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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, 1996
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
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) 41,812,865 as of October 28, 1996
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CAPSTEAD MORTGAGE CORPORATION
FORM 10-Q
FOR THE QUARTER ENDED SEPTEMBER 30, 1996
INDEX
PART I. -- FINANCIAL INFORMATION
PAGE
----
ITEM 1. Financial Statements
Consolidated Balance Sheet -- September 30, 1996 and
December 31, 1995.................................................... 3
Consolidated Statement of Income -- Quarter and Nine Months Ended
September 30, 1996 and 1995.......................................... 4
Consolidated Statement of Cash Flows -- Nine Months Ended
September 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, EXCEPT PER SHARE AMOUNTS)
ITEM 1. FINANCIAL STATEMENTS
SEPTEMBER 30, 1996 DECEMBER 31, 1995
------------------ -----------------
(UNAUDITED)
ASSETS
Mortgage investments $4,521,635 $4,522,954
Mortgage securities collateral 4,716,768 4,830,020
---------- ----------
9,238,403 9,352,974
Mortgage servicing rights 611,782 423,360
Prepaids, receivables and other 122,284 108,570
Cash and cash equivalents 19,788 18,702
---------- ----------
$9,992,257 $9,903,606
========== ==========
LIABILITIES
Short-term borrowings $5,097,521 $4,628,782
Collateralized mortgage securities 4,090,382 4,538,863
Accounts payable and accrued expenses 26,519 23,339
Mortgage servicing rights
acquisitions payable 98,910 47,898
---------- ----------
9,313,332 9,238,882
---------- ----------
STOCKHOLDERS' EQUITY
Preferred stock - $0.10 par value;
100,000 shares authorized:
$1.60 Cumulative Preferred Stock,
Series A, 489 and 550 shares
issued and outstanding ($8,020
aggregate liquidation preference) 6,831 7,685
$1.26 Cumulative Convertible
Preferred Stock, Series B, 27,030
and 30,686 shares issued and
outstanding ($307,601 aggregate
liquidation preference) 291,545 330,065
Common stock - $0.01 par value; 100,000
shares authorized; 41,019 and 35,282
shares issued and outstanding 410 235
Paid-in capital 400,233 321,207
Undistributed income (deficit) 1,541 (2,370)
Unrealized gain (loss) on debt (21,635) 7,902
securities ---------- ----------
678,925 664,724
---------- ----------
$9,992,257 $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 NINE MONTHS ENDED
SEPTEMBER 30 SEPTEMBER 30
-------------------- --------------------
1996 1995 1996 1995
--------- --------- --------- ---------
INTEREST INCOME:
Mortgage investments $ 72,464 $ 61,611 $225,913 $171,284
Mortgage securities collateral 92,640 94,932 271,834 290,338
-------- -------- -------- --------
Total interest income 165,104 156,543 497,747 461,622
-------- -------- -------- --------
INTEREST AND RELATED EXPENSES:
Short-term borrowings 66,057 55,526 199,075 154,279
Collateralized mortgage securities 77,619 89,718 240,526 275,511
Mortgage insurance and other 1,791 2,847 6,190 8,720
-------- -------- -------- --------
Total interest and related expenses 145,467 148,091 445,791 438,510
-------- -------- -------- --------
Net margin on mortgage assets 19,637 8,452 51,956 23,112
-------- -------- -------- --------
MORTGAGE SERVICING REVENUES:
Servicing fees 25,774 17,218 72,089 47,780
Other 8,062 5,837 20,264 13,303
-------- -------- -------- --------
Total mortgage servicing revenues 33,836 23,055 92,353 61,083
-------- -------- -------- --------
MORTGAGE SERVICING EXPENSES:
Direct servicing expenses 3,013 3,103 9,969 7,959
Indirect servicing expenses 2,109 575 5,097 1,677
Amortization of mortgage servicing rights 11,172 7,809 31,398 17,993
Interest 4,232 1,839 11,460 4,150
-------- -------- -------- --------
Total mortgage servicing expenses 20,526 13,326 57,924 31,779
-------- -------- -------- --------
Net margin on mortgage servicing 13,310 9,729 34,429 29,304
-------- -------- -------- --------
OTHER REVENUES:
Gain on sales and other 1,875 5,484 12,196 9,688
CMO administration 859 887 2,559 2,732
-------- -------- -------- --------
Total other revenues 2,734 6,371 14,755 12,420
-------- -------- -------- --------
OTHER OPERATING EXPENSES 3,253 3,255 9,711 10,435
-------- -------- -------- --------
NET INCOME $ 32,428 $ 21,297 $ 91,429 $ 54,401
======== ======== ======== ========
Net income $ 32,428 $ 21,297 $ 91,429 $ 54,401
Less cash dividends on preferred stock (8,838) (9,846) (28,525) (29,467)
-------- -------- -------- --------
Net income available to common stockholders $ 23,590 $ 11,451 $ 62,904 $ 24,934
======== ======== ======== ========
NET INCOME PER SHARE:
Primary $ 0.60 $ 0.33 $ 1.67 $ 0.72
Fully diluted 0.53 0.32 1.50 0.72
CASH DIVIDENDS PAID PER SHARE:
Common $ 0.55 $ 0.33 $ 1.55 $ 0.72
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
---------------------------
1996 1995
------------ ------------
OPERATING ACTIVITIES:
Net income $ 91,429 $ 54,401
Noncash items:
Amortization of discount and premium 41,635 12,842
Amortization of mortgage servicing rights 31,398 17,993
Depreciation and other amortization 2,624 1,899
Net change in prepaids, receivables, other assets,
accounts payable and accrued expenses 7,353 (13,290)
Net gain from investing activities (12,075) (8,275)
------------ -----------
Net cash provided by operating activities 162,364 65,570
------------ -----------
INVESTING ACTIVITIES:
Purchases of agency securities (1,314,450) (2,066,002)
Purchases and originations of mortgage loans (20,295) (96,898)
Purchases of interest-only mortgage securities (437,892) (114,511)
Purchases of derivative financial instruments (35,179) (17,230)
Purchases of mortgage servicing rights (208,480) (120,564)
Principal collections on mortgage investments 773,617 323,648
Proceeds from sales and redemptions of mortgage assets 596,979 1,058,726
Proceeds from sales of derivative financial instruments - 24,012
Mortgage securities collateral:
Principal collections on collateral 448,201 356,132
Decrease in accrued interest receivable 3,480 3,063
Decrease in short-term investments 11,780 4,587
----------- -----------
Net cash used by investing activities (182,239) (645,037)
----------- -----------
FINANCING ACTIVITIES:
Increase in short-term borrowings 468,739 1,066,343
Increase (decrease) in mortgage servicing
acquisitions payable 51,012 (23,508)
Collateralized mortgage securities:
Issuance of securities 41,323 -
Principal payments on securities (492,933) (423,126)
Increase in accrued interest payable 1,088 2,348
Capital stock transactions 39,117 6,368
Dividends paid (87,385) (54,436)
----------- -----------
Net cash provided by financing activities 20,961 573,989
----------- -----------
Net increase (decrease) in cash and cash equivalents 1,086 (5,478)
Cash and cash equivalents at beginning of period 18,702 21,741
----------- -----------
Cash and cash equivalents at end of period $ 19,788 $ 16,263
============ ===========
See accompanying notes to consolidated financial statements.
-5-
CAPSTEAD MORTGAGE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 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 nine months ended September
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.
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
throughout 1996 the fair value of mortgage servicing rights has exceeded
recorded amounts, the adoption of SFAS 122 has had an immaterial impact on the
accounting results for the quarter and nine months ended September 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 nine months
ended September 30, 1996 are comparable to prior periods.
Certain amounts for prior periods have been reclassified to conform to the 1996
presentation. On October 30, 1995 and July 31, 1996 the Company completed 3-for-
2 common stock splits. All references to the number of common shares and share
amounts in the accompanying consolidated financial statements and related notes
have been restated to reflect the stock splits.
-6-
NOTE 3 - 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 9,487,236 102,412 149,811
Run-off/amortization (2,747,819) (20,366) (31,398)
Results of hedging activity - - 9,878
----------- ------- --------
Loans serviced at September 30, 1996 32,297,047 328,931 497,891
Purchases pending transfer* 6,478,627 69,589 113,891
Subservicing 753,635 4,119 -
----------- ------- --------
Total portfolio at September 30, 1996 $39,529,309 402,639 $611,782
=========== ======= ========
* IN ADDITION, AS OF OCTOBER 15, 1996 THE COMPANY HAD COMMITTED TO PURCHASE
THE RIGHT TO SERVICE ANOTHER 9,427 LOANS WITH AN UNPAID PRINCIPAL BALANCE
OF NEARLY $1.0 BILLION.
The Company services mortgage loans in all 50 states and the District of
Columbia. As of September 30, 1996, 15.2 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 September
30, 1996 and December 31, 1995, escrow and fiduciary funds for loans being
serviced approximated $473 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 adoption
date of SFAS 122 and throughout the nine months ended September 30, 1996, no
impairment charges or direct writedowns of mortgage servicing rights have been
recorded.
-7-
NOTE 4 - MORTGAGE INVESTMENTS
Mortgage investments and the related average effective interest rates
(calculated excluding unrealized gains and losses) were as follows (dollars in
thousands):
QUARTER NINE MONTHS
ENDED ENDED
AS OF SEPTEMBER 30 SEPTEMBER 30 SEPTEMBER 30
---------------------- ------------- -------------
1996 1995 1996 1995 1996 1995
---------- ---------- ---- ---- ---- ----
Agency securities:
Fixed-rate $ 462,567 $ 499,171 6.36% 6.31% 6.37% 6.33%
Adjustable-rate 3,554,351 2,405,036 6.31 6.24 6.17 6.04
Callable notes - 48,969 - 7.15 - 6.99
AAA-rated private
mortgage pass-
through securities:
Fixed-rate 1,341 1,910 8.67 8.78 9.36 8.73
Medium-term 287,768 431,868 7.05 6.88 7.06 6.95
Adjustable-rate 213,049 808,624 7.65 7.06 7.58 6.78
Mortgage loans 2,559 13,267 7.16 8.33 7.72 7.00
---------- ----------
$4,521,635 $4,208,845
========== ==========
The Company classifies its mortgage investments by the 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 U.S. 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 September 30, 1996 the AAA-rated private mortgage pass-through securities
("Mortgage Pass-Throughs") and Agency Securities were pledged to secure short-
term borrowings.
NOTE 5 - 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 mortgage securities, and (iv) investments in other
-8-
collateralized mortgage obligation ("CMO") securities such as other agency and
private-issue interest-only and principal-only mortgage securities.
The components of mortgage securities collateral are summarized as follows (in
thousands):
SEPTEMBER 30, 1996 DECEMBER 31, 1995
------------------ ------------------
Pledged mortgage collateral $4,137,438 $4,627,409
Short-term investments 12,925 24,705
Accrued interest receivable 25,651 29,130
---------- ----------
Total pledged mortgage collateral 4,176,014 4,681,244
Unamortized discount (6,620) (7,147)
---------- ----------
4,169,394 4,674,097
Released mortgage collateral 25,021 33,095
FNMA Trust interest-only mortgage
securities 503,002 107,554
Other CMO securities 19,351 15,274
---------- ----------
$4,716,768 $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 7.41 percent
during both the quarter and nine months ended September 30, 1996.
FNMA Trust interest-only mortgage securities are entitled to receive 100 percent
of coupon interest stripped from pools of FNMA mortgage-backed securities. At
September 30, 1996 the Company's investment in FNMA Trust interest-only mortgage
securities yielded 12.12 percent with related notional amounts aggregating $1.5
billion. These and certain other CMO securities were pledged to secure short-
term borrowings as of September 30, 1996.
NOTE 6 - 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.
The fair values of debt securities were estimated using quoted market prices
when available, including quotes made by lenders in connection with designating
collateral for repurchase arrangements. The pledged mortgage collateral
component of mortgage securities collateral 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 pledged mortgage
collateral after payment on the related collateralized mortgage securities
determined using market discount rates and prepayment assumptions.
-9-
The following tables summarize fair value disclosures for available-for-sale
debt securities for the periods indicated (in thousands):
AS OF SEPTEMBER 30, 1996
----------------------------------------------
GROSS GROSS
UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
---------- ---------- ---------- ----------
Agency Securities:
Fixed-rate $ 492,510 $ - $29,943 $ 462,567
Adjustable-rate 3,556,836 4,947 7,432 3,554,351
Mortgage Pass-Throughs:
Fixed-rate 1,304 37 - 1,341
Medium-term 289,432 291 1,955 287,768
Adjustable-rate 208,648 4,401 - 213,049
Mortgage securities 691,602 10,173 2,154 699,621
collateral ---------- ------- ------- ----------
$5,240,332 $19,849 $41,484 $5,218,697
========== ======= ======= ==========
AS OF DECEMBER 31, 1995
----------------------------------------------
GROSS GROSS
UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
---------- ---------- ---------- ----------
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 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
Mortgage securities 356,159 9,063 10,566 354,656
collateral ---------- ------- ------- ----------
$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 September 30, 1996 $4,017,147 $3,088 $56,367 $3,963,868
========== ====== ======= ==========
As of December 31, 1995 $4,475,364 $5,042 $60,920 $4,419,486
========== ====== ======= ==========
During the quarter and nine months ended September 30, 1996, $8,920,000 and
$494,276,000 of debt securities held available-for-sale were sold at gross
realized gains of $1,834,000 and $11,083,000, 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 $12,316,000 and $(29,537,000) during the quarter and nine months
ended September 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.
-10-
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 SEPTEMBER 30
-------------------------------------
1996 1995
------------------ -----------------
AMOUNT AVERAGE AMOUNT AVERAGE
-------- -------- -------- --------
Interest income:
Mortgage investments $ 72,464 6.43% $ 61,611 6.58%
Mortgage securities collateral 92,640 7.85 94,932 7.61
-------- --------
Total interest income 165,104 156,543
-------- --------
Interest expense:
Short-term borrowings 66,057 5.43 55,526 5.90
Collateralized mortgage securities 77,619 7.56 89,718 7.65
-------- --------
Total interest expense 143,676 145,244
-------- --------
Net interest $ 21,428 $ 11,299
======== ========
NINE MONTHS ENDED SEPTEMBER 30
-------------------------------------
1996 1995
------------------ -----------------
AMOUNT AVERAGE AMOUNT AVERAGE
-------- -------- -------- --------
Interest income:
Mortgage investments $225,913 6.37% $171,284 6.49%
Mortgage securities collateral 271,834 7.70 290,338 7.60
-------- --------
Total interest income 497,747 461,622
-------- --------
Interest expense:
Short-term borrowings 199,075 5.45 154,279 6.01
Collateralized mortgage securities 240,526 7.53 275,511 7.60
-------- --------
Total interest expense 439,601 429,790
-------- --------
Net interest $ 58,146 $ 31,832
======== ========
-11-
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, 1996, compared to the same
periods in 1995 (in thousands):
QUARTER ENDED SEPTEMBER 30, 1996
-----------------------------------
RATE* VOLUME* TOTAL
----- ------- ------
Interest income:
Mortgage investments $ (1,481) $ 12,334 $ 10,853
Mortgage securities collateral 3,044 (5,336) (2,292)
-------- -------- --------
Total interest income 1,563 6,998 8,561
-------- -------- --------
Interest expense:
Short-term borrowings (4,711) 15,242 10,531
Collateralized mortgage securities (1,124) (10,975) (12,099)
-------- -------- --------
Total interest expense (5,835) 4,267 (1,568)
-------- -------- --------
Net interest $ 7,398 $ 2,731 $ 10,129
======== ======== ========
NINE MONTHS ENDED SEPTEMBER 30, 1996
------------------------------------
RATE* VOLUME* TOTAL
----- ------- ------
Interest income:
Mortgage investments $ (3,034) $ 57,663 $ 54,629
Mortgage securities collateral 3,780 (22,284) (18,504)
-------- -------- --------
Total interest income 746 35,379 36,125
-------- -------- --------
Interest expense:
Short-term borrowings (15,585) 60,381 44,796
Collateralized mortgage securities (2,800) (32,185) (34,985)
-------- -------- --------
Total interest expense (18,385) 28,196 9,811
-------- -------- --------
Net interest $ 19,131 $ 7,183 $ 26,314
======== ======== ========
* 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.
-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 mortgage servicing rights),
the Company has become one of the 20 largest mortgage servicers in the country.
The mortgage servicing portfolio (excluding pending transfers and subservicing)
increased a net $779 million during the current quarter to $32.3 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 29.9 basis points. The September 30, 1996 balance of mortgage
servicing rights related to this portfolio was $498 million (154 basis points,
or a 5.2 multiple of the Average Service Fee). An additional $7.5 billion of
mortgage servicing that was acquired as of October 15, 1996 is pending transfer
into the portfolio and is being subserviced by the sellers. This portfolio has a
weighted average interest rate of 7.61 percent earning an Average Service Fee of
31.8 basis points. At an average cost of 180 basis points, this portfolio is
being acquired at a 5.7 multiple.
Annualized portfolio run-off, consisting of prepayments and scheduled payments
on mortgage loans serviced, was 12.07 percent in the current quarter, up from
10.86 percent during the third quarter of 1995 but down from 13.17 percent
during the second quarter of 1996. The rate of prepayments diminished throughout
the third quarter in response to higher mortgage interest rates and is expected
to decline further in the fourth quarter. Derivative financial instruments,
specifically interest rate floors, are held from time to time as partial hedges
against prepayment risk (see "Effects of Interest Rate Changes"). Outstanding
hedge positions, with a $6.25 billion notional amount, carried a $1.7 million
unrealized gain at September 30, 1996.
During the second quarter of 1996, the Company entered into a subservicing
arrangement with a large national mortgage originator. As of September 30, 1996
the subservicing portfolio stood at $754 million. 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 the mortgage servicing operation and could lead to other
such relationships in the future.
After growing substantially in 1995, holdings of mortgage investments peaked at
$5.0 billion by the end of the first quarter of 1996 consisting primarily of
$4.1 billion of adjustable-rate mortgage ("ARM") mortgage-backed securities. In
light of market conditions, the Company modestly reduced holdings of ARM
securities during the second quarter and in the third quarter made additional
purchases solely to replace run-off such that at September 30, 1996 mortgage
investments totaled $4.5 billion with ARM securities representing nearly $3.8
billion of the total.
During the quarter and nine months ended September 30, 1996, respectively, the
Company acquired $247 million and $1.3 billion of ARM securities issued by
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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"). The
Company did not sell any mortgage investments during the current quarter. Year-
to-date sales of ARM Agency Securities and AAA-rated private mortgage pass-
through securities ("Mortgage Pass-Throughs") totaled $432 million. In addition,
$49 million of callable agency-issued notes were redeemed by the issuer early in
the year.
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 retained residual interests in these securitizations consisting
primarily of interest-only and principal-only mortgage securities. Other than
modest issuances of previously-held residual interests, the Company has not
issued any CMOs since 1994. In lieu of issuing CMOs, the Company increased its
CMO investments (defined as CMO collateral, net of related bonds, plus similar
mortgage securities) by acquiring interest-only mortgage securities. During the
quarter and nine months ended September 30, 1996, the Company acquired $131
million and $438 million, respectively, of interest-only mortgage securities.
Most of these securities have been FNMA Trust interest-only mortgage securities,
which represent the right to receive 100 percent of coupon interest stripped
from pools of FNMA mortgage-backed securities. After considering these
acquisitions, run-off, modest sales and CMO issuances, as well as changes in
market value, total CMO investments increased $88 million and $335 million
during the quarter and nine months ended September 30, 1996, respectively, to
$626 million. Derivative financial instruments, specifically interest rate
floors, are held from time to time as partial hedges against prepayment risk on
interest-only mortgage securities (see "Effects of Interest Rate Changes").
Outstanding hedge positions, with a $2.425 billion notional amount, carried a
$3.7 million unrealized gain at September 30, 1996.
The following table summarizes the Company's utilization of capital as of
September 30, 1996 (in thousands):
CAPITAL
ASSETS BORROWINGS EMPLOYED
---------- ---------- --------
Agency Securities:
Fixed-rate $ 462,567 $ 457,231 $ 5,336
Adjustable-rate 3,554,351 3,474,749 79,602
Mortgage Pass-Throughs:
Fixed-rate 1,341 1,301 40
Medium-term 287,768 278,385 9,383
Adjustable-rate 213,049 207,441 5,608
Mortgage loans 2,559 - 2,559
CMO investments 4,716,768 4,642,796* 73,972
Mortgage servicing rights 611,782 224,910** 386,872
---------- ----------- --------
$9,850,185 $ 9,286,813 563,372
========== ===========
Other assets, net of other 115,553
liabilities --------
Total stockholders' equity $678,925
========
* INCLUDES APPROXIMATELY $552 MILLION OF RELATED SHORT-TERM BORROWINGS.
** REPRESENTS AMOUNTS OWED UNDER CONTRACTS FOR BULK PURCHASES OF MORTGAGE
SERVICING RIGHTS AND $126 MILLION DRAWN ON A $450 MILLION LINE OF CREDIT
SECURED BY EXISTING MORTGAGE SERVICING RIGHTS.
Rising interest rates in 1996 and selected sales of mortgage assets resulted in
nearly a $30 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 $22 million at September 30, 1996. This unrealized loss will
be realized only if the securities are sold. The Company has the ability
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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 related operating costs), by source, was as follows
(in thousands, except percentages and per share amounts):
QUARTER ENDED NINE MONTHS ENDED
SEPTEMBER 30 SEPTEMBER 30
------------------ --------------------
1996 1995 1996 1995
-------- -------- --------- ---------
Agency Securities $ 9,338 $ 3,109 $ 25,244 $ 8,605
Mortgage Pass-Throughs 1,619 1,718 6,782 4,730
Mortgage loans 44 248 347 1,139
CMO investments 8,636 3,377 19,583 8,638
Mortgage servicing 13,310 9,729 34,429 29,304
CMO administration 859 887 2,559 2,732
Gain on sales and other 1,875 5,484 12,196 9,688
------- ------- -------- --------
Contribution to income 35,681 24,552 101,140 64,836
Other operating expenses (3,253) (3,255) (9,711) (10,435)
------- ------- -------- --------
Net income $32,428 $21,297 $ 91,429 $ 54,401
======= ======= ======== ========
Net income per share:*
Primary $ 0.60 $ 0.33 $ 1.67 $ 0.72
Fully diluted 0.53 0.32 1.50 0.72
Return on average
stockholders' equity 18.72% 13.11% 17.94% 11.21%
* PRIOR PERIOD PER SHARE INFORMATION HAS BEEN ADJUSTED FOR THE 3-FOR-2 COMMON
STOCK SPLITS EFFECTIVE OCTOBER 30, 1995 AND JULY 31, 1996.
Operating results for the quarter and nine months ended September 30, 1996
improved substantially over those achieved in the same periods of 1995. Lower
borrowing costs and improving interest spreads on the Company's investments in
mortgage securities, together with improved mortgage servicing results,
contributed to the significant improvement in results compared to the same
period in 1995. An investment decision during the second quarter of 1996 to
modestly reduce the Company's commitment to ARM securities and increase
investments in interest-only mortgage securities also improved profitability
during the third quarter.
Agency Securities contributed more to current operating results than in 1995 due
to increased holdings of these securities and improved net interest spreads.
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 nine months ended September 30, 1996, compared to $2.4
billion and $2.2 billion during the same periods in 1995. Spreads improved
despite marginally lower yields due to a more favorable short-term interest rate
environment.
Agency Security yields averaged 6.31 percent and 6.20 percent during the quarter
and nine months ended September 30, 1996, respectively, compared to 6.35 percent
and 6.26 percent during the same periods in 1995, while borrowing costs were
5.44 percent and 5.43 percent, respectively, compared to 5.82 percent and 5.86
percent during the same periods in 1995. Yields were marginally lower in 1996
primarily due to sales and redemptions by September 30, 1995 of substantially
all of the Company's investments in relatively high yielding callable agency
notes. In addition, continued high
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purchase premium amortization on investments in ARM securities largely offset
the improvements in pass-through rates resulting from the periodic resetting of
coupon interest rates on underlying ARM loans (see "Effects of Interest Rate
Changes").
Mortgage Pass-Throughs contributed less to income in the current quarter
compared to the same period in 1995 primarily because of reduced holdings of
these securities as a result of asset sales and run-off. Results for the nine
months ended September 30, 1996 were higher compared to the same period in 1995
despite the lower portfolio outstanding due to increases in net interest
spreads. Average yields for this portfolio were higher at 7.31 percent and 7.33
percent for the quarter and nine months ended September 30, 1996, respectively,
compared to 7.00 percent and 6.84 percent during the same periods in 1995, while
average borrowing rates were lower at 5.63 percent and 5.69 percent,
respectively, compared to 6.08 percent and 6.19 percent during the same periods
in 1995. The rise in yields is primarily due to the periodic resetting of
coupon interest rates on underlying ARM loans (see "Effects of Interest Rate
Changes"). Lower borrowing rates reflect lower prevailing short-term interest
rates. The average outstanding portfolio was $517 million and $717 million for
both the quarter and nine months ended September 30, 1996, respectively,
compared to nearly $1.3 billion for the same periods in 1995.
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 earlier in 1996 to discontinue soliciting telephone
originations.
CMO investments contributed substantially more to current net operating results
compared to the same periods in 1995 due primarily to substantial investments
made during the past year in interest-only mortgage securities (see above,
"Financial Condition").
Higher mortgage servicing results reflect continued growth in this operation.
Revenues increased to $34 million and $92 million for the quarter and nine
months ended September 30, 1996, respectively, compared to $23 million and $61
million during the same periods in 1995. 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 $11 million and $31 million during the quarter and
nine months ended September 30, 1996, respectively, were higher than the $8
million and $18 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 portfolio growth contributed to higher borrowing costs in 1996 compared
to 1995. Because throughout 1996 the fair value of the mortgage servicing
portfolio has exceeded recorded amounts by large margins, the adoption of SFAS
122 has had an immaterial impact on servicing results for the quarter and nine
months ended September 30, 1996 (see Notes 1 and 3 to the financial statements).
The Company has incurred lower operating expenses in 1996 than in the prior year
because of the November 1995 closure of its mortgage conduit unit and, to a
lesser extent, the second quarter closure of its telephone origination unit.
These two decisions have also reduced requirements for loan loss provisions. In
addition, with the growth of the mortgage servicing operation, more operating
costs have been identified with that unit then in the prior year.
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During the quarter and nine months ended September 30, 1996, the Company sold
$14 million and $597 million, respectively of mortgage assets consisting of
mortgage loans, Mortgage Pass-Throughs, Agency Securities and CMO investments.
This compares to similar sales in the same periods of 1995 totaling $464 million
and $767 million, respectively.
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 September 30, 1996 the mortgage servicing operation had available $324
million of a $450 million revolving line of credit agreement with an investment
banking firm that matures September 30, 1998. 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 nine months ended September 30, 1996, the Company raised
$21.8 million and $45.8 million, respectively, through its dividend reinvestment
and stock purchase plans, stock option exercises and modest open market sales.
The Company anticipates continuing to raise equity through these channels as
market conditions allow. In June the Company purchased and retired options to
acquire 1,687,500 split-adjusted shares of its common stock issued in 1992 in
connection with the Company's severance of a relationship with a former
affiliate. The $6.5 million purchase price of the options 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 1 million split-adjusted shares of common stock 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
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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 mortgage
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 mortgage securities behave similarly to CMO Residuals. In a
falling interest rate environment prepayments on the underlying mortgage loans
generally 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 mortgage
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
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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 mortgage 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 nine months ended September 30, 1996 and 1995.
Exhibit 27 - Financial Data Schedule (electronic filing only).
(b) Reports on Form 8-K:
Form 8-K Reporting Date - August 20, 1996
Items Reported -
Item 5. Other Events
This Current Report was filed solely in order to file the following
exhibits as part of the Registrant's Registration Statement on Form S-3
(No. 33-62212), as amended:
Exhibit No. Description
----------- -----------
1.4 Amendment No. 1 to the Sales Agency Agreement dated as
of September 10, 1996 between Capstead Mortgage
Corporation and PaineWebber Incorporated (the "Common
Stock Sales Agency Agreement").
1.5 Sales Agency Agreement dated as of August 17, 1996
Capstead Mortgage Corporation and PaineWebber
Incorporated (the "Series B Preferred Stock 1996 Sales
Agency Agreement").
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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: October 28, 1996 By /s/ RONN K. LYTLE
------------------------------------
Ronn K. Lytle
Chairman and Chief Executive Officer
Date: October 28, 1996 By /s/ ANDREW F. JACOBS
------------------------------------
Andrew F. Jacobs
Senior Vice President - Control
and Treasurer
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