Why CYS Investments reported a 2nd quarter increase in book value
Book value per share is a critical metric for mortgage REITs
Since REITs are financials, they tend to trade off of two important metrics:
- Dividend yield
- Book value per share
Dividend yield is typically why investors buy REITs in the first place. They tend to have much higher dividend yields than a typical S&P 500 stock. This is due to the fact that they must distribute 90% of their earnings as dividends.
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That said, book value per share is often thought of as a floor level for the stock. In other words, if dividends are high, it may trade at an excess of book value. But REITs tend to trade at or just under book value.
Book value, in theory, represents what a stockholder would expect to receive if the company were wound down.
CYS Investments reports its second consecutive increase in book value per share
Book value per share increased from $9.74 in Q1 2014 to $10.31 last quarter. This increase was driven by an increase in shareholder’s equity from $1.84 billion to $1.95 billion. The company opportunistically traded some longer-term Treasuries, which it sold subsequent to the end of the quarter.
CYS benefited from a drop in Treasury rates over the quarter
As a REIT primarily invested in mortgages, CYS is long-duration. This means it’s exposed to interest rate movements. As rates fell, the value of the company’s MBS increased. Since it added to its 30-year MBS during the quarter, it benefited a little more from the 19 basis point drop in bond yields over the quarter.
The REITs with the biggest exposure to interest rates are those that are heavily invested in 30-year-fixed rate MBS—think Annaly Capital (NLY) and American Capital Agency (AGNC). These REITs suffered bigger declines in book value per share last year than their peers like MFA Financial (MFA), Hatteras (HTS), or Capstead (CMO), which invest primarily in adjustable-rate mortgage-backed securities (ARM MBS). These mortgages have a fixed rate for the first three, five, or seven years and then the interest rate floats. This means they have shorter duration, which is another way of saying they have less exposure to increasing interest rates.
Mortgage REIT investors should pay particular attention to a REIT’s duration risk.