CYS Investments Inc (CYS): This Agency mREIT Could Expand its Spread

Cypress Sharpridge Investments reported its first quarter results on April 17 with an earnings beat. The company reported EPS of $0.32, $0.02 ahead of the consensus mean expectations. CYS Investments Inc (NYSE:CYS) is a pure-play mortgage REIT since it invests exclusively in Agency mortgage backed securities. Therefore, the trends visible in its first quarter performance could be seen in the results of other pure-play mortgage RIETs including American Capital Agency Corp. (NASDAQ:AGNC), Annaly Capital Management, Inc. (NYSE:NLY) and ARMOUR Residential REIT, Inc. (NYSE:ARR). The remainder of the investment thesis aims to review the latest performance of CYS Investments Inc (NYSE:CYS).

Investment Portfolio

The company’s Agency residential mortgage backed securities at the end of the first quarter of the current year totaled $20.2 billion, down 5% from the prior quarter. Its composition was more tilted towards MBS forwards with 23.2% invested in forwards (Forward MBS isderivedfrom the fact that actual mortgage backed securities that will be delivered to fulfill a To Be Announced (TBA) trade is not designated at the time of the trade). Given the prevailing QE3 and the resultant attractiveness of MBS forwards, you can expect CYS Investments Inc (NYSE:CYS) to maintain a larger weighting to forwards for the remainder of the current year.

Financials

The company reported interest income of $73.1 million compared to 79.6 million at the end of the linked quarter. This can be attributed to declines in the investment portfolio and the net interest rate spread. Interest expense of $37 million increased 4% over the prior quarter as a result of a hike in cost of funds. As a result, the company posted $36.1 million in net interest income, down 18% sequentially.

Interest Rate Spread

Since CYS Investments invests exclusively in Agency mortgage backed securities, you can expect it to report a decline in its key matrix, the net interest rate spread. During the quarter, the company reported a 19 bps sequential decline in its spread of 0.75%. Much of the decline in the spread was a result of the 17 bps plunge in asset yields, while the 2 bps hike in the cost of funds covered the rest.

Including the forward MBS, CYS Investments Inc (NYSE:CYS) reported a 1.16% net interest spread, down 15 bps from the linked quarter. As some of the forward MBS settle in the coming quarters, you can expect the company to report a higher spread.

However, the spreads are much more dependent on the Fed’s activities. If QE3 continues or is increased, you should expect the spreads at CYS Investments to contract further. Therefore, you should keep a close eye on the Fed’s moves.

Hedges and Leverage

The company has started hedging more during the quarter. The percentage of repurchase agreements swapped increased from 54% during the prior quarter to 65% during the most recent quarter. Further, the company increased its hedge with additional interest rate cap coverage to 30% from the prior quarter’s 24%.