MORL Dividend Yield Now $25.5% - Benefits From Higher Indicative Value

| About: UBS ETRACS (MORL)

Summary

MORL has recovered from the January 2016 low on views that the Federal Reserve will be hesitant to raise rates.

The dividends paid by leveraged ETNs like MORL increase when the indicative or net asset value increases, even if the dividends paid by the index components are unchanged.

Lower interest rates for longer is still my view for various reasons which should benefit MORL and the mREITs.

On December 16, 2015, UBS ETRACS Monthly Pay 2X Leveraged Mortgage REIT ETN (NYSEARCA: MORL) closed at $12.93. That was the day after the Federal Reserve increased short-term rates. Various market participants then made predictions as to how many times the Federal Reserve would increase short-term rates in 2016. Some predicted as many as four rate increases during the year 2016.

I said in: MORL Dividend Will Actually Increase In January, Yield Now 29.2% published in Seeking Alpha on December 22, 2015:

"..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 recent 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 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..."

Even those who were the most bearish on MORL and the mREITs on December 22, 2015 would have likely conceded that if there were no Federal Reserve increases in short-term rates in 2016 and long-term rates fell or held steady, then MORL and the mREITs would soar. However, they thought that the prospect of no Federal Reserve increases in short-term rates in 2016 negligible. The view of multiple 2016 Federal Reserve increases in short-term rates became more prevalent and MORL closed at $9.22 on January 21, 2016.

Now, in the aftermath of the United Kingdom's vote to leave the EU, the debate seems to be between those who say there might be one Federal Reserve increase in short-term rates in 2016 or none at all. MORL has significantly recovered from the January 2016 low and is slightly above the December 16, 2015 level. It does continue to provide monthly dividends in excess of 20% on an annualized basis.

Even though MORL has increased in price, I am still a buyer. With leveraged ETNs like MORL, higher prices cause higher dividends even in the component mREITs keep their dividends unchanged. 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." This effect can be illustrated using American Capital Agency Corp. (NASDAQ: AGNC), the second largest component by weight in MORL which has paid a monthly dividend of $0.20 since May 2015. The table below shows the weight, ex-date, dividend amount, dividend frequency and contribution to the dividend 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.

AGNC has a weight of 8.8% in the index. Multiplying the 8.8% by 2X the MORL indicative value of $14.31 gives 2.519. Dividing 2.519 by the $18.99 AGNC price gives 0.1326 as the number of shares of AGNC that a share of MORL includes. Multiplying the 0.1326 share figure by the monthly AGNC dividend of $0.20 gives a contribution to the MORL July dividend of $0.2652. The monthly July 2016 MORL dividend will be the sum of all of the contributions from those components that have ex-dividends in June 2016. My projection for the monthly July 2016 MORL dividend is $0.655. That will be the highest monthly dividend since January.

If the indicative or net asset value of MORL was the January 21, 2016 all-time low level of $9.29, the contribution to the MORL dividend from AGNC would be lower even though the monthly dividend of AGNC was still $0.20. For comparison purposes, assume the weight of AGNC was still 8.8% and the share price of AGNC was $14.96 reflecting the exact decline that would be commensurate with the lower indicative or net asset value of MORL.

Then the number of shares of AGNC that a share of MORL included would be only 0.1094 and the contribution to the MORL dividend from the monthly $0.20 dividend of AGNC would be only $0.2188. Thus, on a ceteris paribus basis, or all other things being equal, the increase in the indicative or net asset value of MORL from $9.29 to $14.31 increased the monthly MORL dividend by 21.2% without any change in the dividends paid by the index components.

My projection for the July 2016 dividend for MORL and MORL and its essentially identical twin the UBS ETRACS Monthly Pay 2X Leveraged Mortgage REIT ETN Series B is $0.655. The projection for the dividend is calculated using the contribution by component method. The Market Vectors Mortgage REIT Income ETF (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 MORT Provides Strong Yield With Less Risk Than MORL published on June 21, 2016, I predicted that MORT will declare a $0.52 quarterly dividend for the second quarter of 2016.

Most of the MORL components pay dividends quarterly. Only two of the MORL components: 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.

PennyMac Mortgage Investment (NYSE:PMT) had its last quarterly ex-date on April 8, 2016, so it will not contribute to the July 2016 MORL dividend. Hannon Armstrong Sustainable Infrastructure Capital (NYSE:HASI) has its next quarterly ex-date on July 1, 2016, so I have to assume it will also not contribute to the July 2016 MORL dividend. iStar Inc. (NYSE:STAR) does not currently pay any dividends. New Residential Investment Corp. (NYSE:NRZ) has not declared a second quarter dividend as of this writing. I have assumed it will pay the same quarterly $0.46 dividend that it paid in the first quarter of 2016. If any of my assumptions regarding PMT, HASI, STAR or NRZ turn out to be incorrect, the projection would be different.

The belief that interest rates will rise significantly in 2016 is still held by some 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 the 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 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 rates to fall into negative territory. Japanese and German 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 for such capital to be deployed.

Investors in mREITs cannot ignore political risks and considerations. My focus in this article is on mREITs not politics. However, some of the proposals from the candidates and others could have significant impacts on the markets and mREITs in particular. There are various proposals in Congress to change or replace Fannie Mae (OTCQB:FNMA) and Freddie Mac (OTCQB:FMCC) which could impact the real estate and mortgage markets.

There are some things that a possible 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. Current law allows an administration to deport any illegal alien.

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 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. Trump's camp is now suggesting that to get around the controversy surrounding his proposal to ban all Moslems from entering the country, he could just stop issuing visas to everyone. That would destroy the hotel industry. The only real estate sector that might survive 12 million less people would be the extremely high end. This would be a continuation of the trend favoring the rich.

There is no real mystery as to what a President Trump would do with regard to taxes. A Republican in the White House would have the same consequences regarding taxes, if any of the 17 candidates in the Republican primaries had become president. There is no doubt as to what Republican control of both congress and the presidency would be with regard to tax policy.

There will be a further shift in the tax burden away from the rich and onto the middle class. 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 a 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.

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 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 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 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 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.

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 worldwide. 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 has caused many problems worldwide. 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 July 2016, the total projected dividends are $0.8167. The annualized dividends would be $3.267. This is a 22.9% simple annualized yield with MORL priced at $14.26. On a monthly-compounded basis, the effective annualized yield is 25.5%.

Aside from the fact that with a yield around 25%, even without reinvesting or compounding you almost get back your initial investment in only 4 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 25.5% on a compounded basis, the return on a strategy of reinvesting all dividends would be enormous. An investment of $100,000 would be worth $311,110 in five years. More interestingly, for those investing for future income, the income from the initial $100,000 would increase from the $25,500 initial annual rate to $83,745 annually.

Holdings of MORL, MRRL and MORT as of June 1, 2016, weight end of May

Name

Ticker

Weight

Price

ex-div

dividend

frequency

contribution

Annaly Capital Management Inc.

NLY

13.51

10.65

6/28/2016

0.3

q

0.1089

American Capital Agency Corp.

AGNC

8.8

18.99

6/28/2016

0.2

m

0.0265

Starwood Property Trust Inc.

STWD

6.75

20.92

6/28/2016

0.48

q

0.0443

New Residential Investment Corp.

NRZ

5.59

13.31

3/31/2016

0.46

q

0.0553

Blackstone Mortgage Trust Inc.

BXMT

5.05

27.93

6/28/2016

0.62

q

0.0321

Two Harbors Investment Corp.

TWO

4.96

8.64

6/28/2016

0.23

q

0.0378

Chimera Investment Corp.

CIM

4.94

15

6/28/2016

0.48

q

0.0439

Colony Financial Inc.

CLNY

4.78

18

6/24/2016

0.2

q

0.0155

Hatteras Financial Corp.

HTS

4.59

16

6/21/2016

0.45

q

0.0367

Invesco Mortgage Capital Inc.

IVR

4.5

14

6/23/2016

0.4

q

0.0359

MFA Financial Inc.

MFA

4.39

7.3

6/24/2016

0.2

q

0.0347

CYS Investments Inc.

CYS

4.03

8.4

6/20/2016

0.25

q

0.0345

PennyMac Mortgage Investment.

PMT

3.7

16

4/8/2016

0.47

q

Apollo Commercial Real Estat

ARI

2.88

17

6/28/2016

0.46

q

0.0229

Capstead Mortgage Corp.

CMO

2.73

9.8

6/28/2016

0.23

q

0.0184

Hannon Armstrong Sustainable Infrastructure Capital Inc.

HASI

2.59

21

7/1/2016

0.3

q

ARMOUR Residential REIT Inc.

ARR

2.31

19

6/13/2016

0.22

m

0.0075

New York Mortgage Trust Inc.

NYMT

2.29

6.4

6/23/2016

0.24

q

0.0246

Redwood Trust Inc.

RWT

2.23

14

6/14/2016

0.28

q

0.0130

American Capital Mortgage Investment Corp.

MTGE

2.05

16

6/28/2016

0.4

q

0.0148

iStar Inc.

STAR

1.67

9.6

0

0.0000

Ladder Capital Corp.

LADR

1.55

13

6/9/2016

0.275

q

0.0097

Anworth Mortgage Asset Corp.

ANH

1.45

4.7

6/28/2016

0.15

q

0.0133

Western Asset Mortgage Capital Corp.

WMC

1.37

9.9

6/30/2016

0.31

q

0.0123

Resource Capital Corp.

RSO

1.31

13

6/28/2016

0.42

q

0.0124

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

Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.

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