狗仔卡
发表于 2015-8-9 08:18 AM
Summary
- MORL and the mREITs that comprise the index upon which MORL is based have declined sharply.
- These declines have been due to a "perfect storm" situation involving expectations of higher interest rates, hedges not working effectively and the unusual circumstance of lower prices and prepayment speeds.
- My projected August 2015 monthly dividend brings MORL's yield to 29.4% on a annualized compounded basis.
Dr. Paul Krugman, the Nobel Prize-winning economist, writes op-ed pieces for the New York Times. He is one of the most vociferous advocates for the view that the Federal Reserve should not raise interest rates in the near future. His argument is mainly that of nonsymmetrical risks. Krugman says that given the state of the worldwide economy, the risk of raising interest rates too late is simply a little more inflation that can easily be handled. However, if the Federal Reserve raises interest rates too soon, the risk is of triggering a recession or even a global economic collapse. The International Monetary Fund has also urged the Federal Reserve not to raise interest rates in the near future. I believe Krugman is right on this issue.
Dr. Krugman is usually quite blunt is his New York Times pieces. He uses terms like" idiocy" to describe the views of those who have been calling the Federal Reserve to raise interest rates. He often points out that for the last seven years those who are calling for the Federal Reserve to raise interest rates have been continually predicting higher inflation and interest rates as a consequence of the easy money policies and fiscal stimulus. Krugman correctly notes that those predictions of higher inflation and interest rates have been consistently wrong.
I occasionally submit comments to Krugman's New York Times op-ed pieces. Usually, my comments suggest that Krugman should pay greater attention to the extent that the shift in the tax burden from the rich to the middle class has impacted economic activity. My view is that shift in tax burden has significantly reduced economic performance. See: A Depression with Benefits: The Macro Case for mREITs.
My most recent comments on Krugman's New York Times op-ed pieces have begun with a slight attempt at humor, hoping that he at least made some good money from his accurate prediction that interest rates would remain low for a long period, when many were predicting the exact opposite. I assumed that anyone who correctly foresaw that short-term interest rates would remain at near-zero levels and that the ten-year treasury rates would remain below 3% could have made a fortune. There are many ways that a bet that the Federal reserve would not raise rates could have generated enormous returns over the last seven years. These include entering into swaps paying floating and receiving fixed, various interest rate futures, inverse floaters and carry trades. The carry trades would involve buying fixed-income securities such as bonds or mortgage-backed securities and using leverage to finance the fixed-income securities at very low interest rates. Buying treasury bonds or agency mortgage-backed securities on margin would not involve any credit risk, only interest rate risk.
Recently, it has occurred to me that Dr. Krugman may not have made much money from his accurate prediction that interest rates would remain low for a long period, not for lack of trying but possibly an inability to find suitable investment vehicles. Investors such as myself who have their investable funds in IRAs or similar retirement accounts cannot enter into swaps paying floating and receiving fixed, utilize interest rate futures or borrow money to finance securities on margin to take advantage of carry trades. Small investors are usually unable to borrow at rates close to the repo or fed funds rate that institutional investors can.
I have no idea as to whether Dr. Krugman ever attempted to profit from his accurate prediction that interest rates would remain low for a long period, when many were predicting the exact opposite. My only correspondence with him has been to request his permission to use some of his material in my college courses, which he graciously granted. I, however have attempted to profit from my similar view that interest rates would remain low for a long period. The results have been somewhat disappointing.
The obvious choice for an investor who believes that interest rates would remain low for a long period, but cannot or does not want to take the margin call risk associated with swaps paying floating and receiving fixed, interest rate futures or borrowing money to finance securities on margin, would be inverse floaters. Unfortunately, due to the media vilification and the persecution by regulatory agencies of financial institutions that invested in agency inverse floaters in the 1990s, I as a retail have been unable to buy any inverse floaters. See: Are mREITs The New Inverse Floaters?
After not being able to find any inverse floaters, I looked for the next best thing. An inverse floater is usually an instrument that takes a pool of fixed income securities and divides it into two tranches. For example, you could start with $10 million treasury bonds or mortgage-backed securities paying a 4% coupon. You would use those securities to issue $9 million floating rate securities that might pay LIBOR +1%. Then, the other $1 million would be an inverse floater that paid 31.0% - (9 x Libor). Thus, if LIBOR was .25% as it has been for the last few years, the floating rate note would pay 1.25% and the inverse floater would pay 28.75%. This would mean that the $400,000 annually paid by the $10,000,000 fixed income securities with the 4% coupon would be divided with $112,500 going to the floating rate security holders and the remaining $287,500 going to the inverse floater holders.
Typically, the rates would be adjusted monthly with LIBOR. Thus, the inverse floater holders are bearing the interest rate risk. The principal payments made by the $10,000,000 in bonds or mortgage backed securities are passed through to the holders. Thus, the holders of the inverse floater will absolutely receive their principle back at some point. However, they bear the risk that if LIBOR interest rates rise high enough, their coupon will be zero for some period. There never can be a margin call.
An institution or large investor who could borrow at LIBOR + 1.0% could emulate the return on the inverse floater by buying the same $10,000,000 in fixed income securities and financing $9,000,000 at LIBOR + 1.0%. Today, institutions including mREITs can finance such securities at about LIBOR making the income from such a carry trade even more lucrative. However, a major difference between owning an inverse floater and buying the same underlying security on margin is that if the value of the underlying securities falls below a certain point, you can have a margin call.
Mutual funds are not allowed to borrow more than 33% of their assets. A mutual fund that simply owned fixed-income securities and borrowed 33% would not be much of an improvement over just owning the fixed-income securities outright, after the mutual fund fees and expenses are considered. Ideally, I would have liked to find a mutual fund that owned a significant amount of inverse floaters. I still would.
One investment vehicle that is not limited as to its borrowing and leverage in an mREIT. The Securities and Exchange Commission is not too happy with what they consider a loophole and have at times made some noise about regulating the amount of borrowing and leverage in mREITs. However, that would involve taking on the powerful real estate lobby. So action by the Securities and Exchange Commission in regard to mREIT leverage is not likely any time soon.
On the surface, an mREIT that buys agency mortgage backed securities using leverage via repurchase agreements looks a lot like an inverse floater. Actually, using the above example of an agency mortgage-backed security with a 4.0% coupon using 9-1 leverage, since an mREIT can borrow at close to LIBOR rather than the LIBOR + 1% that was assumed in the inverse floater example, its yield would be even more. With LIBOR at .25%, the inverse floater would pay 28.75% while the agency mREIT would pay 37.75% less any non-interest mREIT expenses.
From an investor's viewpoint, the biggest drawback in terms of agency mREITs as opposed to inverse floaters is that with agency inverse floaters you will receive the full face value at some point, but not with mREITs. Agency mREITs must mark their borrowings to market and thus will receive a margin call if the value of the underlying agency mortgage-backed securities declines beyond a certain point. In an attempt to avoid the possibility of a margin call or even forced liquidation, the mREITs use various hedging strategies.
I would prefer an mREIT that employed no hedging but reduced risk with less leverage. An mREIT with only 4 to 1 leverage and no hedges would have paid double-digit dividends in each of the last seven years and not have lost any share price. It would have declined in value during the taper tantrum but would have fully recovered in price, and then some, by today.
Despite my apprehension over the fact that mREITs did not guarantee ultimate return of 100% of face value, as agency inverse floaters would, I started buying mREITs based on my view that interest rates would remain low for much longer than many market participants believed. Logically, if interest rates were to remain low, there should not be that much risk that agency mREITs would decline in value. When the UBS ETRACS Monthly Pay 2x Leveraged Mortgage REIT ETN (NYSEARCA:MORL) was created in October 2012, it looked like an even better way to bet on my view that interest rates would remain low.
MORL is structured as a note and thus circumvents the regulation that limits mutual fund leverage to only 33%. With very low borrowing costs, MORL would be paying almost twice as much in dividends than the weighted average of the mREITs that comprised the index upon which MORL is based. As long as the value in the mREITs did not decline significantly, the 2X leverage would not be a problem.
Unfortunately, mREITs and MORL have not delivered the returns that I would have expected given the accuracy of my interest rate forecast. MORL began trading at $25 on October 17, 2012. Since then, it has paid a total of $12.816 in dividends. Thus, the original $25 investment has returned a total of $28.816 or 14.8% with MORL now at $15.89. The $12.816 in dividends only modestly exceed the $9.11 in price decline over that period. That does not take into consideration any income that might have been earned by reinvesting the dividends nor any losses that could have been incurred if the dividends had been reinvested in additional shares of MORL. An investment in agency inverse floaters or a hypothetical simple mREIT that employed only 4 to 1 leverage but engaged in no hedges or trading since then, would have had almost as much income but no loss of value over that period.
There are valid reasons for mREITs to use hedges to reduce interest rate risk. However, lowering leverage and eliminating the hedges would have resulted in much better results. There are some reasons for using hedges such as swaps, swaptions, options and futures that may not be so legitimate. Those hedges generate significant income for the investment banks and brokerage firms that the mREITs obtain them from. Being a very good customer of those investment banks and brokerages has advantages in addition to getting free tickets to the Super Bowl and U.S. Open. Unlike no-load mutual funds that are sold direct to the public via advertising, mREITs must rely on investment banks and brokerage firms to raise capital by underwriting the public offerings of shares in the mREITs.
Another reason for the excessive use of hedges by some mREITs might have to do with creating complexity. The possibility that an activist might force share buybacks by threatening to take control over the mREIT via a tender offer or proxy fight is always on the minds of mREIT managers. This could be both a cause of and be caused by the large discounts to net asset value that many mREITs are trading at. One defense mREIT managers have against takeovers is complexity. Agency mortgages are fairly easy to value and/or liquidate. However, the various complex swaps and swaptions that mREITs use to hedge interest rate risk are another story. These complex derivatives could be difficult for a potential takeover activist to value and/or liquidate. Thus, complexity may dissuade potential takeover activists and could also be contributing to the large discounts themselves.
So far, hedges have been a negative for mREITs and thus MORL. They reduced returns on balance and have not significantly reduced volatility. Possibly, if interest rates had actually risen sharply, the hedges may have been beneficial. If the Federal Reserve does raise short-term rates, the hedges might prevent erosion in price and dividends relative to what would be the case without the hedges. In some respects the hedges are like insurance policies that create costs but might be necessary
As of July 25, 2015, all the 25 mREITs that comprise the index that MORL and the Market Vectors Mortgage REIT Income ETF (NYSEARCA:MORT) are based on, have indicated whether or not they will have ex-dividend dates in July 2015. As I explained in '30% Yielding MORL, MORT And The mREITs: A Real World Application And Test Of Modern Portfolio Theory', MORL pays widely varying dividends each month since most of the mREITs in the index pay dividends quarterly on various schedules. During any three-month period, usually all of the components would have paid their dividends. Thus, a three-month moving average is the most relevant indicator when computing an annualized yield for MORL.
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 August 2015 dividend will be a "small month" dividend as only five of the 25 mREITs will have ex-dates in July.
The monthly dividend for August 2015 is projected to be $0.1192 using the contribution by component method. In the table below, the name, ticker and weight of all of the 25 mREITs that comprise the index upon which MORL is based are shown. For those mREITs that have ex-dates in July 2015 and thus will contribute to the August 2015 dividend, the price, dividend, ex-dividend date and contribution to the dividend are also shown. All five of the mREITs with ex-dates in July 2015 also paid the exact same dividends in April 2015. The dividend for August 2015 is 7.2% lower than the $0.1285 dividend paid in May 2015. Since there was no change in the individual dividends the decline was due entirely to the decline in the indicative or net asset value of MORL from $19.5347 to the current $15.8766.
The contribution by component method involves multiplying the indicative or net asset value of MORL by the weight of each component with an ex-date during the month prior to the month in question, then multiplying that product by 2 to account for the 2X leverage. That product is then divided by the share price of the component. This is an imputed value for how many shares of the component each share of MORL represents. Multiplying the shares of the component per MORL share, times the dividend declared by the component gives the contribution by component for each component. Adding all of the contributions of all of the components with an ex-date in the month prior to the month for which the dividend is being computed gives a projection for the dividend.
The contribution by component method is somewhat less intuitive to follow than my previous methodology, but gives identical results. However, it does have the advantage of using less columns since no share counts, imputed shares or gross dividends need be displayed. Some readers have complained about not being able to see all columns in the table on smaller screens. To further reduce the number of columns and allow the entire table to be visible on smaller screens, I have eliminated the pay-dates and only display the ex-dates. Some readers with small screens have suggested this as well.
There are two issues that most influence the future performance of the mREITs and thus MORL. 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. The most succinct way that I can express my view on the outlook for interest rates is that the Federal Reserve has many reasons not to raise rates. The economy is now showing modest growth with tepid inflation. The reason why we now have the current modest growth rates and tepid inflation, as compared to negative growth and deflation, is primarily due to the policy of the Federal Reserve since 2008. Over the past few years, fiscal policy has had very little impact on the economy.
If anything, the reduction in Federal deficits and thus fiscal thrust has been a headwind to economic growth. The Federal Reserve is the reason why economic conditions are what they are now. It is somewhat of an "if it ain't broke, don't fix it" argument. The Federal Reserve should not raise interest rates as long as the current modest growth rates and tepid inflation situation exists. To raise rates just to bring back "normality "or to head off future inflation that may or may not actually occur, is an experiment with the economy that is not worth taking. Krugman is correct.
It has been said that the purpose of financial markets is to punish the majority opinion. Thus, mREITs are out of favor now, and have very high yields. My view is still that interest rates will stay lower for longer than many people think. In "Can mREITs Live Happily Ever After?" I suggested that there are various scenarios where highly leveraged mREITs could continue to deliver very high returns over an extended period, even if interest rates were to return to what many consider normal levels, highly leveraged mREITs could still do well.
It is not inconceivable that an increase in short-term rates by the Federal Reserve might have the opposite effect of what happened during the taper tantrum, when the fear that the Federal Reserve might taper the pace at which it was buying treasury bonds and agency securities caused a spike upward in long-term rates. If the markets were to perceive that the reason why long-term rates are low is due to a large number of investors and lenders who want to buy fixed income assets with little or no credit risk, relative to the number of qualified borrowers, an increase in short-term rates might not cause an increase in long-term rates.
If the effect on mREITs and MORL of an increase in short-term rates was that it did not cause an increase in long-term rates, or was even accompanied by an actual decrease in long-term rates, it would be interesting. Many point out that mREITs make their money from the spread between long and short rates. Thus, in the long run, higher short rates accompanied by lower long rates would erode the earnings ability of mREITs. However, as John Maynard Keynes replied when asked if in the long run using deficit spending to stimulate the economy during the depression would eventually have dire consequences, "in the long run we are all dead." In the 1970s, some said it's now the long run; Keynes is dead but we still have the deficits.
While, in the long run, higher short rates accompanied by lower long rates would erode the earnings ability of mREITs, it would take a considerable time for the lower long-term rates to significantly impact the interest income of mREITs, since the only money they generally have available to buy new securities is the principal payments they receive from the mortgage backed securities they own. The interest is paid out as dividends. Typically, mortgage-backed securities pay less than 1% of their principal balance each month.
Ironically, in the short run, higher short rates accompanied by lower long rates would boost the book value of mREITs. Lower long-term rates make the fixed-income assets owned by the mREITs more valuable. Additionally, higher short-term rates would typically increase the value of the swaps and swaption positions that the mREITs use to hedge.
It would almost be worth it to have Janet Yellen be completely honest when and if she announces an increase in short-term interest rates and say something to the effect "We are doing this because there are not enough people unemployed and those who are employed might be getting higher wages in the future. Higher interest rates will keep the number of unemployed from falling and prevent wages from rising." I doubt she would use those words.
An issue related to the market's view of the future direction of interest rates is the relatively large discount to net asset value that many mREITs are trading at now. It should be noted that MORL itself never can trade at a significant discount or premium to indicative or net asset value since it can be created and redeemed at indicative value in large blocks. The mREITs cannot be redeemed at net asset value. Thus, like many closed-end funds, the mREITs can trade at prices that are significant discounts (or at times premiums) to their net asset values.
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, even if you held the belief that interest rates were going up in the future. You would only value it based on the current prices of the portfolio. There is some argument to be made that mREITs and closed-end funds trade at discounts due to the fees they charge.
Discounts to net asset value can be reduced when an mREIT buys back its shares at a discount to net asset value, putting upward pressure on the market price of the shares. This also has the beneficial effect of automatically increasing the book or net asset value. Many mREITs have outside managers and are thus very reluctant to buy back shares since it reduces the management fee. Some mREITs have bought the shares of other mREITs at large discounts to net asset value. This has the effect of possibly increasing value without lowering the management fees, but does not automatically increase book or net asset value the way that buying back the mREITs' own shares does.
One catalyst for share buybacks is activist action. Javelin Mortgage Investment Corp. (NYSE:JMI) a small sister mREIT of ARMOUR Residential REIT Inc. (NYSE:ARR), that is not in MORL but is in the iShares Mortgage Real Estate Capped ETF (NYSEARCA:REM) a larger non-leveraged mREIT ETF, was forced by an activist who took a large position in JMI to buy back some shares that were trading at a large discount. This did boost the JMI market price but it later fell back.
Despite the underperformance of mREITs relative to what could have been obtained from inverse floaters or unhedged mREITs, I am still a buyer at these levels. To some extent, the recent sharp decline in mREITs could be considered as a "perfect storm." CYS Investments Inc. (NYSE:CYS) recently reported that they lost value both as price of their mortgage backed securities declined and lost money as the prepayment speeds on their premium mortgage backed securities increased. Normally, lower prices for mortgage backed securities are associated with lower prepayment speeds. There can be lags involved, so it is likely that there will be some catch-up, which benefits CYS and other mREITs that may have been affected similarly.
Recently, I saw presidential candidate Rick Santorum in a television interview saying that he would not reappoint Janet Yellen because he believes that the Federal Reserve has erred in "propping up" the economy, which has allowed the Federal government to avoid taking the measures that would restore the economy to full employment. He indicated that balancing the budget would bring full employment and if the Federal Reserve stopped propping up the economy with low interest rates, the Federal Government would thus be "forced" to balance the budget in order to restore economic growth. I would hope that Janet Yellen and the other members of the Federal Reserve open market committee, think long and hard and consider the thought process of those who are advocating raising rates as compared to those like Krugman who are urging caution.
The longer that short-term rates remain low, the greater the likelihood that MORL will provide substantial positive returns. I still think that low interest rates will remain longer than the market believes, as indicated by futures prices. 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 relatively stable while prices of mREITs could actually rise. This could occur as the double-digit yields become irresistible to more investors in such an environment.
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. 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 August 2015, the total projected dividends are $1.0341. The annualized dividends would be $4.1364. This is a 26.0% simple annualized yield with MORL priced at $15.89. On a monthly compounded basis, the effective annualized yield is 29.4%%.
Aside from the fact that with a yield close to 30%, even without reinvesting or compounding you get back your initial investment in about only 3 years and still almost have your original investment shares intact, if someone thought that over the next five years interest rates would remain relatively stable, and my calculations were correct and, thus, MORL would continue to yield 29.4% on a compounded basis, the return on a strategy of reinvesting all dividends would be enormous. An investment of $100,000 would be worth $362,428 in five years. More interestingly, for those investing for future income, the income from the initial $100,000 would increase from the $29,400 initial annual rate to $106,553 annually.
Holdings of MORL
Editor's Note: This article covers one or more stocks trading at less than $1 per share and/or with less than a $100 million market cap. Please be aware of the risks associated with these stocks.
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