A Contrarian Bet on a Mortgage REIT with a 15.6% Yield

Nicholas Vardy

Nicholas Vardy has a unique background that has proven his knack for making money in different markets around the world.

This week’s Dividend Pro recommendation, Apollo Residential Mortgage Inc. (AMTG), is a contrarian bet on yet another high-yielding mortgage real estate investment trust (REIT).

Similar to your other mortgage REIT holdings like Two Harbors Investment Corp. (TWO) and Annaly Capital Management (NLY), AMTG invests in, finances and manages residential mortgage loans, and other residential mortgage assets in the United States.

As you know, the Fed recently expanded its efforts to flatten the yield curve and make long-term borrowing cheaper through “Operation Twist” and quantitative-easing part III (QE3). This Fed policy hit mortgage REIT interest rate spreads hard and also increased prepayment risk, sending the shares of mortgage REITs tumbling.

I’ve already written in a previous issue of Dividend Pro why I think mortgage REITs remain a compelling investment in spite of the Fed’s actions.

Sure enough, most REITs have rebounded strongly since then.

Beyond the general investment case for mortgage REITs, I think AMTG’s unique blend of low pre-payment risk, a remarkably high interest rate spread, solid growth in profitability and attractive valuation just might make it the best of the mortgage REIT bunch.

Here’s why…

First, with the Fed pushing down interest rates, it’s true that pre-payment risk has grown for mortgage REITS. Yet, that risk is much less for AMTG than for rival REITs. The CPR (Constant Prepayment Rate) of AMTG’s Agency RMBS (Real Estate Mortgage Backed Securities) was an incredibly low 5.2% for Q3 2012. It was an even lower 3.4% for the non-Agency RMBS. This compares to a 20% CPR for Annaly Capital Management (NLY) and 9% for American Capital Agency (AGNC).

Second, AMTG targets a 60% Agency, 30% non-Agency, and a 10% cash equity allocation. That’s why AMTG has been able to achieve the remarkable blended interest rate spread of 2.8%. That compares with a spread of 1.5% achieved by most other REITs. AMTG is simply in a better position to make money. And clearly, AMTG manages its portfolio mix of assets very well.

Finally, AMTG is one of the very few mortgage REITs that has announced an increase in its quarterly dividends — from $0.75/share to $0.85/share in Q3 — even as rivals have cut dividends. AMTG’s book value also saw a huge 9.2% increase from $19.65/share to $21.46/share during the same quarter.

After the recent sharp sell-off, AMTG offers terrific value, trading at a 24% discount to its book value. AMTG now is one of the cheapest REITs around. A 15.6% yield also makes it one of the highest-yielding REITs among its peer group.

So buy Apollo Residential Mortgage Inc. (AMTG) at market today, and place your stop at $17.90. If you want more bang for your buck — and are willing to take on some additional risk — buy the February $22.50 calls (AMTG130216C00022500).

Portfolio Update

Global X SuperDividend ETF (SDIV) rose 0.74% last week. SDIV paid out a dividend of 13 cents on Dec. 3. Trading back above its 50-day moving average (MA), SDIV is now a BUY.

Two Harbors Investment Corp. (TWO) jumped 3.11% this past week, as mortgage REITs continue to recover. TWO has been rising on unusually high trading volume. TWO is now back to a BUY.

PIMCO Municipal Income Fund II (PML) ended the week flat. PML declared a monthly dividend of 6.5 cents per share. Look for your monthly payout on or around Dec. 8. PML remains a BUY.

Apollo Investment (AINV) fell 0.25%. Apollo currently offers investors an annual dividend of $0.80 per share for a yield of approximately 9.9%. Shares of Apollo have gained over 25% year-to-date. Trading above its 50-day moving average, AINV is a BUY.

Omega Healthcare Investors Inc.(OHI) rose 1.32%. Healthcare REITs’ are known for their defensive fundamentals and non-cyclical nature. After all, healthcare spending patterns generally don’t depend on the state of the economy. Back above its 50-day moving average, OHI is now a BUY.

PowerShares Preferred (PGX) fell 0.34%. PGX pays a monthly dividend and yields 6.36% with very low volatility. PGX will pay out its monthly dividend in the middle of December. This monthly income payer is a HOLD.

Fifth Street Finance Corp. (FSC) fell back 2.34%. Fifth Street will issue 14 million shares of its common stock, priced at $10.68 per share, raising approximately $149.5 million. The company intends to use proceeds from the stock offering to pay down existing debt. The company has confirmed this monthly dividend of 9.6 cents through the end of February 28, 2013. FSC remains a HOLD.

CVR Partners, LP (UAN) dropped 2.81% this past week. CVR’s focus on growth will increase both the share price and future distribution payouts. According to some analysts, shareholders could enjoy an increase of $0.50 (27%) to the 2013 distribution as a result of the company’s expanded capacity. Still trading below its 50-day moving average, UAN is a HOLD.

Rentech Nitrogen Partners, L.P. (RNF) dropped 2.83%, after hitting close to an all-time high earlier in the week. Yielding 8.60%, this fertilizer play remains a BUY.

Annaly Capital Management (NLY) dropped 1.91%. Annaly President Kevin Keyes recently purchased 100,000 shares of Annaly at $13.90 per share. Insider buying is always a good sign for the prospects of a stock. NLY remains a HOLD.

Peritus High Yield ETF (HYLD) rose 0.71%. On Nov. 26, HLYD announced a 32.4 cent distribution per share. Still below its 50-day moving average, HYLD is a HOLD.

Northern Tier Energy Trust LP (NTI) rose 3.33% as U.S. regional oil refiners continue to soar. The company’s first distribution came in at $1.48/unit, far above original projections of $1.01. So there is certainly significant upside in its current payout projections. NTI remains a BUY.

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