I am bullish on Apollo Residential Mortgage (AMTG). The company's hybrid nature of MBS holdings, solid growth in profitability, low prepayment risk and attractive relative valuations are the reason why I am bullish on the stock. Therefore, I recommend investors to buy the stock to benefit from its 15.6% dividend yield.
As a consequence of the third round of easing by the Fed, the treasury yield curve flattened. The following graph shows how much the yield curve flattened since the announcement of QE3 by Fed.
Given the situation, where the Fed is committed to flatten the yield curve through its various efforts, I favor Apollo Residential Mortgage for the following reasons:
Apollo Residential Mortgage is a small cap residential mortgage REIT that invests in Agency and non-Agency mortgage backed securities. Managed externally by ARM Manager, Apollo has an asset portfolio of over $4.23 billion (fair value) at the end of the most recent quarter. Over $560 million of the MBS are non-Agency, while the rest are Agency mortgage backed securities. After looking at the macro economic situation, Apollo increased the holdings of non-agency MBS. The following charts compare the proportion of each type of security in the company's MBS portfolio over the past 9 months.
At the beginning of the year, non-Agency MBS were only 3% of the entire MBS holdings. During the year, Fed extended its Operation Twist and launched QE3. Both the programs were aimed at flattening the yield curve to make long term borrowing cheaper and to stimulate the US economy. This led Apollo to increase its holdings of non-Agency MBS. By the end of the third quarter of the current year, non-Agency MBS were 13% of the entire company's holdings. The following chart compares the yield curves at the beginning of the year with the current yield curve.
Interest income and Spread
Fed's programs aimed at stimulating the US economy led to the 76 basis points decline in net interest spreads for Apollo during the past 9 months. However, the net interest income over the same time period increased over two folds from $10.7 million to $22.15 million. Much of the improvement in the net interest income, despite a decline in the net interest spread, was a result of increase in the proportion of high yielding non-Agency MBS in the company's MBS portfolio.
Lower Prepayment Risk
Apollo happens to be one of the mortgage REITs that is exposed to the least amount of prepayment risk. The conditional prepayment rate (CPR) for its Agency securities is 5.2% at the end of the third quarter. The CPR of 3.4% for its non-Agency mortgage backed securities is even lower. This was a result of the large amount of HARP and low balance residential MBS in the company's MBS portfolio.
This is compared to a 20% CPR for Annaly Capital Management (NLY) and 9% for American Capital Agency (AGNC). American Capital Agency is considered to have the least prepayment risk among Agency mortgage REITs. View a detailed report on Annaly Capital Management .
Elevated Shareholder Distribution
Apollo remains one of the very few mortgage REITs that have announced an increase in their quarterly dividends. With a 13.3% sequential surge, the stock currently offers a dividend yield of 15.6%.
Trading at a 24% discount to its book value, the stock that has seen 46% year to date performance has attractive valuations compared to most of its peers in the hybrid mortgage REITs sector. American Mortgage Capital Investment (MTGE) trades at a moderate 1% premium to its book value.