14.32% Dividend Payer Apollo Residential Mortgage Is Performing Well

| About: Apollo Residential (AMTG)

Apollo Residential Mortgage Inc. (NYSE:AMTG) is a REIT that invests in, finances, and manages Agency and non-Agency residential mortgage backed securities, residential mortgage loans, and other residential mortgage assets in the US. The company is externally managed by ARM Manager LLC a subsidiary of Apollo Global Management LLC (NYSE:APO). AMTG IPO'd July 27, 2011, so it does not have a long history yet.

This industry is being supported by the Fed. The Fed has kept interest rates low and steady. This makes homes more affordable, and it lessens foreclosures. This is an excellent environment for AMTG. AMTG has a $3.01B portfolio of RMBS. This consists of $2.64B (average cost basis of 106%) in Agency RMBS and $368 million (average cost basis of 65%) in non-Agency RMBS. This portfolio has allowed the company to achieve a 2.7% blended net interest spread and a 5.5x leverage as of June 30, 2012. It is allowing the company to pay a hefty 14.32% dividend. AMTG is a small company with a market cap of just $506.90 million. However, it has strong sponsorship from the bigger Apollo Global Management , which has $105B in assets under management and a market cap of $1.81B.

AMTG aims for a portfolio split of 60% Agency RMBS, 30% non-Agency RMBS, and 10% cash. At the end of Q2 its actual allocation was 58% Agency RMBS, 23% non-Agency RMBS, and 19% cash. The two charts below show the break out of the Q2 2012 Agency and non-Agency portfolios.

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The Agency portfolio focuses on securities likely to have low prepayment rates, especially low loan balances and those that have already used HARP. The Non-Agency portfolio focuses on seasoned, sub-prime assets with credit enhancement. In Q2 a portion of the non-Agency portfolio was rotated into both Alt-A and pay-option adjustable mortgages.

The table below shows the net interest spreads and the leverages applied for AMTG's portfolios.

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The leverage ratio of the blended portfolios was 5.5x in Q2. This is lower than most of AMTG's competitors. AMTG has mitigated the added risk of the non-Agency RMBS by using lower leverage in this portfolio. AMTG also uses 5 and 10 year interest rate swaps to mitigate the interest rate risk with the Agency RMBS borrowings. These interest rate swaps had a notional amount of $995 million as of June 30, 2012. Most of these are currently in the 3-5 years until expiration range. AMTG also uses Agency IO's to mitigate some of its interest rate risk on Agency RMBS. The Agency IO's pay only the interest on the mortgage payments. As market interest rates increase, prepayments on mortgages underlying an Agency IO will decrease. This in turn will increase the cash flow and the value of the securities. The opposite is also true. The IO's are a second effective hedge against the effects of higher interest rates on AMTG's Agency RMBS.

The company has recently gotten larger. On April 20, 2012 it completed a follow on public offering. It issued 13,900,000 shares for net proceeds of $249,719,000 after expenses. Using these funds AMTG increased the value of its portfolios from $1,336,536,000 on March 31, 2012 to $3,009,971,000 on June 30, 2012. This money was not invested all at once. Instead it was invested over the quarter. Hence the earnings seen in Q2 are expected to get better in Q3 and beyond. During Q2 AMTG purchased some non-Agency RMBS at an average of 62.7% of par value. ATMG believes these represent an attractive investment opportunity, especially with the US real estate market bottoming. The US real estate market is even showing signs of a rebound.

The Fed has extended Operation Twist through December 2012. It has advised that it will keep rates low through 2014; and many are expecting it to announce a new round of QE in the near future (perhaps Thursday September 13, 2012). This may include a further extension of the time for which the Fed will keep interest rates low. The low interest rate, relatively steady real estate price environment is a nearly ideal one for mortgage REITs. It should mean that they will be able to continue to make good money at least into 2014.

AMTG did miss on adjusted earnings in Q2 2012 by -$0.02 per share. However, it far outperformed on net income. During the quarter as the interest rates tightened, it sold about $612 million of mostly high coupon securities for realized gains for $11.5 million or $0.55 per share. The company then reinvested the proceeds in lower coupon Agency RMBS and non-Agency RMBS. This management team has not been asleep. AMTG may have missed with adjusted earnings of $0.66 per share, but it far outperformed with GAAP net income per share of $1.24. There were other smaller items aside from the RMBS sales. The charts below of the dividend per share and the book value per share make on think this is a company with good potential. Virtually any investor has to be happy with the 14.32% dividend.

The IPO to date chart of AMTG provides some technical direction for this trade.

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The slow stochastic sub chart shows that AMTG is overbought. The main chart shows that AMTG is in a strong uptrend. With the book value per share at $19.65 as of June 30, 2012, the stock (priced at $21.01 as of the close on Monday September 11, 2012) is unlikely to continue to go up as quickly. I note that most mortgage REIT's are priced by the market at slightly above their book values.

It does seem likely that AMTG will be able to hold its value well; and it does pay a 14.32% dividend. No one knows exactly where this still young stock will go, but it does seem worth at least a small investment. CAPS has given it a five star rating, and Zacks has given it a #1 rating. The management team is highly experienced, and AMTG has gotten off to a great start. It trades at a P/E of 20.16 and an FPE of 7.32. It's small, but it looks like the real deal. If you think you will be happy with just the dividend for the near term, it is a buy now. With the overall market perhaps set for a significant retracement, averaging in may be the best strategy.

If you liked the characteristics of AMTG above, you might also be interested in other good dividend payers in the mortgage REIT area such as: American Capital Agency Corp. (NASDAQ:AGNC), Annaly Capital Management Inc. (NYSE:NLY), American Capital Mortgage Investments (NASDAQ:MTGE), and Two Harbors Investment Corp. (NYSE:TWO).

Note: Some of the fundamental data above is from Yahoo Finance.

Good Luck Trading.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in AMTG over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.