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MORL: Stupid Income Investment of the Week
Published Thu, Oct 25th, 2012   Louis Basenese, Chief Income Strategist

“Leverage cuts both ways, so be careful.”
That should be the only warning I need to make about the newest income product on the block – UBS’s ETRACS Monthly Pay 2xLeveraged Mortgage REIT ETN (NYSE: MORL).
But it won’t be.
Like a teenage girl at a Justin Bieber concert, income-starved investors are liable to lose all their senses just at the sight of the yield.
It checks in at an eye-popping 24.82%.
Like I said, a simple warning won’t be enough.
But trust me. You need to check yourself, before you wreck yourself. Literally.
Thank You, Sir. May I Get Some More Leverage?
Exactly one week ago, UBS launched the new ETN. As its name suggests, it uses leverage to offer two times the monthly exposure to the Market Vectors Global Mortgage REITs Index.
Two times leverage isn’t a deal breaker by any means. Here’s where the problem comes in…
The Index the ETN tracks is comprised of nothing but mortgage REITs (mREITs).
If you’re not familiar with mREITs, they’re pretty straightforward. Instead of buying physical real estate, mREITs buy government-backed mortgage securities and/or housing debt at risk of default. Then they use those securities as collateral to borrow more money – to buy even more securities.
The way they make money is by pocketing the “spread” – the difference between the interest rate it pays on the money it borrows and the interest rate it earns on the mortgages it buys. And since they’re structured as REITs, they pass 90% of taxable income to shareholders.
Long story short, mREITs already use a hefty amount of leverage in their normal course of business. So by investing in nothing but mREITs, the ETN ratchets the leverage up another notch.
The end result? An investment providing 16 times leverage to mortgage securities, according to John Aziz of
There’s no way to rationalize that much leverage as being prudent. It’s downright stupid.
But wait, the stupidity doesn’t end there…
Blame it on the Fed (Two Times)
While the Federal Reserve believes its QE-infinity program is necessary to avert another recession, it’s setting up two major risks for investors in mREITs.
First, by buying $40 billion per month in mortgage-backed securities (MBS), the Fed is acting as a buyer of last resort in the market. That’s creating a false sense of security, encouraging purchases of riskier and riskier mortgages by mREITs, since the Fed’s going to buy them all up.
But when the Fed stops, which it will eventually, the bottom’s going to fall out on prices to reflect actual risks. The problem? Nobody can predict exactly when the Fed’s going to end its MBS purchases.
So instead of a normal old crapshoot investment, this is a crapshoot with 16 times leverage. Even for our speculative capital, that’s a stupid bet.
The second consequence of the Fed’s QE program is that it’s encouraging more and more refinancing. It’s the natural offshoot of keeping mortgage rates artificially low. It’s not going to stop, either. People are going to keep capitalizing on the opportunity to reduce their mortgage payments.
The problem for mREITs, though, is that refinancing results in prepayments on their high yield mortgage investments. In a meaningful way, too.
Prepayment rates for mREITs currently range anywhere from 12% to 25% of the entire portfolio. They’re likely headed higher, too.
That means mREITs will be forced to reinvest the proceeds from the prepayment in lower-yielding investments.
Or put simply, the Fed’s policies promise to squeeze the spreads earned by mREITs. Even more than they’re already being squeezed.
You see, mREITs have been cutting their distributions ever since the end of 2009. That includes some of the biggest weightings in the ETRACS Monthly Pay 2xLeveraged Mortgage REIT ETN – like Annaly Capital Management (NYSE: NLY), American Capital Agency Corp. (Nasdaq: AGNC) and Hatteras Financial Corp. (NYSE: HTS).

Bottom Line: Thanks to the obscene amounts of leverage, the ETRACS Monthly Pay 2xLeveraged Mortgage REIT ETN is the runaway winner of the Stupid Income Investment of the Week trophy.
What’s more, given the market fundamentals for mREITs, it’s next to impossible that it’s actually going to deliver its stated 24.82% yield. And even UBS knows it.
As Paul Somma, Executive Director and Senior ETRACS Structurer, said in the product announcement news release, “MORL offers high monthly income potential.”
Potential? That’s not exactly reassuring.
Forget caveat emptor. Avoid MORL like the plague.
Safe investing,
Louis Basenese
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