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CYS Investments: Be Ready To Grab Shares On Monday Morning

Their reporting quality is exceptional and they deserve to trade in line with larger Agency mREITs or even at a slight premium to those peers.

The mREIT went ex-dividend on Friday and opened a little weak.

If retail investors decide over the weekend that they should exit after collecting the dividend, a temporary excess of sellers could provide a buying opportunity.

Investors can use AGNC and NLY to determine fair relative pricing. If CYS opens low relative to those peers, investors should take advantage of it.

CYS Investments (NYSE:CYS) should be on the radar for mREIT investors. When analyzing mREITs simply on the quality of their financial reporting and the talent of management, CYS stands as the champion. Until another mREIT puts in an enormous volume of effort to establish the same level of transparency that CYS produces, this mREIT will be holding onto that belt. Of course, investors need to be aware of other very important factors in buying mREITs. Making a good buy in the mREIT market requires more than simply buying the best quality investment available. Even though CYS Investments is quite arguably the king within the mREIT sector for reporting quality, it is critical that investors get a good entry price.

Evidence of Reporting Quality

Look at the slide below from their latest supplemental presentation:

Note the enormous area that I have surrounded with a green box. There are 16 individual disclosures in there. Normally, when mREITs need to make a huge volume of disclosures it is a negative sign, but CYS is using these disclosures to tell investors the precise methodology of their calculations. That is excellent. Every so often when I'm going through presentations and testing calculations, I will find an mREIT that is using an "interesting" method to calculate their numbers. It could include making adjustments with little economic rationale or it could simply be incorrect math. Certainly investors would like to believe that no professional management team would release slides with fundamental errors in their calculations, but I've seen it happen. Of course, it hasn't happened with CYS Investments. Because CYS discloses their methodology, it encourages higher quality reporting.

The benefit here is not only transparency about what CYS is doing in calculating the numbers, it is also transparency into the earnings of the mREIT. The way CYS investments structures hedges and reports the economic interest costs results in lower numbers for "Core EPS" than other mREITs would report if they held a portfolio that was economically identical. For instance, CYS enters into LIBOR swaps with an option to terminate the swap at preset dates.

If another mREIT wanted the exact same economic option, they would enter into the LIBOR swap and buy a swaption that gave them the right to receive the same rate they were paying on the swap. Economically, this would be the same as canceling the existing swap. The difference is that buying a swaption would result in a cash outflow that would never flow through "Core EPS". Building the effective option cost into the interest rate on the swap results in CYS recognizing that cost in Core EPS.

Potential Opportunity

On Friday, September 18th, the mREIT went ex-dividend and dropped accordingly. Because retail investors occasionally make irrational decisions, I would suggest that readers watch for the opening prices on Annaly Capital Management (NYSE:NLY) and American Capital Agency Corp. (NASDAQ:AGNC). If CYS opens significantly weaker than NLY and AGNC, it would most likely reflect retail investors setting sell orders over the weekend to "get out" after collecting the dividend. Yes, they had that dividend locked up Friday morning, but behavioral analysis is all about recognizing when investors do things that don't make sense.

If CYS opens up weak compared to AGNC/NLY, it is an opportunity to get in cheap and take advantage of investors leaving sell orders open. Such an error would likely be corrected very quickly. There is a good chance that CYS opens just fine, but if it does open weak, I would expect a rapid bounce back.

Why Behavior Analysis Matters

As an mREIT analyst, the focus of my work is figuring out which mREITs are trading at more attractive values. The major goal is to find an mREIT trading below fair comparable values so investors can get the best prices for a given level of expected future income.

Because I believe that it is possible for some mREITs to offer superior risk-adjusted returns based off market prices (which are constantly fluctuating), I must believe that markets are not always efficient. The first step in handling inefficient markets is to look for which investments are mispriced. Declaring that an mREIT has been incorrectly priced by the market takes a certain level of either confidence or arrogance. By definition, declaring that the mREIT is underpriced or overpriced is stating that the marginal buyer or seller of that security is substantially wrong about the intrinsic value.

The second step in handling those inefficient markets is to work on predicting which events might trigger an imbalance between buyers and sellers. If the market fails in pricing a security for 30 minutes, there is not sufficient time to perform a new analysis and determine the intrinsic value. The ideal analysis would recognize in advance that there was an event that could cause a temporary pricing failure.

When predicting potential opportunities, the biggest challenge is that it is entirely possible that those potential opportunities do not occur. There is very little I can do to predict whether CYS will actually open at a significant discount to peers, but if it does, I'm fairly confident it would be a short-term weakness.

Conclusion

CYS Investments is an mREIT that offers high-quality financial data and deserves to trade in line with the larger Agency mREITs. If anything, I believe CYS should trade at a fairly slight premium based on current (not last reported) book values. When mREITs go ex-dividend, there is a higher frequency of short-term market failures. Investors should watch for that weakness on Monday morning if they are angling to get an attractive entry price. Note that a relative weakness of 1 to 3% would be sufficient to establish CYS as being quite attractively priced. I would be shocked if it came in with a relative weakness bigger than 5%, but if that happened it would make CYS an absolute screaming buy.

Additional disclosure: Information in this article represents the opinion of the analyst. All statements are represented as opinions, rather than facts, and should not be construed as advice to buy or sell a security. Ratings of “outperform” and “underperform” reflect the analyst’s estimation of a divergence between the market value for a security and the price that would be appropriate given the potential for risks and returns relative to other securities. The analyst does not know your particular objectives for returns or constraints upon investing. All investors are encouraged to do their own research before making any investment decision. Information is regularly obtained from Yahoo Finance, Google Finance, and SEC Database. If Yahoo, Google, or the SEC database contained faulty or old information it could be incorporated into my analysis.


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