Mortgage REITs are popular with many investors right now for the high dividend yields they currently provide. Sporting a dividend yield north of 19%, CYS Investments
Mortgage REITs issue shares to investors to raise capital, which they use to buy mortgage-backed securities. They also use short-term financing to boost their returns. They repay lenders out of the mortgage payments they collect, and most of the rest is returned to shareholders in dividends.
Here's a simple visualization:
Let's take a quick look at four things investors in CYS Investments need to know. After that, we'll find out how the company stacks up next to its competitors.
1. Interest rate spread
A REIT's interest rate spread is the difference between a REIT's financing costs and its interest income. It's a decent measure of investing profitability -- and portfolio risk.
2. Debt-to-equity ratio
Since interest rate spreads tend to be pretty narrow, REITs like to leverage those returns to generate bigger returns. Companies with safer portfolios can afford to take on more leverage risk than those with riskier investments.
3. Share growth
Since REITs have to pay out the vast majority of their earnings in dividends, the only way to grow their business is to take on more leverage or issue new shares. If a company issues a lot of shares, we want to make sure it does so at attractive prices so investors aren't diluted.
4. Dividend yield
The main reason to buy mortgage REITs is for their dividend. The forward yield tells us what dividends we'll get paid over the next year if earnings hold constant.
Let's see how CYS Investments stacks up next to its peers in these four crucial areas:
Interest Rate Spread (Q2 2011)
2-Year Annual Share Count Growth
Source: Capital IQ, a division of Standard & Poor's.
CYS Investments has grown its share count considerably since going public in 2009. Over that period, shares traded an average price-to-book value of approximately one, suggesting the company was able to get decent but not great prices for its shares.
Like Annaly and ARMOUR, CYS Investments carries a high debt-to-equity ratio. That's because the three tend to invest in ultra-safe "agency securities" -- mortgages whose interest payments are guaranteed by Fannie Mae and Freddie Mac. Because these are the safest type of mortgage to own (from the perspective of possible default), they produce an interest rate spread that's lower than riskier buyers, like Chimera. Though it means taking on greater leverage, and all the potential interest rate risk that could entail, CYS Investments' high debt-to-equity ratio and moderate interest rate spread allows the company to carry little default risk while still paying out a juicy 19%-plus dividend yield.
Ilan Moscovitz doesn't own shares of any company mentioned. The Motley Fool owns shares of Annaly Capital Management and Chimera Investment. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.