Apollo Commercial Real Estate Finance - The Goldilocks Yield Play ...

Yield searching investors face some very tough risk versus reward scenarios in today's rising interest rate environment. The recent carnage in a multitude of yield plays, such as long-term investment grade corporate debt, preferred stock, junk bonds and REITs reveals that there are few safe harbors when expectations turn to rising interest rates. One of the biggest mistakes an investor can make in a low yield environment is to chase yield by purchasing a security with an extended maturity or in some cases, no maturity at all. Any rise in interest rates, especially from historically low levels, will magnify losses the longer the maturity of the investment. On the other hand, if you limit your investment horizon to about a 5 year maturity and look to the investment grade corporate bond market, you will only earn about 2.00% even after the recent spike in rates.

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So what traits should one look for in the current environment where interest rates will likely rise? Here is my Goldilocks hit list:

1. Attractive yield.
2. Average maturity of no greater than 5 years.
3. Diversified portfolio of borrowers.
4. Loans secured by collateral.
5. Professional management.

I can see Goldilocks looking over the universe of yield type investments available and saying, in her hard to satisfy way, ... "This rate is too low!", "This maturity is too loooong!", "This loan is not secured!", etc., etc. However, if she took a look at Apollo Commercial Real Estate Finance, Inc. (ARI), she might just find that comfy bed to rest in for the next year or so.

Here are how these relevant traits apply to ARI after a sharp decline to a recent price of about $15.90, following the Dow's 200 point drop on Ben Bernanke's press conference.

1. Dividend Yield - 10.06%
2. Weighted Average Portfolio Duration - only 3 years
3. Collateral - Commercial Real Estate Loans Diversified by Property Type and Geography (but, of course concentrated in commercial real estate).
4. Loan-To-Value of Debt Portfolio (excluding leveraged CMBS portfolio) - 53.6%
5. Experienced management team: Apollo Management

In comparison to all the other available choices, this sounds like a pretty good alternative, in my opinion. I have looked at this company pretty closely and have recently picked up some shares as it has been hit hard along with all of the other high yielding investments. The fact that the average duration of the portfolio is only 3 years and that loans are secured by hard assets makes this an attractive asset to consider. A short duration means that the underlying portfolio can't get hit too hard by a rise in long-term interest rates as the portfolio is rolling over in a relatively short time frame and reinvested at the higher rates. Interestingly, given its recent secondary in March where it raised $148.5 million, the rise in interest rates is somewhat fortuitous as ARI reinvests this new money at higher rates.

However, before considering ARI, there are a few caveats that should be understood:

• With any REIT or closed end fund, the stock price can trade away from the underlying value of the portfolio for extended periods of time. The last reported fair value per common share was $16.71, so the current price is currently trading at a sizeable discount to fair value.
• In the last 5 quarters, ARI has issued $2.00 in dividends on only $1.89 in operating EPS. So let's not deceive ourselves, $0.11 is a return of stockholders' capital and a direct hit to NAV (but already priced in).
• The way I see it, the management team's self interests don't always coincide with shareholders. As an investor, my main concern is the dividend yield and the stock price. Management has an inherent incentive to grow the portfolio by issuing new shares. If they do so at or above the fair value per share, it is can be acceptable depending on investment opportunities for the cash raised. However, there is nothing stopping ARI from issuing shares, regardless of price, to grow the portfolio and its management fees. On the other hand, when the share price trades well below the NAV, management should be buying back shares if it is the most efficient use of shareholder capital, regardless of any reduction in management fees. Currently ARI does not have a share buyback program in place.
• Consider that this company IPO'd at $20 in 2009 after the financial meltdown. If you bought in at the IPO price, you haven't done so well. Not really relevant to today's investment merits but worth noting.
• The company uses leverage to boost yield. Nothing wrong with that if it is not excessive but it should be understood.

Even after considering all the caveats, the risk reward profile of ARI is as close to Goldilocks as you can get in today's environment. One extra bonus; purchasers of ARI before June 26 earn a $0.40 dividend as the stock goes ex-dividend that day. Investors can find more information about the portfolio at the company's website.

Disclosure: I am long ARI. 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. (More...)

Additional disclosure: These are the personal views of Wall Street Titan and should not be relied upon for your investment decisions. All Investors should always do their own due diligence.

Source: http://seekingalpha.com/article/1514242-apollo-commercial-real-estate-finance-the-goldilocks-yield-play-for-today-s-environment?source=feed

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