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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
- -----
EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED: SEPTEMBER 30, 1995
OR
______ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ____________ TO ______________
COMMISSION FILE NUMBER: 1-8996
CAPSTEAD MORTGAGE CORPORATION
(Exact name of Registrant as specified in its Charter)
MARYLAND 75-2027937
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
2711 NORTH HASKELL AVENUE, DALLAS, TEXAS 75204
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (214) 874-2323
2001 BRYAN TOWER, DALLAS, TEXAS 75201
(Former name, former address and formal fiscal year, if changed from last
report)
The Registrant meets the conditions set forth in General Instruction H(1)(a) and
(b) for Form 10-Q and is therefore filing this Form under the reduced disclosure
format.
Indicate by check mark whether the Registrant (1) has filed all documents and
reports required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. YES X NO
----- -----
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the last practicable date.
Common Stock ($0.01 par value) 15,528,141 as of November 9, 1995
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CAPSTEAD MORTGAGE CORPORATION
FORM 10-Q
FOR THE QUARTER ENDED SEPTEMBER 30, 1995
INDEX
PART I. - FINANCIAL INFORMATION
PAGE
----
ITEM 1. Financial Statements
Consolidated Balance Sheet - September 30, 1995 and
December 31, 1994................................................ 3
Consolidated Statement of Income - Quarter and Nine Months Ended
September 30, 1995 and 1994...................................... 4
Consolidated Statement of Cash Flows - Nine Months Ended
September 30, 1995 and 1994...................................... 5
Notes to Consolidated Financial Statements........................ 6
ITEM 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations............ 12
PART II. - OTHER INFORMATION
ITEM 6. Exhibits and Reports on Form 8-K........................... 19
SIGNATURES......................................................... 20
- 2 -
PART I. -- FINANCIAL INFORMATION
CAPSTEAD MORTGAGE CORPORATION
CONSOLIDATED BALANCE SHEET
(IN THOUSANDS)
ITEM 1. FINANCIAL STATEMENTS
SEPTEMBER 30, 1995 DECEMBER 31, 1994
------------------- ------------------
(UNAUDITED)
ASSETS
Mortgage securities collateral $4,971,715 $5,270,103
Mortgage investments 4,208,845 3,305,984
---------- ----------
9,180,560 8,576,087
Less allowance for possible losses (5,603) (7,354)
---------- ----------
9,174,957 8,568,733
Cash and cash equivalents 16,263 21,741
Prepaids, receivable and other 98,117 70,415
Mortgage servicing rights 373,610 282,969
---------- ----------
$9,662,947 $8,943,858
========== ==========
LIABILITIES
Collateralized mortgage securities $4,686,757 $5,102,145
Short-term borrowings 4,256,925 3,190,582
Accounts payable and accrued expenses 16,812 11,568
Mortgage servicing rights
acquisitions payable 52,380 75,888
---------- ----------
9,012,874 8,380,183
---------- ----------
STOCKHOLDERS' EQUITY
Preferred stock - $0.10 par value;
100,000 shares authorized:
$1.60 Cumulative Preferred Stock,
Series A, 572 and 623 shares
issued and outstanding ($9,381
aggregate liquidation preference) 8,054 8,720
$1.26 Cumulative Convertible
Preferred Stock, Series B, 30,558
and 30,277 shares issued and
outstanding ($347,750 aggregate
liquidation preference) 328,480 324,779
Common stock - $0.01 par value; 100,000
shares authorized; 15,450 and 15,304
shares issued and outstanding 154 153
Paid-in capital 314,098 310,766
Undistributed income (deficit) (2,263) (2,228)
Unrealized gain (loss) on debt and
equity securities 1,550 (78,515)
---------- ----------
650,073 563,675
---------- ----------
$9,662,947 $8,943,858
========== ==========
See accompanying notes to consolidated financial statements.
- 3 -
CAPSTEAD MORTGAGE CORPORATION
CONSOLIDATED STATEMENT OF INCOME
(UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
QUARTER ENDED NINE MONTHS ENDED
SEPTEMBER 30 SEPTEMBER 30
--------------------- ---------------------
1995 1994 1995 1994
--------- --------- --------- ---------
INTEREST INCOME:
Mortgage securities collateral $ 94,932 $ 89,304 $290,338 $261,436
Mortgage investments 61,611 55,587 171,284 145,008
-------- -------- -------- --------
Total interest income 156,543 144,891 461,622 406,444
-------- -------- -------- --------
INTEREST AND RELATED EXPENSES:
Collateralized mortgage securities 89,718 84,646 275,511 247,663
Short-term borrowings 55,526 41,375 154,279 91,002
Mortgage insurance and other 2,847 3,187 8,720 10,436
Provision for possible losses 500 2,000 1,700 3,000
-------- -------- -------- --------
Total interest and related expenses 148,591 131,208 440,210 352,101
-------- -------- -------- --------
Net margin on mortgage assets 7,952 13,683 21,412 54,343
-------- -------- -------- --------
MORTGAGE SERVICING REVENUES:
Servicing fees 17,218 8,848 47,780 16,517
Other 5,837 1,241 13,303 1,831
-------- -------- -------- --------
Total mortgage servicing revenues 23,055 10,089 61,083 18,348
-------- -------- -------- --------
MORTGAGE SERVICING EXPENSES:
Salaries and related costs 2,005 923 4,615 1,878
General, administrative and other 3,512 975 9,171 1,623
Amortization of mortgage servicing
rights 7,809 1,697 17,993 2,856
-------- -------- -------- --------
Total mortgage servicing expenses 13,326 3,595 31,779 6,357
-------- -------- -------- --------
Net margin on mortgage servicing
operations 9,729 6,494 29,304 11,991
-------- -------- -------- --------
OTHER REVENUES:
Gain on sales 5,131 4,923 8,275 7,080
CMO administration 887 1,019 2,732 3,044
Other 353 198 1,413 800
-------- -------- -------- --------
Total other revenues 6,371 6,140 12,420 10,924
-------- -------- -------- --------
OTHER EXPENSES:
Salaries and related costs 1,306 2,067 4,587 6,441
General and administrative 1,449 1,983 4,148 5,051
-------- -------- -------- --------
Total other expenses 2,755 4,050 8,735 11,492
-------- -------- -------- --------
NET INCOME $ 21,297 $ 22,267 $ 54,401 $ 65,766
======== ======== ======== ========
Net income $ 21,297 $ 22,267 $ 54,401 $ 65,766
Less cash dividends on preferred stock (9,846) (9,729) (29,467) (29,119)
-------- -------- -------- --------
Net income available to common
stockholders $ 11,451 $ 12,538 $ 24,934 $ 36,647
======== ======== ======== ========
NET INCOME PER SHARE:
Primary $0.74 $0.82 $1.62 $ 2.40
Fully diluted 0.73 0.81 1.61 2.36
CASH DIVIDENDS PAID PER SHARE:
Common $0.74 $0.83 $1.62 $ 2.49
Series A preferred 0.40 0.40 1.20 1.20
Series B preferred 0.32 0.32 0.95 0.95
See accompanying notes to consolidated financial statements.
- 4 -
CAPSTEAD MORTGAGE CORPORATION
CONSOLIDATED STATEMENT OF CASH FLOWS
(UNAUDITED)
(IN THOUSANDS)
NINE MONTHS ENDED
SEPTEMBER 30
--------------------------
1995 1994
----------- -----------
OPERATING ACTIVITIES:
Net income $ 54,401 $ 65,766
Noncash items:
Amortization of discount and premium 12,842 5,331
Amortization of mortgage servicing rights 17,993 2,856
Depreciation and other amortization 1,899 1,289
Provision for possible losses 1,700 3,000
Net change in prepaids, receivables, other assets,
accounts payable and accrued expenses (14,990) (36,765)
Net gain from investing activities (8,275) (7,080)
----------- -----------
Net cash provided by operating activities 65,570 34,397
----------- -----------
INVESTING ACTIVITIES:
Mortgage securities collateral:
Principal collections on collateral 356,132 1,031,618
Decrease in accrued interest receivable 3,063 8,143
Decrease in short-term investments 4,587 159,737
Purchases of mortgage loans (93,023) (1,835,687)
Originations of mortgage loans (3,875) -
Purchases of agency securities (2,066,002) (1,531,873)
Purchases of equity securities - (17,808)
Purchases of other mortgage securities (114,511) -
Purchases of mortgage servicing rights (120,564) (170,114)
Principal collections on mortgage investments 323,648 255,276
Purchases of hedge instruments (17,230) -
Proceeds from sales of hedge instruments 24,012 -
Proceeds from sales and redemptions 1,058,726 39,911
----------- -----------
Net cash used by investing activities (645,037) (2,060,797)
----------- -----------
FINANCING ACTIVITIES:
Collateralized mortgage securities:
Issuance of securities - 2,093,822
Principal payments on securities (423,126) (1,226,309)
Increase (decrease) in accrued interest payable 2,348 (7,909)
Capital stock transactions 6,368 4,852
Dividends paid (54,436) (67,089)
(Decrease) increase in mortgage servicing
acquisitions payable (23,508) 33,295
Increase in short-term borrowings 1,066,343 1,120,062
----------- -----------
Net cash provided by financing activities 573,989 1,950,724
----------- -----------
Net decrease in cash and cash equivalents (5,478) (75,676)
Cash and cash equivalents at beginning of period 21,741 87,760
----------- -----------
Cash and cash equivalents at end of period $ 16,263 $ 12,084
=========== ===========
NONCASH INVESTING AND FINANCING ACTIVITIES:
Charges to allowance for possible losses $ 3,451 $ 2,044
Transfers from mortgage investments to mortgage
securities collateral $ - $ 2,151,695
See accompanying notes to consolidated financial statements.
- 5 -
CAPSTEAD MORTGAGE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 1995
(UNAUDITED)
NOTE A - BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements have been prepared
in accordance with generally accepted accounting principles for interim
financial information and with the instructions to Form 10-Q and Rule 10-01 of
Regulation S-X. Accordingly, they do not include all of the information and
footnotes required by generally accepted accounting principles for complete
financial statements. In the opinion of management, all adjustments (consisting
of normal recurring accruals) considered necessary for a fair presentation have
been included. Operating results for the quarter and nine months ended
September 30, 1995 are not necessarily indicative of the results that may be
expected for the calendar year ending December 31, 1995. For further
information refer to the consolidated financial statements and footnotes thereto
included in the Company's annual report on Form 10-K for the year ended December
31, 1994. Certain amounts for prior periods have been reclassified to conform
to the 1995 presentation.
NOTE B - MORTGAGE INVESTMENTS
Mortgage investments and the related average effective interest rates
(calculated excluding unrealized gains and losses) during the periods indicated
were as follows (dollars in thousands):
QUARTER NINE MONTHS
ENDED ENDED
AS OF SEPTEMBER 30 SEPTEMBER 30 SEPTEMBER 30
---------------------- --------------------- ----------------------
1995 1994 1995 1994 1995 1994
---------- ---------- ---------- --------- ---------- ----------
MORTGAGE LOANS HELD FOR SALE $ 6,880 $ - 8.11% -% 8.06% -%
MORTGAGE LOANS 6,387 336,922 8.61 6.99 6.97 6.66
AAA-RATED MORTGAGE PASS-
THROUGH SECURITIES
PORTFOLIO:
Fixed-rate securities 1,910 309,709 8.78 6.69 8.73 6.71
Medium-term securities 431,868 472,988 6.88 6.95 6.95 6.90
Adjustable-rate securities 808,624 794,361 7.06 5.50 6.78 5.27
AGENCY SECURITIES PORTFOLIO:
Fixed-rate securities 499,171 504,525 6.31 6.44 6.33 6.44
Adjustable-rate securities 2,405,036 1,012,345 6.24 4.51 6.04 4.52
Notes 48,969 333,660 7.15 7.01 6.99 7.01
---------- ----------
$4,208,845 $3,764,510
========== ==========
The Company classifies its mortgage investments by term and interest rate
characteristics of the underlying mortgage loans. Fixed-rate mortgage
investments (i) have fixed rates of interest for their entire terms, or (ii)
have an initial fixed rate period of ten years after origination and then adjust
annually based on a specified margin over 1-year United States Treasury
Securities ("1-year Treasuries"). Medium-term mortgage investments (i) have an
initial fixed-rate period of three or five years after origination and then
adjust annually based on a specified margin over 1-year Treasuries or (ii) have
initial interest rates that adjust one time, approximately five years following
origination of the mortgage loan, based on a specified margin over the Federal
National Mortgage Association ("FNMA") yields for 30-year
- 6 -
fixed-rate commitments at the time of adjustment. Adjustable-rate mortgage
investments either (i) adjust semiannually based on a specified margin over the
6-month London Interbank Offered Rate ("LIBOR"), or (ii) adjust annually based
on a specified margin over 1-year Treasuries. Fixed-rate and adjustable-rate
mortgage agency securities consist of mortgage-backed securities issued by
government-sponsored entities, either the Federal Home Loan Mortgage
Corporation, FNMA or the Government National Mortgage Association. Agency notes
are unsecured, callable, fixed-rate notes issued by the Federal Home Loan Bank
Board and mature in 1997.
At September 30, 1995 the AAA-rated private mortgage pass-through securities
("Mortgage Pass-Throughs") and the agency securities were pledged to secure
short-term borrowings.
NOTE C - NET INTEREST INCOME ANALYSIS
The following tables summarize interest income and interest expense and average
effective interest rates for the periods indicated (dollars in thousands):
QUARTER ENDED SEPTEMBER 30
--------------------------------------
1995 1994
------------------ ------------------
AMOUNT AVERAGE AMOUNT AVERAGE
-------- -------- -------- --------
Interest income:
Mortgage securities collateral $ 94,932 7.61% $ 89,304 7.55%
Mortgage investments 61,611 6.58 55,587 5.94
-------- --------
Total interest income 156,543 144,891
-------- --------
Interest expense:
Collateralized mortgage securities 89,718 7.65 84,646 7.44
Short-term borrowings 55,526 5.90 41,375 4.69
-------- --------
Total interest expense 145,244 126,021
-------- --------
Net interest $ 11,299 $ 18,870
======== ========
NINE MONTHS ENDED SEPTEMBER 30
--------------------------------------
1995 1994
------------------ ------------------
AMOUNT AVERAGE AMOUNT AVERAGE
-------- -------- -------- --------
Interest income:
Mortgage securities collateral $290,338 7.60% $261,436 7.65%
Mortgage investments 171,284 6.49 145,008 6.06
-------- --------
Total interest income 461,622 406,444
-------- --------
Interest expense:
Collateralized mortgage securities 275,511 7.60 247,663 7.52
Short-term borrowings 154,279 6.01 91,002 4.25
-------- --------
Total interest expense 429,790 338,665
-------- --------
Net interest $ 31,832 $ 67,779
======== ========
- 7 -
The following tables summarize the amount of change in interest income and
interest expense due to changes in interest rates versus changes in volume for
the quarter and nine months ended September 30, 1995, compared to the same
periods in 1994 (in thousands):
QUARTER ENDED SEPTEMBER 30, 1995
-----------------------------------
RATE* VOLUME* TOTAL
----------- ---------- ----------
Interest income:
Mortgage securities collateral $ 703 $ 4,925 $ 5,628
Mortgage investments 6,027 (3) 6,024
-------- ------- --------
Total interest income 6,730 4,922 11,652
-------- ------- --------
Interest expense:
Collateralized mortgage securities 2,423 2,649 5,072
Short-term borrowings 11,272 2,879 14,151
-------- ------- --------
Total interest expense 13,695 5,528 19,223
-------- ------- --------
Net interest $ (6,965) $ (606) $ (7,571)
======== ======= ========
NINE MONTHS ENDED SEPTEMBER 30, 1995
------------------------------------
RATE* VOLUME* TOTAL
------------ ---------- ----------
Interest income:
Mortgage securities collateral $ (1,995) $30,897 $ 28,902
Mortgage investments 10,648 15,628 26,276
-------- ------- --------
Total interest income 8,653 46,525 55,178
-------- ------- --------
Interest expense:
Collateralized mortgage securities 2,897 24,951 27,848
Short-term borrowings 42,679 20,598 63,277
-------- ------- --------
Total interest expense 45,576 45,549 91,125
-------- ------- --------
Net interest $(36,923) $ 976 $(35,947)
======== ======= ========
* THE CHANGE IN INTEREST DUE TO BOTH VOLUME AND RATE HAS BEEN ALLOCATED TO
VOLUME AND RATE CHANGES IN PROPORTION TO THE RELATIONSHIP OF THE ABSOLUTE
DOLLAR AMOUNTS OF THE CHANGE IN EACH.
NOTE D - DISCLOSURES REGARDING FAIR VALUES OF DEBT AND EQUITY SECURITIES
The estimated fair values of debt and equity securities have been determined
using available market information and appropriate valuation methodologies.
However, considerable judgment is required in interpreting market data to
develop these estimates. In addition, fair values fluctuate on a daily basis.
Accordingly, the estimates presented herein are not necessarily indicative of
the amounts that could be realized in a current market exchange. The use of
different market assumptions and/or estimation methodologies may have a material
effect on the estimated fair values.
- 8 -
The following tables summarize available-for-sale and held-to-maturity debt and
equity securities as of September 30, 1995 and December 31, 1994 (in thousands):
SEPTEMBER 30, 1995: AVAILABLE-FOR-SALE SECURITIES
----------------------------------------------
GROSS GROSS
UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
---------- ---------- ---------- ----------
Mortgage Pass-Throughs:
Fixed-rate mortgage
securities $ 1,879 $ 32 $ 1 $ 1,910
Medium-term mortgage
securities* 27,923 116 8,159 19,880
Adjustable-rate mortgage
securities 799,719 8,905 - 808,624
Adjustable-rate mortgage
agency securities 2,404,590 534 88 2,405,036
Other mortgage securities 114,286 1,189 978 114,497
---------- ------- ------- ----------
$3,348,397 $10,776 $ 9,226 $3,349,947
========== ======= ======= ==========
HELD-TO-MATURITY SECURITIES
----------------------------------------------
GROSS GROSS
UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
---------- ---------- ---------- ----------
Medium-term Mortgage Pass-
Throughs* $ 411,988 $ 7,600 $ - $ 419,588
Agency securities:
Fixed-rate mortgage securities 499,171 - 19,993 479,178
Notes 48,969 52 - 49,021
Mortgage securities collateral 170,461 5,143 56,831 118,773
---------- ------- ------- ----------
$1,130,589 $12,795 $76,824 $1,066,560
========== ======= ======= ==========
DECEMBER 31, 1994: AVAILABLE-FOR-SALE SECURITIES
----------------------------------------------
GROSS GROSS
UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
---------- ---------- ---------- ----------
Debt securities:
Mortgage Pass-Throughs:
Fixed-rate mortgage
securities $ 427 $ - $ 18 $ 409
Medium-term mortgage
securities* 9,054 - 9,054 -
Adjustable-rate mortgage
securities 780,224 - 24,601 755,623
Adjustable-rate mortgage
agency securities 1,088,252 - 45,391 1,042,861
Other mortgage securities 10,369 1,734 810 11,293
---------- ------- ------- ----------
Total debt securities 1,888,326 1,734 79,874 1,810,186
Equity securities 1,113 - 375 738
---------- ------- ------- ----------
$1,889,439 $ 1,734 $80,249 $1,810,924
========== ======= ======= ==========
- 9 -
HELD-TO-MATURITY SECURITIES
----------------------------------------------
GROSS GROSS
UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
---------- ---------- ---------- ----------
Medium-term Mortgage
Pass-Throughs* $ 459,874 $ - $ 12,342 $ 447,532
Agency securities:
Fixed-rate mortgage securities 504,023 - 62,586 441,437
Notes 333,687 - 9,690 323,997
Mortgage securities collateral 5,258,810 7,159 61,700 5,204,269
---------- ---------- -------- ----------
$6,556,394 $7,159 $146,318 $6,417,235
========== ========== ======== ==========
* MEDIUM-TERM MORTGAGE PASS-THROUGHS HELD-TO-MATURITY WERE HELD AVAILABLE-
FOR-SALE UNTIL THE THIRD QUARTER OF 1994. AN UNREALIZED LOSS AT THE
TRANSFER DATE REMAINS A COMPONENT OF THE RECORDED MARK TO MARKET FOR
AVAILABLE-FOR-SALE SECURITIES AND IS BEING AMORTIZED OVER THE LIFE OF THESE
INVESTMENTS. AT SEPTEMBER 30, 1995 THE UNAMORTIZED BALANCE OF THIS
UNREALIZED LOSS WAS $8.1 MILLION.
The fair value of debt and equity securities was estimated using either (i)
quoted market prices when available, including quotes made by lenders in
connection with designating collateral for repurchase arrangements, (ii) offer
prices by the Company for similar mortgage assets, or (iii) expected
securitization results. Mortgage securities collateral has been permanently
financed through the issuance of collateralized mortgage securities and, as a
result, the exposure to changes in the fair value of the underlying assets (and
liabilities) is limited. For this reason, the table above presents the fair
value of the net projected cash flows of the mortgage securities collateral
after payments on the related collateralized mortgage securities using market
discount rates and prepayment assumptions.
The maturity of the Company's mortgage assets is directly affected by the rate
of principal prepayments by mortgagors and redemptions by issuers, including the
Company, of remaining debt securities outstanding (referred to as "clean-up
calls"). As a result, the actual maturity of the Company's mortgage assets
usually occurs well in advance of stated maturities. The Company anticipates
that through prepayments and exercising clean-up calls, a significant portion of
its higher cost collateralized mortgage securities will be retired within the
next several years and a residual amount of high coupon mortgage securities
collateral will be released and can be sold or continued to be held as
investments. Included in mortgage securities collateral is $35.1 million and
$4.6 million of collateral released from the related indentures at September 30,
1995 and December 31, 1994, respectively.
During the first quarter of 1995, $36 million of mortgage securities collateral
previously released from the related indentures pursuant to clean-up calls was
sold at gross realized gains of $966,000. No such sales have occurred since
March. Similar sales aggregating $21 million, which resulted in gross realized
gains of $2,157,000, occurred during the nine months ended September 30, 1994.
During the quarter and nine months ended September 30, 1995, debt and equity
securities held available-for-sale aggregating $431 million and $606 million,
respectively, were sold for gains aggregating $4,960,000 and $6,752,000,
respectively. During the quarter ended September 30, 1994, available-for-sale
equity securities totaling $12 million were sold for gains aggregating
$4,923,000. No other sales of debt and equity securities held available-for-
sale occurred in the nine months ended September 30, 1994. The net unrealized
gains (losses) on available-for-sale securities included as a separate component
of stockholders' equity improved by $3.5 million and $80 million during the
quarter and nine months ended September 30, 1995, respectively.
- 10 -
NOTE E - STOCK SPLIT
On October 20, 1995 the Company declared a 3-for-2 split of the $0.01 par value
common stock, payable on November 15, 1995 to stockholders of record on October
30, 1995. The accompanying consolidated balance sheets, consolidated statements
of income, and notes to consolidated financial statements have not been restated
to reflect the stock split.
- 11 -
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
FINANCIAL CONDITION
- -------------------
The jumbo mortgage loan market has changed dramatically over the last several
years. Mortgage loan originations reached all time highs in 1992 and 1993
because of steadily declining mortgage interest rates which made refinancing
increasingly attractive to mortgagors. In the meantime, more competitors for
the acquisition of jumbo product entered the marketplace. Mortgage interest
rates reached 20 year lows by the fall of 1993; however, by early 1994 rates
began a steady rise. As rising rates choked off the 1992/1993 refinancing boom,
competition to acquire remaining originations intensified. Additionally, the
securitization of mortgage loans (typically through publicly offered
collateralized mortgage obligations or "CMOs") became increasingly less
advantageous due to the increasing cost of credit enhancements such as mortgage
pool insurance and lower investor appetite for CMO bonds, particularly the more
esoteric derivative securities such as certain forms of interest-only strips and
other residual interests.
In an attempt to meet these challenges, the Company implemented a strategy of
selling individual mortgage loans purchased through our jumbo mortgage loan
conduit operation to private investors shortly after the commitment to purchase,
instead of accumulating $100 million or more of similar mortgage loans for an
efficient securitization. This strategy allowed the Company to reduce market
risk associated with accumulating and securitizing jumbo mortgage loans but did
not enable the Company to compete successfully in a more competitive
environment. In November 1995 the Company reached a decision to exit the jumbo
mortgage loan conduit business altogether. This does not represent a
fundamental shift in the direction of the Company, although in the past the
mortgage conduit has been an important source of mortgage investments. Rather,
the Company is continuing to build its mortgage securities and mortgage
servicing portfolio with the goal of producing reasonably balanced results in a
rising or falling interest rate environment.
During the quarter ended September 30, 1995, the Company purchased 161 mortgage
loans totaling $32 million. During the nine months ended September 30, 1995,
387 mortgage loans were purchased totaling $92 million. This compares to
purchases of 819 mortgage loans totaling $214 million, and 6,459 mortgage loans
totaling $1.8 billion during the same periods in 1994, respectively. During the
quarter and nine months ended September 30, 1995, $33 million and $127 million
of mortgage loans were sold, respectively. These sales, low purchase volume,
and the first quarter 1995 formation of $160 million of AAA-rated private
mortgage pass-through securities ("Mortgage Pass-Throughs") substantially
reduced holdings of mortgage loans.
Of the $160 million of Mortgage Pass-Throughs formed during the first quarter of
1995, $137 million were backed by adjustable-rate mortgage ("ARM") loans. No
additional Mortgage Pass-Throughs have been formed in 1995. In addition to
reducing exposure to fraud and credit risk, a primary benefit of pooling
mortgage loans into Mortgage Pass-Throughs is the improved liquidity of AAA-
rated securities over that of individual loans. As a result, when securing
short-term borrowings, the Company is able to negotiate more favorable terms.
The Company acquired $1.6 billion and $1.9 billion of ARM agency securities
during the quarter and nine months ended September 30, 1995, respectively.
Sales during the third quarter included $431 million of ARM agency securities.
After considering these sales and run-off of existing portfolio, the Company's
holdings of ARM investments increased $1.0 billion during the quarter to
- 12 -
$3.2 billion. The Company's investment in agency notes has declined to $49
million as of September 30, 1995 due to redemptions by issuers totaling $285
million during the quarter.
In past years, the Company has been an active issuer of CMOs and other
securities backed by jumbo mortgage loans from the conduit operation. In the
issuance of CMOs, the Company generally retained residual interests in the
securities issued consisting primarily of interest-only and principal-only
strips. During the quarter and nine months ended September 30, 1995, the
Company did not issue any CMOs; however, the Company did acquire $23 million and
$115 million of FNMA trust interest-only securities, respectively, thus
increasing the CMO investment portfolio to $285 million at September 30, 1995,
compared to a portfolio of $168 million at December 31, 1994 and $151 million at
September 30, 1994. Interest-only securities have characteristics similar to
investments in mortgage servicing in that these securities are subject to
prepayment risk in that if the underlying loans prepay faster than anticipated,
it becomes necessary to accelerate amortization of the costs of the securities
and, if high prepayments continue for an extended period, such costs may not be
fully recovered. Derivative financial instruments, specifically 10-year U.S.
Treasury interest rate floors, are held as a partial hedge against prepayment
exposure (see "Effects of Interest Rate Changes"). Open hedge positions with a
$1.0 billion notional amount carried a $507,000 unrealized gain at September 30,
1995.
The mortgage servicing portfolio (excluding pending transfers) increased during
the quarter to $22.0 billion with a weighted average interest rate of 7.34% and
earning an average annual service fee excluding ancillary revenue and earnings
on escrows (the "Average Service Fee") of 30.3 basis points. The September 30,
1995 balance of mortgage servicing rights related to this portfolio was $313
million (142 basis points, or a 4.7 multiple of the Average Service Fee).
Another $3.7 billion of servicing had been acquired as of September 30, 1995
that was pending transfer into our portfolio and is being subserviced by the
sellers. Additional mortgage servicing has been acquired subsequent to quarter-
end. As of November 6, 1995, pending transfers of mortgage servicing totaled
$7.6 billion with a weighted average interest rate of 7.52% and earning an
Average Service Fee of 31.6 basis points. At an average cost of 165 basis
points, these servicing assets are being acquired at a 5.2 multiple of the
Average Service Fee. By early 1996 the mortgage servicing portfolio is expected
to total over $29 billion.
Annualized portfolio run-off, consisting of prepayments and scheduled payments
on mortgage loans serviced, was 10.86% for the quarter, up from 8.35% in the
second quarter due to lower prevailing interest rates and seasonal factors.
Derivative financial instruments, specifically 10-year U.S. Treasury interest
rate floors and 3-month London Interbank Offered Rate ("LIBOR") interest rate
floors, are held as a partial hedge against prepayment exposure (see "Effects of
Interest Rate Changes"). Open hedge positions with a $3.2 billion notional
amount carried a $2.6 million unrealized gain at September 30, 1995.
In an effort to capture as much run-off of our servicing portfolio as possible,
the Company formed the "Home Loan Center," a centralized mortgage origination
unit that offers a variety of loan programs including first mortgage loans and
home equity loans. The Home Loan Center relies heavily on outsourcing labor
intensive aspects of the loan origination process in an effort to remain as
efficient as possible. The Home Loan Center closed its first loan in April 1995
and has originated $3.9 million in first mortgage loans and home equity loans
year-to-date, $2.7 million of which closed in the third quarter. Loans
originated by the Home Loan Center are sold to FNMA, FHLMC or private investors
shortly after the commitment to purchase.
- 13 -
The following table summarizes the Company's utilization of capital as of
September 30, 1995 (in thousands):
CAPITAL
ASSETS BORROWINGS EMPLOYED
---------- -------------- ---------
Mortgage loans $ 13,267 $ - $ 13,267
Mortgage Pass-Through portfolio:
Fixed-rate mortgage securities 1,910 1,839 71
Medium-term mortgage securities 431,868 420,064 11,804
Adjustable-rate mortgage securities 808,624 783,622 25,002
Agency securities portfolio:
Fixed-rate mortgage securities 499,171 476,855 22,316
Adjustable-rate mortgage securities 2,405,036 2,348,866 56,170
Notes 48,969 49,093 (124)
CMO investment portfolio 4,971,715 4,855,343/(A)/ 116,372
Mortgage servicing rights 373,610 60,380/(B)/ 313,230
---------- ---------- --------
$9,554,170 $8,996,062 558,108
========== ==========
Other assets, net of other liabilities 91,965
--------
Total stockholders' equity $650,073
========
(A) INCLUDES $169 MILLION OF RELATED SHORT-TERM BORROWINGS.
(B) REPRESENTS AMOUNTS OWED UNDER CONTRACTS FOR BULK PURCHASES OF MORTGAGE
SERVICING RIGHTS AND $8 MILLION DRAWN ON A $200 MILLION LINE OF CREDIT
SECURED BY EXISTING MORTGAGE SERVICING RIGHTS. EFFECTIVE OCTOBER 14, 1995
THIS LINE OF CREDIT WAS INCREASED TO $300 MILLION.
A significant impact of the rise in mortgage interest rates in 1994 was a
corresponding decline in value of most of the Company's mortgage assets
(excluding servicing rights). The decline in intermediate- and long-term
interest rates since early February 1995 has restored much of the value to these
assets. The effect is most apparent on the $3.3 billion of mortgage securities
held available-for-sale at September 30, 1995 where the unrealized loss of $78.5
million at December 31, 1994 has improved to a net unrealized gain of $1.5
million. Changes in value and ongoing market value risk associated with
remaining mortgage securities will not have a direct impact on the earnings of
the Company as these assets are classified as held-to-maturity and can only be
sold under very limited circumstances.
RESULTS OF OPERATIONS
- ---------------------
Operating results for the current quarter improved markedly from results for the
second quarter of 1995. Net income per common share increased 42% to 74 cents
on net income of $21.2 million from 52 cents on net income of $17.7 million in
the second quarter. Current quarter earnings benefited from slightly lower
borrowing costs, improved interest spreads on mortgage investments and gains on
sales of mortgage assets. Asset sales became attractive as values on mortgage
assets improved during the year due to declines in interest rates. Offsetting
these increases in value were higher prepayment rates on mortgage loans, also
due to declining interest rates. These higher prepayments resulted in increased
amortization costs in the mortgage servicing portfolio and interest-only
securities as well as increased amortization of premiums paid on adjustable-rate
mortgage investments.
- 14 -
Comparative net operating results (interest income or fee revenues, net of
related interest expense or direct operating costs), by source, was as follows
(in thousands, except percentages and per share amounts):
QUARTER ENDED NINE MONTHS ENDED
SEPTEMBER 30 SEPTEMBER 30
------------------ -------------------
1995 1994 1995 1994
-------- -------- -------- ---------
Mortgage loans $ 248 $ 4,579 $ 1,139 $ 25,053
Mortgage Pass-Throughs 1,718 5,112 4,730 14,159
Agency securities 3,109 3,430 8,605 11,759
CMO investments 3,377 2,562 8,638 6,372
Mortgage servicing 9,729 6,494 29,304 11,991
Gain on sales 5,131 4,923 8,275 7,080
CMO administration 887 1,019 2,732 3,044
Other income 353 198 1,413 800
------- ------- ------- --------
Contribution to income 24,552 28,317 64,836 80,258
General and administrative
expenses (2,755) (4,050) (8,735) (11,492)
Provision for possible losses (500) (2,000) (1,700) (3,000)
------- ------- ------- --------
Net income $21,297 $22,267 $54,401 $ 65,766
======= ======= ======= ========
Net income per share*:
Primary $ 0.74 $ 0.82 $ 1.62 $ 2.40
Fully diluted 0.73 0.81 1.61 2.36
Return on average total
stockholders' equity 13.11% 13.83% 11.21% 13.61%
* NOT ADJUSTED FOR THE 3-FOR-2 COMMON STOCK SPLIT PAYABLE ON NOVEMBER 15, 1995
TO STOCKHOLDERS OF RECORD ON OCTOBER 30, 1995.
Operating results for the quarter and nine months ended September 30, 1995
declined 4.4% and 17.3%, respectively, from those achieved in the same periods
of 1994. Results were significantly affected by a series of moves by the
Federal Reserve beginning in February 1994 raising short-term interest rates a
total of three percentage points by February of 1995. These increases resulted
in corresponding increases in the Company's borrowing costs that had the effect
of substantially reducing net interest spreads on mortgage investments. Since
February 1995, intermediate- and long-term interest rates have declined
considerably. While this significant decrease in rates has had little effect on
borrowing costs, the Federal Reserve did reduce short-term interest rates 0.25
of 1% in early July. This reduction in short-term rates reduced borrowing costs
in the third quarter. Any further short-term interest rate cuts by the Federal
Reserve will serve to improve already widening net interest spreads on mortgage
investments.
The net interest spread earned from mortgage loans contributed significantly
less to net operating results than in 1994, due primarily to significantly lower
average holdings of mortgage loans during 1995. Average holdings for the
quarter and nine months ended September 30, 1995, were $13 million and $59
million, respectively, compared to the $662 million and $972 million held during
the same periods in 1994. Lower mortgage loan purchase volume, in the latter
part of 1994 and in 1995, along with 1994 CMO issuances, the formation of
Mortgage Pass-Throughs and $127 million of sales in 1995 has substantially
reduced holdings of mortgage loans. This reflects the Company's efforts to
reduce market risk associated with aggregating and securitizing jumbo mortgage
loans culminating in the decision in November 1995 to exit the jumbo mortgage
loan conduit business (see the discussion above under "Financial Condition").
Mortgage Pass-Throughs contributed less to net operating results compared to the
same periods in 1994 primarily due to substantially higher borrowing costs
- 15 -
offset somewhat by higher yields. Borrowing costs for this portfolio averaged
6.08% and 6.19% for the quarter and nine months ended September 30, 1995,
respectively, compared to 4.79% and 4.31% for the same periods in 1994.
Mortgage Pass-Through yields were higher at 7.00% and 6.84% for the quarter and
nine months ended September 30, 1995, respectively, compared to 6.22% and 6.08%
for the same periods in 1994. The rise in yields is due primarily to the
periodic resetting of coupon rates on underlying ARM loans (see "Effects of
Interest Rate Changes"). The average portfolio outstanding was $1.3 billion for
both the quarter and nine months ended September 30, 1995, compared to $1.5
billion and $1.2 billion, respectively, for the same periods in 1994.
Agency securities contributed less to net operating results compared to the same
periods in 1994 because of substantially higher borrowing costs despite sizable
increases in average portfolio outstanding and higher agency security yields.
Borrowing costs were 5.82% and 5.86%, in the quarter and nine months ended
September 30, 1995, respectively, compared to 4.50% and 4.01% during the same
periods in 1994. The average agency securities portfolio outstanding was $2.4
billion and $2.2 billion for the quarter and nine months ended September 30,
1995, respectively, compared to $1.6 billion and $1.1 billion for the same
periods in 1994. The increase in average portfolio outstanding was primarily
the result of substantial acquisitions of ARM securities in 1994 and 1995.
Agency security yields were 6.35% and 6.26% during the quarter and nine months
ended September 30, 1995, respectively, compared to 5.21% and 5.46% during the
same periods in 1994. The rise in yields is due primarily to the periodic
resetting of coupon rates on underlying ARM loans and the acquisition of higher
yielding ARM securities (see "Effects of Interest Rate Changes").
CMO investments contributed more to net operating results during the quarter and
nine months ended September 30, 1995, than in the same periods in 1994 due
primarily to investments made in FNMA trust interest-only securities during
1995. Additionally, prepayments on mortgage securities collateral were still
relatively high in the first quarter of 1994, the end of the last major
refinancing boom. During the quarter and nine months ended September 30, 1995,
the Company received principal collections on mortgage securities collateral
totaling $145 million and $356 million, respectively, compared to $172 million
and $1.0 billion of run-off in the same periods in 1994. Lower levels of
prepayments have the effect of lowering amortization of bond discounts and
improving operating results (see "Effects of Interest Rate Changes").
Higher mortgage servicing results reflect growth in this operation. Revenues
increased to $23 million and $61 million for the quarter and nine months ended
September 30, 1995, respectively, compared to $10 million and $18 million during
the same periods in 1994. Operating costs also increased, but not to the same
extent as revenues, which reflects efficiencies gained in the servicing process
as the servicing portfolio continues to grow. Amortization of mortgage
servicing rights amounted to nearly $8 million during the current quarter and
$18 million year-to-date, significantly higher than in the same periods in 1994
due to portfolio growth and higher levels of prepayments caused by lower
interest rates.
During the quarter and nine months ended September 30, 1995, the Company sold
$464 million and $767 million, respectively, of mortgage assets consisting of
agency securities, mortgage loans and mortgage securities collateral previously
released from CMOs pursuant to "clean-up calls."
General and administrative expenses were lower for the quarter and nine months
ended September 30, 1995 compared to the same periods in 1994 due primarily to
- 16 -
additional allocations of costs to the mortgage servicing operation in light of
this operation's growth relative to that of the rest of the Company.
LIQUIDITY AND CAPITAL RESOURCES
- -------------------------------
The Company's primary sources of funds include monthly principal and interest
payments on mortgage loans and mortgage securities, short-term borrowings,
excess cash flows on CMO investments, proceeds from securitizations and sales of
mortgage assets, servicing fees and other revenue from the mortgage servicing
portfolio, and equity offerings when available. The Company currently believes
that these funds are sufficient for the acquisition of mortgage assets,
repayments on short-term borrowings, growth of the mortgage servicing portfolio
and the payment of cash dividends as required for Capstead's continued
qualification as a Real Estate Investment Trust ("REIT"). It is the Company's
policy to remain strongly capitalized and conservatively leveraged.
The Company may, from time to time, sell mortgage assets which may increase
quarterly income volatility because of the recognition of transactional gains or
losses. Sales in 1995 were related to reducing holdings of mortgage loans and
collateral released from CMOs pursuant to clean-up calls and sales of certain
agency securities made attractive as values on our mortgage investments improved
during the year because of declines in interest rates.
Short-term borrowings are primarily made under repurchase arrangements. The
Company has uncommitted repurchase facilities with investment banking firms to
finance mortgage loan holdings and the Mortgage Pass-Through portfolio, subject
to certain conditions. Interest rates on borrowings under these facilities are
based on overnight to 30-day LIBOR rates. The Company also enters into
repurchase and dollar repurchase arrangements with investment banking firms to
whom the Company pledges agency securities and other mortgage assets as
collateral. The terms and conditions of these arrangements, including interest
rates, are negotiated on a transaction-by-transaction basis.
At September 30, 1995 the Company had available $192 million of a $200 million
line of credit with an investment banking firm to be secured by servicing
assets, $120 million of which is committed. Effective October 14, 1995 this
line of credit was increased to $300 million. Advances have separate maturities
and rates of interest with interest due monthly. Interest rates on advances
under this facility are based on LIBOR rates related to the term of the advance.
EFFECTS OF INTEREST RATE CHANGES
Changes in interest rates may impact the Company's earnings in various ways.
The Company's earnings depend, in part, on the difference between the interest
received on mortgage investments and the interest paid on related short-term
borrowings (primarily repurchase arrangements). The resulting spread may be
reduced in a rising interest rate environment. For ARM loans the risk of rising
short-term interest rates is offset to some extent by increases in the rates of
interest earned on these loans. Since ARM loans generally limit the amount of
such increase during any single interest rate adjustment period and over the
life of the loan, the interest rates on the repurchase arrangements can rise to
levels that may exceed the interest rates on the underlying ARM loans resulting
in a negative interest spread.
Changes in interest rates also impact earnings recognized from CMO investments,
which consist primarily of fixed-rate CMO residuals and interest-only and
principal-only securities. The amount of income that may be
- 17 -
generated from the typical CMO residual is dependent upon the rate of principal
prepayments on the underlying mortgage collateral. If mortgage interest rates
fall significantly below the interest rate on the collateral, principal
prepayments will increase, reducing or even eliminating the overall return on
the investment in the CMO residual. This is due primarily to the acceleration of
the amortization of bond discounts, a noncash item, as bond classes are repaid
more rapidly than originally anticipated. Conversely, if mortgage interest rates
rise significantly above the interest rate on the collateral, principal
prepayments will typically diminish, resulting in a greater overall return on
the investment in the fixed-rate CMO residual because of an increase in the
period of time over which the Company receives the larger positive interest
spread.
Similarly, in a falling interest rate environment, prepayments on the mortgage
collateral underlying investments in interest-only securities generally will be
high and the Company could incur losses on these securities. Conversely, in
periods of rising interest rates, interest-only securities will tend to perform
favorably because the underlying mortgage collateral will generally prepay at
slower rates. Principal-only securities react differently to changes in
interest rates. Lower interest rates result in the recovery of these
investments more rapidly thus increasing yields. During periods of rising
rates, it takes longer for the Company to recover its investments thus lowering
yields. Principal-only securities owned by the Company represent a much smaller
investment than interest-only investments.
Another effect of changes in interest rates is that when interest rates decrease
the rate of prepayment of mortgage loans underlying mortgage investments
generally increases. To the extent the proceeds of prepayments on mortgage
investments cannot be reinvested at a rate of interest at least equal to the
rate previously earned on such investments, earnings may be adversely affected.
In addition, the rates of interest earned on ARM loans generally will decline
during periods of falling interest rates.
The above discussion regarding how changes in interest rates impact mortgage
investments also applies to the Company's growing investment in mortgage
servicing rights. When interest rates rise, mortgage servicing rights become
more valuable since the average lives of the related mortgage loans tend to be
longer and earnings from large, temporarily held cash balances will be greater.
Conversely, lower interest rates will spur prepayments thus reducing the period
of time the Company can service the related loans.
The Company's business plan is to build its mortgage securities and mortgage
servicing portfolios with the goal of producing reasonably balanced results in a
rising or falling interest rate environment. The Company expects to continue to
supplement its business plan with interest rate hedges from time to time;
however, hedging of interest rate risks is imprecise and costly. To fully
protect income from every interest rate scenario would be cost prohibitive.
- 18 -
PART II. - OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K:
(a) Exhibits: The following Exhibit is presented herewith:
--------
Exhibit 11 - Computation of Earnings Per Share for the quarter and nine
months ended September 30, 1995 and 1994.
Exhibit 27 - Financial Data Schedule (electronic filing only).
(b) Reports on Form 8-K: None.
-------------------
- 19 -
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
CAPSTEAD MORTGAGE CORPORATION
Date: November 10, 1995 By /s/ RONN K. LYTLE
------------------------------------
Ronn K. Lytle
Chairman and Chief Executive Officer
Date: November 10, 1995 By /s/ ANDREW F. JACOBS
------------------------------------
Andrew F. Jacobs
Senior Vice President - Control
and Treasurer
- 20 -