CYS Investments, Inc (CYS) is among specialty finance companies that invest is residential mortgage pass through securities. Both interest payments and principal amounts are backed by government agencies such as Fannie Mae, Freddie Mac and Ginnie Mae. I am bullish on the company because wider spreads will manage to sustain dividends even after the sharp decline in book values due to rising interest rates. I also believe that the stock price is depressed, as the company is currently trading at a discount to its book value.
In the recent quarter, the company experienced a massive decline of -20.7% QoQ in its book value per share. As shown in the table below, the loss in book value is higher than that of its competitors. The primary reasons behind the loss in the book value are the rising interest rates and the shift in the portfolio mix of 30-year fixed MBS to 45% of the total portfolio. This has been a major concern for investors, as the stock price has experienced a drop of 32.8% YTD and is currently trading at a significant discount to its book value.
BV per share 1Q'13
BV per share 2Q'13
American Capital Agency (AGNC)
ARMOUR Residential (ARR)
Anworth Mortgage Asset (ANH)
Hatteras Financial (HTS)
Western Asset Mortgage Capital (WMC)
Source: Companies Data
However, I believe that the third quarter's results will paint an encouraging outlook for the company. Last week the Fed announced that it was not cutting $85 billion monthly asset purchases because the economy was not strong enough to afford the cut. William Dudley, the President of New York Fed and Vice-Chair of the rate-setting Federal Open Market committee, is reported to have said, "The economy has not picked up forward momentum and a 2 percent growth rate-not be sufficient even if sustained-might not be sufficient to generate further improvement in labor market conditions."
So, this will help reduce the interest rate pressure built in recent months.
Furthermore, the company has also managed to improve its net income margin because of the improved yield on assets, with the expansion of the 30-year fixed MBS to 45% in 2Q'13 from 18% in the first quarter of the year. Also, these 30-years MBS are attractive because their prices are depressed due to the recent hike in interest rates.
CYS has been historically trading at a slight premium to its books value, as shown in the figure below. It is currently trading at a P/BV ratio of 0.79x. My price target is $10.20 based on 1xBVPS, which means we can expect price appreciation of around 20.58%. Moreover, the company has initiated a share buyback program and has managed to buy around 2.5 million shares in the first half of the year, which shows that the management thinks that its shares are trading at cheap valuations.
CYS has been among the few mortgage REIT companies that have decided not to cut their dividends even though CYS experienced a largest decline in its book value per share. The company has maintained its quarterly dividends of $0.34 per share, which is payable on October 16, 2013. So, the company continues to offer a striking dividend yield of 17.10% and retains its attractiveness for income-seeking investors. Total earnings per share of $0.37 ($ 0.18 core earnings and $ 0.19 drop income) are sufficient to meet dividends of $0.34 per share.
Change in percent (QoQ)
Source: Company Data
The company's drop income is higher than that of its core earnings, which means the drop has been favorable for the company in the past. So, if the dollar does not remain special in the future, CYS' bottom line might take a big hit. The company has been funding its long term assets with a short-term repurchase agreement, so if there is any disruption in the repo market, CYS might have to sell its assets to generate liquidity. Interest rate risk is one of the major risks, as a rapid rise in interest rates will shrink the company's net asset value.
I believe the company continues to remain its attractiveness for income-seeking investors, as it has maintained its dividends. Also, it offers the highest dividend yield of 17.10% among its competitors. CYS also offers a significant opportunity of price appreciation of 20.5%, which means the company offers a promising total return of 37.10%.