully in "MORL's Net Asset Value Rises - Implications For The Dividends."

The belief that interest rates will rise significantly is held by many market participants who think that the Federal Reserve is artificially depressing rates below what would be a "normal" level. I disagree. As I indicated in " The Federal Reserve is actually propping up Interest Rates and what that means for Mortgage REITS," one benchmark rate that he Federal Reserve has absolute control of is the rate paid on reserves deposited at the FED. That rate is now 50 basis points, and was 25 basis points in until December 2015 after being zero since the inception of the FED in 1913 and almost a hundred years after that.

At the biannual monetary policy hearings, required by law, congressmen were becoming upset about the billions of dollars that were being directly transferred to the banks from the American taxpayers as a result of paying banks interest on reserves. From the inception of the Federal Reserve in 1913 until a few years ago banks never were paid on reserves deposited at the Federal Reserve. This was true even when the prime rate reached 21% in 1981. Janet Yellen, Federal Reserve Chair, explained that Federal Reserve was paying banks on reserves because that was the only way to get market interest rates up. She asserted that the traditional Federal Reserve tools of raising the target rate on Federal Funds or raising the discount rate would not be effective in forcing banks to increase the interest rates they charged borrowers on loans or paid depositors. Congressmen from both parties were not completely satisfied by Yellen's explanation.

I regard Yellen's explanation as supportive of my assertion in the above mentioned article that absent the policy of paying banks on reserves, the rate on US treasury bills would be actually negative. Throughout the industrial world, in many countries their equivalent of treasury bills are actually negative. Among major developed countries only in the USA are the monetary authorities trying to increase interest rates. In Europe and Japan many central banks have allowed short-term rate to fall into negative territory. Japanese 10-year bonds now have negative interest rates.

More important than the issue of whether interest rates would be negative absent Federal Reserve policy, is the question of why interest rates have been so low for so long. The world is clearly not in the grip of 1930's style unemployment or deflation. My view is that interest rates are low because of the tremendous imbalance between the amount that savers have to lend and invest as compared with opportunities such capital to be deployed. Whether that situation will continue depends on political as well as economic considerations.

One cannot ignore the coming election. My focus in this article is on mREITs not politics. However, some of the proposals from the candidates could have significant impacts on the markets and mREITs in particular. There are some things that a President Trump could do without any assent or cooperation from Congress or any other branch of government, while there are others like imposing tariffs that Trump could not do unilaterally. One thing that Trump could do absolutely without Congressional approval would be to deport 12 million illegal aliens. As to the feasibility of doing so, it could be accomplished quicker than many think. Trump could use 100,000 military and law enforcement personnel to search every household in the USA. Assume that each soldier or police officer could knock-on or knock down the doors of 10 residences each day. It would take only about 150 days to search every residential unit in America, then round up and deport 12 million people. Assume that those 12 million people are now occupying about 3 million housing units. Thus, their deportation would leave 3 million vacancies. This would destroy the housing market. Home prices and rents would plummet. The departure of 12 million people would also devastate the commercial real estate market as well, especially retail. REITs and mREITs that take credit risk could suffer.

Politics has been a factor in the tremendous imbalance between the supply of loanable funds and the demand for them which is the true reason why interest rates are so low. Since 1969 there has been a tremendous shift in the tax burdens away from the rich on onto the middle class. Corporate income tax receipts, whose incidence falls entirely on the owners of corporations, were 4% of GDP then and are now less than 1%. During that same period, payroll tax rates as percent of GDP have increased dramatically.

What Warren Buffett the CEO of Berkshire Hathaway Inc. (NYSE: BRK.A) (NYSE: BRK.B) has called a rout, would turn into a massacre under any Republican administration. Inheritance taxes on estates above $10 million would be eliminated, as would most of what remains of the corporate income tax. Warren Buffett said "Through the tax code, there has been class warfare waged, and my class has won," Buffett told Business Wire CEO Cathy Baron Tamraz at a luncheon in honor of the company's 50th anniversary. "It's been a rout." Shifting income to the rich by taxing dividends, capital gains and corporate profits much less than the tax rates on wages also tends to make even more funds available for investment since when investment is taxed relatively less more funds are made available for investment. That would put downward pressure on interest rates.

There has been a tremendous shift in the tax burdens away from the rich and onto the middle class. Corporate income tax receipts, whose incidence falls entirely on the owners of corporations, were 5% of GDP in the Eisenhower-Nixon administration and are now less than 1%. During that same period, payroll tax rates as percent of GDP have increased dramatically. The overinvestment problem caused by the reduction in taxes on the wealthy is exacerbated by the increased tax burden on the middle class. While overinvestment creates more factories, housing and shopping centers; higher payroll taxes reduces the purchasing power of middle-class consumers. Income inequality due to tax policy, not lack of regulation was the cause of the great recession.

One does not have to be a Keynesian to see that shifts in income to those with lower marginal propensities to consume will cause an increase in savings. The wealthy clearly have lower marginal propensities to consume. As I explained in "A Depression with Benefits: The Macro Case for mREITS":

..In free-market capitalism, capital generates income for the owners of the capital which in turn is used to create additional capital. This is very good. Sometimes, it can be actually too good. As capital continues to accumulate, its owners find it more and more difficult to deploy it efficiently. The business sector generally must interact with the household sector by selling goods and services or lending to them. When capital accumulates too rapidly, the productive capacity of the business sector can outpace the ability of the household sector to absorb the increasing production.
The capitalists, or if you prefer, job creators use their increasing wealth and income to reinvest, thus increasing the productive capacity of the business they own. They also lend their accumulated wealth to other businesses as well as other entities after they have exhausted opportunities within the business they own. As they seek to deploy ever more capital, excess factories, housing and shopping centers are built and more and more dubious loans are made. This is overinvestment....

The laws of supply and demand apply differently to the market for loanable funds as compared to commodities. With commodities, equilibrium reached when the quantity supplied is equal to the quantity demanded. The debt or loanable funds market is more complex. A simple example illustrates this. An increase in government deficits accompanied by a commensurate increase in the issuance of government debt would normally be thought of as causing an increase in interest rates. However, the cause and/or purpose of the government deficits have a tremendous impact in terms of how interest rates are affected.

A government deficit for the purpose of funding a tax cut for those with high propensity to save has a much different impact on interest rates than the a deficit of similar magnitude who purpose is to fund an increase in social or defense spending. When the Federal government sells bonds and uses the proceeds to cut taxes on the wealthy, who in turn now have more money to lend, the net effect is to push down interest rates. This is especially true when the central banks are the buyers of much of the government debt.

As long as there is a much greater supply of loanable funds than the demand for them in the risk-free credit market, risk-free and near risk-free interest rates should remain low. Attempts by the Federal Reserve to push risk-free rates higher than what supply and demand would otherwise indicate, will only result in weaker economic activity. Lower risk-free short-term rates are by far the best environment for UBS ETRACS Monthly Pay 2xLeveraged ETNs such as MORL and MRRL.

One could argue that my view on interest rates has prevailed for the last three years and mREITs have declined in price over that period. Some of the decline is due to actions taken by some of the mREITs managers which have been inept or worse. However, most mREITs have gone from trading at premium to book value to very deep discounts to book value. While there are risks and problems associated with mREITs and MORL it is the enormous yields which I think will ultimately result in mREITs and MORL providing substantial returns as long as interest rates remain subdued.

The most bullish environment for the mREITs and thus MORL, MRRL and MORT is when the Federal Reserve reduces interest rates or is expected to do so. Now, there can be some hope, however slight, that the Federal Reserve actually reduces interest rates from current levels. There is one thing about the Federal Reserve decision to increase rates that can absolutely be construed as positive for those still constructive about the mREITs. Now, in contrast to before December 15, 2015, there is some possibility that the Federal Reserve will cut interest rates. Obviously, a zero interest rate policy meant no further rate cuts were possible, or at least that was thought to be the case before the European monetary authorities cut their deposit rate below zero. The dream by mREIT investors of a 2016 or 2017 rate cut may not be as far-fetched as it seems. Since the 2008 financial crisis every central bank in a developed country that has tightened monetary policy had to reverse course and lower rates in response to weakening economic conditions.

There have been many who have claimed that monetary policy is either no longer effective or never was effective in combating the sluggish growth rates that have occurred world-wide. They say that only fiscal policy can restore growth to acceptable levels. Even if you agree with that argument, raising interest rates makes no sense. An analogy would be if you were trying to lose weight via an exercise program and decided that the results were not satisfactory. If you added a diet it would not make sense to cut back on the exercise. Likewise, adding more fiscal stimulus to increase growth while simultaneously raising interest rates makes no sense. Raising interest rates which increase government deficits by themselves combined with more deficit spending aimed at achieving growth has caused many problems world wide. If low growth is the problem raising rates are definitely not the answer.

Even after the rebound in MORL and MRRL from the January 2016 lows, the yields are still relatively large. For the three months ending June 2016, the total projected dividends are $0.7221. The annualized dividends would be $2.8884. This is a 20.5% simple annualized yield with MORL priced at $14.10. On a monthly compounded basis, the effective annualized yield is 22.5%.

Aside from the fact that with a yield around 20%, even without reinvesting or compounding you almost get back your initial investment in only 5 years and still have your original investment shares intact, if someone thought that over the next five years interest rates would remain relatively stable, and thus, MORL would continue to yield 22.5% on a compounded basis, the return on a strategy of reinvesting all dividends would be enormous. An investment of $100,000 would be worth $276,110 in five years. More interestingly, for those investing for future income, the income from the initial $100,000 would increase from the $22,500 initial annual rate to $62,125 annually.

Holdings of MORL, MRRL and MORT as of May 13, 2016, weights end of April









Annaly Capital Management Inc






American Capital Agency Corp








Starwood Property Trust Inc






New Residential Investment Corp






Blackstone Mortgage Trust Inc






Chimera Investment Corp






Colony Financial Inc






Two Harbors Investment Corp






Hatteras Financial Corp






MFA Financial Inc






Invesco Mortgage Capital Inc






CYS Investments Inc






Pennymac Portgage Investment






Apollo Commercial Real Estat






Capstead Mortgage Corp






Hannon Armstrong Sustainable Infrastructure Capital Inc






ARMOUR Residential REIT Inc








Redwood Trust Inc






New York Mortgage Trust Inc






American Capital Mortgage Investment Corp






Istar Inc




Ladder Capital Corp






Anworth Mortgage Asset Corp






Western Asset Mortgage Capital Corp






Resource Capital Corp






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Disclosure: I am/we are long MORL, AGNC, MRRL.

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.