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CYS Investments Inc (CYS): Will This mREIT’s Recent Results Set the Trend for Others?

CYS Investments IncThe mortgage REITs earnings season has kicked off with CYS Investments Inc (NYSE:CYS) reporting its results. The progress visible in its earnings would probably set the trend for the rest of the sector, so it’s important to review the second-quarter performance of CYS Investments Inc (NYSE:CYS) in the light of the current macro environment, and see whether its peers can do better.

Highlights

The company reported earnings per share (EPS) of $0.37, up 15.6%, and book value per share of $10.20, down 26% over the prior-year quarter. This means that the stock is trading at 12.8% discount to its second quarter-end book value. Remember, CYS Investments Inc (NYSE:CYS) is a pure-play mREIT with investments in fixed rate and hybrid adjustable-rate mortgages (ARMs).

Other highlights of the results include a leverage ratio that went slightly down to 7.5 times and an interest rate spread that expanded 20 bps over the prior quarter. During the quarter, expense as a proportion of total assets surged 4 bps to 0.98%. This was largely due to relatively flat operating expenses and lower average net assets.

Accumulating 30-year fixed rate paper

At the end of the second quarter, nearly a third of CYS Investments Inc (NYSE:CYS)’ assets were the 15-year fixed rate MBS. This is surprisingly down from 46% at the end of the linked quarter. The 30-year fixed rate MBS was a significant 45% of the assets, up from 31% at the end of the prior quarter. Hybrid ARMs were 15%, while the 20-year fixed rate MBS was flat at 6%.

It seems like CYS Investments Inc (NYSE:CYS) sold some of the 15-year fixed rate MBS during the quarter and accumulated the 30-year fixed rate MBS, which others (American Capital Agency) were getting rid of. The 30-year fixed rate MBS is considered highly sensitive to changes in interest rates.

At the same time, management provides a disclosure of the declines in the prices of this security on the days of the release of minutes of the Federal Open Market Committee meetings. In total, it fell nearly 3.1% in only three days. So, I believe this was not an advisable move.

15-year fixed rate paper outperformed

During the quarter, the company reported a hike in the yield it earned on its interest earning assets. Average yield on assets increased 30 bps, while the cost of funds increased 10 bps, which left the company with a 20 bps expanded net interest rate spread.

Much of the hike in the asset yield was a result of the increase in the yields on the 15-year fixed rate MBS, which the company reduced during the quarter. So, the company could have reported an even higher spread if it didn’t decrease its exposure in the 15-year fixed rate MBS.

Peer analysis

Since, CYS Investments Inc (NYSE:CYS) is an Agency-only mREIT, I would take American Capital Agency Corp. (NASDAQ:AGNC) and Annaly Capital Management, Inc. (NYSE:NLY) as its closest peers. According to Yahoo! Finance, both American Capital Agency Corp. (NASDAQ:AGNC) and Annaly Capital Management, Inc. (NYSE:NLY) are scheduled to report their second-quarter results on July 29, 2013.

Annaly Capital Management, Inc. (NYSE:NLY) is heavily invested in the 30-year fixed rate Agency MBS, which brought most of the damage at CYS Investments in the shape of a significant book value decline. While I have not come across any portfolio re-balancing efforts at Annaly Capital Management, it’s hard to believe that it would ignore it.

In another attempt to manage its book value, the company lowered its leverage and placed some CRE loans in its assets, which are considered less sensitive to changes in interest rates. This will offset some of the effect of the large exposure in the 30-year fixed rate Agency MBS.

Besides, Annaly’s recent acquisition of CreXus Investments would add low double-digit returns to the top line. So, I believe Annaly is scheduled to report a top and bottom line surge, with a relatively less book value erosion, compared to what we saw at CYS Investments.

While American Capital Agency Corp. (NASDAQ:AGNC) was also heavily invested in the trouble-making 30-year fixed rate Agency MBS, its management decided to get rid of some of it in a portfolio re-balancing exercise conducted recently. This re-balancing, coupled with the active management of assets and hedges, will probably cause the company to report lower top and bottom lines at the end of the second quarter.

I also believe that the re-balancing exercise will lead the company to report a book value decline lower than 9% (which it had reported at the end of the first quarter).

Conclusion

I believe only Annaly Capital Management is positioned to report a second-quarter performance that should be better than CYS Investments Inc (NYSE:CYS)’. I believe that it will report some expansion in its net interest rate spread, which would translate into a boost in the bottom line. Also, it would probably be able to report the lowest book value decline among the mREITs considered in this article.

The article Will This mREIT’s Recent Results Set the Trend for Others? originally appeared on Fool.com and is written by Adnan Khan.

Adnan Khan has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Adnan is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.

Copyright © 1995 – 2013 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.

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