We have a position in CYS Investments (CYS) and we noticed that it went ex-dividend on June 21st. Before it went ex-dividend, we were concerned that the company would take advantage of its market price premium in comparison to its book value and issue a secondary share offering. Now that the company's shares are trading ex-dividend with regards to its $.50 per share quarterly dividend, we believe that the likelihood of a secondary offering is less than likely to happen since its estimated premium based on our forecasted book value as of June 30th will only be 1.89%, which wouldn't be worth the costs involved to issue shares.
Source: CYS Investor Relations
CYS Investments (formerly CYS Sharpridge) is one of our favorite mREITs. The first thing we like about it is that it is located in the next town from where we live. More importantly, we like where its portfolio stands right now. We like the fact that although its dividend distribution declined by 17% versus last year's comparable quarter levels, an investor is still achieving a 14.1% dividend yield by holding CYS. Moreover, the company's net interest income per share increased from $.477 in Q1 2011 to $.513 in Q1 2012, in spite of the steadily flattening yield curve and the increased shares outstanding due to the secondary offering that brought in nearly $377M worth of equity capital on February 1, 2012.
Source: CYS Q1 10-Q Report
Another thing we like about CYS is that it is a self-managed mREIT. A number of mREITs are managed by external companies. Previously CYS's mortgage book was managed by Sharpridge Capital Management, an affiliate of The Cypress Group. When CYS Sharpridge acquired Sharpridge Capital Management on September 1, 2011 from The Cypress Group, it changed its name to CYS Investments. The best thing about the internalization of the asset management activities was that it saved CYS at least $12M in management fees annually, which we believe contributed to CYS's increase in net income per share net of employee compensation expenses.
In comparison, Annaly Capital Management's FIDAC subsidiary FIDAC (NLY) has always managed its $120B proprietary asset book. FIDAC also manages the mortgage books for Chimera Investment Corporation (CIM) and Crexus Investment Corporation (CXS). In addition to FIDAC managing mortgage books for two other mREITs, Annaly also has another RIA subsidiary-- Mergenser. Other areas Annaly operates in are warehousing mortgage financing (Shannon Funding LLC), a fixed income broker-dealer (RCAP Securities) and middle market debt financing (Charlesfort). While we would be interested in seeing CYS Investments try to generate additional asset management fees for managing the mortgage books for other firms, we would also be concerned of the potential for conflict of interest between the different parties. We would also be interested in seeing if CYS could replicate the Annaly model to a degree if it could potentially reduce costs and enable it to maintain its dividend yield advantage on Annaly.
We also like CYS's size. CYS was founded in 2007, went public in 2009 and it has already increased its size to $13.5B as of Q1 2012. We believe that CYS has the scale to compete favorably against smaller mREITs and the ability to move quicker than larger mREITs.
The last item that sticks out in our opinion is CYS's mortgage portfolio. 58% of CYS's Agency Residential Mortgage Backed Securities portfolio is invested in 15-year fixed rate mortgages. We are attracted to this sector because these bonds have much lower Conditional Prepayment rates than the longer duration mortgages. We were also surprised that these mortgages had lower prepayment speeds than hybrid Adjustable Rate Mortgages. Maybe that is because it is a hybrid ARM and the mortgages have 5.5 years before the mortgages become variable rates.
Source: CYS's Q1 10-Q Report
In conclusion, we continue to hold our investment in CYS and recommend it to investors who want or need high current income from their investments. We believe that the Federal Reserve will maintain its low interest rate policy. Though we were disappointed to see the Fed persist in its Operation Twist program, we were glad that it did not go further with a third round of quantitative easing. This ensures that if CYS and other mREITs have to cut dividends, the dividend cuts will not be steep and investors will still be able to generate satisfactory double-digit dividend yields on their mREIT investments.
Disclosure: I am long CYS.
Additional disclosure: Saibus Research has not received compensation directly or indirectly for expressing the recommendation in this report. Under no circumstances must this report be considered an offer to buy, sell, subscribe for or trade securities or other instruments.