Why CYS Investments Inc' Second Quarter Results Bode Well for Annaly Capital Management and AGNC

Source: Company

After most banks presented quarterly earnings last week, it's now time for investors to shift their attention to mortgage REITs. CYS Investments (NYSE: CYS  ) is one of the first mortgage REITs which reported earnings on Monday and solid results they were indeed.

CYS Investments' large, sequential increase in its book value is not only a major success for the company, but also raises hopes that other, bigger mortgage REITs will be able to follow suit and also report sizable book value increases.

Psychological effects of book value growth
Many mortgage REITs posted a return to positive book value growth in the first quarter of 2014 after declines throughout 2013 and investors were throwing away their shares in mortgage REITs in panic mode.

A sequential increase in book value certainly can be seen as a huge confidence boost and indicate that the worst is over for mortgage REITs in terms of the bleeding. Just a short while ago, sector wide book value declines caused extreme uncertainty in the mortgage REIT sector and made investors run for the hills.

CYS Investments has increased its second quarter book value to $10.31 per share which compares against $9.68 per share in the first quarter of 2014 and against $10.20 per share in the second quarter of 2013.

The 6.5% sequential increase in CYS Investments' book value is the clearest sign yet, that mortgage REITs are regaining their strength.

More importantly, the growth in CYS Investments' book value is likely to raise expectations with respect to the development of book values and higher potential valuations at larger sector rivals Annaly Capital Management (NYSE: NLY  ) and American Capital Agency Corporation (NASDAQ: AGNC  ) . Why?

Because these mortgage REITs are industry leaders with market capitalizations of approximately $11 billion and $8 billion respectively, and both REITs clearly have the potential to move the entire sector.

CYS Investments' strong book value growth is also likely to increase confidence in its ability to hold steady its dividend payments and continue to produce a nearly 15% dividend yield for investors.

Stabilizing dividends
It is all about confidence in the mortgage REIT sector and nothing signals more confidence in the dividend prospects of a mortgage REIT than when its dividends bottom out.

Dividends of mortgage REITs have declined substantially over the last two years as companies adjusted their dividend payouts in light of higher interest rate volatility and lower earnings forecasts.

CYS Investments was no exception to this sectorwide theme of dividend adjustments: The mortgage REIT has reduced its quarterly dividend payout from $0.50 per share in the second quarter of 2012 to just $0.32 per share in the most recent quarter.

However, CYS Investments held its dividend steady at $0.32 per share for three consecutive quarters, which gives further credence to the assumption that the process of dividend downward adjustments has come to an end. 

Lower dividends usually go hand in hand with lower share prices for mortgage REITs, as lower share prices bring the price/yield relationship back into balance after a company cut its payouts.

CYS Investments, therefore, continues to exhibit a high dividend yield of nearly 15% and actually outperforms both Annaly Capital Management and American Capital Agency.

Valuation
Mortgage REITs still largely trade at slight discounts to their net asset values. However, should Annaly Capital Management and American Capital Agency also deliver equally strong book value gains as CYS Investments, investor confidence could return quickly to the mortgage REIT sector and drive valuations upward.

The Foolish Bottom Line
CYS Investments' second quarter results were largely a psychological victory for mortgage REIT investors.

The most important take-away of CYS Investments' earnings release was the whopping 6.5% sequential increase in its book value, which should bode well for Annaly Capital Management and American Capital Agency.

With a nearly 15% dividend yield and a high likelihood, that dividends have bottomed, CYS Investments is an interesting alternative to more established mortgage REITs in the sector.

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