I own 45,000 shares of CYS, and I am long the $12 dec puts for 0.40. (450 contracts)
My reasoning: AGNC will cut their dividend below $1 per quarter, I believe. This is based on net interest margins. I think the damage from AGNC and nly will extend beyond and hit my CYS. I do not think CYS will cut its dividend though because it already has reduced its dividend as the spread narrowed. This sector is full of surprises and with the recent craziness, you'd be crazy not have your downside protected. Last week was turkey day week, most people left on that Wednesday and they will come back NEXT Wednesday. So that is why we have low volume moves to the upside. AGNC's treasury hedges are failing. MBS is selling off while treasury prices are doing well. Because of this, I see the NAV seriously damaged, perhaps as low as $27. Its a function of market level. MBS prices are much much lower. SEE symbol "MBB" to get an idea of where we are today. That market level + the failed hedges... that is where the damage is going to come from. So maybe you want to buy both call and a put. Dividend run up OR sell off.. we will see but i think one of them is due.
You are correct that the market is pricing MREITs according to core income. The risk is calculating the probability of what will happen this quarter. A cut in dividend is guaranteed in the future, core income cannot support the dividend and comp income cannot be used all at once. It is against the interest of management to reduce the size of their portfolio.
The risk is figuring out what management will do. Will they decide to maintain the dividend for one more quarter as a Christmas bonus? Will they cut this quarter and how much will they cut?
Div maintained. Price 35
Div cut to 1.10 Price 33
Div cut to .90. Price 30
Div cut to .70. Price 28
Good luck with your AGNC puts. I'll take the other side of the trade.
I like CYS and AGNC here. CYS is cheaper, but AGNC has better BV protection in an environment where CPR speeds may be somewhat elevated near term on generic collateral. CYS does have a lot of newly originated product that is likely to have more moderate CPRs than most generic pools, so I think investors have oversold that one in grouping it with the NLYs of the world. AGNC stands in a class by itself in navigating through this environment in great shape (highly predictable cash flows plus excellent BV protection).
I disagree with your assertion that AGNC's hedges aren't working. Your BV estimate of $27 is seriously detached from reality. I think BV is around $32 at the moment. MBS collateral (MBB is not a good proxy for what AGNC holds) has cheapened a bit vs. Treasuries in 4Q but only by a moderate degree (and with the aggressive Fed bid that may reverse somewhat into 2013), and pay-ups on prepayment protected MBS pools (70% of AGNC's portfolio) have risen to largely offset this divergence. AGNC is underearning its dividend at the moment but part of this is due to much higher assumed lifetime CPR than the current speeds suggest, temporarily elevated funding costs due to repo rates being 10-15 bps above normal (which should reverse in early 2013), as well as relatively low leverage (7.0X). If AGNC decided to take advantage of wider spreads so far in 4Q and added 1X turn of leverage it would be earning well north of $1 in EPS. Also, AGNC can book gains on its significantly appreciated MBS portfolio to keep taxable earnings up, and it has $1.50ish in UTI to supplement the higher dividend. I agree that the quarterly dividend is probably headed toward $1.00-1.10, but that may be a 2013 event, and still equates to a 13+% dividend yield with decent BV protection.
Well said! The competition from the Fed should drive the MBS prices up reducing yield( and therefore the spread) but increasing the value of the portfolio thereby increasing BV. With the UTI you mentioned there should be plenty of extra moolah to cover the 1.25 for Dec.
Management is well hedged for this scenario and will most likely feed the Fed with the right members of their portfolio. Shed high, scoop low...;-)