MORT Provides Strong Yield With Less Risk Than MORL

| About: VanEck Vectors (MORT)

Summary

I project that MORT will declare a $0.52 quarterly dividend for the second quarter of 2016.

This will bring the annualized yield to about 10%.

MORT provides less yield than MORL, but MORL has some additional risk factors not present in MORT.

MORT is a safer way to benefit from the lower interest rates for long scenario.

Now that it appears that Janet Yellen and other Federal Reserve officials may have seen the light in terms of the relative advantages of delaying further interest rate increases, some investors may want to consider mREITs. The Market Vectors Mortgage REIT Income ETF (NYSEARCA:MORT) is an exchange-traded fund comprised of mREITs. My projection for the MORT quarterly dividend that will be paid at the end of June 2016, indicates that the yield on MORT will be about 10%. Discounts to book value also make the mREITs that comprise MORT attractive.

The table below shows each of the 26 securities in the MORT portfolio, the weight, number of shares, price, ex-dividend date, dividend amount and the dividend frequency from each component using data as of June 17, 2016.Multiplying the shares of each component by the dividend gives a dollar amount for each component. Dividing the sum of the dividend amounts by the 4.9 million shares outstanding gives the gross dividend. Some mREITs pay monthly. To calculate the amount that a monthly-paying component pays during a quarter, the dividend is multiplied by three. One component, iStar, Inc. (NYSE: STAR), with a weight of 1.61, does not currently pay dividends. Using a 0.51% annual net expense ratio reduces the quarterly dividend by $0.027. This would imply a quarterly dividend, which will be paid at the end of June 2016 of $0.52. On a trailing 12-month basis, the annual dividend for MORT would be $1.99. This would be a current yield of 9.5% at a price of $21.04. On a quarterly compounded basis the $.52 quarterly dividend is an annualized yield of 10.3%.

Most of the components of MORT have declared their dividends for the second quarter of 2016. For those that have not I have assumed they will be unchanged from the previous, which is what I assume MORT management will do when they declare the second quarter dividend shortly. Only a few of the components have changed their dividends from the prior period. There were some reductions. ARMOUR RESIDENTIAL REIT INC (NYSE:ARR) pays monthly and has declared a $0.22 dividend for both June and May 2016. The ARR dividend with an ex-date in April 2016 was $0.27. Prior to that the monthly dividend was $0.33. I have assumed the $0.22 in calculation the projected MORT dividend. CYS INVESTMENTS INC (NYSE:CYS) reduced the quarterly dividend to $0.25 from $0.26 previously. WESTERN ASSET MORTGAGE CAPITAL (NYSE:WMC) reduced its quarterly dividend to $0.45 for the March 2016 dividend from $0.58 previously. It has not yet announced the second quarter dividend and I have assumed it will be unchanged from the previous.

One issue with forecasting dividends for MORT is that it is an exchange-traded fund as opposed to an exchanged-trade note. ETNs such as the UBS ETRACS Monthly Pay 2X Leveraged Mortgage REIT ETN (NYSEARCA: MORL) and its' new, effectively identical sister, the UBS ETRACS Monthly Pay 2X Leveraged Mortgage REIT ETN Series B (NYSEARCA: MRRL), which are based on the same index as MORT, must pay their dividends as per a formula in their indenture, based on the dividends based by the components in the index they are based on. Funds such as MORT can pay whatever they want as long as they comply with Investment Company and Internal Revenue Service regulations on an annual basis. I have been working under the assumption that MORT, unlike some funds, will what the dividends on its' holdings indicate.

MORT is still a good way to collect high yields if you are comfortable with the interest rate risks associated with mREITs. With 26 different components, the ETF provides diversification. 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 some of MORT's portfolio could do somewhat better in periods of increased economic activity, which provides some diversification for the risks that agency mREITs will suffer when economic activity increases. Additionally, some of the mREITs in MORT have both substantial agency and non-agency mortgages. Thus, a stronger economy is positive in some ways as well a negative. An example of an mREIT with non-agency exposure is Chimera Investment Corp. (NYSE:CIM) which comprises 5.09% of MORT.

There are two issues that most influence the prices of the mREITs and thus MORT. The major issue is the future level of interest rates. A second related issue is the discount to net asset value that many mREITs are trading at. One reason why I am constructive on MORT and the mREITS in general is that they are trading close to historic discounts to book or net asset value. In theory it is illogical for an mREIT to trade at a large discount to net asset value. If you or an institution held a portfolio of mortgage-backed securities that was financed using short-term borrowing, you would not value it at anything other than net asset value, based on the belief that interest rates were going up in the future. There is some argument to be made that mREITs trade at discounts due to the fees that they charge.

The belief by many market participants that the Federal Reserve would raise interest rates as many as four times in 2016 has kept mREITs under pressure. This has resulted in significant discounts to book value and double digit yields for many mREITs. The recent weak payroll numbers may have caused some to reconsider the future path of interest rates. To be sure, low interest rates 2013 have not produced the results I had hoped for in mREITs.

In my article What's Wrong With The mREITs? - MORL Now Yields 29.4%, I presented reasons why mREITs have way underperformed what could have been expected given the fact that short-term interest rates have been close to zero since 2008 and long-term rates have been relatively benign over that period with the benchmark 10-year treasury now yielding only 1.6%.

As long as inflation remains low, mREITs and MORT should produce high returns. MORT would be a very good vehicle for those seeking to benefit from an extended period of low interest rates, but do not want to take on the 2X leverage associated with MORL. I own and have owned MORL but not MORT. This is because I want to benefit from my view that short-term rates will remain lower for longer and like to 20% yield that MORL pays. However, MORL is 2x leveraged which essentially doubles the price volatility. Additionally, MORL has certain risks that MORT does not have. I do not consider these significant, but they do exist. MORL is an unsecured debt of UBS Group AG (NYSE:UBS). While UBS is the world's largest wealth manager by assets, there is some credit risk associated with MORL that is not present with MORT. As a leveraged ETN, there are call provisions associated with MORL that are not present in MORT. If MORL fall to precipitously or the indicative value falls below $5, it could be called and investors would be paid whatever the indicative value was t the time. That would probably to be the opportune point to sell.

MORT could also be a good investment for those who want higher yields and want to use their own leverage to do so. Buying MORT on a 50% margin would return a higher or at least comparable yield to buying MORL for those who could borrow at LIBOR plus 0.4% or some similar level. Many retail investors cannot borrow at interest rates low enough to make buying MORT on margin a better proposition than buying MORL. However, larger investors with access to low margin rates might do better by buying MORT on margin. The explicit risks of being forced out of your position associated with MORL, could exist with an investment in MORT using margin. If the market price of MORT like any other security purchased on margin, were to decline below a certain point, the investor must post additional margin or their account would be liquidated.

Even some small investors could do better buying MORT than MORL. For example, someone might have $10,000 in a brokerage account in a money market fund and wanted to get at least some return by investing a small part of the $10,000 in MORL or MORT. Some brokerage firms pay 0.01% on money market funds. Even paying only 0.01%, those money market funds are not covering their expenses. The annual return on $10,000 at 0.01% is $1 per year.

If this hypothetical investor was thinking of either investing $1,000 of his $10,000 in MORL and keeping $9,000 in the money market fund or investing $2,000 of his $10,000 in MORT and keeping $8,000 in the money market fund, either choice would entail the same amount of risk and potential capital gain. This is because MORL being 2X leveraged would be expected to move either way twice as much as a basket of mREITs while MORT would move in line with a basket of mREITs. For this hypothetical investor, his effective borrowing cost is the rate on the money market fund. Thus, his income from the $2,000 of his $10,000 in MORT and $8,000 in the money market fund should exceed that of $1,000 of his $10,000 invested in MORL and $9,000 in the money market fund since his effective borrowing rate on the extra $1,000 invested in MORT is less than the imputed borrowing cost that MORL uses.

MORT as of June 17, 2016

Holding

Ticker

Shares

% of net assets

Price

ex-div

dividend

frequency

amount

Annaly Capital Management Inc

NLY

1,302,038

13.48%

10.65

6/28/2016

0.30

q

390611

American Capital Agency Corp

AGNC

475,108

8.84%

18.99

6/28/2016

0.20

m

285065

Starwood Property Trust Inc

STWD

333,709

6.69%

20.92

6/28/2016

0.48

q

160180

New Residential Investment Corp

NRZ

419,466

5.49%

13.31

3/31/2016

0.46

q

192954

Chimera Investment Corp

CIM

336,174

5.09%

15

6/28/2016

0.48

q

161364

Two Harbors Investment Corp

TWO

596,645

5.03%

8.64

6/28/2016

0.23

q

137228

Blackstone Mortgage Trust Inc

BXMT

182,547

4.98%

27.93

6/28/2016

0.62

q

113179

Hatteras Financial Corp

HTS

290,915

4.61%

16

6/21/2016

0.45

q

130912

Invesco Mortgage Capital Inc

IVR

318,674

4.49%

14

6/23/2016

0.40

q

127470

Colony Capital Inc

CLNY

265,952

4.44%

18

6/24/2016

0.20

q

53190

Mfa Financial Inc

MFA

620,686

4.42%

7.3

6/24/2016

0.20

q

124137

Cys Investments Inc

CYS

502,504

4.13%

8.4

6/20/2016

0.25

q

125626

Pennymac Mortgage Investment Trust

PMT

244,845

3.85%

16

4/8/2016

0.47

q

115077

Apollo Commercial Real Estate Finance I

ARI

181,121

2.91%

17

6/28/2016

0.46

q

83316

Capstead Mortgage Corp

CMO

287,791

2.75%

9.8

6/28/2016

0.23

q

66192

Hannon Armstrong Sustainable Infrastruc

HASI

129,911

2.67%

21

7/1/2016

0.30

q

38973

New York Mortgage Trust Inc

NYMT

391,924

2.51%

0

Armour Residential Reit Inc

ARR

121,459

2.30%

19

6/13/2016

0.22

m

80163

Redwood Trust Inc

RWT

159,494

2.14%

14

6/14/2016

0.28

q

44658

American Capital Mortgage Investment Co

MTGE

131,721

2.04%

16

6/28/2016

0.40

q

52688

Ladder Capital Corp

LADR

128,558

1.62%

13

6/9/2016

0.28

q

35353

Istar Inc

STAR

165,940

1.61%

9.6

0.00

0

Western Asset Mortgage Capital Corp

WMC

150,232

1.46%

9.9

3/31/2016

0.45

q

67604

Anworth Mortgage Asset Corp

ANH

318,553

1.45%

4.7

6/28/2016

0.15

q

47783

Resource Capital Corp

RSO

105,014

1.34%

13

6/28/2016

0.42

q

44106

Click to enlarge

Disclosure: I am/we are long MORL, ARR, CYS, 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.