Disclosure: The author is long MORL, AGNC, CYS, RAS, ARR. (More...)
I am still constructive on MORL and the mREIT sector based on my outlook for interest rates.
The significant discount to book value that many mREITs are trading at further supports a constructive view on the sector.
The projected May 2015 monthly dividend for MORL will bring the annualized compounded yield to 23.3%.
As of April 23, 2015, all of the 24 mREITs that comprise the UBS ETRACS Monthly Pay 2x Leveraged Mortgage REIT ETN (NYSEARCA:MORL) and the Market Vectors Mortgage REIT Income ETF (NYSEARCA:MORT) have indicated whether or not their dividends will have ex-dividend dates in April 2015. Five of the components have declared dividends with ex-dates in April 2015, and thus, will be included in the calculation of the May 2015 MORL dividend.
"PennyMac Mortgage Investment Trust (NYSE:PMT) has not yet declared a dividend for the current quarter. I am assuming it will declare the same $0.61 dividend it has paid in the previous two quarters and have an ex-date in March 2015, as its last quarterly dividend had an ex-date of December 26, 2014. I have used this data to project that the MORL April 2015 dividend will be $0.9665."
As it turned out, PMT declared a dividend after I wrote the above-mentioned article with an ex-date in April 2015. This resulted in the actual MORL April 2015 dividend being less than my forecast. It also means that the May 2015 MORL "small month" dividend will be one of the highest "small month" dividend MORL has ever paid. My calculation indicates that the May 2015 MORL will be $0.1305. Only the "small month" dividends of $0.1316 paid in December 2014 and the $0.1643 paid in November 2013 would be higher.
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. The table below shows the weight, price, ex-date, pay date, dividend, the imputed value, the imputed number of shares, and the imputed gross dividends for each of the 24 MORL components. Many readers have asked to see exactly how the projected dividend is computed.
The calculation of the May 2015 MORL dividend begins with a computation of the total assets of the portfolio. This is done by multiplying the net asset value of MORL on April 23, 2015, of $20.347 by the shares outstanding of 16,150,000 and multiplying that product $328,604,050 by 2 to account for the 2x leverage. This results in an asset total of $657,208,100. The value of each of the holding is computed by multiplying the weight of the component by the net asset total of $642,669,720. For the largest MORL component, Annaly Capital Management, Inc. (NYSE:NLY) with a weight of 16.97%, this results in a value of $111,528,215. Dividing the value of $111,528,215 by the $10.26 share price of NLY results in an imputed share count of 10,870,196. Multiplying the imputed share count of 10,870,196 by the dividend of $0.30 gives an imputed gross dividend of $3,261,059.
The imputed dividends of the 5 components with ex-dates in April 2015 are added up to give a total of $2,108,344. This is divided by the number of shares, 16.5 million, to give a projected dividend for the month of May 2015 of $0.1305. The 5 components used are the previously mentioned PMT, American Capital Agency Corp. (NASDAQ:AGNC), ARMOUR Residential REIT, Inc. (NYSE:ARR), RAIT Financial Trust (NYSE:RAS) and Dynex Capital, Inc. (NYSE:DX).
The results of investing in leveraged ETNs, whose index portfolios are in turn comprised of securities that in turn borrow money to acquire income- generating assets, will depend, to a large extent, on how long short-term interest rates stay low. As I indicated in MORL August Dividend Precisely My Prediction - mREITs Will Benefit From Attitude Shifts, my view was that the Federal Reserve would be very hesitant to raise rates if there is any question as to whether the economy is at full employment or that inflation is at least close to the 2% target. That is still my view.
Janet Yellen has said that even though the Federal Reserve has removed the world "patient" from its communication, it does not mean that it will be impatient in terms of when it raises interest rates. More important is that the Federal Reserve has lowered its view of where unemployment is low enough to reignite inflation from 5.5% to 5.2%. A few years ago, I became convinced that short-term rates were likely to remain low for an extended period (see my article: Federal Reserve Actually Propping Up Interest Rates: What This Means For mREITs), and I concluded that agency inverse floaters would be the ideal investment vehicle to take advantage of that scenario. I was told by dealers in agency securities that there were very few agency inverse floaters around anymore and that you would not want the ones that were there. I wanted an investment with negligible credit risk and no margin call risk that would profit from an extended environment of very low short-term interest rates.
As agency inverse floaters and swaps paying floating and receiving fixed were not available to me as a retail investor, I concluded that mREITs, and later MORL, were the next best thing to profit from a continuation of the carry generated by very low short-term rates. This was explained in: Are mREITs The New Inverse Floaters?
While MORL is not as pure a play on the continuation of low short-term rates as inverse floaters or swaps paying floating and receiving fixed, barring exceptionally bad decisions by the management of the mREITs, it is hard to envision any scenario where short-term rates remain low for an extended period, and MORL does not have a positive total return. If one reinvests the monthly dividends of an ETN yielding about 24%, as MORL is now, they will double their money in three years.
The longer that short-term rates remain low, the greater the likelihood that MORL will provide substantial positive returns. Clearly, the Federal Reserve and Janet Yellen will mostly be basing their decision making on economic data. However, there will be a significant behavioral science aspect involved as well. While there are 12 voting members on the Federal Reserve Open Market Committee, previous experience suggests that the view of the Chair of the Board of Governors is by far the most important. There have been dissents in votes on the Federal Reserve Open Market Committee. However, the votes have never gone against the wishes of the chair.
Separate from any forecast of the economic variables, I think there are some reasons why I believe that Janet Yellen will be reluctant to raise short-term rates. Were the Federal Reserve to raise rates, Janet Yellen would be asked in her periodic testimony to Congress something similar to the following question: Is it true that the purpose of the Federal Reserve raising interest rates was to reduce the number of people in the USA with jobs and in that way suppress the growth in wages?
Only if a raging wage-price spiral was in full force would she be totally comfortable answering that question. I think Janet Yellen's greatest fear is being responsible for another 1937. Most agree that the premature Federal Reserve tightening in 1937 worsened the depression. A more speculative theory related to the fear of another 1937 could be related to the fact that Janet Yellen is the first female chair of the Board of Governors. In one of her possible nightmares, not only is she blamed for the economy tanking as a result of her raising short-term rates, but people unfairly using that as an argument against electing Hillary Clinton as the first female president.
I still think that low interest rates will remain longer than the market, as indicated by futures prices, believes. As most mREITs are trading at substantial discounts to book value, my net take is that the return on mREITs may be higher over the next few years than many expect, as the dividends remain stable while prices of mREITs could actually rise. This could occur as the double-digit yields become irresistible to more investors. CYS Investments (NYSE:CYS) is a component of MORL and an example of a well-run mREIT, paying a steady $0.30 quarterly dividend priced at $9.10, yielding 13.2%. Even with no growth in the dividend rate, I could see an improvement in the price, which would still result in a generous double-digit yield. Leveraged mREIT instruments, such as MORL, would do even better in such an environment.
My constructive view of the mREIT sector is also based on the significant discounts to book value that many of the mREITs are trading at. NLY is at a 20% discount and AGNC is at a 15% discount. One problem with using the price/book ratios is that the book values for mREITs are only released periodically, and thus, are not always current. CYS just reported a book value per share of $10.53. With a price of $9.10, CYS is trading at a 13.6% discount to book value. Since MORL began trading, the best buying opportunities have been when the mREITs were trading at the largest discounts to book value.
For the three months ending May 2015, the total projected dividends are $1.0764. The annualized dividends would be $4.3056. This is a 21.1% simple annualized yield with MORL priced at $20.39. On a monthly compounded basis, the effective annualized yield is 23.2%.
If someone thought that over the next five years interest rates would remain relatively stable, and thus, MORL would continue to yield 23.3% on a compounded basis, the return on a strategy of reinvesting all dividends would be enormous. An investment of $100,000 would be worth $284,804 in five years. More interestingly, for those investing for future income, the income from the initial $100,000 would increase from the $23,300 initial annual rate to $66,359 annually.