CYS reported third-quarter results on Oct. 20, becoming the first mortgage real estate investment trust, or mREIT, to report quarterly numbers in this earning season. Here are three of the most interesting takeaways for Annaly Capital Management leading into its earning on Nov. 5.
3. Earnings were OK
Because Annaly and CYS are investment companies they will have unrealized gains on investments. This is why "core earnings" -- which include unrealized gains and losses on investments -- is one of the first things I look for in a mortgage REIT's quarterly results.
As you can see, comparing CYS's net income over the course of 2014 makes the third quarter looks like a disaster. However, including unrealized gains improves the picture. Unfortunately, it was still necessary for CYS to lower its dividend from $0.32 per share to $0.30.
On the positive side, more assets means more income, and CYS took advantage of a slight cheapening of mortgage-backed securities by adding $1.8 billion worth of securities in the third quarter.
Overall, I don't see anything too eye-popping. Mortgage real estate investment trusts as a sector are preparing for rising interest rates -- which includes holding fewer assets -- and that has and will continue to strain earnings. I would be shocked if Annaly increased its dividend; instead, I expect it to remain right around the $0.30 mark where it stands today.
2. The U.S. Federal Reserve is still hogging the supply
The Federal Reserve later this month is likely to end the massive bond-buying program associated with "quantitative easing." The U.S. central bank will, however, continue to reinvest interest and principal payments from its $1.7 trillion (link opens a PDF) worth of mortgage-backed securities. Therefore, it seems unlikely there will be a boost in mortgage supply or a significant cheapening of prices in the near future.
CYS Investments CEO Kevin Grant said it best in the company's most recent conference call: "[W]e'll have opportunities, but they're going to be fleeting to add mortgage securities at wider spreads."
Mortgage REITs earn the spread, or difference, between what it costs to borrow and the yield on securities. The wider the spreads the greater the returns. But, as Grant suggested, CYS and Annaly might be looking at a prolonged period of tighter spreads, fewer opportunities, and strained earnings.
1. Best available opportunity
That is now twice I have used the phrase "strained earnings," which I think appropriately sums up my feelings. However, there's always a silver lining. According to Grant, that opportunity is share buybacks: "[I]f you want to pin me down on what the best use of capital is right now, the entire sector is cheap. It's probably the best place to deploy capital."
Year to date, Annaly has a total return of 23% and CYS has a return of 34%. However, as a group, mREITs are still trading at historically cheap valuations. In buying back shares of stock companies can reduce the total shares outstanding and immediately increase the value per share.
Despite suggesting that this is a great opportunity, CYS did not repurchase shares in the third quarter. As more companies start reporting earnings, I'll be most interested to see which, if any, are taking advantage of this opportunity.