I don’t envy managers of mortgage real estate investment trusts (REITs), like the company I’m analyzing in today’s Safety Net. It’s tough to generate big profits these days. And that means problems when it comes to mortgage REITs’ dividends.

Mortgage REITs make money by borrowing cash in the short term at lower interest rates and lending it out longer-term at higher rates. The difference, minus expenses, is called net interest income and is how we measure a mortgage REIT’s financial performance.

When the difference (the spread) between short- and long-term rates is large, mortgage REITs make more money. When it tightens, they make less. And over the past decade, the spread has been getting smaller.

The chart below shows the difference between the yields of the 10-year Treasury and 2-year Treasury. In 2020 and 2021, the spread started to widen, which is positive for mortgage REITs, though it was still quite low by historical standards.

Unfortunately for mortgage REITs and their investors, the spread is declining again.

In this environment, it’s not surprising that Apollo Commercial Real Estate Finance (NYSE: ARI) has cut its dividend twice in the past year and a half. It currently pays a $0.35 per share quarterly dividend, down from $0.40 in March of last year and $0.46 in 2019. The current dividend yield is 8.9%.

Apollo Commercial Real Estate Finance invests in commercial real estate mortgages in the U.S. and Europe.

In 2020, net interest income was $278.7 million, down considerably from the $334.5 million the previous year.

The company paid out $251.3 million in dividends, so the dividend was covered. This year, net interest income is forecast to dip again to $276.5 million.

SafetyNet Pro does not like to see that. The model penalizes companies whose cash flow or net interest income are declining.

Combine two years of falling net interest income with two dividend cuts in 18 months, and you get a low dividend safety rating, suggesting another cut is coming in the next year or so. And if the spread continues to decline, the company is even more likely to have to reduce the payout.

Dividend Safety Rating: F