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Apollo Residential Mortgage (NYSE:AMTG) has announced its fourth quarter dividend payment which includes both a dividend reduction and a bonus dividend payment. The announcement paints an interesting picture of what is going on in the mortgage REIT sector.

Apollo Residential Mortgage is a hybrid mREIT, investing in both agency and non-agency MBS. The company went public in July 2011, so it has just four full quarters of operations under its belt. For the third quarter a dividend of 85 cents per share was paid, a significant increase from the 75 cents paid for the previous two quarters.

The Apollo Residential Mortgage third quarter results included net income of $2.91 per share. The income breakdown was $22 million of net interest income and $52 million of other income. The other income was realized and unrealized gains on the MBS portfolio offset by losses on derivative instruments. The company reported operating earnings for the quarter of 67 cents per share, significantly less than the dividend paid.

Fourth Quarter Dividends

For the 2012 fourth quarter, Apollo Residential declared a 70 cent per share regular dividend and a 35 cent per share special dividend. According to the press release, the special payout is to make sure the company meets the REIT distribution requirements. Realized gains during the year made the special dividend necessary.

According to the press release, the 70 cent dividend is more aligned with the company's earnings potential. It appears that management is attempting to set a dividend which will be sustainable based on net interest income and not from gains on the value of securities.

New Yield - New Outlook

The bottom line is that Apollo Residential Mortgage has reduced its dividend by about 18% to put the distribution in line with what the company expects to earn at least in the near future. A $2.80 annual rate - assuming it can be maintained - puts a 13.2% yield on the stock at the current $21.21 share price. Still an attractive yield, but may be a disappointment to those investors looking for another 85 cents. The special dividend will more than make up the difference for the current quarter.

I am impressed that the Apollo Residential Mortgage management bit the bullet and made a significant reduction in the quarterly dividend rate. The mortgage REITs have been using realized gains for the last several quarters to cover the payouts. Investors in other mREIT stocks should be looking for 15% to 20% dividend reductions in the upcoming corners. In the long run, paying lower, sustainable dividends will be better for the sector than trying to support unreasonably high dividends. The big gains in MBS values may be in the past and results going forward will be based on net interest earnings.

This chart shows how mREITs in general have been hit hard by the MBS market over the last 3 months as indicated by the Market Vectors Mortgage REIT Income ETF (NYSEARCA:MORT).

MORT Chart

MORT data by YCharts

Source: Apollo Residential Mortgage Muddies Up The mREIT Dividend Waters