CYS: Collect Significant Profits At Least Until 2015

| About: CYS Investments, (CYS)

REITs like CYS Investments (NYSE:CYS) are very special for yield and dividend investors because, in order to retain their tax exempt status, they must distribute at least 90% of their annual income to shareholders as dividends. As a result, REITs generally offer dividend yields well in excess of what you can get from other companies. The downside is that there is some volatility in the level of dividends paid from year to year, and you could see large dividends when there are high profits, or small payouts or no payouts in less profitable or losing periods. Income investors are primarily interested in stocks that produce stable and high dividend yields and are available at reasonable valuations.

In the case of CYS, equity analysts at Wells Fargo have given the company an "outperform" rating, based on a range of factors that include an experienced and accomplished management team, strong risk management controls and procedures and the fact that the company is managed to align the interests of both management and investors closely. In my opinion, there are many reasons to favorably consider an investment in CYS now.

Like the other companies in the REIT industry, CYS stands to gain from the decision of the Federal Reserve to keep the Fed funds rate low at near 0% until the end of 2014 and possibly into 2015. This means that there is unlikely to be any diminution in the value of the CYS investment portfolio until this rate is changed. This is also likely to preserve the interest spread, which is the difference between what CYS earns and what it pays on its borrowings, and represents its net income. This could of course change, if lenders, independent of the Fed, perceive a higher risk in accepting mortgage backed securities as collateral, and proceed to raise their lending rates to compensate for the additional risk.

Lets look at some of the strengths that CYS brings to the table. Given that the shares are trading ex dividend, the current price makes it extremely unlikely that there will be a dilution of equity with a secondary stock offering. Despite a yield curve that is flattening, and the issue of additional capital in February 2012, the company was able to increase net interest income per share from $.47 a share to $.51 a share on a year-on-year basis. This is why, despite a 17% decline in dividend distribution, shareholders still achieved a dividend yield of better than 14%. CYS also manages to save on costs by managing its own portfolio instead of using an external manager like Annaly (NYSE:NLY). This means that it could generate additional fee revenue by managing the portfolio of other and REITs. Finally, with a market cap in excess of $13 billion, CYS has the size and the financial stability to compete with its peers and competitors.

Let's also evaluate some other REITs to see how attractive they are as investment candidates compared to CYS. Annaly is beginning to lose some credibility in the market because of the huge compensation package of $35 million it is offering its CEO. This package (which is higher than the total packages offered to the CEOs of the top six American banks) has upset investors, particularly at a time when dividends have been declining over the past three quarters. Chimera (NYSE:CIM) looks good at first glance, but I would caution against it as an investment for two reasons. The company has finally resolved its auditor problem, but we have yet to see the audited financials for the year 2011, and delayed financials are always a red flag. The company also has a high risk investment portfolio, with about 75% consisting of non-agency mortgage backed securities which should be regarded as junk bonds.

Vornado Realty Trust (NYSE:VNO) is facing the displeasure of its investors for a number of reasons; one is that they are unhappy with the performance of the stock price. The company has announced that it is considering a number of alternatives to improve performance by selling its stake in Toys R Us, buying back shares, or perhaps even abandoning the REIT business altogether. I would wait to assess the impact of these moves before deciding on any investment. Equity Residential (NYSE:EQR) has decided to buy a 26.5% ownership interest in privately held Archstone which owns and operates multi-family apartment properties. It has a right to first offer, along with another partner, and will surely benefit whether it exercises the right or allows another partner with the same right to do so. AvalonBay Communities (NYSE:AVB) appears to have positioned itself strategically to benefit from the change in housing markets caused by the limited availability of mortgage financing for home buyers. The company hopes to capitalize on the increasing trend of rental housing.

I personally believe that the moves by the Federal Reserve open up an excellent window of opportunity for investment in the REIT industry, and this should continue at least until the end of 2014. You will need to be selective in your investment and avoid companies with high risk portfolios, such as non-agency backed mortgage securities, as well as companies that are aggressive in their use of derivatives. If you are looking for a good income investment opportunity, I would certainly recommend that you seriously consider buying CYS. You should, however, monitor interest-rate developments and further actions by the Fed so that, if there are unfavorable developments, you can exit your position.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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