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CYS Investments Inc (CYS), Capstead Mortgage Corporation (CMO): Book Value Still the Biggest Concern for mREITs

A few weeks ago, an Agency mREIT, CYS Investments Inc (NYSE:CYS), reported a worse than expected book value decline when it disclosed its second-quarter performance. Back then, I thought it would be a concern for the rest of the Agency mREITs. Now, Capstead Mortgage Corporation (NYSE:CMO) is out with its second-quarter results. Let’s compare and contrast these two performances and see why I still prefer hybrids over their Agency-only counterparts.

Book value and spread decline

Capstead Mortgage Corporation (NYSE:CMO) is an Agency mREIT that invests largely in adjustable-rate securities. Capstead Mortgage reported earnings per share (EPS) of $0.27, which was $0.05 per share behind the consensus estimate. Book value plunged 5.9% over the prior quarter.

CYS Investments IncIts book value plunged 5.9% over the first quarter. Apart from portfolio pricing changes, much of the decline was associated with the preferred capital raised during the quarter. The company reported a book value of $12.80 per share, while the stock is currently trading at $8.34 per share. So, from a book value perspective, the stock is still trading at 35% discount. At the same time, the company reported a net interest rate spread that plunged 15 bps over the prior quarter.

Book value decline with expansion in spread

As noted above, CYS Investments Inc (NYSE:CYS) is a similar mREIT, however, with large investments in fixed rate MBS. It reported a 26% decline in its book value over the prior year, while it was able to expand its net interest rate spread by 20 bps over the prior quarter.

During the quarter, CYS Investments Inc (NYSE:CYS) seems to have accumulated the 30-year fixed rate security, while the 15-year fixed rate security that the company held outperformed. While the 15-year MBS outperformed, CYS sold some of it to purchase the 30-year MBS that is considered highly sensitive to changes in interest rates. I believe that’s the reason behind the massive book value decline that CYS Investments reported.

Let’s look at how the company reported an expansion in its net interest rate spread. Over the prior quarter, the average asset yields increased 30 bps, while the cost of funds increased only 10 bps, leading the company to report a 20 bps increase in the spread. However, much of the increase in the asset yield was associated with the 15-year MBS.

Looking ahead

Given the scenario, Two Harbors Investment Corp (NYSE:TWO) is one of the most favored mREITs as it’s classified as a hybrid mREIT with investments in both Agency and non-Agency MBS. The company is scheduled to report its second-quarter results on Aug. 6, 2013.

During the second quarter, Two Harbors Investment Corp (NYSE:TWO) increased its portfolio balance, which should increase its net interest income. Analysts at Barclays expect that Two Harbors is scheduled to report as much as 8 bps expansion in its net interest rate spread, driven by higher yield on its credit sensitive assets.

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