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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, 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 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) 56,145,0002 as of October 31, 1997
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CAPSTEAD MORTGAGE CORPORATION AND SUBSIDIARIES
FORM 10-Q
FOR THE QUARTER ENDED SEPTEMBER 30, 1997
INDEX
PART I.--FINANCIAL INFORMATION
PAGE
----
ITEM 1. Financial Statements
Consolidated Balance Sheet--September 30, 1997 (unaudited) and
December 31, 1996................................................ 3
Consolidated Statement of Income--Quarter and Nine Months Ended
September 30, 1997 and 1996 (unaudited).......................... 4
Consolidated Statement of Cash Flows--Nine Months Ended
September 30, 1997 and 1996 (unaudited).......................... 5
Notes to Consolidated Financial Statements (unaudited)............ 6
ITEM 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations............ 12
PART II.--OTHER INFORMATION
ITEM 6. Exhibits and Reports on Form 8-K........................... 19
SIGNATURES......................................................... 20
-2-
PART I.--FINANCIAL INFORMATION
CAPSTEAD MORTGAGE CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
ITEM 1. FINANCIAL STATEMENTS
SEPTEMBER 30, 1997 DECEMBER 31, 1996
------------------- ------------------
(UNAUDITED)
ASSETS
Mortgage investments $ 6,145,850 $ 4,840,417
CMO collateral and investments 4,552,432 4,501,646
----------- -----------
10,698,282 9,342,063
Mortgage servicing rights 669,797 637,979
Prepaids, receivables and other 226,029 156,293
Cash and cash equivalents 13,895 21,003
----------- -----------
$11,608,003 $10,157,338
=========== ===========
LIABILITIES
Short-term borrowings $ 6,947,817 $ 5,462,856
Collateralized mortgage obligations 3,682,328 3,861,892
Accounts payable and accrued expenses 67,459 33,924
Mortgage servicing rights
acquisitions payable 31,581 71,797
----------- -----------
10,729,185 9,430,469
----------- -----------
STOCKHOLDERS' EQUITY
Preferred stock - $0.10 par value;
100,000 shares authorized:
$1.60 Cumulative Preferred Stock,
Series A, 415 and 470 shares
issued and outstanding ($6,806
aggregate liquidation preference) 5,803 6,567
$1.26 Cumulative Convertible
Preferred Stock, Series B, 18,660
and 23,932 shares issued and
outstanding ($212,351 aggregate
liquidation preference) 206,031 259,829
Common stock - $0.01 par value; 100,000
shares authorized; 54,786 and 44,743
shares issued and outstanding 548 447
Paid-in capital 654,171 461,045
Undistributed income 12,999 4,582
Unrealized loss on debt securities (734) (5,601)
----------- -----------
878,818 726,869
----------- -----------
$11,608,003 $10,157,338
=========== ===========
See accompanying notes to consolidated financial statements.
-3-
CAPSTEAD MORTGAGE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF INCOME
(UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
QUARTER ENDED NINE MONTHS ENDED
SEPTEMBER 30 SEPTEMBER 30
--------------------------- -----------------------------
1997 1996 1997 1996
------------- ------------ -------------- -------------
INTEREST INCOME:
Mortgage investments $ 90,762 $ 73,032 $248,139 $227,502
CMO collateral and investments 85,153 92,072 256,072 270,245
-------- -------- -------- --------
Total interest income 175,915 165,104 504,211 497,747
-------- -------- -------- --------
INTEREST AND RELATED EXPENSES:
Short-term borrowings:
Mortgage investments 80,688 61,208 214,192 192,100
CMO investments 7,336 4,849 19,358 6,975
Collateralized mortgage obligations 65,617 77,619 203,227 240,526
Mortgage insurance and other 1,224 1,791 4,005 6,190
-------- -------- -------- --------
Total interest and related expenses 154,865 145,467 440,782 445,791
-------- -------- -------- --------
Net margin on mortgage assets 21,050 19,637 63,429 51,956
-------- -------- -------- --------
MORTGAGE SERVICING REVENUES:
Servicing fees 31,307 25,774 92,166 72,089
Other 13,263 8,062 32,682 20,264
-------- -------- -------- --------
Total mortgage servicing revenues 44,570 33,836 124,848 92,353
-------- -------- -------- --------
MORTGAGE SERVICING EXPENSES:
Direct servicing expenses 4,498 3,013 12,794 9,969
Indirect servicing expenses 2,089 2,109 5,640 5,097
Amortization of mortgage servicing rights 15,738 11,172 46,150 31,398
Interest 5,992 4,232 16,404 11,460
-------- -------- -------- --------
Total mortgage servicing expenses 28,317 20,526 80,988 57,924
-------- -------- -------- --------
Net margin on mortgage servicing 16,253 13,310 43,860 34,429
-------- -------- -------- --------
OTHER REVENUES:
Gain on sales and other 5,845 1,875 17,130 12,196
CMO administration 775 859 2,459 2,559
-------- -------- -------- --------
Total other revenues 6,620 2,734 19,589 14,755
-------- -------- -------- --------
OTHER OPERATING EXPENSES 2,056 3,253 7,952 9,711
-------- -------- -------- --------
NET INCOME $ 41,867 $ 32,428 $118,926 $ 91,429
======== ======== ======== ========
Net income $ 41,867 $ 32,428 $118,926 $ 91,429
Less cash dividends on preferred stock (6,073) (8,838) (19,934) (28,525)
-------- -------- -------- --------
Net income available to common stockholders $ 35,794 $ 23,590 $ 98,992 $ 62,904
======== ======== ======== ========
NET INCOME PER SHARE:
Primary $ 0.66 $ 0.60 $ 1.96 $ 1.67
Fully diluted 0.61 0.53 1.78 1.50
CASH DIVIDENDS PAID PER SHARE:
Common $ 0.610 $ 0.550 $ 1.785 $ 1.550
Series A Preferred 0.400 0.400 1.200 1.200
Series B Preferred 0.315 0.315 0.945 0.945
See accompanying notes to consolidated financial statements.
-4-
CAPSTEAD MORTGAGE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS
(UNAUDITED)
(IN THOUSANDS)
NINE MONTHS ENDED
SEPTEMBER 30
-----------------------------------
1997 1996
---------------- -----------------
OPERATING ACTIVITIES:
Net income $ 118,926 $ 91,429
Noncash items:
Amortization of discount and premium 76,268 41,635
Amortization of mortgage servicing rights
and related hedge instruments 46,150 31,398
Depreciation and other amortization 2,625 2,624
Unrealized loss (gain) on open market positions 569 (38)
Net change in prepaids, receivables, other assets,
accounts payable and accrued expenses (843) 7,353
Net gain from investing activities (17,161) (12,037)
----------- -----------
Net cash provided by operating activities 226,534 162,364
----------- -----------
INVESTING ACTIVITIES:
Purchases of mortgage investments (2,990,259) (1,334,745)
Purchases of CMO investments (359,268) (437,892)
Purchases of mortgage servicing rights (82,590) (208,480)
Purchases of derivative financial instruments (50,054) (35,179)
Principal collections on mortgage investments 944,805 773,617
Proceeds from sales and redemptions of mortgage assets 661,373 596,979
Proceeds from sales of derivative financial instruments 305 -
CMO collateral:
Principal collections 357,330 448,201
Decrease in accrued interest receivable 1,152 3,480
Decrease (increase) in short-term investments (2,133) 11,780
----------- -----------
Net cash used by investing activities (1,519,339) (182,239)
----------- -----------
FINANCING ACTIVITIES:
Increase in short-term borrowings 1,484,961 468,739
Increase (decrease) in mortgage servicing
acquisitions payable (40,216) 51,012
Collateralized mortgage obligations:
Issuance of securities 284,672 41,323
Principal payments on securities (474,417) (492,933)
Increase in accrued interest payable 3,529 1,088
Capital stock transactions 137,677 39,117
Dividends paid (110,509) (87,385)
----------- -----------
Net cash provided by financing activities 1,285,697 20,961
----------- -----------
Net change in cash and cash equivalents (7,108) 1,086
Cash and cash equivalents at beginning of period 21,003 18,702
----------- -----------
Cash and cash equivalents at end of period $ 13,895 $ 19,788
=========== ===========
See accompanying notes to consolidated financial statements.
-5-
CAPSTEAD MORTGAGE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 1997
(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 a mortgage
banking operation with investments in mortgage servicing and mortgage securities
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 and nine months ended
September 30, 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. 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 7,144,481 72,823 128,675
Run-off/amortization* (3,474,388) (26,794) (42,662)
Results of hedging activity - - (8,011)
----------- ------- --------
Loans serviced at September 30, 1997 39,232,690 412,402 637,859
Purchases pending transfer** 1,791,855 14,050 31,938
----------- ------- --------
Total portfolio at September 30, 1997 $41,024,545 426,452 $669,797
=========== ======= ========
* EXCLUDES AMORTIZATION OF HEDGE INSTRUMENTS AND PURCHASES PENDING TRANSFER.
** EXCLUDES A $2.6 BILLION BULK ACQUISITION CONTRACTED FOR SUBSEQUENT TO
QUARTER-END.
In addition, as of September 30, 1997 the Company subserviced $9.1 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):
QUARTER NINE MONTHS
ENDED ENDED
AS OF SEPTEMBER 30 SEPTEMBER 30 SEPTEMBER 30
--------------------------- ------------------- ------------------
1997 1996 1997 1996 1997 1996
------------ ------------- -------- --------- -------- --------
Agency securities:
Fixed-rate $ 719,113 $ 462,567 6.68% 6.36% 6.56% 6.37%
Medium-term 59,297 - 6.84 - 6.84 -
Adjustable-rate 4,933,738 3,554,351 6.14 6.31 6.23 6.17
Callable notes - - - - - 7.05
AAA-rated private
mortgage pass-
through securities:
Fixed-rate 38,361 28,920 8.13 9.39 8.53 9.28
Medium-term 221,135 287,768 6.57 7.05 6.63 7.06
Adjustable-rate 174,206 213,049 7.15 7.65 7.15 7.58
---------- ----------
$6,145,850 $4,546,655
========== ==========
The Company classifies its mortgage investments by interest rate characteristics
of the underlying mortgage loans. Fixed-rate mortgage investments (i) have
fixed rates of interest for their entire terms, (ii) have 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"), or
(iii) were previously classified as medium-term and have adjusted to a fixed
rate for the remainder of their terms. 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,
-7-
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-, medium- 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 (collectively,
"Agency Securities").
At September 30, 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 Company-issued collateralized mortgage obligations ("Pledged CMO
Collateral"). CMO investments include investments in FNMA and FHLMC Trust
interest-only mortgage securities and investments in other CMO securities such
as other agency or private-issue interest-only and principal-only mortgage
securities. The components of CMO collateral and investments are summarized as
follows (in thousands):
SEPTEMBER 30, 1997 DECEMBER 31, 1996
------------------- ------------------
Pledged mortgage securities $3,715,458 $3,908,623
Short-term investments 13,188 11,055
Accrued interest receivable 22,860 24,012
---------- ----------
Total Pledged CMO Collateral 3,751,506 3,943,690
Unamortized discount (3,148) (7,166)
---------- ----------
3,748,358 3,936,524
FNMA and FHLMC Trust interest-only
mortgage securities 788,499 546,539
Other CMO investments 15,575 18,583
---------- ----------
$4,552,432 $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 7.37 percent and 7.34 percent during the
quarter and nine months ended September 30, 1997, respectively.
FNMA and FHLMC Trust interest-only mortgage securities are entitled to receive
100 percent of coupon interest stripped from pools of FNMA or FHLMC mortgage-
backed securities. At September 30, 1997 the Company's investment in FNMA and
FHLMC Trust interest-only mortgage securities, after certain hedging costs,
yielded 10.42 percent with related notional amounts aggregating $2.4 billion.
These and certain other CMO investments were pledged to secure short-term
borrowings at September 30, 1997.
-8-
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
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 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.
Held-to-maturity debt securities consist of Pledged CMO Collateral and
collateral released from related CMO indentures pursuant to clean-up calls and
held as Mortgage Pass-Throughs. The following tables summarize fair value
disclosures for available-for-sale and held-to-maturity debt securities for the
periods indicated (in thousands):
GROSS GROSS
UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
------------ ------------ ------------ ------------
AVAILABLE-FOR-SALE:
- -------------------------------
SEPTEMBER 30, 1997
Mortgage investments:
Agency Securities:
Fixed-rate $ 727,679 $ 4,681 $13,247 $ 719,113
Medium-term 59,209 88 - 59,297
Adjustable-rate 4,899,499 34,498 259 4,933,738
Mortgage Pass-Throughs:
Fixed-rate 9,222 273 - 9,495
Medium-term 220,329 806 - 221,135
Adjustable-rate 170,212 3,994 - 174,206
CMO investments 835,642 - 31,568 804,074
---------- ------- ------- ----------
$6,921,792 $44,340 $45,074 $6,921,058
========== ======= ======= ==========
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
========== ======= ======= ==========
-9-
GROSS GROSS
UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
---------- ------------ ------------ ------------
HELD-TO-MATURITY:
- ----------------
SEPTEMBER 30, 1997
Pledged CMO Collateral $3,748,358 $ 3,141 $50,852 $3,700,647
Mortgage Pass-Throughs 28,866 1,076 - 29,942
---------- ------- ------- ----------
$3,777,224 $ 4,217 $50,852 $3,730,589
========== ======= ======= ==========
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
---------- ------- ------- ----------
$3,933,957 $ 5,464 $54,983 $3,884,438
========== ======= ======= ==========
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 NINE MONTHS ENDED
SEPTEMBER 30 SEPTEMBER 30
--------------------------- -----------------------
1997 1996 1997 1996
----------- -------------- ----------- ----------
Sale of securities held
available-for-sale:
Cost basis $223,846 $ 8,920 $570,925 $494,276
Gains 5,050 1,834 14,136 11,083
Redemption of callable agency
notes and sale of released
CMO
collateral
held-to-maturity:
Cost basis - 14,655 73,324 63,632
Gains - 1,098 2,986 1,098
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 SEPTEMBER 30
--------------------------------------------------
1997 1996
------------------------- -----------------------
AMOUNT AVERAGE AMOUNT AVERAGE
---------- ------------- ---------- -----------
Interest income:
Mortgage investments $ 90,762 6.30% $ 73,032 6.44%
Mortgage securities collateral 85,153 7.95 92,072 7.84
-------- --------
Total interest income 175,915 165,104
-------- --------
Interest expense:
Short-term borrowings 88,024 5.54 66,057 5.45
Collateralized mortgage securities 65,617 7.69 77,619 7.56
-------- --------
Total interest expense 153,641 143,676
-------- --------
Net interest $ 22,274 $ 21,428
======== ========
-10-
NINE MONTHS ENDED SEPTEMBER 30
--------------------------------------------------
1997 1996
------------------------- -----------------------
AMOUNT AVERAGE AMOUNT AVERAGE
---------- ------------- ---------- -----------
Interest income:
Mortgage investments $248,139 6.37% $227,502 6.39%
Mortgage securities collateral 256,072 7.84 270,245 7.68
-------- --------
Total interest income 504,211 497,747
-------- --------
Interest expense:
Short-term borrowings 233,550 5.52 199,075 5.46
Collateralized mortgage securities 203,227 7.57 240,526 7.53
-------- --------
Total interest expense 436,777 439,601
-------- --------
Net interest $ 67,434 $ 58,146
======== ========
The following table summarizes changes 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, 1997 compared to the same periods in 1996 (in
thousands):
QUARTER ENDED SEPTEMBER 30, 1997
----------------------------------------------
RATE* VOLUME* TOTAL
-------------- -------------- --------------
Interest income:
Mortgage investments $(1,635) $ 19,365 $ 17,730
CMO collateral and investments 1,311 (8,230) (6,919)
------- -------- --------
Total interest income (324) 11,135 10,811
------- -------- --------
Interest expense:
Short-term borrowings 1,079 20,888 21,967
CMOs 1,334 (13,336) (12,002)
------- -------- --------
Total interest expense 2,413 7,552 9,965
------- -------- --------
Net interest $(2,737) $ 3,583 $ 846
======= ======== ========
NINE MONTHS ENDED SEPTEMBER 30, 1997
----------------------------------------------
RATE* VOLUME* TOTAL
-------------- -------------- --------------
Interest income:
Mortgage investments $ (661) $ 21,298 $ 20,637
CMO collateral and investments 5,434 (19,607) (14,173)
------ -------- --------
Total interest income 4,773 1,691 6,464
------ -------- --------
Interest expense:
Short-term borrowings 2,326 32,149 34,475
CMOs 1,272 (38,571) (37,299)
------ -------- --------
Total interest expense 3,598 (6,422) (2,824)
------ -------- --------
Net interest $1,175 $ 8,113 $ 9,288
====== ======== ========
* 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.
-11-
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 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 $48.3 billion (including primary servicing
and subservicing), an increase of $2.4 billion over the previous quarter. The
primary mortgage servicing portfolio (which excludes pending transfers and
subservicing) increased to $39.2 billion at September 30, 1997, with a weighted
average interest rate of 7.43 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 September 30, 1997 balance of mortgage
servicing rights related to this portfolio was $638 million (163 basis points,
or a 5.37 multiple of the Average Service Fee). An additional $1.8 billion of
mortgage servicing acquired during the quarter, and another $2.6 billion
contracted for subsequent to quarter-end, is pending transfer into the portfolio
and is being subserviced by the sellers. These pending acquisitions have a
weighted average interest rate of 7.49 percent earning an Average Service Fee of
35.8 basis points. At an average cost of 204 basis points, these acquisitions
are being acquired at a 5.69 multiple.
Primary mortgage servicing portfolio run-off, consisting of prepayments and
scheduled payments on mortgage loans serviced, was 14.13 percent during the
quarter, up from 12.07 percent in the third quarter of 1996 and up from 12.12
percent in the second quarter of 1997. The increase in prepayments experienced
in the current quarter was prompted by lower mortgage interest rates and
seasonal factors. Derivative financial instruments, specifically interest rate
floors, are held as partial hedges against prepayment risk (see "Effects of
Interest Rate Changes"). Outstanding hedge positions, with a $9.4 billion
notional amount, carried a $13.6 million unrealized gain at September 30, 1997.
During the second quarter of 1996, the Company entered into a subservicing
arrangement with a large national mortgage conduit. As of September 30, 1997
the subservicing portfolio totaled $9.1 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.
As of September 30, 1997, holdings of mortgage investments totaled $6.1 billion
with adjustable-rate mortgage ("ARM") mortgage-backed securities representing
$5.1 billion of the total. During the quarter and nine months ended September
30, 1997, the Company acquired $1.3 million and $2.5 billion of ARM securities
issued by government-sponsored entities, either the Federal Home Loan Mortgage
Corporation ("FHLMC"), Federal National Mortgage Association ("FNMA") or the
Government National Mortgage Association ("GNMA") (collectively, "Agency
Securities"). During the quarter and nine months ended September 30, 1997, the
Company also acquired $25 million and $242 million of fixed-rate Agency
Securities, respectively. Sales of ARM Agency Securities and AAA-rated private
mortgage pass-through securities ("Mortgage Pass-
-12-
Throughs") totaled $206 million and $582 million during the quarter and nine
months ended September 30, 1997, respectively.
Prior to 1995 the Company had been an active issuer of collateralized mortgage
obligations ("CMOs") and other 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 until this quarter (see below). In lieu of issuing
CMOs, the Company has increased its CMO investments (defined as CMO collateral
and investments, net of related bonds) by acquiring interest-only mortgage
securities. During the quarter and nine months ended September 30, 1997, the
Company acquired $188 million and $359 million, respectively, of FNMA and FHLMC
Trust interest-only mortgage securities, which represent the right to receive
100 percent of coupon interest stripped from pools of FNMA or FHLMC 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 $114 million and $230 million during the quarter and nine months ended
September 30, 1997, respectively, to $870 million. Derivative financial
instruments, specifically interest rate floors, are held as partial hedges
against prepayment risk on interest-only mortgage securities (see "Effects of
Interest Rate Changes"). Outstanding hedge positions, with a $7.2 billion
notional amount, carried a $20.7 million unrealized gain at September 30, 1997.
Since the Company exited the jumbo mortgage loan conduit business in 1995, it
has maintained several finance subsidiaries with remaining capacity to issue
CMOs and other securitizations ("securitization shelves"). In an effort to
recover costs associated with these securitization shelves, and to add to the
Company's CMO administration activities, the Company may, from time to time,
purchase mortgage loans from originators or conduits and issue CMOs or other
securities backed by these loans. The Company may or may not retain any
residual economic interest in these securitizations. In the current quarter the
Company issued a $285 million CMO in such a transaction and completed a similar
$938 million transaction subsequent to quarter-end.
The following table summarizes the Company's utilization of capital as of
September 30, 1997 (in thousands):
CAPITAL
ASSETS BORROWINGS EMPLOYED
------------- ---------------- ----------
Agency Securities:
Fixed-rate $ 719,113 $ 713,992 $ 5,121
Medium-term 59,297 57,621 1,676
Adjustable-rate 4,933,738 4,798,996 134,742
Mortgage Pass-Throughs 433,702 428,354 5,348
CMO collateral and investments 4,552,432 4,295,342* 257,090
Mortgage servicing rights 669,797 367,421 302,376
----------- ----------- --------
$11,368,079 $10,661,726 706,353
=========== ===========
Other assets, net of other liabilities 172,465
--------
Total stockholders' equity $878,818
========
* INCLUDES $613 MILLION OF RELATED SHORT-TERM BORROWINGS.
During the quarter and nine months ended September 30, 1997, the Company raised
$58.0 million and $137.7 million, respectively, of new capital through its
dividend reinvestment and stock purchase plans, stock option exercises and open
market sales. The proceeds from these issuances were profitably employed to
increase investments in mortgage assets and mortgage servicing. Assuming
favorable market conditions continue, the Company anticipates raising a similar
amount of capital in the fourth quarter and in 1998. Because the
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Company distributes virtually all of its net income in dividends, it is
important that the Company access the capital markets at favorable prices to
continue its growth. The more capital raised at favorable prices, the more
assured we are of continuing to increase net income and dividends.
During the quarter and nine months ended September 30, 1997, 2,111,307 and
5,907,321 shares of Series B Preferred Stock, respectively, were converted into
1,529,656 and 4,279,980 shares of common stock, respectively. Had these shares
been converted as of the beginning of the quarter and nine months, reported
primary earnings per share would not have changed for the quarter but would have
been $0.04 lower for the nine months ended September 30, 1997. Fully diluted
earnings would not have been impacted as such shares are already deemed
converted in that calculation. It is anticipated that holders of the Series B
Preferred Stock will continue to convert their shares into common shares as long
as it is advantageous to do so from a dividend yield perspective.
Securities held available-for-sale were carried at a net unrealized loss of
$734,000 at September 30, 1997, a net $4.9 million improvement in value from
December 31, 1996. Underlying this change was a $30.9 million increase in value
of the mortgage investment component of securities held available-for-sale
that was largely offset by a $26.0 million decline in value of CMO investments
held available-for-sale. This reflects the impact of a 31 basis point decline
year-to-date in the 10-year U.S. Treasury rate to 6.11 percent at quarter-end
along with purchase and sale activity (see "Effects of Interest Rate Changes").
The Company has the ability to hold mortgage assets 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 and, in the case of mortgage servicing and CMO
administration, related direct and indirect operating expenses), were as follows
(in thousands, except percentages and per share amounts):
QUARTER ENDED NINE MONTHS ENDED
SEPTEMBER 30 SEPTEMBER 30
---------------------------- ---------------------------------
1997 1996 1997 1996
------------ -------------- ------------- ------------------
Agency Securities $ 8,376 $ 9,338 $ 27,948 $ 25,244
Mortgage Pass-Throughs 1,245 1,908 4,593 7,841
CMO investments 11,429 8,391 30,888 18,871
Mortgage servicing 16,253 13,310 43,860 34,429
Gain on sales and other 5,845 1,875 17,130 12,196
CMO administration 775 859 2,459 2,559
------- ------- -------- --------
Contribution to income 43,923 35,681 126,878 101,140
Other operating expenses (2,056) (3,253) (7,952) (9,711)
------- ------- -------- --------
Net income $41,867 $32,428 $118,926 $ 91,429
======= ======= ======== ========
Net income per share:
Primary $ 0.66 $ 0.60 $ 1.96 $ 1.67
Fully diluted 0.61 0.53 1.78 1.50
Return on average
stockholders' equity 19.58% 18.72% 19.66% 17.94%
Operating results for the quarter and nine months ended September 30, 1997
reached record levels and were comfortably above those achieved in the same
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periods in 1996. Quarterly income of $41.9 million represents an increase of 29
percent over the third quarter of 1996, while primary net income per share
increased 10 percent. Much of the improvement in operating results is
attributable to the profitable investment of new capital raised over the past
year (see discussion above). The benefit to larger holdings of mortgage
securities and CMO investments was offset somewhat by a narrowing of financing
spreads. Yields were negatively impacted by a higher rate of mortgage loan
prepayments, among other factors. Borrowing costs were slightly higher as a
result of the increase in short-term interest rates by the Federal Reserve Open
Markets Committee earlier in the year. Lower long-term interest rates, which
contributed to the higher rate of prepayments, allowed for greater gain on sales
in 1997 compared to the same periods in the prior year.
Agency Securities contributed less to income during the third quarter of 1997
than in the same period in 1996. The benefit to earnings of a $1.3 billion
increase in average holdings of these securities during the current quarter was
offset by lower financing spreads due primarily to a less favorable interest
rate environment (see below). Financing spreads declined 23 basis points to 64
basis points. Agency Security yields averaged 6.21 percent and 6.27 percent
during the quarter and nine months ended September 30, 1997, respectively,
compared to 6.31 percent and 6.20 percent during the same periods in 1996, while
borrowing rates were higher at 5.57 percent and 5.54 percent, respectively,
compared to 5.44 percent and 5.43 percent during the same periods in 1996.
Lower long-term interest rates have contributed to higher run-off as more
mortgagors have found it advantageous to refinance into fixed-rate mortgage
loans. As a result, purchase premium amortization has been higher resulting in
lower yields on ARM securities. In addition, lower 6-month LIBOR and 1-year
U.S. Treasury rates have led to declines in yields on ARM securities because
underlying ARM loans reset periodically to those indexes. This also impacts
yields on acquisitions of ARM securities because loans underlying new securities
often have initial mortgage rates below the referenced indexes (referred to as
"teaser-rate ARM securities"). At the same time intermediate- and long-term
rates have trended lower in 1997, interest rates on overnight to 30-day
borrowings were higher than during the same periods in the prior year resulting
in higher borrowing rates and thus further reducing financing spreads.
One favorable aspect of lower long-term interest rates has been the improvement
in value of Agency Securities held by the Company, allowing these assets to
support a proportionately higher level of borrowings than in the prior year.
Although this has had a negative impact on income earned directly on Agency
Securities, it has allowed the Company to reduce higher-cost debt secured by
other, less efficiently financed, mortgage assets and mortgage servicing rights,
and has contributed to higher gains on sale (see "Effects of Interest Rate
Changes").
Mortgage Pass-Throughs contributed less to income during the current quarter
than in the same period in 1996 due primarily to a 15 basis point decrease in
financing spreads and a 17 percent reduction in the average outstanding
portfolio. As a result of asset sales and run-off, the average outstanding
portfolio was $451 million and $461 million during the quarter and nine months
ended September 30, 1997, respectively, compared to $544 million and $746
million for the same periods in 1996. Average yields for this portfolio
(calculated including mortgage insurance costs) were 6.95 percent and 6.99
percent during the quarter and nine months ended September 30, 1997,
respectively, compared to 6.98 percent and 6.99 percent during the same periods
in 1996, while average borrowing rates were higher at 5.76 percent and 5.72
percent, respectively, compared to 5.64 percent and 5.69 percent during
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the same periods in 1996. Higher borrowing rates reflect higher prevailing
short-term interest rates (see "Effects of Interest Rate Changes").
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 21 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 $44.6 million and
$124.8 million during the quarter and nine months ended September 30, 1997,
respectively, compared to $33.8 million and $92.4 million during the same
periods 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 and related hedge instruments of $15.7 million and $46.2
million during the quarter and nine months ended September 30, 1997,
respectively, was higher than the $11.2 million and $31.4 million recorded
during the same periods in 1996 due primarily to portfolio growth and
expectations of higher future mortgagor prepayments (see "Effects of Interest
Rate Changes"). 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. In addition,
with the continued growth of the mortgage servicing operation, more indirect
operating costs have been identified with that unit than in the prior year.
During the quarter and nine months ended September 30, 1997, the Company sold
$224 million and $644 million, respectively, of mortgage assets consisting of
Agency Securities, Mortgage Pass-Throughs and interest-only mortgage securities
for gains totaling $5.1 million and $17.1 million, respectively. This compares
to sales of mortgage assets totaling $14 million and $597 million during the
same periods in 1996. Derivative financial instruments held for trading
purposes contributed $565,000 to earnings during the current quarter and a loss
of $531,000 for the nine months ended September 30, 1997, which reflects higher
interest rates earlier in 1997 from rates prevailing at quarter-end. These
instruments (primarily interest-rate floors) tend to decrease in value in a
rising interest-rate environment and increase in value when interest rates fall
(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 above
"Financial Condition"). 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.
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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 September 30, 1997 the mortgage servicing operation had available $488
million of a $625 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. The mortgage servicing operation is in compliance with all
requirements. Interest rates on borrowings under this facility are based on
LIBOR.
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
September 30, 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 financing 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 financing 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 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
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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 investment in a fixed-
rate CMO residual because of an increase in time over which the Company receives
the net financing 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. As a result, 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, particularly since 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 servicing and mortgage securities with the goal of
producing reasonably balanced operating results in a variety of interest rate
environments. The Company supplements its business plan 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,
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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.
PART II.--OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K:
(a) Exhibits: The following Exhibits are presented herewith:
Exhibit 11 - Computation of Earnings Per Share for the quarter and nine
months ended September 30, 1997 and 1996.
Exhibit 12 - Computation of Ratio of Earnings to Combined Fixed Charges and
Preferred Stock Dividends.
Exhibit 27 - Financial Data Schedule (electronic filing only).
(b) Reports on Form 8-K:
Form 8-K Reporting Date - August 18, 1997
Items Reported:
Item 5. Other Events
This Current Report was filed solely in order to file the following exhibit
as part of the Registrant's Registration Statement on Form S-3 (No. 333-
26865), as amended:
Exhibit No. Description
----------- -----------
12.1 Computation of Ratio of Earnings to Combined Fixed Charges
and Preferred Stock Dividends.
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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 31, 1997 By: /s/ RONN K. LYTLE
------------------------------------
Ronn K. Lytle
Chairman and Chief Executive Officer
Date: October 31, 1997 By: /s/ ANDREW F. JACOBS
------------------------------------
Andrew F. Jacobs
Senior Vice President - Control
and Treasurer
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