Dividends Put MORL's Total Returns Into Positive Territory

| About: UBS ETRACS (MORL)

Summary

MORL has turned in a 32.1% total return year to date.

The August 2016 MORL dividend will be higher than the August 2015 dividend. However, this was due to some quirks in the ex-dates of some of the components.

Normalization of interest rates based on post-WWII levels may not be consistent with the very abnormal economic conditions of this century.

Lower rates for longer may be the new normal, with positive implications for MORL.

My projection for the August 2016 monthly dividend of $0.1347 for the UBS ETRACS Monthly Pay 2X Leveraged Mortgage REIT ETN (NYSEARCA: MORL) will be the first month this year that the monthly dividend was higher than the prior year's monthly dividend. The August 2016 dividend is projected to be 13.6% higher than the August 2015 dividend of $0.1185. On a year-to-date basis, MORL has returned 32.1% based on a purchase at the end of 2015 at $13.28 and the July 29, 2016, price of $15.41 and the dividends of $2.1344 paid this year through to July 2016. This does not include any reinvestment of dividends or any gains or losses on the reinvestment of dividends.

The table I below shows the month-end prices for MORL since its inception in October 2012, the monthly dividends, the cumulative dividends from inception, the sum of the dividends that would have been paid to date after a purchase of MORL at the end of each month, the total return on a purchase after a purchase of MORL at the end of each month, and the year-over-year total return on a purchase after a purchase of MORL at the end of each month. This does not include any reinvestment of dividends or any gains or losses on the reinvestment of dividends.

For example, for the month of July 2016 table shows the July 29, 2016, month-end price of 15.41, the monthly dividend paid in the month of July 2016 of $0.6195, the cumulative dividends from inception in 2012 to the July 29, 2016, month-end price of $16.0424, the sum of the dividends that would be received from a purchase of MORL made on the last day of July 2016, the total return from a purchase of MORL made on the last day of July 2016 of .87% and the year-over-year total return from a purchase of MORL made on the last day of July 2015. The year-over-year figure is calculated by taking the month-end July 2015 price of $16.64, less the July 2016 month-end price of 15.41, plus the dividends of $3.1517 paid from August 2015 to July 2016 and dividing that by the July 2015 price of $16.64. This results in a year-over-year total return of 11.55%. Note that the total return from a purchase of MORL made on the last day of July 2016 of .87% is based on the assumption of an August 2016 monthly dividend of $13.47 and the price remaining at $15.41.

Using month-end prices does not illustrate some of the returns that could have resulted for the purchases on other dates, such as my ill-timed MORL purchase on March 18, 2013, at $30.96 or my purchase on January 25, 2016, at $9.92.

Table I - MORL's Prices, Dividends and Returns

month

Price

dividend

cumulative

div post buy

return from buy

y/y return

Aug-16

15.41

0.1347

16.1771

0.0000

0

23.08%

Jul-16

15.41

0.6195

16.0424

0.1347

0.87%

11.55%

Jun-16

15.05

0.0324

15.4229

0.6195

6.51%

10.05%

May-16

14.11

0.1293

15.3905

0.6519

13.83%

-10.36%

Apr-16

13.09

0.5583

15.2612

0.7812

23.69%

-15.84%

Mar-16

13.27

0.0364

14.7029

1.3395

26.22%

-18.10%

Feb-16

11.57

0.0389

14.6665

1.3759

45.08%

-25.01%

Jan-16

11.15

0.7196

14.6276

1.4148

57.35%

-25.02%

Dec-15

13.28

0.0426

13.9080

2.1344

32.11%

-17.73%

Nov-15

13.9

0.1371

13.8654

2.1770

26.53%

-18.91%

Oct-15

13.61

0.6702

13.7283

2.3141

30.23%

-16.02%

Sep-15

14.38

0.0489

13.0581

2.9843

27.92%

-6.26%

Aug-15

15.19

0.1185

13.0092

3.0332

21.42%

-14.50%

Jul-15

16.64

0.7853

12.8907

3.1517

11.55%

-1.31%

Jun-15

16.69

0.1296

12.1054

3.9370

15.92%

-9.06%

May-15

19.55

0.1285

11.9758

4.0666

-0.38%

5.75%

Apr-15

19.61

0.8858

11.8473

4.1951

-0.02%

10.83%

Mar-15

20.77

0.0601

10.9615

5.0809

-1.34%

16.54%

Feb-15

20.45

0.0742

10.9014

5.1410

0.49%

14.40%

Jan-15

19.94

0.949

10.8272

5.2152

3.44%

22.06%

Dec-14

21.04

0.1316

9.8782

6.1642

2.54%

33.91%

Nov-14

22.22

0.1206

9.7466

6.2958

-2.31%

49.91%

Oct-14

21.09

0.9916

9.6260

6.4164

3.49%

32.77%

Sep-14

20.06

0.074

8.6344

7.4080

13.75%

22.24%

Aug-14

22.97

0.0802

8.5604

7.4820

-0.34%

47.60%

Jul-14

21.33

0.9642

8.4802

7.5622

7.70%

25.30%

Jun-14

23.4

0.0691

7.5160

8.5264

2.29%

28.04%

May-14

22.77

0.0724

7.4469

8.5955

5.43%

15.65%

Apr-14

21.73

1.0129

7.3745

8.6679

10.80%

-15.92%

Mar-14

21.77

0.0171

6.3616

9.6808

15.25%

-16.62%

Feb-14

21.86

0.062

6.3445

9.6979

14.86%

-7.15%

Jan-14

20.06

0.8072

6.2825

9.7599

25.47%

-10.78%

Dec-13

19

0.0869

5.4753

10.5671

36.72%

-0.32%

Nov-13

17.73

0.1643

5.3884

10.6540

47.01%

-7.53%

Oct-13

19.2

0.7938

5.2241

10.8183

36.61%

Sep-13

19.85

0.0884

4.4303

11.6121

36.13%

Aug-13

18.42

0.1062

4.3419

11.7005

47.18%

Jul-13

20.41

1.1045

4.2357

11.8067

33.35%

Jun-13

21.7

0.1155

3.1312

12.9112

30.51%

May-13

23.52

0.1263

3.0157

13.0267

20.90%

Apr-13

31.18

1.3213

2.8894

13.1530

-8.39%

Mar-13

31.86

0.113

1.5681

14.4743

-6.20%

Feb-13

28.81

0.0313

1.4551

14.5873

4.12%

Jan-13

27.93

1.3195

1.4238

14.6186

7.51%

Dec-12

24.45

0.1043

0.1043

15.9381

28.21%

initial ipo

25

0

0.0000

16.0424

25.81%

Click to enlarge

The year-to-date total return on MORL of 32.1% is what could have been expected given that there have been no rate increases by the Federal Reserve in 2016. In January 2016, even those most bearish on MORL and the mREITs would have conceded that if there were no rate increases by the Federal Reserve this far into 2016, then MORL would have had a high total return at this point in time. Obviously, those who were bearish on MORL at the beginning of 2016 were expecting multiple interest rate increases by now.

Even some Federal Reserve officials seem to be coming around to the view that the new normal may be lower rates for longer. Generally, Janet Yellen and other Federal Reserve officials do not talk about raising rates, but rather use the term normalization of interest rates. My view is that normal interest rates are not appropriate when you have very abnormal economic conditions.

Those calling for a normalization suggest that interest rates should be returned to somewhere near the averages that prevailed since the end of World War II. However, there has been a fundamental change world-wide this century that suggests that the rates that prevailed in the second half of the last century should not be considered as normal for the current period.

The primary change that has fundamentally changed the economy can be best described by Warren Buffett, CEO of Berkshire Hathaway (NYSE:BRK.A) (NYSE:BRK.B), who said, "Through the tax code, there has been class warfare waged, and my class has won," to Business Wire CEO Cathy Baron Tamraz at a luncheon in honor of the company's 50th anniversary. "It's been a rout."

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 and a decline in consumer spending. The wealthy clearly have lower marginal propensities to consume. As I explained in a Seeking Alpha article "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..."

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 more funds available for investment since when the investment is taxed relatively less, more funds are made available for the investment. That would also put downward pressure on interest rates.

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 deficit of a similar magnitude whose 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, which in turn now has 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 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 much of 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 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.

Even though MORL has increased in price, I am still a buyer. Mostly for the high dividend yield. The August 2016 MORL dividend may be an anomaly since it was boosted by some quirks. However, it is still substantial. 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.

There were five MORL components that had ex-dividend dates in July 2016. That is more than in typical "small months." In addition to ARR and AGNC, three of the quarterly payers had ex-dates in July 2016 and will thus contribute to the August 2016 dividend. It should be noted that AGNC has reduced its monthly dividend from $0.20 to $0.18. However, the reduction does not come into effect until the next monthly payment with an ex-date in August 2016. Thus, the higher $0.20 dividend will be used in the calculation of the dividend that will be paid in August 2016. Table II below shows the weights of each of the mREITs that comprise the index upon which MORL and its essentially identical twin, UBS ETRACS Monthly Pay 2X Leveraged Mortgage REIT ETN Series B, are based. The table also shows the price, ex-date, dividend, dividend frequency and contribution to the dividend for the five components that will contribute to the August 2016 dividend.

In addition to the monthly payers AGNC and ARR, and quarterly payers New Residential Investment Corp. (NYSE:NRZ), PennyMac Mortgage Investment (NYSE:PMT) and Hannon Armstrong Sustainable Infrastructure Capital (NYSE:HASI), l also had ex-dates in July 2016 and thus will contribute to the August 2016 dividend.

The increase in MORL's net asset or indicative value has also been a factor in the increase in the dividend. The 2X leverage requires a rebalancing each month to maintain the equivalent of 50% equity and 50% borrowing in the dividend and value calculations. This means that effectively the number of shares in each component that each share of MORL represents is increased when the indicative value rises and is reduced when the indicative value declines. Thus, even if every mREIT in the index kept its dividend unchanged, an increase in MORL's indicative value would cause an increase in MORL's monthly dividend. 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."

My projection for the August 2016 dividend for MORL and MRRL is $0.1347. The projection for the dividend is calculated using the contribution by component method. The VanEck 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.

Even after the rebound in MORL and MRRL from the January 2016 lows, the yields are still relatively large. For the three months ending August 2016, the total projected dividends are $0.7866. The annualized dividends would be $3.267. This is a 20.4% simple annualized yield with MORL priced at $15.41. On a monthly-compounded basis, the effective annualized yield is 22.4%.

Aside from the fact that with a yield around 20%, even without reinvesting or compounding you get back your initial investment in only five 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 22.4% on a compounded basis, the return on a strategy of reinvesting all dividends would be enormous. An investment of $100,000 would be worth $275,174 in five years. More interestingly, for those investing for future income, the income from the initial $100,000 would increase from the $22,400 initial annual rate to $61,756 annually.

Table II Holdings of MORL and MRRL

Name

Ticker

Weight

Price

ex-div

dividend

frequency

contribution

Annaly Capital Management

NLY

16.18

American Capital Agency Corp.

AGNC

9.48

19.62

7/27/2016

0.2

m

0.0297

Starwood Property Trust, Inc.

STWD

6.94

0

Chimera Investment, Corp.

CIM

5.34

0

Two Harbors Investment Corp.

TWO

5.18

0

Blackstone Mortgage Trust, Inc.

BXMT

5.09

0

New Residential Investment Corp.

4.94

13.56

7/5/2016

0.46

q

0.0515

MFA Financial, Inc.

MFA

4.7

0

CYS Investments, Inc.

CYS

4.55

0

Colony Capital

CLNY

4.33

0

PennyMac Mortgage Investment

PMT

3.85

16.22

7/12/2016

0.47

q

0.0343

Invesco Mortgage Capital

IVR

3.79

0

Apollo Commercial Real Estate

ARI

3.16

0

Capstead Mortgage Corp.

CMO

2.94

0

Hannon Armstrong Sustainable Infrastructure Capital, Inc.

HASI

2.69

22.56

7/1/2016

0.3

q

0.011

ARMOUR Residential REIT, Inc.

ARR

2.6

21.34

7/13/2016

0.22

m

0.0082

New York Mortgage Trust, Inc.

NYMT

2.59

0

American Capital Mortgage Investment

MTGE

1.95

0

Redwood Trust, Inc.

RWT

1.9

0

iStar, Inc.

STAR

1.78

0

Ladder Capital Corp.

LADR

1.74

0

Anworth Mortgage Asset Corp.

ANH

1.56

0

Western Asset Mortgage Capital Corp.

WMC

1.53

0

Resource Capital Corp.

RSO

1.22

0

Click to enlarge

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

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.