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CYS Investments, Inc. (NYSE:CYS)

Q1 2014 Earnings Conference Call

April 22, 2014, 9:00 AM ET

Executives

Rick Cleary - Chief Operating Officer

Kevin Grant - Chairman, President and Chief Executive Officer

Frances Spark - Chief Financial Officer

Bill Shean - Managing Director

Analysts

Steve DeLaney - JMP Securities

Mark DeVries - Barclays

Ken Bruce - Bank of America Merrill Lynch

Dan Altscher - FBR

Aaron Saganovich - Evercore

Douglas Harter - Credit Suisse

Joel Houck - Wells Fargo

Jackie Earle - Compass Point

Merrill Ross - Wunderlich Securities

Michael Widner - KBW

Operator

Good morning and welcome to the CYS Investments Incorporated 2014 first quarter earnings conference call. During management's presentation, your line will be in a listen-only mode. At the conclusion of management's remarks, there will be a question-and-answer session. I will provide you with instructions to enter the Q&A queue after management's comments.

For opening remarks and introductions, I will now turn the call over to Rick Cleary, CYS Chief Operating Officer. Please go ahead, Mr. Cleary.

Rick Cleary

Thank you. Good morning and welcome to CYS 2014 first quarter earnings conference call. Today's call is being recorded and access to the recording of the call will be available on the company's website at www.cysinv.com beginning at 3 PM Eastern Time this afternoon.

Please be reminded that certain information presented and certain statements made during this morning's presentation with respect to future financial or business performance, strategies or expectations may constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements indicate or are based on management's beliefs, assumptions and expectations of the company's future performance taking into account information currently in the company's possession. Beliefs, assumptions and expectations are subject to change, risk and uncertainty as a result of possible events or factors, not all of which are known to management or within management's control. If management's underlying beliefs, assumptions and expectations prove incorrect or change, then the company's performance and its business, financial condition, liquidity and results of operation may vary materially from those expressed, anticipated or contemplated in any of their forward-looking statements. In any event, actual results may differ.

You are invited to refer to the forward-looking statement disclaimer contained in the company's Annual Report on Form 10-K and quarterly reports on Form 10-Q filed with the SEC, which provide a description of some of the factors that could have a material impact on the company's performance and could cause actual results to differ from those that may be expressed in forward-looking statements.

Also, please note that the content of this conference call contains time-sensitive information that is accurate only as of today, Tuesday, April 22, 2014. The company does not intend to and undertakes no duty to update the information to reflect future events or circumstances. To better understand our results, it'd be helpful to have available the press release that we issued last night. As in past releases, the earnings release includes information regarding non-GAAP financial measures including reconciliation of those measures to GAAP measures, which may be discussed on the call.

And now I'd like to turn the call over to our CEO, Kevin Grant.

Kevin Grant

Thank you, Rick. Good morning and welcome everybody to our 2014 first quarter earnings conference call. As usual, joining Rick and myself this morning are our CFO, Frances Spark, and Bill Shean from our investment team. We look forward to your questions.

The Agency mortgage securities rallied through the first quarter of 2014 and the 10 year U.S. Treasury seemed to find a stable equilibrium of around 275 basis points or 250 basis points above the Fed Funds target rate. This yield curve steepness is very consistent with the past 40 years or so of history. When the market senses a tightening by the Fed on the horizon even if it's 12 months or 18 months out, the 10 year Treasury often finds equilibrium at plus-250 basis points to plus-300 basis points level above the Fed Funds target rate.

The Agency mortgage market had an especially strong first quarter, following the rise in rates nearly a year ago now. Refi activity fell sharply. The very narrow credit box defined by the QM rules worked to greatly diminish mortgage origination. The drop in gross mortgage supply from these two factors coupled with the Fed appetite over the past several months has kept mortgage-backed securities prices quite firm.

The recovery in the bond market helped our book value per common share rise over the quarter and also provided us with an opportunity to adjust the risk profile of our assets. We reduced the interest rate risk of our assets by reducing leverage and reducing our holdings of 30-year fixed rate Agency mortgage securities. Looking forward however, with the Fed continuing to taper their asset purchases, we anticipate Agency mortgage securities prices to cheapen later in the year and we're preparing the company's balance sheet to take advantage of this scenario. Despite the lower leverage, we continue to expect our portfolio to generate attractive earnings, and we expect to see an opportunity later in the year to deploy more of our capital at higher yields. A far view of market volatility crystallizes later in the year. We expect to see a much better investing environment in Q3, Q4.

Last week, Chairwoman Yellen's comments indicated that the Fed is intent on continuing to bolster bank regulation, implement tougher standards on large banks and support money market mutual fund reform. This was the case with the recently approved US supplementary leverage ratio. At 5%, the US hurdle is higher than the 3% Basel III requirements. Yellen suggests higher required capital levels or higher required levels of liquid assets for those large global banks using wholesale funding. She also considers minimum required haircuts for securities financing transactions, that is repo. These policies will be further contractions to credit to consumers. So it's very hard to believe there will be much upward pressure on inflation.

We [ph] for these suggestions floated previously by other government officials and we've seen virtually no public debate about the contractionary implications. So it seems the first time homebuyer will continue to be pushed out of owning a home.

Also on the regulatory front, we continue to see activity around housing finance reform. The jobs and Crapo proposal seems to have infused some more momentum into the effort. However in the last week or so, it appears that perhaps the momentum is wading. The banking committee continues to bolster support for the bill before offering up more capable legislation, which had been expected to be offered on April 29th, but now we're sensing that there may be further delays. At the FHFA, Mel Watt is taking very studios and considered approach and has not made any public positions known yet. In the meantime, Fannie and Freddie continue to earn significant profits and those profits go to the Treasury. As the mid-term elections approach, progress on GSE reform seems to become more and more unlikely.

Now I'd like to turn it over to Frances to make a few comments on our revised financial statements.

Frances Spark

Thank you, Kevin. As we noted during our earnings call in February, effective January 1, the company discontinued the use of investment accounting in accordance with the requirements of FASB ASC 946. As a result, I wanted to highlight a few items for you to consider relative to the information provided in this earnings release until when you'll read our 10-Q, which we expect to have filed later today.

On our balance sheet, you'll see no real changes other than the stockholders' equity and used book value of current share now rather than the concept of net asset value. And since the company has presented all portfolio securities as available for sale and elected the fair value option, investment gains and losses flow through the income statement as before. There's no other comprehensive income with which you'll likely be familiar from some of the mortgage REIT.

The schedule in investment is no longer required. So in the 10-Q, these are at portfolio is now provided in the available for sale table in the footnotes and also in the MD&A under the section Financial Conditions.

On our statement of operations, there's a small change in the geography of a couple of line items. Interest expense now comprises both the interest expense on repo borrowing and the net interest expense in swaps and curves, whereas these amounts were previously showed separately from each other. Compensation and benefits and G&A fall together to expenses in the bottom half of the income statement. More specific information as to changes is provided in the significant accounting policies moved to, to the financial statements in the Q.

We'd also be making available additional courting information through a supplemental presentation, which will be available on the CYS website simultaneous with the filing of the 10-Q. That's all I want to note for now. And we'll be pleased to take any questions later in the call or offline once you see the 10-Q.

Kevin Grant

Thank you very much, Frances. Operator, at this point, we'd like to turn it over to questions. And everybody, it'll take a few moments to develop a queue.

Question-and-Answer Session

Operator

(Operator Instructions) And it seems like we have our first question from Steve DeLaney with JMP Securities.

Steve DeLaney - JMP Securities

Kevin, it's clear from the repositioning and deleveraging that you certainly want to be prepared for the eventuality of spread widening or MBS cheapening. Could you or Bill give us a sense just looking at where spreads are, I don't know whether you prefer to discuss this based on spreads or prices, either ways, but where we are today versus sort of historical levels of where MBS would trade against swaps or treasuries and how much widening or cheapening do you think might be reasonable to expect over the next six to 12 months?

Kevin Grant

I'll let Bill make a few comments on the kind of supply/demand situation. But from a longer-term perspective, I think I commented on this in the February call. The last time we had this gap in demand, meaning that the Fed is not a buyer, the GSEs are not a buyer and so forth was later '80s. And spreads were 100 basis points wider then. Now this is a different environment and (inaudible) mortgage securities back then were not good collateral at the Fed for repo. It was a different environment, but that environment suggests that spreads could be meaningfully wider.

Here in the short run, in the very near term, we've got a little bit of a mirage at play. And that is here in the short run, the supply situation has very much contracted, but the Fed is still taking out cash burn. So Bill has got some numbers and I might be able to picture on this.

Bill Shean

Steve, a year ago, this monthly supply numbers were running roughly in the 160 billion area. And last month, we were down to 60 billion. This month looks like it will be pretty similar. Halfway through the month, we're at about 35 billion. So the numbers are down over 50%. So as Kevin said that that is the little bit of mirage, because this is the first time ever that the Fed has been buying all the bonds and we know that that's coming to an end by a matter of September or October, sometime in that timeframe.

Kevin Grant

So the timing of all this, Steve, is the big question. And we just don't know when the market is going to start to price this in.

Steve DeLaney - JMP Securities

Understandable, but no one has a crystal ball and who knows we may get a taper at some point depending on the numbers the Fed has in front of them. And I guess a follow-up question, you added Treasury securities this quarter. It appeared to be based on the yield sort of in the five-year maturity range. It's one thing to take leverage down, right, on just the MBS, but sort of switching some of the capital allocation from Agency MBS to treasuries, can you just give us a little insight to your thought behind that move?

Kevin Grant

Sure. Well, treasuries are very interesting securities, because we use them for collateral, for swaps and all those sorts of things. So there is the natural need to have some treasuries. But treasuries are financing really, really cheaply. So this sounds very strange, but treasuries at times have been financing at negative 20, negative 30. So treasuries have this unique characteristic of being able to generate a pretty attractive net interest spread versus mortgages, and I think this just underscores the point that mortgages are probably a little rich side right now, because you can create a competitive net interest spread by using treasuries and repo.

They also have the advantage of rolling down the curve and the curve is so steep that those five-year treasuries soon become four-and-a-half year treasuries and four-year treasuries and the price just has a natural proclivity to go up.

Steve DeLaney - JMP Securities

Sure, sure. Yeah, almost the same way that a hybrid arm would and those are in shorter supply and obviously a lot less liquid asset class than treasuries. Thank you both for the color. Thanks.

Operator

Our next question comes from Mark DeVries with Barclays.

Mark DeVries - Barclays

Kevin, could you talk a little bit about the timing in the quarter of when you delevered and repositioned the treasuries. Just trying to get a sense of how the earnings run rate in 2Q might look relative to the first quarter.

Kevin Grant

Actually, in general, it was probably steady through the quarter with kind of a hint of being opportunistic. In other words, if the (inaudible) ran up, we take that opportunity to do a trade. I hope that helps.

Mark DeVries - Barclays

Is the dividend probably a better reflection here of where you think kind of the core earnings run rate is at this point?

Kevin Grant

I think so. It's hard to know what's going to happen over the next several weeks. And if we get a cheapening on mortgages, then we got an opportunity sooner than might be normally expected. So it's just hard to know what's going on in the next couple of weeks. I think maybe the more direct answer is I think where the leverage is right now, we're pretty comfortable. I don't see us getting a leverage to a 5-handle. It could get a 5-handle on it, but I don't see any compelling reason to go there right now.

Mark DeVries - Barclays

Given the potential for additional spread widening here, are you tempted to take down leverage, either just sell mortgages or short (inaudible) there?

Kevin Grant

If we didn't have this contraction in supply, I'd feel very differently. But the supply situation has gotten so destroyed really. Bill has some trading volume numbers. And what's the trading volume versus last year, Bill?

Bill Shean

Yeah. Mark, the trading volume is down about 40% as well. So just the number of bonds that are flowing through the mortgage space are down considerably from a year ago. And the Street is feeling that across all the desks.

Mark DeVries - Barclays

And then finally, could you just talk about your thoughts on repurchasing shares here? You didn't buy anything back this quarter (inaudible) in fourth quarter, just your thoughts there.

Kevin Grant

Well, we look at it everyday just like everything. And if we see an opportunity to do something meaningfully accretive, we pull the trigger. And we really didn't get any of those opportunities during the quarter.

Operator

Our next question is from Ken Bruce with Bank of America Merrill Lynch.

Ken Bruce - Bank of America Merrill Lynch

Kevin, if we just look at where many mortgage REITs are going today, they are beginning to diversify into non-Agency assets. And I wonder is CYS is considered tacking back in that direction in the capacity or what your thoughts would be around beginning to migrate out-of-Agency MBS?

Kevin Grant

Well, if the production was there and there were real businesses that could be made out of it, it might be a different story. But the non-Agency residential market, the regulatory environment is still tilted against the holders of assets. If you calibrate that against where spreads are right now, you actually can't even generate a competitive net interest margin versus the Agency strategy right now. And it's really hard to see the supply picture being significant.

The commercial world is a different story. Then you get commercial terms and all that kind of stuff. That's a much smaller business opportunity than the residential space, although it's certainly there. So it's tough. I certainly wouldn't rule it out longer term, but here in the near term, we're not seeing the opportunities for the returns. So we're perfectly content to be an Agency-only business for now.

Ken Bruce - Bank of America Merrill Lynch

And I assume that MSRs would fall into that camp as well. There's obviously been a move in that direction just as an alternative to either IO trusts or having some upright protection.

Kevin Grant

Yeah, MSR pricing has gone way up and in concert with mortgage spreads need real tightening. So I don't see it as a great opportunity now. And keep in mind that once MSRs and IO prices for that matter, those prices can get pretty high, which is our view today, and they no longer really have their hedging potential. In other words, if rates go up from here, MSR prices really aren't going to go up that much higher. So they've really lost their ability to provide a significant hedge. So I don't see that anytime soon.

Ken Bruce - Bank of America Merrill Lynch

And maybe just lastly, your thoughts on this and in your prepared remarks and then your response to some other questions, basically you're looking at a mortgage that you think is going to cheapen up, you're basically sitting in treasuries today, because they've got good economic value, but you expect to rotate that into MBS as you see the market environment change. I think that's what we're seeing.

Kevin Grant

Yeah, that's right.

Operator

Our next question comes from Dan Altscher with FBR.

Dan Altscher - FBR

None of us are maybe housing more humble around per se, but it kind of seems like the winter and the snowy conditions were really terrible and maybe that's helping to add to maybe some of the mirage we're seeing with really low supply and really favorable demand from the Fed still buying. Is that maybe something that you're nervous about that that spring selling season is going to come on really big and we're going to see that supply/demand balance really shift very soon?

Kevin Grant

It's definitely possible with some of the contractions in suppliers related to do the winter contraction. But that would kind of play into how we're positioned.

Dan Altscher - FBR

And in the press release, you mentioned that some of the de-risking was to close the duration gap. And I know you often provide or you do provide the interest rate expense saving in the Q. But is there anything maybe you can give us a heads-up view of where the duration gap maybe has narrowed to at the end of the first quarter versus maybe last quarter or even a year ago?

Kevin Grant

It'll be out in the supplemental deck, Dan. So if you just wait a couple of hours, you'll get it.

Dan Altscher - FBR

And maybe just one final one, bigger picture as well. Kevin, your remarks were it sounds like GSE reform is not really moving forward very fast, which I think appears to be right as well. Do you think this is a good or a bad thing? It kind of maybe just kicks the can down the road further and maybe just leads to more uncertainty, or is it kind of safe (inaudible) for now and will define place with that?

Kevin Grant

Good versus bad, I can't judge that. The reality is Fannie Mae and Freddie Mac did what they were designed to do. And for 60 years, they worked great. And the 100-year flood came in, they lost their equity and it was private equity. So they did exactly what they were designed to do. And the sentiment in Washington is, at least the visible sentiment is that somehow this needs to be fixed. And behind closed doors in Washington, I don't know what the balance of opinion is. But the fact that there is a lot of discussion, but it can't get out of committee I think speaks volumes to the more broadly held sentiment in Congress that you know what, maybe these institutions are fine. But I'm just thinking out loud, my sense is that this is going to go nowhere in 2014.

Dan Altscher - FBR

And so you're not managing the business around that in any sort of way?

Kevin Grant

No, we are visiting Washington as frequently as we can just to kind of keep our ear to the ground, just so that we sense what's going on, if anything. But we're not sensing meaningful broad consensus.

Operator

Our next question is from Aaron Saganovich with Evercore.

Aaron Saganovich - Evercore

You're clearly dealing with potential spread widening by lowering your leverage. But are there any other aspects on the risk side to help, I guess, reduce the risk of balance sheet or equity volatility or value volatility over the next half of the year?

Kevin Grant

Well, this impact that we're concerned about is it seems squarely at the Agency mortgage market, because this is the 30-year market in particular is what the Fed has been buying and it's slowing down their purchases. Although there's definitely a rate component that's part of it. So our feeling is really the only way to deal with this is to simply own less of the asset that's exposed to this. So we can get fancy. We could write coverage calls against it. We could all sorts of clever kind of derivatives around it. But at the end of the day, it boils down to reducing exposure to that asset. So it's a pretty simple thing we think.

Aaron Saganovich - Evercore

And I guess the last thing, the prepay environment still has been extraordinarily favorable for you. Is there any expectation that there would be an increase (inaudible) just like there's some seasonal factors.

Kevin Grant

Yeah, but it's really just normal seasonal pick-ups and we wouldn't be surprised if prepay has picked up a little bit from here. It's still rates driven and refi has effectively turned off. And the mortgage market, it's so far out of the money in G fees and the primary rate versus the secondary rate, that spread is so extraordinary that it's just not on the table right now.

Operator

Our next question is from Douglas Harter with Credit Suisse.

Douglas Harter - Credit Suisse

Kevin, you talked a little bit about Chairwoman Yellen's comments around potential haircuts and contraction of credit. Can you talk about how that might impact you and how you see that impacting the repo market?

Kevin Grant

Yeah, our sense is that haircuts in the repo market for agencies probably aren't going to change. I don't think they're going to change at all, to tell you the truth. Market is kind of 5% right now with a few counterparties a little bit lower than that. It's probably the non-Agency world that is going to feel the pressures. And the number of lenders willing to do it is not all of them and haircuts and controls around that will probably continue to get more regulatory scrutiny. So we don't really see it as being significant in the Agency market. If anything, what we've observed is that some of the counterparties that were trying to get down in gross balance sheet size, what have you, at the end of the day, they still come back to government bonds that's collateral, which is all we've got.

Operator

Our next question is from Joel Houck with Wells Fargo.

Joel Houck - Wells Fargo

I guess the first question is given the kind of moving the treasuries and your comments about the financing being attractive, how much further could you take that if you wanted to in kind of the second quarter, knowing that obviously you have to have certain assets you have to hold for REIT rules? But just kind of curious as to where that could go if you really wanted to get defensive heading into potential spread widening in the second half?

Kevin Grant

That's a really good question, Joel. In the old days, we could have gone to other kinds of agencies. We could have gone to hybrids, but there's very little origination. We could have gone to ARMs and so forth. There's so little secondary trading in these other assets that they're really just very difficult to buy in the secondary market these days. So essentially what's being traded and being created are largely 30 years and you can see that we're trying to avoid 30 years at this point to get those exposures down. In 15 years, which is our kind of sweet spot. So our sense is this supply/demand judgment is suggesting that we want to keep our leverage at the low end of our range, but the supply situation has contracted so much that I think that at that low 6x leverage number is probably we feel most comfortable.

Joel Houck - Wells Fargo

I was wondering what the allocation of treasuries, it sounds like it's getting close to the same current return with treasuries, given the financing. You could take that up and then theoretically reduce your book value volatility heading in the spread widening.

Kevin Grant

There's a compliance limit right. The limit would be 20% of gross assets. I don't think we'd ever get that right to the edge there. But that would be the limit for the REIT rules.

Joel Houck - Wells Fargo

I guess the last question is given the repositioning, what is it done to kind of book value sensitivity to say the increase in rates of, say, 100 basis points, I can't remember what you guys disclose in your tables, but I was just kind of curious as to how the sensitivity has changed given the repositioning?

Kevin Grant

Yeah, you'll see it in the tables when they come out later today. It'll be black and white for you.

Joel Houck - Wells Fargo

But I should say is it correct to assume that it's a meaningful change in sensitivity?

Kevin Grant

Yeah, absolutely. But I would point out one thing, this is still corporate bonds. They roll down the yield curve. So an instantaneous 50 basis point moving rates, you could see a small benefit from being in treasuries. But if that 50 basis point move happens over six months, well, that five-year treasury is now a four-and-a-half year treasury, it's a lower point on the yield curve and in fact its price could be up. And in the near term, that's really the benefit of it. So the question is how long does this scenario take to play out. If it plays out over a year or two, then those treasuries roll down the curve an awful lot.

Operator

Our next question is from Jackie Earle with Compass Point.

Jackie Earle - Compass Point

You guys mentioned earlier that the maturity for the treasuries you purchased is in the five-year range. Will that be broken out later today, in the 10-Q?

Frances Spark

Yes, that will be shown in the investment schedule. We shared the coupon of the (inaudible) of our holdings. So you'll be able to see that, Jackie.

Operator

Our next question is from Merrill Ross with Wunderlich Securities.

Merrill Ross - Wunderlich Securities

Which coupons in particular are you rolling?

Bill Shean

Well, they are in the 30-year for us. We've got a robust rolling also, but the 15-year treasuries have a very robust rollout. And that's been pretty consistent for a while. I think you look to where the Fed is purchasing and you find those are the attractive roll. So there're a couple of others, but those are the most dominant ones.

Merrill Ross - Wunderlich Securities

And I just wonder how (inaudible) the puts and bonds you would like to own when the volatility peaks?

Kevin Grant

Well, it's hard to say. You're probably trying to figure out how to model us, what we might buy. I think it's going to depend on the circumstances at the time. If there is a rate move as part of the cheapening, I think that's a hard one to figure out just far ahead.

Merrill Ross - Wunderlich Securities

Yes. So basically you just have to stay pretty scattered in the coupon stacks when you roll, so that you eventually can roll on to them?

Kevin Grant

So what's the product mix now? In 30 years, it's like 4.5s and 4s.

Bill Shean

Yeah, 4s.

Kevin Grant

So that's the production mix. It's largely 4s and that's really going to be the driver.

Operator

Our next question is from Michael Widner with KBW.

Michael Widner - KBW

Let me take a little bit more blurring one just upfront and then I'll get back to the more interesting ones. But let me ask about operating expenses. On total operating expense number, this is your highest quarter I think you've reported yet since, putting aside the internalization quarter? I mean is that a representative run rate going forward and how should we think about projecting that?

Kevin Grant

It's all about compensation and accruals. So at the beginning of the year, we have to pick a number to accrue compensations for the year. And then as the year goes on and we, I guess, it's all performance-based, as we get close to year-end, then we can adjust to whatever the actual performance is. So you'll notice last year that our lowest quarter was Q4 and that's when we had a better indication of what the performance compensation was going to look like. So I would say Q1 is our most conservative quarter in the year and that's probably the way to look at it.

Michael Widner - KBW

Okay, makes sense. And the fact that it's up year-over-year suggests you guys think you're going to have a better year this year. Is that fair?

Frances Spark

One of the fact is that we have some restricted stocks from a number of years ago and last year for that restricted stock to vest and so that expense is hitting into 2014. So that explains a little bit more of the uptick, because the larger portion of the stock is vest in this current year. So that's the fact of it. So that also contributed to the increase.

Michael Widner - KBW

For modeling purpose, can you quantify that sort of incremental restricted stock? I mean is that spread over the course of the year or is that one-quarter thing?

Frances Spark

It's spread over the course of the year, Mike.

Michael Widner - KBW

Everybody seems to be talking about the same thing. Oh, yeah, the supply is down, spreads are tightening up and they're going to widen up later in the year. I guess a thing that I'm curious about is everybody knows that refi volume is down and rates are up and so on and so forth. The vast majority of the world, Agency MBS holders are just like you guys and just like the Fed, where you need to reinvest the paydowns every quarter. So I guess what I'm wondering about is when you talk about the supply being down, but the amount that you guys have to buy every month is down as well and certainly you're going to see the trading volume down as well, because the refi volume is down as well. I mean we've seen in all the various episodes so far of the Fed doing QE and increasing QE and so on and so forth. I mean the bond market reacts pretty much at or before the date of the official announcement. And then after that, it's already priced in. So I guess I'm curious what is so different other than just volumes are down because refi is down, but that must means everyone has to buy less? Why is it so different? We expect a major change in such a great opportunity in the back half of the year as opposed to what looks like a pretty good opportunity to me right with spreads being where they are.

Kevin Grant

Well, this is a plumming question. So let me go through plumming for you, because you would think like equities when a government makes announcement about something that would instantly be priced in, but that's not really the case in the mortgage market for the following and it very much is a plumming reason. We like the Fed and anybody else that participates in the mortgage market are participating in a forward market. So when we do a trade today, we're actually doing that trade for settlement in probably June. And that bond that we purchased has not been built yet. Time goes by, you get to June and the dealer that we bought the bond from or the originator that we bought the bond from has to actually put that bond together, give us a (inaudible) give us an actual cash bond. Normal investors in the mortgage market, they might take delivery or they might roll that purchase, but now we've got this entity, the Fed that is actually insisting on taking cash bond. They do roll a little bit, but they really want to take cash bonds. So they're actually removing cash bonds from the market.

Historically, these effects have happened in the past and the material meaningful cheapening in the mortgage market actually happens when you get to settlement date. And voila, there're plenty of cash bonds available and the Street is not failing on trades. So we think that the crossover point is probably the June/July timeframe, maybe August. And the market kind of knows this. So the question is will a little bit of cheapening happen in May, will it happen later in the summer. But historically, you could walk on a settlement date and all of a sudden mortgages have gapped down half a point, because the system is flushed with cash bonds. That has not happened for years. But it's going to happen sometime later this year.

Michael Widner - KBW

So I hear you on the plumming, as you call it, the mechanics. But I guess where I'm still struggling is the Fed has started slowing, they started tapering back in December, so we're several months in. And the forward market is a pretty big market. And again, I mean if every bond buyer is at here going CPRs are running at multi-year lows and in some cases a decade-plus lows, I would think that everybody would be doing the same thing. I mean if everybody can see it, if it's so obvious, then everyone can see it, the market generally prices that in advance. And so I guess when I hear so many of you guys saying the same thing, it just puzzles that you would still end up with that in balance if everybody can see it.

Kevin Grant

The mortgage market is a little kid playing with matches. The roll is so attractive for a month or two months that mortgage investors love the roll. And we certainly love the specialness of the roll. It's when you get to that month when the rolls collapse, that's when you burn your fingers. And we just don't know when everybody's fingers are going to get burnt. The traders that play in this market, they know this and they know they are playing with matches.

Michael Widner - KBW

I mean is it essentially market that play with matches, because you only have one settlement day a month. So it's not like equities where you can be day faster than the other guy. I mean that's pretty chunk. So it just surprises me that there'd be that 50 basis point kind of impact.

Kevin Grant

I don't know if it will be 50 basis points, but it could certainly be half a point in price.

Bill Shean

And, Mike, you don't know how long it will last either, which is going to be the tricky part. I mean obviously as you said, the whole market could be aware of this, but that doesn't mean that there won't be some severe volatility for short periods of time.

Michael Widner - KBW

So let me ask you quickly on the treasury position. If you're buying a five-year treasury, I mean what you're saying about them sliding down the curve, but I mean I guess my question on those is how do you think about hedging the rate risk, because you're getting the lower yield on a treasury relative to a comparable duration Agency. You guys trim the hedges a little bit.

Kevin Grant

We're getting a lower yield, but we're financing them 40 basis points, 50 basis points, 60 basis points cheaper.

Michael Widner - KBW

So how do you think about that?

Kevin Grant

It's really just an alternative for the same duration that we would have if we were in a mortgage without the extension risk and without the other risks.

Michael Widner - KBW

Let's just call for simplicity, if you had $1.5 billion of five-year treasury, what kind of hedges would you specifically allocate against that? If you do with five-year swaps, you're not making anything.

Kevin Grant

Actually you are, because five-year swap, that's positive carry trade. You can buy a five-year treasury, finance it a repo, put on a matched five-year swap against it and have a positive carry. If you were a hedge fund, you would do that all day long. And it's all because the treasury is financing negative.

Michael Widner - KBW

So maybe my math is wrong here, but I'm looking at five-year swaps today going at $181 million?

Kevin Grant

And the mortgage is going to finance at probably plus 30 and let's say the treasury is going to finance at negative 20. Don't forget on the swap, you receive LIBOR. So if you're receiving 23 or something and you're financing at negative 25, so just on the short end of that trade, you're picking up 50. I know it doesn't make any sense, but this is the way the market works.

Michael Widner - KBW

Well, I guess I am having a hard time. So aren't we around the 10 times leverage treasury REIT instead of a mortgage REIT?

Kevin Grant

You wouldn't be a REIT. You'd be something else. I'll let you start that business, Mike.

Operator

(Operator Instructions) And we have no further questions at this time. I will now turn the call back to Mr. Cleary for closing remarks.

Rick Cleary

Thanks. And on behalf of Kevin, Frances, Bill and the entire CYS management team, I'd like to thank you for taking the time to participate and speak with us this morning. Thank you for your continued support and interest. Have a good day.

Operator

Thank you, ladies and gentlemen. This concludes today's conference. Thank you for participating. You may now disconnect.

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