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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: MARCH 31, 1997
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, 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) 48,564,836 as of April 28, 1996
CAPSTEAD MORTGAGE CORPORATION
FORM 10-Q
FOR THE QUARTER ENDED MARCH 31, 1997
INDEX
PAGE
----
PART I. - FINANCIAL INFORMATION
ITEM 1. Financial Statements
Consolidated Balance Sheet - March 31, 1997 and December 31, 1996.. 3
Consolidated Statement of Income - Quarter Ended
March 31, 1997 and 1996........................................... 4
Consolidated Statement of Cash Flows - Quarter Ended
March 31, 1997 and 1996........................................... 5
Notes to Consolidated Financial Statements......................... 6
ITEM 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations............... 11
ITEM 4. Submission of Matters to a Vote of Security Holders......... 17
PART II. - OTHER INFORMATION
ITEM 6. Exhibits and Reports on Form 8-K............................ 17
SIGNATURES.......................................................... 18
-2-
PART I. -- FINANCIAL INFORMATION
CAPSTEAD MORTGAGE CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
ITEM 1. FINANCIAL STATEMENTS
MARCH 31, 1997 DECEMBER 31, 1996
--------------- ------------------
(UNAUDITED)
ASSETS
Mortgage investments $ 4,789,745 $ 4,840,417
CMO collateral and investments 4,471,131 4,501,646
----------- -----------
9,260,876 9,342,063
Mortgage servicing rights 662,472 637,979
Prepaids, receivables and other 143,097 156,293
Cash and cash equivalents 18,598 21,003
----------- -----------
$10,085,043 $10,157,338
=========== ===========
LIABILITIES
Short-term borrowings $ 5,485,414 $ 5,462,856
Collateralized mortgage obligations 3,753,694 3,861,892
Accounts payable and accrued expenses 34,673 33,924
Mortgage servicing rights
acquisitions payable 32,253 71,797
----------- -----------
9,306,034 9,430,469
----------- -----------
STOCKHOLDERS' EQUITY
Preferred stock - $0.10 par value;
100,000 shares authorized:
$1.60 Cumulative Preferred Stock,
Series A, 451 and 470 shares
issued and outstanding ($7,396
aggregate liquidation preference) 6,304 6,567
$1.26 Cumulative Convertible
Preferred Stock, Series B, 22,094
and 23,932 shares issued and
outstanding ($251,430 aggregate
liquidation preference) 241,180 259,829
Common stock - $0.01 par value; 100,000
shares authorized; 47,836 and 44,743
shares issued and outstanding 478 447
Paid-in capital 515,985 461,045
Undistributed income 7,428 4,582
Unrealized gain (loss) on debt 7,634 (5,601)
securities ----------- -----------
779,009 726,869
----------- -----------
$10,085,043 $10,157,338
=========== ===========
See accompanying notes to consolidated financial statements.
-3-
CAPSTEAD MORTGAGE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF INCOME
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
QUARTER ENDED
MARCH 31
--------------------
1997 1996
--------- ---------
INTEREST INCOME:
Mortgage investments $ 77,904 $ 76,682
CMO collateral and investments 87,377 89,702
-------- --------
Total interest income 165,281 166,384
-------- --------
INTEREST AND RELATED EXPENSES:
Short-term borrowings:
Mortgage investments 64,855 65,385
CMO investments 6,235 160
Collateralized mortgage obligations 70,499 83,177
Mortgage insurance and other 1,426 2,284
-------- --------
Total interest and related expenses 143,015 151,006
-------- --------
Net margin on mortgage assets 22,266 15,378
-------- --------
MORTGAGE SERVICING REVENUES:
Servicing fees 30,132 22,575
Other 8,606 5,396
-------- --------
Total mortgage servicing revenues 38,738 27,971
-------- --------
MORTGAGE SERVICING EXPENSES:
Direct servicing expenses 4,016 3,157
Indirect servicing expenses 1,725 1,473
Amortization of mortgage servicing
rights 14,026 10,087
Interest 4,929 3,299
-------- --------
Total mortgage servicing expenses 24,696 18,016
-------- --------
Net margin on mortgage servicing 14,042 9,955
-------- --------
OTHER REVENUES:
Gain on sales and other 2,600 3,921
CMO administration 820 833
-------- --------
Total other revenues 3,420 4,754
-------- --------
OTHER OPERATING EXPENSES 2,340 3,259
-------- --------
NET INCOME $ 37,388 $ 26,828
======== ========
Net income $ 37,388 $ 26,828
Less cash dividends on preferred stock (7,198) (9,890)
-------- --------
Net income available to common
stockholders $ 30,190 $ 16,938
======== ========
NET INCOME PER SHARE:
Primary $ 0.64 $ 0.47
Fully diluted 0.58 0.45
CASH DIVIDENDS PAID PER SHARE:
Common $ 0.580 $ 0.467
Series A Preferred 0.400 0.400
Series B Preferred 0.315 0.315
See accompanying notes to consolidated financial statements.
-4-
CAPSTEAD MORTGAGE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
QUARTER ENDED
MARCH 31
----------------------
1997 1996
---------- ----------
OPERATING ACTIVITIES:
Net income $ 37,388 $ 26,828
Noncash items:
Amortization of discount and premium 23,352 10,389
Amortization of mortgage servicing
rights 14,028 10,087
Depreciation and other amortization 1,016 1,271
Net change in prepaids, receivables,
other assets, accounts payable and
accrued expenses 2,211 (2,366)
Net gain from investing activities (2,453) (4,036)
--------- ---------
Net cash provided by operating
activities 75,542 42,173
--------- ---------
INVESTING ACTIVITIES:
Purchases of mortgage investments (405,272) (946,040)
Purchases of CMO investments (52,058) (25,887)
Purchases of mortgage servicing rights (31,656) (68,078)
Purchases of derivative financial
instruments (10,937) (7,536)
Principal collections on mortgage
investments 258,983 283,639
Proceeds from sales and redemptions of
mortgage assets 178,605 203,447
CMO collateral:
Principal collections 111,157 147,341
Decrease in accrued interest
receivable 723 1,067
Increase in short-term investments (1,910) (1,170)
--------- ---------
Net cash provided (used) by
investing activities 47,635 (413,217)
--------- ---------
FINANCING ACTIVITIES:
Increase in short-term borrowings 22,558 519,810
Increase (decrease) in mortgage
servicing acquisitions payable (39,544) 9,933
Collateralized mortgage obligations:
Principal payments on securities (110,792) (144,252)
Increase in accrued interest payable 962 256
Capital stock transactions 35,776 11,143
Dividends paid (34,542) (26,726)
--------- ---------
Net cash provided (used) by
financing activities (125,582) 370,164
--------- ---------
Net decrease in cash and cash
equivalents (2,405) (880)
Cash and cash equivalents at beginning
of period 21,003 18,702
--------- ---------
Cash and cash equivalents at end of
period $ 18,598 $ 17,822
========= =========
See accompanying notes to consolidated financial statements.
-5-
CAPSTEAD MORTGAGE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 1997
(UNAUDITED)
NOTE 1 - BUSINESS
Capstead Mortgage Corporation, a national mortgage banking firm, earns income
from investing in mortgage-backed securities, servicing mortgage loans and other
investment strategies. The Company's business plan is to build a mortgage
banking operation with investments in mortgage securities and mortgage servicing
with the goal of producing reasonably balanced operating results in a variety of
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 ended March 31, 1997 are not
necessarily indicative of the results that may be expected for the calendar year
ending December 31, 1997. 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, 1996.
On January 1, 1997 the Company adopted Statement of Financial Accounting
Standards No. 125, "Accounting for Transfers and Servicing of Financial Assets
and Extinguishments of Liabilities" ("SFAS 125"). SFAS 125 provides accounting
and reporting standards for all types of securitization transactions involving
the transfer of financial assets including repurchase agreements and
collateralized borrowing arrangements. Under SFAS 125 most securitizations of
financial assets other than repurchase arrangements are recorded as sales. The
adoption of SFAS 125 has not had a material impact on the results of operations
or financial position of the Company.
Certain amounts for prior periods have been reclassified to conform to the 1997
presentation.
-6-
NOTE 3 - MORTGAGE SERVICING
The following table provides information regarding the primary mortgage
servicing portfolio (which excludes subservicing) 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, 1996 $35,562,597 366,373 $559,857
Additions 4,152,971 42,769 77,727
Run-off/amortization (896,224) (6,280) (12,968)
Results of hedging activity - - 5,805
----------- ------- --------
Loans serviced at March 31, 1997 38,819,344 402,862 630,421
Purchases pending transfer* 1,887,925 19,030 32,051
----------- ------- --------
Total portfolio at March 31, 1997 $40,707,269 421,892 $662,472
=========== ======= ========
* IN ADDITION, IN APRIL 1997 THE COMPANY COMMITTED TO PURCHASE THE RIGHT TO
SERVICE ANOTHER 6,775 LOANS WITH AN UNPAID PRINCIPAL BALANCE OF $623 MILLION.
In addition, as of March 31, 1997 the Company subserviced $5.1 billion of
single-family mortgage loans under a subservicing arrangement with a large
national mortgage conduit.
NOTE 4 - MORTGAGE INVESTMENTS
Mortgage investments and the related average effective interest rates
(calculated including mortgage insurance costs and excluding unrealized gains
and losses) were as follows (dollars in thousands):
AS OF QUARTER ENDED
MARCH 31 MARCH 31
---------------------- ---------------
1997 1996 1997 1996
---------- ---------- ------- ------
Agency securities:
Fixed-rate $ 455,512 $ 471,527 6.38% 6.37%
Adjustable-rate 3,945,105 3,682,003 6.28 6.12
Callable notes - - - 7.05
AAA-rated private mortgage pass-
through securities:
Fixed-rate 3,952 47,722 8.82 9.18
Medium-term 261,188 366,912 6.69 6.66
Adjustable-rate 123,988 435,564 7.16 7.14
---------- ---------- ---- ----
$4,789,745 $5,003,728 6.37% 6.32%
========== ========== ==== ====
The Company classifies its mortgage investments by 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
-7-
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, FNMA or the
Government National Mortgage Association (collectively, "Agency Securities").
At March 31, 1997 the AAA-rated private mortgage pass-through securities
("Mortgage Pass-Throughs") and Agency Securities were pledged to secure short-
term borrowings.
NOTE 5 - CMO COLLATERAL AND INVESTMENTS
CMO collateral consists of mortgage securities and related investments pledged
to secure CMO borrowings ("Pledged CMO Collateral"). CMO investments include
investments in FNMA Trust interest-only mortgage securities and investments in
other CMO securities such as other agency and private-issue interest-only and
principal-only mortgage securities. The components of CMO collateral and
investments are summarized as follows (in thousands):
MARCH 31, 1997 DECEMBER 31, 1996
--------------- ------------------
Pledged mortgage securities $3,797,063 $3,908,623
Short-term investments 12,964 11,055
Accrued interest receivable 23,289 24,012
---------- ----------
Total Pledged CMO Collateral 3,833,316 3,943,690
Unamortized discount (7,018) (7,166)
---------- ----------
3,826,298 3,936,524
FNMA Trust interest-only mortgage
securities 627,039 546,539
Other CMO investments 17,794 18,583
---------- ----------
$4,471,131 $4,501,646
========== ==========
Pledged mortgage securities consist of fixed-rate, medium-term and adjustable-
rate mortgage-backed securities. All principal and interest on pledged mortgage
securities 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 pledged mortgage securities and reinvestment
income earned thereon are available for the payment of principal and interest on
CMOs issued by the Company. The weighted average effective interest rate for
total Pledged CMO Collateral was 7.34 percent during the quarter ended March 31,
1997.
FNMA Trust interest-only mortgage securities are entitled to receive 100 percent
of coupon interest stripped from pools of FNMA mortgage-backed securities. At
March 31, 1997 the Company's investment in FNMA Trust interest-only mortgage
securities, after certain hedging costs, yielded 10.81 percent with related
notional amounts aggregating $1.8 billion. These and certain other CMO
investments were pledged to secure short-term borrowings as of March 31, 1997.
NOTE 6 - DISCLOSURES REGARDING FAIR VALUES OF DEBT SECURITIES
Estimated fair values of debt securities have been determined using available
market information and appropriate valuation methodologies; however,
considerable judgment is required in interpreting market data to develop these
estimates. In addition, fair values fluctuate on a daily basis. Accordingly,
estimates presented herein are not necessarily indicative of the amounts that
could be realized in a current market exchange. The use of different market
-8-
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. Pledged CMO Collateral has been
permanently financed through the issuance of CMOs. Gross unrealized gains and
losses are based on projected net cash flows of the Pledged CMO Collateral after
payment on the related CMOs determined using market discount rates and
prepayment assumptions. The maturity of Pledged CMO Collateral is directly
affected by the rate of principal payments by mortgagors and clean-up calls of
the remaining CMOs outstanding.
The following table summarizes fair value disclosures for available-for-sale
debt securities for the periods indicated (in thousands):
GROSS GROSS
UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
---------- ---------- ---------- ----------
MARCH 31, 1997
- --------------
Mortgage investments:
Agency Securities:
Fixed-rate $ 489,429 $ - $33,917 $ 455,512
Adjustable-rate 3,929,624 17,660 2,179 3,945,105
Mortgage Pass-Throughs:
Fixed-rate 3,913 39 - 3,952
Medium-term 262,284 259 1,355 261,188
Adjustable-rate 121,468 2,520 - 123,988
CMO collateral and investments 698,495 24,994 387 723,102
---------- ------- ------- ----------
$5,505,213 $45,472 $37,838 $5,512,847
========== ======= ======= ==========
DECEMBER 31, 1996
- -----------------
Mortgage investments:
Agency Securities:
Fixed-rate $ 490,893 $ - $23,006 $ 467,887
Adjustable-rate 3,858,339 20,977 489 3,878,827
Mortgage Pass-Throughs:
Fixed-rate 4,144 44 - 4,188
Medium-term 278,473 283 569 278,187
Adjustable-rate 128,110 2,691 - 130,801
CMO collateral and investments 653,748 2,119 7,651 648,216
---------- ------- ------- ----------
$5,413,707 $26,114 $31,715 $5,408,106
========== ======= ======= ==========
Held-to-maturity debt securities consist of Pledged CMO Collateral and
collateral released from the related CMO indentures pursuant to clean-up calls
and held as Mortgage Pass-Throughs. The following table summarizes fair value
disclosures for debt securities held-to-maturity for the periods indicated (in
thousands):
GROSS GROSS
UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
---------- ---------- ---------- ----------
MARCH 31, 1997
- --------------
Pledged CMO Collateral $3,748,028 $3,238 $54,097 $3,697,169
DECEMBER 31, 1996
- -----------------
Pledged CMO Collateral 3,853,430 3,150 54,889 3,801,691
Mortgage Pass-Throughs 80,527 2,314 94 82,747
-9-
Sales of released CMO collateral occasionally occur provided the collateral has
paid down to within 15 percent of its original issuance amounts. The following
table summarizes disclosures related to the disposition of debt securities held
available-for-sale and held-to-maturity (in thousands):
QUARTER ENDED MARCH 31
----------------------
1997 1996
---------- ----------
Sale of securities held
available-for-sale:
Cost basis $101,418 $150,434
Gains 877 4,036
Redemption of callable agency notes and
sale of Released CMO Collateral
held-to-maturity:
Cost basis 73,324 48,977
Gains 2,986 -
NOTE 7 - NET INTEREST INCOME ANALYSIS
The following table summarizes interest income and interest expense and average
effective interest rates for the periods indicated (dollars in thousands):
QUARTER ENDED MARCH 31
--------------------------------------
1997 1996
------------------ ------------------
AMOUNT AVERAGE AMOUNT AVERAGE
-------- -------- -------- --------
Interest income:
Mortgage investments $ 77,904 6.37% $ 76,682 6.32%
CMO collateral and investments 87,377 7.83 89,702 7.62
-------- --------
Total interest income 165,281 166,384
-------- --------
Interest expense:
Short-term borrowings 71,090 5.43 65,545 5.51
CMOs 70,499 7.51 83,177 7.53
-------- --------
Total interest expense 141,589 148,722
-------- --------
Net interest $ 23,692 $ 17,662
======== ========
The following table summarizes changes in interest income and interest expense
due to changes in interest rates versus changes in volume for the quarter ended
March 31, 1997 compared to the same period in 1996 (in thousands):
RATE* VOLUME* TOTAL
-------- --------- ---------
Interest income:
Mortgage investments $ 579 $ 643 $ 1,222
CMO collateral and investments 2,441 (4,766) (2,325)
------- -------- --------
Total interest income 3,020 (4,123) (1,103)
------- -------- --------
Interest expense:
Short-term borrowings (869) 6,414 5,545
CMOs (209) (12,469) (12,678)
------- -------- --------
Total interest expense (1,078) (6,055) (7,133)
------- -------- --------
Net interest $ 4,098 $ 1,932 $ 6,030
======= ======== ========
* 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.
-10-
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 securities and mortgage servicing with the goal of
producing reasonably balanced operating results in a variety of interest rate
environments.
The Company commenced mortgage servicing operations in 1993 and through steady
growth has become one of the 20 largest mortgage servicers in the country with a
total mortgage servicing portfolio of $44.0 billion (including primary servicing
and subservicing). The primary mortgage servicing portfolio (which excludes
pending transfers and subservicing) increased a net $3.3 billion during the
quarter ended March 31, 1997 to $38.8 billion with a weighted average interest
rate of 7.42 percent and earning an average annual service fee, excluding
ancillary revenue and earnings on escrows, (the "Average Service Fee"), of 30.3
basis points. The March 31, 1997 balance of mortgage servicing rights related
to this portfolio was $630 million (162 basis points, or a 5.36 multiple of the
Average Service Fee). An additional $1.9 billion of mortgage servicing acquired
during the current quarter is pending transfer into the portfolio and is being
subserviced by the sellers. These pending acquisitions have a weighted average
interest rate of 7.69 percent earning an Average Service Fee of 30.5 basis
points. At an average cost of 170 basis points, these acquisitions are being
acquired at a 5.57 multiple.
Primary mortgage servicing portfolio run-off, consisting of prepayments and
scheduled payments on mortgage loans serviced, was 9.70 percent during the
quarter, down from 12.58 percent in the first quarter of 1996 and 10.87 percent
in the fourth quarter of 1996. The decrease in prepayments experienced in the
first quarter of 1997 was prompted by higher mortgage interest rates and
seasonal factors. 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
$8.4 billion notional amount, carried a $6.4 million unrealized loss at March
31, 1997.
During the second quarter of 1996, the Company entered into a subservicing
arrangement with a large national mortgage conduit. As of March 31, 1997 the
subservicing portfolio totaled $5.1 billion. An advantage of subservicing
arrangements 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.
As of March 31, 1997, holdings of mortgage investments totaled $4.8 billion with
adjustable-rate mortgage ("ARM") mortgage-backed securities representing nearly
$4.1 billion of the total. During the current quarter the Company acquired $405
million 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 of ARM Agency Securities and AAA-
rated private mortgage pass-through securities ("Mortgage Pass-Throughs")
totaled $175 million during the quarter.
-11-
Prior to 1995 the Company had been an active issuer of collateralized mortgage
obligations ("CMOs") and other CMO securities backed by jumbo mortgage loans.
In lieu of issuing CMOs, the Company has increased its net CMO investments
(defined as CMO collateral, net of related bonds, plus other CMO investments) by
acquiring interest-only mortgage securities. During 1996 and the quarter ended
March 31, 1997, the Company acquired $522 million and $52 million of interest-
only mortgage securities, respectively. 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 and changes in market
value (see below), net CMO investments increased $78 million during the quarter
to $717 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 $3.7 billion notional amount, carried a $6.0
million unrealized loss at March 31, 1997.
The following table summarizes the Company's utilization of capital as of March
31, 1997 (in thousands):
CAPITAL
ASSETS BORROWINGS EMPLOYED
---------- ----------- ---------
Agency Securities:
Fixed-rate $ 455,512 $ 462,073 $ (6,561)
Adjustable-rate 3,945,105 3,803,895 141,210
Mortgage Pass-Throughs:
Fixed-rate 3,952 3,744 208
Medium-term 261,188 216,988 44,200
Adjustable-rate 123,988 113,341 10,647
CMO collateral and investments 4,471,131 4,388,067* 83,064
Mortgage servicing rights 662,472 283,253** 379,219
---------- ----------- --------
$9,923,348 $ 9,271,361 651,987
========== ===========
Other assets, net of other liabilities 127,022
--------
Total stockholders' equity $779,009
========
* INCLUDES APPROXIMATELY $634 MILLION OF RELATED SHORT-TERM BORROWINGS.
** REPRESENTS AMOUNTS OWED UNDER CONTRACTS FOR BULK PURCHASES OF MORTGAGE
SERVICING RIGHTS AND $251 MILLION DRAWN ON A $450 MILLION LINE OF CREDIT
SECURED BY EXISTING MORTGAGE SERVICING RIGHTS.
Securities held available-for-sale were carried at a net unrealized gain of $7.6
million at March 31, 1997, a $13.2 million improvement in value from December
31, 1996. Higher prevailing interest rates resulted in a $30.1 million
improvement in value of CMO investments carried available-for-sale, which was
partially offset by a $16.9 million decline in value of mortgage investments.
The Company has the ability to hold mortgage assets for the foreseeable future
and, therefore does not expect to realize losses on security sales.
-12-
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
MARCH 31
------------------
1997 1996
-------- --------
Agency securities $10,644 $ 7,171
Mortgage pass-through securities 1,946 3,186
CMO investments 9,676 5,021
Mortgage servicing 14,042 9,955
CMO administration 820 833
Gain on sales and other 2,600 3,921
------- -------
Contribution to income 39,728 30,087
Other operating expenses 2,340 3,259
------- -------
Net income $37,388 $26,828
======= =======
Net income per share:
Primary $ 0.64 $ 0.47
Fully diluted 0.58 0.45
Return on average stockholders' equity 19.76% 16.12%
Operating results for the quarter ended March 31, 1997 improved substantially
over those achieved in the first quarter of 1996. Improved net interest margins
on mortgage investments, a larger portfolio of CMO investments, together with
improved mortgage servicing results, contributed to significantly higher net
income compared to the same period in 1996. Record quarterly net income of
$37.4 million represents an increase of over 39 percent over the first quarter
of 1996, while primary net income per common share increased over 36 percent.
Return on average stockholders' equity increased nearly 23 percent over the
return achieved in the first quarter of 1996.
Agency Securities contributed significantly more to income in the first quarter
of 1997 than in the same period in 1996 due primarily to a 16 basis point
increase in net interest margins and a $503 million increase in average holdings
of these securities. Spreads improved primarily due to improvements in pass-
through rates resulting from the periodic resetting of coupon interest rates on
underlying ARM loans (see "Effects of Interest Rate Changes"). Agency Security
yields averaged 6.29 percent during the quarter compared to 6.16 percent during
the same period of 1996, while borrowing rates were 5.44 percent compared to
5.47 percent in the first quarter of 1996.
Mortgage Pass-Throughs contributed less to income during the current quarter
than in the same period in 1996 despite a 24 basis point increase in net
interest margins because of a $436 million reduction in the average outstanding
portfolio. As a result of asset sales and run-off, the average outstanding
portfolio was $473 million during the current quarter compared to nearly $909
million in the same period of 1996. Average yields for this portfolio
(calculated including mortgage insurance costs) were higher at 7.11 percent
during the current quarter compared to 7.03 percent in the same period in 1996
while average borrowing rates were lower at 5.60 percent compared to 5.76
percent. Yields were impacted by sales of ARM Mortgage Pass-Throughs and the
periodic resetting of coupon interest rates on underlying ARM and medium-term
loans (see "Effects of Interest Rate Changes"). Lower borrowing rates reflect
lower prevailing short-term interest rates.
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Net CMO investments contributed significantly more to income during the current
quarter than in the same period in 1996 due primarily to substantial investments
made during the past 12 months in interest-only mortgage securities (see above,
"Financial Condition").
Higher mortgage servicing results reflect continued growth in this operation
(see above "Financial Condition"). Revenues increased to $38.7 million during
the current quarter, compared to $28.0 million in the same period in 1996.
Servicing expenses also increased, but not to the same extent as revenues, which
reflects efficiencies gained in the servicing process primarily due to improved
economies of scale. Amortization of mortgage servicing rights of $14.0 million
during the current quarter was higher than the $10.1 million recorded in the
same period in 1996 due primarily to portfolio growth. Greater use of external
borrowings secured by the mortgage servicing portfolio to finance growth
contributed to higher borrowing costs in 1997 compared to 1996.
Operating expenses during the current quarter were lower than in same period in
1996 primarily because of lower compensation-related accruals due in part to the
closure of the telephone origination unit during the second quarter of 1996.
This decision, along with the closure of the mortgage conduit unit in 1995,
eliminated the requirement for a loan loss provision.
During the quarter the Company sold $175 million of mortgage assets consisting
of Agency Securities and Mortgage Pass-Throughs for gains totaling $3.9 million
which were partially offset by $1.4 million in losses on derivative financial
instruments held for trading purposes. This compares to sales of mortgage
assets totaling $150 million in the same period in 1996. Losses during the
current quarter on derivative financial instruments held for trading purposes
reflect increases in interest rates since December 31, 1996. These instruments
(primarily interest-rate floors) tend to decrease in value under these
conditions (see "Effects of Interest Rate Changes").
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 (see below). 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 London
Interbank Offered Rate ("LIBOR") rates. The terms and conditions of these
arrangements, including interest rates, are negotiated on a transaction-by-
transaction basis.
At March 31, 1997 the mortgage servicing operation had available $199 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
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mortgage servicing operation maintain certain financial ratios and specified
levels of unencumbered servicing rights. The mortgage servicing operation is in
compliance with all requirements. Interest rates on borrowings under this
facility are based on LIBOR.
During the quarter ended March 31, 1997, the Company raised $35.8 million
through its dividend reinvestment and stock purchase plans, stock option
exercises and open market sales. The Company anticipates continuing to raise
equity through these channels as market conditions allow. In 1996 the board of
directors approved the repurchase of up to 1 million shares of common stock to
fund employee stock option and stock grant programs. As of March 31, 1997 no
such share repurchases had occurred.
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. This 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 net 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 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, improving the overall return on an
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investment in a fixed-rate CMO residual because of an increase in time over
which the Company receives the net 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 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, periodic amortization of amounts paid for mortgage
servicing rights is less since the average lives of the related mortgage loans
tend to be longer and earnings from large, temporarily held cash balances will
be greater. Additionally, mortgage servicing rights become more valuable under
these conditions. Conversely, lower interest rates will spur prepayments thus
reducing the 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, because this investment is evaluated for impairment on a
disaggregated basis and impairment charges are necessary if the amount for an
individual servicing stratum exceeds its fair value.
The Company's business plan is to build a mortgage banking operation with
investments in mortgage securities and mortgage servicing with the goal of
producing reasonably balanced operating results in a variety of interest rate
environments. The Company supplements its business plan from time to time with
derivative financial instruments, primarily 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 trading purposes. 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 trading purposes, changes in value will be recorded in income as they
occur, which could increase income volatility.
RECENT ACCOUNTING PRONOUNCEMENTS
In February 1997 the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 128, "Earnings per Share" ("SFAS 128"). SFAS
128 establishes simplified standards for computing and presenting earnings per
share ("EPS"). Under SFAS 128 the presentation of primary EPS will be replaced
with a presentation of basic EPS. Basic EPS is computed excluding dilution
caused by common stock equivalents such as stock options and, therefore, will
tend to be slightly higher than primary EPS. The presentation of fully diluted
EPS is replaced with a presentation of diluted EPS. Diluted EPS is computed in
a similar fashion to how fully diluted EPS is computed. The Company will adopt
this pronouncement to report results of operations for the fourth quarter of
1997 and for the year ended December 31, 1997. Previously reported EPS will be
restated at that time to conform to SFAS 128. This adoption is not expected to
have a material impact on EPS as currently presented by the Company.
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ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
(a) The annual meeting of stockholders was held April 18, 1997.
(b) The following directors were elected to Board of Directors (constituting
the entire Board of Directors):
Bevis Longstreth Harriet E. Miers
Paul M. Low William R. Smith
Ronn K. Lytle John C. Tolleson
(c) The following items were voted on at the annual meeting:
VOTES
---------------------------------------------
WITHHELD/ BROKER
FOR AGAINST ABSTENTIONS NON-VOTES
---------- --------- ----------- ---------
Election of Board Members:
Bevis Longstreth................ 43,013,326 - 187,399 -
Paul M. Low..................... 43,005,729 - 194,996 -
Ronn K. Lytle................... 43,015,379 - 185,346 -
Harriet E. Miers................ 43,011,233 - 189,492 -
William R. Smith................ 43,019,024 - 181,701 -
John C. Tolleson................ 43,008,846 - 191,879 -
Other matters (no other matters) 38,953,352 3,344,238 899,656 2,201
PART II. - OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
The following Exhibits are presented herewith:
Exhibit 10.31 - Amendment No. 1 dated March 3, 1997 to the Employment
Agreement dated August 1, 1992 between the Company and Ronn K. Lytle.
Exhibit 10.32 - 1997 Flexible Long Term Incentive Plan
Exhibit 11 - Computation of Earnings Per Share for the quarter ended March
31, 1997 and 1996.
Exhibit 27 - Financial Data Schedule (electronic filing only).
(b) Reports on Form 8-K:
Current Report on Form 8-K dated March 26, 1997 to file the following:
Exhibit 1.6 - The Second Amendment dated as of March 4, 1997 to the Sales
Agency Agreement dated as of December 6, 1995 between the Company and
PaineWebber Incorporated (the "Sales Agency Agreement").
Exhibit 1.7 - The First Amendment dated as of March 4, 1997 to the Sales
Agency Agreement dated as of September 17, 1996 between the Company 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: April 28, 1997 By /s/ RONN K. LYTLE
------------------------------------
Ronn K. Lytle
Chairman and Chief Executive Officer
Date: April 28, 1997 By /s/ ANDREW F. JACOBS
------------------------------------
Andrew F. Jacobs
Senior Vice President - Control
and Treasurer
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