Cypress Sharpridge is another of the recently IPO’d generation of mREITs. Starting with a $100 million IPO in June of 2009, the company has grown its capital base quickly with secondary offerings, but its history as an Agency mortgage REIT dates back to 2006.
Its (second) secondary last week pushed it to a market cap in the $350 million neighborhood and put it into the discussion by the dividend hound investors, so it’s worth a look.
I have to say that a lot of those investors were unhappy with CYS when they announced this secondary, in no small measure because of the timing.
On June 14th, the filing for up to $750 million additional common or preferred stock was announced ten minutes after the second quarter dividend (60 cents a share) was announced. For a company with less than $250 million in market cap at the time, such a large filing stunned some investors. They also structured the dividend record and payment dates (both) for June 28th.
Adding injury to insult, when the registration became effective on June 23rd with the stock trading over $14 a share, the company announced after the market closed that they would launch the offering with an expected price range of $12 to $14 a share. Not letting moss grow under their feet, they priced the very next day, at $12.50.
That was beneath the current book value per share ($13.85 in a June 23rd SEC filing), making the offer dilutive in both senses of the word (book value and earnings per share).
The news is not all bad, however, as the new capital pushes the company into the next (lower) tier of fees paid to the manager, Sharpridge (owned by CEO Kevin Grant). When the company had net capital beneath $250 million, it was paying 1.5% in base management fees. The latest capital raise is subject to 1.25% fees.
The other benefit was to lower the per-share effect of $9 million invested in legacy corporate bank loan CLO’s, which were purchased when the world seemed like a much safer place. Unfortunately, it looks like Sharpridge chose to reach for yield in those investments, taking exposure pretty far down the stack of credit priority, so a round of bad news for corporate America could easily wipe out that investment. At least now it amounts to less than 3% of equity capital.
As to asset mix and hedging, CYS is fairly aggressive in its portfolio selection, with just under half of its portfolio at December 31, 2009 consisting of 4.5% fixed rate MBS, and another large slug consisting of hybrid ARMs with average reset dates nearly 4 years in the future. The short reset ARMs and monthly reset ARMs were less than 25% of the portfolio in the snapshot in the 2009 annual report.
They were hedging just 54% of their repo book at the end of 2009, which enabled them to enjoy a fatter net interest margin after hedging than their peers. That was reported at 300 basis points average for 2009, but we should expect that to decline fairly rapidly with the new capital deployed in today’s world with far tighter spreads. My guess is that it has already declined by 50 BP’s or more, so it was a surprise to me when they raised their quarterly dividend from 55 cents to 60 cents the day before they launched the recent secondary issue.
Kevin Grant, the driving force behind CYS, began his career on the buy side (Aetna in 1985), did a stint on the sell side as a strategist (Morgan Stanley until 1993), and made his mark running money at Fidelity until he started Sharpridge in 2005/2006.
With only 24 employees at the Manager dedicated to running CYS, it’s clear that they intend to stay in Agency paper, and avoid building out the credit analysis function.
The current high yield (over 19%) is primarily the result of the lowered price set to sell the latest secondary. It does not seem likely that they will be able to maintain the fat spreads they showed last year for the next 4 to 6 quarters even if the Fed continues to accommodate with near-zero short rates.
Having said that, some investors I respect hold reasonably large exposures to CYS. I’m just not joining them at this point, though further discounts to the price might bring out my inner bargain hunter.
AS ALWAYS, THIS IS NOT INVESTMENT ADVICE.