CYS Investments Inc (NYSE:CYS) hiked its quarterly dividend in the second quarter of the current year. Given the challenging macroeconomic situation that mREITs are currently facing, the correct interpretation of the hike in CYS Investments dividends is important. Let’s see where did the hike come from and what is does it mean for other Agency mREITs.
CYS Investments has a fairly simple policy of investing in residential mortgage backed securities that have the government’s backing (Agency MBS). This qualifies the company to be a pure-play mREIT. The company’s Agency MBS’ are both fixed rate and adjustable rate in nature.
The dividend hike
Given the speculation about the Fed’s exit, mortgage rates have climbed, causing erosion in the book values of most mREITs. Analysts are expecting sector-wide dividend cuts. However, Credit Suisse expected CYS Investments to continue its first quarter’s dividend rate of $0.32 per share. In contrast, CYS Investments Inc (NYSE:CYS) reported a 6.25% sequential increase in the quarterly dividend rate, to $0.34 per share. The recent dividend hike is also in sharp contrast to the dividend cuts during prior quarters.
Where did the hike come from?
Since Ben Bernanke’s recent speech, Agency residential mREITs have been under tremendous pressure. Mortgage rates started climbing, causing mREITs to estimate huge book value depreciations. In particular, CYS Investments was not prepared for the hike in rates, and had constructed its portfolio to create benefit for the company if the rates dropped further. In the case of a 25 bps increase in the rates, CYS Investments anticipates a 10.3% decline in the coming quarter’s net income.
So, rates are on the rise, and CYS Investments Inc (NYSE:CYS) expects a decline in its bottom line: Where did the hike come from? The answer: realized gains from the past.
The company realized $500 million in gains over the past two years. Even during the first quarter, CYS investments generated $55 million from gains on investments, compared to $30 million from interest income. Around $0.16 per share was withheld by the company during the first quarter, which is now being distributed and is the source of the dividend rate increase. However, further hikes are highly unlikely as gains on investments have dried up due to higher mortgage rates.
Significance of the hike
Since CYS Investments Inc (NYSE:CYS) is a pure-play mREIT, I will attempt to compare it with other pure-play mREITs like American Capital Agency Corp. (NASDAQ:AGNC), Annaly Capital Management, Inc. (NYSE:NLY) and ARMOUR Residential REIT, Inc. (NYSE:ARR). It is evident that CYS Investments dividend hike was due to past undistributed income. Therefore, investors should not expect American Capital to follow.