As a REIT, CYS must pay out 90% of its net income in dividends
Mortgage REITs like CYS Investments (CYS), Annaly (NLY), American Capital Agency (AGNC), Capstead (CMO), and MFA Financial (MFA) are real estate investment trusts. This means they don’t pay federal income tax at the corporate level. Instead, as long as they distribute 90% of their net income via dividends, they escape corporate taxation.
This also means a REIT will experience a volatile dividend. Most corporations loathe cutting their dividend because of the message it sends to Wall Street, so volatile dividends are generally rare. For REITs, they’re a fact of life. Since 2008, they’ve paid a quarterly dividend of as low as 32 cents and as high as $0.60 a share. They have also paid some special dividends.
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Highlights of the income statement
The company’s average asset yield for the quarter was 2.48%, as opposed to 2.71% for the end of the first quarter. As the yield curve flattened, spreads narrowed.
CYS’s expense ratio increased a basis point, from 1.25% to 1.26%.
Prepayment assumptions represent the fact that mortgages can be paid off early, which means the amount of interest an investor will receive on an MBS is uncertain. Changes in prepayment assumptions will affect the returns of the bond since any premium or discount must be amortized, and if the expected life of the bond changes, the amortization amount will change as well. This makes yields somewhat more volatile. But these are largely non-cash adjustments.
CYS Investments’ prepayment rate increased to 7.6% in the second quarter from 5.6% in the first quarter.
CYS ended up declaring a dividend of $0.32 a share for the first quarter. This is what it paid last quarter. In the second of 2013, it paid $0.34 a share.
This volatility shows you one of the biggest mistakes you can make when looking at a mortgage REIT—annualizing the current dividend and assuming that dividend yield will stay intact over time. Almost by definition, it won’t.