Popular REIT ETN Closes Creations

UBS has closed the most popular REIT exchange-traded note (ETN) to new creations, a rare—but not unheard of—event that will likely result in the emergence of high trading premiums within the note.

Effective Thursday, Sept. 6, UBS issued a "sales halt" for its ETRACS Monthly Pay 2x Leveraged Mortgage REIT ETN (MORL), effectively suspending further sales from its outstanding inventory of the note until further notice.

MORL continues to trade on its listing exchange, NYSE Arca, however.

A similar situation occurred in February 2012, when Credit Suisse halted creations for the VelocityShares Daily 2X VIX Short-Term ETN (TVIX); as well as in July 2009, when US Commodity Funds halted creations for the United States Natural Gas Fund LP (UNG). In both cases, a significant trading premium developed in the shares.

No More MORL Made Available

MORL is the largest ETN and sixth-largest exchange-traded product in the REIT segment, with $500 million in assets under management.

It is also a complex, niche product. MORL is designed to deliver twice the daily returns of the MVIS U.S. Mortgage REITs Price Return Index, a benchmark of mortgage REIT companies in the U.S.

Unlike ETFs, ETNs are generally "created to inventory" by their issuing bank—in MORL's case, UBS. Shares of the ETN are then resold by that bank on the secondary market.

In late 2015, UBS had announced that it didn't intend to issue any new notes of MORL. This latest announcement, then, means UBS doesn't even intend to sell the previously issued, but as of yet unsold, slices of MORL still in its inventory—or any inventory that investors may sell back to UBS in the future.

What's out on the secondary market remains available to trade, but effectively, no more new shares of MORL will be made or even made available to sell.

‘Breaking The Premise Of ETPs’

That's no small thing, says Dave Nadig, managing director of ETF.com, because whenever supply becomes limited in an exchange-traded product, it tends to result in that product trading at a premium to its NAV.

"Closing for creations effectively breaks the entire premise of exchange-traded products," he added.

In 2012, Credit Suisse halted creations for TVIX, after the note took in almost $200 million in new assets in two weeks—or almost 40% of the ETN's total assets under management. The new flows had exceeded the bank's "internal limits," meaning Credit Suisse was either unable or unwilling to purchase the necessary positions to hedge. As a result of the creation halt, massive premiums to NAV resulted in TVIX (read: "Creations Of VelocityShares' TVIX Halted").

Something similar took place three years earlier in UNG, which took in billions of dollars of new investment money over a span of just three months. UNG, which is a commodity pool and therefore must register a fixed number of shares with the SEC, saw its number of shares available for creations effectively exhausted.

While US Commodity Funds waited for the SEC to approve the issuance of more shares, UNG was closed to creations, and significant trading premiums to NAV emerged (read: "With Creations Closed, UNG Trades To A Premium").

More Modest Inflows To MORL

One big difference exists between MORL and TVIX or UNG, however: MORL has seen a far more modest pace of inflows in recent months. Since May, MORL has taken in $54 million in new net money, or roughly 10% of its current total assets under management—nothing like the hundreds of millions or even billions of dollars swamping TVIX and UNG before they closed.

That means that, while trading premiums are likely to emerge in MORL, those premiums may not be of the same magnitude as those that arose in TVIX or UNG, simply because proportionally, the demand for MORL shares isn't quite as high.

Closing MORL to creations doesn't affect the other ETNs in the same series, including the ETRACS Monthly Pay 2XLeveraged Mortgage REIT ETN Series B (MRRL) or the ETRACS Monthly Pay 2xLeveraged MSCI US REIT Index ETN (LRET).  

Contact Lara Crigger at [email protected]