Summary:
·CYS Incvestments Inc (CYS, Financial) pays a 13.4% annual dividend. The dividend is a bit shaky in the current environment; but even if it gets cut, it should still be over 10%.
·CYS had a +$0.36 per common share book value gain in Q4 2014. It will likely see its $10.50 book value be flat or slightly higher after Q1 2015.
·The Latest U.S. Fed dovish statement should take possible skyrocketing interest rates off the table. This makes CYS a much less risky stock to own.
History, Description:
Cypress Sharpridge Investments is a real estate investment trust (REIT) that invests in residential mortgage backed securities (RMBS). The company was founded in 2006.
The RMBS are collateralized by Agency ARMs, Agency Hybrid ARMs, and Agency fixed rate mortgages. It’s a good investment when such a company grow its book value while paying a 13.4% annual dividend. In FY 2014, CYS grew its book value from $9.24 to $10.50 per share as comparison to its previous year Q4 earnings. The increase of $1.26 per share amounts to increase of 13.64% for FY 2014. If we consider the CYS investments pays a 13.4% annual dividend on the top of its book value of $10.50 to its investors that means CYS was a great investment in 2014. It generated a total return for FY2014 of about +26.6% based on the December 31, 2013 book value of $9.24. It is also likely still a good investment for 2015.
Insider Ownership:
Kevin E Grant the Chairman, CEO, CIO, President of the company holds the highest number of shares 739,847 as of 08/02/2015 holding which is 0.46% of all the outstanding shares, followed by CFO Frances Spark holding 177,981 shares as of 20/02/2015 which is 0.11% of all the outstanding shares.
Outlook:
After the latest dovish statement from Fed many Mortgage Backed Security portfolio managers have been worried that interest rates would skyrocket at almost any time, some managers start hedging strongly against the risk of high interest rate. When some portfolio managers hedging against the risk of interest rate hike the CYS has been instead betting that the still strong downtrend in the 10-year US Treasury Note & yield would continue. CYS strategy proved beneficiary for the entire FY2014; for them. However, the worry had increased in 2015 as the Fed had formerly said it expected to end Q4 2015 at a Fed Funds rate of 1.125%. This implied several raises, which would probably start as early as June or even April 2015. The new statement expects an end of 2015 Fed Funds rate of 0.625%, which is much less. This announcement suggests the Fed Funds rate is more likely to see the first raise in September or October of 2015 as opposed to June 2015.
In the recent meeting the Fed lowered its inflation estimate for FY2015 from 1.0%-1.6% to 0.6%-0.8%. The Fed also lowered its FY2016 inflation estimate slightly to 1.7%-1.9%. The Fed downgraded its view of U.S. GDP growth for FY2015 from 2.6%-3.0% to 2.3%-2.7% and FY2016 GDP growth from 2.7% to 2.5%.
U.S. GDP growth in Q4 2014 was only 2.2%. Lower oil prices, lower refined products prices, lower oil companies' Capex’s for 2015, and lower oil company employment in 2015, all argue that U.S. GDP growth in Q1 2015 will be much less than the GDP growth seen in Q4 2014. Investors should be prepared to see this; and they should strategize accordingly. The Fed could easily put off raising rates again. Near term, the U.S. economy seems sure to be much weaker than they are thus far predicting. It may be near-zero growth in Q1 2015.
Regardless of the exact specifics, a weaker economy should lead to lower U.S. interest rates. Further the ECB QE buying of many weak (some strong) EU country sovereign bonds is dragging their yields down. Hence you have an environment where stronger, safer, cheaper, higher yielding U.S. Treasuries should have their yields dragged downward by free market economic forces due to the weaker, more expensive, lower yielding bond of such countries as Spain and Italy.
Looking at the 10 year U.S. Treasury Note Yield which is at 1.93% as of close to March 15, on its counterpart Spain & Italian 10 year interest rate is 1.18 & 1.20% government Notes are far lower yielding currently; and they have been trending strongly downward for some time. CYS' current strategy is betting on lower rates. As of December 31, 2014, CYS had a fair value Agency portfolio of approximately $14.6B. For this, CYS had hedges with a notional value of $10.15B (about 70% hedged) as of December 31, 2014. This was light hedging for a situation in which many expected interest rates to possibly skyrocket.
With the Fed's latest dovish announcement, the possibility of skyrocketing interest rates is probably off the table for the next year or two. This should mean that CYS' strategy is a good one for the current U.S. and world economic situation. Lower cost hedging allows it to keep more of the net interest spread income. Plus it allows it to profit more from the likely gains in MBS values as interest rates decline. In a more heavily hedged case, the losses to the values of the hedges would eat virtually all of those gains.
Now taking an assumption that if CYS strategy remains on the correct path how is it likely to do in Q1 2015? We have to look at the actual portfolio to get a reasonable feel for this (see the December 31, 2014 portfolio below).
If we look at the above portfolio details as of December  2014, we found that CYS two largest holding one is in their 15 year Mortgage Security at 3% with amount $ 4,889,226,000 and the other one in the 30 year at 4% with total amount of $ 3,679,782,000.
If we compare the CYS portfolio interest rate with the above diagrams one would think that CYS' Agency MBS would have gone up in value, as the 10-year U.S. Treasury Note yield has fallen from 2.17% on December 31, 2014 to 1.93% as of the close on March 20, 2015. Taking the above charts as approximation one can see that the value of the 30-year fixed rate FNMA 4.0% coupon MBS is almost precisely the same value it was on December 31, 2014. The value of the 15-year fixed rate FNMA 3.0% coupon MBS is substantially higher than it had been on December 31, 2014. One might posit that the basis spread might be tighter for the 15-year fixed case. One might posit that the 15-year fixed case lost less value due to increasing CPRs (constant prepayment rates). With interest rates likely trending down between now and the end of Q1 2015 (March 31, 2015), both types of MBS seem likely to gain more value. This should mean that CYS will see a small book value gain for Q1 2015. The gain is likely to be less than the gain in Q4 2014 of $0.36 per common share. 15-year fixed rate Agency RMBS are approximately 50% of the portfolio. This should be good news for the book value because they are the biggest book value gainers.
Of course, the 30-year fixed rate Agency RMBS probably provide the most revenue. For the portfolio overall, this revenue likely shrank slightly in Q1 2015 as the yield on the 10-year U.S. Treasury Note fell -24 bps to the close on March 20, 2015. The net interest rate spread with Dollar Roll income was 1.55% for Q4 2014. For Q4 2014, the drop income (dollar roll income) was about $0.08 per common share of the $0.31 per common share in Core Earnings. This barely covered the $0.30 per common share dividend for Q4 2014. A drop in the net interest spread with Dollar Roll income may mean that it will be hard for CYS to cover the dividend fully for Q1 2015 out of Core Earnings. This will likely depend on how much Dollar Roll income is generated by CYS in Q1 2015.
Valuation & Risk Catalyst:
Looking at the impact of decrease in the interest rate and dollar role income CYS Peer Company American Capital Agency Corp. income dropped amounted to about 51% of total monies available to pay the dividend in Q4 2014. The way its peer company income dropped CYS income also dropped to about 25% of the income available to pay the dividend. There are possibilities that CYS tried to make more drop in income in its first quarter of FY15 if no wild swings will come in interest rate in near future and that can be confirmed only from its upcoming earnings on the contrary to this CYS might decide to continue to pay the $0.30 per common share dividend because the Fed is getting closer to raising rates. If this strategy goes at right way then, the net interest spread should go up. That is to say, CYS might not have a hard time covering future dividends of the same yield. Supplementary, if the dividend is cut, it will likely still be above 10%.
The book value of CYS common share was $10.50 on 31 December, 2014. It seems likely to be at that level or slightly higher after Q1 2015. With a current stock price of $9.11 at the close on March 23, 2015, the stock would then have to raise at least $1.39 per share (+15.25%) to get to its December 31, 2014 book value. The 15.25% discount to book value was due to the fear of increase in the interest rates. The Fed has taken the "skyrocketing" fear off the table and Fed has delayed its raise of the Fed Funds rates by an estimated three months to six months. This should help primarily Agency mortgage REITs to trade closer to their book values.
If we make an assumption that Interest rates may not go up that would not happen the interest will definitely go up but slowly than was being previously anticipated. Mortgage REITs can "manage" through slow interest rate rises. In this scenario, CYS stock price might rise about 10 to 15% from its current value. When CYS is also paying a 13.4% dividend, the stock is attractive. It is also attractive that CYS' management has been consistently making the right interest rate calls for the last year or more. CYS is a buy, although it is perhaps a low buy in the still uncertain conditions.
Conclusion:
Looking at its multiyear chart we see that CYS has been consolidating sideways for more than one year blue line is showing it for smaller time but if we look at the chart it’s consolidating from Feb 14. Investors can also see that the red rising bottoms line is a slightly positive indicator for an eventual upward movement in the stock. Some might take the current chart as a groundnut formation that could push the stock either way; but as we see we take it as more positive than negative as the above blue line in the chart shows that the stock price is trying to cross the resistance line, and considering the fundamentals back up a positive move up, especially after the dovish Fed announcement in its last meeting. Strike a note that, the stock is far below its book value; and we only assume that CYS might erase about half of the difference between the stock price and the book value. Plus, we are seeing a flat to slightly positive book value gain for Q1 2015 for CYS.
This stock might well have a 20%+ total return for 2015. Many income investors will likely be interested in that. The RSI in CYS' sub chart is also trending upward. With management making good strategy calls, CYS is a buy.
Disclosure:
1) As an author I declare that I don’t have any investment in the aforementioned stock, nor do I get paid from the aforementioned stock company to write, and I have no plans to invest in the stock for the next 72 hours.
2) The above details are taken from the company filings 10K, Wikinvest, transcript from seeking alpha & some research article of huntong9.net 7 seeking alpha authors.
3) The closing stock price of CYS is taken from Yahoo finance.
4) And the above diagrams showing:
Ø Company’s interest portfolio is taken from 10K.
Ø Interest rate chart of 15 & 30 year is taken from the one of the writing of huntong9.net
Ø For technical analysis the chart is subject to copyright of stockcharts.com
Ø The Top director holding image includes all the insider holding is subject to copyright of Gurufocus.com
