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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: JUNE 30, 1996
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
- ----- EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO
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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, DALLAS, TEXAS 75204
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (214) 874-2323
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) 25,005,840 as of July 29, 1996
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CAPSTEAD MORTGAGE CORPORATION
FORM 10-Q
FOR THE QUARTER ENDED JUNE 30, 1996
INDEX
PART I. -- FINANCIAL INFORMATION
PAGE
----
ITEM 1. Financial Statements
Consolidated Balance Sheet -- June 30, 1996 and December 31, 1995.. 3
Consolidated Statement of Income -- Quarter and Six Months Ended
June 30, 1996 and 1995........................................... 4
Consolidated Statement of Cash Flows -- Six Months Ended
June 30, 1996 and 1995........................................... 5
Notes to Consolidated Financial Statements........................ 6
ITEM 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations.............. 13
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
JUNE 30, 1996 DECEMBER 31, 1995
-------------- ------------------
(UNAUDITED)
ASSETS
Mortgage investments $4,458,133 $4,522,954
Mortgage securities collateral 4,763,904 4,830,020
---------- ----------
9,222,037 9,352,974
Cash and cash equivalents 23,375 18,702
Prepaids, receivables and other 125,692 108,570
Mortgage servicing rights 529,812 423,360
---------- ----------
$9,900,916 $9,903,606
========== ==========
LIABILITIES
Short-term borrowings $4,961,291 $4,628,782
Collateralized mortgage securities 4,225,089 4,538,863
Accounts payable and accrued expenses 30,169 23,339
Mortgage servicing rights
acquisitions payable 41,120 47,898
---------- ----------
9,257,669 9,238,882
---------- ----------
STOCKHOLDERS' EQUITY
Preferred stock - $0.10 par value;
100,000 shares authorized:
$1.60 Cumulative Preferred Stock,
Series A, 516 and 550 shares
issued and outstanding ($8,462
aggregate liquidation preference) 7,213 7,685
$1.26 Cumulative Convertible
Preferred Stock, Series B, 30,487
and 30,686 shares issued and
outstanding ($346,942 aggregate
liquidation preference) 327,807 330,065
Common stock - $0.01 par value; 100,000
shares authorized; 24,862 and 23,521
shares issued and outstanding 249 235
Paid-in capital 341,735 321,207
Undistributed income (deficit) 194 (2,370)
Unrealized gain (loss) on debt securities (33,951) 7,902
---------- ----------
643,247 664,724
---------- ----------
$9,900,916 $9,903,606
========== ==========
See accompanying notes to consolidated financial statements.
-3-
CAPSTEAD MORTGAGE CORPORATION
CONSOLIDATED STATEMENT OF INCOME
(UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
QUARTER ENDED SIX MONTHS ENDED
JUNE 30 JUNE 30
---------------------- ----------------------
1996 1995 1996 1995
--------- --------- --------- ---------
INTEREST INCOME:
Mortgage investments $ 77,521 $ 55,926 $153,448 $109,673
Mortgage securities collateral 88,738 97,054 179,194 195,406
-------- -------- -------- --------
Total interest income 166,259 152,980 332,642 305,079
-------- -------- -------- --------
INTEREST AND RELATED EXPENSES:
Short-term borrowings 67,474 50,541 133,018 98,755
Collateralized mortgage securities 79,730 91,608 162,907 185,793
Mortgage insurance and other 2,118 2,943 4,402 5,871
-------- -------- -------- --------
Total interest and related expenses 149,322 145,092 300,327 290,419
-------- -------- -------- --------
Net margin on mortgage assets 16,937 7,888 32,315 14,660
-------- -------- -------- --------
MORTGAGE SERVICING REVENUES:
Servicing fees 23,739 16,147 46,314 30,563
Other 6,806 4,691 12,202 7,465
-------- -------- -------- --------
Total mortgage servicing revenues 30,545 20,838 58,516 38,028
-------- -------- -------- --------
MORTGAGE SERVICING EXPENSES:
Direct servicing expenses 3,799 2,590 6,956 4,851
Indirect servicing expenses 1,514 526 2,987 1,101
Amortization of mortgage servicing
rights 10,139 5,934 20,226 10,185
Interest 3,929 1,683 7,228 2,315
-------- -------- -------- --------
Total mortgage servicing expenses 19,381 10,733 37,397 18,452
-------- -------- -------- --------
Net margin on mortgage servicing
operations 11,164 10,105 21,119 19,576
-------- -------- -------- --------
OTHER REVENUES:
Gain on sales and other 6,403 2,587 10,324 4,205
CMO administration 867 861 1,700 1,844
-------- -------- -------- --------
Total other revenues 7,270 3,448 12,024 6,049
-------- -------- -------- --------
OTHER OPERATING EXPENSES 3,198 3,702 6,457 7,180
-------- -------- -------- --------
NET INCOME $ 32,173 $ 17,739 $ 59,001 $ 33,105
======== ======== ======== ========
Net income $ 32,173 $ 17,739 $ 59,001 $ 33,105
Less cash dividends on preferred
stock (9,800) (9,823) (19,690) (19,621)
-------- -------- -------- --------
Net income available to common
stockholders $ 22,373 $ 7,916 $ 39,311 $ 13,484
======== ======== ======== ========
NET INCOME PER SHARE:
Primary $ 0.90 $ 0.35 $ 1.60 $ 0.59
Fully diluted 0.79 0.34 1.47 0.59
CASH DIVIDENDS PAID PER SHARE:
Common $ 0.80 $ 0.35 $ 1.50 $ 0.59
Series A preferred 0.40 0.40 0.80 0.80
Series B preferred 0.31 0.31 0.63 0.63
See accompanying notes to consolidated financial statements.
-4-
CAPSTEAD MORTGAGE CORPORATION
CONSOLIDATED STATEMENT OF CASH FLOWS
(UNAUDITED)
(IN THOUSANDS)
SIX MONTHS ENDED
JUNE 30
------------------------
1996 1995
------------ -----------
OPERATING ACTIVITIES:
Net income $ 59,001 $ 33,105
Noncash items:
Amortization of discount and premium 25,674 6,521
Amortization of mortgage servicing rights 20,226 10,185
Depreciation and other amortization 1,564 1,292
Net change in prepaids, receivables, other assets,
accounts payable and accrued expenses 6,612 3,590
Net gain from investing activities (10,375) (3,132)
----------- ---------
Net cash provided by operating activities 102,702 51,561
----------- ---------
INVESTING ACTIVITIES:
Purchases of agency securities (1,067,343) (479,059)
Purchases and originations of mortgage loans (19,584) (61,270)
Purchases of interest-only securities (307,005) (91,634)
Purchases of derivative financial instruments (33,972) (13,492)
Purchases of mortgage servicing rights (114,038) (78,838)
Principal collections on mortgage investments 581,182 157,487
Proceeds from sales and redemptions of mortgage assets 581,538 301,541
Proceeds from sales of derivative financial instruments - 24,012
Mortgage securities collateral:
Principal collections on collateral 305,406 211,396
Decrease in accrued interest receivable 2,344 2,060
Decrease in short-term investments 3,949 11,212
----------- ---------
Net cash used by investing activities (67,523) (16,585)
----------- ---------
FINANCING ACTIVITIES:
Increase in short-term borrowings 332,509 316,254
Decrease in mortgage servicing acquisitions payable (6,778) (35,711)
Collateralized mortgage securities:
Principal payments on securities (317,936) (278,268)
Increase in accrued interest payable 324 1,395
Capital stock transactions 17,812 2,606
Dividends paid (56,437) (33,104)
----------- ---------
Net cash used by financing activities (30,506) (26,828)
----------- ---------
Net increase in cash and cash equivalents 4,673 8,148
Cash and cash equivalents at beginning of period 18,702 21,741
----------- ---------
Cash and cash equivalents at end of period $ 23,375 $ 29,889
=========== =========
See accompanying notes to consolidated financial statements.
-5-
CAPSTEAD MORTGAGE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 1996
(UNAUDITED)
NOTE 1 -- BUSINESS
Capstead Mortgage Corporation, a national mortgage banking firm, earns income
from servicing mortgage loans, investing in mortgage-backed securities and other
investment strategies. The Company's business plan is to build its mortgage
servicing and mortgage securities portfolios with the goal of producing
reasonably balanced operating results in rising or falling interest rate
environments.
NOTE 2 -- 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 six months ended June 30,
1996 are not necessarily indicative of the results that may be expected for the
calendar year ending December 31, 1996. 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, 1995.
Certain amounts for prior periods have been reclassified to conform to the 1996
presentation.
On January 1, 1996 the Company adopted Statement of Financial Accounting
Standards No. 122, "Accounting for Mortgage Servicing Rights" ("SFAS 122").
SFAS 122 sets forth new accounting principles for capitalizing mortgage
servicing rights and recording impairment of existing mortgage servicing rights.
Because the fair value of mortgage servicing rights has exceeded recorded
amounts for the periods presented, and the Company formerly originated mortgage
loans on only a small scale, the adoption of SFAS 122 has had an immaterial
impact on the accounting results for the quarter and six months ended June 30,
1996 and would not have had a material impact on previous periods. Therefore,
although the new accounting principles have been applied on a prospective basis
only as required by SFAS 122, the accounting results for the quarter and six
months ended June 30, 1996 are comparable to prior periods.
-6-
NOTE 3 -- MORTGAGE INVESTMENTS
Mortgage investments and the related average effective interest rates
(calculated excluding unrealized gains and losses) were as follows (dollars in
thousands):
QUARTER SIX MONTHS
ENDED ENDED
AS OF JUNE 30 JUNE 30 JUNE 30
---------------------- ------------ ------------
1996 1995 1996 1995 1996 1995
---------- ---------- ----- ----- ----- -----
MORTGAGE LOANS $ 7,296 $ 11,886 7.05% 7.70% 7.85% 6.90%
AAA-RATED PRIVATE MORTGAGE
PASS-THROUGH SECURITIES:
Fixed-rate 1,343 1,931 8.65 8.77 9.66 8.71
Medium-term 302,474 456,092 7.04 6.99 7.06 6.98
Adjustable-rate 229,824 860,800 7.58 6.80 7.57 6.65
AGENCY SECURITIES:
Fixed-rate 462,692 500,642 6.37 6.32 6.37 6.34
Adjustable-rate 3,454,504 1,337,863 6.09 6.11 6.11 5.90
Callable notes - 333,742 - 6.95 7.05 6.93
---------- ----------
$4,458,133 $3,502,956
========== ==========
The Company classifies its mortgage investments by term and interest rate
characteristics of the underlying mortgage loans. Fixed-rate mortgage
investments have (i) fixed rates of interest for their entire terms, or (ii) an
initial fixed rate period of 10 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 have (i) an initial fixed-
rate period of 3 or 5 years after origination and then adjust annually based on
a specified margin over 1-year Treasuries or (ii) initial interest rates that
adjust one time, approximately 5 years following origination of the mortgage
loan, based on a specified margin over Federal National Mortgage Association
("FNMA") yields for 30-year fixed-rate commitments at the time of adjustment.
Adjustable-rate mortgage investments either adjust (i) semiannually based on a
specified margin over the 6-month London Interbank Offered Rate ("LIBOR"), or
(ii) annually based on a specified margin over 1-year Treasuries. Fixed- and
adjustable-rate mortgage agency securities consist of mortgage-backed securities
issued by government-sponsored entities, either the Federal Home Loan Mortgage
Corporation ("FHLMC"), FNMA or the Government National Mortgage Association
("GNMA"). Callable agency notes are unsecured, fixed-rate notes issued by FNMA,
FHLMC, or the Federal Home Loan Bank Board ("FHLBB") and mature in 1997, unless
redeemed earlier. Collectively, mortgage-backed securities and callable notes
issued by government-sponsored entities are referred to as "Agency Securities."
At June 30, 1996 certain of the mortgage loans, and all of the AAA-rated private
mortgage pass-through securities ("Mortgage Pass-Throughs") and Agency
Securities were pledged to secure short-term borrowings.
NOTE 4 -- MORTGAGE SECURITIES COLLATERAL
Mortgage securities collateral includes (i) collateral pledged to secure
borrowings through collateralized mortgage securities ("pledged mortgage
collateral"), (ii) collateral released from the related indentures pursuant to
clean-up calls ("released mortgage collateral"), (iii) investments in FNMA Trust
interest-only securities, and (iv) investments in other collateralized
-7-
mortgage obligation ("CMO") securities such as other agency and private-issue
interest-only and principal-only securities.
The components of mortgage securities collateral are summarized as follows (in
thousands):
JUNE 30, 1996 DECEMBER 31, 1995
-------------- ------------------
Pledged mortgage collateral $4,308,643 $4,627,409
Short-term investments 20,756 24,705
Accrued interest receivable 26,787 29,130
---------- ----------
Total pledged mortgage collateral 4,356,186 4,681,244
Unamortized discount (7,096) (7,147)
---------- ----------
4,349,090 4,674,097
Released mortgage collateral - 33,095
FNMA Trust interest-only securities 384,027 107,554
Other CMO securities 30,787 15,274
---------- ----------
$4,763,904 $4,830,020
========== ==========
Pledged mortgage collateral consists of fixed-rate, medium-term and adjustable-
rate mortgage-backed securities. All principal and interest on pledged mortgage
collateral is remitted directly to a collection account maintained by a trustee.
The trustee is responsible for reinvesting those funds in short-term
investments. All collections on the pledged mortgage collateral and the
reinvestment income earned thereon are available for the payment of principal
and interest on collateralized mortgage securities. The weighted average
effective interest rate for total pledged mortgage collateral was 7.38 percent
and 7.41 percent during the quarter and six months ended June 30, 1996,
respectively.
FNMA Trust interest-only securities are entitled to receive 100 percent of
coupon interest stripped from pools of FNMA mortgage-backed securities. The
Company's investment in FNMA Trust interest-only securities yields 12.48 percent
with related notional amounts aggregating $1.1 billion. At June 30, 1996 the
FNMA Trust interest-only securities and certain other CMO securities were
pledged to secure short-term borrowings.
NOTE 5 -- DISCLOSURES REGARDING FAIR VALUES OF DEBT SECURITIES
Estimated fair values were 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, 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 estimated fair values.
-8-
The following tables summarize fair value disclosures for available-for-sale
debt securities for the periods indicated (in thousands):
AS OF JUNE 30, 1996
----------------------------------------------
GROSS GROSS
UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
---------- ---------- ---------- ----------
Mortgage Pass-Throughs:
Fixed-rate $ 1,311 $ 32 $ - $ 1,343
Medium-term 304,857 261 2,644 302,474
Adjustable-rate 225,762 4,062 - 229,824
Agency Securities:
Fixed-rate 494,724 - 32,032 462,692
Adjustable-rate 3,470,892 289 16,677 3,454,504
Mortgage securities collateral 568,751 13,920 1,162 581,509
---------- ------- ------- ----------
$5,066,297 $18,564 $52,515 $5,032,346
========== ======= ======= ==========
AS OF DECEMBER 31, 1995
----------------------------------------------
GROSS GROSS
UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
---------- ---------- ---------- ----------
Mortgage Pass-Throughs:
Fixed-rate $ 1,723 $ 48 $ - $ 1,771
Medium-term 420,910 3,455 36 424,329
Adjustable-rate 555,944 7,259 - 563,203
Agency Securities:
Fixed-rate 497,785 - 8,096 489,689
Adjustable-rate 2,977,794 6,657 - 2,984,451
Callable notes 48,974 118 - 49,092
Mortgage securities collateral 356,159 9,063 10,566 354,656
---------- ------- ------- ----------
$4,859,289 $26,600 $18,698 $4,867,191
========== ======= ======= ==========
The following table summarizes fair value disclosures for mortgage securities
collateral held-to-maturity for the periods indicated (in thousands):
GROSS GROSS
UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
---------- ---------- ---------- ----------
As of June 30, 1996 $4,182,395 $4,515 $56,870 $4,130,040
========== ====== ======= ==========
As of December 31, 1995 $4,475,364 $5,042 $60,920 $4,419,486
========== ====== ======= ==========
The fair values of debt securities held available-for-sale and related
derivative financial instruments held for hedging purposes were estimated using
quoted market prices when available, including quotes made by lenders in
connection with designating collateral for repurchase arrangements. Mortgage
securities collateral classified as held-to-maturity has been permanently
financed through the issuance of collateralized mortgage securities. Gross
unrealized gains and losses are based on projected net cash flows of the
mortgage securities collateral after payment on the related collateralized
mortgage securities determined using market discount rates and prepayment
assumptions; however, because the Company intends to hold these assets to
maturity, it does not anticipate realizing such gains or losses and instead
expects these assets will continue to make a positive contribution to income in
future periods.
-9-
During the quarter and six months ended June 30, 1996, $345,103,000 and
$485,356,000 of debt securities held available-for-sale were sold at gross
realized gains of $5,297,000 and $9,249,000, respectively. Additionally,
$48,977,000 of callable agency notes were redeemed by the issuer in the first
quarter of 1996. Net adjustments to unrealized holding gains (losses) on
available-for-sale securities included as a separate component of stockholders'
equity were $(12,817,000) and $(41,853,000) during the quarter and six months
ended June 30, 1996, respectively.
During the second quarter of 1996, $14,655,000 of mortgage collateral previously
released from the related indentures pursuant to clean-up calls was sold at
gross realized gains aggregating $1,098,000.
NOTE 6 -- MORTGAGE SERVICING
The following table provides information regarding the mortgage servicing
portfolio and the related investment in mortgage servicing rights (dollars in
thousands):
UNPAID MORTGAGE
PRINCIPAL NUMBER SERVICING
BALANCE OF LOANS RIGHTS
------------ --------- ----------
Loans serviced at December 31, 1995 $25,557,629 246,885 $369,600
Additions 7,751,676 82,109 121,658
Run-off/amortization (1,790,761) (13,228) (20,226)
Results of hedging activity - - 11,591
----------- ------- --------
Loans serviced at June 30, 1996 31,518,544 315,766 482,623
Purchases pending transfer 3,196,900 36,445 47,189
----------- ------- --------
Total portfolio at June 30, 1996 $34,715,444 352,211 $529,812
----------- ------- --------
The Company services mortgage loans in all 50 states and the District of
Columbia. As of June 30, 1996, 15.3 percent of loans serviced and loans pending
transfer were located in California (based on unpaid principal balances).
In connection with mortgage servicing activities, the Company maintains
segregated escrow deposits that are held in bank trust accounts. At June 30,
1996 and December 31, 1995, escrow and fiduciary funds for loans being serviced
approximated $434 million and $316 million, respectively, and are excluded from
the accompanying balance sheet.
SFAS 122 requires that mortgage servicing rights be evaluated for impairment on
a disaggregated basis by predominant risk characteristics. A valuation
allowance is established through a charge to income to the extent that the
recorded amount for servicing rights within an individual stratum exceeds fair
value. Any such valuation allowance may be adjusted in the future, again
through a charge or benefit to income, as the fair value of the servicing rights
changes. Fair values are established through use of a discounted cash flow
valuation model that incorporates assumptions the Company believes market
participants would use in estimating the fair value of future net servicing
income including assumptions regarding prepayment speeds, discount rates,
servicing costs, etc. Results of the valuation model are compared to recent
market prices for bulk servicing acquisitions when available. For impairment
evaluation purposes, the Company stratifies its servicing portfolio on the basis
of term, interest rate and loan type (fixed-rate versus adjustable-rate).
Because the fair value of the mortgage servicing rights for each stratum of the
servicing portfolio exceeded recorded amounts at the January 1, 1996
-10-
adoption date of SFAS 122 and during the six months ended June 30,1996, no
impairment charges or direct writedowns of mortgage servicing rights have been
recorded.
NOTE 7 -- 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 JUNE 30
--------------------------------------
1996 1995
------------------ ------------------
AVERAGE AVERAGE
AMOUNT RATE AMOUNT RATE
-------- -------- -------- --------
INTEREST INCOME:
Mortgage investments $ 77,521 6.32% $ 55,926 6.54%
Mortgage securities collateral 88,738 7.62 97,054 7.61
-------- --------
Total interest income 166,259 152,980
======== ========
INTEREST EXPENSE:
Short-term borrowings 67,474 5.41 50,541 5.89
Collateralized mortgage securities 79,730 7.49 91,608 7.59
-------- --------
Total interest expense 147,204 142,149
-------- --------
Net interest $ 19,055 $ 10,831
======== ========
SIX MONTHS ENDED JUNE 30
-------------------------------------
1996 1995
------------------ ------------------
AVERAGE AVERAGE
AMOUNT RATE AMOUNT RATE
-------- -------- -------- --------
INTEREST INCOME:
Mortgage investments $153,448 6.35% $109,673 6.43%
Mortgage securities collateral 179,194 7.62 195,406 7.59
-------- --------
Total interest income 332,642 305,079
-------- --------
INTEREST EXPENSE:
Short-term borrowings 133,018 5.46 98,755 5.92
Collateralized mortgage securities 162,907 7.51 185,793 7.58
-------- --------
Total interest expense 295,925 284,548
-------- --------
Net interest $ 36,717 $ 20,531
======== ========
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 six months ended June 30, 1996 compared to the same periods in
1995 (in thousands):
QUARTER ENDED JUNE 30, 1996
------------------------------
RATE* VOLUME* TOTAL
-------- --------- ---------
INTEREST INCOME:
Mortgage investments $(1,950) $ 23,545 $ 21,595
Mortgage securities collateral 127 (8,443) (8,316)
------- -------- --------
Total interest income (1,823) 15,102 13,279
------- -------- --------
INTEREST EXPENSE:
Short-term borrowings (4,347) 21,280 16,933
Collateralized mortgage securities (1,169) (10,709) (11,878)
------- -------- --------
Total interest expense (5,516) 10,571 5,055
------- -------- --------
Net interest $ 3,693 $ 4,531 $ 8,224
======= ======== ========
-11-
SIX MONTHS ENDED JUNE 30, 1996
---------------------------------
RATE* VOLUME* TOTAL
--------- ---------- ----------
INTEREST INCOME:
Mortgage investments $(1,450) $ 45,225 $ 43,775
Mortgage securities collateral 642 (16,854) (16,212)
------- -------- --------
Total interest income (808) 28,371 27,563
------- -------- --------
INTEREST EXPENSE:
Short-term borrowings (8,297) 42,560 34,263
Collateralized mortgage securities (1,581) (21,305) (22,886)
------- -------- --------
Total interest expense (9,878) 21,255 11,377
------- -------- --------
Net interest $ 9,070 $ 7,116 $ 16,186
======= ======== ========
* 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 8 -- STOCK SPLIT
On July 22, 1996 the Company declared a 3-for-2 split of the $0.01 par value
common stock, payable on August 15, 1996 to stockholders of record on July 31,
1996. The accompanying consolidated balance sheets, consolidated statements of
income, and notes to consolidated financial statements have not been restated to
reflect the stock split.
The board of directors also approved the repurchase of up to 667,000 shares of
common stock (1,000,000 shares after the common stock split described above) to
fund employee stock option and stock grant programs. The share repurchase will
be subject to the market price of the common stock as well as the Company's
assessment of its capital needs and other market conditions.
-12-
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
FINANCIAL CONDITION
- -------------------
The Company's business plan is to build a mortgage banking operation with
investments in mortgage servicing and mortgage securities with the goal of
producing reasonably balanced results in rising or falling interest rate
environments.
The Company formed its mortgage servicing operation in 1993, and through steady
growth (primarily through the bulk acquisition of servicing rights), the Company
has become one of the 20 largest mortgage servicers in the country. The
mortgage servicing portfolio (excluding pending transfers) increased a net $3.8
billion during the current quarter to $31.5 billion with a weighted average
interest rate of 7.37 percent and earning an average annual service fee
excluding ancillary revenue and earnings on escrows (the "Average Service Fee")
of 30.0 basis points. The June 30, 1996 balance of mortgage servicing rights
related to this portfolio was $483 million (153 basis points, or a 5.10 multiple
of the Average Service Fee). An additional $3.2 billion of mortgage servicing
that was acquired during the quarter is pending transfer into the portfolio and
is being subserviced by the seller. This portfolio has a weighted average
interest rate of 7.43 percent earning an Average Service Fee of 26.7 basis
points. At an average cost of 148 basis points, this portfolio is being
acquired at a 5.55 multiple.
Annualized portfolio run-off, consisting of prepayments and scheduled payments
on mortgage loans serviced, was 13.17 percent in the current quarter, up from
8.35 percent during the second quarter of 1995 and 12.58 percent in the first
quarter of 1996. Run-off peaked early in the second quarter and then began
declining in response to higher mortgage interest rates and is expected to
decline further in the third quarter. Derivative financial instruments,
specifically 10-year U.S. Treasury and 3-month London Interbank Offered Rate
("LIBOR") interest rate floors, are held from time to time as partial hedges
against prepayment risk (see "Effects of Interest Rate Changes"). Certain of
these hedge positions were closed out during 1995 at gains aggregating $18
million which were deferred, lowering the basis of the servicing rights hedged.
During the current quarter, the Company undesignated many of these derivatives
as hedges and applied $12 million in unrealized losses at that date to the basis
of the servicing rights hedged. Outstanding hedge positions, with a $850
million notional amount, carried a $934,000 unrealized gain at June 30, 1996.
The Company recently entered into a subservicing arrangement with a large
national mortgage originator whereby in the third quarter the mortgage servicing
operation will begin servicing single-family mortgage loans for the originator.
An advantage of subservicing arrangements such as this is that further growth
and enhanced efficiencies can be achieved without the cost of acquiring
additional mortgage servicing rights. This arrangement is viewed by the Company
as a confirmation of the quality and cost effectiveness of its mortgage
servicing operation and could lead to other such relationships in the future.
In the first quarter of 1996, the Company continued to accumulate adjustable-
rate mortgage ("ARM") mortgage-backed securities bringing total holdings to $4.1
billion as of March 31, 1996. In light of market conditions, the Company
modestly reduced holdings of ARM securities during the current quarter. After
considering sales, run-off and changes in market value, holdings declined $433
million during the current quarter to $3.7 billion. During the quarter
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and six months ended June 30, 1996, respectively, the Company acquired $131
million and $1.1 billion of ARM securities issued by government-sponsored
entities, either the Federal Home Loan Mortgage Corporation ("FHLMC"), Federal
National Mortgage Association ("FNMA") or the Government National Mortgage
Association ("GNMA") (collectively, "Agency Securities"). Sales during the
current quarter included $108 million of ARM Agency Securities and $208 million
of AAA-rated private mortgage pass-through securities ("Mortgage Pass-
Throughs"). Year-to-date sales of Mortgage Pass-Throughs totaled $324 million.
In addition, $49 million of callable agency-issued notes were redeemed by the
issuer.
Prior to 1995 the Company had been an active issuer of collateralized mortgage
obligations ("CMOs") and other CMO securities backed by jumbo mortgage loans.
The Company generally retained residual interests in CMOs issued consisting
primarily of interest-only and principal-only strips. Beginning in 1995 the
Company increased its CMO investments by acquiring interest-only securities in
lieu of issuing CMOs. Most of the interest-only securities acquired by the
Company are FNMA Trust interest-only securities, which are entitled to receive
100 percent of coupon interest stripped from pools of FNMA mortgage-backed
securities.
During the quarter and six months ended June 30, 1996, the Company acquired $281
million and $307 million, respectively, of interest-only securities. After
considering run-off, modest sales early in the year, and changes in market
value, holdings of FNMA Trust interest-only securities increased $269 million
and $276 million during the quarter and six months ended June 30, 1996,
respectively, to $384 million, while total CMO investments (defined as CMO
collateral, net of related bonds, plus similar mortgage securities such as
interest-only strips) increased $246 million and $248 million during the quarter
and six months ended June 30, 1996, respectively, to $539 million. Derivative
financial instruments, specifically 10-year U.S. Treasury interest rate floors,
are held from time to time as partial hedges against prepayment risk on
interest-only securities (see "Effects of Interest Rate Changes"). Certain of
these hedge positions were closed out during 1995 at gains aggregating $5
million which were deferred, lowering the basis of the securities hedged.
During the current quarter, the Company undesignated many of these derivatives
as hedges and applied $3 million in unrealized losses at that date to the basis
of the securities hedged. Outstanding hedge positions, with a $2.4 billion
notional amount, carried a $1,482,000 unrealized gain at June 30, 1996.
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The following table summarizes the Company's utilization of capital as of June
30, 1996 (in thousands):
CAPITAL
ASSETS BORROWINGS EMPLOYED
---------- ----------- --------
Mortgage loans $ 7,296 $ 2,978 $ 4,318
Mortgage Pass-Throughs:
Fixed-rate 1,343 1,303 40
Medium-term 302,474 292,020 10,454
Adjustable-rate 229,824 222,695 7,129
Agency Securities:
Fixed-rate 462,692 456,197 6,495
Adjustable-rate 3,454,504 3,374,409 80,095
CMO investments 4,763,904 4,646,778* 117,126
Mortgage servicing rights 529,812 231,120** 298,692
---------- ----------- --------
$9,751,849 $ 9,227,500 524,349
========== ===========
Other assets, net of other liabilities 118,898
--------
Total stockholders' equity $643,247
========
* INCLUDES APPROXIMATELY $422 MILLION OF RELATED SHORT-TERM BORROWINGS.
** REPRESENTS AMOUNTS OWED UNDER CONTRACTS FOR BULK PURCHASES OF MORTGAGE
SERVICING RIGHTS AND $190 MILLION DRAWN ON A $300 MILLION LINE OF CREDIT
SECURED BY EXISTING MORTGAGE SERVICING RIGHTS.
Rising interest rates in 1996 and selected sales of mortgage assets resulted in
a $42 million net decline in value of securities held available-for-sale during
1996. At December 31, 1995 securities held available-for-sale were carried at a
net unrealized gain of $8 million, which declined to a net unrealized loss of
$34 million at June 30, 1996. This unrealized loss will be realized only if the
securities are sold. The Company has the ability to hold these securities for
the foreseeable future and therefore does not expect to realize losses on
security sales.
RESULTS OF OPERATIONS
- ---------------------
Comparative net operating results (interest income or fee revenues, net of
related interest expense or direct operating costs), by source, were as follows
(in thousands, except percentages and per share amounts):
QUARTER ENDED SIX MONTHS ENDED
JUNE 30 JUNE 30
------------------ ------------------
1996 1995 1996 1995
-------- -------- -------- --------
Mortgage loans $ 128 $ 176 $ 303 $ 891
Mortgage pass-through
securities 2,505 1,487 5,161 3,012
Agency securities 8,735 2,571 15,906 5,496
CMO investments 5,569 3,654 10,945 5,261
Mortgage servicing 11,164 10,105 21,119 19,576
CMO administration 867 861 1,700 1,844
Gain on sales and other 6,403 2,587 10,324 4,205
------- ------- ------- -------
Contribution to income 35,371 21,441 65,458 40,285
Other operating expenses (3,198) (3,702) (6,457) (7,180)
------- ------- ------- -------
Net income $32,173 $17,739 $59,001 $33,105
======= ======= ======= =======
Net income per share:*
Primary $ 0.90 $ 0.35 $ 1.60 $ 0.59
Fully diluted 0.79 0.34 1.47 0.59
Return on average
stockholders' equity 19.01% 10.98% 17.57% 10.26%
* NOT ADJUSTED FOR THE 3-FOR-2 COMMON STOCK SPLIT PAYABLE ON AUGUST 15, 1996 TO
STOCKHOLDERS OF RECORD ON JULY 31, 1996.
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Operating results for the quarter and six months ended June 30, 1996 improved
substantially over those achieved in the same periods of 1995. Improved
interest spreads on mortgage investments, together with gains on sales and
higher mortgage servicing results contributed to record earnings.
The net interest spread earned from mortgage loans contributed less to current
operating results than in 1995 due to lower average holdings of mortgage loans.
This reflects the November 1995 decision to exit the jumbo mortgage loan conduit
business and the decision this quarter to discontinue soliciting telephone
originations.
Mortgage Pass-Throughs contributed more to current operating results than in
1995 despite a lower average outstanding portfolio due to increases in net
interest spreads compared to the same periods in 1995. Average yields for this
portfolio were higher at 7.33 percent and 7.34 percent for the quarter and six
months ended June 30, 1996, respectively, compared to 6.87 percent and 6.77
percent during the same periods in 1995, while average borrowing costs were
lower at 5.66 percent and 5.71 percent, respectively, compared to 6.25 percent
and 6.23 percent during the same periods in 1995. The rise in yields is
primarily due to the periodic resetting of coupon rates on underlying ARM loans
(see "Effects of Interest Rate Changes"). Lower borrowing costs reflect lower
prevailing short-term interest rates. The average outstanding portfolio was
$765 million and $817 million during the quarter and six months ended June 30,
1996, compared to nearly $1.3 billion for the same periods in 1995.
Agency Securities contributed substantially more to current operating results
than in 1995 due to sizable increases in average outstanding portfolios and
improved net interest spreads. Spreads improved despite lower yields because
borrowing costs were lower. Acquisitions in 1995 and in the first quarter of
1996 of over $3.5 billion of ARM Agency Securities increased average outstanding
portfolios to $4.0 billion for both the quarter and six months ended June 30,
1996 compared to over $2.0 billion during the same periods in 1995. Yields were
negatively impacted by continued high prepayments that increased purchase
premium amortization (see "Effects of Interest Rate Changes"), as well as lower
yields on acquisitions. Lower borrowing costs reflect lower prevailing interest
rates. Yields averaged 6.13 percent and 6.14 percent during the quarter and six
months ended June 30, 1996, respectively, compared to 6.32 percent and 6.20
percent during the same periods in 1995, while borrowing costs were 5.39 percent
and 5.43 percent, respectively, compared to 5.95 percent and 5.88 percent during
the same periods in 1995.
CMO investments contributed substantially more to current net operating results
compared to the same periods in 1995 due primarily to investments made during
1995 and 1996 in interest-only securities (see above, "Financial Condition").
Higher mortgage servicing results reflect continued growth in this operation.
Revenues increased to $30.5 million and $58.5 million during the quarter and six
months ended June 30, 1996, respectively, compared to $20.8 million and $38.0
million during the same periods in 1995. Direct and indirect servicing expenses
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 of $10.1 million
and $20.2 million during the quarter and six months ended June 30, 1996,
respectively, were higher than the $5.9 million and $10.1 million recorded in
the same periods in 1995 due to portfolio growth and higher levels of
prepayments caused by lower interest rates. Greater use of external borrowings
secured by the mortgage servicing portfolio to finance
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portfolio growth contributed to higher borrowing costs in 1996 compared to 1995.
Because the fair value of the mortgage servicing portfolio exceeds recorded
amounts by a large margin and the Company formerly originated mortgage loans on
only a small scale, the adoption of SFAS 122 has had an immaterial impact on
servicing results for the quarter and six months ended June 30, 1996 (see Notes
1 and 6 to the financial statements).
The improvement in other operating expenses over the same periods in 1995
reflect lower provisions for possible loan losses attributable to the seasoning
of remaining Mortgage Pass-Throughs, exiting the mortgage conduit business in
November 1995 and the current quarter shut down of the Company's telephone
origination unit. Included in current quarter operating expenses is $425,000 in
costs associated with exiting this business activity.
During the quarter and six months ended June 30, 1996, the Company sold $372
million and $522 million, respectively of mortgage assets consisting of mortgage
loans, released CMO collateral, Mortgage Pass-Throughs, Agency Securities and
interest-only securities. This compares to similar sales in the same periods of
1995 totaling $199 million and $298 million, respectively. Additionally, the
Company's $3.3 million of derivative financial instruments held for investment
contributed marginally to earnings during the current quarter.
LIQUIDITY AND CAPITAL RESOURCES
- -------------------------------
The Company's primary sources of funds include monthly principal and interest
payments on mortgage investments, short-term borrowings, excess cash flows on
CMO investments, servicing fees and other revenue from mortgage servicing,
proceeds from sales of mortgage assets, and equity offerings, when available.
The Company currently believes that these funds are sufficient for growth of the
mortgage servicing portfolio, the acquisition of mortgage assets, repayments on
short-term borrowings, the payment of cash dividends as required for Capstead's
continued qualification as a Real Estate Investment Trust ("REIT"), and common
stock repurchases, if any, as described below. It is the Company's policy to
remain strongly capitalized and conservatively leveraged.
Short-term borrowings are primarily made under repurchase arrangements. The
Company has uncommitted repurchase facilities with investment banking firms to
finance mortgage assets, subject to certain conditions. Interest rates on
borrowings under these facilities are based on overnight to 30-day LIBOR rates.
The terms and conditions of these arrangements, including interest rates, are
negotiated on a transaction-by-transaction basis.
At June 30, 1996 the mortgage servicing operation had available $110 million of
a $300 million revolving line of credit agreement with an investment banking
firm that matures in October 1997. The line is to be used primarily to finance
acquisitions of mortgage servicing rights on a collateralized basis. The
agreement requires, among other things, that the mortgage servicing operation
maintain certain financial ratios and specified levels of unencumbered servicing
rights, as defined. The mortgage servicing operation is in compliance with all
requirements. Interest rates on borrowings under this facility are based on
LIBOR.
During the quarter and six months ended June 30, 1996, the Company raised $13.0
million and $24.0 million, respectively, through its dividend reinvestment and
stock purchase plans, modest open market sales of common stock and stock option
exercises. The Company anticipates continuing to raise equity through these
channels as market conditions allow. In June the Company purchased and retired
options to acquire 1,125,000 shares of its common stock
-17-
issued in 1992 in connection with the Company's severance of a relationship with
a former affiliate. The purchase price of the options in the amount of $6.5
million was charged to stockholders' equity with no effect on net income.
On July 22, 1996 the Company announced that the board of directors had approved
the repurchase of up to 667,000 shares of common stock (1,000,000 shares after
the common stock split) to fund employee stock option and stock grant programs.
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. The resulting spread may be reduced in a rising interest rate
environment. Because most of the Company's mortgage investments are ARM
mortgage securities, the risk of rising short-term interest rates is offset to
some extent by increases in the rates of interest earned on underlying ARM
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, interest
rates on borrowings can rise to levels that may exceed the interest rates on the
underlying ARM loans resulting in a negative interest spread. The Company may
invest in derivative financial instruments from time to time, specifically
interest rate caps, as a hedge against rising interest rates on a portion of its
short-term borrowings. Interest rate caps increase in value as interest rates
rise and decline in value when rates fall.
Another effect of changes in interest rates is that as 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.
Because prolonged periods of high prepayments can significantly reduce the
expected life of mortgage investments, the actual yields realized can be lower
due to faster amortization of purchase premiums. In addition, the rates of
interest earned on ARM investments generally will decline during periods of
falling interest rates as the underlying ARM loans reset at lower rates. The
Company may, from time to time, sell mortgage assets which may increase income
volatility because of the recognition of transactional gains or losses. Such
sales may become attractive as values of mortgage assets fluctuate with changes
in interest rates.
Changes in interest rates also impact earnings recognized from CMO investments,
which consist primarily of fixed-rate CMO residuals and interest-only
securities. The amount of income that may be 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
interest rates 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
interest rates on the collateral, principal prepayments will typically diminish,
resulting in a greater overall return on an investment in a fixed-rate CMO
residual because of an increase in the period of time over which the Company
receives the larger positive interest spread.
Interest-only securities behave similarly in a falling interest rate environment
in that prepayments on the underlying mortgage loans generally
-18-
will be higher thereby reducing or even eliminating overall returns on these
securities. Sustained periods of high prepayments can result in losses.
Conversely, in periods of rising interest rates, interest-only securities will
tend to perform favorably because underlying mortgage loans will generally
prepay at slower rates thereby increasing overall returns.
The above discussion regarding how changes in interest rates impact mortgage
assets also applies to the Company's 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. Sustained periods of high prepayments
can result in losses on the Company's investment in mortgage servicing rights,
particularly now that the Company has adopted SFAS 122 and must evaluate its
investment in servicing rights for impairment on a disaggregated basis and
record impairment charges if the recorded amount for an individual servicing
stratum is more than its fair value.
The Company's business plan is to build a mortgage servicing operation with
investments in mortgage servicing and mortgage securities with the goal of
producing reasonably balanced results in rising or falling interest rate
environments. The Company supplements its business plan from time to time with
derivative financial instruments, specifically interest rate floors, which may
be used to hedge certain assets, such as mortgage servicing rights or interest-
only securities or may be held for investment. Interest rate floors decrease in
value when interest rates rise and increase in value when rates decline. In
instances where floors are designated as hedges, any changes in value will
adjust the basis of the assets hedged. In instances where floors are held for
investment, changes in value will be recorded in income as they occur, which
could increase income volatility.
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 six
months ended June 30, 1996 and 1995.
Exhibit 27 - Financial Data Schedule (electronic filing only).
(b) Reports on Form 8-K: None.
-------------------
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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: July 29, 1996 By /s/ RONN K. LYTLE
------------------------------------
Ronn K. Lytle
Chairman and Chief Executive Officer
Date: July 29, 1996 By /s/ ANDREW F. JACOBS
------------------------------------
Andrew F. Jacobs
Senior Vice President - Control
and Treasurer
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